FAR3 Flashcards

Intro to Business Combination to

1
Q

What is the designation of the investee

in a business combination?

A

Subsidiary company

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2
Q

Define/describe a “legal merger.”

A
One entity acquires either a group of
assets constituting a business or a
controlling interest of another entity
and "collapses" the acquired
assets/entity into the acquiring
company
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3
Q

Describe how income is determined at

the date of a combination.

A

Only the acquirer’s operating results up
to the date of combination enter into
determination of “consolidated” net
income

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4
Q

What may be acquired in a business

combination?

A

A business entity acquires either a
group of net assets that constitutes a
business or equity interest in an entity.

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5
Q

Define “parent company” as it relates

to business combinations.

A

Designation of the investor in a

business combination

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6
Q

List the three legal forms of business

combinations.

A
  1. Merger
  2. Consolidation
  3. Acquisition
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7
Q

List the primary means of

accomplishing a business combination.

A

The acquisition by one entity of the
common stock of another entity to gain
control of the investee

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8
Q

Describe how income is determined at

the end of the year for a combination.

A
The acquirer's operating results for the
year plus the acquiree's operating
results after the combination enter into
the determination of consolidated
income for the year of combination.
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9
Q

Define/describe a “legal acquisition.”

A

One entity acquires controlling interest
of another entity, but both continue to
exist and operate as separate legal
entities

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10
Q

Identify the legal forms of business
combination that will not require
preparation of consolidated financial
statements.

A
A legal merger or a legal consolidation
will not require preparation of
consolidated financial statements.
Only a legal acquisition will require
preparation of consolidated financial
statements.
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11
Q

Define/describe a “legal

consolidation.”

A

A new entity is formed to combine
(consolidate) two or more preexisting
entities.

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12
Q

Describe how income is determined for

subsequent years of a combination.

A

The acquirer’s and the acquiree’s
operating results enter into the
determination of consolidated net
income.

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13
Q

In which of the following legal forms of business combination does at least one preexisting entity cease to exist?

Merger
Consolidation
Acquisition

A

Merger - YES
Consolidation - YES
Acquisition - NO

In a merger and a consolidation, at least one preexisting entity ceases to exist, but in an acquisition, no entity ceases to exist. In an acquisition, one preexisting entity acquires controlling interest in another preexisting entity, and both continue to exist as separate legal entities. In a legal merger, one preexisting entity is combined into another preexisting entity; one entity ceases to exist. In a legal consolidation, two or more existing entities are combined into one new entity; two or more entities cease to exist.

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14
Q

In which of the following legal forms of business combination are the assets and liabilities of an acquired entity or entities recorded on the books of the acquiring entity?
Merger
Acquisition
Consolidation

A

Merger - YES
Acquisition - NO
Consolidation - YES

n a merger and in a consolidation, the assets and liabilities of the acquired entity/entities are recorded on the books of the acquiring entity, but in an acquisition, the assets and liabilities of the acquired entity remain on the books of the acquired entity. In a merger and in a consolidation, at least one preexisting entity ceases to exist, and the assets and liabilities are recorded on the books of the surviving entity. In an acquisition, one preexisting entity acquires controlling interest in another preexisting entity, and both continue to exist as separate legal entities.

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15
Q

On December 1, 200X, Betaco agreed to be acquired 100% by Alphaco at a cost equal to Betaco’s book value. The combination was initiated at that time, and the closing date for the acquisition was December 31, 200X. Both firms have December 31 fiscal year-ends. There were no other transactions between the firms during 200X or 200Y. Each firm had the following net incomes for the periods shown:

                                  Alphaco	 Betaco 1/1/0X–11/30/0X	    $20,000	$5,000 12/1/0X–12/31/0X	        4,000	   1,000 1/1/0Y–1/31/0Y	                2,000	  3,000

Which one of the following is the consolidated net income that Alphaco should recognize for 200X?

A

$24,000

The consolidated net income recognized by Alphaco for 200X would be its net income only. Therefore, the amount would be $20,000 for January 1 through November 30 and $4,000 for December, or a total of $24,000. Betaco’s net income before the closing of the combination (the acquisition date) would not be included in consolidated net income. Basically, Betaco’s net income for all of 200X was “paid for” by Alphaco in the consideration it transferred to acquire Betaco.

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16
Q

In which of the legal forms of business combination does more than one entity survive?
Merger
Consolidation
Acquisition

A

Merger - No
Consolidation - No
Acquisition - YES

Only in a legal acquisition does more than one entity survive. In an acquisition, one preexisting entity acquires controlling interest in another preexisting entity, and both continue to exist as separate legal entities. In a legal merger, one preexisting entity is combined into another preexisting entity; only one entity survives. In a legal consolidation, two or more existing entities are combined into one new entity; only the new entity survives.

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17
Q

In which of the following legal forms of business combination are two or more entities combined into one new entity?
Merger
Consolidation
Acquisition

A

Merger - No
Consolidation - Yes
Acquisition - No

Only a legal consolidation results from the combination of two or more existing entities into one new entity. In a merger, one preexisting entity is combined into another preexisting entity; no new entity is formed. In an acquisition, one preexisting entity acquires controlling interest in another preexisting entity, and both continue to exist as separate legal entities; no new entity is formed.

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18
Q

Topco owns 60% of the voting common stock of Midco and 40% of the voting common stock of Botco. Topco wishes to gain control of Botco by having Midco buy shares of Botco’s voting stock. Which one of the following minimum levels of ownership of Botco must Midco additionally need to obtain in order for Topco to have controlling interest of Botco’s voting stock?

A

11%

In order for Topco to gain control of Botco, it must own, either directly or indirectly, more than 50% of Botco’s voting stock. Since it directly owns 40% of Botco’s voting stock, it must acquire control over 10+% more. Also, since Topco owns 60% of Midco, it controls Midco. Therefore, if Midco acquires 11% of Botco, Topco will be able to exercise 51% of Botco’s voting stock — 40% directly and 11% indirectly through its control of Midco.

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19
Q

On December 1, 200X, Betaco agreed to be acquired 100% by Alphaco at a cost equal to Betaco’s book value. The combination was initiated at that time, and the closing date for the acquisition was December 31, 200X. Both firms have December 31 fiscal year-ends. There were no other transactions between the firms during 200X or 200Y. Each firm had the following net incomes for the periods shown:

                                 Alphaco	Betaco 1/1/0X–11/30/0X	    $20,000	$5,000 12/1/0X–12/31/0X	         4,000	   1,000 1/1/0Y–1/31/0Y	                 2,000	  3,000

Which one of the following is the amount of consolidated net income that should be recognized for January 200Y?

A

$5,000

The correct amount is Alphaco’s net income for January 200Y ($2,000) plus Betaco’s net income for the period ($3,000), or $5,000. Income earned by the firms during 200X would not enter into 200Y income determination under any assumption.

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20
Q

On October 1, 200X, Parco acquired 100% controlling interest of Setco in a legal acquisition. There were no other transactions between the entities during 200X. The two companies reported the following net incomes/(losses) for the periods shown:

                               Parco	        Setco 1/1/0X - 9/30/0X	 $125,000	$40,000 10/1/0X - 12/31/0X	  30,000	        ($15,000)

Which one of the following would be the amount of income recognized by Parco in its consolidated financial statements for the year ended December 31, 200X?

A

$140,000

Consolidated income for the year ended December 31, 200X, would consist of Parco’s net income for the full year ($125,000 + $30,000 = $155,000) plus Setco’s net loss for the period following its acquisition by Parco ($15,000 loss). Therefore, Parco’s net income for the full year would be $155,000 − $15,000 = $140,000.

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21
Q

What method is required to be used in
accounting for most business
combinations?

A

Acquisition method

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22
Q

List the business combinations for
which the acquisition method of
accounting does not apply.

A

Joint ventures

Entities under common control

Between not-for-profit
organizations

For-profit entity acquired by a
not-for-profit organization

Acquisition of assets that do not
constitute a business

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23
Q

List the five elements (or steps)
involved in applying the acquisition
method of accounting to a business
combination.

A
  1. Identify the acquirer.
  2. Determine the acquisition date
    and measurement period.
  3. Determine the cost of the
    acquisition.
  4. Recognize and measure the
    identifiable assets acquired,
    liabilities assumed, and any
    noncontrolling interest in the
    acquired entity.
  5. Recognize and measure goodwill
    or a gain from a bargain
    purchase.
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24
Q

Define “acquisition date.”

A

The date on which the acquirer obtains
control of another business (i.e., group
of assets that constitute a business or a
separate legal entity). It usually is also
the “closing date” for the combination.

