far_-_cpa_excel_copy_20190610234509 Flashcards
On October 1, 2004, Fleur Retailers signed a 4-month, 16% note payable to finance the purchase of holiday merchandise.At that date, there was no direct method of pricing the merchandise, and the note’s market rate of interest was 11%. Fleur recorded the purchase at the note’s face amount. All of the merchandise was sold by December 1, 2004.Fleur’s 2004 financial statements reported interest payable and interest expense on the note for three months at 16%. All amounts due on the note were paid February 1, 2005.As a result of Fleur’s accounting treatment of the note, interest, and merchandise, which of the following items was reported correctly? 12/31/04 retained earnings 12/31/04 interest payable
12/31/04 retained earnings - No12/31/04 interest payable - YesInterest expense on notes should reflect the market interest rate at the date of issuing the note. This firm is recording interest expense at the 16% stated rate rather than the 11% market rate. Thus, interest expense is incorrectly recorded.Also, the merchandise and note should have been recorded at the present value of the note using the market interest rate. Thus, cost of goods sold is incorrectly measured. The result of these two effects is that income and retained earnings are misstated.However, interest payable reflects the stated rate which determines the cash amount to be paid. Interest payable is correctly stated.
On September 1, 2003, Brak Co. borrowed on a $1,350,000 note payable from the Federal Bank.The note bears interest at 12% and is payable in three equal annual principal payments of $450,000. On this date, the bank’s prime rate was 11%. The first annual payment for interest and principal was made on September 1, 2004.At December 31, 2004, what amount should Brak report as accrued interest payable?
$36,000Although the question is not completely clear, interest is paid at the time each principal payment is made. Thus, on 9/1/04, after the principal payment of $450,000 (and interest as well) is made, the remaining note balance is $900,000 ($1,350,000 - $450,000). Note that only the principal payment reduces the note balance. Interest for four months to 12/31/04 is recorded in accrued interest payable: $36,000 ($900,000 x .12 x 1/3 year).
On October 1, 2005, Fleur Retailers signed a 4-month, 16% note payable to finance the purchase of holiday merchandise. At that date, there was no direct method of pricing the merchandise, and the note’s market rate of interest was 11%.Fleur recorded the purchase at the note’s face amount. All of the merchandise was sold by December 1, 2005. Fleur’s 2005 financial statements reported interest payable and interest expense on the note for three months at 16%. All amounts due on the note were paid February 1, 2006.Fleur’s 2005 cost of goods sold for the holiday merchandise was A. Overstated by the difference between the note’s face amount and the note’s October 1, 2005 present value. B. This is overstated by the difference between the note’s face amount and the note’s present value at October 1, 2005 plus 11% interest for two months. C. Understated by the difference between the note’s face amount and the note’s October 1, 2005 present value. D. Understated by the difference between the note’s face amount and the note’s October 1, 2005 present value plus 16% interest for two months.
C. The note (and merchandise) should have been recorded at its present value using the market interest rate of 11%. This rate is lower than the stated rate of 16% implying that the present value of the note (face value and interest payments at 16%) using 11% exceeds the face value of the note.Thus, the merchandise was recorded at an amount which understated its market value. All the merchandise was sold before the end of the year causing cost of goods sold to be similarly understated.
T/F: Noncurrent Notes Payable are issued for the present value of all future cash flows, including Principal payments only.are not current in the next year. Due in 2-5 years. longer would be bond payable
False. The PV of all future cash flows, including Principal and interest payments.
How does the Effective interest method calculate the interest expense for a period?
Interest expense for a period = market rate x beginning note balanceThe difference between cash interest paid and interest expense recognized at each payment date is the amortization of discount or premium
T/F: At the date of issuance and subsequent balance sheets, noncurrent notes payable are reported at the PV of remaining payments, using the yield rate at the date of issuance.
True.
T/F: The straight line method of amortizing the discount or premium is only allowed if it results in interest expense amounts not materially different from the effective interest method.
True.
A company issued a short-term note payable to a bank with a stated 12 percent rate of interest . The bank charged a .5% loan origination fee and remitted the balance to the company.The effective interest rate paid by the company in this transaction would be A. Equal to 12.5%. B. More than 12.5% C. Less than 12.5%. D. Independent of 12.5%
B. The .5% loan origination fee reduces the proceeds to the borrower AND increases the total interest to be paid by the same amount. The effect is to raise the interest rate above 12.5%.Assume the loan amount is $1,000 before the loan origination fee. Therefore, the net amount loaned is $995 [1 - .005($1,000)]. However, the full $1,000 must be paid at maturity. The total interest to be paid is thus increased by the $5 origination fee ($1,000 - $995).For simplicity, assume the loan is for a full year. Then total interest paid is: .12($1,000) + $5 = $125.The effective rate of interest for the year then is: $125/$995 = .1256. This exceeds 12.5%.
At December 31, 2005, a $1,200,000 note payable was included in Cobb Corp.’s liability account balances. The note is dated October 1, 2005, bears interest at 15%, and is payable in three equal annual payments of $400,000. The first interest and principal payment was made on October 1, 2006. In its December 31, 2006 balance sheet, what amount should Cobb report as accrued interest payable for this note?
$30,000 equals ($1,200,000 - $400,000)(.15)(3/12).On 10/1/06, the first $400,000 principal payment was made. That left $800,000 of principal balance remaining on 10/1/06. The interest on that amount is computed as shown above.
Seco Corp. was forced into bankruptcy and is in the process of liquidating assets and paying claims. Unsecured claims will be paid at the rate of forty cents on the dollar.Hale holds a $30,000 noninterest-bearing note receivable from Seco collateralized by an asset with a book value of $35,000, and a liquidation value of $5,000.The amount to be realized by Hale on this note is A. $5,000 B. $12,000 C. $15,000 D. $17,000
C. Bankruptcy law specifies that secured creditors are to be satisfied before any assets are paid to unsecured creditors. Hale is a secured creditor for the $5,000 liquidation value. A liquidation value is paid at the liquidation of the firm and thus acts as a secured debt. The remaining claim of $25,000 ($30,000 - $5,000) is unsecured and at the 40% rate yields an additional claim of $10,000, for a total amount to be realized of $15,000.