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25
Define "measurement period."
``` The period after the acquisition date during which the acquirer may adjust any provisional amounts recorded at the acquisition date. It provides the acquirer reasonable time to obtain information needed to identify and measure accounts and amounts that existed as of the acquisition date. It ends when the acquirer obtains that information or determines that no additional information is available, but in no case should it exceed one year. ```
26
``` When a business combination is effected through an exchange of equity interest, what are five factors to consider that indicate which entity is the acquirer? ```
``` Which combining entity/entities: 1. Issued new equity interest. 2. Owners have the larger portion of the voting rights. 3. Owners can select or remove a voting majority of the governing body. 4. Former management dominates that of the combined entity. 5. Paid a premium over the precombination fair value of the equity interest of the other combining entities. ```
27
For the purposes of applying the acquisition method to a business combination, what may constitute a "business"?
``` A business may be: 1. A group of assets or a group of net assets (that constitute a business). 2. A separate legal entity (that is a business). ```
28
Which one of the following would be subject to the acquisition accounting requirements of ASC 805, Business Combinations?
Acquisition of a manufacturing entity by a holding company The acquisition of a manufacturing entity by a holding company would be subject to the acquisition accounting requirements of ASC 805. 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.
29
If a business combination is effected through an exchange of equity interests, assuming all other factors are equal, which one of the following independent circumstances would not indicate the likely acquirer in a business combination?
The combining entity whose debt-holders have the larger portion of the debt of the combined entity Because debt-holders do not have voting rights and cannot exercise control over an investee, the combining entity whose debt-holders have the larger portion of the debt of the combined entity by itself would not indicate that the entity is an acquirer in a business combination.
30
The requirements of ASC 805, Business Combinations, apply to all of the following business combinations except for which one?
Combination between not-for-profit organizations The requirements of ASC 805 do not apply to combinations between not-for-profit organizations (or to the formation of a joint venture, an acquisition of assets that do not constitute a business, a combination of entities under common control, or the acquisition of a for-profit entity by a not-for-profit organization).
31
At the closing date of a business combination, goodwill was recognized. During the subsequent measurement period, additional identifiable assets were properly recognized as part of the business combination. If no other changes occurred during the measurement period, which one of the following would be the effect, if any, of the additional assets recognized on the amount of goodwill recognized in the combination?
A decrease in the amount of goodwill recognized The recognition of additional identifiable assets would result in a decrease in the amount of goodwill initially recognized in a business combination. Since goodwill is basically the difference (residual) between the investment fair value and the fair value of the net identifiable assets acquired, an increase in the identifiable assets will result in a decrease in the amount of goodwill.
32
Which of the following statements concerning the acquisition date of a business combination is/are correct? I. The acquisition date may be before the closing date. II. The acquisition date may be on the closing date. III. The acquisition date may be after the closing date.
I, II, and III. All three statements are correct. The acquisition date may be before the closing date, on the closing date, or after the closing date, if by agreement or otherwise the acquirer gains control of the acquiree at an earlier or later date than the closing date.
33
When using the acquisition method of accounting for a business combination, which of the following statements concerning the measurement period is/are correct? I. It provides time for the acquiring entity to identify assets acquired and liabilities assumed that existed as of the acquisition date. II. It provides time for the acquiring entity to determine the fair value of assets acquired and liabilities assumed that existed as of the acquisition date. III. It should not exceed one year from the acquisition date.
I, II, and III. All three statements are correct. The measurement period provides time for the acquiring entity to identify assets acquired and liabilities assumed (Statement I), to determine the fair value of those assets and liabilities (Statement II), both as of the acquisition date, and is limited to one year from the acquisition date (Statement III).
34
Which of the following statements concerning the nature of an acquired business in a business combination is/are correct? I. A business may be a group of assets. II. A business may be a group of net assets. III. A business may be a separate legal entity.
I, II, and III. All three statements are correct. A business may be a group of assets (that constitute a business), a group of net assets (that constitute a business), or a separate legal entity (that is a business).
35
Which one of the following is not a characteristic associated with the concept of a "business" for the purposes of ASC 805, Business Combinations?
Must be in the form of a separate legal entity For the purposes of ASC 805, a business does not have to be in the form of a separate legal entity. Specifically, a business is an integrated set of activities and assets that is capable of being conducted and managed through the use of inputs and processes for the purpose of providing economic benefits to owners, members, or participants. The concept of a "business" for the purposes of ASC 805 does not have to be in the form of a separate legal entity. Under this definition, a "business" may be a group of assets (or net assets) that constitute a business (e.g., a line of business) and does not have to be in the form of a separate legal entity.
36
Zipco, Inc. acquired 100% of the voting stock of Narco, Inc. with an acquisition date of March 31, 2009. During the following three months, Zipco learned the following: I. A major credit customer of Narco had declared bankruptcy on March 1, 2009, but the adverse effect on Narco's accounts receivable had not been recognized in the amount of accounts receivable recognized in the acquisition date amounts. II. Narco had a lawsuit against it that existed at the acquisition date of the combination but was not recognized on Narco's books or in the liabilities recognized at the acquisition date. Analysis determined that it was more likely than not that the party that brought the lawsuit would win a material judgment against Narco/Zipco. Which of these items of new information, if any, should be recognized in accounting for the business combination?
Both I and II. The effects of both the reduced accounts receivable and the lawsuit liability would be recognized in accounting for the business combination. Since the effects on Narco's accounts receivable and the lawsuit liability both occurred before the acquisition date, both items would be recognized in accounting for the business combination and would be adjustments made during the measurement period. The effects would be to reduce accounts receivable (Item I) and to increase liabilities (Item II) in the final recording of the business combination.
37
Which of the following are requirements of using the acquisition method of accounting for a business combination? I. Determining the acquiring entity. II. Determining the acquisition date of the business combination. III. Determining the cost of the acquisition.
I, II, and III. Determining the acquiring entity (Statement I), determining the acquisition date of the combination (Statement II), and determining the cost of the acquisition (Statement III), and other elements, are all requirements of the acquisition method of accounting for a business combination.
38
Which one of the following correctly describes the maximum length of the measurement period for a business combination?
One year from the acquisition date of the combination The measurement period may extend up to one year from the acquisition (closing) date of a business combination. The measurement period is the period after the acquisition date during which the acquirer may adjust any provisional amounts recognized as part of the business combination, and it may extend for as long as one year after the acquisition date.
39
Company Z is formed to consolidate three preexisting entities: Companies W, X, and Y. Company Z pays cash to acquire the net assets of Company W and issues debt to acquire the net assets of Company X. Company Z acquires all of the stock of Company Y in the market for cash. Which one of the companies is most likely the acquirer in the business combination?
Company Z Because Company Z only paid cash and issued debt to effect the combination (no new equity was issued to effect the combination), Company Z is most likely the acquirer.
40
Which of the following statements, if any, concerning the accounting for business combinations is/are correct? I. All business combinations in the U.S. are subject to the acquisition accounting requirements of ASC 805, Business Combinations. II. The acquisition accounting requirements of ASC 805, Business Combinations, are identical to those of IFRS #3, Business Combinations.
Neither I nor II. Neither statement is correct. Not all business combinations in the U.S. are subject to the acquisition accounting requirements of ASC 805 (Statement I). That pronouncement specifically excludes certain combinations, including 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. In addition, the requirements of ASC 805 are not identical to those of IFRS #3 (Statement II). Differences exist between the two pronouncements in the areas of scope; the definition of control; how fair value, contingencies, employee benefit obligations, noncontrolling interest, and goodwill are measured; and disclosure requirements.
41
In which one of the following cases is Company A most likely to be the acquirer of Company B in a business combination?
Company A owns 35% of Company B's voting stock and 60% of Company C's voting stock, which owns 20% of Company B's voting stock. Generally, to be an acquirer, an entity must own, either directly or indirectly, more than 50% of the voting stock of another entity. In this case, Company A owns 35% of Company B directly and would control 20% indirectly, or a total of 55%. (Since Company A owns 60% of Company C, it has absolute control of C and could control C's 20% ownership of B.) Thus, Company A would control Company B and likely would be an acquirer in a business combination.
42
When a new entity is formed to effect a business combination, which of the following statements, if any, is/are correct? I. A legal consolidation has occurred. II. The new entity is always the acquirer in the business combination.
I only. Statement I is correct; Statement II is not correct. When a new entity is formed to effect a business combination, a legal consolidation has occurred (Statement I), but the new entity is not always the acquirer in the combination (Statement II). If the new entity transfers cash or other assets or incurs liabilities to effect the combination, the new entity is likely the acquirer, but if the new entity issues equity interest to effect the business combination, one of the pre-existing combining entities must be the acquirer.
43
Which of the following is/are acceptable methods to account for a business combination? Purchase Method Acquisition Method Pooling of Interests Method
Purchase Method - No Acquisition Method - Yes Pooling of Interests Method - No Only the acquisition method is acceptable in accounting for a business combination. The purchase method and the pooling of interests method of accounting for a business combination are not acceptable methods. The pooling of interests method was eliminated in 2001 and the purchase method was changed to the acquisition method in 2008. Although the acquisition method is a variation of the purchase method, it has sufficiently different requirements that it is not identified as the "purchase method," but rather as the "acquisition method."
44
The acquisition date of a business combination is generally which one of the following?
The closing date The acquisition date of a business combination is the date on which the acquiring entity obtains control of the acquired business; usually, it is also the closing date (of the business combination).
45
Under what circumstance is fair value not used to measure assets and liabilities transferred in a business combination?
``` When the assets and liabilities are transferred to the acquiree but remain under the control of the acquirer because the acquirer obtained control of the acquiree (which holds the transferred asset or liability). In such a case, the asset or liability should be transferred at carrying value, not fair value. ```
46
How is the exchange of share-based employee awards treated in a business combination?
If the exchange is required: ``` The portion of the value of the replacement awards that relates to precombination services is part of the cost of the acquired business. ``` The portion of the value of the replacement awards that relates to postcombination services is expensed. If the exchange is voluntary, the value of the replacement awards is expensed.
47
List the elements that make up the cost | of an acquired business.
``` Fair value of: Assets transferred Liabilities incurred Equity interest issued Contingent consideration obligations of the acquirer Required share-based employee awards for precombination services ```
48
Describe the nature of contingent consideration in a business combination.
Contingent consideration is either: ``` An obligation of the acquirer to transfer additional assets or equity to the former owners of the acquired business if future conditions are met; or ``` A right of the acquirer to a return of previously transferred consideration if future conditions are met. Contingent consideration is recognized at fair value as of the acquisition date as part of the cost of the acquiree.
49
A company acquires another company for $3,000,000 in cash, $10,000,000 in stock, and the following contingent consideration: $1,000,000 after Year 1, $1,000,000 after Year 2, and $500,000 after year 3, if earnings of the subsidiary exceed $10,000,000 in each of the three years. The fair value of the contingent -based consideration portion is $2,100,000. What is the total consideration transferred for this business combination?
$15,100,000 ``` All consideration, including contingent consideration, must be measured at acquisition date fair value. The total consideration transferred is: Cash $ 3,000,000 Stock 10,000,000 Contingent consideration 2,100,000 Total $15,100,000 ```
50
An obligation of an acquirer to pay contingent consideration to the former owners of an acquired entity in a business combination can be recognized as which of the following? A Liability An Equity Item
A Liability - Yes An Equity Item - Yes An obligation to pay contingent consideration in a business combination may be recognized by the acquirer as either a liability or as an equity item, depending on the nature of the obligation under the provisions of ASC 480, Distinguishing Liabilities from Equity.
51
Changes in the fair value of contingent consideration transferred in a business combination resulting from occurrences after the acquisition date should be recognized as a gain or loss in the current income when the contingent consideration is classified as An Asset or a Liability An Equity Item
An Asset or a Liability - Yes An Equity Item - No Changes in the fair value of contingent consideration resulting from occurrences that occur after the acquisition date are recognized as gains or losses when the contingent consideration is classified as an asset or a liability. Contingent considerations classified as equity are not remeasured, and no gain or loss is recognized. The change in fair value of equity items is recognized as an adjustment within equity.
52
Which of the following statements concerning the acquisition of a business is/are correct? I. Most consideration transferred to effect a business combination should be measured at fair value. II. Contingent consideration should be included in the cost of an acquired business at fair value existing on the acquisition date. III. The cost of carrying out a business combination should be included in the cost of an acquired business.
I and II only. Statement I and Statement II are correct; Statement III is not correct. Most consideration used to effect a business combination should be measured at fair value (Statement I). The only exception is when the consideration transferred remains under the control of the acquirer. Contingent consideration should be included in the cost of an acquired business at fair value as of the acquisition date (Statement II). The cost of carrying out a business combination should not be included in the cost of an acquired business (Statement III); most such costs should be expensed.
53
The terms of a business combination can provide that former shareholders of the acquired firm may receive additional compensation based on post-combination earnings or post-combination market share price. Would additional compensation based on such earnings or market price be considered an additional cost of the business combination? Based on Earnings Based on Share Price
Based on Earnings - No Based on Share Price - No Additional compensation to former shareholders of an acquired entity based on either post-combination earnings or post-combination share price would not be recognized as changes in the cost of the business combination. Changes in the fair value of contingent consideration resulting from occurrences after the acquisition date, including meeting earnings targets and reaching a specified share price, are not measurement period adjustments and do not enter into the cost of a business combination.
54
Which one of the following, incurred by an acquiring entity in carrying out a business combination, would not be included in the cost of an acquired entity?
Cost of legal fees to carry out the combination Cost of legal fees (and other direct costs) to carry out the combination would not be included in the cost of an acquired business but would be expensed in the period incurred.
55
A business combination is accounted for using the acquisition method. Which of the following should be deducted in determining the combined corporation's net income for the current period? Direct Costs Of Acquisition General Expenses Related to Acquisition
Direct Costs Of Acquisition - Yes General Expenses Related to Acquisition - Yes Acquisition-related costs incurred to carry out a business combination, including both direct costs of acquisition (e.g., finders' fees; legal, accounting, and consulting fees; etc.) and general expenses related to an acquisition (e.g., cost of acquisition department), are expensed when incurred and enter into the determination of income for the period.
56
Bale Co. incurred $100,000 of acquisition costs related to the purchase of the net assets of Dixon Co. The $100,000 should be
Expensed as incurred in the current period. This question implies that the acquisition is a business combination. The costs associated with a business combination are expensed as incurred.
57
Describe the requirements of the acquisition when a business combination is carried out in stages (or steps).
``` Equity interest in the acquiree that is acquired by the acquirer prior to the business combination is remeasured to fair value at the date of the combination (acquisition date). Any difference between the precombination carrying value and the acquisition date fair value is recognized as a gain or loss in income of the period of the combination. The fair value of the precombination investment is included as part of the cost of the investment value (i.e., cost of the investment in the acquiree) to the acquirer. ```
58
``` Identify at least three items acquired in a business combination for which the acquirer has to make a decision as to the classification or designation of the item. ```
1. Debt investments, as to whether held to maturity, held for trading, or available for sale 2. Derivative instruments, as to whether used for hedging or speculation 3. Embedded derivatives, as to whether they will be separated from the host instrument or not 4. Long-term assets, as to whether they will be used or held for sale
59
Identify the general acquiree-related elements that must be recognized and measured by the acquirer in a business combination.
Identifiable assets acquired Liabilities assumed Noncontrolling interest, if any
60
Identify at least five items acquired in a business combination that would be measured at something other than fair value.
1. Income tax items: Use Accounting Standards Codification (ASC) No. 740 and other guidelines. 2. Acquiree's employee benefit liability/asset: Use various related generally accepted accounting principles. 3. Indemnification assets: Use the same measurement basis as for indemnified items. 4. Reacquisition rights: Use unamortized balance. 5. Share-based employee awards: Use ASC No. 718. 6. Long-term assets held for sale: Use ASC No. 360.
61
On December 31, Year 1, Andover Co. acquired Barrelman, Inc. Before the acquisition, a product lawsuit seeking $10 million in damages was filed against Barrelman. As of the acquisition date, Andover believed that it was probable that a liability existed and that the fair value of the liability was $5 million. What amount should Andover record as a liability as of December 31, Year 1?
$5,000,000 A noncontractual liability that is more likely than not (greater than 50%) to meet the definition of a liability, should be recorded at acquisition date fair value. This lawsuit is probable to occur and should be recorded as part of the business combination at $5 million.
62
Which of the following kinds of intangible assets on the books of an acquired entity immediately before a business combination would be recognized by the acquiring entity? Future benefits that derive from legal rights Future benefits that can be separately sold
Future benefits that derive from legal rights - Yes Future benefits that can be separately sold - Yes Intangible assets on the books of an acquired entity immediately before a business combination would be recognized by the acquiring entity if they either have future benefits that arise from contractual or legal rights (e.g., trademarks, copyrights, franchise agreements, etc.) or are capable of being separately sold, transferred, licensed, rented, or exchanged (e.g., customer lists, databases, etc.).
63
On July 1, 2009, Lazer, Inc. acquired all of the assets, with a fair value of $400,000, and liabilities, with a fair value of $150,000, of Tipco, Inc. for $250,000 cash. In addition, Lazer paid $20,000 in legal and accounting fees for the combination and expects to pay $50,000 to close one of Tipco's plants and relocate its employees. Which one of the following is the amount of liability that Lazer should recognize in recording the business combination?
$150,000 Lazer will recognize $150,000 in liabilities, the fair value of the amount acquired from Tipco. The $20,000 legal and accounting fees will be expensed as cost of carrying out the combination. The expected cost of closing one of Tipco's plants and relocating its employees will not be recognized until there is an actual liability.
64
Which one of the following payments by an acquirer in a business combination is most likely to be a part of the cost in recording a business combination transaction?
Payment by the acquirer to the acquiree for a valid patent not previously recognized by the acquiree Payment for a valid patent, even though not previously recognized by the acquiree, most likely would be a part of the business combination transaction. Since costs of developing a patentable item are expensed when incurred, the acquiree may not have recognized any asset associated with the patent, but the acquirer should record the patent acquired in a business combination at fair value.
65
Which one of the following items acquired in a business combination is least likely to require that the acquirer reconsider the acquiree's classification?
A lease classified as a sales-type capital lease by the acquiree In a business combination, an acquirer that obtains a lease contract should continue to classify the contract as established at the inception of the contract. The classification of a lease contract is established at the inception of the lease and would not change as a result of a transfer of ownership in a business combination.
66
Generally, which of the following items acquired in a business combination should be measured at fair value? Identifiable Assets Acquired Liabilities Assumed Noncontrolling Interest
Identifiable Assets Acquired -YES Liabilities Assumed - YES Noncontrolling Interest - YES Generally, identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquiree are measured at fair value. A few exceptions exist for selected assets and liabilities.
67
Which of the following contingencies that exist on the acquisition date should be recognized by the acquirer in a business combination? I. A contractual contingency to provide warranty services to prior customers of the acquiree. II. An outstanding lawsuit against the acquiree for which an expert legal authority believes there is a 20% probability that the suit will be successful.
I only. Item I would be recognized; Item II would not be recognized. Contractual contingencies (contingencies related to existing contracts) are recognized by the acquirer and measured at fair value. Noncontractual contingencies (contingencies that do not result from an existing contract), including lawsuits, are recognized only if it is more likely than not that the contingency will give rise to a liability (or an asset). A probability of 20% that the suit will be lost is not more likely than not, and the lawsuit would not be recognized.
68
Zooco, Inc. acquired 40% of the voting stock of Stubco, Inc. on September 1, 2008, and accounted for the investment using the equity method of accounting. On May 1, 2009, Zooco acquired an additional 20% of Stubco's voting stock to achieve a business combination. Which one of the following is the value Zooco should use to measure its original 40% investment in Stubco when recording the combination?
Fair value, May 1, 2009 When a business combination is accomplished in stages (or steps), the fair value of the investment on the date of the combination is used to value the business combination. In this case, that would be the fair value on May 1, 2009. Any difference between the carrying value and the fair value on the acquisition date would be recognized as a gain or loss for the period.
69
On May 1, 2017, Hico, Inc. acquired 20% of the voting securities of Lowco, Inc. for $400,000 cash. The investment did not give Hico significant influence over Lowco and was carried at fair value with unrealized gains and losses recorded in earnings. On July 1, 2018, Hico acquired the remaining 80% of Lowco's voting securities in a business combination for $1,800,000 cash. At that time, Hico's original 20% investment in Lowco had a fair value of $450,000. At what amount should Hico record as the total fair value of Lowco as a result of the business combination?
$2,250,000 The $450,000 fair value of the original investment plus the $1,800,000 of cash paid is the total fair value of Lowco.
70
Which of the following statements, if any, concerning a noncontrolling interest in an acquiree is/are correct? I. The value assigned to a noncontrolling interest in an acquiree should be based on the proportional share of that interest in the net assets of the acquiree. II. The fair value per share of the noncontrolling interest in an acquiree must be the same as the fair value per share of the controlling (acquirer) interest.
Neither I nor II. Neither Statement I nor Statement II is correct. The value assigned to a noncontrolling interest in an acquiree would not be based simply on the proportional share of that interest in the net assets of the acquiree (Statement I), but rather on the separately determined fair value of the noncontrolling interest. The fair value per share of the noncontrolling interest in an acquiree does not have to be the same as the fair value per share of the controlling interest (Statement II), because there is likely to be a premium in value associated with having control of an entity that the noncontrolling interest would not enjoy.
71
What values are compared to determine if there is goodwill or a bargain purchase in a business combination?
``` The fair value of the total investment in the acquiree (including the acquirer's consideration transferred and the noncontrolling interest in the acquiree) and the fair value of the net assets (Assets – Liabilities) of the acquiree ```
72
Under what conditions will a bargain purchase be recognized in a business combination?
``` A bargain purchase is recognized when the fair value of the total investment in an acquiree (both the investment of the acquirer and that of any noncontrolling interest) is less than the fair value of the acquiree's net assets. ```
73
Under what conditions will goodwill be | recognized in a business combination?
``` Goodwill is recognized when the fair value of the total investment in an acquiree (both the investment of the acquirer and that of any noncontrolling interest) is greater than the fair value of the acquiree's net assets. ```
74
Windco, Inc. acquired 100% of the voting common stock of Trace, Inc. by transferring the following consideration to Trace's shareholders: Cash $100,000 5,000 new shares of Windco's $10 par common stock $ 50,000 (par) (which is less than 1% of Windco’s outstanding stock) In addition, Windco paid $12,000 direct cost of carrying out the combination. At the date of the acquisition, Windco's common stock was selling in an active market for $18 per share. Also, at the date of the acquisition, Trace had the following assets and liabilities with the book values and fair values shown: Book Value Market Value Accounts Receivable $ 20,000 $ 20,000 Property and Equipment 80,000 100,000 Land 60,000 80,000 Other Assets 40,000 40,000 Total Assets $200,000 $240,000 Accounts Payable $ 15,000 $ 15,000 Other Short-term Debt 10,000 10,000 Long-term Debt 35,000 35,000 Total Liabilities $ 60,000 $ 60,000 Which one of the following is the amount that Windco should treat as its cost consideration for the acquisition of Trace?
$190,000 The total cost (consideration transferred) of acquiring Trace should be the cash paid plus the fair value of the stock issued. The cost of carrying out the combination ($12,000) should be expensed. Therefore, the cost would be $100,000 + (5,000 share × $18 market price = $90,000), or $100,000 + $90,000 = $190,000.
75
On July 1, Dill, Inc. exchanged 10,000 shares of its common stock for all 20,000 shares of Ledo, Inc.'s outstanding common stock. Dill's stock is closely held and seldom traded; it has a par value of $10 per share and a book value of $12 per share. Ledo's stock is traded in an active market and has a par value of $5 per share, a book value of $8 per share, and a market price of $11 per share. Which one of the following amounts is most likely the appropriate value of Dill's investment in Ledo?
$220,000 Stock issued in a business combination should be measured at fair value. In some cases in which equities are exchanged, the fair value of the acquiree's stock may be a more reliable measure of the value of the transaction than can be determined for the acquirer's stock. In this question, that is the case. Since Dill's stock is closely held and seldom traded, it is less likely to be the basis for determining fair value than is Ledo's stock, which is traded in an active market. Therefore, the most likely value for the transaction would be the 20,000 shares of Ledo's stock that were obtained multiplied by the $11 market price of those shares, or 20,000 shares × $11 = $220,000.
76
In which of the following circumstances of a business combination, if any, could the recognition of a gain occur at the time of the combination? Investment Value > Fair Value of Net Assets Investment Value < Fair Value of Net Assets
Investment Value > Fair Value of Net Assets - No Investment Value < Fair Value of Net Assets - Yes A gain can occur in a business combination only when the investment value in the acquired entity is less than the fair value of the entity's net assets, and not when the investment value is greater than the fair value of those net assets. Thus, when the fair value of the investment by the acquirer and any noncontrolling interest in the acquiree is less than the fair value of the net assets of the acquiree, a bargain purchase gain will be recognized.
77
Windco, Inc. acquired 100% of the voting common stock of Trace, Inc. by transferring the following consideration to Trace's shareholders: Cash $100,000 5,000 new shares of Windco's $10 par common stock $ 50,000 (par) (which is less than 1% of Windco’s outstanding stock) In addition, Windco paid $12,000 direct cost of carrying out the combination. At the date of the acquisition, Windco's common stock was selling in an active market for $18 per share. Also, at the date of the acquisition, Trace had the following assets and liabilities with the book values and fair values shown: Book Value Market Value Accounts Receivable $ 20,000 $ 20,000 Property and Equipment 80,000 100,000 Land 60,000 80,000 Other Assets 40,000 40,000 Total Assets $200,000 $240,000 Accounts Payable $ 15,000 $ 15,000 Other Short-term Debt 10,000 10,000 Long-term Debt 35,000 35,000 Total Liabilities $ 60,000 $ 60,000 Which one of the following is the fair value of Trace's net assets at the date of the business combination?
$180,000 The correct calculation would be the fair value of Trace's assets $240,000 - the fair value of the liabilities, $60,000 = $180,000.
78
Windco, Inc. acquired 100% of the voting common stock of Trace, Inc. by transferring the following consideration to Trace's shareholders: Cash $100,000 5,000 new shares of Windco's $10 par common stock $ 50,000 (par) (which is less than 1% of Windco’s outstanding stock) In addition, Windco paid $12,000 direct cost of carrying out the combination. At the date of the acquisition, Windco's common stock was selling in an active market for $18 per share. Also, at the date of the acquisition, Trace had the following assets and liabilities with the book values and fair values shown: Book Value Market Value Accounts Receivable $ 20,000 $ 20,000 Property and Equipment 80,000 100,000 Land 60,000 80,000 Other Assets 40,000 40,000 Total Assets $200,000 $240,000 Accounts Payable $ 15,000 $ 15,000 Other Short-term Debt 10,000 10,000 Long-term Debt 35,000 35,000 Total Liabilities $ 60,000 $ 60,000 Which one of the following is the amount of gain Windco will recognize in connection with its acquisition of Trace?
$ - 0 - (no gain) No gain will be recognized by Windco in connection with its acquisition of Trace. Neither the cash transferred nor the common stock issued had a carrying value less than (or different than) fair value. The carrying value and fair value of the cash are the same, $100,000. And, since the common stock was newly issued, it would be valued at the market price of the stock, with the excess over par value recognized as additional paid-in capital, not as a gain. Further, there was no bargain purchase amount to be recognized as a gain.
79
In which of the following circumstances will goodwill be recognized in a business combination?
The fair value of the investment by the acquiring entity and any noncontrolling interest in the acquired entity is greater than the fair value of the acquired entity's net assets. Goodwill is based on the excess of investment value over the fair value of net assets. Thus, an acquirer will recognize goodwill only when the fair value of its investment and that of any noncontrolling interest in the acquiree exceeds the fair value of the acquiree's net assets.
80
In a business combination accounted for as an acquisition, the fair value of the identifiable net assets acquired exceeds the fair value of the consideration paid by the acquirer and the fair value of the noncontrolling interest in the acquiree. The excess fair value of net assets over investment value should be reported as a:
Gain. A gain occurs in a business combination when the investment value in the acquired entity is less than the fair value of the entity's net assets. Thus, when the fair value of the identifiable net assets acquired exceeds the fair value of the investment by the acquirer and any noncontrolling interest in the acquiree, a bargain purchase gain will be recognized.
81
On July 1, 2009, Nexto, Inc. had the following summarized balance sheet with the book values and fair values shown: Book Value Fair Value Accounts Receivable (net) $ 40,000 $ 40,000 Inventories 80,000 80,000 Plant and Equipment (net) 160,000 200,000 Land 120,000 160,000 TOTAL ASSETS $400,000 $480,000 Accounts Payable $ 20,000 $ 20,000 Short-term Note 30,000 30,000 Bonds Payable 70,000 70,000 TOTAL LIABILITIES $120,000 $120,000 On that date, Pesto, Inc. acquired 100% of Nexto's voting stock from its shareholders by paying the following consideration: Cash $200,000 10,000 newly-issued shares of Pesto's $10 par common stock 100,000 (par) Prior to the combination, Pesto had 1,000,000 shares of voting stock outstanding trading in an active market at $15 per share. Pesto paid $25,000 for legal and accounting fees to carry out the combination. Which one of the following is the amount of goodwill or bargain purchase gain that Pesto should recognize as a result of its acquisition of Nexto? Goodwill Bargain Purchase Gain
Goodwill - $ 0 Bargain Purchase Gain - $ $10,000 A bargain purchase gain is the excess of the fair value of the net assets acquired in a business combination over the fair value of the cost of the investment. The cost of investment to Pesto is $350,000, consisting of $200,000 cash and $150,000 fair value of stock issued (10,000 shares × $15 per share). The fair value of Nexto's net assets is $360,000 ($480,000 assets − $120,000 liabilities). Therefore, the fair value of the net assets exceeds the cost of the investment by $10,000, resulting in a bargain purchase gain.
82
How should assets and liabilities arising from contingencies be measured and reported subsequent to a business combination?
``` If the contingency is a liability, measure and report at the higher of: 1. Its acquisition-date fair value; or 2. The amount that would be recognized if the requirements of Accounting Standards Codification (ASC) No. 450 were followed. If the contingency is an asset, measure and report at the lower of: 1. Its acquisition-date fair value; or 2. The best estimate of its future settlement amount. ```
83
How should contingent consideration be measured and reported subsequent to a business combination?
If changes are of fair value as it existed at acquisition date, the change is an adjustment to the cost of the investment. If changes result from events after the acquisition date: 1. Changes in contingent assets or liabilities are recognized in earnings in the period of change. 2. Changes in contingent equity are an adjustment to equity accounts, not an earnings item.
84
What assets or liabilities recognized in a business combination require "specialized" post-combination accounting treatments?
Reacquired rights asset Assets and liabilities arising from contingencies Indemnification assets Contingent consideration as asset or liability (or equity)
85
Which one of the following assets recognized in a business combination will require that the amount recognized be amortized over future periods?
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.
86
Which one of the following items that was acquired in a business combination is most likely to be accounted for using post-combination accounting requirements specific for the item?
Contingency-based assets Assets (and liabilities) arising from contingencies are likely to be accounted for using specific post-combination accounting requirements. Those requirements provide that when new information is obtained about a contingency-based asset, it will be measured at the lower of (1) its acquisition-date fair value or (2) the best estimate of its future settlement amount.
87
In recording its acquisition of Lambda, Inc., Omega, Inc. properly recognized a contingent consideration liability of $28,000 associated with a possible payment based on a target amount of post-combination cash flow from operations. Shortly after the combination, but during the measurement period, the national economy experienced a significant downturn which made it unlikely that the target amount would be reached. As a consequence, at the end of Omega's fiscal period, the liability was properly revalued to a fair value of $9,000. Which one of the following is the amount of gain or loss that will be recognized in income as a result of the reevaluation of the contingent liability?
$19,000 gain A contingent consideration liability is the obligation of an acquirer to transfer additional consideration, if specific conditions are met. Contingent consideration liabilities are initially recognized at fair value and adjusted to fair value each period until the contingency is resolved or expires. A change in fair value resulting from occurrences after the acquisition date would be recognized as a gain or loss in income in the period of the change. In this question, a $19,000 gain (reduction in liability) would be recognized ($28,000 − $9,000 = $19,000).
88
In recording its acquisition of Lambda, Inc., Omega, Inc. properly recognized a contingent consideration liability of $28,000 associated with a possible payment based on a target amount of post-combination cash flow from operations. Shortly after the combination, but during the measurement period, the national economy experienced a significant downturn which made it unlikely that the target amount would be reached. As a consequence, at the end of Omega's fiscal period, the liability was properly revalued to a fair value of $9,000. Which one of the following is the amount of increase or decrease, if any, in the consideration paid to acquire Lambda that results from the change in the fair value of the contingent liability?
$ - 0 - (no increase or decrease) A contingent consideration liability is the obligation of an acquirer to transfer additional consideration, if specific conditions are met. Contingent consideration liabilities are initially recognized at fair value and adjusted to fair value each period until the contingency is resolved or expires. A change in fair value resulting from occurrences after the acquisition date would be recognized as a gain or loss in income in the period of the change, not as an adjustment to the consideration paid to acquire the acquiree. In this question, a $19,000 gain (reduction in liability) would be recognized ($28,000 − $9,000 = $19,000) and no change in the consideration paid will be recognized.
89
How should the acquirer recognize a bargain purchase in a business acquisition?
As a gain in earnings at the acquisition date A bargain purchase means that the acquirer paid less than the fair market value of the identifiable net assets. The seller must have been under some sort of duress (perhaps eminent bankruptcy) and was willing to accept a price less than the value of the net assets. In this case the acquirer recognizes that gain on the date of the acquisition.
90
A building suffered uninsured water and related damage. The damaged portion of the building was refurbished with upgraded materials. The cost and related accumulated depreciation of the damaged portion are identifiable. To account for these events, the owner should:
Capitalize the cost of refurbishing and record a loss in the current period equal to the carrying amount of the damaged portion of the building. When the portion of an asset is damaged, and that portion has identifiable costs and accumulated depreciation, the identifiable amounts associated with the damage are removed from the general ledger. The difference between the cost and accumulated depreciation is the carrying value of the damaged portion of the larger asset. In this problem there was no insurance proceeds. Therefore, the carrying value of the damaged portion of the asset is written off as a loss and the replacement of that asset is capitalized. The entries would be: ``` Portion removed DR: Loss DR: Accumulated Depreciation CR: Asset Cost of replacement DR: Asset CR: Cash ```
91
Identify the most significant general information about a business combination that must be disclosed.
``` Name and description of the acquired business The acquisition date The percentage voting interest acquired (if relevant) How the acquirer gained control of the acquired business The primary reason for the business combination ```
92
In which periods does an acquirer have to disclose information about a business combination in its financial statements?
In the reporting period in which the combination occurs and in each reporting period that includes the measurement period
93
What information must be disclosed about goodwill recognized in a business combination?
``` A quantitative description of the factors that make up the goodwill The amount of goodwill expected to be deductible for tax purposes The amount of goodwill assigned to each reportable segment During the measurement period, a reconciliation of the beginning and ending balance in goodwill ```
94
When provisional amounts for a business combination are reported in financial statements, what must be disclosed about those amounts?
Identification of the items (assets, liabilities, equity, or consideration) for which accounting is not complete The reasons why the accounting is not finalized ``` The nature and amounts of any measurement-period adjustments made to the provisional amounts during the reporting period ```
95
When goodwill is recognized in a business combination, which of the following types of information about that goodwill must be disclosed? I. A quantitative description of the factors that make up the goodwill. II. The amount of goodwill that is expected to be deductible for tax purposes. III. The amount of goodwill allocated to each reportable segment.
I, II, and III. Statements I, II, and III are all required. When goodwill is recognized in a business combination, a quantitative description of the factors that make up the goodwill (Statement I), the amount of goodwill that is expected to be deductible for tax purposes (Statement II), and the amount of goodwill allocated to each reportable segment (Statement III) must all be disclosed.
96
Which of the following occurrences in a business combination, if any, identify circumstances that require extensive disclosures in the period of the combination? I. The existence of a noncontrolling interest. II. Achieving control in step acquisition.
Both I and II. Both Statements I and II identify circumstances that require extensive disclosures in the period of a combination. When there is a noncontrolling interest in the acquiree, the fair value of the noncontrolling interest at the acquisition date, and the valuation techniques and inputs used to measure that fair value, must be disclosed. When control is achieved in steps (or stages), the fair value of the equity held by the acquirer immediately before the combination, the amount of any gain or loss resulting from adjusting the interest to fair value, and the line item in the income statement where the gain or loss is reported must be disclosed.
97
When a bargain purchase occurs in a business combination, which of the following types of information must be disclosed in the period of the combination? I. The amount of gain recognized. II. The income statement line item that includes the gain. III. A description of the basis for the bargain purchase amount.
I, II, and III. All three statements identify required disclosures. When a bargain purchase occurs in a business combination, the amount of the gain (Statement I), the income statement line item that includes the gain (Statement II), and a description of the basis for the bargain purchase amount (Statement III) must be disclosed.
98
If provisional amounts are reported for items recognized in a business combination, which of the following kinds of information must be disclosed? I. The reasons why the accounting is incomplete. II. The amount of adjustment(s) made to the provisional amounts during the period. III. The date at which each provisional amount is expected to be resolved.
I and II only. Statements I and II are correct. Statement III is not correct. If provisional amounts are reported for items recognized in a business combination, the reasons why the accounting is incomplete (i.e., the amounts are provisional) (Statement I) and the amounts of adjustment(s) made to the provisional amounts during the period (Statement II) - as well as the specific items for which the amounts are provisional - must be disclosed. The date at which each provisional amount is expected to be resolved is not a required disclosure (Statement III).
99
An entity must disclose information about a business combination it carries out if the acquisition date occurs: During the Reporting Period After the Reporting Period but Before Statements are Released
During the Reporting Period - Yes After the Reporting Period but Before Statements are Released - Yes Financial statement disclosures that enable users to evaluate the nature and financial effects of a business combination must be made both when the combination occurs during the reporting period and when the combination occurs after the reporting period but before the financial statements are released.
100
Which of the following general types of information about a business combination must be disclosed? I. The primary reason for a business combination. II. How the acquirer gained control of the business. III. The acquisition-date fair value of consideration transferred and each major class of asset acquired and liability assumed.
I, II, and III. Statements I, II, and III are all required disclosures. The primary reason for a business combination (Statement I), how the acquirer gained control of the business (Statement II), and the acquisition date fair value of consideration transferred and each major class of asset acquired and liability assumed (Statement III) must all be disclosed.
101
In a business combination, what is recognized when the cost of the investment is less than the fair value of the net assets acquired?
Bargain purchase.
102
How is a wholly owned subsidiary | reported?
Reported in consolidated statements, unless the parent lacks effective control
103
List the journal entry by the investor to record a legal merger/consolidation using the acquisition method.
DR: Assets acquired (at fair value) CR: Liabilities assumed (at fair value) CR: Cash/Other Consideration Paid (Cost)
104
What accounting method is used to | record a legal merger or consolidation?
Acquisition method
105
In a business combination, what is recognized when the cost of the investment is greater than the fair value of the net assets acquired?
Goodwill
106
What method is used by a parent company to carry "investment in subsidiary" on its books?
Cost, equity or fair value method
107
What is the journal entry by an investor | to record a legal acquisition?
DR: Investment in Subsidiary | CR: Cash/Other Consideration (Cost)
108
Seashell Corp. was organized to consolidate Sea Company and Shell Company in a business combination. Seashell issued 25,000 shares of its $10 par value common stock in exchange for all of the outstanding common stock of Sea and Shell. At the time of the consolidation, the fair market value of Sea's and Shell's assets and liabilities are equal to their book values. The shareholders' equity accounts of Sea and Shell on the date of the consolidation were: Sea Shell Total Common stock, at par $100,000 $200,000 $300,000 Additional paid-in capital 50,000 75,000 125,000 Retained Earnings 22,500 47,500 70,000 Totals $172,500 $322,500 $495,000 What is the balance in Seashell's additional retained earnings account immediately following its issuing common stock to effect the consolidation?
$-0- As a newly formed entity, Seashell will have no retained earnings until after an operating period. Seashell's shareholders' equity immediately following the consolidation will consist of the common stock issued (at par), $250,000, and additional paid-in capital, $245,000. Immediately after the consolidation, there will be no retained earnings.
109
Sayon Co. issues 200,000 shares of $5 par value common stock to acquire Trask Co. in an acquisition-business combination. The market value of Sayon's common stock is $12 per share. Legal and consulting fees incurred in relation to the acquisition are $110,000 paid in cash. Registration and issuance costs for the common stock are $35,000. What should be recorded in Sayon's additional paid-in capital account for this business combination?
$1,365,000 The calculation is: Fair value (200,000 sh. × $12/sh.) $2,400,000 Par value (200,000 sh. × $5/sh) (1,000,000) Gross additional paid-in capital $1,400,000 Less: Registration and issuance costs 35,000 Net additional paid-in capital $1,365,000 The legal and consulting fees ($110,000) were paid in cash and would be expensed in the period incurred. The registration and issuance costs of the common stock are properly deducted from the additional paid-in capital derived from the issuance of the stock. Acquisition-related costs (expect as noted below) should be expensed in the period in which the costs were incurred and the services are received. These costs, in this case the $110,000 legal and consulting fees incurred in relation to the acquisition, are not included as part of the cost of an aquired business. The cost of issuing debt and equity securities for the purposes of a business combination are not treated as cost of the acquired business, but should be accounted for generally as follows: Debt issuance costs may be either recognized as a deferred asset and amortized over the life of the debt, or expensed when incurred. In this case, equity was issued in the acquisition, not debt. Equity issuance costs reduce the proceeds from the securities issued and, in effect, reduce Additional Paid-in Capital. In this case, the information states $35,000 is incurred for registration and issuance costs for the stock issued.
110
Plant Company acquired controlling interest in Seed Company in a legal acquisition. Which one of the following could not be part of the entry to record the acquisition?
Debit: Goodwill The entry that Plant will make to record its legal acquisition of Seed cannot include a debit to Goodwill. The entry Plant makes will debit (only) the Investment account and credit whatever form(s) of consideration is given (e.g., Cash, Bonds Payable, Common Stock, etc.). Goodwill cannot be debited at the time of the acquisition, though it may be recognized at the time of consolidation.
111
Seashell Corp. was organized to consolidate Sea Company and Shell Company in a business combination. Seashell issued 25,000 shares of its newly authorized $10 par value common stock in exchange for all of the outstanding common stock of Sea and Shell. At the time of the consolidation, the fair value of Sea's and Shell's assets and liabilities are equal to their book values. The shareholders' equity accounts of Sea and Shell on the date of the consolidation were: Sea Shell Total Common stock, at par $100,000 $200,000 $300,000 Additional paid-in capital 50,000 75,000 125,000 Retained Earnings 22,500 47,500 70,000 Totals $172,500 $322,500 $495,000 Which one of the following is the amount of goodwill Seashell would recognize upon issuing its common stock to effect the consolidation?
$-0- Since Seashell's stock is newly issued to effect the consolidation, it has no prior market value. In the absence of a market value, the fair value of Seashell's stock is determined by the fair value of the net assets acquired in the consolidation. Therefore, the consideration given (common stock issued) is equal to the fair value of net assets acquired, and no goodwill is recognized.
112
On August 31, 2005, Wood Corp. issued 100,000 shares of its $20 par value common stock for the net assets of Pine, Inc. in a business combination accounted for by the acquisition method. The fair value of Wood's common stock on August 31 was $36 per share. Wood paid a fee of $160,000 to the consultant who arranged this acquisition. Costs of registering and issuing the equity securities amounted to $80,000. No goodwill was involved in the purchase. What should Wood capitalize as the cost of acquiring Pine's net assets?
$3,600,000 The cost of acquiring a company includes all cash and other assets distributed, liabilities incurred, and equity shares issued, all at fair value. Direct costs of carrying out a combination (such as accounting, legal, consulting, and finders' fees) are expensed in the period incurred; they are not included as part of the acquired entity. The cost of registering and issuing securities used to effect a business combination are charged against the fair value of the securities issued and, for equity securities, serve to reduce the amount of additional paid-in capital recognized. Thus, this correct answer ($3,600,000) was computed as 100,000 shares issued × $36 per share (fair market value) = $3,600,000. The $160,000 fees paid to a consultant would have been expensed, and the $80,000 cost of registering and issuing the common stock would have reduced the amount recognized from the sale of the stock.
113
Pine Company acquired all of the assets and liabilities of Straw Company for cash in a legal merger. Which one of the following would not be recognized by Pine on its books in recording the business combination?
Investment in Straw. Pine will not recognize on its books an investment in Straw. Because the business combination is a legal merger, Pine recognizes on its books almost all of Straw's assets and liabilities, not an investment in Straw. There can be no investment in Straw, because Straw will cease to exist.
114
Seashell Corp. was organized to consolidate Sea Company and Shell Company in a business combination. Seashell issued 25,000 shares of its $10 par value common stock in exchange for all of the outstanding common stock of Sea and Shell. At the time of the consolidation, the fair value of Sea's and Shell's assets and liabilities are equal to their book values. The shareholders' equity accounts of Sea and Shell on the date of the consolidation were: Sea Shell Total Common stock, at par $100,000 $200,000 $300,000 Additional paid-in capital 50,000 75,000 125,000 Retained Earnings 22,500 47,500 70,000 Totals $172,500 $322,500 $495,000 Which of the following is the balance in Seashell's additional paid-in capital account immediately following its issuing common stock to effect the consolidation?
$245,000 Since Seashell's stock is newly issued to effect the consolidation, it has no prior market value. In the absence of a market value, the fair value of Seashell's stock is determined by the fair value of the net assets acquired in the consolidation. Therefore, the fair value of the stock issued is equal to the fair value (and book value) of the net assets acquired (i.e., A − L = SE), or $495,000. The par value of the stock issued is $250,000 (25,000 × $10). Therefore, additional paid-in capital is $495,000 − $250,000 = $245,000.
115
On September 29, Year 5, Wall Co. paid $860,000 for all of the issued and outstanding common stock of Hart Corp. On that date, the carrying amounts of Hart's recorded assets and liabilities were $800,000 and $180,000, respectively. Hart's recorded assets and liabilities had fair values of $840,000 and $140,000, respectively. In Wall's September 30, Year 5, balance sheet, what amount should be reported as goodwill?
$160,000 Goodwill is measured as the amount by which the cost of an investment in an entity exceeds the fair value of the net assets acquired. In this question, the cost of the investment is $860,000, and the fair value of net assets acquired is $700,000 ($840,000 − $700,000), resulting in goodwill of $160,000.
116
Under which one of the following circumstances will goodwill be recognized in a business combination carried out as a legal merger?
Fair value of net assets acquired < Cost of investment Goodwill is recognized when the cost of the investment is greater than the fair value of net assets acquired (= the fair value of net assets acquired is less than the cost of the investment). In a legal merger, the goodwill would be recognized on the books of the surviving firm at the time of the business combination.
117
In a business combination, are contingent assets recognized under U.S. GAAP or IFRS or both?
Contingent assets are recognized only | under U.S. GAAP.
118
Fill in the blank: Under International Financial Reporting Standards (IFRS), goodwill is allocated to _________?
Cash-generating units
119
Under International Financial Reporting Standards (IFRS), are you required to disclose assumptions related to acquired contingencies?
Yes, you are required to disclose these | assumptions.
120
Under IFRS, the asset goodwill may be recognized
When it is acquired in a business combination. The requirement is to identify the statement that correctly describes how goodwill may be recognized under IFRS. Goodwill can be recognized only if it is acquired in a business combination.
121
Per IFRS, intangible assets acquired in a business combination should be initially measured at:
Fair value at the acquisition date. An intangible asset that is acquired in a business combination is initially measured at acquisition date fair value.
122
Under IFRS, which of the following would not be recognized as part of a business combination?
Contingent asset Under IFRS, contingent assets are not recognized. Under U.S. GAAP, contingent assets are recognized if the item meets the criteria of the definition of an asset.
123
Identify at least five financial liabilities.
1. Accounts payable 2. Notes and bonds payable 3. Option contracts (with unfavorable terms) 4. Futures and forward contracts (with unfavorable terms) 5. Swap contracts (with unfavorable terms)
124
What are the basic types or categories | of financial instruments?
``` Cash Evidence of an ownership interest in an entity Contracts that result in an exchange of cash or ownership interest in an entity that: Imposes on one entity a contractual obligation (liability) and Conveys to a second entity a contractual right (asset) ```
125
Identify at least five financial assets.
1. Cash and cash equivalents 2. Accounts receivable 3. Investments in debt or equity securities 4. Ownership interest in a partnership, joint venture, or other entity 5. Option contracts (with favorable terms) 6. Futures and forward contracts (with favorable terms) 7. Swap contracts (with favorable terms)
126
For financial accounting purposes, which one of the following is not a type of hedge carried out using derivatives?
Speculative. When derivatives are used for speculative purposes, the intent is not to hedge an existing position, because there is no existing position to hedge. Rather, when used for speculative purposes, the intent is to make a profit.
127
Which of the following accounts would reflect the existence of a financial instrument(s)? Investments in Debt Securities Investments in Equity Securities Bonds Payable
Investments in Debt Securities - Yes Investments in Equity Securities - Yes Bonds Payable - Yes
128
Which one of the following is not a characteristic of financial instruments?
All financial instruments have the same accounting requirements. All financial instruments do not have the same accounting requirements. Because financial instruments cover a variety of assets and liabilities, and are used for different purposes, there are different accounting requirements for different financial instruments, including derivatives. Financial instruments do include derivatives instruments. Derivatives are a special form of financial instrument with unique characteristics. Not all financial instruments are derivatives, but all derivatives are financial instruments. Certain disclosure requirements do apply to all financial instruments. Specific disclosure requirements include the fair value of the instrument, whether the instrument is an asset or liability, and any concentrations of credit risks associated with the instruments. Financial instruments, and especially derivative financial instruments, can be used for hedging purposes.
129
Which one of the following is not a characteristic of derivative instruments?
All derivative instruments have the same accounting requirements. All derivative instruments do not have the same accounting requirements. The appropriate accounting requirements depend on the specific purpose of holding or issuing the derivative instrument. Derivative instruments are a form of financial instrument. Derivatives are a special form of financial instrument with unique characteristics. All financial instruments are not derivatives, but all derivatives are financial instruments. Derivative instruments can be used for hedging purposes. When used for hedging purposes, the intent is that the derivative instrument will provide an outcome that is the opposite of the item being hedged. For example, if the hedged item incurs a loss, the hedging instrument (derivative) would be expected to incur a gain. Derivative instruments can be used to hedge foreign currency risk. Foreign currency risk derives from the possible loss resulting from adverse changes in the exchange rate between currencies. When used for foreign currency hedging purposes, the intent is that the derivative instrument will provide an outcome that is the opposite of the foreign currency being hedged. For example, if the change in exchange rate would result in a loss on the item hedged, the change in exchange rate would be expected to result in a gain on the hedging instrument (derivative).
130
Under International Financial Reporting Standards (IFRS), how is an impairment of a financial asset determined and reported?
``` Under IFRS, an impairment loss is determined as the difference between the carrying amount of the asset and its recoverable amount. The amount of any impairment loss is recognized in current income. ```
131
What are the categories of financial assets identified under International Financial Reporting Standards (IFRS)?
``` Financial assets measured at fair value with changes reported through profit/loss Loans and receivables Instruments held to maturity (other than loans and receivables) Instruments available for sale ```
132
``` How are financial assets that are classified as "loans and receivables" measured and reported under International Financial Reporting Standards (IFRS)? ```
``` Financial assets classified as "loans and receivables" under IFRS are measured at amortized cost, with related interest and amortization recognized in current income. ```
133
What are the categories of financial liabilities identified under International Financial Reporting Standards (IFRS)?
Financial liabilities measured at fair value with changes reported through profit/loss, including: Liabilities held for trading. Derivatives (that are liabilities). Financial liabilities for which the fair value option is elected. Other liabilities
134
Under IFRS, which one of the following instruments is most likely to be treated in its entirety as a financial liability?
Redeemable preferred stock. Under IFRS, redeemable preferred stock would likely be treated in its entirety as a financial liability because the stock can be redeemed (repurchased) by the issuing corporation at its discretion. Since the preferred shares can be redeemed at the discretion of the issuing corporation, it is not treated as equity, but rather as a liability. Under IFRS, common stock with a preemptive right would not be treated as a financial liability. Common stock that contains a preemptive right grants the holder of the stock the right to acquire a proportionate share of newly issued common stock. Common stock with a preemptive right has no characteristics of debt and would not be treated as a financial liability under IFRS. Redeemable preferred stock is most likely to be treated in its entirety as a financial asset. Under IFRS, convertible preferred stock is not likely to be treated in its entirety as a financial liability, but will be treated in its entirety as equity. Convertible preferred stock, which is convertible to common stock, has no characteristics of debt and would not be treated as a financial liability under IFRS (or under U.S. GAAP). Redeemable preferred stock is most likely to be treated in its entirety as a financial asset. Under IFRS, convertible debt is not likely to be treated in its entirety as a financial liability, but is likely to be treated as both a financial liability, for the value of the debt element, and equity, for the value of the convertible feature. Redeemable preferred stock is most likely to be treated in its entirety as a financial asset.
135
Which of the following describes an "accounting mismatch" as that expression is used in IFRS?
Related assets and liabilities are valued using different measures. An "accounting mismatch" refers to a circumstance where related assets and liabilities are valued using different measures. As used in IFRS, an "accounting mismatch" does not describe a circumstance where the value of a hedging instrument does not equal the value of the hedged item. As used in IFRS, an "accounting mismatch" does not describe a circumstance where liabilities exceed assets. As used in IFRS, an "accounting mismatch" does not describe a circumstance where debts don't equal credits.
136
Which of the following is the correct accounting measurement and treatment under IFRS for assets classified as "Loans and Receivables"?
Amortized cost, with interest and amortization recognized in current income. Financial assets classified as "Loans and Receivables" are measured at amortized cost, with interest and amortization related to the instrument recognized in current income. This treatment is the same as the treatment under U.S. GAAP for investments held to maturity.
137
What must be disclosed about each | significant concentration of credit risk?
Information about the common activity, region, or economic characteristic that identifies the concentration ``` The maximum (gross) amount of loss due to the credit risk The entity's policy of requiring collateral or other security to support financial instruments subject to credit risk ``` ``` The entity's policy of entering into master netting arrangements to reduce the credit risk associated with financial instruments ```
138
Define "market risk."
``` Market risk is the possibility of loss from changes in market values due to changes in economic circumstances, not necessarily due to the failure of another party to perform. ```
139
List the disclosure requirements for financial instruments where it is practicable to estimate fair value.
Fair value Related carrying amount Whether the instrument/amount is an asset or liability
140
If it is not practicable to estimate the fair value of a financial instrument, what must be disclosed?
``` The reasons why it is not practicable to estimate fair value Information pertinent to estimating fair value, such as carrying amount, effective interest rate, maturity date, and so on ```
141
Define "credit risk."
Credit risk is the possibility of loss from the failure of another party (or parties) to perform according to the terms of a contract.
142
Disclosure of information about significant concentrations of credit risk is required for:
All financial instruments. All entities must disclose all significant concentrations of credit risk arising from all financial instruments, whether from a single entity or a group of parties that engage in similar activities and that have similar economic characteristics. Disclosure of information about significant concentrations of credit risk is not limited to financial instruments with off-balance-sheet risk of accounting loss, but must be provided for all financial instruments. Risk of accounting loss refers to the possibility of a loss being recognized for accounting purposes as a result of changes in market risk, credit risk, or other risk associated with financial instruments.
143
Fair value disclosure of financial instruments may be made in the: Body of Financial Statements Footnotes to Financial Statements
Financial Statements Footnotes to - Yes Financial Statements - Yes Fair value disclosure of financial instruments may be made in either the body of the financial statements or in the footnotes to the financial statements. If in the footnotes, one note must show fair values and carrying amounts for all financial instruments.
144
When a concentration of credit risk must be disclosed and the exact amount is uncertain, which one of the following amounts must be disclosed?
Maximum amount at risk. When a concentration of credit risk exists, the maximum amount at risk must be disclosed. The maximum amount is measured as the gross fair value of all financial instruments that would be lost if the other parties fail completely to perform according to the terms of the contract(s) and assuming any collateral was of no value.
145
If it is not practicable for an entity to estimate the fair value of a financial instrument, which of the following should be disclosed? I.Information pertinent to estimating the fair value of the instrument. II.The reasons it is not practicable to estimate fair value.
Both I and II. When it is not practicable for an entity to estimate the fair value of a financial instrument, both information pertinent to estimating the fair value of the instrument and the reasons it is not practicable to estimate fair value must be provided.
146
What is an embedded derivative?
An embedded derivative is a portion of, or term in, a contract (host contract that is not itself a derivative) that behaves like a derivative.
147
What is the "underlying" element of a | derivative instrument?
A specified price, rate, or other variable (e.g., a stock price, interest rate, currency exchange rate, etc.)
148
Define "hedging."
Hedging is a risk management strategy that involves using offsetting (or counter) transactions or positions.
149
What are the three basic elements of a | derivative?
``` 1. One or more underlying and one or more notional amounts 2. Requires no initial net investment 3. Terms require or permit a net settlement. ```
150
How is the value or settlement amount | of a derivative determined?
By multiplication (or other calculation) of the notional amount and the underlying
151
What is the "notional" amount element | of a derivative instrument?
A specified unit of measure (e.g., number of shares of stock, pounds or bushels of a commodity, number of foreign currency units, etc.)
152
A derivative financial instrument is best described as:
A contract that has its settlement value tied to an underlying notional amount. A contract that has its settlement value tied to an underlying notional amount best describes a derivative financial instrument. The value or settlement amount of a derivative is the amount determined by the multiplication (or other arithmetical calculation) of a notional amount and an underlying. Simply put, a derivative instrument is a special class of financial instrument which derives its value from the value of some other financial instrument or variable.
153
Which of the following is the characteristic of a perfect hedge?
No possibility of future gain or loss. Hedging is a risk management strategy which involves making an investment (the hedge) so as to offset (or counter) another investment (the hedged item) so that a loss on one investment (the hedged item) would be offset (at least in part) by a gain on the other investment (the hedge), and vice versa. A perfect hedge is achieved when the hedge investment has a 100% inverse correlation to the initial investment (hedged item) so that there is no possibility of future gain or loss. A perfect hedge rarely exists.
154
Assume Instco acquires an option to buy (a call option) 100 shares of Opco for $50 per share when the market price of Opco is $45 per share and that Instco paid a premium of $1.00 per share to acquire the options. Which one of the following is the underlying related to Instco's options?
$50.00 per option. Stock options are derivatives; they derive their value from the value of the stock to which the option applies. The underlying of a derivative is a specified price, rate, or other monetary variable, in this case the (strike) price of each option, $50.00.
155
Smythe Co. invested $200 in a call option for 100 shares of Gin Co. $.50 par common stock, when the market price was $10 per share. The option expired in three months and had an exercise price of $9 per share. What was the intrinsic value of the call option at the time of initial investment?
$100 The intrinsic value of a call option is the difference between the exercise (strike) price and the market price. This call option has an exercise price of $9 / share and the market price is $10 / share. Therefore, there is a $1 / share intrinsic value (I can buy the stock at a price less than the market). The option is to purchase 100 shares so the total intrinsic value is $100.
156
Which one of the following is not a characteristic of a derivative?
A derivative requires contractual satisfaction by delivery of the subject matter of the contract. A derivative does not require contractual satisfaction by delivery of the subject matter of the contract. Specifically, the terms of a derivative require or permit the contract to be settled with cash or an asset readily convertible to cash, in lieu of physical delivery of the subject matter of the contract. In addition, a derivative includes an underlying, a notional amount, and requires no initial net investment or one that is less than normally would be required. A derivative does identify a specific quantity or other quantitative unit of measure, called a "notional amount." In addition, a derivative includes an underlying, requires no initial net investment or one that is less than normally would be required, and has terms that require or permit a net settlement. A derivative does identify a specific price, rate, or other monetary measured, called an "underlying." In addition, a derivative includes a notional amount, requires no initial net investment or one that is less than normally would be required, and has terms that require or permit a net settlement. A derivative is a financial instrument (or similar contract) with specific characteristics, including an underlying, a notional amount, no initial net investment or one that is less than normally would be required, and terms that require or permit a net settlement.
157
List the four different possible uses of | derivatives.
1. Derivatives not used as a hedge 2. Fair value hedges 3. Cash flow hedges 4. Foreign currency hedges
158
Hedges of foreign currency risks can be the hedge of: Fair Value Cash Flows
Fair Value - Yes Cash Flows - Yes The risks associated with a foreign currency that can be hedged can be either the risk to fair value in the foreign currency or the risk to cash flows in the foreign currency.
159
Which of the following statements, if either, concerning accounting for derivative financial instruments is/are correct? I. Derivative instruments can be used only for hedging purposes. II. Derivative instruments can be used only to hedge fair value.
Neither I nor II. Neither Statement I nor Statement II is correct. Derivative instruments can be used not only for hedging purposes (Statement I), but also for speculative purposes. In addition, derivative instruments can be used not only to hedge fair value (Statement II), but also to hedge cash flows.
160
Which of the following are basic kinds of risks that can be hedged for accounting purposes? Fair Value Cash Flows
Fair Value - Yes Cash Flows - Yes The two basic kinds of risks that can be hedged for accounting purposes are fair value risks and cash flow risks.
161
Which one of the following is an item for which risk associated with the item cannot be hedged for accounting purposes?
Fair value of an investment accounted for using the equity method of accounting. The fair value of an investment accounted for using the equity method of accounting is specifically excluded as being eligible to be hedged for accounting purposes under U.S. GAAP. The foreign currency risk associated with a net investment in a foreign operation (e.g., an investment in a foreign subsidiary) can be hedged for accounting purposes. The fair value of an investment accounted for using the equity method of accounting cannot be hedged for accounting purposes. The credit risk of investments classified as held for trading can be hedged for accounting purposes. The fair value of an investment accounted for using the equity method of accounting cannot be hedged for accounting purposes. The overall change in the fair value of a non-financial asset (e.g., inventory) can be hedged for accounting purposes. The fair value of an investment accounted for using the equity method of accounting cannot be hedged for accounting purposes.
162
Define a "fair value hedge."
The hedge of exposure to changes in fair value of a recognized asset, recognized liability, or an unrecognized firm commitment from a particular risk
163
List the conditions under which an "unrecognized firm commitment" exists.
When an entity enters into a contract to buy or sell but has not yet booked the transaction
164
``` What are the accounting requirements for a change in the fair value of a fair value hedging instrument and the asset, liability, or firm commitment being hedged? ```
``` Adjusting the carrying amount of the derivative and hedged item to fair value Recognizing gains/losses from revaluing the derivative and the hedged item in current income ```
165
What is the formal documentation required at the inception of a fair value hedge?
The hedging relationship The objective and strategy for undertaking the hedge Identification of the hedging instrument and hedged item Nature of the risk being hedged How effectiveness of the hedge will be assessed
166
On October 1, 2008, Buyco entered into a legally enforceable contract to acquire raw material inventory in 180 days for $20,000. In order to mitigate the risk of a change in the value of the raw materials, Buyco also entered into a qualified 180-day forward contract to hedge the fair value of the raw materials. At December 31, 2008, the value of the raw materials had decreased by $500, and the fair value of the futures contract had increased by $480. On March 29, 2009, the date the raw materials were delivered to Buyco, they had a fair value of $19,300, and the forward contract had a fair value of $700. Which one of the following is the net gain or loss that would be recognized on the raw material and related forward contract by Buyco in its 2009 net income?
$20 Because Buyco entered into the forward contract (hedging instrument) to hedge the risk of change in the fair value of the raw materials (hedged item), the change in fair value of the forward contract during 2009 offsets the change in the fair value of the raw materials. Specifically, the decrease in the value of the raw materials, $200 ($19,500 − $19,300 = $200), was offset by the increase in the value of the forward contract of $220 ($700 − $480 = $220), so the net gain recognized in 2009 was $220 − $200 = $20, which is the correct answer.
167
On October 1, 2008, Buyco entered into a legally enforceable contract to acquire raw material inventory in 180 days for $20,000. In order to mitigate the risk of a change in the value of the raw materials, Buyco also entered into a qualified 180-day forward contract to hedge the fair value of the raw materials. At December 31, 2008, the value of the raw materials had decreased by $500, and the fair value of the futures contract had increased by $480. On March 29, 2009, the date the raw materials were delivered to Buyco, they had a fair value of $19,300, and the forward contract had a fair value of $700. Which one of the following is the amount by which the derivative is ineffective as a fair value hedge for 2008?
$20 Because Buyco entered into the forward contract (hedging instrument) to hedge the risk of change in the fair value of the raw materials (hedged item), the change in fair value of the forward contract offsets the change in the fair value of the raw materials. Since during 2008 the change in the value of the raw materials decreased more than the value of the forward contract increased, the difference is the amount by which the derivative is ineffective as a fair value hedge. Specifically, the decrease in the value of the raw materials, $500, was offset by the increase in the value of the forward contract of $480, so the hedge was ineffective by $500 − $480 = $20, which is the correct answer.
168
Which one of the following is least likely to be a characteristic of a firm commitment?
It has been recorded as an asset or liability. A firm commitment has not been recorded (yet) as an asset or liability. A firm commitment occurs when an entity has a contractual obligation or contractual right, but no transaction has been recorded (and no asset or liability recognized) because GAAP requirements for recognition have not yet been met. Nevertheless, the subject matter of the firm commitment is at risk of change in fair value and can be hedged. The subject matter of a firm commitment is at risk of change in fair value. A firm commitment occurs when an entity has a contractual obligation or contractual right, but no transaction has been recorded (and no asset or liability recognized) because GAAP requirements for recognition have not yet been met. Nevertheless, the subject matter of the firm commitment is at risk of change in fair value and can be hedged. firm commitment is evidenced by a contractual obligation (or contractual right) - that is the nature of the "firm" part of the commitment. Despite the firm nature of the contract (or commitment), no transaction has been recorded (and no asset or liability recognized) because GAAP requirements for recognition have not yet been met.
169
On October 1, 2008, Buyco entered into a legally enforceable contract to acquire raw material inventory in 180 days for $20,000. In order to mitigate the risk of a change in the value of the raw materials, Buyco also entered into a qualified 180-day forward contract to hedge the fair value of the raw materials. At December 31, 2008, the value of the raw materials had decreased by $500, and the fair value of the futures contract had increased by $480. On March 29, 2009, the date the raw materials were delivered to Buyco, they had a fair value of $19,300, and the forward contract had a fair value of $700. Which one of the following is the amount of net gain or loss that would be recognized on the raw materials and related forward contract by Buyco in its 2008 net income?
$20 Because Buyco entered into the forward contract (hedging instrument) to hedge the risk of change in the fair value of the raw materials (hedged item), the change in fair value of the forward contract during 2008 offsets the change in the fair value of the raw materials. Specifically, the decrease in the value of the raw materials, $500, was offset by the increase in the value of the forward contract of $480, so the net loss recognized in 2008 was $500 − $480 = $20, which is the correct answer.
170
Define a "cash flow hedge."
``` The hedge of an exposure to variability (changes) in the cash flow associated with a (recognized) asset, liability, or a forecasted transaction due to a particular risk. ```
171
Define a "forecasted transaction."
A forecasted transaction is a planned or expected transaction for which there is not yet either a firm commitment or any rights or obligations established.
172
What are the conditions necessary for a forecasted transaction to be the hedged item in a cash flow hedge?
``` The forecasted transaction is: Specifically identified as a single transaction or group of individual transactions with the same risk exposure; Probable of occurring; With an external party (with limited exceptions); Capable of affecting cash flows and earnings; and Not for acquisition of an asset or incurrence of a liability accounted for at fair value with the change reported in current income. ```
173
How are changes in the fair value of derivatives used to hedge cash flows treated?
``` Each period the change in fair value of the derivatives is used to: Adjust the derivative instrument to fair value. Recognize the change in value in other comprehensive income. ```
174
In a cash flow hedge, the item being hedged is measured using:
The present value of expected cash inflows or outflows. The item being hedged in a cash flow hedge is measured using the present value of expected cash inflows or cash outflows. The item being hedged in a cash flow hedge may be associated with an asset, a liability, or a forecasted transaction. The value of such items is measured using the present value of either cash inflows (e.g., receivable) or cash outflows (e.g., payable), depending on the nature of the item being hedged.
175
Which one of the following is a characteristic of a forecasted transaction?
Can be a hedged item in a cash flow hedge. A forecasted transaction can be the hedged item in a cash flow hedge. A forecasted transaction is a planned or expected transaction which has not yet been recognized, but which is subject to the risk of changes in related cash flow. As such, the cash flow (inflow or outflow) associated with forecasted transactions can be hedged.
176
Qualified derivatives may be used to hedge the cash flow associated with a/an: Asset Forecasted Transaction
Asset - Yes Forecasted Transaction - Yes Derivative instruments may be used to hedge the cash flows associated with assets, liabilities, or forecasted transactions. Derivative instruments may be used not only to hedge the cash flows associated with forecasted transactions, but also with assets and liabilities.
177
Define "foreign currency hedge."
``` The hedge of an exposure to changes in the dollar value of assets or liabilities (including certain investments) and planned transactions that are denominated (to be settled) in a foreign currency ```
178
Identify five kinds of foreign currency | exposure that may be hedged.
``` 1. Forecasted foreign currency– denominated transactions 2. Unrecognized foreign currency– denominated firm commitments 3. Foreign currency–denominated recognized assets or liabilities 4. Investments in AFS securities 5. Net investments in foreign operations ```
179
Which one of the following is not a characteristic of a foreign currency hedge?
Are all treated as fair value hedges. All foreign currency hedges are not treated as fair value hedges. While foreign currency hedges of unrecognized firm commitments, investments in available-for-sale securities, and net investments in foreign operations are treated as fair value hedges, foreign currency hedges of forecasted transactions are treated as cash flow hedges, and foreign currency hedges of recognized assets or liabilities may be treated either as fair value hedges or cash flow hedges, depending on management's designation.
180
Which of the following statements concerning derivatives used as foreign currency hedges is/are correct? I. Can be used to hedge the risk of exchange rate changes on planned transactions. II. Can be used to hedge the risk of exchange rate changes on available-for-sale investments. III. Can be used to hedge the risk of exchange rate changes on accounts receivable and accounts payable.
I, II, and III. Foreign currency hedges can be used to hedge the risk of exchange rate changes on planned (forecasted) transactions, available-for-sale investments, and accounts receivable/accounts payable (and unrecognized firm commitments and net investments in foreign operations).
181
If a firm used a derivative to hedge the risk of exchange rate changes between the time a liability is recorded and the time it is settled in a foreign currency, which one of the following is being hedged?
Recognized liability. A foreign currency hedge of a recognized liability hedges the risk of exchange rate changes on the cash flow (or fair value) of a liability between the time it is recorded (recognized) and the time it is settled in a foreign currency.
182
Which of the following, if any, can be the risk being hedged in a foreign currency hedge? Fair Value Cash Flow
Fair Value - Yes Cash Flow - Yes Foreign currency hedges may be either fair value or cash flow hedges. Foreign currency hedges of unrecognized firm commitments, investments in available-for-sale securities, and net investments in foreign operations are fair value hedges. Foreign currency hedges of forecasted transactions are cash flow hedges. Additionally, foreign currency hedges of recognized assets or liabilities may be treated either as fair value hedges or cash flow hedges, depending on management's designation.
183
List the required disclosures for derivatives designated as fair value hedges.
Net gain/loss recognized in earnings and where net gain/loss is reported in the financial statements Net gain/loss recognized in earnings from hedged firm commitments that no longer qualify for hedge treatment
184
What should disclosures for derivatives designated as fair value hedges distinguish between?
Fair value hedges, cash flow hedges, hedges of investments in foreign operations, and other derivatives
185
Specific disclosures are required for entities that: Issue Derivatives Hold Derivatives
Issue Derivatives - Yes Hold Derivatives - Yes Entities that either issue or hold derivatives (or other contracts used for hedging) must disclose a considerable amount of information concerning their reasons for using derivatives and the outcomes (e.g., gains/losses) of their accounting for the derivatives. Generally, these disclosures must distinguish between instruments used for different purposes (e.g., fair value hedges, cash flow hedges, etc.).
186
Which one of the following is not a required disclosure for derivatives used as fair value hedges?
The amount of gain or loss arising during the period that was deferred. When derivatives are used for fair value hedges, the amount of gain or loss arising during the period that was deferred does not exist (and therefore is not required). When fair value hedges are used, any resulting gain or loss is recognized in current income, not deferred.
187
Derivatives used for hedging purposes that require disclosure of reclassifications of accumulated other comprehensive income are most likely related to which of the following hedging purposes, if any?
II only. When derivatives are used as cash flow hedges, an amount of gain or loss can be deferred in other comprehensive income and subsequently become part of accumulated other comprehensive income. Amounts of accumulated other comprehensive income (on the hedging instrument) will be reclassified to income when the hedged item affects income.
188
Which of the following statements concerning disclosure requirements for derivatives used as cash flow hedges is/are correct? I. The net gain or loss recognized in earnings during the period must be disclosed. II. The amount of gain or loss deferred in other comprehensive income must be disclosed. III. A listing of each of the derivatives used for cash flow hedges and the amount of each must be disclosed.
I and II only. Both the net gain or loss recognized in earnings during the period (Statement I) and the amount of gain or loss deferred in other comprehensive income (Statement II) must be disclosed. Statement III is not a required disclosure.
189
``` Which U.S. generally accepted accounting principles (GAAP) characteristic of a derivative is not included in the definition of a derivative under International Financial Reporting Standards (IFRS)? ```
Notional amount
190
Are part term hedges allowed under International Financial Reporting Standards (IFRS)?
Part-term hedges are allowed.
191
Which of the following statements, if either, concerning differences between U.S. GAAP and IFRS in accounting for hedges is/are correct? I. IFRS permits hedging a forecasted business combination that is subject to foreign exchange risk; U.S. GAAP does not permit hedging in that case. II. IFRS permits hedging part of the life of a hedged item; U.S. GAAP does not permit hedging of part of the life of a hedged item.
Both I and II. Both Statement I and Statement II are correct. IFRS permits (1) hedging a forecasted business combination that is subject to foreign exchange risk, and (2) hedging part of the life of a hedged item. U.S. GAAP does not permit hedging in either case.
192
Which of the following concepts is not part of the definition of a derivative under IFRS?
The instrument has a notional amount. The definition of a derivative under IFRS does not include the concept of notional amount. The definition of a derivative under IFRS does include the concept of underlying. The definition of a derivative under IFRS does include the concept of little or no initial net investment. The definition of a derivative under IFRS does include the concept of net settlement.
193
Define "functional currency."
The currency of the primary economic environment in which an entity operates and generates cash flows
194
Define "foreign currency transactions."
Transactions of a domestic entity denominated in a foreign currency but to be recorded on the domestic entity's books in the domestic currency
195
What is the general rule for handling a foreign currency–denominated account that is outstanding as of a balance sheet date?
``` 1. Determine the dollar amount to settle the transaction at balance sheet date (# of foreign currency units × Exchange rate/Spot = $ Value). 2. Determine the difference between recorded amount and settlement amount. 3. Record the difference as an adjustment to the foreign currency–denominated account and as an exchange gain/loss for the period. ```
196
Define "forward rate."
The exchange rate (existing now) for a | specified future date
197
What is the general rule for handling a foreign currency–denominated account at the settlement date of the account?
``` 1. Determine the dollar amount to settle the transaction at balance sheet date (# of foreign currency units × Exchange rate/Spot = $ Value). 2. Determine the difference between the recorded amount and the settlement amount. 3. Record the difference as an adjustment to foreign currency– denominated account and as an exchange gain/loss for the period. 4. Record settlement of the foreign currency–denominated account. ```
198
Define "indirect exchange rate."
The foreign price of one domestic unit | of currency
199
Define "spot rate."
The exchange rate at current date
200
Define "exchange rate."
The price of one unit of a country's currency expressed in units of another country's currency
201
Define "foreign currency translation."
``` Financial statements denominated in (expressed in terms of) a foreign currency but to be reported in the domestic currency (on financial statements) ```
202
What is the general rule for recording a foreign currency operation transaction at the date the transaction is initiated?
``` 1. Translate transaction into dollars using current spot exchange rate (# of foreign currency units × Exchange rate/Spot = $ Value). 2. Record asset, liability, revenue, expense, loss and/or gain at dollar amount. ```
203
How do you determine the dollar amount to settle a transaction denominated in a foreign currency?
Multiply the number of foreign currency units specified by the terms of the transaction by the spot exchange rate at the current date.
204
What is a foreign currency operating | transaction?
A transaction that is denominated (will be settled) in a foreign currency (i.e., other than the recording entity's currency)
205
What are the general rules for treatment of a foreign currency operating transaction?
``` Measure and record the transaction on books in terms of the functional currency. Convert foreign currency units to functional currency units using the spot exchange rate. Recognize the effect of exchange rate changes as gains/losses in the period of the exchange rate change. ```
206
At what dates can a gain or loss be recognized on a foreign currency– denominated operating transaction account balance?
``` At balance sheet date, if one occurs between the date the transaction is initiated and settled At settlement date of the foreign currency–denominated account balance ```
207
If $1.00 will buy 0.76 Euros, then how many dollars will one Euro buy (rounded)?
$1.32 If $1.00 will buy 0.76 Euro, then 0.76E = $1.00, and E = $1.00/0.76, or E = $1.32. So, one Euro will buy $1.32, the correct answer.
208
On October 1, 20X4, Mild Co., a U.S. company, purchased machinery from Grund, a German company, with payment due on April 1, 20X5. If Mild's 20X4 operating income included no foreign exchange transaction gain or loss, then the transaction could have:
Been denominated in U.S. dollars. If the transaction was denominated in U.S. dollars, there is no foreign exchange gain or loss for Mild. (There would be a gain or loss for Grund.)
209
Which one of the following is a direct quotation for a U.S. entity when buying Japanese Yen (JPY)? I. 0.89 JPY per $1.00. II. $.011 per 1.00 JPY.
I. 0.89 JPY per $1.00. II. $.011 per 1.00 JPY. II only. A direct quotation, or direct exchange rate, states the domestic price of one unit of a foreign currency. In this case, each JPY costs $.011, which is a direct quotation.
210
On December 31, 20X8, the end of its fiscal year, Domco had a foreign currency account payable with a settlement amount greater than its previously recorded carrying amount. Which one of the following would Domco recognize for 20X8?
Exchange loss. Since the foreign currency account payable had a settlement amount greater than its previously recorded carrying amount, Domco would have to recognize the change in settlement amounts in the period in which the settlement amount changed—20X8. Specifically, since the amount to settle the account payable increased during 20X8, Domco would have to recognize an exchange loss - it will take more dollars to acquire the foreign currency needed to settle the account.
211
Which of the following is not associated with the general principles of accounting for foreign currency operating transactions?
Gains and losses are deferred until transactions are settled. Gains and losses on foreign currency operating transactions that result from changes in currency exchange rates are not deferred. Such gains and losses must be recognized in current income of the period in which the currency exchange rate changes.
212
If a foreign currency exchange gain results from the effects of a change in exchange rates on an account receivable, where will the exchange gain be reported in the financial statements?
As an item of income from continuing operations. Foreign currency exchange gains (or losses) on accounts receivable are reported in current income as an item of income from continuing operations.
213
Soco plans to buy 100,000 Euros with U.S. dollars. The exchange rate is $1.00 = 0.75 Euro. Assuming no transaction cost, how much will Soco have to pay in dollars (rounded) for 100,000 Euros?
$133,333 If $1.00 will buy 0.75 Euro, then 0.75E = $1.00, and E = $1.00/0.75, or E = $1.33. So, one Euro will cost $1.33; therefore, 100,000 E × $1.33 = $133,333, the correct answer.
214
In preparing consolidated financial statements of a U.S. parent company with a foreign subsidiary, the foreign subsidiary's functional currency is the currency:
Of the environment in which the subsidiary primarily generates and expends cash. By definition (SFAS #52), an entity's functional currency is the currency of the primary economic environment in which the entity operates. Normally, that is the currency of the environment in which the entity primarily generates and expends cash.
215
RWB Co., a U.S. entity, purchased goods for resale from a Thai manufacturer. The purchase agreement provided that the U.S. entity would pay the Thai entity 500,000 baht, the Thai currency. The goods were delivered on July 1, 20X8, with payment due August 29, 20X8. The following exchange rates were determined for the number of baht to the dollar (i.e., B/$): Spot Rate 60-day Forward Rate July 1, 20X8 35.0B/$ 36.5B/$ August 29, 20X8 37.0B/$ 38.0B/$ Which one of the following is the amount (rounded) of exchange gain or loss, if any, that RWB Co. would recognize on the purchase of goods from the Thai manufacturer?
$772 Since the exchange rate changed between the date the obligation was incurred (July 1) and the date it was settled (August 29), the effects of the exchange rate change must be recognized as an exchange gain or loss. The correct answer would be the difference between the spot rate on July 1 and the spot rate on August 29, or (500,000B/35.0B per $ = $14,286) - (500,000B/37.0B per $ = $13,514) = $772.
216
Toigo Co. purchased merchandise from a vendor in England on November 20 for 500,000 British pounds. Payment was due in British pounds on January 20. The spot rates to purchase one pound were as follows: November 20 $1.25 December 31 1.20 January 20 1.17 How should the foreign currency transaction gain be reported on Toigo's financial statements at December 31?
A gain of $25,000 in the income statement. A gain of $25,000 should be reported in the current income statement. The gain was computed as: November 20 $1.25 × 500,000 British pounds = $625,000 December 31 $1.20 × 500,000 British pounds = $600,000 Gain $ 25,000 And, gains (and losses) on foreign currency transactions should be reported in current income.
217
A December 15, 20X8, purchase of goods was denominated in a currency other than the entity's functional currency. The transaction resulted in a payable that was fixed in terms of the amount of foreign currency and was paid on the settlement date, January 20, 20X9. The exchange rate of the currency in which the transaction was denominated changed at December 31, 20X8, resulting in a loss that should:
Be included as a component of income from continuing operations for 20X8. The foreign currency exchange loss that occurred as a result of the exchange rate change in 20X8 should be recognized in 20X8 as a component of income from continuing operations in the income statement. Gains and losses resulting from changes in exchange rates are recognized in current earnings in the period in which the exchange rate changes.
218
Which one of the following is most likely a foreign currency import transaction by a U.S. company?
Purchase of goods to be paid in a foreign currency. The purchase of goods by a U.S. entity would most likely reflect an import transaction and, since it is to be settled in a foreign currency, would be a foreign currency import transaction.
219
Can a gain or loss on a foreign currency import transaction be recognized if the transaction is initiated in one fiscal period and settled: In the same fiscal period In a later fiscal period
In the same fiscal period - Yes In a later fiscal period - Yes A gain or loss on a foreign currency import transaction can be recognized if the transaction is initiated in one fiscal period and settled in either the same fiscal period or a later fiscal period. The effect of exchange rate changes on accounts denominated in a foreign currency should be recognized in the period(s) in which the exchange rate changes. Therefore, if such an account (e.g., account payable) exists in more than one period, the effects of exchange rate changes in either or both periods would result in the recognition of a gain or loss in either or both periods.
220
Fogg Co., a U.S. company, contracted to purchase foreign goods. Payment in foreign currency was due one month after the goods were received at Fogg's warehouse. Between the receipt of goods and the time of payment, the exchange rates changed in Fogg's favor. The resulting gain should be included in Fogg's financial statements as a(an):
Component of income from continuing operations. The foreign currency exchange gain that occurred as a result of the exchange rate change should be recognized as a component of income from continuing operations in the income statement. Gains and losses resulting from changes in exchange rates are recognized in current earnings in the period in which the exchange rate changes.
221
Which of the following is not associated with accounting for a foreign currency import transaction?
A settlement amount greater than the recorded amount results in an exchange gain. Because an import transaction normally results in a liability to the buyer (importer), a settlement amount (of the liability) greater than the current carrying amount of the liability will result in an exchange loss, not an exchange gain.
222
What amount should Yumi report as a foreign currency transaction loss in its income statement for the year ended December 31, 20X5?
$1,500 When a monetary obligation in a foreign currency exists, all gains and losses reflective of changes in exchange rates are recognized in current income. The loss would be based on the rate at initiation and the rate at year end. (The recovery in the next period would be treated as a gain in that period.) The loss is $1,500 [($.55 – $.70)10,000], making this response correct.
223
On June 19, Don Co., a U.S. company, sold and delivered merchandise on a 30-day account to Cologne GmbH, a German corporation, for 200,000 euros. On July 19, Cologne paid Don in full. Relevant currency exchange rates were: June 19 July 19 Spot rate $ .988 $ .995 30-day forward rate .990 1.000 What amount should Don record on June 19 as an account receivable for its sale to Cologne?
$197,600 At the date Don Co. entered into the transaction, June 19, and agreed to accept euros in satisfaction of its account receivable, it should record the transaction (sale and account receivable) at the (then existing or current) spot exchange rate of .988. Thus, the dollar amount of the account receivable (and sale) would be computed as 200,000 E × .988 = $197,600, which also is the dollar value that would be received if the transaction were settled at that date.
224
A sale of goods, denominated in a currency other than the entity's functional currency, resulted in a receivable that was fixed in terms of the amount of foreign currency that would be received. Exchange rates between the functional currency and the currency in which the transaction was denominated changed. The resulting gain should be included as a:
Transaction gain reported as a component of income from continuing operations. The event described is a foreign currency (FC) transaction, not FC translation, and the gain (or loss) would be reported as a component of income from continuing operations for the current period.
225
On November 15, 20X5, Celt Inc., a U.S. company, ordered merchandise FOB shipping point from an East German company for 200,000 marks. The merchandise was shipped and invoiced to Celt on December 10, 20X5. Celt paid the invoice on January 10, 20X6. The spot rates for marks on the respective dates are as follows: November 15, 20X5 $.4955 December 10, 20X5 .4875 December 31, 20X5 .4675 January 10, 20X6 .4475 In Celt's December 31, 20X5, income statement, the foreign exchange gain is:
$4,000 December 31, 20X5 .4675 - January 10, 20X6 .4475 Equals 0.02 0.02 x 200,000 = 4000 Cash or amounts owed by or to a company that are denominated in a foreign currency should be translated at the current rate with a gain or loss being recognized. Recognition is based on the change in the spot rate between the recording of the transaction and the date of the financial statements. The other critical date is the date at which the transaction became an amount owed by or to the company. This occurs at the transfer of title date of December 10, 20X5. Any change before that date is an adjustment in the cost of the merchandise. This correctly picks up the gain as the change between when the debt was established and the balance sheet date.