On March 1, 2004, Fine Co. borrowed $10,000 and signed a two-year note bearing interest at 12% per annum compounded annually. Interest is payable in full at maturity on February 28, 2006.What amount should Fine report as a liability for accrued interest at December 31, 2005?
$2,320he accrued interest covers the period from the borrowing to 12/31/94 because no interest has yet been paid. The interest is also compounded (this is a stumbling point easily missed).The 2005 ending balance in accrued interest payable therefore includes interest on 2004’s accrued interest:2004: $10,000(.12)(10/12) $1,0002005: ($10,000 + $1,000)(.12)(12/12) 1,320Total accrued interest payable, December 31, 2005 $2,320
On August 21, 2003, Vann Corp.’s $500,000, one-year, noninterest-bearing note due July 31, 2004 was discounted at Homestead Bank at 10.8%. Vann uses the straight-line method of amortizing bond discounts.What amount should Vann report for notes payable in its December 31, 2003 balance sheet? A. $500,000 B. $477,500 C. $468,500 D. $446,000
The period from August 21, 2003 to July 31, 2004 is 11 1/3 months. The correct calculation is:Maturity value (note is noninterest bearing) $500,000Less discount to bank $500,000(.108)[(11 1/3 months)/12 months] ( 51,000)Equals book value at date of discounting = proceeds from bank 449,000Plus amortization of discount to December 31, 2003 $51,000[(4 1/3 months)/(11 1/3 months)]19,500Equals book value at December 31, 2003 $468,500The bank’s discount represents the total interest to be paid over the 11 1/3 month term. As the note is amortized, the note’s book value increases and interest expense is recognized. At maturity, the note book value is $500,000 and the total interest of $51,000 is paid as part of the single payment of $500,000. Total interest is $51,000 because that is the difference between the maturity value of $500,000 less the $449,000 proceeds.
T/F: Interest revenue is based on the ending book value of the debt.
False.The total interest over the note term equals the difference between the total pmts required under the note and the principal amount.
T/F: The market rate relating to a long-term debt issue has changed dramatically since issuance several years ago. Therefore, the rate used for recording the debt and computing interest should be changed.
False.The interest rates at issuance are the rates that are used throughout the term of the note.
T/F: The book value of a note is less under the net method compared with the gross method.
False.
T/F: Equipment purchased with a discounted note is recorded at a bargain price.
False.Purchase is recorded at the discount, and the discount is amortized over the note term.
T/F: All noninterest-bearing notes are recorded at a discount from face value.
TrueThey are recorded at the PV of future cash flows, using the market rate of interest as the discount rate.
The purpose of financial accounting is to provide information primarily for…
Investors and creditorsPurpose is provide information relevant to the decision making of investors and creditors. These people make decisions about allocating resources across thousands of firms.
What is the primary protection for investors against fraudulent financial reporting by corporations?
The requirement that financial statements be audited.It must be performed by independent third party CPAs. The auditors do not prepare the information, nor do they have employment ties with either the reporting firm or the intended audience of the FS. However, even the audit of FS is not a perfect protection as indicated by the frequency of fraud and audit failure.
In reference to proposed accounting standards, the term “negative economic consequences” includes: A. The cost of complying with GAAP. B. The inability to raise capital. C. The cost of government intervention when not in compliance with GAAP. D. The failure of internal control systems.
B. The inability to raise capital.A proposed standard may cause firm earnings to fall, for example when they are adopted. Firms will be concerned that lower earnings may make it more difficult to sell stock or to secure loans. As a result, negative economic consequences become a focal point for arguments against the proposed standard.
T/F: The FASB is a governmental unit.
False. The FASB is a Private sector body.The FASB has no official connection with the US Government although the SEC, an agency of the federal government, can modify or rescind an accounting standard adopted by the FASB.
The operating procedure for issuing a new FASB statement includes
- Considers whether to add a project to its agenda, in consultation with the FAF.2. Conducts research on the topic and issues a Discussion Memo detailing the issues surrounding the topic.3. Holds a public hearing on the topic.4. Evaluates the research and comments from interested parties and issues an Exposure Draft.5. Solicits add’l comments, modifies Exposure Draft if needed.6. Finalizes the new statement only after a majority vote by the members of the FASB. At least four of the seven members of the FASB must vote in favor of a proposed Statement of Financial Accounting Standards.7. Issues an Accounting Standards Update (ASU).
T/F: The Wheat Committee was involved in the formation of the FASB.
TrueIn 1971, the AICPA appointed the Wheat Committee, which recommended the formation of yet another private sector body - the FASB - to take over the reins from the APB. In 1973, the FASB assumed the role of standard setter for the accounting profession. The FASB is not affiliated with the AICPA.
T/F: Recognition in accounting refers to the process of recording a measurable attribute such that it affects one or more of the FS.
TRUE
T/F: The Accounting Principles Board was the standard-setting body that immediately preceded the FASB.
TrueIn 1959, the AICPA created the Accounting Principles Board (APB), another committee, to take over the work of CAP. The APB is the second private sector group designated to formulate GAAP. Members were required to be CPAs. The APB issued 31 opinions, many of which remain as GAAP, in whole or in part.
T/F: The conceptual framework is not GAAP.
Truethe FASB’s conceptual framework plays a role in this process by providing a theoretical structure for guiding the development of a specific standard
Savor Co. had $100,000 in cash-basis pretax income for 1999. At December 31, 1999, accounts receivable had increased by $10,000 and accounts payable had decreased by $6,000 from their December 31, 1998, balances. Compared to the accrual-basis method of accounting, Savor’s cash pretax income is:
Lower by $16,000The computation is: 100,000+10,000+6,000 = 116,000, or a $16,000 increase from cash to accrual. The increase in accounts receivable would be added to cash income as it increases sales in accrual income. The decrease in accounts payable, decreases the liabilities, which increases accrual income as there is more money available to pay AP.
An increase in prepaid expenses indicates
that more cash was paid than expensed.