226
On October 1, 20X8, RWB Co., a U.S. entity, signed a contract to provide equipment to Pronto, a Spanish entity, for 300,000 Euros. The terms of the sale provided for the equipment to be delivered FOB-Destination on December 1, 20X8, with payment by Pronto on January 30, 20X9. The following dollar cost per Euro exchange rate information was available: Spot Forward Forward Forward Rate Rate 12/01 Rate 12/31 Rate 01/30 October 1 $1.30 $1.29 $1.28 $1.27 December 1 $1.29 - $1.28 $1.27 December 31 $1.28 - - $1.27 January 30 $1.27 - - - Which of the following is the amount (rounded) at which RWB Co. should recognize sales as a result of its sale to Pronto?
$387,000 The correct answer is derived by multiplying the number of Euros to be received (300,000) by the dollar cost (value) per Euro at the date of the sale ($1.29), or 300,000E × $1.29 = $387,000. The amount of the sale would not be adjusted for subsequent changes in exchange rates.
227
On October 1, 20X8, RWB Co., a U.S. entity, signed a contract to provide equipment to Pronto, a Spanish entity, for 300,000 Euros. The terms of the sale provided for the equipment to be delivered FOB-Destination on December 1, 20X8, with payment by Pronto on January 30, 20X9. The following dollar cost per Euro exchange rate information was available: Spot Forward Forward Forward Rate Rate 12/01 Rate 12/31 Rate 01/30 October 1 $1.30 $1.29 $1.28 $1.27 December 1 $1.29 - $1.28 $1.27 December 31 $1.28 - - $1.27 January 30 $1.27 - - - Which of the following is the amount (rounded) of the exchange gain or loss that RWB Co. should recognize in 20X8 as a result of its sale to and receivable from Pronto?
$3,000 The correct exchange gain or loss would be calculated by multiplying the 300,000 Euros to be received by the spot exchange rates on December 1, the date of the sale, and December 31, the end of 20X8, and getting the difference. That calculation would be (300,000E × $1.29 = $387,000) – (300,000E × $1.28 = $384,000) = $3,000, the correct answer.
228
Which of the following is a foreign currency export transaction for a U.S. entity?
Sale of goods to be collected in a foreign currency. The sale of goods to be collected in a foreign currency would be a foreign currency export transaction. A foreign currency transaction occurs when a U.S. entity enters into a transaction that is denominated (to be settled) in a foreign currency, not in dollars.
229
On October 1, 20X8, RWB Co., a U.S. entity, signed a contract to provide equipment to Pronto, a Spanish entity, for 300,000 Euros. The terms of the sale provided for the equipment to be delivered FOB-Destination on December 1, 20X8, with payment by Pronto on January 30, 20X9. The following dollar cost per Euro exchange rate information was available: Spot Forward Forward Forward Rate Rate 12/01 Rate 12/31 Rate 01/30 October 1 $1.30 $1.29 $1.28 $1.27 December 1 $1.29 - $1.28 $1.27 December 31 $1.28 - - $1.27 January 30 $1.27 - - - Which of the following is the amount (rounded) of the exchange gain or loss that RWB Co. should recognize in 20X9 as a result of its sale to and receivable from Pronto?
$3,000 The correct exchange gain or loss would be calculated by multiplying the 300,000 Euros to be received by the spot exchange rates on December 31, the end of 20X8, and January 30, the settlement date, and getting the difference. That calculation would be (300,000E × $1.28 = $384,000) – (300,000E × $1.27 = $381,000) = $3,000, the correct answer.
230
On October 1 of the current year, a U.S. company sold merchandise on account to a British company for 2,000 pounds (exchange rate, 1 pound = $1.43). At the company's December 31 fiscal year end, the exchange rate was 1 pound = $1.45. The exchange rate was $1.50 on collection in January of the subsequent year. What amount would the company recognize as a gain (loss) from foreign currency translation when the receivable is collected?
$100 A foreign currency exchange gain will be recognized for the change in exchange rate between December 31 and the January collection date. That gain is computed as $1.45 -> $1.50 = $0.05 × 2,000 pounds = $100 gain.
231
A sale of goods was denominated in a currency other than the entity's functional currency. The sale resulted in a receivable that was fixed in terms of the amount of foreign currency that would be received. Exchange rates between the functional currency and the currency in which the transaction was denominated changed so that a loss was incurred. The loss should be included as a:
Transaction loss reported as a component of income from continuing operations. The event described is a foreign currency (FC) transaction, not FC translation, and the loss (or gain) would be reported as a component of income from continuing operations for the current period.
232
On September 1, 20X5, Cano & Co., a U.S. corporation, sold merchandise to a foreign firm for 250,000 francs. Terms of the sale require payment in francs on February 1, 20X6. On September 1, 20X5, the spot exchange rate was $.20 per franc. At December 31, 20X5, Cano's year end, the spot rate was $.19, but the rate increased to $.22 by February 1, 20X6, when payment was received. How much should Cano report as a foreign exchange gain or loss in its 20X6 income statement?
$7,500 gain A foreign exchange gain or loss is recognized for any change in value of a monetary debt denominated in a foreign currency. This is true at balance sheet time as well as when it is realized. Thus, a $2,500 loss would have been recognized at December 31, 20X5 (250,000 francs * [.20 - .19]). Then, in 20X6, the full difference between the $.19 and $.22 (250,000 francs * .03) would be realized for a total gain of $7,500.
233
Which one of the following sets correctly identifies the relationship between a recorded amount and a related settlement amount that will result in an exchange gain on an import transaction and an exchange loss on an export transaction? Gain on Import Transaction Loss on Export Transaction
Gain on Import Transaction - Recorded > Settlement Loss on Export Transaction - Recorded > Settlement A gain on an import transaction would occur when the recorded amount is greater than the settlement amount, and a loss on an export transaction would occur when the recorded amount is greater than the settlement amount. An import transaction will result in a payable. A gain on a foreign currency payable would occur when the settlement amount is less than the recorded amount. An export transaction will result in a receivable. A loss on a foreign currency receivable would occur when the recorded amount is greater than the settlement amount.
234
Define "foreign currency transaction."
When a domestic entity engages in a transaction with a foreign entity and the transaction is denominated in (i.e., to be settled in) a foreign currency
235
What is the difference between a foreign currency forward exchange contract and a foreign currency option contract?
``` In a foreign currency forward contract, an exchange of currencies (or comparable settlement) must occur as provided by the terms of the contract. In a foreign currency option contract, an exchange of currencies may occur at the option of the option holder. If the option is exercised, an exchange of currencies will occur; if it is not exercised, no exchange of currencies will occur. ```
236
List the two general purposes for | entering into a forward contract.
1. Hedging | 2. Speculation
237
Define "forward exchange contract."
Agreement to exchange units of currencies at a specified future date at an exchange rate set now
238
What is a forward contract?
``` An agreement (contract) to buy or sell (or that give the right to buy or sell) a specified commodity in the future at a price (rate) determined at the time the forward contract is executed ```
239
What is the nature of a foreign currency | option contract?
``` An agreement that gives the right (option) to buy or sell a specified amount of a foreign currency at a specified (forward) rate during or at the end of a specified time period ```
240
Which of the following kinds of transactions, all denominated in a foreign currency, would be a foreign currency transaction? Transaction Types: Export Lending Investing
Export - Yes Lending - Yes Investing - Yes Any transaction denominated (that is, to be settled) in a foreign currency is a foreign currency transaction, including import, export, borrowing, lending, and investing transactions.
241
Which of the following statements concerning foreign exchange forward contracts is/are correct? I. A foreign currency forward exchange contract will result in the exchange of currencies. II. All forward contracts require the exchange of currencies
I only. A foreign currency forward exchange contract will result in the exchange of currencies (Statement I). Unlike foreign currency option contracts, which give the right (but not an obligation) to exchange currencies, foreign currency forward exchange contracts establish an obligation to exchange currencies.
242
Which of the following is not a characteristic associated with foreign currency transactions?
Occur only when initiated by a foreign entity. Foreign currency transactions do not occur only when initiated by a foreign entity. A foreign currency transaction occurs when a domestic entity (e.g., U.S. entity) agrees to settle a transaction (pay, receive, exchange, etc.) in a non-domestic (e.g., non-dollar) currency, regardless of whether the transaction is initiated by the domestic entity or the foreign entity.
243
Forward exchange contracts may be used to: Hedge Risk Speculate
Hedge Risk - Yes Speculate - Yes Forward exchange contracts may be used both to hedge risk and to speculate. When used to hedge risk, the intent is to use the change in value of the forward exchange contract (hedging instrument) to offset, in part at least, an opposite change in value of whatever is being hedged (hedged item). When used to speculate, the forward exchange contract is entered into with the intent of making a profit on the change in its value.
244
When used for speculative purposes, which of the following contracts is likely to result in a foreign currency loss to the contract holder who initiated the contract? Foreign Currency Forward Exchange Contract Foreign Currency Option Contract
Foreign Currency Forward Exchange Contract - Yes Foreign Currency Option Contract - No While a foreign currency forward exchange contract entered into for speculative purposes is likely to result in a foreign currency loss (or gain) for the contract holder, a foreign currency option contract entered into for speculative purposes is not likely to result in a foreign currency loss for the contract holder.. Since the contract holder has the option of whether or not to exercise the contract option to exchange currencies, it is not likely that the option would be exercised if it would result in a loss.
245
For accounting purposes, which of the following are forward contracts? Foreign Currency Forward Exchange Contracts Foreign Currency Option Contracts
Foreign Currency Forward Exchange Contracts - Yes Foreign Currency Option Contracts - Yes Both foreign currency forward exchange contracts, which establish an obligation to exchange currencies, and foreign currency option contracts, which give the right (but not an obligation) to exchange currencies, are forward contracts for accounting purposes.
246
Which one of the following sets correctly identifies the characteristics of foreign currency transactions for a U.S. entity? Transaction Denominated In Transaction Measured In
Transaction Denominated In - Non-Dollars Transaction Measured In - Dollars For a U.S. entity, a foreign currency transaction will be denominated (settled) in non-dollars, but measured and recorded on the U.S. entity's books in dollars.
247
Which of the following general types of transactions could be a foreign currency transaction? Operating Transactions Forward Exchange Contract Transactions
Operating Transactions - Yes Forward Exchange Contract Transactions -Yes Either operating transactions (export, import, lending, borrowing, investing, etc.) or forward exchange contract transactions (contracts to exchange currencies) could be foreign currency transactions. A foreign currency transaction occurs when a domestic entity (e.g., U.S. entity) agrees to settle a transaction (pay, receive, exchange, etc.) in a non-domestic (e.g., non-dollar) currency.
248
Which one of the following would be a foreign currency transaction for the U.S. entity?
A U.S. entity purchases goods from a British entity to be settled in pounds sterling. If a U.S. entity purchases goods from (or sells goods to) a British entity and the U.S. entity is to settle in a currency other than the dollar (pounds sterling), it is a foreign currency transaction to the U.S. entity (but would not be to the British entity). A foreign currency transaction occurs when a domestic entity agrees to settle a transaction in a foreign currency.
249
What is the risk being hedged when using a forward contract for speculation?
There is no separate risk being hedged. The forward contract and the resulting loss or gain are recorded in earnings.
250
Even if the use of a forward contract for hedging prevents a loss (or gain) from exchange rate changes on the hedged item, which of the following may result in a cost to an entity that uses forward contracts for hedging purposes? I. Fees imposed by the counterparty to the forward contract. II. A difference between the spot rate and the forward rate when the forward exchange contract is executed.
Both I and II. A firm that engages in a forward contract will both incur fees imposed by the counterparty and incur the cost of the difference between the spot rate and the forward rate at the time the forward contract is executed. The difference between the spot rate and the forward rate is the premium (or discount) on the forward contract and must be amortized over the life of the contract as a financing expense, not an exchange gain or loss.
251
Which one of the following sets identifies the correct relationship between a foreign currency hedged item and a hedging instrument? When the Hedged Then the Hedging Item is Instrument is I. Receivable Receivable II. Receivable Payable
II only. Because a hedging instrument is intended to offset changes in the hedged item, when the hedged item is a receivable, the hedging instrument would have to be a payable.
252
The net effect of a change in value of a hedged item and its related hedging instrument may be: I. A gain. II. A loss. III. Neither a gain nor a loss.
I, II, and III. The net effect of a change in value of a hedged item and its related hedging instrument may be a gain, a loss, or neither a gain nor a loss (a perfect hedge).
253
Which of the following exchange rates may be used in accounting for a forward contract hedging instrument? Spot Rate Forward Rate
Spot Rate - Yes Forward Rate - Yes Both the spot rate and the forward rate will be used in accounting for a forward contract used for hedging. The forward rate is used as the basis for determining the change in value of a forward contract. As the forward rate changes, so also will the carrying value of the forward contract, resulting in exchange gains and losses. The spot rate is used to determine the premium or discount on the forward contract. Specifically, the difference between the spot rate and the forward rate at the date of the forward contract is the premium (or discount) on the forward contract, which enters into the determination of income over the life of the contract.
254
Which one of the following is not a characteristic of hedging?
Assures no gain or loss on the item being hedged. While the intent of hedging is to mitigate the risk of loss (or gain) attributable to the item being hedged, hedging does not assure that no gain or loss will be incurred on the hedged item. Only in a perfect hedge does no gain or loss occur. In order to be a perfect hedge, the hedging instrument would need to have a 100% inverse correlation to the hedged item. Such an outcome is rare.
255
What purpose does hedging of foreign | currency commitments serve?
Offsets the risk of exchange rate changes on a firm commitment denominated in a foreign currency for a future purchase or sale
256
``` If change in the value of the hedge is ineffective in offsetting the change in the expected cash flow of the forecasted transaction, how should that loss or gain be reported? ```
The loss or gain should be reported in | current income.
257
What purpose does hedging of | forecasted transactions serve?
``` Offsets risk of exchange rate changes on non-firm but budgeted foreign currency transactions between the time the transaction is planned and when it becomes firm ```
258
List the criteria for designation of hedging foreign currency commitments.
The commitment being hedged must be firm, be identified, and present exposure to foreign currency price changes. ``` The forward contract must be designated and effective as a hedge of a commitment and must be in an amount that does not exceed the amount of the commitment ```
259
What purpose does hedging of a | forecasted transaction serve?
Offsets the risk of exchange rate changes on non-firm but budgeted transactions denominated in a foreign currency
260
``` If the change in value of the forward contract is effective in offsetting a decrease or an increase in the expected cash flow of the forecasted transaction, how should the gain or the loss be deferred and reported? ```
The gain or the loss should be deferred and reported as a component of other comprehensive income.
261
List the criteria for designation of | hedging forecasted transactions.
``` The forecasted transaction must be identified, probable of occurring, and present an exposure to foreign currency price changes; and ``` Use of a forward contract to hedge must be consistent with company risk management policy.
262
What purpose does hedging of | recognized assets or liabilities serve?
``` Hedges exposed receivables or payables to offset the risk of exchange rate changes on already booked assets and liabilities denominated in a foreign currency ```
263
What purpose does hedging of | available-for-sale investments serve?
``` Offsets the risk of exchange rate changes on this class of investments denominated in a foreign currency ```
264
What purpose does hedging of | unrecognized firm commitments serve?
Offsets the risk of exchange rate changes on firm commitments for a future purchase or sale to be denominated in a foreign currency
265
What kind of hedge is the hedge of a | firm commitment?
The hedge of a firm commitment can be either a fair value hedge or a cash flow hedge.
266
What kind of a hedge is the hedge of a | forecasted transaction?
A cash flow hedge
267
What purpose does hedging of net | investment in foreign operations serve?
Offsets risk of exchange rate changes | on an investment in a foreign operation
268
Which one of the following is not a characteristic associated with hedging foreign currency firm commitments?
The hedged item is for an already booked asset or liability. A firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirements of GAAP. Therefore, an asset or liability has not been booked (recognized) already.
269
If a firm commitment denominated in a foreign currency is hedged with a forward exchange contract, which of the following statements is/are correct? I. Even though the firm commitment is hedged, a net gain or loss can be reported. II. As a result of hedging the firm commitment, an otherwise unrecognized asset or liability may have to be recognized.
Both I and II. Both Statement I and Statement II are correct. Even though a firm commitment is hedged, a net gain or loss can be reported (Statement I) if the changes in value of the firm commitment (hedged item) and the forward contract (hedging instrument) are not identical. Additionally, as a result of hedging a firm commitment, an otherwise unrecognized asset or liability may have to be recognized (Statement II) to offset any gain or loss recognized on the forward contract.
270
Based on preliminary discussions with a foreign customer, Alcoco, a U.S. entity, budgeted a significant sale to the foreign entity denominated in its foreign currency expected in June 20X9. To hedge the risk of an adverse exchange rate change on the dollar value of the expected sale, on January 2, 20X9, Alcoco entered into a forward exchange contract to sell an amount of the foreign currency equal to the expected sale. On March 31, 20X9, the value of the expected sale amount in dollars had decreased by $3,800. The fair value of the forward contract at that date had increased by $4,000. Which one of the following is the amount that should be recognized in current income for the forward contract only (the hedging instrument) in Alcoco's quarterly financial statements as of March 31?
$200 The ineffective portion of the (cash flow) hedge should be reported in current income. The effective portion of the hedge ($3,800) should be reported in other comprehensive income, and the ineffective portion ($200) should be reported in current income. The effective portion of the hedge is the amount of change in the forward contract (hedging instrument) equal to the change in the fair value of the expected sale amount (the hedged item) ($3,800); the ineffective portion is the difference ($200) and should be reported in current income.
271
A hedge to offset the risk of exchange rate changes on converting the financial statements of a foreign subsidiary to the domestic (functional) currency would be the hedge of:
A net investment in a foreign operation. A hedge to offset the risk of exchange rate changes on converting the financial statements of a foreign subsidiary to the domestic (functional) currency would be the hedge of a net investment in a foreign operation. Changes in exchange rates will result in changes in the amount of domestic (functional) currency that will result from converting (translating) financial statements from a foreign currency. Hedges of net investments in a foreign operation are intended to offset that risk.
272
Which of the following types of firm commitment denominated in a foreign currency can be hedged? Firm Purchase Commitments Firm Sales Commitments
Firm Purchase Commitments - Yes Firm Sales Commitments - Yes Both firm purchase commitments and firm sales commitments can be hedged. A firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirements of GAAP. The risk of an exchange rate change on the contract is the same as if the purchase or sale had been recognized, and such risk can be hedged.
273
What kind of hedge can be used to hedge a foreign currency firm commitment? Cash Flow Fair Value
Cash Flow - Yes Fair Value - Yes A forward contract used to hedge a foreign currency firm commitment can be either a cash flow hedge (as permitted by the FASB's Derivatives Implementation Group) or a fair value hedge (as permitted by FASB #133).
274
Which of the following types of planned transactions to be denominated in a foreign currency can be hedged? Planned Sale Planned Purchase
Planned Sale - Yes Planned Purchase - Yes Either a planned sale or a planned purchase would be a forecasted transaction and, if denominated in a foreign currency, could be hedged. Either a planned sale or a planned purchase would be a forecasted transaction and, if denominated in a foreign currency, could be hedged.
275
Which one of the following correctly reflects a set of events that may result in a sequence of related hedges?
Forecasted transaction -> firm commitment -> recognized liability. A forecasted transaction (a planned or expected transaction) would occur before a firm commitment, which would occur before a recognized liability. A forecasted transaction is a non-firm but intended (perhaps even budgeted) transaction. A firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirement of GAAP. A recognized liability would be one that is already booked by the entity. Thus, the correct sequence would be forecasted transaction -> firm commitment -> recognized liability.
276
What purpose does hedging of a | recognized asset/liability serve?
Offsets the risk of exchange rate | changes on an existing asset or liability
277
What purpose does hedging of an | investment in foreign operations serve?
Offsets risk of exchange rate changes on translation of financial statements of foreign operation from foreign currency to dollars
278
What is the purpose of a hedge of a foreign currency–denominated investment classified as available-for-sale?
Offsets the risk of exchange rate changes on a foreign currency– denominated investment in securities classified as available for sale.
279
List the criteria for designation of | hedging recognized assets/liabilities.
The asset or liability is denominated in a foreign currency and has already been booked. The gain or loss on the hedged asset or liability must be recognized in earnings.
280
List the criteria for designation of | hedging investments available for sale.
The securities being hedged must be identified and must not be traded in the investor's currency. ``` The forward contract must be designated and highly effective as a hedge of the investment, and in an amount that does not exceed the amount of the investment being hedged. ```
281
List the criteria for designation of hedging investments in foreign operations.
The use of a hedge instrument to hedge net investment in foreign operations requires that the contract: Is designated as a hedge of net investment and Is highly effective.
282
What hedge form can a hedge of a recognized asset or liability be designated as?
Either a cash flow hedge or a fair value | hedge
283
A hedge of a net investment in a foreign | operation is what type of hedge?
A fair value hedge
284
What kind of hedge is a hedge of an | investment available for sale?
A fair value hedge
285
Hedging a recognized asset is intended to offset the risk of exchange rate changes between which of the following dates?
Between the dates an asset is recognized and when the asset is fully satisfied. The time between when an asset is recognized and when the asset is fully satisfied would be intended to offset the risk of changes in the exchange rate on a recognized asset (or liability).
286
Which of the following statements concerning the hedging of an investment in a foreign operation is/are correct? I. The hedged item is the result of translating the foreign operation's financial statements. II. Only forward contracts can be used to hedge an investment in a foreign operation.
I only. Statement I is correct; Statement II is not. In the hedging of an investment in a foreign operation, the hedged item is the result of translating the foreign operation's financial statements from a foreign currency to the functional currency (Statement I). The intent of the hedge is to offset changes in the translated results that are caused by changes in exchange rates. Statement II is not correct; either derivatives (e.g., forward contracts) or non-derivatives can be used to hedge an investment in a foreign operation. For example, borrowing in the same foreign currency would hedge the investment, but the borrowing is not necessarily a derivative (e.g., forward contract).
287
Which of the following actions would an entity most likely take to hedge an investment in a foreign operation?
Borrow from another foreign entity with the same foreign currency as the operation being hedged. Borrowing from another foreign entity with the same foreign currency as the operation being hedged would hedge the (equity) investment in the foreign operation. Since the equity investment in a foreign operation is an asset and the borrowing would be a liability, both in the same foreign currency, a change in the exchange rate would have offsetting effects. Thus, if an exchange rate change caused a decrease in the value of the investment (asset), it would cause an increase in the value of the borrowing (liability).
288
What general kind of hedge, if any, is the hedge of a recognized asset or liability? I. Fair value. II. Cash flow.
Either I or II. The hedge of a recognized asset or liability may be either a fair value hedge or a cash flow hedge, depending on management's designation. However, the hedge of a recognized asset or liability denominated in a foreign currency generally will be a cash flow hedge.
289
Which of the following statements concerning the use of a forward contract to hedge a foreign currency investment held available-for-sale is/are correct? I. The investment security must not be traded in the investor's functional currency. II. The forward contract used as the hedging instrument must be highly effective in hedging the investment.
Both I and II. Both Statement I and Statement II are correct. In hedging a foreign currency investment held available-for-sale, the investment security must not be traded in the investor's functional currency, and the forward contract used as the hedging instrument must be highly effective in hedging the investment.
290
On December 12, 20X8, Averseco entered into a forward exchange contract to purchase 100,000 units of a foreign currency in 90 days. The contract was designated as and qualified as a fair value hedge of a purchase of inventory made that day and payable in March 20X9. The relevant direct exchange rates between the foreign currency and the dollar are as follows: Spot Rate Forward Rate (for March 12, 20X9) December 12, 20X8 $0.88 $0.90 December 31, 20X8 0.98 0.93 At December 31, 20X8, what amount of foreign currency transaction net gain or loss should Averseco recognize in income as a result of its foreign currency obligation and related hedge contract? (Ignore premium/discount and present value considerations.)
$7,000 The net loss will be $7,000. The gain or loss on the payable will be measured as the number of foreign currency units multiplied by the change in the spot rate between the date the liability arose, December 12, and the end of the year, December 31. Thus, the loss on the payable will be 100,000 foreign currency units × ($0.98 − $0.88 = $0.10) = $10,000. The gain or loss on the forward contract (disregarding any premium/discount at initiation of the contract and without using a present value factor) will be measured as the number of foreign currency units multiplied by the change in the forward rate between the date the contract was executed, December 12, and the end of the year, December 31. Thus, the gain on the forward contract will be 100,000 foreign currency units × ($0.93 − $0.90 = .03) = $3,000. The net will be $10,000 − $3,000 = $7,000, the correct answer.
291
On December 12, 20X8, Imp Co. entered into a forward exchange contract to hedge a purchase of inventory in November 2008, payable in March 20X9. The forward contract was to purchase 100,000 Euros in 90 days as a fair value hedge of the payable due in March. The relevant direct exchange rates were as follows: Spot Rate Forward Rate (for 3/12/X9) December 12, 20X8 $1.86 $1.80 December 31, 20X8 $1.96 $1.83 At December 31, 20X8, what amount of foreign currency transaction gain should Imp include in income from this forward contract only? (Ignore discount and present value considerations.)
$3,000 The gain (or loss) recognized on the contract will be computed as the number of Euros to be purchased (100,000E) multiplied by the change in the forward exchange rate between the date the contract was executed ($1.80) and the end of the fiscal period, December 31, 20X8 (1.83). Therefore, the gain recognized will be 100,000E × ($1.83 − $1.80 = $0.03) = $3,000. It is a gain because the forward contract increased in value as of December 31. The gain on the forward contract will partially offset the loss on the inventory for the period. A complete determination of the gain on the forward contract (only) would include amortization of the difference between the spot rate and forward rate at the initiation of the contract ($6,000) and discounting the nominal gain of $3,000 for the period December 31 to the March settlement date.
292
What general kind of hedge, if any, is the hedge of an available-for-sale investment denominated in a foreign currency? I. Fair value. II. Cash flow.
I only. The hedge of an available-for-sale investment denominated in a foreign currency is a fair value hedge. The risk hedged is the effect of exchange rate changes on the fair value in dollars of the investment.
293
What is the risk being hedged when using a forward contract for speculation?
There is no separate risk being hedged. The forward contract and the resulting loss or gain are recorded in earnings.
294
How are forward contracts entered into for speculative purposes accounted for?
``` The forward exchange contract is measured (valued) and recorded at the forward exchange rate (quoted now) for exchanges that will occur at the maturity date of the contract. Any change in value resulting from changing forward exchange rates will be recognized in current income. ```
295
What purpose does foreign currency | speculation serve?
``` To make a gain as a result of exchange rate changes by buying foreign currency for future delivery at a price lower than its value when delivered or by selling foreign currency for future delivery at a price higher than it can be bought at delivery date. ```
296
On November 2, 20X5, Platt Co. entered into a 90 day futures contract to purchase 50,000 Swiss francs when the contract quote was $.70. The purchase was for speculation in price movement. The following exchange rates existed during the contract period: 30 day futures Spot rate November 2, 20X5 $.62 $.63 December 31, 20X5 .65 .64 January 30, 20X6 .65 .68 What amount should Platt report as foreign currency exchange loss in its income statement for the year ended December 31, 2005?
$2,500 A futures contract entered into for speculative purposes (not to hedge) is valued using futures rates, and any gain or loss as a result of changes in futures rates is recognized in net income in the period during which the rate changed. At initiation of Platt's contract, the 90-day futures rate was $.70, as quoted in the contract. On December 31, 20X5, 30 days before Platt's contract was to be settled, the 30-day futures rate was $.65. Platt's loss would be computed as follows: November 2, 20X5, 50,000 Swiss francs × $.70 = $35,000 December 31, 20X5, 50,000 Swiss francs × $.65 = $32,500 Loss in dollar value of futures contract = $2,500
297
Which of the following statements concerning the use of a forward contract for speculative purposes is/are correct? I. The forward contract is not intended to offset an existing risk. II. Changes in the value of the forward contract are deferred until the contract matures.
I only. When used for speculative purposes, a forward contract is not entered into to offset, or hedge, an existing risk. Rather, the purpose of entering into a speculative forward contract is to make a profit. Statement II is not correct. Changes in the value of a forward contract used for speculative purposes, measured using the forward rate, are recognized in the period in which the forward rate changes and are not deferred until the contract matures.
298
or forward contracts entered into for speculative purposes, which of the following exchange rates, if any, will be used to measure the contracts prior to maturity? Spot Rate Forward Rate
Spot Rate - No Forward Rate - Yes The forward rate is used, and the spot rate is not. When a forward contract is entered into for speculative purposes, the contract is measured using the forward rates as of the dates the contract is initiated and at any subsequent measurement date(s) (e.g., balance sheet date). Changes in the forward rate create gains and losses on the forward contract, which are recognized in the period in which the forward rate changes.
299
A hedge to offset the risk of loss on a recognized asset or liability is which of the following types of hedge?
Either a cash flow hedge or a fair value hedge, at management's discretion. A hedge to offset the risk of loss on a recognized asset or liability could be either a cash flow hedge or a fair value hedge, at management's discretion. If the risk of loss on the recognized asset or liability being hedged is from changes in exchange rates, the hedge would be classified as a cash flow hedge.
300
A hedge to offset the risk of loss on a recognized asset or liability is which of the following types of hedge?
Either a cash flow hedge or a fair value hedge, at management's discretion. A hedge to offset the risk of loss on a recognized asset or liability could be either a cash flow hedge or a fair value hedge, at management's discretion
301
In which of the following hedges using a forward contract will at least a portion of any currency exchange gain or loss on the hedging instrument be reported as a translation adjustment in other comprehensive income?
Net investment in foreign operations hedge. The hedge of a net investment in foreign operations is a fair value hedge, but changes in the fair value of the forward contract (hedging instrument) that are equal to or less than the change in the translated value of the financial statements of the foreign operation are reported as a translation adjustment in other comprehensive income. The change in the forward contract reported as a translation adjustment offsets the change in the value of the translated financial statements of the foreign operation, which also are reported as a translation adjustment.
302
In which of the following hedges will at least a portion of any currency exchange gain or loss on the hedging instrument be reported as a translation adjustment in other comprehensive income?
Net investment in foreign operations hedge. The hedge of a net investment in foreign operations offsets the change in the value of the translated financial statements of the foreign operation, which also are reported as a translation adjustment.
303
On December 12, Year 1, Imp Co. entered into three forward exchange contracts, each to purchase 100,000 francs in 90 days. The relevant exchange rates are as follows: Spot rate Forward rate (for March 12, Year 2) December 12, Year 1 $.88 $.90 December 31, Year 1 .98 .93 Imp entered into the third forward contract for speculation. At December 31, Year 1, what amount of foreign currency gain should Imp include in income from this forward contract?
$3,000 All gains and losses in a speculative forward foreign exchange contract are included in income of the period in which the forward exchange rate changes. Gains and losses are measured based on the purchase price of the contract and its current settlement value using forward rates. In this case, those rates are the $.90 purchase price (forward rate December 12) and the $.93 settlement price (forward rate December 31). Thus, this $3,000 amount is correct [($.93-$.90)100,000].
304
In September 1, 2004, Brady Corp. entered into a foreign exchange contract for speculative purposes by purchasing 50,000 Euros for delivery in 60 days. The rates to exchange $1 for 1 Euro follow: 9/1/04 9/30/04 Spot rate .75 .70 30-day forward rate .73 .72 60-day forward rate .74 .73 In its September 30, 2004, income statement, what amount should Brady report as foreign exchange loss?
$1,000 The correct answer is the difference between the 60-day forward rate on September 1 of $0.74 and the 30-day forward rate on September 30 of $0.72, or $0.02 × 50,000 Euros = $1,000, the correct amount of the loss.
305
On November 1, year 2, Kir Co. signed a contract to purchase 10,000 British pounds on February 2, year 3. The relevant exchange rates are as follows: Spot rate Forward rate November 1, year 2 $1.98 $2.05 December 31, year 2 2.00 2.06 Kir accounts for the forward contract as a speculative transaction. What amount of gain, if any, should Kir report from this forward contract in its income statement for the year ended December 31, year 2?
$100 Forward contracts are derivatives, and all derivatives are recorded at fair value with unrealized gains and losses recorded in earnings. (The only exception is for certain derivatives that qualify for hedge accounting.) The forward contract price is at $2.05 on November 1, and the forward price increased to $2.06 on December 31. Kir is in a gain position because the November forward contract to buy (Kir's strike price) is less than the December forward price. The 10,000 British pounds times $.01 is $100 gain.
306
When does Functional currency = | Another foreign currency?
``` When a foreign entity generates most of its cash flows in the currency of another foreign country or when it is required to use another currency by law or contract. ```
307
What is a functional currency?
``` It is the currency of the primary economic environment in which an entity operates and generates net cash flows. It can be the recording currency, an affiliate's reporting currency, or another currency. ```
308
``` When does Functional currency = Reporting currency ($)? ```
The functional currency would be the reporting currency: When the foreign entity is a direct and integral component or extension of a U.S. entity's operations; or When the local economy of the foreign entity is highly inflationary.
309
What is a recording currency?
``` It is the currency in which an entity maintains its books of accounts. Normally, the recording currency is the local currency of the country in which an entity is located. ```
310
When does Functional currency = | (Local, foreign) Recording currency?
``` When operations of the foreign entity are relatively self-contained and integrated within the country in which it is located, and the economy of that country is not in hyperinflation. ```
311
What is foreign currency translation?
``` It is the conversion (translation) of financial statements expressed in one currency into comparable financial statements expressed in another currency. ```
312
What is a reporting currency?
It is the currency in which final financial | statements are expressed.
313
Why might an entity need to translate financial statements expressed in a foreign currency?
Translation may be needed to: Apply the equity method of accounting to an investee. Prepare combined financial statements. Prepare consolidated financial statements.
314
The financial statements expressed in a foreign currency that need to be converted to a domestic currency could be the financial statements of a/an: Equity Investee Subsidiary to be Consolidated
Equity Investee - Yes Subsidiary to be Consolidated - Yes The financial statements expressed in a foreign currency needing to be converted to a domestic currency could be those of either an equity investee or a subsidiary to be consolidated (or a branch, a joint venture, a partnership, or any other separate foreign operation).
315
In which one of the following independent circumstances would the local foreign currency of a country least likely be the functional currency for a manufacturing subsidiary of a U.S. company located in that country?
The subsidiary makes all of its product for sale to and for use by its U.S. parent. If a subsidiary makes all of its product for sale to and for use by its parent, the subsidiary is likely to be a direct and integral extension of its parent and, therefore, the parent's currency is likely to be the functional currency, not the local foreign currency of the subsidiary. In the circumstances described, the subsidiary likely receives virtually all of its cash inflow from its parent, which it converts to the local currency for operating costs. Therefore, it generates most of its cash flows in the U.S. dollar, and that is its functional currency, not the local foreign currency.
316
Which one of the following would best describe the functional currency of a foreign subsidiary of a U.S. parent?
The currency of the primary economic environment in which the subsidiary operates and generates most of its net cash flow. The functional currency of a foreign subsidiary would be the currency of the primary economic environment in which the subsidiary operates and primarily generates and expends cash. That currency could be the recording currency, the reporting currency, or another foreign currency.
317
Operating transactions denominated in a foreign currency are converted to the functional currency using the:
Current exchange rate Operating transactions denominated in a foreign currency are converted to the functional currency using the current (or spot) exchange rate. The current (or spot) exchange rate is the exchange rate in effect at the current time (or as close thereto as possible); that is, at the time of the transaction or revaluation.
318
Which of the following statements concerning the determination of a functional currency is/are correct? I. The functional currency can be selected at management's discretion. II. The functional currency could be the recording currency of the foreign entity. III. The functional currency could be the reporting currency of a parent.
II and III, only. The functional currency could be either the recording currency of the foreign entity (Statement II) or the reporting currency of a parent (Statement III) (or even another foreign currency). The functional currency will be the currency of the primary economic environment in which an entity operates and primarily generates and expends cash, not whatever currency management chooses (Statement I).
319
Determining a foreign subsidiary's functional currency will take into account which of the following? I. The extent to which the subsidiary operates, and generates and expends cash in the local foreign economy in which it is located. II. The cumulative inflation rate in the local foreign economy in which it is located.
Both I and II. Determining a foreign subsidiary's functional currency will take into account both the extent to which the subsidiary operates, and generates and expends cash in the local foreign economy in which it is located and the cumulative inflation rate of that economy.
320
Which one of the following best describes the currency in which the final consolidated financial statements are presented?
The reporting currency. The reporting currency is the currency in which the final consolidated financial statements are presented (reported).
321
The specific method to be used to convert financial statements of a subsidiary expressed in a foreign currency into the domestic currency of the parent depends primarily on:
The functional currency of the subsidiary. The method to be used to convert financial statements of a subsidiary from a foreign currency to the parent's currency depends primarily on the functional currency of the subsidiary. Whether the functional currency of the subsidiary is the local foreign currency, the parent's currency, or another foreign currency will determine the conversion method or methods to be used.
322
Which of the following could be the functional currency of a foreign subsidiary? I. The recording currency of the foreign subsidiary. II. The reporting currency of the subsidiary's parent. III. A currency other than either the recording currency of the foreign subsidiary or the reporting currency of the subsidiary's parent.
I, II, and III. The functional currency of a foreign subsidiary could be the recording currency of the foreign subsidiary, the reporting currency of the subsidiary's parent, or a currency other than either the recording currency of the subsidiary or the reporting currency of its parent.
323
What exchange rate or rates should be used to translate (not remeasure) asset and liability accounts from one currency to another currency?
The spot exchange rate (closing rate) as | of the balance sheet date
324
What current exchange rates are used when applying a conversion using translation for revenues, expenses, gains, and losses?
``` The exchange rate that existed when the items was earned or incurred; or The average exchange rate for the period, if that is not materially different than the actual rates when earned or incurred ```
325
What exchange rate or rates should be used to translate (not remeasure) paidin capital accounts from one currency to another currency?
``` The historic exchange rate that existed when the paid-in capital items arose, but not earlier than when the investment in the entity was initially made ```
326
How is retained earnings converted from one currency to another when translation (not remeasurement) is used?
Retained earnings is not translated but rather is calculated as of the balance sheet date. The calculation is: ``` Beginning retained earnings ($) + Translated net income / –Net loss ($) – Dividends declared translated at the spot rate at date of declaration = Ending retained earnings ($) ```
327
Which one of the following could not be translated using the weighted average exchange rate for the fiscal year?
Cash. When converting financial statements from a foreign currency to a reporting currency using translation, assets and liabilities are translated using the spot (or current) exchange rate as of the balance sheet date, not the weighted average exchange rate for the period. Therefore, cash could not be translated using the weighted average exchange rate for the fiscal year.
328
Orr Corporation had a realized foreign exchange loss of $13,000 for the year ended December 31, 20X8, and must also determine whether the following items will require year-end adjustment. Orr had a $7,000 gain resulting from the translation of the accounts of its wholly owned foreign subsidiary for the year ended December 31, 20X8. Orr had an account payable to an unrelated foreign supplier payable in the supplier's local currency. The U.S. Dollar equivalent of the payable was $60,000 on October 31, 20X8 and $64,000 on December 31, 20X8. The invoice is payable on January 30, 20X9. In Orr's 20X8 consolidated income statement, what amount should be included as foreign exchange loss?
$17,000 The correct amount of foreign exchange loss is $17,000. The $4,000 loss on the account payable ($64,000 − $60,000 = $4,000) would be included in net income. Therefore, the correct amount of foreign exchange loss is $13,000 + $4,000 = $17,000. The translation loss (or gain) would not be included in net income for the year, but rather would be reported as an item of other comprehensive income (outside net income) for the year.
329
A foreign subsidiary's functional currency is its local currency, which has not experienced significant inflation. The weighted average exchange rate for the current year would be the appropriate exchange rate for translating: Wages Expense Sales to Customers
Wages Expense - Yes Sales to Customers - Yes Since the functional currency is the local currency, the income statement of the subsidiary would be converted using translation, which requires the use of the exchange rate when a revenue/gain was earned or expense/loss was incurred, or the weighted average exchange rate for the year. Therefore, the weighted average exchange rate for the current year would be an appropriate rate for converting both wages expense and sales to customers.
330
A subsidiary's functional currency is the local currency which has not experienced significant inflation. The appropriate exchange rate for translating the depreciation on plant assets in the income statement of the foreign subsidiary is the:
Weighted average exchange rate for the current year. The weighted average exchange rate for the current year is the correct rate to use to convert depreciation expense. Since the functional currency is the local currency, the income statement of the subsidiary would be converted using translation, which requires the use of the exchange rate when a revenue/gain was earned or expense/loss was incurred, or the weighted average exchange rate for the year. Since depreciation expense is incurred throughout the year, the weighted average exchange rate normally is the appropriate basis for conversion.
331
Which one of the following would not be translated using the spot (or current) exchange rate as of the balance sheet date?
Common stock. When converting financial statements from a foreign currency to a reporting currency using translation, paid-in capital accounts are translated using the historic exchange rate in effect when the account amount arose (or when the investment was made, if later). Therefore, common stock would not be translated using the spot (or current) exchange rate as of the balance sheet date, but the historic exchange rate for the common stock.
332
6 Click to bookmark question 6 bookmark removedbookmark removedAICPA.090302FAR-SIM Use V-O keys to navigate. Panco, a U.S. entity, has a subsidiary, Sanco, located in a foreign country. Sanco's operations are concentrated in the country in which it is located and are essentially independent of Panco. The economy of the foreign country is not highly inflationary. Sanco prepared the following shortened financial statements in its local currency, the FCU, for the fiscal year ended December 31, 20X8: Statement of Net Income and FCUs Comprehensive Income (20X8) (in 000) Sales 12,000 COGS (4,000) Depreciation Expense (1,000) Other Expenses (3,000) Net Income 4,000 Other Comprehensive Income 0 Comprehensive Income 4,000 Retained Earnings (20X8) Beginning Retained Earnings (end 20X7) 6,000 Add: Net Income (20X8) 4,000 Deduct: Dividends (20X8) (1,000) Ending Retained Earnings 9,000 Balance Sheet (12/31/20X8) Cash and Account Receivable 2,000 Inventory 6,000 Fixed Assets 10,000 Total Assets 18,000 Liabilities 2,000 Common Stock 7,000 Retained Earnings 9,000 Subtotal 18,000 Accumulated Other Comprehensive Income 0 Total Liabilities + Equity 18,000 The following exchange rates were available: Historic exchange rate when Sanco was established by Panco: 1 FCU = $1.200 Weighted average exchange rate for 20X8: 1 FCU = $1.300 Spot exchange rate at date dividend declared: 1 FCU = $1.290 Spot exchange rate at December 31, 20X8: 1 FCU = $1.310 Which one of the following is the amount (in 000) of Sanco's dividends declared and paid in 20X8 in U.S. dollars?
$1,290 Since translation should be used to convert Sanco's financial statements expressed in FCUs to U.S. dollars, dividends declared should be translated at the exchange rate in effect when the dividends were declared (the same would be true for remeasurement). In this case, the exchange rate is given as 1 FCU = $1.290. Therefore, the correct dollar amount of Sanco's dividends declared would be 1,000 FCUs × $1.290 = $1,290.
333
Panco, a U.S. entity, has a subsidiary, Sanco, located in a foreign country. Sanco's operations are concentrated in the country in which it is located and are essentially independent of Panco. The economy of the foreign country is not highly inflationary. Sanco prepared the following shortened financial statements in its local currency, the FCU, for the fiscal year ended December 31, 20X8: Statement of Net Income and FCUs Comprehensive Income (20X8) (in 000) Sales 12,000 COGS (4,000) Depreciation Expense (1,000) Other Expenses (3,000) Net Income 4,000 Other Comprehensive Income 0 Comprehensive Income 4,000 Retained Earnings (20X8) Beginning Retained Earnings (end 20X7) 6,000 Add: Net Income (20X8) 4,000 Deduct: Dividends (20X8) (1,000) Ending Retained Earnings 9,000 Balance Sheet (12/31/20X8) Cash and Account Receivable 2,000 Inventory 6,000 Fixed Assets 10,000 Total Assets 18,000 Liabilities 2,000 Common Stock 7,000 Retained Earnings 9,000 Subtotal 18,000 Accumulated Other Comprehensive Income 0 Total Liabilities + Equity 18,000 The following exchange rates were available: Historic exchange rate when Sanco was established by Panco: 1 FCU = $1.200 Weighted average exchange rate for 20X8: 1 FCU = $1.300 Spot exchange rate at date dividend declared: 1 FCU = $1.290 Spot exchange rate at December 31, 20X8: 1 FCU = $1.310 Which one of the following is the amount (in 000) of Sanco's depreciation expense in U.S. dollars?
$1,300 Since translation should be used to convert Sanco's financial statements expressed in FCUs to U.S. dollars, depreciation expense should be converted using the exchange rate in effect when depreciation was incurred during the year or the weighted average exchange rate for the period. In this case, the weighted average exchange rate for the period is given as 1 FCU = $1.300. Therefore, the correct dollar amount of Sanco's depreciation expense would be 1,000 FCUs × $1.300 = $1,300.
334
In converting financial statements from a foreign currency to a reporting currency, which one of the following accounts would not be translated using an exchange rate?
Retained earnings. When converting financial statements from a foreign currency to a reporting currency using translation (or remeasurement), retained earnings is not translated using an exchange rate. Rather, retained earnings is calculated using already converted values. Specifically, beginning retained earnings in dollars + converted net income - converted dividends declared = ending retained earnings in dollars.
335
Which one of the following would not be translated using either the spot exchange rate as of the balance sheet date or the weighted average exchange rate for the period?
Common stock. When converting financial statements from a foreign currency to a reporting currency using translation, paid-in capital accounts are translated using the historic exchange rate in effect when the account amount arose (or when the investment was made, if later). Therefore, common stock would not be translated using either the spot (or current) exchange rate as of the balance sheet date or the weighted average exchange rate for the period, but the historic exchange rate for the common stock.
336
When is the remeasurement method of converting financial statements from one currency to another currency used?
``` Remeasurement is used when converting from a recording currency (that is not the functional currency) to the functional currency. This might occur, for example, when: ``` ``` The recording currency is in a highly inflationary economy. The operations of the foreign entity are a direct and integral component or extension of its parent. ``` The functional currency is not the local foreign currency but another foreign currency (other than the reporting currency).
337
``` How is the conversion adjustment reported when the remeasurement (not translation) method of converting financial statements from one currency to another is used? ```
The adjustment is reported as a translation gain or loss in the income from the continuing operations section of the income statement.
338
What is the name of the method used when financial statements are remeasured?
Conversion method used to convert accounts from foreign currency units to dollars
339
What exchange rate or rates should be used to remeasure (not translate) monetary accounts from one currency to another currency?
Current (spot) exchange rate
340
What exchange rate or rates should be used to remeasure (not translate) nonmonetary accounts from one currency to another currency?
Historic exchange rate.
341
Which one of the following expenses would be remeasured using a historic exchange rate?
Depreciation expense. Under the remeasurement method of converting financial statements from a foreign currency to a reporting currency, most expenses (and revenues, gains, and losses) are converted using the current exchange rate. Expenses related to assets and liabilities converted at a historic rate are an exception - they are converted using a historic exchange rate. Therefore, since depreciation expense does result from an asset (property, plant, and equipment) measured using a historic exchange rate, depreciation expense would be remeasured using a historic exchange rate.
342
Papco, a U.S. entity, has a subsidiary, Sapco, located in a foreign country. Sapco is essentially a sales unit for Papco. Sapco prepared the following shortened financial statements in its local currency, the FCU, for the fiscal year ended December 31, 20X8: Statement of Net Income and FCUs Comprehensive Income (20X8) (in 000) Sales 12,000 COGS (4,000) Depreciation Expense (1,000) Other Expenses (3,000) Net Income 4,000 Other Comprehensive Income 0 Comprehensive Income 4,000 Retained Earnings (20X8) Beginning Retained Earnings (end 20X7) 6,000 Add: Net Income (20X8) 4,000 Deduct: Dividends (20X8) (1,000) Ending Retained Earnings 9,000 Balance Sheet (12/31/20X8) Cash and Account Receivable 2,000 Inventory at cost, acquired evenly in 20X8 6,000 Fixed Assets 10,000 Total Assets 18,000 Liabilities 2,000 Common Stock 7,000 Retained Earnings 9,000 Subtotal 18,000 Accumulated Other Comprehensive Income 0 Total Liabilities + Equity 18,000 The following exchange rates were available: Historic exchange rate when Sanco was established by Panco: 1 FCU = $1.200 Historic exchange rate when Sanco's fixed assets were acquired: 1 FCU = $1.250 Weighted average exchange rate for 20X8: 1 FCU = $1.300 Spot exchange rate at date dividend declared: 1 FCU = $1.290 Spot exchange rate at December 31, 20X8: 1 FCU = $1.310 Which one of the following is the amount (in 000) of Sapco's sales in U.S. dollars?
$15,600 Since remeasurement should be used to convert Sapco's financial statements expressed in FCUs to U.S. dollars, and since sales is not an income statement item derived from a balance sheet item remeasured using a historic cost, sales should be converted using the current exchange rate in effect when each sale took place or the weighted average exchange rate for the period. In this case, the weighted average exchange rate for the period is given as 1 FCU = $1.300. Therefore, the correct dollar amount of Sapco's sales would be 12,000 FCUs × $1.300 = $15,600.
343
Remeasurement, based on the temporal method of conversion, converts foreign currency amounts to reporting currency amounts using different exchange rates for different accounts based on which of the following distinctions?
Monetary and non-monetary. The distinction used for applying different exchange rates to different accounts when using remeasurement is based on whether the account is monetary or non-monetary.
344
Papco, a U.S. entity, has a subsidiary, Sapco, located in a foreign country. Sapco is essentially a sales unit for Papco. After remeasuring Sapco's financial statements from the foreign currency to Papco's reporting currency, Papco determined that it had a loss on the remeasurement. How should Papco report the loss in its consolidated financial statements?
As income from continuing operations. Under the remeasurement method of converting from a foreign currency to a reporting currency, any resulting loss (or gain) is reported as an item of income from continuing operations in current income.
345
When a foreign entity's financial statements are converted to a reporting currency using remeasurement, how will the adjustment needed to make the converted balance sheet balance (the "translation adjustment") be reported?
As an item in income from continuing operations. When remeasurement is used to convert financial statements expressed in a foreign currency to a reporting currency, any resulting translation adjustment (gain or loss) is reported as an item in income from continuing operations.
346
Eagle, Inc. is a manufacturer and distributor of consumer products in the U.S. It has a wholly owned foreign subsidiary, El Rio, which sells Eagle products in Mexico. El Rio receives all of its products from Eagle, sells those products, and remits the proceeds to Eagle. El Rio maintains its books and prepares its financial statements in the Mexican peso. Which one of the following methods will Eagle most likely use to convert El Rio's financial statements to dollar-based statements?
Remeasurement. Because El Rio's operations are a direct extension of Eagle, the peso is not El Rio's functional currency; Eagle's currency, the U.S. dollar, is El Rio's functional currency. Therefore, El Rio's financial statements will be converted to U.S. dollars using remeasurement.
347
Papco, a U.S. entity, has a subsidiary, Sapco, located in a foreign country. Sapco is essentially a sales unit for Papco. Which one of the following processes should Papco use to convert Sapco's financial statements to dollar-based statements for consolidation purposes?
Remeasurement. Because Sapco's operations are a direct extension of Papco, Sapco's local foreign currency is not its functional currency. Rather, Papco's currency, the U.S. dollar, is Sapco's functional currency. Therefore, its financial statements expressed in the foreign currency will be converted to U.S. dollars using remeasurement.
348
Which one of the following would not be remeasured using a historic exchange rate?
Cash. Under the remeasurement method of converting financial statements from a foreign currency to a reporting currency, monetary assets and liabilities are converted using the current exchange rate, not a historic exchange rate. Therefore, cash (the most monetary of assets) would be converted using the current exchange rate, not a historic exchange rate.
349
Papco, a U.S. entity, has a subsidiary, Sapco, located in a foreign country. Sapco is essentially a sales unit for Papco. Sapco prepared the following shortened financial statements in its local currency, the FCU, for the fiscal year ended December 31, 20X8: Statement of Net Income and FCUs Comprehensive Income (20X8) (in 000) Sales 12,000 COGS (4,000) Depreciation Expense (1,000) Other Expenses (3,000) Net Income 4,000 Other Comprehensive Income 0 Comprehensive Income 4,000 Retained Earnings (20X8) Beginning Retained Earnings (end 20X7) 6,000 Add: Net Income (20X8) 4,000 Deduct: Dividends (20X8) (1,000) Ending Retained Earnings 9,000 Balance Sheet (12/31/20X8) Cash and Account Receivable 2,000 Inventory at cost, acquired evenly in 20X8 6,000 Fixed Assets 10,000 Total Assets 18,000 Liabilities 2,000 Common Stock 7,000 Retained Earnings 9,000 Subtotal 18,000 Accumulated Other Comprehensive Income 0 Total Liabilities + Equity 18,000 The following exchange rates were available: Historic exchange rate when Sanco was established by Panco: 1 FCU = $1.200 Historic exchange rate when Sanco's fixed assets were acquired: 1 FCU = $1.250 Weighted average exchange rate for 20X8: 1 FCU = $1.300 Spot exchange rate at date dividend declared: 1 FCU = $1.290 Spot exchange rate at December 31, 20X8: 1 FCU = $1.310 Which one of the following is the amount (in 000) of Sapco's inventory in U.S. dollars?
$7,800 Since remeasurement should be used to convert Sapco's financial statements expressed in FCUs to U.S. dollars, inventory should be converted using the historic exchange rate in effect when the inventory was acquired. In this case, the inventory was acquired evenly during 20X8 and the weighted average exchange rate for the year was $1.300. Therefore, the correct dollar amount of Sapco's inventory would be 6,000 FCUs × $1.300 = $7,800.
350
``` How are financial statements converted when the functional currency is neither the recording currency nor the reporting currency but the currency of another (third) country? ```
``` The financial statements are first remeasured from the recording currency to the functional currency and then translated from the functional currency to the reporting currency. ```
351
Park Co.'s wholly-owned subsidiary, Schnell Corp., maintains its accounting records in Pounds Sterling. Because all of Schnell's branch offices are in Germany, its functional currency is the Euro. Remeasurement of Schnell's 20X8 financial statements resulted in a $7,600 gain, and translation of its financial statements resulted in an $8,100 gain. What amount should Park report as a foreign exchange gain in its other comprehensive income for the year ended December 31, 20X8?
$8,100 Gains and losses from translation are recognized in other comprehensive income (outside of net income) in the period in which the gains and losses occur; gains and losses from remeasurement enter into the determination of net income in the period in which the gains or losses occur. Therefore, the correct answer is $8,100, the gain from translation.
352
Which one of the following sets shows the correct reporting of an adjustment (gain or loss) that results from translation and one that results from remeasurement of financial statements from a foreign currency to a reporting currency? Translation Adjustment Remeasurement Adjustment
Translation Adjustment - Other comprehensive income Remeasurement Adjustment - Net Income An adjustment resulting from translation of financial statements would be reported in other comprehensive income, and an adjustment resulting from remeasurement would be reported in net income.
353
If the functional currency of a foreign subsidiary is a foreign currency other than the subsidiary's recording currency, which one of the following will be used to convert the subsidiary's financial statements to the final reporting currency?
Remeasurement and then translation. Remeasurement and then translation would be used to convert to the reporting currency when a foreign currency other than the foreign subsidiary's recording currency is the functional currency. Specifically, the financial statements would be remeasured from the recording currency to the other foreign functional currency, and the remeasured financial statements would then be translated to the reporting currency
354
Gordon Ltd., a 100% owned British subsidiary of a U.S. parent company, reports its financial statement in local currency, the British pound. A local newspaper published the following U.S. exchange rates to the British pound at year end: Current rate $1.50 Historical rate (acquisition) 1.70 Average rate 1.55 Inventory (FIFO) 1.60 Which currency rate should Gordon use to convert its income statement to U.S. dollars at year end?
$1.55 Since Gordon prepares its financial statements in its local currency, the British pound, and since the British economy has not been in hyperinflation, Gordon's functional currency would be the British pound, and its financial statements would be converted to U.S. dollars using translation, not remeasurement. Under the translation method of converting, income statement items are converted using the average exchange rate for the period.
355
Park Co.'s wholly-owned subsidiary, Schnell Corp., maintains its accounting records in pounds sterling. Because all of Schnell's branch offices are in Germany, its functional currency is the Euro. Remeasurement of Schnell's 20X8 financial statements resulted in a $7,600 gain, and translation of its financial statements resulted in an $8,100 gain. What amount should Park report as a foreign exchange gain in its income statement for the year ended December 31, 20X8?
$7,600 Gains and losses from remeasurement enter into the determination of net income in the period in which the gains and losses occur. Gains and losses from translation do not enter into the determination of net income, but are recognized in other comprehensive income (outside of net income) in the period in which the gains and losses occur. Therefore, the correct answer is $7,600, the gain from remeasurement.
356
How is depreciation recorded by the | lessee in an operating lease?
The lessee does not record depreciation under an operating lease. The lessee amortizes the right-ofuse asset.
357
Define “finance lease.”
A lease that transfers the control (or ownership) of the leased asset to the lessee. The lessee records a right-of-use asset and lease liability. The lessee amortizes the right-of-use asset and recognizes interest expense.
358
Define “operating lease.”
A lease that does not meet any of the finance lease criteria and has a lease term longer than 12 months.
359
In accounting for an operating lease by the lessee, the annual lease expense effectively consists of two components. What are the two components?
``` The lessee calculates an interest component and an amortization component based on the right-of-use asset. Annual lease expense is recognized evenly over the lease period, but the amount of the lease expense represented by each component changes over time. In other words, the lease expense remains the same each period. The proportion of the interest component and amortization that contribute to the lease expense amount changes over time ```
360
How does a lessor account for an | operating lease?
The lessor records annual lease or rent revenue. The lessor retains the leased asset on its books. The lessor records annual depreciation for the leased asset.
361
How does a lessee calculate the | interest component of lease expense?
The lessee used the effective interest method to calculation the interest component based on the interest rate and the lease liability balance.
362
What accounts are reported by a lessee accounting for an operating lease? On what statement does each account appear?
``` Lease liability—Balance Sheet Right-of-use asset—Balance Sheet Lease expense—Income Statement Also note that accounts payable and cash may be impacted ```
363
On 1/31/Y1, Clay Company leased a new machine from Saxe Corp. The following data relate to the lease transaction at its inception: Lease term 10 years Annual rental payable at beginning of each lease year $50,000 Useful life of machine 15 years Implicit interest rate 10% Present value of an annuity of 1 in advance for 10 periods at 10% 6.76 Present value of annuity of 1 in arrears for 10 periods at 10% 6.15 Fair value of the machine $400,000 The lease has no renewal option, and the possession of the machine reverts to Saxe when the lease terminates. At the inception of the lease, Clay should record a lease liability of
$338,000. At the inception of a lease, the lessee records a lease liability. To be considered a finance lease, a lease must satisfy any one of the five criteria specified in ASC Topic 842. This lease does not satisfy any of the five criteria. The lease has no bargain purchase option and does not transfer title. The lease term is not 75% or more of the useful life (10 years out of 15 years is 67%), and the PV of the lease payments is not 90% or more of the FV of the asset [(6.76 × $50,000) / $400,000 = 84.5%]. Therefore, this is an operating lease, not a finance lease. The lessee will record a lease liability of $338,000 ($50,000 annual payment multiplied by the present values of an annuity due factor of 6.76).
364
Marnie Company enters into a two-year lease. The terms of the lease do not transfer ownership and do not contain a bargain purchase option. The lease is for 60% of the asset's economic life and represents 80% of its fair value. The asset is not a specialized asset and does have alternative uses. How should Marnie classify and record the lease?
The lease should be classified as an operating lease, and a lease liability should be recorded at the inception of the lease. The lease exceeds 12 months but does not meet any of the classification criteria for a finance lease. Marnie should classify this lease as an operating lease and record a lease liability at the inception of the lease.
365
A lessee recording monthly lease expense for a short-term lease will determine expense by
Recording the expense as time passes, likely recognizes the expense on a monthly basis. Because this is a short-term lease, the lease expense is the amount associated with the expense of leasing that asset typically recognized on a monthly basis.
366
On 1/31/Y1, Bailey Company leased a new machine from Sussex Corp. The following data relate to the lease transaction at its inception: Lease term 10 years Annual rental payable at beginning of each lease year $50,000 Useful life of machine 15 years Implicit interest rate 10% Present value of an annuity of 1 in advance for 10 periods at 10% 6.76 Present value of annuity of 1 in arrears for 10 periods at 10% 6.15 Fair value of the machine $400,000 The lease has no renewal option, the possession of the machine reverts to Sussex when the lease terminates, and the machine does have alternative uses. The first lease payment of $50,000 is paid at the inception of the lease. What is the amount of the first year's lease expense attributable to the interest component?
$28,800 The lease liability at the inception is recorded as $338,000 ($50,000 × Present value factor of an annuity due 6.76). The first payment made on the date of inception is applied entirely to the lease liability because no time has passed for interest to accrue. The lease liability balance is $288,000 for the first year. Multiply the lease liability balance of $288,000 by the implicit interest rate of 10% to calculate the amount of the first year's lease expense attributable to interest: $288,000 × 10% = $28,800.
367
On 1/31/Y1, Bailey Company leased a new machine from Sussex Corp. The following data relate to the lease transaction at its inception: Lease term 10 years Annual rental payable at beginning of each lease year $50,000 Useful life of machine 15 years Implicit interest rate 10% Present value of an annuity of 1 in advance for 10 periods at 10% 6.76 Present value of annuity of 1 in arrears for 10 periods at 10% 6.15 Fair value of the machine $400,000 Depreciation method Straight line The lease has no renewal option, the possession of the machine reverts to Sussex when the lease terminates, and the machine does have alternative uses. The first lease payment of $50,000 is paid at the inception of the lease. What amount does Sussex Corp. report for depreciation expense in year 1?
$26,667 The lease is an operating lease, and Sussex retains the asset on its books. Sussex uses the straight-line method of depreciation and depreciates the asset over its useful life. Because no cost is given, we assume the cost is equal to the fair value of the machine. To calculate depreciation expense, Sussex divides the fair value or cost basis ($400,000) by the useful life (15 years). Depreciation equals $26,667.
368
Define "lease term."
The fixed noncancelable term of the lease plus periods covered by bargain renewal options plus all periods covered by renewal options during which there is a loan outstanding from the lessor to the lessee
369
Define "bargain purchase option (BPO)."
An option whereby the lessee has the opportunity to purchase the asset at an amount that is significantly less than the asset's expected fair value at the end of the lease term
370
Define "executory costs."
Costs for insurance, maintenance, and taxes
371
Define "implicit interest rate."
The lessor's desired rate of interest or desired rate of | return.
372
Define "lessee's incremental borrowing rate."
The rate, at lease inception date, the lessee would have incurred to borrow the funds necessary to purchase the leased asset
373
List the criteria for a lessee to classify a lease as a | finance lease.
Meet one or more of the following: Lease transfers ownership. Lease contains a bargain purchase option. Lease term is 75% or more of useful life. Present value of minimum lease payments is 90% or more of market value. The asset does not have an alternative use.
374
What rate is the lessor required to use to calculate | the present value in a capital lease?
Interest rate implicit in the lease
375
List the two classifications of finance leases for the | lessor.
1. Direct financing | 2. Sales type
376
Arena Corp. leased equipment from Bolton Corp. and correctly classified the lease as a finance lease. The present value of the minimum lease payments at lease inception was $1,000,000. The executory costs to be paid by Bolton were $50,000, and the fair value of the equipment at lease inception was $900,000. What amount should Arena report as the lease liability at the lease's inception?
$900,000 The lessee capitalizes the lease at the lesser of the present value of the minimum lease payments or the fair value of the leased asset at the inception of the lease. Because the fair value of the equipment is less than the present value of the minimum lease payments, Arena Corp. will report a lease liability of $900,000.
377
Which of the following is a criterion for a lease to be classified as a finance lease in the books of a lessee?
The lease contains a bargain purchase option. A bargain purchase option is one of the five criteria for a finance lease to be recorded by the lessee. Only one criterion needs to be met. A bargain purchase option implies that, at inception, the lessee will purchase the asset at the end of the lease term because the option price will be significantly below the market price of the asset at that time. Meet one or more of the following: Lease transfers ownership. Lease contains a bargain purchase option. Lease term is 75% or more of useful life. Present value of minimum lease payments is 90% or more of market value. The asset does not have an alternative use.
378
On January 1, year 1, Frost Co. entered into a 2-year lease agreement with Ananz Co. to lease 10 new computers. The lease term begins on January 1, year 1 and ends on December 31, year 2. The lease agreement requires Frost to pay Ananz two annual lease payments of $8,000. The present value of the minimum lease payments is $13,000. Which of the following circumstances would require Frost to classify and account for the arrangement as a finance lease?
The fair value of the computers on January 1, year 1 is $14,000. There are five criteria for a finance lease. In summary, they are: The lease agreement transfers ownership of the leased asset to the lessee at the conclusion of the lease term (Title transfer). Bargain purchase option Lease term is 75% or more of estimated economic life Present value of minimum lease payments at least 90% of excess of fair value of leased property. The asset does not have an alternative use. This answer meets item #4 above.
379
Which of the following is a characteristic of a finance lease?
The lease contains a bargain purchase option. A bargain purchase option is one of the five finance lease criteria. The option allows the lessee to purchase the asset at the end of the term for significantly less than the estimated market value at that time. Thus, the lease arrangement is considered an installment purchase because the lessee is expected to exercise the option. Meet one or more of the following: Lease transfers ownership. Lease contains a bargain purchase option. Lease term is 75% or more of useful life. Present value of minimum lease payments is 90% or more of market value. The asset does not have an alternative use.
380
Lease M does not contain a bargain purchase option, but the lease term is equal to 90% of the estimated economic life of the leased property. Lease P does not transfer ownership of the property to the lessee at the end of the lease term, but the lease term is equal to 75% of the estimated economic life of the leased property. How should the lessee classify these leases? Lease M Lease P
Lease M - Finance lease Lease P - Finance lease Both are finance leases. The relevant criterion for a finance lease in this question is: If the lease term is equal to or greater than 75% of the remaining useful life of the asset at the inception of the lease, then the lease is a finance lease. Only one of five criteria must be met for a lessee to account for the lease as a finance lease. Transfer of ownership is not required. The rationale for this criterion is that if 75% of the useful life is used by the lessee, then substantially all of the rewards and obligations of ownership have been passed to the lessee.
381
What rate is the lessee required to use to calculate | the present value of a capital lease?
Lower of implicit rate or incremental | borrowing rate
382
List the items included at present value in a lease | liability balance for lessee.
Annual lease payments Bargain purchase option Lessee guarantee of residual less the expected residual value of the asset at the end of the lease
383
What is the amount on which a lease payment is | based for a simple financing lease (DFL)?
Fair value of asset leased
384
To which party does a direct financing lease or sales type lease distinction make a difference on accounting for the lease?
It makes a difference for the lessor only.
385
Koby Co. entered into a finance lease with a vendor for equipment on January 2 for 7 years. The equipment has no guaranteed residual value. The lease required Koby to pay $500,000 annually on January 2, beginning with the current year. The present value of an annuity due for 7 years was 5.35 at the inception of the lease. What amount should Koby capitalize as leased equipment?
$2,675,000 The amount to be capitalized is the present value of the lease payments. This amount is $2,675,000 ($500,000 × 5.35) and should be equal to the market value of the equipment if the useful life is also 7 years. Although $3,500,000 (7 × $500,000) will be paid by Koby over the lease term, the difference between that amount and $2,675,000 represents interest to be recognized over the term. The $2,675,000 amount is the current sacrifice required to obtain the use of the equipment and should be close to the purchase price if the equipment is available by purchase. If Koby invested that amount at the interest rate implied in the lease, the investment would be sufficient to cover all seven payments.
386
Steam Co. acquired equipment under a finance lease for 6 years. Minimum lease payments were $60,000 payable annually at the year's end. The interest rate was 5% with an annuity factor for 6 years of 5.0757. The present value of the payments was equal to the fair value of the equipment. What amount should Steam report as interest expense at the end of the first year of the lease?
$15,227 This lease is capitalized because the present value of the lease payments is 90% or more of the fair value of the asset (in this case, 100%). The capitalized lease liability at inception is $60,000 × 5.0757 = $304,542. Interest expense at the end of the first year is .05 × $304,542 = $15,227. A capitalized lease liability is much like a mortgage note with payments including both principal and interest. The principal portion of the first payment is $60,000 − $15,227, or $44,773.
387
On December 31, 20X5, Neal, Inc. leased machinery with a fair value of $105,000 from Frey Rentals Co. The agreement is a 6-year noncancelable lease requiring annual payments of $20,000 beginning December 31, 20X5. The lease is appropriately accounted for by Neal as a finance lease. Neal's incremental borrowing rate is 11%. Neal knows the interest rate implicit in the lease payments is 10%. The present value of an annuity due of $1 for 6 years at 10% is 4.7908. The present value of an annuity due of $1 for 6 years at 11% is 4.6959. In its December 31, 20X5 balance sheet, Neal should report a lease liability of
$75,816. The $75,816 lease liability at December 31, 20X5 is the initial liability at inception less the first payment, which is completely a principal payment. The first payment occurs at inception and therefore could have no interest component. The initial liability at inception is the present value of an annuity due of six periods. Ending 20X5 lease liability = liability at inception − $20,000 first payment = $20,000(4.7908) − $20,000 = $75,816 The lessee must use the lower of its incremental borrowing rate (11%) and the rate implicit in the lease (10%), hence the use of the 4.7908 present value factor.
388
On January 1, 20X5, Blaugh Co. signed a long-term lease for an office building. The terms of the lease required Blaugh to pay $10,000 annually, beginning December 30, 20X5 and continuing each year for 30 years. The lease qualifies as a finance lease. On January 1, 20X5, the present value of the lease payments is $112,500 at the 8% interest rate implicit in the lease. In Blaugh's December 31, 20X5 balance sheet, the finance lease liability should be
$111,500. The entry at December 31, 20X5: Dr.Interest expense ($112,500 × .08) 9,000 Dr. Lease liability 1,000 Cr. Cash 10,000 The ending lease liability for 20X5 is $111,500 ($112,500 − $1,000 from entry).
389
Jay's lease payments are made at the end of each period. Jay's liability for a finance lease would be reduced periodically by the
Minimum lease payment less the portion of the minimum lease payment allocable to interest. Each lease payment includes interest based on the lease liability at the beginning of the period. The amount of each payment exceeding the interest component is the amount of principal reduction. This amount reduces the lease liability used to compute the interest portion of the next payment. Thus, the interest component decreases with each payment as more principal is paid off.
390
On January 1, 20X4, Harrow Co. as lessee signed a 5-year noncancelable equipment lease with annual payments of $100,000 beginning December 31, 20X4. Harrow treated this transaction as a finance lease. The five lease payments have a present value of $379,000 at January 1, 20X4 based on interest of 10%. What amount should Harrow report as interest expense for the year ending December 31, 20X4?
$37,900 The beginning lease liability balance at 1/1/X4 is $379,000. That balance is unchanged the entire year because the first lease payment is made 1 year later. Therefore, the interest expense for the first year is $37,900 (.10 × $379,000).
391
What sources of income are derived from a salestype | lease for the lessor?
Interest income and gross profit
392
What amount is the lease payment based on for a | simple sales-type lease?
Fair value of asset leased
393
List the amount on which interest expense is based | for first payment, assume ordinary annuity
Lease liability
394
In what period is sales revenue for a sales-type lease | recognized?
Immediate recognition of full sales amount (fair | value of asset)
395
What is the amount of cost of goods sold recognized | on a sales-type lease (STL)?
The amount recognized is book value of the asset | under lease.
396
What is the effect of a sales-type lease on a lessor's | pretax income over the lease term?
Increase by total interest (Sum of lease payments – Fair value of asset) + Gross profit (Fair value of asset – Book value of asset)
397
On December 31, Year 1, Ball Co. leased a machine from Cook for a 10-year period expiring December 30, Year 10. Annual payments of $100,000 are due on December 31. The first payment was made on December 31, Year 1, and the second payment was made on December 31, Year 2. The present value at the inception of the lease for the 10 lease payments discounted at 10% was $676,000. The lease is appropriately accounted for as a finance lease by Ball. In its December 31, Year 2 balance sheet, Ball should report a lease liability of
$533,600. The ending Year 2 lease liability balance is the present value of remaining payments and also equals the initial lease liability amount less the principal portion of the first two payments. The first payment is made at the inception and therefore is all principal. It reduces the lease liability by $100,000. The opening Year 2 lease liability balance is $676,000 − $100,000 or $576,000. Dr. Interest expense .10($576,000) 57,600 Dr. Lease liability 42,400 Cr. Cash 100,000 Thus, the ending Year 2 lease liability balance is $533,600 = $676,000 − $100,000 − $42,400.
398
In a lease that is recorded as a sales-type lease by the lessor, interest revenue
Should be recognized over the period of the lease using the effective interest method. For all sales-type leases, the lessor uses the effective interest method to compute interest over the period of the lease. The interest revenue recognized each period equals the interest rate implicit in the lease multiplied by the beginning net lease receivable.
399
On December 31, 20X5, Day Co. leased a new machine from Parr with the following pertinent information: Lease term 6 years Annual rental payable at beginning of each year $50,000 Useful life of machine 8 years Day's incremental borrowing rate 15% Implicit interest rate in lease (known by Day) 12% Present value of an annuity of one in advance for six periods at: 12% 4.61 15% 4.35 The lease is not renewable, and the machine reverts to Parr at the termination of the lease. The cost of the machine on Parr's accounting records is $375,500. At the beginning of the lease term, Day should record a lease liability of
$230,500. The lease is a finance lease because the lease term of 6 years is 75% of the useful life of the machine (8 years). The lower of the two rates of interest must be used because Day knows the lessor's implicit interest rate. The $230,500 lease liability is the present value of the lease payments = (4.61)$50,000.
400
On December 29, 20X4, Action Corp. signed a 7-year finance lease for an airplane to transport its sports team around the country. The airplane's fair value was $841,500. Action made the first annual lease payment of $153,000 on December 31, 20X4. Action's incremental borrowing rate was 12%, and the interest rate implicit in the lease, which was known by Action, was 9%. The following are the rounded present value factors for an annuity due: 9% for 7 years 5.5 12% for 7 years 5.1 What amount should Action report as lease liability in its December 31, 20X4 balance sheet?
$688,500 Action must use the 9% rate because it is the lower of the two and Action knows the lessor's implicit rate of 9%. The initial capitalized value is $153,000 times the present value of a 7-year annuity due because the first payment is due at inception. Multiplying the 5.5 factor by $153,000 yields the fair value of $841,500, the initial capitalized value before the first payment. After the first payment was made, which is all principal because it was made at the inception, the remaining lease liability is $688,500 ($841,500 − $153,000).
401
Farm Co. leased equipment to Union Co. on July 1, 20X5 and properly recorded the sales-type lease at $135,000, the present value of the lease payments discounted at 10%. The first of eight annual lease payments of $20,000 due at the beginning of each year was received and recorded on July 3, 20X5. Farm had purchased the equipment for $110,000. What amount of interest revenue from the lease should Farm report in its 20X5 income statement?
$5,750 The interest for the first 6 months of the lease term is (1/2).10($135,000 − $20,000) = $5,750. The first lease payment reduces the principal by the full amount of the payment because no time has elapsed since inception (it was paid essentially at the inception of the lease). When the fiscal year is not specified, the student should assume a calendar fiscal year. Therefore, as of 12/31/X5, only 6 months of the term had elapsed.
402
A 6-year finance lease entered into on December 31, 20X5 specified equal minimum annual lease payments due on December 31 of each year. The first minimum annual lease payment, paid on December 31, 20X5, consists of which of the following? Interest expense Lease liability
Interest expense - No Lease liability - Yes The first payment, which is made at inception, is completely a principal payment because no time has elapsed in the lease term. Thus, the entire payment is applied to principal and reduces the lease liability by the amount of the payment.
403
Name two conditions that typically give rise to a | direct financing lease for the lessor.
1. The lease does not meet any of the five lease criteria for a sales-type lease. 2. The residual value is guaranteed by a third party.
404
Describe the process by which the lessor determines the interest rate that is effectively reflected by the lease payments.
The lessor finds the interest rate that will amortize the net lease receivable down to zero based on the annual lease payments, which were determined using the implicit interest rate.
405
Describe how deferred gross profit is calculated.
Deferred gross profit is the difference between the fair value of the asset and the carrying amount of the asset.
406
Define “net lease receivable” in terms of account | relationships.
Net lease receivable = Gross lease receivable – | Deferred gross profit
407
Describe how the amortization of deferred gross | profit is calculated.
The lessor calculates the interest on the gross lease receivable based on the implicit interest rate (given in the problem). Then the lessor calculates the interest based on the effective interest rate multiplied by the net lease receivable. The difference between the interest calculations is the amount of deferred gross profit amortized during the period.
408
At the end of a lease in which a third party guarantees the residual value (RV), describe the journal entries associated with the possible outcomes.
If the residual value of the leased assets is equal to or greater than the guaranteed residual value, then the following journal entry is recorded: Dr. Equipment/Inventory XX  Cr. Lease Receivable XX If the residual value is less than the guaranteed residual value, then the third-party guarantor will provide consideration for the difference in amount. Dr. Equipment/Inventory XX Dr. Cash (diff. between GRV and RV) XX   Cr. Lease Receivable XX
409
On January 1, Year 1, Bear Company leased an asset to Cub Company and appropriately accounted for the lease as a direct financing lease. The asset has a fair value of $36,000 and a carrying amount of $30,000. The lease has an implicit rate of 6% and a third-party guaranteed residual value of $5,000. The lease term is three years, and the asset has a five-year useful life. Lease payments of $11,897 are due at the end of the year, and the present value factor of an ordinary annuity at 6% for three years is 2.67301. The present value of a single sum at 6% and three years is .83962. Assume a rate of 15.85% amortizes the net lease receivable to zero over the lease term. What amount should Bear record as the amortization of deferred gross profit associated with the first lease payment made December 31, Year 1?
$2,595 Bear records a net lease receivable of $30,000 and uses an effective interest rate of 15.85%. Bear calculates interest associated with the net receivable of $4,755. Bear also calculates interest based on the gross lease receivable ($36,000) and the implicit interest rate of 6%. Interest associated with the gross lease receivable is $2,160. The amortization of the deferred gross profit is $2,595 ($4,755 – $2,160).
410
On January 1, Year 1, Bear Company leased an asset to Cub Company and appropriately accounted for the lease as a direct financing lease. The asset has a fair value of $36,000 and a carrying amount of $30,000. The lease has an implicit rate of 6% and a third-party guaranteed residual value of $5,000. The lease term is three years, and the asset has a five-year useful life. Lease payments of $11,897 are due at the end of the year, and the present value factor of an ordinary annuity at 6% for three years is 2.67301. The present value of a single sum at 6% and three years is .83962. Assume a rate of 15.85% amortizes the net lease receivable to zero over the lease term. What amount should Bear record as the lease revenue associated with the first lease payment made December 31, Year 1?
$4,755 The lease revenue is calculated based on the net lease receivable and the interest rate that effectively amortizes the net lease receivable to zero at the end of the lease term. Bear has a net lease receivable of $30,000 and an interest rate to apply of 15.85%. $30,000 multiplied by 15.85% equals $4.755.
411
Direct financing leases typically have a
Residual value guaranteed by a third-party. For a lease to qualify as a direct financing lease, the residual value is usually guaranteed by a third party. A direct financing lease does not meet any of the lease criteria used to classify a sales-type lease. A direct financing lease does not meet any of the lease criteria used to classify a sales-type lease. Typically, when the residual value is guaranteed by the lessee, the lease meets the present value test (90%). A bargain renewal option would effectively extend the lease term, likely meeting the lease criteria associated with the majority of the asset's useful life (75% test).
412
The interest rate applied to the net lease receivable is
The rate that amortizes the net lease receivable to zero at the end of the lease term. The lessor must determine the rate that will amortize the net lease receivable to zero by the end of the lease term. The lessor applies the implicit rate to the gross lease receivable. The incremental borrowing rate may be used by lessee's under certain circumstances. The question focuses on the lessor. The lessor does not focus on amortizing the gross lease receivable to zero because it includes the residual value.
413
Define a “sale-leaseback transaction.”
The owner of property sells its asset and | immediately leases it back.
414
Describe the conditions of a failed sale.
If a seller-lessee sells an asset but control does not effectively pass to the buyer-lessor, then revenue recognition criteria have not been met. The sellerlessee may not account for the transaction as a sale and instead must account for the transaction as a financing transaction.
415
From a seller-lessee's perspective, what types of | leases are most likely to follow in a sale-leaseback?
A short-term lease or an operating lease, not a | finance lease
416
How does a seller-lessee calculate the gain or loss on | the sale of an asset that it immediately leases back?
The transaction is recorded in the same manner as any other sale transaction of an asset. Dr. Cash XX Dr. Accumulated Depreciation XX Cr. Equipment XX Cr. Gain XX The above journal entry assumes a gain. A gain or loss is calculated based on the difference between the sales price and the carrying amount of the asset.
417
After a sale-leaseback transaction, which party | depreciates the asset?
Buyer-lessor The buyer-lessor now owns and controls the asset. They record the asset on their books and record depreciation expense.
418
On December 31, Year 1, Bain Corp. sold a machine to Ryan and simultaneously leased it back for 1 year. Pertinent information at this date follows: Sales price $360,000 Carrying amount $330,000 Present value of reasonable rentals 34,100 Estimated remaining useful life 12 years In Bain's December 31, Year 1 balance sheet, the deferred revenue or gain from the sale of this machine should be:
$0. The transaction appears to meet the criteria of a sale, so Bain will recognize a gain of $30,000 on the sale of the equipment on the date of the sale. None of the gain is deferred.
419
Able sold its headquarters building at a gain and simultaneously leased back the building. The lease met the criteria for a finance lease. At the time of sale, the gain should be reported as
No gain reported. Because the lease meets the finance lease criteria, the buyer-lessor has not taken control of the asset. Able will account for the transaction as a failed sale and effectively record the effects as a financing transaction as opposed to a sale-leaseback.
420
In a sale-leaseback transaction, the seller-lessee has leased back the asset and has retained physical possession of the property. The gain on the sale should be recognized at the time of the sale-leaseback when the lease is classified as a(n) Finance Lease Operating Lease
Finance Lease - No Operating Lease - Yes If the leaseback is classified as an operating lease by the seller-lessee, then control of the asset has likely passed to the buyer-lessor and the revenue recognition criteria are met. The seller-lessee may recognize the gain at the time of the sale.
421
The following information pertains to a sale and leaseback of equipment by Mega Co. on December 31, Year 1: ``` Sales price $400,000 Carrying amount $300,000 Monthly lease payment $3,250 Present value of lease payments $36,900 Estimated remaining life 25 years Lease term 1 year Implicit rate 12% ``` What amount of gain on the sale should Mega report at December 31, Year 1?
$100,000 The transaction appears to meet the sale criteria for a sale-leaseback. Assuming the buyer-lessor paid cash for the asset and pretending the asset had a cost of $500,000 and accumulated depreciation of $200,000 (made-up numbers to illustrate the journal entry), Mega would record a $100,000 gain and the following journal entry at the time of the sale transaction: Dr. Cash $400,000 Dr. Accumulated depreciation $200,000   Cr. Equipment $500,000   Cr. Gain on sale $100,000
422
The following information pertains to a sale and leaseback of equipment by Mega Co. on December 31, Year 1: ``` Sales price $400,000 Carrying amount $300,000 Monthly lease payment $3,250 Present value of lease payments $36,900 Estimated remaining life 25 years Lease term 1 year Implicit rate 12% ``` What amount should the buyer-lessor record for the purchase of the equipment?
$400,000, the sales price The buyer-lessor just purchased the asset for $400,000. This will serve as the cost basis of the asset at the onset of ownership.
423
A lessor recording the journal entry at the inception of a sales-type lease will subtract the present value of the unguaranteed residual value from which two accounts?
Cost of Goods Sold | Sales Revenue
424
A lessee recording amortization of a right-of-use asset will use the lease term to amortize the asset unless…
…the remaining useful life of the asset is shorter than the lease term. Study hint: This would be an unlikely scenario. Expect to see the vast majority of right-of-use assets amortized over the lease term by the lessee.
425
How does a lessee account for a lease with a bargain | purchase option?
The bargain purchase option is accounted for in a manner similar to a guaranteed residual value. The present value of the bargain purchase option is included in the lease liability.
426
How does a lessee account for initial direct costs?
If the cost is an initial direct cost, then it is included in the right-of-use asset amount and amortized over the life of the lease. An initial direct cost does not add to the lease liability. An example of an initial direct cost is a document preparation fee associated with a lease that has been executed.
427
How does a lessee account for variable lease payments when the amount of the variable payment changes from period to period and is unknown at the inception of the lease?
Because the amount of the variable lease payments and the fluctuation in the payment are unknown, the lessee will expense the variable amount in the period incurred.
428
Louie the lessee leased an asset for a three-year lease term. Louie appropriately accounted for the lease as a finance lease and recorded a right-of-use asset for $45,000. The asset has a useful life of four years. How much amortization expense should Louie record each year?
$15,000 Louie will amortize the asset over the shorter of the lease term or useful life. In this question, the lease term is shorter at three years. The right-of-use asset divided by the three-year lease term results in $15,000 amortization expense each year ($45,000 / 3-year lease term).
429
Lessee and lessor entered into a lease. The lease is classified as an operating lease by both the lessee and lessor. The lease term is shorter than the useful life of the asset. How will the leased asset be accounted for?
The lessor will retain the asset on its books and record depreciation expense over the asset's useful life. Because the lease is an operating lease for the lessor, the lessor maintains the asset on its books and continues to depreciate it using an acceptable depreciation method.
430
When accounting for an initial direct cost, the lessee will
Include the initial direct cost at its cost in the calculation of the right-of-use asset. A cost that qualifies as an initial direct cost will be included in the lessee's calculation of the right-of-use asset at its costs because these costs occur around the time of execution of the lease. Because the costs are included in the right-of-use asset amount, they are effectively amortized over the lease term as the right-of-use asset is amortized.
431
When accounting for a bargain purchase option, the lessee will
Include the bargain purchase option at its present value using a single-sum present value factor in the calculation of the lease liability at the inception of the lease. The lessee treats a bargain purchase option as an expected one-time (or single) payment occurring at the end of the lease. The lessee applies the present value factor to the bargain purchase option amount and includes that amount in the lease liability at the inception of the lease.
432
A lessor enters a sales-type lease with an unguaranteed residual. The lessor will record
A credit to sales revenue for the fair value of the asset less the present value of the unguaranteed residual value. The lessor will subtract the present value of the unguaranteed residual value from both the cost of goods sold (debit) and the sales revenue (credit).
433
List the four broad categories of not-for-profit | organizations.
1. Hospitals and other health care entities 2. Colleges and universities 3. Voluntary health and welfare organizations 4. Other not-for-profit organizations
434
What authoritative body has jurisdiction over private | not-for-profit organizations?
The Financial Accounting Standards Board (FASB)
435
Which one of the following is a voluntary health and welfare organization?
Charity raising money for underprivileged children Nursing home, Clinic, Hospital are all health care organizations.
436
Nongovernmental not-for profit organizations that wish to follow generally accepted accounting principles in the preparation of their financial statements should follow
FASB standards. The Financial Accounting Standards Board (FASB) sets accounting standards for not-for-profit and for-profit organizations.
437
Nongovernmental not-for-profit organizations are required to report their financial statements on
An economic resources measurement focus. Nongovernmental not-for-profit organizations use full accrual accounting and the flow of economic resources measurement focus.
438
The primary standards-setting body for a public museum that receives the majority of its funding from local property taxes is the
Governmental Accounting Standards Board (GASB). A museum that receives the majority of its funding from property taxes is most likely a part of a city government and will be subject to accounting and reporting standards established by the Governmental Accounting Standards Board (GASB).
439
List the three financial statements that are required | for all private not-for-profit organizations.
1. Statement of financial position 2. Statement of activity (operations) 3. Statement of cash flows
440
List the two categories of a not-for-profit | organization's net assets.
1. Net assets without a donor restriction | 2. Net assets with a donor restriction
441
List the two broad classifications for expenditures | within a not-for-profit organization.
1. Program services | 2. Supporting services
442
List the two subclassifications of expenditures for supporting services within a not-for-profit organization.
1. Management and general | 2. Fund raising
443
In what net asset categories are operating expenses | recognized by a private not-for-profit organization?
Net assets without a donor restriction. Expenses are not recognized in the net assets with a donor restriction category.
444
List two types of temporary restrictions for private | not-for-profit organizations.
1. Time restrictions, when the donor stipulates that the resources must be spent in a certain time period 2. Purpose restrictions, when the donor stipulates that the resources must be spent on a specific manner
445
Describe the accounting entry for a not-for-profit organization that has a donor restriction of $5,000 satisfied.
The entry is a reclassification. "Net assets released from restrictions" is reported as a $5,000 decrease in the revenue section of net assets with a donor restriction and as a $5,000 increase in the revenue section of net assets without a donor restriction.
446
Where can a not-for-profit (NFP) organization report | the nature and function of its expenses?
There are three options: on the face of its statement of operations, as a schedule in the notes to the financial statements, or as a separate financial statement. Note that prior to ASU 2016–14, only Voluntary Health and Welfare Organizations (VHWO) were required to report functional expenses. Now all NFP organizations are required to include this information.
447
Kind Nurses Assoc. is a voluntary health and welfare organization. Nurses are paid to visit homes of elderly people and are reimbursed for mileage and supplies. Which of the following items should Kind record as a support activity expense in its statement of functional expense?
Fundraising costs. Support activities include general administration and fundraising expenses. The nurses’ mileage cost, employee benefits, and supplies are expenses necessary to visit the elderly that further the mission of the organization and are classified as a part of “program services” in the statement of functional expenses.
448