An increase in accrued liabilities indicates
that more expense was accrued than paid.
On February 12, 2005, VIP Publishing, Inc. purchased the copyright to a book for $15,000 and agreed to pay royalties equal to 10% of book sales, with a guaranteed minimum royalty of $60,000. VIP had book sales of $800,000 in 2005. In its 2005 Income Statement, what amount should VIP report as royalty expense?
$80,000A royalty is an amount to be paid based on the sales of a commodity or product, in this case a book. The royalty expense is 10% of $800,000 sales ($80,000) because this amount exceeds the minimum of $60,000 that would be paid if sales were less than $600,000.
Under a royalty agreement with another company, Wand Co. will pay royalties for the assignment of a patent for three years. When should the royalties paid be reported as an expense?
In the period incurred.Under accrual accounting, expenses are recognized when incurred. This is the point in time when obligations come into existence. The period to which specific royalty amounts relate is the period for expense recognition. Often, royalty payments occur at specified intervals that do not correspond to the period in which the royalties were earned.
A collection of note receivable from a related party would be placed in what section of the cash flow statement?
Investing activities. The company is lending money to the related party and lending is not a primary business activity - the fact that the loan is in the form of a note implies that it is interest bearing.
T/F: The codification is the sole source of US GAAP for nongovernmental entities.
TRUE
Class Corp. maintains its accounting records on the cash basis, but it restates its financial statements to the accrual method of accounting. Class had $60,000 in cash-basis pretax income for 2002. The following information pertains to Class operations for the years ended December 31, 2002 and 2001: AR balance was 20,000 in 2001 and 40,000 in 2002AP balance was 30,000 in 2001 and 15,000 in 2002Under the accrual method, what amount of income before taxes should Class report in its December 31, 2002, Income Statement?
95,000 = 60,000+20,000+15,000Plus increase in accounts receivable (this represents sales that were not collected and thus are included in accrual income but not in cash-basis income), Plus decrease in accounts payable (this represents payments in excess of expenses and thus causes accrual income to exceed cash-basis income),
What period of time is used to define a current asset?
The definition of a current asset uses the period “operating cycle or one year, whichever is longer.”
In analyzing a company’s financial statements, which financial statement would a potential investor use primarily to assess the company’s liquidity and financial flexibility?
The Balance Sheet discloses the assets and liabilities, usually classified by proximity to realization (assets) or payment (liabilities). The balance shows the relative magnitude of assets and liabilities and, therefore, the ability to pay obligations in the near and longer term. It also shows the degree of leverage and ability to adapt to changing financial conditions as well as the ability to manage future cash flows when conditions change. Much of the potential of the firm is disclosed in the Balance Sheet. It is a statement of the wealth position of the firm and allows an assessment of the relative risk of the enterprise.
Y/N: Hahn Co. prepared financial statements on the cash basis of accounting. The cash basis was modified so that an accrual of income taxes was reported. Are these financial statements in accordance with the modified cash basis of accounting?
Yes.Under a strict cash basis of accounting, revenues and expenses are recorded only when cash is received or paid. Under a modified cash basis of accounting, certain accruals and/or deferrals are recorded for financial-statement purposes. The most common modifications are the capitalization and amortization of long-lived assets and the accrual for income taxes (recognition of income tax expense and related liability).
Pak Co.’s professional fees expense account had a balance of $82,000 on December 31, 2001, before considering year-end adjustments relating to the following: •Consultants were hired for a special project at a total fee not to exceed $65,000. Pak has recorded $55,000 of this fee based on billings for work performed in 2001.•The attorney’s letter requested by the auditors dated January 28, 2002, indicated that legal fees of $6,000 were billed on January 15, 2002, for work performed in November 2001, and unbilled fees for December 2001 were $7000.What amount should Pak report for professional fees expense for the year ended December 31, 2001?
$95,000The two amounts listed in the attorney’s letter should be added to the preadjusted amount of expense, but the appropriate amount of the consultant expense has been included in the preadjusted amount. The ending expense balance therefore is $95,000 ($82,000 + $6,000 + $7,000).The $10,000 of consulting fees not yet earned should NOT be included.
Under East Co.’s accounting system, all paid insurance premiums are debited to prepaid insurance. For interim financial reports, East makes monthly estimated charges to insurance expense with credits to prepaid insurance. Additional information for the year ended December 31, 2005, is as follows:Prepaid insurance at December 31, 2004 $105,000 Charges to insurance expense during 2005 (including a year-end adjustment of 17,500) 437,500 Prepaid insurance at December 31, 2005 122,500 What was the total amount of insurance premiums paid by East during 2005?
Beginning prepaid balance + Premiums paid - Expense charges = Ending prepaid balance $105,000 + Premiums paid - $437,500 = $122,500 Premiums paid = $455,000
When changing from cash basis to accrual basis, what is the general rule regarding liabilities and assets?
The general rule to convert from cash to accrual is to add the beginning liability balances and subtract the ending liability balances; also, subtract beginning asset balances and add ending asset balances.
Before 2001, Droit Co. used the cash basis of accounting. As of December 31, 2001, Droit changed to the accrual basis. Droit cannot determine the beginning balance of supplies inventory. What is the effect of Droit’s inability to determine beginning supplies inventory on its 2001 accrual basis net income and December 31, 2001, accrual basis owners’ equity?
2001 net income = Overstated12/31/01 owner’s equity = No effectSupplies expense for 2001 under the accrual method is: supplies expense = beginning supplies + purchases - ending supplies. If beginning supplies cannot be determined, then it is assumed to be zero and supplies expense is understated, causing 2001 income to be overstated. However, total supplies expense for the entire life of the business is unaffected by the inability to determine beginning supplies for 2001. Total supplies expense for the life of the business is total purchases less ending inventory in 2001. These two amounts are determinable, and thus, owners’ equity at the end of 2001 can be determined.
A company has the following accrual-basis balances at the end of its first year of operation: Unearned consulting fees $2,000 Consulting fees receivable 3,500 Consulting fee revenue 25,000 The company’s cash-basis consulting revenue is what amount?
$23,500Cash-basis revenue is the amount of cash collected for the period. $25,000 of accrual-basis revenue was recognized for the period. Start with the $25,000 amount, and add the $2,000 unearned fees. This amount is not included in the $25,000 because it is not earned but was collected during the period. Subtract the $3,500 receivable, which is included in the $25,000 but was not collected. The result is that $23,500 in cash was collected ($25,000 + $2,000 - $3,500).
U Co. had cash purchases and payments on account during the current year totaling $455,000. U’s beginning and ending accounts payable balances for the year were $64,000 and $50,000, respectively. What amount represents U’s accrual-basis purchases for the year?
Using an equation, or a T-account, to analyze accounts payable (AP) yields accrual purchases: Beginning AP ($64,000) + Accrual purchases - Cash payments ($455,000) = Ending AP ($50,000). Solving for accrual purchases yields $441,000.
On November 1, 2005, Key Co. paid $3,600 to renew its insurance policy for three years. At December 31, 2005, Key’s unadjusted trial balance showed a balance of $90 for prepaid insurance and $4,410 for insurance expense. What amounts should be reported for prepaid insurance and insurance expense in Key’s December 31, 2005, financial statements?
Prepaid insurance = $3,400Insurance expense = $1,100Prepaid insurance at year end is $3,400, which is the portion of the prepayment on November 1 that continues to the next three years. Insurance expense includes three items: (1) the $90 of prepaid insurance remaining in the trial balance that has expired, (2) the $200 of insurance expense related to the November 1 purchase above ($3,600-$3,400 remaining prepaid), and (3) the expense portion of the $4,410 insurance expense amount in the unadjusted trial balance ($4,410-$3,600) = $810. This firm must have expensed the entire $3,600 November 1 purchase because it was not reflected in prepaid insurance. The difference of $810 reflects actual expense. Therefore, total insurance expense equals $1,100 = $90 + $200 + $810.
If the accrued expenses decrease during the year, would this increase or decrease the net income when comparing the cash basis NI to the accrual basis of NI?
IncreaseIf the accrued expenses account (a current liability, often called accrued expenses payable) decreased during the year, then a greater amount of cash was paid for those expenses than were accrued throughout the year. This would cause cash-basis net income to be less than accrual-basis net income. Cash-basis net income reflects expenses paid; accrual-basis net income reflects expenses recognized (accrued).
T/F: A deferred revenue is a liability account.
TRUE
T/F: The top level of the GAAP hierarchy is the FASB Accounting Standards Codification.
FalseThere is no implied hierarchy for any sources used for GAAP.
T/F: The FASB Accounting Standards Codification presents accounting standards as an individual discrete accounting standard.
FalseMaterial is organized by major area and topic. Basis for conclusions, appendices and other ancillary content are included in the Codification only if the material is considered essential to the understanding and application of GAAP.
T/F: The balance sheet is dated differently from the income statement and the statement of cash flows.
TrueThe balance sheet is a snapshot as of a particular date, whereas the IS and CF cover a period of time.
What document is typically issued as part of the due-process activities of the Financial Accounting Standards Board (FASB) for amending the FASB Accounting Standards Codification?
A proposed accounting standards update.ASUs
Is IFRS included in the Codification?
No. IFRS are not US GAAP and thus are not included in the Codification.
What are the three elements of faithful representation?
Neutrality, completeness and free from material error.Neutrality means lack of bias-that financial reporting does not have a preconceived objective or agenda. Completeness means that the info includes all data necessary to be faithfully representative.Free from error is when there are no omissions of errors.
What are the primary characteristics of relevance?
Predictive value, confirmatory value, and materiality.Predictive value info assists capital providers in forming expectations about future events.Confirmatory value info confirms or changes past (or present) expectations based on previous evaluations. Materiality is info that determines how it will impact a user’s decision. Materiality is somewhat pervasive throughout the objectives of financial reporting in the sense that the FS should present material info because it is decision useful.
During the period when an enterprise is under the direction of a particular management, will its FS directly provide information about management performance and/or enterprise performance?
Enterprise performance, but not directly provide information about management performance.The financial statements provide a wealth of information about the performance and financial position of the enterprise, but they do not directly allow an evaluation of management. There are too many factors that affect the firm’s performance to be able to single out management’s contribution (or lack of it). Many factors interact to determine the performance of the enterprise, one of them being management’s performance. Also, for example, current enterprise performance is affected by the past actions of managers that may no longer be with the enterprise.
According to the conceptual framework, the objectives of financial reporting for business enterprises are based on: A. The need for conservatismB. Reporting on management’s stewardshipC. GAAPD. The needs of the users
D. User needs define the objectives of FS. FS exist solely to satisfy the information needs of users. One of these information needs might be an evaluation of how well management has carried out its stewardship responsibility to owners for the use of enterprise resources entrusted to it. However, that is just one of many information needs. More important are the information needs concerning the assessments of future performance and cash flow generation. The objectives of financial statements are more involved with forward-looking purposes than with evaluation of the past.
What is the conceptual framework intended to establish?A. GAAP in financial reporting by business enterprises. B. The meaning of “present fairly in accordance with GAPP.” C. The objectives and concepts for use in developing standards of financial accounting and reporting. D. The hierarchy of sources of GAAP
C. The concepts statements, also collectively called The Conceptual Framework, provide the general underpinnings for specific GAAP. In a way, it is a “constitution” for developing specific accounting principles. The concepts statements are not GAAP, however.
T/F: When the reported measure of an economic condition or situation aligns with the economic condition or situation, then it is representationally faithful.
TrueInformation faithfully represents an economic condition or situation when the reported measure and the condition or situation are in agreement. Financial information that faithfully represents an economic phenomenon portrays the economic substance of the phenomenon. Information is representationally faithful when it is complete, neutral, and free from material error.
What are the four enhancing qualitative characteristics of the FS?