Which of the following financial statements would provide information about the ongoing revenues and expenses associated with a voluntary health and welfare organization?
The statement of activities. The statement of activities is the operating statement for all not-for-profit organizations, which includes voluntary health and welfare organizations.
449
What is the appropriate characterization of the net assets of a nongovernmental not-for-profit organization?
Residual interest. Not-for-profit organizations do not have owners and, therefore, the difference (residual) between assets and liabilities is referred to as “net assets.”
450
A voluntary health and welfare organization had the following asset inflows: ``` Cash gifts $40,000 Membership dues 8,000 Dividend income 5,000 Interest income 3,000 Donated supplies 2,000 How should these items be reported? ``` ``` Revenues Public Support A. $16,000 $42,000 B. $2,000 $56,000 C. $56,000 $2,000 D. $10,000 $48,000 ```
Row A Revenues are membership dues, dividend income, and interest income for a total of $16,000. Public support consists of cash gifts and donated supplies for a total of $42,000.
451
Which of the following is required for private, not-for-profit organizations?
Statement of financial position, statement of activities, and a statement of cash flows FASB ASC 958 requires a statement of financial position, a statement of activities, and a statement of cash flows for private, not-for-profit organizations. Moreover, all not-for-profit organizations must report expenses by nature and function in one place: on the face of the statement of activities, as a schedule in the notes to the financial statements, or as a separate financial statement.
452
The statement of financial position for a private, not-for-profit college should show separate dollar amounts for:
Net assets without donor restriction, net assets with donor restriction, and total net assets. FASB ASC 958–210–45–1, Not-for-Profit Entities, requires separate dollar amounts for net assets without donor restriction, net assets with donor restriction, and total net assets.
453
Smith College, a private, not-for-profit college, received the following cash inflows: Cash contributions of $200,000 to be permanently invested Cash dividends and interest of $10,000 restricted for long-term purposes How would these cash inflows be disclosed on the Smith College cash flow statement?
$210,000 from financing activities The $200,000 cash contribution is a financing activity because it has been donor restricted for the long term. Related interest and dividends that are donor restricted for long-term purposes are also shown as cash receipts from financing activities.
454
The cash flows from operating activities section of the cash flow statement for a private, not-for-profit college using the indirect method would begin with
Total changes in net assets. Under the indirect method, the cash flow statement would begin with total changes in net assets. Conversely, using the direct method, we begin with the cash flows from operating activities section. Please note that following ASU 2016–14, the reconciliation of direct method to the indirect method is no longer required for those using the direct method. (It was required prior to ASU 2016–14.)
455
An unrestricted cash contribution should be reported in a nongovernmental not-for-profit organization's Statement of Cash Flows as an inflow from
Operating Activities. Unrestricted cash contributions should be included in the Operating Activities section of the Statement of Cash Flows, along with unrestricted investment earnings, revenue restricted for operating purposes (Program Restrictions), revenue from exchange transactions, and operating expenditures (salaries, supplies, interest expense), including grants to other organizations Investing Activities. This section includes inflows and outflows from the sale of capital assets and investment assets. Financing Activities. This section includes contributions and investment revenues restricted for long-term purposes (e.g., restrictions for acquisition of capital assets, endowments) and debt-related activities (debt proceeds, repayments, lease payments, etc.) Capital and Related Financing Activities. The Statement of Cash Flows for not-for-profit organizations does not have a "Capital and Related Financing Activities" section (this section is found in the Statement of Cash Flows for governmental entity's Proprietary Funds)
456
A voluntary health and welfare organization received a $700,000 permanent endowment in a prior year. The donor stipulated that the income and investment appreciation be used to maintain its senior center. In the current year, the endowment fund reported a net investment appreciation of $80,000 and investment income of $50,000. The organization spent $60,000 to maintain its senior center during the year. What amount of change in net assets with donor restriction should the organization report?
$70,000 Gains on the principal of an endowment, whether realized or unrealized, are normally not available for expenditure and are consequently not recognized as income. However, in this instance, the trust agreement stipulates that both the income and appreciation on the investment are to be used for support. Because of this, both the investment income of $50,000 and the net investment appreciation of $80,000 increase net assets with donor restriction; net assets with donor restriction would be decreased by the $60,000 spent to maintain the senior center. The $700,000 endowment principal would have been recognized in the year of the donation as part of net assets with donor restriction. The remaining $70,000 increase in correctly reflects the changes for the period.
457
Which of the following assets of a nongovernmental not-for-profit charitable organization must be depreciated?
A freezer costing $150,000 for storing food for the soup kitchen The freezer is classified as equipment and therefore must be depreciated. Although the building will ultimately be depreciated, depreciation does not begin until the asset is completed. Construction in progress is not a depreciable asset. Land is not a depreciable asset. Linens, even when purchased in a large quantity such as this, are short-lived assets and expensed when placed into service.
458
A nongovernmental not-for-profit organization borrowed $5,000, which it used to purchase a truck. In which section of the organization's Statement of Cash Flows should the transaction be reported?
In cash inflow from financing activities and cash outflow from investing activities The structure of the Statement of Cash Flows for a not-for-profit organization is identical to that of a for-profit organization: debt proceeds are reported as cash inflows under financing activities, and purchases of capital assets are reported as cash outflows under investing activities.
459
A nongovernmental not-for-profit organization's Statement of Activities is similar to which of the following for-profit financial statements?
Income statement According to ASC 958–205–5–5, the Statement of Activities for not-for-profit organizations is the financial statement that is issued instead of a business entity's income statement.
460
Arkin Corp. is a nongovernmental not-for-profit organization involved in research. Arkin's Statement of Functional Expenses should classify which of the following as support services?
Salaries of fund-raisers for funds used in research The Statement of Functional Expenses requires that expenses be reported by functional classification as either (a) program related or (b) support service related. Support expenses include management, general administrative, and fund-raising expenses required to operate. Program expenses are directly related to the program or mission of the organization. The salaries of researchers, cost of equipment used in research, and cost of laboratory supplies used in research are all examples of program expenses. The salaries of fund-raisers for funds used in research are support expenses because their efforts are not directly related to conducting the research itself.
461
Birdlovers, a community foundation, incurred $5,000 in management and general expenses during Year 1. In Birdlovers' Statement of Activities for the year ending December 31, Year 1, the $5,000 should be reported as
Part of supporting services. Expenses for not-for-profit organizations fall into two broad categories: (1) program services and (2) supporting services. Expenses for program services are incurred because of the stated mission of the not-for-profit. All other expenses fall under the supporting services classification. The $5,000 in management and general expenses should be reported as part of supporting services.
462
Describe the general revenue recognition rule for | contributions.
In general, contributions are recognized as revenue in the period when the contribution is made, regardless of whether they are received in cash or not.
463
What is the journal entry to record receipt of $100,000 in pledges when it is estimated that 20% of the pledges will be uncollectible?
DR: Pledges Receivable $100,000 CR: Est. Uncollectible Pledges $20,000 CR: Contribution (Revenue) $80,000
464
What value is used to record donated capital assets?
Fair market value at the date of donation
465
List the three conditions that must be met in order | for assets to be classified as "collectibles."
Held for public exhibition, education, or research rather than financial gain Protected, kept unencumbered, cared for, and preserved Subject to a policy that requires proceeds from sales of collection items to be used to acquire other items for collections
466
When is a contribution of services recognized?
It is recognized if the services require special skills, the person providing the services possess those skills, and the services would have been purchased if not obtained by donation.
467
List the characteristics of a contribution.
Unconditional Voluntarily made Nonreciprocal Not made by an owner
468
When are conditional promises to give recognized?
They are recognized when the conditions are substantially met or the likelihood of the conditions not being met is remote.
469
List the five types of governmental funds. (Tip: DRIP | CEG PIPPA, consonants in DRIP CEG.)
``` General fund Special revenue funds Capital project funds Debt service funds Permanent funds ```
470
A donor gave $15,000 to a not-for-profit organization and specified a beneficiary (a particular individual) to receive the funds. What must the not-for-profit organization possess in order to recognize the $15,000 as a contribution?
Variance power. The not-for-profit (NFP) must have the ability to set aside the donor restriction (e.g., redirect the resources to another beneficiary or revoke the restriction). The NFP would recognize a liability if it does not have variance power.
471
When should a conditional pledge to a nongovernmental not-for-profit organization be recognized as revenue?
When the pledge conditions are met. Contribution revenue is recognized when the following characteristics occur: a “condition” does not exist or has been met, it is not part of an exchange transaction, it is made voluntarily, and it does not involve an ownership interest. This answer is correct because the pledge condition (perhaps a condition to “match” the pledge) has been met. Contribution revenue recognition is not tied to the timing of cash collections.
472
Clay University, a not-for-profit university, earned $300,000 from bookstore revenue and spent $100,000 for faculty research in 20X1. The $100,000 for faculty research came from a $150,000 research grant received in the previous year. What is the effect of these events on net assets without a donor restriction in 20X1?
Increase $300,000. The $300,000 in bookstore revenue increased net assets without a donor restriction by $300,000. The $100,000 spent came from a net assets with a donor restriction. The $100,000 expense (decrease) and $100,000 amount "released" from donor restriction (increase) will appear in the net asset without a donor restriction section.
473
On December 31, Year 1, the board of trustees of a private, not-for-profit college designated $1,000,000 of net assets without a donor restriction for the construction of an addition to the gymnasium. What effect does this designation have on the college's net assets shown on the statement of financial position on December 31, Year 1? ``` Net Assets without a Donor Restriction Net Assets with a Donor Restriction A. No effect No effect B. Decrease Increase C. Decrease No effect D. No effect Increase ```
Row A Because the restriction is an internal, not an external, restriction, the classification of net assets without a donor restriction does not change.
474
On the statement of activities for a private, not-for-profit entity, the account net assets released from restrictions would be shown under revenues, gains, and other support as a
Decrease in net assets with a donor restriction and increase in net assets without a donor restriction. Net assets released from restrictions would cause a decrease in net assets with a donor restriction and an increase in net assets without a donor restriction.
475
Home Care, Inc. (Home Care), a nongovernmental voluntary health and welfare organization, received two contributions in 20X3. One contribution of $250,000 was restricted for use as general support in 20X4. The other contribution of $200,000 carried no donor restrictions. What amount should Home Care report as contributions with a donor restriction in its 20X3 statement of activities?
$250,000 Because the $250,000 cannot be spent until 20X4, a time restriction applies, and the contribution would be classified as net assets with a donor restriction in the 20X3 financial statements. The $200,000 contribution is not restricted and would be reported as contributions without a donor restriction.
476
Glen Hope, a voluntary health and welfare organization, received a cash donation from George Swinney to purchase equipment for the organization's kitchen. The donation was received in 20X1, but the equipment was not purchased until 20X2. For 20X1, Glen Hope should report the donation on the statement of activities as
Contributions with a donor restriction. Since the donation was not spent in the current year, it should be considered a contribution with a donor restriction. When the equipment is purchased in 20X2, the amount will be "released" from donor restriction as an increase in net assets without a donor restriction and a matching decrease amount in net assets with a donor restriction.
477
The Jones family lost its home in a fire. On December 25, 20X4, a philanthropist sent money to the Amer Benevolent Society to purchase furniture for the Jones family. During January 20X5, Amer purchased this furniture for the Jones family. How should Amer, a not-for-profit organization, report the receipt of the money in its 20X4 financial statements? As a(n):
Liability. The contribution received was a donation to be delivered to another beneficiary. Amer is the intermediary; therefore, the cash contribution is recorded as a liability at year-end.
478
Oz, a nongovernmental not-for-profit organization, received $50,000 from Ame Company to sponsor a play given by Oz at the local theater. Oz gave Ame 25 tickets, which generally cost $100 each. Ame received no other benefits. What amount of ticket sales revenue should Oz record?
$2,500 Because Ame received tickets in connection with its contribution to Oz , the transaction must be treated partly as an exchange transaction and partly as a contribution. Oz must recognize Revenue equivalent to the value of the goods or services provided to Ame (25 tickets × $100 = $2,500). Oz and Ame must each deduct the value of the goods or services exchanged from the total amount received/contributed to arrive at the amount to be recognized as a charitable contribution ($50,000 − $2,500 = $47,500). Journal Entry: Cash 50,000 Ticket Sales Revenue 2,500 Contributions Revenue 47,500
479
Janna Association, a nongovernmental not-for-profit organization, received a cash gift with the stipulation that the principal be held for at least 20 years. How should the cash gift be recorded?
As a net asset with a donor restriction Since the resources must be retained for 20 years, they must be reported under a restricted classification of net assets. However, because they are not permanently restricted but may ultimately be expended, they should be recorded as a temporarily restricted asset rather than a permanently restricted asset.
480
Which of the following contributions would not have to be reported as an asset on the Statement of Financial Position of a not-for-profit organization?
An art collector donated a famous oil painting to a local nongovernmental art museum for display in its exhibit hall. Collections (i.e., inexhaustible fixed assets) donated to a not-for-profit organization do not need to be capitalized. Three conditions must be met: (1) the asset is held for public exhibition, education, or research rather than financial gain; (2) the asset must be protected, unencumbered, cared for, and preserved; and (3) the asset is subject to a policy that requires proceeds from sales of collection items to be used to acquire other items for the collection. Only the famous painting donated for display appears to meet these three conditions.
481
How should a nongovernmental not-for-profit organization report depreciation expense in its Statement of Activities?
It should be included as a decrease in net assets without a donor restriction. It should be included as a decrease in net assets without a donor restriction. ASC 958-360-35 requires depreciation of capital assets by not-for-profit organizations. Depreciation expense is allocated to programs and therefore is a decrease in net assets without a donor restriction. The answer that depreciation is not included is incorrect because ASC 958-360-35 requires depreciation. The other two answers are incorrect choices that are based on the option, which was eliminated by ASU 2016-14, for a not-for-profit organization to adopt a policy of an implied time restriction on gifts of long-term assets.
482
Whitestone, a nongovernmental not-for-profit organization, received a contribution in December Year 1. The donor restricted use of the contribution until March Year 2. How should Whitestone record the contribution?
Report as income in Year 1. The contribution has a time restriction and will be recognized contribution revenue in the net assets with a donor restriction category for Year 1. When the time restriction is met in Year 2, the amount will be recorded as a decrease in net assets with a donor restriction and as an increase in net assets without a donor restriction—essentially a reclassification of net assets.
483
During the current year, the local humane society, a nongovernmental not-for-profit organization, received a $100,000 permanent endowment from Cobb. Cobb stipulated that the income must be used to care for older horses that can no longer race. The endowment reported income of $8,000 in the current year. What amount of contribution revenue without a donor restriction should the humane society report for the current year?
$0 The $100,000 endowed is recognized as contribution revenue in the net asset with a donor restriction category. The $8,000 current-year earnings on the endowment are recognized in the net asset with a donor restriction category because there is a purpose (use) restriction. As expenses related to the care for older horses occur, an amount equal to those expenses will be reclassified (i.e., "released") from net assets with a donor restriction to net assets without a donor restriction to offset the expenses.
484
A nongovernmental not-for-profit organization received a $2 million gift from a donor who specified it be used to create an endowment fund that would be invested in perpetuity. The income from the fund is to be used to support a specific program in the second year and beyond. An investment purchased with the gift earned $40,000 during the first year. At the end of the first year, the fair value of the investment was $2,010,000. What is the net effect on net assets with a donor restriction at year end?
$2,050,000 increase The $2,000,000 gift is permanently invested and will be reported as part of net assets with a donor restriction. The income is dedicated to a specific program starting in Year 2. Therefore, in Year 1 all the income and the change in fair value of the investment are restricted by the donor as to time, so $50,000 is also classified as net assets with a donor restriction in the first year. In Year 2, the $50,000 will be reclassified from net assets with a donor restriction to net assets without a donor restriction.
485
On January 1, Read, a nongovernmental not-for-profit organization, received $20,000 and an unconditional pledge of $20,000 for each of the next four calendar years to be paid on the first day of each year. The present value of an ordinary annuity for four years at a constant interest rate of 8% is 3.312. What amount of net assets with a donor restriction is reported in the year the pledge was received?
$ 66,240 The $20,000 received on January 1 is a contribution in that year and is an increase in net assets without a donor restriction. The pledge in the next four years is a net asset with a donor restriction as to time and is recognized at the net present value ($20,000 × 3.312 = $66,240).
486
Which of the following types of information would be included in total net assets in the statement of financial position for a nongovernmental not-for-profit organization?
Net assets with a donor restriction, net assets without a donor restriction, and total net assets ASC 958-201-45-1 requires three categories of net assets: (1) net assets with donor restrictions, (2) net assets without donor restrictions, and (3) total net assets (i.e., 1 plus 2). This is a major change found in ASU 2016-14, which replaced the three categories of net assets previously used (permanently, temporarily, and unrestricted net assets). which is the answer given here.
487
Lea Meditators is a not-for-profit religious organization. A storm broke glass windows in Lea's building. A member of Lea's congregation, a professional glazier, replaced the windows at no charge. In Lea's Statement of Activities, the breakage and replacement of the windows should
Be reported as an increase in both expenses and contributions. ASC 958-605-25-16 requires nongovernmental not-for-profits to account for contributions received at fair value as revenues or gains, assets, decreases in liabilities, or expenses. When the contribution takes the form of donated services, it can only be recognized if the services donated require specialized skills, are provided by individuals possessing those skills, and would have been purchased if not donated. In the case at hand, the broken windows were replaced by a professional glazier (a person who sets glass). If the glazier had not donated his services, then Lea Mediators would have hired someone to replace the broken windows. The conditions for recognizing the donated services as a contribution have been met. Lea would make the following entry, which would be reflected in the Statement of Activities. Expenses xxx Revenues - Contributions xxx
488
Define "term endowments."
Gifts and bequests from third parties that are to be retained and invested for a period of time or until a specific event occurs, but after the criterion has been met, the full amount can be spent.
489
How are special event revenues and direct costs | reported?
Revenues and direct costs are reported at gross amounts. Expenses to promote the event, such as printing and mailing, are treated as fund-raising and are not charged against the special event.
490
Define “underwater” endowments and how they are | reported in the financial statements.
An endowment is underwater when its fair value is less than the original gift or a level set by the donor or by law. The amount underwater is disclosed in the net assets with a donor restriction of the statement of financial position.
491
When are donated long-term assets recognized?
When they are placed in service. Note: ASU 2016-14 removed the option for not-for-profits to have a policy to “imply” a time restriction on donated longterm assets.
492
CIBA, a nonprofit performing arts organization, received a contribution of a term endowment and a regular endowment from two external donors. These endowments should be reported on the statement of activities as: Term Endowments Regular Endowments A. Temporarily restricted Permanently restricted B. Net assets with Net assets with donor restriction donor restriction C. Temporarily restricted Temporarily restricted D. Net assets without Net assets with donor restriction donor restriction
Row B Both endowments are part of net assets with donor restriction. The term endowment allows a portion of the principal to be spend each period. The regular endowment does not allow any of the principal to be spent. Following ASU 2016-14, both endowments are donor-restricted net assets when the contributions were made.
493
Which of the following terms is used to indicate that a donor provided a gift with explicit instructions that the gift is to be used for a specific purpose by the not-for-profit organization but the entire amount may be spent right away?
Net assets with donor restriction This is an example of a use restriction for which the gift will be recognized as an increase in net assets with donor restriction at the time of the gift.
494
Securities donated to an NPO should be recorded at the
Fair value at the date of the gift. Donated securities are reported at fair value at the time of donation.
495
Investments in equity securities that have a readily determinable market value and all debt securities of a not-for-profit organization are reported at
Fair value. According to ASC 958-320-35-1, not-for-profit organizations report their investment in debt securities and equity securities at fair value.
496
A nongovernmental not-for-profit organization received the following donations of corporate stock during the year: Donation I Donation II Number of shares 2,000 3,000 Adjusted basis $8,000 $5,500 Fair value at time of donation 8,500 6,000 Fair value at year-end 10,000 4,000 What net value of investments will the organization report at the end of the year?
$14,000 ASC 958-650-30-2 requires donated securities to be initially recorded at their fair value on the date of the gift and to be reported at their market value at the financial reporting date (at the end of the year).
497
How should a nongovernmental not-for-profit organization classify gains and losses on investments purchased with net assets with donor restrictions?
Unless explicitly restricted by donor or law, gains and losses should be reported in the statement of activities as increases or decreases in net assets without donor restriction. If the donor placed restrictions on the use of gains (purpose or time restrictions), the gains are temporarily restricted until the restriction is met. If there are no restrictions, the gains and losses are unrestricted. Revenues and expenses that must be reported should be reported separately but gains and losses may be reported net.
498
At which of the following amounts should a nongovernmental not-for-profit organization report investments in debt securities?
Quoted market prices Unlike for-profit entities, not-for-profit entities do not break debt securities into trading, available-for-sale, and held-to-maturity categories. Following ASC 958-320-35-1, not-for-profits value debt securities at fair value (quoted market price).
499
Define "capitation fees."
Payments made to health care providers for comprehensive client coverage provided for a fixed fee (e.g., health maintenance organizations).
500
List the net asset categories for a not-for-profit | hospital.
Net assets without a donor restriction | Net assets with a donor restriction
501
How is charity care recognized in the financial | statements of a not-for-profit hospital?
It is not recognized (not as revenues, receivable, or bad debt in the financial statements of a not-forprofit hospital). Charity care is reported in the notes to the financial statements, however.
502
List the financial statements required by a not-forprofit hospital.
1. Balance sheet 2. Statement of operations 3. Statement of cash flows
503
List the financial statements required by a | governmental hospital.
1. Balance sheet 2. Statement of revenues, expenses, and changes in net position 3. Statement of cash flows
504
Are cash flows from noncapital financing activities and cash flows from capital and related financing activities required for governmental healthcare agencies and not-for-profit healthcare agencies?
Cash flows from noncapital financing activities and cash flows from capital and related financing activities are required sections of the cash flow statement for governmental health care agencies. Not-for-profit healthcare agencies report cash flows from financing activities (a single category).
505
How are "contractual adjustments" reported by | healthcare organizations?
Contractual adjustments are a contra account deducted from patient service revenues in deriving net patient service revenues, which is the first line in the statement of operations for a healthcare organization.
506
The Johnson Hospital, a private, not-for-profit hospital, received the following revenues in the current year: Proceeds from the sales of the hospital's flower shop $60,000 Dividends and interest revenue not restricted $20,000 Cash contributions for the renovation of the children's ward in the hospital $200,000 Which of these amounts should be reported as other revenues and gains (other revenue) on the statement of operations?
$280,000 All three items are peripheral in nature and should be included in nonoperating revenues and gains.
507
Which one of the following is not one of the financial statements required for a not-for-profit hospital?
Statement of changes in fund balance Hospitals are required to issue a statement of financial position, a statement of activities, and a statement of cash flows.
508
Which of the following types of healthcare organizations recognize depreciation expense? Investor-owned NFP Governmental health healthcare organizations organizations enterprises A. Yes Yes No B. Yes No Yes C. No No Yes D. Yes Yes Yes
Row D All healthcare organizations are required to recognize depreciation expense.
509
Which of the following types of healthcare organizations follow FASB authoritative literature? Investor-owned NFP Governmental health healthcare organizations organizations enterprises A. Yes Yes No B. Yes No Yes C. No No Yes D. Yes Yes Yes
Row B Governmental healthcare organizations follow GASB statements.
510
Describe patient service revenue. The Weyman Hospital, a private, not-for-profit entity, reported the following information: Gross patient service revenue $1,000,000 Allowance for discounts to hospital employees 20,000 Bad debt expense 40,000 Contractual adjustments 100,000 What amount should the hospital report as net patient service revenue, assuming bad debts are not related to patient service revenue and can be reported as operating expenses?
$880,000 Gross patient service revenue ($1,000,000) less the allowance for discounts to hospital employees ($20,000) and less contractual adjustments ($100,000) equals net patient service revenue of $880,000. FASB ASC 954-605-45-4 requires the financial statement presentation of the provision for bad debts associated with patient service revenue. A provision for bad debts must be presented on a separate line as a deduction from net patient service revenue; that is, as a contra–revenue account rather than as an expense. Moreover, the healthcare entity must disclose net patient revenues for each major payor source (e.g., third-party payor and self-pay). Bad debt expense related to receivables other than patient service revenue continues to be presented as an operating expense, which is the case for this situation.
511
Terry, an auditor, is performing test work for a not-for-profit hospital. Listed below are components of the Statement of Operations: Revenue relating to charity care $100,000 Bad debt expense related to patient accounts receivable 70,000 Net assets released from restrictions and used for operations 50,000 Other revenue 80,000 Net Patient Service Revenue (includes revenue related to charity care) 500,000 What amount would be reported as total revenues, gains, and other support on the Statement of Operations?
$460,000 Total revenues, gains, and other support on the Statement of Operations includes net patient revenue, premium revenues (e.g., HMO capitation fees), other revenue, and net assets released from restrictions for operating purposes. Net patient revenues are fees for patient services less contractual adjustments and charity care. Both governmental and not-for-profit hospitals record estimates for uncollectible patient accounts as contra-revenue accounts. The correct answer is $460,000: $500,000 (net patient revenues including charity care) less $100,000 (charity care), less $70,000 uncollectible patient accounts, plus $50,000 (net assets released for operating activities) plus $80,000 (other revenue). Take note that uncollectible accounts other than patient accounts are recorded as bad debt expense by not-for-profit hospitals (ASC 954-605-56-6) and that governmental hospitals will not report bad debt expense since they use a net revenue approach. Moreover, had the net assets released from restrictions not been for operating purposes; such as to acquire fixed assets, the reclassification of net assets released would not be included in total revenues, gains, and other support section. Rather, the amount would appear after the excess (deficiency) of revenues, gains, and other support over expenses and losses (e.g., the performance indicator) near the bottom of the unrestricted net asset section of the Statement of Operations.
512
Metro General is a municipally owned and operated hospital and a component unit of Metro City. In Year 1, the hospital received $7,000 in unrestricted gifts and $4,000 in unrestricted bequests. The hospital has $800,000 in long-term debt and $1,200,000 in fixed assets. The hospital has transferred certain resources to a hospital guild. Substantially all of the guild's resources are held for the benefit of the hospital. The hospital controls the guild through contracts that provide it with the authority to direct the guild's activities, management, and policies. The hospital has also assigned certain functions to a hospital auxiliary, which operates primarily for the benefit of the hospital. The hospital does not have control over the auxiliary. The financial statements of the guild and the auxiliary are not consolidated with the hospital's financial statements. The guild and the auxiliary have total assets of $20,000 and $30,000, respectively. Before the hospital's financial statements were combined with those of the city, the city's statements included data on one Special Revenue Fund and one Enterprise Fund. The city's statements showed $100,000 in Enterprise Fund Long-Term Debt, $500,000 in Enterprise Fund Fixed Assets, $1,000,000 in General Long-Term Debt, and $6,000,000 in General Fixed Assets. What account or accounts should be credited for the $7,000 in unrestricted gifts and the $4,000 in unrestricted bequests?
Nonoperating Revenue $11,000 Both the $7,000 of unrestricted gifts and the $4,000 of unrestricted bequests should be credited to Nonoperating Revenue.
513
Valley's community hospital normally includes proceeds from the sale of cafeteria meals in:
Other Revenues. Government-affiliated hospitals normally have three broad categories of revenues: Patient Service Revenues Premium Fees Other Revenues. Within the Other Revenues category is a variety of different activities including proceeds from the sale of cafeteria meals.
514
Which of the following normally would be included in Other Operating Revenues of a governmental hospital? Revenues from educational programs Unrestricted gifts
Revenues from educational programs - Yes Unrestricted gifts - No Government hospitals classify revenues into three broad categories: Patient Service Revenues, Premium Fees, and Other Revenues. The Other Revenues category includes revenues generated by ongoing activities of the hospital other than patient care. Revenues from educational programs are included in this category. Government hospitals record unrestricted gifts as Nonoperating Gains in the General Fund. If we assume that the hospital is not a government entity, then it must conform with ASC 954-225-45. The revenues from educational programs would still be classified as Other Operating Revenues. The unrestricted gifts would be classified as Revenues from Contributions.
515
In April Year 1, Delta Hospital purchased medicines from Field Pharmaceutical Co. at a cost of $5,000. However, Field notified Delta that the invoice was being canceled and that the medicines were being donated to Delta. Delta should record this donation of medicines as
Other operating revenue of $5,000. Medicine is considered essential to the major ongoing operation of the hospital, therefore the donation of medicine is recorded as other operating revenue at its fair value. dr. Inventory of Medicine cr. Donated Revenues ASC 958-605-30-9
516
Which of the following should normally be considered ongoing or central transactions for a not-for-profit hospital? I. Room and board fees from patients II. Recovery room fees
Both I and II. Both room and board fees from patients and recovery room fees are normal, ongoing activities of a not-for-profit hospital.
517
Define "auxiliary enterprises" of a college or | university.
Activities carried on by an educational institution that are not directly related to the delivery of instruction (i.e., residence halls, dining services, athletics)
518
How is tuition revenue reported?
It is reported net of tuition discounts and scholarship allowances in the operating statement. However, scholarships, assistantships, and tuition waivers granted in return for services are reported as expenses
519
List the net position categories used by a public | university.
1. Unrestricted 2. Restricted 3. Net investment in capital assets
520
List the net asset categories used by a private | university.
1. Net assets without a donor restriction | 2. Net assets with a donor restriction
521
A private, not-for-profit university receives $100,000 that, according to the donor, must be spent for computers. On the last day of the year, $67,000 of this amount was properly spent. No time restriction was set for the use of these computers. In addition, students were charged tuition of $300,000 but were also awarded $110,000 in financial aid. For net assets without a donor restriction, what was the total amount of revenue, contributions, and reclassifications?
$257,000 Tuition revenue is always reported net of scholarships and financial aid. Thus, the net tuition revenue is shown as $190,000. Because the gift is designated by the donor, the $100,000 is initially reported as an increase in net assets with a donor restriction. When $67,000 is properly spent, that amount is reclassified from net assets with a donor restriction to net assets without a donor restriction. Thus, the total increase is $190,000 plus $67,000, or $257,000.
522
Capital assets of universities:
Must be depreciated. Capital assets must be depreciated by both private and public colleges.
523
A private, not-for-profit college holds debt securities in current assets and in noncurrent assets. How would these items be reported on the statement of financial position? Debt securities Debt securities in current assets in noncurrent assets A.Fair value Fair value B.Fair value Carrying value C.Carrying value Fair value D.Carrying value Carrying value
Row A FASB ASC 958 requires that the assets be reported at fair value.
524
What are the differences between not-for-profit and for-profit organizations that necessitate a different accounting and reporting model for not-for-profit organizations?
The principal mission of not-for-profits is to provide goods and services. Primary resources are obtained through nonexchange transactions. There are restrictions on resources. There are no individual ownership interests.
525
What is the authoritative body for state and local | government?
The Government Accounting Standards Board | GASB
526
Which of the following has the highest level of authority for setting GAAP for nongovernmental not-for-profit organizations?
FASB The Financial Accounting Standards Board (FASB) is the highest level of GAAP for all nongovernmental entities, which includes nongovernmental not-for-profit organizations. GASB is the highest level of authority in GAAP for governmental entities. FASAB is the highest level of authority in GAAP for federal government agencies.
527
Which of the following would not be considered a governmental or not-for-profit organization?
A software company that sells educational software exclusively to public elementary schools A vendor who specializes in offering goods and/or services exclusively to a governmental or not-for-profit organization is not considered a governmental or not-for-profit entity. A public independent school district is a governmental organization. A private foundation organized for charitable purposes is a form of not-for-profit organization. Religious organizations, including churches, are a form of not-for-profit organization.
528
Which of the following sources of financial resources is unique to governmental entities?
Proceeds from taxation One of the unique characteristics of government is its power to force involuntary financial resource contributions through taxation. No other form of organization has this power. Most organizations have the ability to charge for services. Grant proceeds are important sources of financial reports for governments and not-for-profit organizations. Most types of organizations have the ability to offer bonds.
529
The primary authoritative body for determining the measurement focus and basis of accounting standards for governmental fund operating statements is the
Governmental Accounting Standards Board (GASB). The Governmental Accounting Standards Board (GASB) was established in 1984 to promulgate standards of financial accounting and reporting for the activities and transactions of state and local governments. The GASB's authority includes determining the measurement focus and basis of accounting standards for governmental fund operating statements. The National Council on Governmental Accounting (NCGA) was the predecessor standard setting body to the GASB. The Government Accounting and Auditing Committee of the AICPA (GAAC) is not an active committee of the AICPA. The Financial Accounting Standards Board (FASB) is the primary standard setting body for businesses and not-for-profit organizations.
530
Characteristics of Financial Reporting?
``` Timeliness Relevance Understandability Comparability Consistency Reliability ```
531
Which of the following should be considered part of one of the three primary user groups of the external financial reports of a state government?
Advocate groups within the state. Advocate groups are part of one of three categories of primary users of government financial reports as identified by GASB Concept Statement No. 1: the citizenry (to which the government is accountable to), legislative and oversight bodies (who represent the citizenry), and investors and creditors (those who lend or participate in the lending process). The citizenry group includes citizens, the media, advocate groups, and public finance researchers.
532
Which of the following is voluntary information within a general purpose external financial report?
Supplemental information GASB Concepts Statement No. 3, basic financial statements, the accompanying notes to the basic financial statements, and required supplemental information are essential information and therefore required in general purpose external financial reporting. Supplemental information is useful but not required. Service efforts and accomplishment information are classified as supplemental information and are therefore voluntarily reported.
533
According to GASB's conceptual framework, the legally adopted annual budget has significant financial reporting implications. Which of the following is not one of the significant financial reporting implications?
To demonstrate that the budget is prepared on the GAAP basis GASB Concepts Statement No. 1 lists the following four financial reporting implications associated with the legally adopted annual budget: (1) expression of public policy, (2) expression of financial intent, (3) form of control, and (4) it may provide a basis for evaluating performance (if the government established service efforts and accomplishment goals as part of its budget process). Since budgets are usually prepared according to requirements of state and local laws, the budget is not required to be prepared on the GAAP basis. Many state and local governments prepare the budget on the cash basis. When this occurs, the budget-to-actual statement is presented on the budget basis (i.e., cash basis) and a reconciliation of the cash basis to the GAAP basis is included in the notes to the basic financial statements.
534
According to GASB's conceptual framework, the primary users of the general purpose external financial report do not include
Internal managers. GASB Concepts Statement No. 1 defines the primary users of the general purpose external financial report as the citizenry (e.g., taxpayers), legislative and oversight bodies (e.g., school boards), and investors and creditors (e.g., bond insurers). Typically, internal managers who have access to information through internal reporting are not considered primary users.
535
The City of Palo Alto's Service Efforts and Accomplishments Report for Fiscal Year 2010 reported that the average response to fire calls within 8 minutes occurred on 90% of the fire calls in 2010. This rate met the benchmark target goal of 90%. According to GASB's conceptual framework, this information is classified as a measure of
Outcome. The example in the question is an outcome measure. Outcome measures indicate the accomplishments or results that occur because of the services provided. Measures of effort are the amount (quantity) of financial and nonfinancial resources that are applied to a service. Example: the amount of salaries paid to firefighters. Measures of output are the quantity of service provided. Example: the number of fire calls responded to by firefighters. Efficiency measures related efforts to the output of services. Example: the cost per fire call answered.
536
Which of the following is the paramount objective of financial reporting by state and local governments?
Accountability. GASB Concept Statement No. 1 defines two paramount objectives for financial reporting in government: (1) Accountability and (2) interperiod equity. Therefore, "Accountabilty" is the correct answer to this question. Concept Statement No. 1 describes six characteristics of effective financial reporting: (1) understandability, (2) reliability, (3) relevance, (4) timeliness, (5) consistency, and (6) comparability (TRUCCR).
537
Interperiod equity is an objective of financial reporting for governmental entities. According to the Governmental Accounting Standards Board, is interperiod equity fundamental to public administration, and is it a component of accountability? Fundamental to public administration Component of accountability
Fundamental to public administration - Yes Component of accountability - Yes GASB Concepts Statement No. 1 states that interperiod equity is a basic component of accountability and fundamental to public administration.
538
Which event(s) is(are) supportive of interperiod equity as a financial reporting objective of a governmental unit? I. A balanced budget is adopted. II. Residual equity transfers out equal residual equity transfers in.
I only The adoption of a balanced budget supports interperiod equity because it is an attempt to ensure that the current generation of citizens does not shift the burden of paying for current-year services to future-years' taxpayers (GASB Concepts Statement 1). Residual equity transfers are nonrecurring or nonroutine transfers of equity between funds (GASB Codification 1800.102). These transfers occur within one accounting period and do not support interperiod equity as an objective of financial reporting.
539
Which of the following items is recognized for governmental activities in the government-wide statement of activities and not in the statement of revenues, expenditures, and changes in fund balance for governmental funds?
Property tax revenue for an amount deferred because it was not available Property tax revenue that is not currently available is not reported at the governmental fund level but is reported in the government-wide statements—this is a very common reconciliation item between governmental fund balance and government-wide net position. This question focuses on the difference between governmental activities in government-wide financial statements that are prepared on the accrual basis of accounting and governmental fund-level financial statements that are prepared on the modified accrual basis of accounting. Salaries payable at the beginning of the next year (i.e., within 60 days in the next year) are considered to be paid from “currently available resources” and therefore will be recognized as liabilities in the current year by both government-wide and fund-level financial statements. Grant monies received and spent on repairs in the same year will be accounted for similarly in the government-wide and fund-level financial statements. Transfers between governmental funds are eliminated in deriving the government-wide financial statements; hence this answer is not correct. (Note that transfers between governmental funds and enterprise funds are reclassified as “internal balances” in the government-wide statement of net position.) Property tax revenue that is not currently available is not reported at the governmental fund level but is reported in the government-wide statements—this is a very common reconciliation item between governmental fund balance and government-wide net position.
540
List the four types of fiduciary funds. (Tip: DRIP CEG | PIPPA, fiduciary funds are "PIPPA.")
1. Pension trust funds 2. Private-purpose trust funds 3. Investment trust funds 4. Agency funds
541
List the two types of proprietary funds. (Tip: DRIP | CEG PIPPA, vowels in DRIP CEG.)
1. Enterprise funds | 2. Internal service funds
542
List the three broad categories of funds for state and | local governmental entities.
Governmental funds Proprietary funds Fiduciary funds
543
What are two important characteristics of a "fund"?
A fiscal entity | An accounting entity (i.e., debits = credits)
544
What fund is used to account for business-type activities that primarily provide services to parties external to the government?
The enterprise fund. Enterprise funds provide the majority of their services to external users for a fee. In contrast, an internal service fund is used to account for business-type activities that provide services to other departments within the government.
545
List the five types of governmental funds. (Tip: DRIP | CEG PIPPA, consonants in DRIP CEG.)
``` General fund Special revenue funds Capital project funds Debt service funds Permanent funds ```
546
Fund accounting is used by governmental units with resources that must be
Segregated for the purpose of carrying on specific activities or attaining certain objectives. Fund accounting is used to segregate resources for accounting purposes. The resources do not have to be physically segregated. Governmental accounting systems are organized and operated on a fund basis. A fund is a fiscal and accounting entity with a self-balancing set of accounts that record cash and other financial resources, along with the related liabilities and residual equities or balances, which are segregated for the purpose of carrying on specific activities or attaining certain objectives. GASB Codification 1100.102
547
Which of the following activities would most likely be accounted for in a proprietary fund?
Wastewater and sewerage services Wastewater and sewerage services are usually provided on a service-fee basis; therefore, they are accounted for in an enterprise fund - one of the two types of proprietary funds. Enterprise funds are also referred to as "business type" funds and use full accrual accounting. Police protection is usually financed by the general revenues of the government and accounted for in the general fund. The tax assessor office is part of the general government and usually accounted for in the general fund. Routine street, curb, and sidewalk maintenance and repairs are usually accounted for in either the general fund, when financed by general revenues, or in a special revenue fund, when financed by resources dedicated for that purpose (e.g., a half-cent sales tax approved by the voters for street repairs).
548
Which of the following funds is not a fiduciary fund type?
Motor pool fund A motor pool fund is a type of internal service fund that charges other parts of the government for services provided on a cost-reimbursement basis. An internal service fund is one of the two types of proprietary service funds. Recall the mnemonic "PIPPA" for fiduciary funds - pension trust funds, investment trust funds, private-purpose trust funds, and agency funds. A county and city tax collection fund is an agency fund administered to collect and distribute property taxes collected to the county and the city. A historical society private-purpose trust fund is a fiduciary fund. A police and fire pension trust fund is a fiduciary fund.
549
Kenn City obtained a municipal landfill and passed a local ordinance that required the city to operate the landfill so that the costs of operating the landfill, as well as the capital costs, are to be recovered with charges to customers. Which of the following funds should Kenn City use to report the activities of the landfill?
Enterprise. An Enterprise Fund is commonly used in situations where user fees are the primarily source of revenue and the fee charged is based on an amount sufficient to cover the costs of operations and to provide for capital maintenance, which is the case here. Note that the fee for a service provided and that most of the users are external to the government.
550
Which of the following local government funds uses the accrual basis of accounting?
Enterprise. Recall the acronym "DRIP-CEG-PIPPA" where the vowels in "DRIP-CEG" represent fund types that use accrual accounting and the consonants use modified accrual accounting. The "I" stands for Internal Service Fund and "E" for Enterprise Funds. This answer is correct. Special Revenue Fund, is a governmental fund type that uses the modified accrual basis of accounting. Capital Projects Fund, is a governmental fund type that uses the modified accrual basis of accounting. Debt Service Fund, is a governmental fund type that uses the modified accrual basis of accounting.
551
Which of the following is not a characteristic of a fund?
Separate legal entity A fund is both a fiscal and an accounting entity. A fund is "fiscal" because it has assets, liabilities, revenue, expenditure or expense, and fund balance or other equity accounts. A fund is "accounting" because it has its own ledgers and contains a self-balancing set of accounts. A fund is not a separate legal entity.
552
One feature of state and local government accounting and financial reporting is that fixed assets used for general government activities
Often are not expected to contribute to the generation of revenues. General fixed assets are items on which financial resources have been expended and accountability must be maintained; however, their main purpose is NOT the generation of revenues. General fixed assets used for government activities need to be maintained at the same level as those of businesses so that the government can continue to provide the citizenry with an adequate level of service. Although these assets are used to provide services to the citizenry, they are NOT expected to contribute to the generation of revenues. The fixed assets of proprietary funds are expected to contribute the generation of resources.