Comparability, verifiability, timeliness, and understandability.Comparability enables users to identify similarities and differences between sets of info. Verifiability - info is verifiable if different knowledgeable and independent observers could reach similar conclusions based on the info.Timeliness is when info is received in time to make a difference to the decision maker.Understandability - if the user comprehends it within the decision context at hand. Users are assumed to have a reasonable understanding of business and accounting and are willing to study the info with reasonable diligence.
Reporting inventory at the lower of cost or market is a departure from the accounting principle of: A. Historical cost. B. Consistency. C. Conservatism. D. Full disclosure
A. LCM departs from historical cost because it provides an ending valuation below cost when market value is below cost. The inventory is actually written down to a value below what was originally paid. This is one of the few such departures.
When a parent-subsidiary relationship exists, consolidated financial statements are prepared in recognition of the accounting concept of: A. Reliability. B. Materiality. C. Legal entity. D. Economic entity
D. Consolidated financial statements are an example of trying to account for the economic entity that comprises more than one legal entity, making this the correct response.
T/F: If the going concern assumption were not met, adherence to the historical cost principle would continue to be appropriate.
False.Only when the going concern assumption is met, then the historical cost principle supports many assets.
T/F: The accounting assumption of separate entity supports the inclusion of prepaid insurance in total assets.
False.The accounting assumption of separate entity assumes that there is a separate accounting entity for each business organization.
T/F: A firm has income of exactly zero for a year during which both specific and general prices (inflation) have increased. The firm maintained its capital under the financial concept of capital maintenance.
True.Capital is said to be maintained when the firm has positive earnings for the year, assuming no changes in price levels. When a firm has income, it has recognized revenue sufficient to replace all the resources used in generating that revenue.
Y/N: Are most assets subsequently adjusted for changes in market value under the historical cost principle?
No.
T/F: Matching is not an accounting assumption.
True.Matching principle: recognize expenses only when expenditures help to produce revenues. Revenues are recognized when earned and realized or realizable; the related expenses are recognized, and the revenues and expenses are “matched” to determine net income or loss.
According to the conceptual framework, the usefulness of providing information in financial statements is subject to the constraint of: A. Consistency. B. Cost-benefit. C. Relevance. D. Representational faithfulness.
B. Cost-benefit is the only constraint among the four answer alternatives. When the cost of information exceeds its benefit, it should not be reported, even if it might be useful.
What is the underlying concept governing the Generally Accepted Accounting Principles pertaining to recording gain contingencies? A. Conservatism. B. Relevance. C. Consistency. D. Faithful representation.
A. Gain contingencies are not recognized, but loss contingencies that are probable and estimable are recognized. This is a classic example of conservatism, which suppresses positive information under conditions of uncertainty but requires the reporting of negative information when the negative outcome is likely.
Which of the following statements concerning the determination of fair value is/are correct?I. The determination of fair value is based on a hypothetical transaction. II. The determination of fair value is based on an exit price. III. The determination of fair value of a nonfinancial asset should be based on the intended use of the asset by the reporting entity.
Both Statements I and II are correct. The determination of fair value is based on a hypothetical transaction and on the use of a (hypothetical) exit price. Statement III is not correct. The determination of fair value of a nonfinancial asset should be based on the highest and best use of the asset by market participants, not based on the intended use by the reporting entity.
A company owns a financial asset that is actively traded on two different exchanges (market A and market B). There is no principal market for the financial asset. The information on the two exchanges is as follows Market A: Price $1,000; Transaction cost $ 75 Market B: Price $1,050; Transaction cost $150 What is the fair value of the financial asset?
The fair value of the financial asset is $1,000, the quoted price in the most advantageous market, but without adjusting that price for transaction costs. Since there is no principal market for the financial asset, the most advantageous market must be used to determine fair value. The most advantageous market is the market that maximizes the amount that would be received to sell the asset (or minimizes the amount that would be paid to transfer a liability), after taking into account transaction costs and transportation costs. Thus, the most advantageous market is Market A, determined as: Market A Market B Quoted price of asset $1,000 $1,050 Transaction cost ( 75) ( 150) Net Proceeds $ 925 $ 900 Even though transaction costs are considered in determining the most advantageous market, the price in the most advantageous (or principal) market used to measure the fair value of the asset (or liability) is not adjusted for transaction costs [ASC 820-10-35-9B]. Therefore, the quoted price of the asset in the most advantage market, unadjusted for the transaction costs, is fair value.
In determining the fair value of an asset in the most advantageous market, the market based exit price should be adjusted for:A. Transaction Cost B. Transportation Cost
B. onlyIn determining the fair value of an asset in the most advantageous market, the market based exit price would not be adjusted for transaction cost associated with executing the (hypothetical) transaction, but would be adjusted for transportation cost to get the asset to the principal or most advantageous market.
T/F: In the determination of fair value of a nonfinancial asset, the highest and best use of the asset may be determined as occurring through use and/or through exchange.
True. Both. The highest and best use of a nonfinancial asset (i.e., its maximum value) to market participants may occur either principally through its use with other assets or principally on the price that would be received to sell (exchange) the asset.
For which of the following circumstances is the guidance for determining fair value as provided in the fair value framework presented in ASC 820, “Fair Value Measurement,” least likely to apply? A. Determination of the fair value to be assigned to land acquired in a business combination. B. Determination of the fair value of a bond liability for applying the fair value option. C. Determination of the fair value of legal services received in exchange for an entity’s common stock. D. Determination of the fair value of a production facility when assessing whether or not an impairment loss has occurred.
C. The guidance for determining fair value provided in the fair value framework is not appropriate for determining the fair value of legal services received in exchange for an entity’s common stock. ASC 820 specifically exempts share-based payment transactions (and inventory valuing and other minor items) from the purview of the fair value framework.
On January 1, year 1, Peabody Co. purchased an investment for $400,000 that represented 30% of Newman Corp.’s outstanding voting stock. For year 1, Newman reported net income of $60,000 and paid dividends of $20,000. At year end, the fair value of Peabody’s investment in Newman was $410,000. Peabody elected the fair value option for this investment. What amount should Peabody recognize in net income for year 1 attributable to the investment?
Since Peabody has elected to report the investment in Newman using the fair value option, it should recognize its share of cash dividends received during the period (.30 x $20,000 = $6,000) and the increase in the fair value of the investment ($400,000 > $410,000 = $10,000), or $6,000 + $10,000 = $16,000.
T/F: The fair value of a liability is based on the amount that would be paid to transfer the liability.
TRUE
T/F: The fair value of an asset is based on the price that would be paid to acquire the asset.
FalseFair value of an asset is based on the price that would be received to sell the asset.
Giaconda, Inc. acquires an asset for which it will measure the fair value by discounting future cash flows of the asset. Which of the following terms best describes this fair value measurement approach? A. Market. B. Income. C. Cost. D. Observable inputs.
B. The income approach to fair value measurement of an asset measures fair value by converting future amounts to a single present amount. Discounting future cash flows would be an income approach to determining fair value.
Which one of the following financial items may not be measured and reported at fair value at the election of an entity? A. Accounts receivable. B. Investment in debt securities to be held to maturity. C. Investment in a subsidiary that is to be consolidated. D. Accounts payable
D. A firm may not use fair value to measure and report an investment in a subsidiary that is to be consolidated. The financial asset “Investment in subsidiary” will be eliminated in the consolidating process and be replaced by the subsidiary’s assets and liabilities (and possibly goodwill) on the consolidated balance sheet.
In determining the fair value of an asset or liability, would the fair value of the asset or the fair value of the liability be determined using an entry price or an exit price?
The appropriate basis for determining the fair value of an asset or a liability is an exit price.
When the fair value of an asset is determined as the amount that currently would be required to replace the service capacity of the asset, which one of the following valuation techniques has been used? A. Income approach. B. Cost approach. C. Expense approach. D. Market approach.
B. When fair value is determined as the amount that currently would be required to replace the service capacity of an asset (i.e., current replacement cost), the cost approach has been used.
Which of the following valuation methods may be used to measure investments classified as held-to-maturity?A. Amortized CostB. Fair Value
Both A and B may be used to measure and report investments classified as held-to-maturity. Amortized cost is the traditional measurement method for investments held-to-maturity and would be used unless an entity elects to use fair value, which is permitted by the fair value option.
Papa Company acquired land with an office building on it from its subsidiary, Sonny Company, for $110,000. Prior to the sale, Sonny’s carrying value of the land was $60,000 and its net carrying value of the building was $50,000. At the time of the transaction, Papa appropriately determined that the land had a fair value of $75,000 and the building had a fair value of $35,000. At what amount should the land and building be reported on Papa’s consolidated statements prepared immediately after the transaction?
Land = $60,000Building = $50,000Even though there was no profit or loss on the intercompany transaction, it resulted in amounts being redistributed between the depreciable asset office building and the non-amortizable asset land, which would result in different amounts of depreciation expense than if the transaction had not occurred. Therefore, the intercompany transaction must be “eliminated” so that the consolidated statements would show land at $60,000 and buildings at $50,000. (Sonny also would need to assess the building for possible impairment.)
T/F: If, at acquisition of an asset or liability, the exit price of the item is different than the transaction price, a gain or loss should be recognized.
TRUE
T/F: A firm may elect to use the fair value option for an eligible firm commitment when it enters into the contract that establishes the firm commitment.
TrueThe entity cannot apply the fair value option prior to the firm commitment being established.
T/F: Discounting a future stream of cash flows to its current value would be an example of the income approach to determining fair value.
TRUE
T/F: An employer’s prepaid pension asset account can be measured and reported at fair value.
FalseEntities may NOT use fair value measurement for Financial assets and liabilities recognized under lease accounting
T/F: Property, plant, and equipment may be measured and reported using fair value.
FalseEntities may NOT use fair value measurement for Financial assets and liabilities recognized under lease accounting
T/F: A change in valuation technique(s) used to measure fair value would be treated as a change in accounting principle.
FalseIt’s a change in accounting estimates.
T/F: A firm may not use the fair value option for investment in common stock which gives the investor significant influence over the investee.
FalseWhen the investor has significant influence over the investee, the fair value option can be used.
Which of the following statements concerning the fair value hierarchy used in ascertaining fair value is/are correct?I. Quoted market prices should be adjusted for a “blockage factor” when a firm holds a sizable portion of the asset being valued.II. Quoted market prices in markets that are not active because there are few relevant transactions cannot be used.
Neither Statement I nor Statement II is correct. Quoted market prices should not be adjusted for a “blockage factor” when a firm holds a sizable portion of the asset being valued (Statement I). A “blockage factor” occurs when an entity holds a sizable portion of an asset (or liability) relative to the trading volume of the asset or liability in the market. Using a “blockage factor” would adjust the market value for the impact of such a large block of securities being sold, but is not permitted in determining fair value. Additionally, quoted market prices in markets that are not active because there are few relevant transactions can be used in determining fair value (Statement II). Such prices would be considered level 2 factors, observable inputs but not in active markets.
Observable inputs, other than quoted prices in active markets for identical items, would constitute what level in the fair value hierarchy?
Level 2 inputs are observable for assets or liabilities, either directly or indirectly, other than quoted prices in level 1. For example, quoted prices for similar items in an active market would be level 2 inputs.
Each of the following would be considered a Level 2 observable input that could be used to determine an asset or liability’s fair value, except A. Quoted prices for identical assets and liabilities in markets that are not active. B. Quoted prices for similar assets and liabilities in markets that are active. C. Internally generated cash flow projections for a related asset or liability. D. Interest rates that are observable at commonly quoted intervals.
C. This response is a false statement—internally generated cash flow projections are not an observable input.
T/F: Observable inputs used in determining fair value are developed based on market data obtained from sources independent of the reporting entity.
TRUE
T/F: In the fair value hierarchy, level 2 inputs would include quoted prices for similar assets or liabilities in active markets.
TRUE
T/F: In the fair value hierarchy, level 3 inputs should be developed based on what market participants would assume.
TRUE
Which of the following statements, if any, concerning disclosures about fair value measurements in periods subsequent to initial recognition is/are correct? I. The fair value hierarchy level within which fair value measurements fall must be disclosed. II. Quantitative fair value measurement disclosures must be in tabular format.