553
Which of the following funds would be reported as a fiduciary fund in Pine City's financial statements?
Private-purpose trust. Recall the acronym "PIPPA" for fiduciary funds. Fiduciary funds include the following 4 types of funds: P ension trust funds, I nvestment trust funds, P rivate- P urpose trust funds, and A gency funds. Internal Service Fund is a Proprietary Fund Type. Permanent Fund is a Governmental Fund Type. Special Revenue Fund is a Governmental Fund Type.
554
Seaview City received a pass-through grant from the state. The money is to be distributed to families who, as determined by the state, are eligible for summer camp scholarships for their children. Seaview does not have administrative or direct financial involvement in the program. In which fund should Seaview record the grant?
Agency. Seaview City is merely acting as an agent for the state and should use an agency fund to receive and then distribute the funds as directed by the state. If Seaview had administrative or direct financial involvement in the summer camp program, then it would recognize revenue for the receipt of the grant and related expenditure or expense in a governmental fund, private-purpose trust fund, or proprietary fund depending on the specifics of the program.
555
What is the measurement focus basis of accounting | for proprietary fund types?
Accrual accounting: Flow of economic resources
556
What is the measurement focus basis of accounting | for governmental fund types?
Modified accrual: Flow of current expendable | financial resources
557
What are the revenue recognition criteria under | modified accrual accounting?
Measurable | Available
558
Dayne County's general fund had the following disbursements during the year: Payment of principal on long-term debt $100,000 Payments to vendors 500,000 Purchase of a computer 300,000 What amount should Dayne County report as expenditures in its governmental funds Statement of Revenues, Expenditures, and Changes in Fund Balances?
$900,000 On the Statement of Revenues, Expenditures, and Changes in Fund Balances, which reports transactions using the modified accrual basis of accounting, repayment of principal on long-term debt, payments to vendors, and purchases of fixed assets are all reported as expenditures.
559
How should a city's general fund report the acquisition of a new police car in its governmental fund statement of revenues, expenditures and changes in fund balances?
Expenditure. Governmental fund types use the modified accrual basis of accounting which focuses on the “flow of financial resources.” Consequently, the use of financial resources is an expenditure rather than an expense without regard to the character of the expenditure (e.g., operating expense or capital expense). Therefore, as this answer states, the new police car (a long-term asset) is recorded as an expenditure in the period of acquisition because it represents an outflow of financial resources. Since it is an immediate expenditure, the General Fund does not list the car as a noncurrent asset. However, in the government-wide Statement of Net Position (not part of this question) the car would be included in the noncurrent assets and depreciated overtime.
560
Todd City formally integrates budgetary accounts into its general fund. Todd uses an internal service fund to account for the operations of its data processing center, which provides services to Todd's other governmental units. During the year ending December 31, 2005, Todd's special revenue fund received a state grant to buy a bus and an additional grant for bus operation in 2005. In 2005, only 90% of the capital grant was used for the bus purchase, but 100% of the operating grant was disbursed. Todd has incurred the following long-term obligations: General obligation bonds issued for the water and sewer fund, which will service the debt. Revenue bonds to be repaid from admission fees collected from users of the municipal recreation center. These bonds are expected to be paid from enterprise funds and secured by Todd's full faith, credit, and taxing power as further assurance that the obligations will be paid. Todd's 2005 expenditures from the general fund include payments for structural alterations to a firehouse and furniture for the mayor's office. In reporting the state grants for the bus purchase and operation, what should Todd include as grant revenues for the year ending December 31, 2005? 90% of the 100% of the capital grant capital grant Operating grant A. Yes No No B. No Yes No C. No Yes Yes D. Yes No Yes
Row D Todd City should recognize the grants as revenues in the accounting period when they are susceptible to accrual. For grants, the expenditure of resources is a prime factor in determining eligibility for accrual. All of the operating grant has been spent; therefore, 100% should be recognized as revenue. Since only 90% of the capital grant has been spent, only 90% can be recognized as revenue.
561
Oro County's Expenditures control account at December 31, 2005 had a balance of $9,000,000. When Oro's books were closed, this $9,000,000 Expenditures control balance should have
Been credited. The Expenditures control account is a temporary account that must be closed at the end of the fiscal year. The Expenditures control account is debited as resources are expended during the year. When the books are closed at the end of the year, this account should be CREDITED for $9,000,000 so that the balance in the account is zero.
562
Which of the following accounts should Moon City close at the end of its fiscal year?
Expenditures The expenditures account is a temporary account that is closed at the end of the fiscal year. Expenditures occur within a given fiscal period and are not carried over into a new fiscal period.
563
Which of the following funds of a governmental unit recognizes revenues in the accounting period in which they become available and measurable? ``` General fund Enterprise fund A. Yes No B. No Yes C. Yes Yes D. No No ```
Row A The general fund uses the modified accrual basis of accounting. Under this basis, revenues are recognized in the accounting period when they become available and measurable. An enterprise fund uses the accrual basis of accounting. Under this basis, revenues are recognized in the period in which they are earned and measurable.
564
Which of the following funds of a governmental unit uses the modified accrual basis of accounting?
Special revenue funds All governmental funds, including special revenue funds, use the modified accrual basis of accounting. All proprietary funds, including enterprise funds, use the accrual basis of accounting.
565
The orientation of accounting and reporting for all proprietary funds of governmental units is
Income determination. Proprietary funds account for activities of the governmental unit that are similar to activities conducted by commercial enterprises. The orientation of accounting and reporting for proprietary funds is similar to that used in private businesses. The accrual basis of accounting is used, and the measurement focus is on income determination, financial position, and cash flow (GASB Codification 1300.102). Program is an expenditure classification, not an orientation of accounting and reporting for proprietary funds. Flow of funds is the focus for governmental type funds. Proprietary funds do NOT have a project orientation.
566
For governmental fund types, which item is considered the primary measurement focus?
Flows and balances of financial resources he primary measurement focus for governmental fund types is on the flows and balances of financial resources (GASB Codification 1300.102). Capital maintenance is not the primary measurement focus of governmental fund types because general fixed assets are not accounted for in these types of funds. General fixed assets are recorded in the General Fixed Asset Account Group. Cash is just one example of financial resources. Income determination is not the primary measurement focus of governmental funds because there is no profit motive associated with these types of funds.
567
What basis of accounting should be used when preparing a governmental funds statement of revenues, expenditures, and changes in fund balances?
Modified accrual basis of accounting. Because the measurement focus basis for governmental funds is the flow of current financial resources, the modified accrual basis of accounting is used to prepare governmental fund financial statements.
568
Which of the following transactions should be reported as a liability in the general fund financial statements?
An amount to be paid from current financial resources The general fund uses the modified accrual basis of accounting, and liabilities are recognized for those amounts that are to be paid from current financial resources, essentially, related to goods and services of the current year. Recall that according to the 60-day rule, “current financial resources” includes the amount the government receives in the first 60 days of the next fiscal year. 60-day rule on determining current financial resources. An amount set aside to pay for an unfilled contract is probably a board-designated amount that would be classified as either committed fund balance or assigned fund balance but not as a liability. This topic is covered in the lesson “Net Position and Fund Balance.”
569
What is the basis of accounting in which budgetary | accounting is used?
Modified accrual basis
570
Is the normal balance of estimated revenues | account a credit or a debit?
It is a debit
571
Is the normal balance of appropriations account a | credit or a debit?
This is a credit.
572
What budgetary account represents the legally | mandated spending limit?
The appropriations account
573
Is the normal balance of estimated other financing | sources account a credit or a debit?
It is a debit.
574
Is the normal balance of estimated other financing | uses account a credit or debit?
It is a credit
575
Describe the journal entry to close budgetary | accounts at the end of the period.
DR: Appropriations CR: Estimated Revenues DR or CR* Budgetary Fund *As required to balance the entry.
576
Describe the journal entry to record a budget at | beginning of year.
DR: Estimated Revenues CR: Appropriations DR or CR* Budgetary Fund *As required to balance the entry
577
When the budget for the General Fund is recorded, the required journal entry will include
A credit to Appropriations. Appropriations are credited so that a schedule to compare Appropriations (credits) to Expenditures (debits) results in reporting whether appropriations are under or over spent. Estimated Revenues will be debited. Encumbrance accounting is used to control expenditures and is not part of the budget. While there may be an entry to Fund Balance, it may not be a credit entry. If planned resources exceed planned spending, Fund Balance will be credited (a budget surplus). If planned resources are less than planned spending, then Fund Balance will be debited (a budget deficit).
578
If a state law requires that local governments prepare General Fund and special revenue fund budgets on a basis that differs from the basis of accounting required by generally accepted accounting principles (GAAP):
The actual amounts in the budgetary comparison schedule should be reported using the government's budgetary basis. Budgets are legally binding on government administrators and lead to the formal recording of the budget, on the basis in which the budget is based, into the ledgers of the General Fund, special revenue funds, and any other funds that are required by law to record a budget. Reporting is on the budget basis. When the budget basis is different from GAAP, a separate schedule is required to reconcile the actual amounts in the budget to the GAAP amounts shown in the statement of revenues, expenditures, and changes in fund balances.
579
Which of the following terms refers to an actual cost rather than an estimate?
Expenditure Under modified accrual accounting, as used by governmental fund types, “expenditures” are the amount of resources used to acquire an asset or service and are recognized when an obligation that will be paid from current financial resources has been incurred. Appropriations are authorized (estimated) spending according to the legally adopted budget Encumbrances are estimated spending recorded when goods and services are ordered. Estimated financing sources are estimated inflows of financial resources that do not meet the criteria for revenues and are recorded when the legally adopted budget is entered into the ledgers.
580
For what funds do budgetary comparisons need to be presented in connection with the basic financial statements?
General Fund and major special revenue funds for which a budget is legally adopted GASB requires budgetary comparisons for the General Fund and all major special revenue funds for which a budget is legally adopted. GASB does not require all governmental funds with legally adopted budgets to report budgetary comparisons. GASB also requires budgetary comparisons for major special revenue funds for which a budget is legally adopted.
581
One characteristic that distinguishes Other Financing Uses from expenditures is that Other Financing Uses
Arise from interfund transfers out. Expenditures are recorded when goods and services are received. Other Financing Uses is recorded when funds are transferred from one fund to another, such as when the General Fund transfers resources to the Debt Service Fund to make payments on bonds payable. Expenditures and other financing uses both decrease fund balance when closed at year-end. Expenditures and Other Financing Uses both decrease the available financial resources of a fund. Expenditures and Other Financing Uses both have normal debit balances.
582
Assuming no outstanding encumbrances at year's end, closing entries for which of the following situations would increase the unassigned fund balance at year's end?
Appropriations exceed actual expenditures. Assuming that both actual and budgetary transactions are closed to the fund balance, closing appropriations, a credit balance account, would increase the fund balance whereas closing expenditures, a debit balance account, would decrease the fund balance. Since appropriations were greater than expenditures, the net effect would be to increase the fund balance. Since expenditures were greater than appropriations, the net effect would be to decrease the fund balance. Since estimated revenues were greater than appropriations, the net effect would be to decrease the fund balance. Since actual revenues were less than estimated revenues, the net effect would be to decrease the fund balance.
583
On January 1, Fonk City approved the following general fund resources for the new fiscal period: Property taxes $5,000,000 Licenses and permits 400,000 Intergovernmental revenues 150,000 Transfers in from other funds 350,000 What amount should Fonk record as estimated revenues for the new fiscal year?
$5,550,000 Transfers in from other funds are classified as "Other Financing Sources" and are not revenues. The other three amounts are classified as revenues and, for budget purposes, should be included in determining "estimated revenues." The total is $5,550,000.
584
Todd City formally integrates budgetary accounts into its general fund. Todd uses an internal service fund to account for the operations of its data processing center, which provides services to Todd's other governmental units. During the year ended December 31, Year 1, Todd received a state grant to buy a bus, and an additional grant for bus operation in Year 1. In Year 1, only 90% of the capital grant was used for the bus purchase, but 100% of the operating grant was disbursed. Todd has incurred the following long-term obligations: General obligation bonds issued for the water and sewer fund which will service the debt. Revenue bonds to be repaid from admission fees collected from users of the municipal recreation center. These bonds are expected to be paid from enterprise funds, and secured by Todd's full faith, credit, and taxing power as further assurance that the obligations will be paid. Todd's Year 1 expenditures from the general fund include payments for structural alterations to a firehouse and furniture for the mayor's office. When Todd records its annual budget, which of the following control accounts indicates the amount of the authorized spending limitation for the year ending December 31, Year 1?
Appropriations. The Appropriations Control account, a budgetary account, would be credited for the amount of the authorized spending limit. The Encumbrances Control would be debited and Reserve for Encumbrances would be credited at the time a commitment is made to spend some of the resources that have been appropriated. There is no such account as Reserved for appropriations in governmental accounting.
585
When Rolan County adopted its budget for the year ending June 30, Year 1, $20,000,000 was recorded for Estimated Revenues Control. Actual Revenues for the year ended June 30, Year 1 amounted to $17,000,000. In closing the budgetary accounts at June 30, Year 1,
Estimated Revenues Control should be credited for $20,000,000. When the budgetary accounts are closed at the end of the fiscal year, the estimated revenues control account will be credited for the amount for which it was debited when the budget was recorded, $20,000,000.
586
Park City uses encumbrance accounting and formally integrates its budget into the general fund's accounting records. For the year ending July 31, 2005, the following budget was adopted: Estimated revenues $30,000,000 Appropriations 27,000,000 Estimated transfer to debt service fund 900,000 When Park's budget is adopted and recorded, Park's budgetary fund balance would be a
$2,100,000 credit balance. Park would credit the budgetary fund balance for $2,100,000 when it makes the following entry to record the budget. Dr. Estimated revenues $30,000,000 Cr. Appropriations $27,000,000 Cr. Estimated transfers to debt service fund$900,000 Cr. Budgetary fund balance $2,100,000
587
What account represents the estimated dollar value | of outstanding purchase orders?
The encumbrances account
588
Is the normal balance of the encumbrances account | a credit or a debit?
It is a debit.
589
A government's police department reports appropriations of $10,000, encumbrances of $2,000, and expenditures of $5,000. What is the amount of available appropriations for the police department?
$3,000 The amount of available appropriations is calculated as follows: Authorized appropriation amount from the budget less outstanding encumbrances and less expenditures. In this example, $10,000 – $2,000 – $5,000 = $3,000.
590
``` The Encumbrances control account of a county is decreased when Goods are ordered Goods are received A. No Yes B. Yes No C. No No D. Yes Yes ```
A. Encumbrances are increased (debited) when goods are ordered and decreased (credited) when goods are received.
591
When computers are ordered by the city controller's office, the purchase order should be recorded in the General Fund as a debit to
Encumbrances. Encumbrances are used to maintain a record of purchase orders issued such as the order by the controller's office for computers.
592
If supplies that were ordered by a department financed by the General Fund are received at an actual price that is less than the estimated price on the purchase order, the department's available balance of appropriations for supplies will be
Increased. The encumbrance is reversed and replaced with the actual expenditure amount, which is less than the encumbered amount. How encumbrance accounting operates is not policy related. The encumbrance is reversed and replaced with the actual expenditure amount. The encumbrance is reversed and replaced with the actual expenditure amount.
593
The Expenditures control account of a government is credited when
Temporary accounts are closed at the end of the year. Expenditures are closed out (credited). Encumbrances are debited and budgetary fund balance is credited when supplies are ordered. Appropriations, not Expenditures, are recorded when the budget is integrated into the ledgers. Expenditures are closed out (credited).
594
A liability is recorded in governmental funds when
Goods and services are received and the invoice is vouchered. When goods and services are received, expenditures are recorded and a liability, vouchers payable, is recorded. Budget amendments result in entries to the budgetary accounts (i.e., estimated revenues, appropriations, estimated other financing uses and sources, and budgetary fund balance). The liability is reduced when invoices are paid.
595
The Encumbrances account is a
Budgetary account. Encumbrance accounting works in conjunction with Appropriations to control spending as authorized in the legally adopted budget. Encumbrances outstanding at the end of the year that will be honored in the subsequent year are part of assigned or committed fund balance, depending on the level of authority by which the commitment was made. A liability is recognized when goods and services are received, not when goods and services are ordered. A liability is recognized when goods and services are received, not when goods and services are ordered.
596
The Blake City uses encumbrance accounting and its fiscal year ends on June 30. On April 15, a purchase order was approved and issued for computers in the amount of $5,000. Blake City received full order of computers on May 8, and the $4,900 invoice was approved for payment. What General Fund journal entry or entries should Blake City make on May 8, upon receipt of the computers and approval of the invoice? Debits Credits A. Budgetary Fund Balance 5,000 Encumbrances 5,000 Expenditures 4,900 Vouchers Payable 4,900 B. Budgetary Fund Balance 4,900 Encumbrances 4,900 Expenditures 4,900 Vouchers Payable 4,9000 C. Equipment 4,900 Vouchers Payable 4,900 D. Appropriations 5,000 Encumbrances 5,000 Equipment 4,900 Vouchers Payable 4,900
A. Since the full order was received, the entire $5,000 encumbrance is reversed out and the actual $4,900 in expenditure is recorded.
597
Encumbrances outstanding at year's end in a state's general fund may be reported as a
Fund balance assigned in the general fund. Encumbrances outstanding at year's end represent outstanding purchase orders or unfilled contracts. The fund balance classification is either restricted, committed, or assigned depending on the level of authority behind the encumbrance. If the government intends to use the resources for specific purposes but it is not done by a constraint imposed by external parties or enabling legislation (i.e., restricted) or by formal action of the government's highest decision making authority (i.e., committed) then a portion of the fund balance needs to be assigned for the outstanding encumbrances to indicate that a portion of the fund balance is not available for future appropriations. Encumbrances do not represent a designation of the fund balance. Encumbrances outstanding at year's end do not represent a long-term liability; therefore, they should not be reported in the general long-term debt account group. Outstanding encumbrances represent outstanding purchase orders or unfilled contracts. Since the goods or services have not been provided, the encumbrances do NOT represent a liability to the general fund.
598
For state and local governmental units, generally accepted accounting principles typically require that encumbrances outstanding at year's end be reported as
Assigned or committed fund balance. The fund balance classification is either restricted, committed, or assigned depending on the level of authority behind the encumbrance. If the government intends to use the resources the specific purposes but is not a constraint imposed by external parties or enabling legislation (i.e., restricted) or by formal action of the government's highest decision making authority (i.e., committed). Assigned fund balances should be used to indicate that a portion of the fund balance is not available for expenditure. The use of assigned or committed indicates that a portion of the fund balance has been segregated for expenditure on vendor performance.
599
Encumbrances would not appear in which fund?
Enterprise. Encumbrance accounting is used for budgetary control and, therefore, is commonly used in Governmental Fund types, including the General, Special Revenue, and Capital Projects Funds. It is usually not used by Debt Service Funds since the terms of the debt control spending. It is rarely used by Proprietary Funds so the Enterprise Fund (answer D) is the best choice for this question.
600
What account is credited when general fund | revenues are received before they are legally due?
The deferred inflow of resources
601
Describe the journal entry to record a levy of property taxes that are to be used to finance the subsequent fiscal year.
DR: Property Taxes Receivable CR: Est. Uncollectible Property Taxes CR: Deferred Inflow of Resources
602
When is revenue related to grants, entitlements, shared revenues, and so on, that are subject to eligibility restrictions recognized for government accounting?
Revenue is recognized when the eligibility requirements are met. (Until then, a liability is recognized).
603
When is revenue related to grants, entitlements, shared revenues, and so on, that are subject to time restrictions recognized for government accounting?
Revenue is recognized when the stated time has arrived or the stated event has occurred. (Until then, deferred inflow of resources is recognized.)
604
Which of the following neither increases nor decreases fund balance of the General Fund during the current period?
Deferred inflows of resources A deferred inflow of resources is the acquisition of net assets by the government that applies to a future reporting period, such as grant monies that are restricted to future periods. Consequently, the grant proceeds are recorded as an asset and a like amount is recorded as a deferred inflow of resources. Revenues increase fund balance. Other financing uses, such as operating transfers out, decrease fund balance. A deferred inflow of resources is the acquisition of net assets by the government that applies to a future reporting period, such as grant monies that are restricted to future periods. Consequently, the grant proceeds are recorded as an asset and a like amount is recorded as a deferred inflow of resources.
605
Excel City was awarded a $900,000 federal operating grant for use in Year 20X2. On December 1 of year 20X1, half of the grant money was received by the city. The journal entry to record receipt of the grant funds will include
A credit to Deferred Inflow of Resources—Grant Proceeds in the amount of $450,000. The $450,000 received in 20X1 has a time restriction and is a deferred inflow of resources in 20X1.
606
How should taxes collected in advance in fiscal year 20X2 be reported in the fiscal year 20X2 General Fund financial statements?
As a deferred inflow on the balance sheet Taxes collected in advance represent resources that pertain to a future time period in which they are legally due and therefore should be reported as deferred inflow of resources.
607
Which of the following is the basic governmental fund accounting equation?
Current financial assets + Deferred outflows – Current financial liabilities – Deferred Inflows = Fund balance Current financial assets + Deferred outflows – Current financial liabilities – deferred inflows = Fund balance is the accounting equation for governmental funds.
608
Which of the following sets of financial statement elements are unique to governmental organizations?
Deferred inflow of resources and deferred outflow of resources GASB Concept Statement 4 established deferred inflows and deferred outflows of resources as financial statement elements. Liabilities are not unique to governments. Assets are not unique to governments.
609
Excel City enters into a five-year service concession agreement with Event Management Inc. (EMI) in which EMI will operate and lease out Excel City's municipal auditorium for entertainment and sporting events. In return for this arrangement, EMI makes an up-front payment to Excel City of $5,000,000. Excel City initially should record the $5,000,000 as
Deferred inflow. The $5,000,000 up-front payment is initially recorded as a deferred inflow of resources and revenue is recognized as the deferred inflow of resources is reduced. A deferred outflow is for the consumption of net assets by the government that is applicable to a future period. Other financing sources are financial resources, other than revenues, such as proceeds from long-term bonds. Revenue should be recognized in a systematic and rational manner over the five-year term of the arrangement.
610
Taxes levied in the Debt Service Fund and due in the Year 20x1 include $200,000 that is not expected to be collected within the first 60 days of the Year 20x2. As of the end of Year 20x1, the $200,000 would be reported as
A deferred inflow of resources. Since the Debt Service Fund uses the modified accrual basis of accounting, revenues are recognized when measurable and available. The $200,000 is not expected to be available and hence should be reported as a deferred inflow of resources in Year 20x1.
611
In Year 20x1 a local government levied $5,000,000 in special assessments. The assessments are due and payable in five equal installments at the beginning of each of the next five fiscal years, starting in Year 20x2. Assume that all installments are collected four months (120 days) into the year that they are due. The Special Assessment Debt Service Fund would report revenue in Year 20x1 in the amount of:
$0 The Debt Service Fund recognizes revenue when it is measurable and available. Since the first installment will be received 120 days into Year 20x2, no revenue is recognized in Year 20x1.
612
In Year 20x1 a local government levied $5,000,000 in special assessments. The assessments are due and payable in five equal installments at the beginning of each of the next five fiscal years, starting in Year 20x2. Assume that all installments are collected four months (120 days) into the year that they are due. The Special Assessment Debt Service Fund would report revenues in Year 20x2 in the amount of:
$1,000,000 The Debt Service Fund reports the amount that is measurable and available as revenue, which in Year 20x2 is the $1,000,000 collected
613
In Year 20x1 a local government levied $5,000,000 in special assessments. The assessments are due and payable in five equal installments at the beginning of each of the next five fiscal years, starting in Year 20x2. Assume that all installments are collected four months (120 days) into the year that they are due. At the end of Year 20x2, the Special Assessment Debt Service Fund would report the $4,000,000 remaining levy as:
Deferred inflow of resources. The remaining levy is measureable and available in Year 20x3 through Year 20x6 and is a deferred inflow of resources in Year 20x2.
614
List the categories of net position in governmentwide financial statements and in enterprise fundlevel financial statements.
Unrestricted Restricted Net investment in capital assets (which is capital assets less accumulated depreciation and less debt related to the capital asset)
615
List the fund balance categories for a government's | governmental funds.
``` Nonspendable Restricted Committed Assigned Unassigned ```
616
Where do you find a positive unassigned fund | balance for a governmental organization?
This balance is found only in the general fund.
617
True or False: Financial reporting for encumbrances outstanding at the end of the year that will be honored in the next year must be displayed separately in the financial statements.
False. Usually they are not displayed separately in the financial statements. Encumbrances that do not lapse are part of committed or assigned fund balance, depending on the nature of the constraint on resources.
618
How are stabilization arrangements reported by a | government?
They may be reported as restricted or committed fund balance if the criteria for either type of constraint are met. Otherwise, they will be reported as unassigned fund balance. Stabilization funds are usually reported in the general fund.
619
True or False: A government's restricted, committed, or assigned fund balance amounts should report only positive amounts.
True. These fund balances should not report negative amounts. Negative amounts can appear in unassigned fund balance.
620
A government's assets include inventory of $2 million, roads constructed for $25 million with accumulated depreciation of $10 million, and equipment acquired for $5 million with accumulated depreciation of $1 million. Its liabilities include an outstanding balance of $5 million for bonds payable issued to construct the roads and a $1 million short-term loan for inventory purchases. What amount should be reported as the net investment in capital assets in the government-wide statement of net position?
$14 million Net investment in capital assets is the amount of long-term capital assets, net of accumulated depreciation, less the outstanding balance of capital-related debt. The gross value of the roads and equipment is $30 million. Accumulated depreciation on the roads and equipment totals $11 million and there is $5 million bonds payable outstanding related to the roads. The net investment in capital assets, therefore, is $14 million [$30 - $11 - $5 = $14]. Note that amounts related to inventory are distractors since inventory is not capital asset related.
621
At the end of the fiscal year, a state government reported capital assets of $20 million, accumulated depreciation of $5 million, restricted assets of $3 million, and liabilities of $7 million. What amount should the government report as the total net position in its government-wide financial statements?
$11 million Three categories of net position make up total net position in government-wide financial statements: (1) net investment in capital assets net position, (2) restricted net position, and (3) unrestricted net position. Based on the information in the question, net investment in capital assets is $15 million calculated as $20 million less $5 million in accumulated depreciation. (The question is silent about whether the $7 million in liabilities is related to capital assets. If it was, you would also reduce net investment in capital assets by the liabilities related to capital assets.) Restricted net position is $3 million. Total net position is net investment in capital assets plus restricted net assets plus unrestricted net assets minus liabilities ($15 million + $3 million – $7 million = $11 million). There is no information about unrestricted net asset so you should assume that it is zero.
622
A Special Revenue Fund may report a positive amount in each of the following fund balance classifications except:
Unassigned. Only the General Fund can report a positive amount in Unassigned Fund Balance. In all other Governmental Fund types (including a Special Revenue Fund), if expenditures exceed amounts restricted, committed, or assigned, it may be necessary to report a negative Unassigned Fund Balance. Should that occur, the Assigned Fund Balance is reduced to eliminate the deficit. If a deficit remains after eliminating Assigned Fund Balance, the negative residual should be classified Unassigned Fund Balance.
623
As of the end of the fiscal year, a Capital Projects Fund has material balances of supplies inventory. Which fund balance classification would reflect the inventory of supplies?
Nonspendable. According to GASB Statement No. 54, a Nonspendable Fund Balance classification pertains to amounts that cannot be spent either because they are not in a spendable form (e.g., inventory) or are legally or contractually required to be maintained intact.
624
Which of the following fund balance classifications is used for budgetary accounting but not for GAAP financial statement reporting?
Unreserved Fund Balance. GASB Statement No. 54 eliminated the use of "reserve" and "unreserved" fund balances. The appropriate fund balance classifications are Nonspendable, Restricted, Committed, Assigned, and Unassigned.
625
A Capital Projects Fund has outstanding encumbrances of $250,000 as of the end of the fiscal year. Assume that all resources in the Capital Projects Fund are considered to be committed due to the constraints established by the enabling legislation of the governing body of the government. How should the encumbrances be reported in the year-end external financial statements?
The encumbrances would only be reported in the note disclosures. According to GASB Statement No. 54, outstanding encumbrances are no longer reported as Reserves in the fund balance section, which was the practice prior to Statement No. 54. Significant encumbrances should be disclosed in the notes to the financial statements.
626
At December 31, Year 1, Alto Township's committed appropriations that had not been expended in 2005 totaled $10,000. The commitment was made by the finance committee. These appropriations do not lapse at year-end. Alto reports on a calendar-year basis. On its December 31, Year 1 Balance Sheet, the $10,000 should be reported as:
Fund Balance Assigned. $10,000 of the fund balance should be assigned to show that those funds are not available for appropriation in the next fiscal year. There is no Budgetary Fund Balance-Reserved for encumbrances account on the balance sheet. The Budgetary Fund Balance account is used to reconcile the difference between estimated revenues and appropriations in the entry to record the budget. A Deferred Expenditures account does not exist in governmental accounting. The $10,000 represent a commitment to spend resources on goods and services that will be received in the future. Since the goods and services have not been received, no liability has been incurred. Therefore, Vouchers Payable should not report the $10,000.
627
In preparing Chase City's reconciliation of the Statement of Revenues, Expenditures, and Changes in fund balances to the Government-Wide Statement of Activities, which of the following items should be subtracted from the changes in fund balances?
Book value of capital assets sold during the year. At the Governmental-Fund level, the entire proceeds from the sale of capital assets is a financial resource of the fund - it is spendable. Only the gain or loss on the sale of capital assets is reported in the Government-Wide Financial Statements. Therefore, the book value of capital assets should be subtracted.
628
What is the primary function of the debt service fund | in governmental accounting?
Payment of interest and principal on general longterm debt
629
Describe the journal entry to record payment of | matured debt principal in a debt service fund.
DR: Expenditures-Principal | CR: Cash
630
When is interest expense on general long-term debt | accrued in a debt service fund?
When the interest payment is due (i.e., on the due | date)
631
Describe the journal entry to record payment of | interest expense now due in a debt service fund.
DR: Expenditures-Interest | CR: Cash
632
Describe the journal entry to record receipt of resources transferred by the general fund to a debt service fund when repayment is not expected.
DR: Cash | CR: Other Financing Sources—Transfers In
633
Describe the journal entry to record a short-term loan for $10,000 by the general fund to a special revenue fund.
DR: Due from Special Revenue Fund | CR: Cash
634
Describe the journal entry to record a long-term loan of $10,000 by the general fund to a special revenue fund.
DR: Advances to Special Revenue Fund | CR: Cash
635
Describe the journal entry to record a transfer of $10,000 from the general fund to a special revenue fund. (The amount is not expected to be repaid).
DR: Other Financing Uses—Transfers Out | CR: Cash
636
Describe the journal entry to record levy of property taxes that are to be used to finance the current fiscal year.
DR: Property Taxes Receivable CR: Est. Uncollectible Property Taxes CR: Property Tax Revenues
637
Describe the journal entry to record a levy of property taxes that are to be used to finance the subsequent fiscal year.
DR: Property Taxes Receivable CR: Est. Uncollectible Property Taxes CR: Deferred Inflow of Resources
638
Describe the journal entry to record an increase in | estimated uncollectible property taxes.
DR: Property Tax Revenues | CR: Est. Uncollectible Property Tax
639
What account is credited when general fund | revenues are received before they are legally due?
The deferred inflow of resources
640
Describe the journal entry to record receipt of the proceeds from issuance of long-term debt for a government entity.
DR: Cash | CR: Other Financing Sources—Bond Proceeds
641
Describe the journal entry to record purchase of a | fixed asset for a government entity.
DR: Expenditures | CR: Cash
642
What is the basis of accounting used by special | revenue funds?
The modified accrual basis
643
Describe the journal entry to record receipt of $10,000 by a special revenue fund from the general fund. (The monies are not expected to be repaid.)
DR: Cash | CR: Other Financing Sources
644
When is revenue related to grants, entitlements, shared revenues, and so on, that are subject to purpose restrictions recognized for government accounting?
When the resources are measurable (i.e., revenue recognition is not deferred solely because of a purpose restriction)
645
When is revenue related to expenditure-driven | grants recognized for government accounting?
When the expenditure is made and reimbursement is | requested
646
What fund is used to accumulate resources and manage expenditures related to major capital projects in government accounting?
The capital projects fund
647
Describe the journal entry to record receipt of grant monies that must be used to finance construction of a major capital project. (No other eligibility restrictions apply.)
DR: Cash | CR: Revenues—Grants
648
What fund generally receives any remaining | resources when a capital projects fund is closed?
The debt service fund
649
Describe the accounting treatment of gains on the sale of investments that are part of the endowment principal for government accounting.
The gain is added to the endowment principal; it is | not expendable.
650
What fund and entry is required to record receipt of an endowment where the earnings are to be expended on a public purpose?
Permanent Fund: DR: Cash CR: Revenues—Endowment Principal
651
A city received a $9,000,000 federal grant to finance the construction of a homeless shelter. In which fund should the proceeds be recorded?
Capital project The primary purpose of a capital project fund is to account for resources dedicated to the acquisition and/or construction of long-term assets, such as this homeless shelter. Special revenue funds are used to account for resources restricted for a particular purpose, such as mosquito abatement, but should not be used for long-term asset acquisition or construction. Although the general fund is used to account for many different types of resources, federal grants typically require that the grant funds not be comingled in with other resources unrelated to the purpose of the grant as would be the case with a general fund. A permanent fund is used to account for endowments from which the related earnings are to be used by the general government.
652
The City of Minton recorded the following transactions in its Special Revenue Fund: Transfer from the General Fund of $400,000 to help finance a fire safety improvement project Transfer of $5,000 from a Capital Projects Fund to pay for office supplies, which the Special Revenue Fund initially paid for in error Federal grant proceeds of $300,000, which can only be used to pay for salary increases for public safety workers Which of the following is correct regarding the recognition of Revenue and Other Financing Source in the Special Revenue Fund? Revenue Other Financing Sources
Revenue - $300,000 Other Financing Sources - $400,000 The $5,000 transferred from the Capital Projects Fund is recognized as an Expenditure Reimbursement (a credit to an expenditure account) rather than a Revenue. The $400,000 transferred from the General Fund is recorded as an Other Financing Source - Transfer-in. The federal grant is recognized as revenue immediately (e.g., the existence of a purpose restriction does not delay revenue recognition).
653
A Capital Projects Fund for a new city courthouse recorded a receivable of $300,000 for a state grant and a $450,000 transfer from the General Fund. What amount should be reported as revenue by the Capital Projects Fund?
$300,000 The $450,000 transfer from the General Fund is classified as an Other Financing Source-Transfer In, but the $300,000 state grant is recognized as Revenue. Though the grant has not yet been received in Cash, GASB #33 requires that it be recognized as Revenue in the Government-Wide Statements when the receivable is recognized, as long as there are no eligibility restrictions. It would also be recognized as Revenue in the fund statements as long as the cash was received within 60 days of the year end.
654
Excel City has $1,000,000 of 8%, 10 year general obligation bonds outstanding. The bonds were issue on October 1, 20x8 to finance construction of city park improvements. Interest is payable semiannually on October 1 and April 1. The bonds also require an annual principal payment of $100,000 each April 1. What amount of debt service expenditures should the government report in its Debt Service Fund for the year ended December 31, 20x9?
$176,000 Both Interest Expenditures and Principal Expenditures are recognized in the Debt Service Fund. Debt Service Expenditures are usually not accrued at year-end but are recorded as Expenditures when due and payable. In 20x9 the Debt Service Fund paid a total of $176,000-$ $40,000 interest and $100,000 principal on April 1 (both Expenditures of the fund) and $36,000 interest on October 1.
655
Excel City received a donation of $400,000. The donor stipulated that the money be permanently invested with the investment proceeds being used to provide funding for the community swimming pools. Which of the following best describes the reporting options for this transaction?
The city should record $400,000 as revenue in a Permanent Fund. Permanent Funds account for the receipt of the endowment principal that is donated to a government and is to be held in trust for the benefit of the government (or of its citizenry as a whole) as revenue.
656
A local citizen donated land and an office complex to a city with the stipulation that net income from the office complex be used help finance the operations of a teenage alcohol and drug treatment center. At the time of donation, the property's fair market value was $800,000. The donor paid $500,000 for the land and house twenty years ago. The city spent $125,000 to upgrade the office complex. The city would capitalize the land and office complex in its permanent fund at:
$925,000 Permanent Funds account for the receipt of the endowment principal that is donated to a government and is to be held in trust for the benefit of the government (or of its citizenry as a whole) as revenue. The property should be capitalized at $925,000-fair market value at the time of donation ($800,000) plus the cost of improvements ($125,000) made by the city. Earnings from the office complex would usually be transferred to and expended through a Special Revenue Fund.
657
During the current year, Wythe County levied $2,000,000 in property taxes, 1% of which is expected to be uncollectible. During the year, the county collected $1,800,000 and wrote off $15,000 as uncollectible. What amount should Wythe County report as Property Tax Revenue in its Government-Wide Statement of Activities for the current year?
$1,980,000 Property taxes are an Imposed Nonexchange Revenue source for which the government receives value without directly giving something in equal value in exchange. In the Government-Wide Financial Statements, a Receivable is recorded when there is an enforceable claim - the property tax levy in this case - and Revenue should be recorded at the amount of Net Estimated Refunds and Estimated Uncollectible Amounts, in the period for which the taxes are levied [GASB Codification Section N50.115]. Given the facts in this question, revenue of $1,980,000 should be recognized ($2,000,000 gross levy less 1%, $20,000, estimated uncollectible amount). Had the question asked about revenue recognition in the General Fund, which uses the modified accrual basis of accounting, the answer would be different. In modified accrual accounting the concept of availability is an aspect of revenue recognition (GASB Codification Section P70.104]. Typically, that means that amounts collected during the year and up to 60 days into the next year are recognized in the current year as revenue. While the facts are incomplete in this question regarding the next year, the implication is that $1,800,000 would be recognized as revenues in the current year and $180,000 as deferred inflow of resources in the current year.
658
Brandon County's General Fund had the following transactions during the year: Transfer to a Debt Service Fund $100,000 Payment to a Pension Trust Fund 500,000 Purchase of equipment 300,000 What amount should Brandon County report for the General Fund as other financing uses in its Governmental Funds Statement of Revenues, Expenditures, and Changes in Fund Balances?
$100,000 Transfers between funds are classified as Other Financing Sources and Uses. The payment to the Pension Trust Fund pertains to employee and employer contributions to the pension plan and is part expenditure (employer share) and liability reduction (employee share that was due to the Pension Trust Fund). Under the modified accrual basis of accounting used by the General Fund, the purchase of the equipment is an expenditure.
659
On December 31, Year 1, Elm Village paid a contractor $4,500,000 for the total cost of a new Village Hall built in Year 1 on Village-owned land. Financing for the capital project was provided by a $3,000,000 general obligation bond issue sold at face value on December 31, Year 1, with the remaining $1,500,000 transferred from the General Fund. What account and amount should be reported in Elm's 2005 financial statements for the General Fund? Other Financing Sources control $4,500,000. Expenditures control $4,500,000. Other Financing Sources control $3,000,000. Other financing uses control $1,500,000.
Row D This answer is correct because the General Fund should report only the $1,500,000 in the Other Financing Uses Control account as an Operating Transfer. The $3,000,000 in bonds proceeds should be reported in the Capital Projects Fund in the Other Financing Sources Control account.
660
Which of the following fund types used by a government would most likely have a Nonspendable Fund Balance for its Inventory of Supplies?
General. This answer is correct because the General Fund normally records the purchase of supplies. The supplies must be reported on the General Fund's balance sheet, even though they do not represent current financial resources. In addition, at year end, a portion of the fund balance must be classified as nonspendable for the inventory amount because that amount of resources is not appropriable for future expenditures.
661
Describe the proprietary fund entry to record | interfund sale of goods.
DR: Due from xxx | CR: Revenues (or Billings to Depts.)
662
Describe the enterprise fund entry to record capital contributions from an external entity (i.e., developer, outside agency).
DR: Capital Assets (Land, Building, Equipment) CR: Contributions from xxx
663
What is the principal revenue of an enterprise fund?
Fees charged to external users
664
What is the principal revenue of an internal service | fund?
Fees charged to internal users
665
Rock County has acquired equipment through a noncancelable lease-purchase agreement dated December 31, Year 1. This agreement requires no down payment and the following minimum lease payments: December 31 Principal Interest Total Year 2 $50,000 $15,000 $65,000 Year 3 $50,000 10,000 60,000 Year 4 $50,000 5,000 55,000 If the equipment is used in Enterprise Fund operations and the lease payments are to be financed with Enterprise Fund revenues, what account should be debited for $150,000 in the Enterprise Fund at inception of the lease?
Equipment. Enterprise Funds use accrual accounting and account for their fund-specific fixed assets. In accounting for capital leases an Enterprise Fund follows FASB ASC 840 - Leases, therefore the Equipment account should be debited for $150,000 at the inception of the lease.
666
The following transactions were among those reported by Corfe City's Electric Utility Enterprise Fund for 20X5: Capital contributed by subdividers $ 900,000 Cash received from customer households 2,700,000 Proceeds from the sale of revenue bonds 4,500,000 In the Electric Utility Enterprise Fund's Statement of Cash Flows for the year ended December 31, 20X5, what amount should be reported as cash flows from capital and related financing activities?
$5,400,000 The statement of cash flows for an Enterprise Fund has four sections: (1) cash flows from operating activities, (2) cash flows from noncapital financing activities, (3) cash flows from capital and related financing activities, and (4) cash flows from investing activities. Both capital contributed by subdividers, $900,000, and proceeds from the sale of revenue bonds, $4,500,000, are considered cash flows from capital and related financing activities, therefore $5,400,000 is the correct answer. The cash received from customer households, $2,700,000, is classified as cash flows from operating activities.
667
Shared revenues received by an Enterprise Fund of a local government for operating purposes should be recorded as:
Nonoperating Revenues. An Enterprise Fund is a type of Proprietary Fund. Shared Revenues received by a Proprietary Fund for operating purposes should be recorded as Non-Operating Revenues in the period in which they are earned and become measurable.
668
Todd City formally integrates budgetary accounts into its General Fund. Todd uses an Internal Service Fund to account for the operations of its data processing center, which provides services to Todd's other governmental units. During the year ended December 31, Year 1, Todd received a state grant to buy a bus and an additional grant for bus operation in Year 1. In Year 1, only 90% of the capital grant was used for the bus purchase, but 100% of the operating grant was disbursed. Todd has incurred the following long-term obligations: General obligation bonds issued for the Water and Sewer Fund, which will service the debt. Revenue bonds to be repaid from admission fees collected from users of the municipal recreation center. These bonds are expected to be paid from Enterprise Funds, and secured by Todd's full faith, credit, and taxing power as further assurance that the obligations will be paid. Todd's Year 1 expenditures from the General Fund include payments for structural alterations to a firehouse and furniture for the mayor's office. Which of Todd's long-term obligations should be accounted for in the general fund? General obligation bonds Revenue bonds
General obligation bonds - No Revenue bonds - No Neither of the long-term obligations should be accounted for in Todd City's general fund. Bonds directly related to and expected to be paid from Proprietary Funds (Water and Sewer Fund and Municipal Recreation Fund) should be included in the accounts of such funds. These are specific fund liabilities, even though the full faith and credit of Todd City has been pledged as further assurance that the obligations will be paid.
669
Which of the following statements is the most significant characteristic in determining the classification of an enterprise fund?