Both I and II are correct. Fair value measurement disclosures require both that fair value amounts be disclosed separately for each level of the fair value hierarchy and that quantitative disclosures be provided in tabular format.
When an entity uses the fair value option for eligible financial assets and liabilities, which one of the following is not an expected outcome of the disclosures required of that entity?A. Users being able to understand management’s reasons for using the fair value option.B. Users being able to understand how changes in fair value affect net income.C. Replace the kind and amount of information that would have been provided if the fair value option had not been used with information related to fair value.D. Users being able to understand the difference between fair value and cash flows.
C. The disclosures required when the fair value option is used are not intended to replace the kind and amount of information that would have been provided if the fair value option had not been used. Rather, the intent is to provide the same kind and amount of information that would have been provided if the fair value option had not been elected.
Under U.S. GAAP the disclosure requirements when fair value measurement is used are differentiated by which of the following classifications? A. Between assets measured at fair value and liabilities measured at fair value. B. Between fair value measurements that result in gains and fair value measurements that result in losses. C. Between items measured at fair value on a recurring basis and items measured at fair value on a non-recurring basis. D. Between items for which fair value measurement is required and items for which fair value measurement is elected.
C. Disclosure requirements when fair value measurement is used are differentiated between items measured at fair value on a recurring basis and items measured at fair value on a non-recurring basis. Items measured at fair value on a recurring basis are adjusted to (measured at) fair value period after period; an example would be investments held-for-trading. Items measured at fair value on a non-recurring basis are adjusted to (measured at) fair value only when certain conditions are met; an example would be the impairment of an asset.
Which level of the fair value hierarchy, if any, requires the greatest amount of disclosures?
Level 3 is the lowest level in the fair value hierarchy. It consists of unobservable inputs and requires the greatest amount of disclosures.
For a firm that elects to measure certain of its financial assets and financial liabilities at fair value, required financial statement disclosures are intended to facilitate which of the following comparisons? I. Comparisons between entities that use different measurement methods for similar assets and liabilities. II. Comparisons between assets and liabilities of a single entity that uses different measurement methods for similar assets and liabilities.
Both Statements I and II are correct. The intended purposes of financial statement disclosures required of a firm that elects to use fair value measurement are to facilitate comparisons both across firms and for differently measured financial assets and liabilities of a single firm.
T/F: The methods and significant assumptions used to estimate fair value must be disclosed in both annual and interim reports.
FalseOnly a MUST for annual reports.
T/F: Transfers in and transfers out of each level of the fair value hierarchy must be disclosed.
TRUE
T/F: The methods and significant assumptions used to estimate fair value must be disclosed only in annual reports.
TRUE
T/F: Management’s reasons for electing the fair value option must be disclosed for each elected eligible item.
TRUE
T/F: Even though the SEC delegates the creation of accounting standards to the private sector, the SEC frequently comments on accounting and auditing issues. The two main pronouncements published by the SEC are: Financial Reporting Regulations (FRR) and the Staff Auditing Bulletins (SAB).
False.The main pronouncements published by the SEC are the Financial Reporting Releases (FRR) and the Staff Accounting Bulletins (SAB).
What are the four divisions of the SEC?
Division of Corporate Finance, Division of Enforcement, Division of Trading and Markets, Division of Investment Management.
Which Division of the SEC oversees the compliance with the securities acts and examines all filings made by publicly held companies?
The Division of Corporate Finance
Which Division of the SEC completes the investigation and takes appropriate actions when there is a violation of a securities law (except the Public Utility Holding Company Act). Then makes recommendations to the Justice Department concerning any punishments or potential criminal prosecution?
The Division of Enforcement
Which Division of the SEC oversees the secondary markets, exchanges, brokers, and dealers?
The Division of Trading and Markets
Which Division of the SEC oversees the investment advisers and investment companies under the Investment Company Act of 1940 and the Investment Advisers Act of 1940?
The Division of Investment Management
The SEC enforces the corporate registration requirements of the Securities Act of 1933 as one of its principal objectives. These requirements are intended to provide info that enables the SEC to:A. Evaluate the financial merits of the corporation offering the securities to the public. B. Ensure that investors are provided with adequate information on which to base investment decisions. C. Guarantee that the facts contained in the registration statement are accurate. D. Assure investors of the accuracy of the financial statements.
B. The mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. In order to carry out the mandates in the Securities Act of 1933, the SEC is ensuring that investors are provided with adequate information on which to base investment decisions. www.SEC.gov, What We Do.
T/F: The SEC is not a member of the International Organization of Securities Commissions (IOSCO).
FalseThe SEC is a member of the IOSCO, which consists of more than 100 securities regulatory agencies or exchanges across the globe.
A company is an accelerated filer that is required to file Form 10-K with the United States Securities and Exchange Commission (SEC). What is the maximum number of days after the company’s fiscal year end that the company has to file Form 10-K with the SEC?
75 daysAn accelerated filer has an aggregate worldwide market value of the voting and nonvoting common stock held by nonaffiliates of $75 million or more, but less than $700 million on the last business day of the issuer’s most recently completed second fiscal quarter. A large accelerated filer has market capitalization (as described) of $700 million or more. Beginning in 2006 the SEC changed the 10-K filing deadline for large accelerated filers to be 60 days from the fiscal year end. Accelerated filers still have 75 days to file their 10-K.
Which of the following is not a required component of the 10-K filing? A. Product market share. B. Description of the business. C. Market price of common stock. D. Executive compensation.
A. The market share of the company’s product is not a required disclosure. The company may chose to voluntarily present this information, but it is not a required disclosure.
Which regulation governs the form and content of financial statement disclosures? A. Regulation S-X. B. Sarbanes Oxley. C. Regulation S-K. D. Regulation S-Q.
A. Regulation S-X governs the form and content of financial statements and financial statement disclosures.
Which regulation enhances corporate governance to mitigate financial accounting abuses? A. Regulation S-X. B. Sarbanes Oxley. C. Regulation S-K. D. Regulation S-Q.