The pricing policies of the activity establish fees and charges designed to recover its cost. There are two types of proprietary funds: (1) Internal Service Funds and (2) Enterprise Funds. Both use accrual accounting. They differ in terms of the primary user of their services and the pricing policy to set fees. Other governmental agencies/departments are the primary user of services provided by an internal service fund and the pricing policy is some portion of routine operating costs (e.g., from 50% to 100%). Motor pools, data processing, and self insurance are some examples of Internal Service Funds. External users are the primary users of services provided by an enterprise fund and the pricing policy is to recover operating costs, depreciation, and to provide for capital maintenance. This answer is correct.
670
At the beginning of the current year, Paxx County's enterprise fund had a $125,000 balance for accrued compensated absences. At the end of the year, the balance was $150,000. During the year, Paxx paid $400,000 for compensated absences. What amount of compensated absences expense should Paxx County's enterprise fund report for the year?
$425,000 Enterprise funds use accrual accounting. The amount of compensated absences expense for the current year can be computed as: ending accrued compensated absences ($150,000) plus compensated absences paid ($400,000) less beginning compensated absences ($125,000), which amounts to $425,000.
671
Maple Township issued the following bonds during the year ended June 30, Year 1: Bond issued for the Garbage Collection Enterprise Fund that will service the debt $500,000 Revenue bonds to be repaid from admission fees collected by the Township Zoo Enterprise Fund 350,000 What amount of these bonds should be accounted for in Maple's Proprietary Funds?
$850,000 All of the long-term liabilities of these Enterprise Funds should be accounted for in the proprietary fund financial statements.
672
Through an Internal Service Fund, New County operates a centralized data processing center to provide services to New's other governmental units. In Year 1, this Internal Service Fund billed New's Parks and Recreation Fund $150,000 for data processing services. What account should New's Internal Service Fund credit to record this $150,000 billing to the Parks and Recreation Fund?
Operating Revenues Control. New's Internal Service Fund is a Proprietary Fund type and uses the accrual basis of accounting. It should recognize revenues when they are earned, not when cash is received. When New's Internal Service Fund bills New's parks and recreation department for services rendered, it should record the following entry: Due from Other Funds-Parks and Recreation 150,000 Operating Revenues Control 150,000
673
What accounts do tax collection custodial funds use?
Most custodial funds accounts consist only of current assets and current liabilities; they do not recognize revenues, expenditures, or net position. The exception is investment pools that are not subject to a formal trust arrangement, which are accounted for as custodial funds with restricted net position for the external entities in the investment pool.
674
Blake City invests $5,000,000 into Kameron County’s pooled investment fund that is subject to a formal trust agreement. What is the journal entry by Kameron County’s Investment Trust Fund?
DR: Cash $5,000,000 CR: Additions–Deposits in Pooled Investments for Blake City $5,000,000
675
Describe the pension trust fund journal entry to record receipt of employer contributions to the employee pension plan.
DR: Cash | CR: Additions—Employer Contributions
676
What equity account is used by pension trust funds?
Net Position Held in Trust for Pension Benefits
677
What funds are used to account for any resources managed in trust by the governmental entity where the beneficiaries are outside of the governmental entity itself?
Private-purpose trust funds
678
The City of Macon maintains a defined contribution pension plan for its employees. During the year, the city contributed $5,000,000 to the plan, which represented 100% of its required contribution for the year. City employees contributed $1,800,000 to the plan. In addition, plan assets earned $4,500,000. What amount should the City report as Additions in its Pension Trust Fund?
$11,300,000 In addition to the actual earnings on plan assets, both employer and employee contributions are recognized as Additions in the Pension Trust Fund.
679
The funded ratio of a pension plan compares:
The plan's fiduciary net position as a percentage of the actuarially determined total pension liability.. According to GASB Statment No. 68 (para 46(b)(1)(d), governmental employers must report as required supplemental information, the pension plan's fiduciary net position as a percentage of the actuarially determined total pension liability.
680
The City of New Hope Rotary Club, a private, not-for-profit organization, recently ended a fund drive that raised $500,000 to be used as a scholarship fund. The $500,000 is to be used to create an endowment that will be invested and retained in perpetuity and the earnings used to provide college scholarships to outstanding local high school graduates selected by the Rotary Club. The City has agreed to manage the investment and disbursement of these monies on behalf of the Rotary Club. The City should account for the $500,000 corpus of the endowment in a(n):
Private-Purpose Trust Fund. A Private-Purpose Trust Fund is used to account for resources, both expendable and non-expendable, which either must be used for a non-governmental purpose or the earnings from which have to be used for a non-governmental purpose. As in this case, Private-Purpose Trust Funds usually disburse monies to individuals or organizations outside the governmental entity. Permanent Funds are used to segregate resources that must be invested in perpetuity, the earnings from which are to be used for a general government purpose. Special Revenue Funds are used to accrue and expend resources for governmental purposes, not for private purposes. Custodial Fund, the monies would have to be distributed to other entities in accordance with narrowly defined guidelines. Custodial Funds cannot account for monies which must be retained in perpetuity.
681
In a Tax Collection Custodial Fund, revenues must be recognized:
None of the above. Revenues are not reported in Custodial Funds. Custodial Funds act as intermediaries in the process of disbursing monies from one governmental entity to another. The government has no claim on the resources in the Custodial Fund and does not recognize revenues when it receives the monies or recognize expenses when the monies are disbursed; rather, additions and deductions are recognized.
682
Harland County received a $2,000,000 capital grant to be equally distributed among its five municipalities. The grant is to finance the construction of capital assets. Harland had no administrative or direct financial involvement in the construction. In which fund should Harland record the receipt of cash?
Custodial Fund. Custodial Funds are used to account for assets received on behalf of and paid to other funds, individuals, or organizations. The capital grant described in this question is an example of a pure pass-through grant in which Harland County acts as a conduit to distribute the funds to the five subrecipient municipalities. Hartland County will not record any revenues or expenditures related to the grant and will record a receivable and payable in the Custodial Fund that acts as a clearinghouse for the funds. Private-Purpose Trust Funds account for the principal or corpus of a trust that must be held intact to produce income whose beneficiaries are private individuals, organizations, or other governments. Special Revenue Funds are used to account for revenues sources that are restricted or committed to expenditure for purposes other than debt service or capital projects. The General Fund is used to account for all activities not properly accounted for by another fund.
683
A government makes a contribution to its pension plan in the amount of $10,000 for year 1. The actuarially-determined annual required contribution for year 1 was $13,500. The pension plan paid benefits of $8,200 and refunded employee contributions of $800 for year 1. What is the pension expenditure for the general fund for year 1?
$10,000 Because the question is about the General Fund, which uses the modified accrual basis of accounting, only the $10,000 contribution to the pension plan, which is a use of financial resources in year 1, is recognized as pension expenditure. The Pension Trust Fund would report the $10,000 received from the General Fund as an "Addition" and not as revenue. Both the $8,200 and $800 paid by Pension Trust Fund would be reported as "Deductions" in that fund and not as expenditures. The actuarially-determined annual required contribution would be reported in the Required Supplemental Information (RSI) and also in the footnotes to the financial statements.
684
Arlen City's Fiduciary Funds contained the following cash balances at December 31, 2004: Under the Forfeiture Act-cash confiscated from illegal activities; disbursements can be used only for law enforcement activities $300,000 Sales taxes collected by Arlen to be distributed to other governmental units 500,000 What amount of cash should Arlen report in its Custodial Funds at December 31, 2004?
$500,000 Arlen should report the $500,000 of sales taxes that it has collected on behalf of others in a Custodial Fund. The $300,000 cash confiscated from illegal acts, which must be used to support law enforcement activities, a general government function, should be reported in a Special Revenue Fund.
685
List the three component parts of net position.
1. Net investment in capital assets 2. Restricted net assets 3. Unrestricted net assets
686
What statement is developed in a functional format | that highlights program revenues and cost?
Statement of activities
687
What funds are included in the Business-type Activities column on the government-wide statements?
Enterprise funds (Internal service funds are primarily adjusted into governmental activities since they provide services to government. Some adjustment may be necessary to business-type activities to the extent that internal service funds provide services to enterprise funds.)
688
What are the required government-wide financial | statements of a government?
Statement of net position | Statement of activities
689
``` List the sections in the comprehensive annual financial report (CAFR). ```
Introductory Financial Statistical
690
A government-wide statement of net position must include which of the following?
A distinction between governmental and business-type activities. The primary focus of the government-wide financial statements is to report two activities: governmental and business-type. The governmental activities are largely funded by nonexchange transaction revenues, such as property taxes, and business-type activities that rely mainly on user fees. Fiduciary funds are not included in government-wide financial statements because the government acts merely as a custodian for others. Unlike for-profit entities, government financial statements, including the two government-wide financial statements, only report on the current fiscal year. (Comparative data is often reported in management's discussion and analysis.)
691
Palm City uses the modified approach for reporting eligible infrastructure assets. In which of the following components of its basic financial statements, if any, would Palm report this information?
Notes to the financial statements. GASB requires, as “required supplemental information,” information about the use of the modified approach for reporting infrastructure in the notes to the financial statements.
692
Management's Discussion and Analysis (MD&A) is:
Required supplementary information MD&A is required supplementary information (RSI) that is included in the financial section of the CAFR along with independent auditor's report, basic financial statements, notes to the financial statements, and other RSI.
693
Excel City has three discretely presented component units, one of which is governmental in nature and two of which are business type in nature. What is the minimum number of discretely presented component unit columns that can be reported in the government-wide financial statements?
1 GASB rules allow the primary government to aggregate all discretely presented component units into a single column.
694
Combining financial statements for nonmajor funds of a government should be included
As part of the financial section of the comprehensive annual financial report. Combining statements of nonmajor governmental funds, nonmajor enterprise funds, internal service funds, trust funds, and agency funds are included as part of the financial section of the comprehensive annual financial report. The basic financial statements include government-wide financial statements and fund-level financial statements that on report major funds with a single column for nonmajor funds (that comes from the total column of the combining financial statement for nonmajor funds). The statistical section provides information to give the reader a historical and trend perspective on the government. The broad categories of information are: (1) financial trends information, (2) revenue capacity information, (3) debt capacity information, (4) demographic and economic information, and (5) operating information. Most of the information is provided for a 10-year period. Individual fund statements and schedules may appear as part of the notes to the financial statements, but this does not include combining financial statements, which are reported elsewhere.
695
The Comprehensive Annual Financial Report (CAFR) of a state or local governmental unit should include fund-level statements for which of the following fund categories: Governmental Funds Proprietary Funds Fiduciary Funds
Governmental Funds - Yes Proprietary Funds - Yes Fiduciary Funds - Yes The CAFR includes Fund statements from all three fund categories. The government-wide statements include data from the Governmental and Proprietary Funds only.
696
The introductory section of a CAFR typically includes all of the following except:
The independent auditor's opinion. The auditor's report is not part of the introductory section of the CAFR. It is part of the financial section of the CAFR.
697
Nack City received a donation of a valuable painting. Nack planned to add the painting to its collection and display it in the protected exhibition area of city hall. Nack had a policy that if such donated art works were sold, the proceeds would be used to acquire other items for its collections. Which of the following would be correct regarding the donated painting?
It may be capitalized, but it is not required, and depreciation is not required. GASB Statement no. 34 para. 27-29, provides not-for-profit organizations with an option to not recognize contributions of donated works or art, historical treasures, or similar assets that are added to collections if the following conditions are met: they are held for public exhibition, education, or research in furtherance of public service rather than financial gain; are protected, kept unencumbered, cared for, and preserved; or are subject to a policy that requires the proceeds of items that are sold to be used to acquire other items for the collection. Capitalized collections or individual items that are exhaustible, such as exhibits whose useful lives are diminished by display or educational or research applications, should be depreciated over their estimated useful lives. Depreciation is not required for collections or individual items that are inexhaustible. In this question, neither capitalization nor depreciation is required.
698
Which of the following statements are required to be presented for special-purpose governments engaged only in business-type activities (such as utilities)?
The financial statements required for Enterprise Funds, including MD&A and RSI. Special-purpose governments engaged in business-type activities follow the reporting standards required for Enterprise Funds, which are a Statement of Net Position; Statement of Revenues, Expenses, and Changes in Net Position; Statement of Cash Flows; and appropriate disclosures in MD&A, and RSI. Governmental Fund financial statements report according to the modified accrual basis of accounting and, therefore, are not appropriate for business-type activities.
699
Jonn City entered into a capital lease for equipment during the year. How should the asset obtained through the lease be reported in Jonn City's government-wide Statement of Net Position?
General Capital Asset. The Government-Wide Financial Statements will present both the asset and the liability associated with a capital lease asset. "Other financing use" is an account at the fund-level and does not appear in the Government-Wide Financial Statements. "Expenditure" would be used in the Governmental Fund Statement but not in the Government-Wide Financial Statements.
700
Define "component units."
Legally separate organizations: Which are fiscally dependent on the primary government and the organization provides benefits to or financial burdens on the primary government; OR For which the primary government appoints a voting majority of the component unit's governing board and either: (1) the primary government is financially accountable for the component unit; or (2) it would be misleading or incomplete to exclude the component unit from the primary government's financial statements
701
When should component units be blended with | primary government?
If the component unit is, in substance, a part of the primary government (e.g., the principal beneficiary of the component units services is the primary government), the component unit's debt is to be paid entirely (or nearly so) by the primary government, and the governing body of the component unit is substantially the same as that of the primary government, it should be blended. Blended component units are much more rare than discretely presenting component units.
702
List the three requirements necessary to be | considered a primary government.
1. A separately elected governing body 2. A legally separate entity 3. Fiscal independence
703
How is discrete presentation of component units | accomplished in the government-wide statements?
A column of aggregated totals for the component units is added to the right of the primary government's data.
704
Define "financial reporting entity" of a government.
A primary government and its component units
705
How is blended presentation of component units | accomplished in the government-wide statements?
The component unit's totals are included with the primary government's data in the Governmental Activities and Business-type activities columns, as appropriate for each component unit.
706
Which of the following factors would not indicate that a potential component unit (PCU) imposes a financial burden or provides a financial benefit to a primary government?
The primary government has an ongoing financial interest in a joint venture, which pays its surpluses to the joint venture participants. A joint venture is a legal entity or other organization that results from a contractual arrangement and that is owned, operated, or governed by two or more participants as a separate and specific activity subject to joint control. “Joint control” means that no single participant has the ability to unilaterally control the financial or operating policies of the joint venture. The joint venture is not included as a component unit. The primary government reports its equity interest in government-wide financial statements and in the affected fund-level statements.
707
Which of the following is evidence of fiscal independence for the purpose of considering whether one legally separate organization is a component unit of another?
The potential component unit sets user fees without authority of the primary government. The ability to raise its fee structure without primary government approval is an example of fiscal independence. The ability of the primary government to veto, overrule, or modify decisions made by the potential component unit's governing body is an example of the primary government imposing its will on the potential component unit. The ability of the primary government approve the budget of the potential component unit (PCU) is evidence of the primary government being able to impose its will on the PCU.
708
Excel City's museum board is appointed by the city council, which has agreed to subsidize the operating costs of the museum. In addition, the city is obligated to service the debt on general obligation bonds issued to construct a museum annex. The museum is
A component unit. Excel City has appointment authority and has a financial burden relationship with the museum. Special-purpose governments provide a single or limited number of functions, such as airport authorities or school districts. Special-purpose governments have the power to levy and collect taxes to raise revenues to finance the services that they provide. If an organization is jointly controlled by two or more participants but there is no ongoing financial interest or ongoing financial responsibility, it is a jointly controlled organization. A joint venture occurs when two or more participants are in joint control of a separate and special activity. “Joint control” means that no single participant has the ability to unilaterally control the financial or operating policies of the joint venture. The participants have an equity interest in the joint venture.
709
An entity is a component unit of another entity if
It is fiscally dependent on the other entity and a benefit or burden relationship exists with the other entity. Fiscal dependence plus a financial benefit or burden relationship indicates financial accountability by the primary government for the component unit. Appointment authority is part of the criteria to determine financial accountability, but it must be combined with additional criteria. A financial burden is part of the criteria to determine financial accountability, but it must be combined with additional criteria. A financial benefit/burden is part of the criteria to determine financial accountability, but it must be combined with additional criteria.
710
The governing board of the Excel City is also the governing board of Mosquito Abatement District, a business-type activity that serves only Excel City. The city is legally obligated to fund deficits of the district. Which of the following statements regarding the financial reporting options is false?
The district is not subject to major fund reporting criteria. This statement is false. The district should be evaluated to determine whether or not it meets the criteria of a major fund. This statement is true. The district has the same governing body, and a financial burden relationship exists. Since the governing bodies are identical and the district provides services only to the city, the district is a component unit deemed to be part of the city in substance, and therefore the blended approach should be used. This statement is true. Since the district is an enterprise fund, it may be reported as a separate column of the Proprietary Fund financial statements if it meets the criteria for a major fund and as part of the business-type activities in the two government-wide financial statements. This statement is true. The district meets the criteria for blended presentation because the district has the same governing body, and a financial burden relationship exists. Since the governing bodies are identical and the district provides services only to the city, the district is a component unit deemed to be part of the city in substance, and therefore the blended approach should be used.
711
Excel City and Excel County are partners in the Excel Transportation Authority, which is a separate legal entity. Both the city and the county are obligated to fund any debt defaults or operating deficits of the authority, which is deemed to be highly unlikely. The authority has seven board members: three appointed by the city, three appointed by the county, and one appointed by Wileytown, which is in the Excel Metropolitan Area. Both Excel City and Excel County should report the Excel Transportation as
A joint venture. The city and county jointly govern the authority, and each has an ongoing financial responsibility. Both the city and the county will report their equity interest in the joint venture as business-type activities in the government-wide financial statements. Neither the city nor the county appoints a voting majoring of the authority's governing body. Jointly governed organizations are subject to the joint control or two or more participating governments, but there is neither an ongoing financial interest nor an ongoing financial responsibility. A related organization is one in which a primary government has met the appointment authority criterion but is not financially accountable for the organization. That is, the primary government does not have the ability to impose its will and does not have a financial benefit or burden relationship with it.
712
For general purpose external financial reporting, discrete component unit information:
Is included in the government-wide statements only. Discretely presented component units are presented in the Government-Wide Financial Statements only and not in the fund-level statements.
713
The Metro Transportation Authority is governed by a seven-member board. Four of the board members are appointed by the town of Metro and the remaining three are appointed by the governing board of Metro County. Neither the town nor the county share in any profits, nor are they required to fund any deficits, of the Authority. The town, however, does approve the Authority's proposed budget. The county may make budgetary recommendations to the Authority, but they are not required to approve the proposed budget. The Authority should be reported as:
A discretely presented component unit of the town. The Metro Transportation Authority (MTA) is a discretely presented component unit of the town of Metro because it is financially accountable to the town since the MTA’s budget must be approved by the town’s governing board, which also appoints a voting majority of the MTA’s board.
714
The Excel City School District has a separate elected governing body that administers the public school system. The district's budget must be approved by the city council of Excel City. The school district's financial activity should be reported in the City's financial statements by:
Not at all. According to GASB Statement No. 61 (para 6), Excel City would have to appoint a voting majority of Excel ISD's governing body. The criteria for financial accountability require that, in addition to the primary government being able to impose its will on the component unit (e.g. approve the budget), at least 50% of the governing body of the component unit be appointed by the primary government. In this case, the governing body is independently elected and so does not meet the criteria for inclusion as a component unit.
715
If a city government is the primary reporting entity, which of the following is an acceptable method to present component units in its combined financial statements?
Discrete presentation. Two approaches are used for component units: (1) discrete presentation in a separate column of the Government-Wide Financial Statements and (2) blended with the primary government.
716
What are the required government-wide financial | statements of a government?
Statement of net position | Statement of activities
717
What funds are reported in a separate column in the fund-level financial statements for governmental fund types?
Major funds. Major funds meet two thresholds: 1. 10% of combined balances (e.g., revenues) of all governmental fund types and 2. 5% of combined balances of governmental and enterprise fund. The general fund is always a major fund.
718
What fund is always a major fund?
The general fund
719
What criteria are used to determine a major fund?
10% of total assets and deferred outflows of resources, liabilities, and deferred inflows of resources, revenues, or expenditures/expenses of the total for all funds in that fund type and at least 5% for the same element for all governmental and enterprise funds combined
720
What funds must report budget-to-actual | comparisons?
General funds | Major special revenue funds
721
Which funds are not included in determining major | funds?
Internal service funds and fiduciary fund types
722
A major governmental fund is one that has one or more elements (e.g., assets, liabilities, revenues, or expenditures) that is at least
10% of the corresponding element(s) of total governmental funds and 5% of the corresponding element(s) of total governmental and enterprise funds combined. Note also the fiduciary funds and internal service funds are never major funds.
723
Use the following information to determine whether the Special Revenue and the Debt Service Funds should be reported as major funds based on asset amounts provided. Special Revenue Fund Assets $750,000 Debt Service Fund Assets $300,000 Total Governmental Fund Assets $8,000,000 Total Governmental Fund and Enterprise Fund Assets $10,000,000
Neither the Development Special Revenue Fund nor the Debt Service Fund should be reported as major. The General Fund is always a major fund. Other governmental funds are major funds if the element (assets in this question) exceed 10% of total governmental fund assets ($800,000) and 5% of total governmental fund and enterprise fund assets combined ($900,000).
724
A city reports two Pension Trust Funds, one Private-Purpose Trust Fund, one Investment Trust Fund, and four Custodial Funds, none on which is an investment pool. How many columns would the city's statement of fiduciary net position report?
Four Fiduciary funds are not subject to major fund criteria and therefore are reported in a separate column for each of the four types of fiduciary funds since none of the custodial funds is related to an investment pool. Combining statements can be used to disclose information on each fiduciary fund.
725
Fiduciary funds are reported
In fund-level financial statements by fund type. Fiduciary funds are reported in fund-level statements and not in the government-wide financial statements.
726
A city reports two Pension Trust Funds, one Private-Purpose Trust Fund, one Investment Trust Fund, and four Agency Funds. How many columns would the city's statement of fiduciary net position report?
Four Fiduciary funds are not subject to major fund criteria and therefore are reported in a separate column for each of the four types of fiduciary funds. Combining statements can be used to disclose information on each fiduciary fund.
727
Assume that a governmental entity has a General Fund and four other governmental funds. Upon applying the quantitative criteria to determine the minimum requirements for major fund reporting, it is determined that two of those four other governmental funds meet the criteria. At a minimum, the governmental entity will report how many major funds?
Three The general fund is always a major fund. The general fund and the two other governmental funds that meet the criteria for major fund reporting will be reported separately in the governmental fund-level financial statements. The other two nonmajor governmental funds will be reported in aggregate in a column entitled “Other Governmental Funds.”
728
Major fund reporting is required for which of the following fund types?
Enterprise funds Enterprise funds and governmental funds are eligible for major fund reporting if they meet the criteria of a major fund. The general fund is always a major fund. Fiduciary funds are never major funds.
729
Tree City reported a $1,500 net increase in the fund balance for Governmental Funds. During the year, Tree purchased general capital assets totaling $9,000 and recorded a depreciation expense of $3,000. What amount should Tree report as the Change in Net Position for governmental activities in Tree's Statement of Activities?
$ 7,500 The increase in the fund balance for Governmental Funds is measured on the modified accrual basis, while the Change in Net Position for governmental activities is measure on the full accrual basis. To convert the increase in fund balance to full accrual: Increase in Fund Balance + $1,500 Add back the Expenditures related to the purchase of capital assets + 9,000 Deduct the depreciation expense not included in Fund Balance - 3,000 Change in Net Position $7,500
730
Nox City reported a $25,000 net increase in the fund balances for total Governmental Funds. Nox also reported an increase in Net Position for the following funds: Motor pool Internal Service Fund $ 9,000 Water Enterprise Fund 12,000 Employee pension fund 7,000 The motor pool Internal Service Fund provides service to the General Fund departments. What amount should Nox report as the Change in Net Position for governmental activities?
$34,000 GASB Stmt. #34 requires that Internal Service Funds be included in the Governmental Activities totals on the Government-Wide Statements since Internal Service Funds supply goods or services only to the government entity. Therefore, the total fund balance for the Governmental Funds in the fund-based statements ($25,000) must be increased by the Net Position of the motor pool ($9,000) when the preparing the Governmental Activities column of the Government-Wide Statement of Net Position ($25,000 + 9,000 = $34,000).
731
According to GASB 34, Basic Financial Statements-and Management's Discussion and Analysis-for State and Local Governments, certain budgetary schedules require supplementary information. What is the minimum budgetary information required to be reported in those schedules?
A schedule showing the original budget, the final appropriations budget, and actual inflows, outflows, and balances on a budgetary basis. The Budgetary Comparison Schedule must report the original budget, the amended/final budget, and actual revenues and expenditures. The revenues and expenditures must be reported using the same basis used to prepare the budget: governmental budgets are frequently prepared on a cash or near-cash basis.
732
How are governmental fund "Due to/Advance from" and "Due from/Advance" to enterprise funds handled in deriving the governmental activities column in the Statement of Net Position?
The net amount of governmental fund interfund payables to and receivables from enterprise funds are reclassified as "Internal Balances" in the government-wide statement of net position.
733
How is the financial information for an internal service fund that primarily serves governmental activities integrated into the government-wide statement of net position?
Current assets and current liabilities of the internal service fund are adjusted into government-wide governmental activities. An adjustment of "Internal Balances" is made for a net amount of the internal service fund operations allocated to business-type activities, if any. Capital assets and long-term liabilities of the Internal Service Fund will be included in the adjustments to add capital assets, accumulated depreciation, and long-term liabilities.
734
List the three major adjustments that must always be made to convert governmental fund-level financial information to governmental activities in the government-wide statement of net position.
``` 1. Add general capital assets and related accumulated depreciation. 2. Add general long-term liabilities. 3. Convert categories of fund balance to categories of net position. ```
735
Excel City's store supply internal service fund provides services only to general government departments. During 20X1, the internal service fund reported operating revenue of $50,000 and operating expenses of $35,000. What amount of adjustment is needed to convert the governmental funds Statement of Revenues, Expenditures, and Changes in Fund Balance to governmental activities in Excel City's government-wide Statement of Activities?
Decrease expenses by $15,000. The general government departments have recorded a total of $50,000 in expenditures related to billings from the internal service fund. The conversion to government-wide financial statements requires the elimination of the $15,000 "profit" by decreasing the $50,000 expenditure to $35,000 and reclassifying it as "expense."
736
The primary adjustment to enterprise fund financial information in preparation of the government-wide financial statements is related to:
Adjustments related to internal service funds. Enterprise funds use the economic resources measurement focus and the accrual basis of accounting, which is also used in government-wide financial statements. Internal service fund activities utilized by enterprise funds are the primary adjustment to enterprise fund financial information.
737
Which of the following items would result in an increase in the reconciliation of governmental funds changes in fund balance to governmental activities changes in net position in the government-wide statement?
Capital outlay expenditures Capital outlay expenditures in the governmental fund-level financial statements are eliminated in converting to governmental-wide financial statements. The adjustment is an increase in reconciling changes in fund balance, at the governmental fund level, to changes in net position at the government-wide level.
738
Under government accounting, what is the modified | approach?
It is an alternative to depreciation of infrastructure assets based on maintaining the condition of infrastructure assets.
739
How is the principal component of debt service | payments on bonds payable reported?
They are reported as a decrease in bonds payable in government-wide financial statements and as an expenditure in the debt service fund-level financial statements.
740
How are payments made to contractors of a major | construction project reported?
They are reported as an increase to long-term assets in government-wide financial statements and as an expenditure in the capital projects fund-level financial statements.
741
How are bonds payable used to finance major | construction projects reported?
They are reported as a liability in the governmentwide financial statements and as other financing sources—bond proceeds in the capital projects fundlevel financial statements.
742
What is the account name for short-term interfund | receivables?
Due from xxx
743
What is the account name for long-term interfund | receivables?
Advances to xxx
744
How are assets grouped for impairment testing under International Financial Reporting Standards (IFRS)?
At the "cash-generating unit" level
745
When is a held-for-sale asset impaired?
It is impaired when book value exceeds its fair value | less cost to sell at the end of the reporting period.
746
If a local government reports eligible infrastructure assets using the modified approach,
No depreciation expense is required to be recognized. Under the modified approach, infrastructure assets that are part of a network or subsystem of a network need not be depreciated if the government uses an asset management system that documents that the assets are being preserved approximately at (or above) a condition level established and disclosed by the government. the modified approach the government must document and complete condition assessments every three years and the three most recent assessments should provide reasonable assurance that assets are being preserved at or above the established and disclosed condition level. Under the modified approach, infrastructure assets that are part of a network or subsystem of a network need not be depreciated if the government uses an asset management system that documents that the assets are being preserved approximately at (or above) a condition level established and disclosed by the government. Maintenance and repair expenses are anticipated by the modified approach and are incurred to "preserve" the condition of the assets. Under the modified approach, these expenditures are a substitution for depreciation.
747
The City of Curtain had the following interfund transactions during the month of May: Billing by the internal service fund to a department financed by the general fund, for services rendered in the amount of $5,000. Transfer of $200,000 from the general fund to establish a new enterprise fund. Routine transfer of $50,000 from the general fund to the debt service fund. What was the total reciprocal interfund activity for Curtain during May?
$ 5,000 There for five types of interfund transactions: (1) loans, (2) reciprocal quasi-external transactions, (3) reimbursements, (4) residual transfers, and (5) operating transfers. A reciprocal transaction occurs from doing business with one another, such as the billing of services by an internal service fund to other funds/departments in the government.
748
A city's General Fund contributes $150,000 to its Debt Service Fund to meet upcoming debt service requirements for a general obligation serial bond. The General Fund should report this as a(n):
Operating Transfer of $150,000. General Fund transfers to the Debt Service Fund to provide for the servicing of debt is an example of a regular, routine, reoccurring transfer of resources between funds to subsidize current activities that are classified as Operating Transfers.
749
Which of the following capital assets are least likely to be considered infrastructure assets of a local government?
Buildings. Infrastructure assets are capital assets that are normally stationary and can be preserved for a longer time than most capital assets. Common infrastructure assets include roads, bridges, sewer systems, lighting systems, and drainage. Buildings are not infrastructure assets.
750
On March 2, Year 1, Finch City issued 10-year general obligation bonds at face amount, with interest payable March 1 and September 1. The proceeds were to be used to finance the construction of a civic center over the period April 1, Year 1, to March 31, Year 2. During the fiscal year ended June 30,Year 1, no resources had been provided to the Debt Service Fund for the payment of principal and interest. The liability for the general obligation bonds should be recorded in the:
Government-wide financial statements. The government-wide financial statements are used to account for all unmatured long-term indebtedness of the government, except for that debt belonging to Proprietary and similar Trust Funds. The liability for the general obligation bonds should be recorded in this account group.
751
In 2011, Kameron City received $4,000,000 from the sale of general obligation bonds to be used for major street and bridge renovations. $3,000,000 is expected to be spent in 2011, and the remainder will be spent in 2012. When will Kameron report bond proceeds as an other financing source in its Capital Projects Fund?
$4,000,000 in 2011. The Capital Project Fund records the entire amount of the bond proceeds as an Other Financing Source in the year that the proceeds are received. Even though the expenditures are to occur over two years, under modified accrual accounting, the entire amount of the proceeds are recorded as a resource of the fund when received.
752
How are pension expenditures in governmental fund | financial statements recognized?
They are recognized on the modified accrual accounting basis of accounting and should be equal to the amount expected to be liquidated with expendable available financial resources.
753
How is the estimated loss from a claim affecting a | governmental fund reported?
It is reported in its entirety in the government-wide financial statements and recognized in the fundlevel statements to the extent that amounts are payable from expendable available financial resources.
754
How are compensated absences in governmental | funds reported?
They should report expenditures accrued that year for which there are expendable available financial resources.
755
Pollution remediation obligations should be recognized if which of the following obligating events has occurred? I. A violation of a pollution prevention permit has occurred. II. The government is named or will be named as the responsible or potentially responsible party to a remediation. III. The government is compelled to take remediation action due to imminent endangerment to the public health. IV. All of the above items are obligating events that would require recognition of a pollution remediation obligation.
Choice IV All three events are obligating events that require recognition of a pollution remediation obligation.
756
Which of the following is not properly reported in the government activities of the government-wide financial reports?
Revenue bonds issued by an enterprise fund Revenue bonds issued by an enterprise fund are reported within business-type activities in government-wide financial statements. Capital lease obligations for general capital assets are reported within governmental activities in government-wide financial statements Tax-supported general obligation bonds are reported within governmental activities in government-wide financial statements. The long-term portion of claims and judgments is reported within governmental activities in government-wide financial statements.
757
Which of the following would not be considered a long-term liability within the governmental activities of the government-wide financial statements?
Capitalized equipment leases of the sewerage and wastewater utility fund The capitalized lease obligation of the sewerage and wastewater utility fund is recognized within the business-type activities of the government-wide financial statements. The capital lease obligation for administrative office computers the liability is recognized within the governmental activities of the government-wide financial statements. Compensated absences of the fire department the liability are recognized as expenses within the governmental activities of the government-wide financial statements. Because the liability is related to the city's public works division, the liability is recognized within the governmental activities of the government-wide financial statements.
758
Excel City's Municipal Solid Waste Landfill Enterprise Fund was established when a new landfill was opened in year 2000. The landfill is expected to close in year 2030. The enterprise fund 2000 expenses include a portion of which of year 2030’s expected disbursements? I. Cost of a final cover to be applied to the landfill II. Cost of equipment to be installed to monitor methane gas buildup
Both I and II Portions of the cost of the final cover and of gas monitoring systems are included.
759
In the year a city enters into a capital lease to finance a new fire engine, the General Fund will report in its funds-level financial statements
An other financing source. The general fund will record an expenditure and an other financing source at the inception of the lease.
760
A court judgment was rendered against a city in which it was ordered to pay $600,000 in equal installments over a six-year period to the plaintiff. The city's General Fund will
Report expenditures of $100,000 in Year 1. Governmental funds report only the portion that is due and payable from available current financial resources..
761
The following benefits are examples of other postemployment benefits (OPEB) except for
Pension benefits. Pension benefits are not an example of other postemployment benefits. Example of other postemployment benefits: Life insurance. Dental benefits Medical insurance
762
A government has the following debt: Capital lease liabilities that mature in more than one year (General Fund department leases)-$2,000,000. Net pension liability associated with general government employees-$4,000,000. General government bonds that mature in the next fiscal year-$14,000,000. What amount of debt should be reported in the long-term liabilities in the government-wide financial positions?
$20,000,000 All of the items listed are Unmatured Long-Term Liabilities of the general government that will not be recorded in any of the Governmental Funds but will appear as liabilities in the Government-Wide Statement of Net Position.
763
Excel City's Water Utility Enterprise Fund issues $10,000,000 in 20-year serial revenue bonds to finance a major expansion of one of its water treatment plants. $500,000 in bonds mature each year. As a result of this transaction, the year-end long-term liability in the governmental activities section of the government-wide financial statements accounts will reflect:
$0 The Water Utility Enterprise Fund uses full accrual accounting and will account for and report on the bonds in the Enterprise Fund. Therefore, this liability appears in the business-type activity section of the government-wide financial statements and not in the governmental activity section.
764
Big City recently lost a lawsuit relating to an incident involving one of their police officers. A judgment was rendered against the city, and, immediately prior to the current fiscal year end, the city was ordered to pay a total of $500,000. $100,000 is due immediately and the remaining is to be paid in installments of $100,000 per year for an additional four years. How will the external financial statements of the city be affected in the year the court case was settled?
The General Fund statements should report expenditures and a current liability of $100,000, and the government-wide statements should report a long-term liability of the present value of the $400,000. The $100,000 portion of the judgment due in the current year is reported in the General Fund and will appear as expenditures in the fund-level statements. The unmatured $400,000 portion is reported in the Government-Wide Statements as a liability at present value. The long-term portion of the liability is RECORDED in the Schedule of General Long-term Debt.
765
List the two items that cause deferral of recognition of nonexchange revenue under Governmental Accounting Standards Board Statement (GASBS) No. 33.
Failure to meet: Time restrictions or Eligibility requirements
766
What expenditure classification identifies the expenditure by the period of time benefited by the expenditure?
Character (Debt Service, Current, Capital Outlay)
767
What expenditure classification identifies the expenditure by the broad purpose of the expenditure?
Program or Function
768
List the categories of nonexchange transactions for a | governmental organization.
``` Derived tax revenues Imposed exchange revenues Government-mandated nonexchange transactions Voluntary nonexchange transactions ```
769
True or False: Sales tax is an example of a derived tax | revenue that is based on an underlying exchange.
This is a true statement. The sales tax revenue is | derived from the sale of products.
770
True or False: Property taxes is an example of an | imposed nonexchange transaction.
This is a true statement.
771
True or False: A federal grant for education is an example of a government mandated nonexchange transaction.
This is a true statement.
772
Sales taxes are an example of which category of nonexchange transactions?
Derived tax revenue Sales taxes are “derived” from underlying taxable exchange transactions of individuals and businesses. Government-mandated nonexchange transactions occur when a senior government legally mandates implementation of a particular program by the recipient government. Imposed nonexchange transactions occur when the government receives something of value without giving anything of equal value in return, such as property taxes imposed on taxpayers by the government. Government-mandated nonexchange transactions occur when a senior government legally mandates implementation of a particular program by the recipient government. Voluntary nonexchange transactions occur when a grantee applies for a grant.
773
Assume the following transactions occurred in a city General Fund during the year: Fines collected—$35,000 Taxes levied—$3,500,000 Taxes collected from current-year levy and prior-year tax levies—$3,310,000 Tax prepayments received—$20,000 Grants earned and received during the year—$500,000 Grants awarded but not yet available—$450,000 The amount of revenues recorded in the General Fund for the year would be
$3,845,000 $3,845,000 is correct because it includes $35,000 in fines collected, $3,310,000 in current- and prior-year property taxes collected, and $500,000 in grants received and earned.
774
Which of the following items are reported differently between the governmental activities of the government-wide financial statements and the governmental fund-level financial statements?
Capital outlays Capital outlays are reported differently in government-wide financial statements and governmental fund-level financial statements. Capital outlays are reported as expenditures in the governmental fund financial statements and as increases in capital assets in the government-wide financial statements.
775
During the current year, Knoxx County levied property taxes of $2,000,000, of which 1% is expected to be uncollectible. The following amounts were collected during the current year: Prior year taxes collected within 60 days of the current year $ 50,000 Prior year taxes collected between 60 and 90 days into the current year 120,000 Current taxes collected in the current year 1,800,000 Current taxes collected within the first 60 days of the subsequent year 80,000 What amount of property tax revenue should Knoxx County report in its entity-wide Statement of Activities?
$1,980,000 The entity-wide statements are presented on the full accrual basis and hence used GASB #33 Revenue recognition rules. GASB #33 requires that property taxes net of the estimated uncollectible taxes be recognized as Revenue in the year for which they were levied, regardless of when cash is actually collected.
776
Which account should Excel City credit when it issues a purchase order for supplies?
Budgetary Fund Balance. The entry to record a purchase order is a debit Encumbrances and a credit to Budgetary Fund Balance. Vouchers Payable is used to record invoices for goods and services received. Appropriation Control is used to record the original legally adopted budget, any subsequent revisions to the budget, and to close out the budget at year-end.
777
Which of the following revenues can be recorded when bills are mailed rather than when they are actually received?
Property taxes. Property taxes are both objectively measurable and available to finance current period expenditures and, therefore, are "susceptible for accrual," and revenues are recorded prior to when cash is collected. Licenses and permits are not objectively measurable. Fines and forfeits are not objectively measurable. Service charges are not objectively measurable.
778
In which fund would "Salaries Expense" appear?
Water Utility Fund. "Expense" is a term reserved for funds that use full accrual accounting. A Water Utility Fund is an Enterprise Fund type using full accrual accounting. The General Fund is a Governmental Fund type that uses modified accrual and the term "expenditures." Pension Trust Funds are Fiduciary Funds. Pension Trust Funds account for the assets of others (i.e., current and retired employees) and salaries expense should not appear in this fund type.
779
"Supplies" is an expenditure classified at the _________ level.
Object. "Supplies" is one of the object classes of expenditures, which describe the type of item purchased or service obtained. Character classes of Expenditures describe period or periods benefited (i.e., current operating, capital outlay, debt service) or as intergovernmental. Functional classes of Expenditure describe the department or organization unit associated with the expenditure (e.g., Public Safety). The fund class of Expenditure describes the fund that accounted for the expenditure (e.g., General Fund).
780
What is the major difference between an Exchange Transaction and a non-Exchange Transaction for governmental units?
The relationship between the amount of value given and received. Exchange Transactions involve a direct relationship between the charge and the service. Nonexchange Transactions, which are frequent in governments, do not have this relationship (e.g., taxes and fines).
781
Fixed assets donated to a governmental unit should be recorded:
At estimated fair value when received. Donated fixed assets should be recorded in the fund to which they relate or in the General Fixed Asset Account group, as appropriate, at their estimated fair value when received. GASB 1400.113