B. The Sarbanes-Oxley Act of 2002 (SOX) contains provisions to enhance corporate governance and to mitigate financial accounting abuses.
Which regulation governs the form and content of non-financial statement disclosures? A. Regulation S-X. B. Sarbanes Oxley. C. Regulation S-K. D. Regulation S-Q.
C. Regulation S-K governs the form and content of nonfinancial statement disclosures. These disclosures are the content of the 10-K outside of the financial statements (remember that “S-K” governs the “10-K” nonfinancial statement content).
A company that is a large accelerated filer must file its Form 10-Q with the United States Securities and Exchange Commission within how many days after the end of the period?
40 daysA large accelerated filer is a company with worldwide market value of outstanding voting and nonvoting common equity held by nonaffiliates of $700 million or more. A large accelerated filer must file its 10Q within 40 days after quarter end. A non-accelerated filer must file its 10Q within 45 days after quarter end.
T/F: Initial registration of securities is typically done via Form S-1.
TRUE
T/F: 2 years balance sheets, 3 years income statement, statements of cash flows, and shareholders’ equity are the audited financial statements provided upon initial registration of a security.
TRUE
T/F: Audited financial information is included in Part II, Item 8 of Form 10-k.
TRUE
Which of the following is a member of the Monitoring Board? A. Global Accounting Technical Officer of the World Bank. B. CEO of the Financial Executives International. C. Chair of the CFA Institute. D. Chair of the U.S. Securities and Exchange Commission
D. The Chair of the U.S. Securities and Exchange Commission is a member of the Monitoring Board. The Monitoring Board provides a formal link between the Trustees and public authorities. The U.S. Securities and Exchange Commission is the primary overseer and regulator of the U.S. securities markets. Its mission is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.
The IFRS Foundation serves as the administrative umbrella for a group of bodies. Which of the following bodies are NOT included under the IFRS Foundation umbrella? A. International Federation of Accountants (IFAC). B. International Accounting Standards Board. C. IFRS Interpretations Committee. D. IFRS Advisory Council.
A. The International Federation of Accountants (IFAC) is a global organization for the accounting profession. Its members are accounting and auditing organizations throughout the world. It is an independent organization not under the IFRS Foundation umbrella, but it does support the activities of the IFRS Foundation by encouraging high-quality practices by the world’s accountants and auditors.
Which of the following is an objective of the IFRS Foundation? A. To enforce the use and rigorous application of those standards. B. To take account of, as appropriate, the needs of a range of sizes and types of entities in diverse economic settings. C. To develop, in the public interest, a single set of high-quality, understandable, enforceable, and globally accepted financial-reporting standards (IFRSs) through its member associations. D. To require adoption of international financial reporting standards (IFRSs) globally.
B. Objectives of the IFRS Foundation from its Constitution:1. To develop, in the public interest, a single set of high-quality, understandable, enforceable, and globally accepted financial-reporting standards based upon clearly articulated principles. 2. To promote the use and rigorous application of those standards. 3. To take account of, as appropriate, the needs of a range of sizes and types of entities in diverse economic settings. 4. To promote and facilitate adoption of international financial reporting standards (IFRSs) globally.
T/F: The IFRS Foundation is the parent to the IASB.
TRUE
T/F: The IASB Board members are elected into their positions.
FalseThe Monitoring Board is composed of public capital market authorities, such as the Chair of the SEC and IOSCO. Responsibilities include participating in the process for appointing Trustees and approving the appointments of Trustees. The Trustees appoint the members of IASB, IFRS Advisory Council, and IFRS Advisory Council.
T/F: International Standards Committee (IASC) was the organization that was the predecessor to the IASB
TRUE
T/F: A Small and Medium-sized (SME) company can apply the IFRS SME standards and be publicly traded.
FalseSME company’s are those that are not publicly traded. These standards cover all reporting areas and is designed to simplify the financial reporting process for SMEs.
Which of the following best describes the term “public accountability” according to IFRSs and IFRS for SME? I. Entity files, or is in the process of filing, its financial statements with a securities commission or other regulatory organization for the purpose of issuing any class of instruments in a public market.II. Entity holds assets in a fiduciary capacity for a broad group of outsiders, such as a bank, insurance entity, securities broker/dealer, pension fund, mutual fund, or investment banking entity.
Both statements are included in the definition of the term “public accountability.” The entity files, or is in the process of filing, its financial statements with a securities commission or other regulatory organization for the purpose of issuing any class of instruments in a public market, and the entity holds assets in a fiduciary capacity for a broad group of outsiders, such as a bank, insurance entity, securities broker/dealer, pension fund, mutual fund, or investment-banking entity. IFRS for SMEs, para. 1.3.
According to the IFRS for Small and Medium-sized Entities (IFRS for SMEs), the intended user is an SME. Which of the following, if any, is (are) included in the definition of that user? I. An entity that does not have public accountability. II. An entity that publishes general purpose financial statements for external users.
Both I and II. The IASB uses a broad definition of an SME. Rather than restrict it by revenue or number of employees, as other organizations, such as the World Bank and U.S. government, have done; the Board simply states that the entity does not have public accountability and that the entity publishes general purpose financial statements for external users, such as owners who are not involved in managing the business, existing and potential creditors, and credit rating agencies. IFRS for SME, para. 1.2.
IAS 8, Accounting Policies, Changes in Accounting Estimates, and Errors includes the IFRS hierarchy. What is the second-level, or the level after the initial level, addressing the requirements and guidance in IFRS? A. The definitions, recognition criteria, and measurement concepts for assets, liabilities, comprehensive income, revenue, expenses, and gains and losses in the Framework. B. The definitions, recognition criteria, and measurement concepts for assets, liabilities, revenue, and expenses in the Framework. C. Pronouncements of other standard-setting bodies, other accounting literature, and accepted industry practices. D. Pronouncements of other standard setting bodies using a similar conceptual framework, other accounting literature, and accepted industry practices.
B.The IFRS hierarchy, as presented in IAS 8, includes first, the requirements in IFRS dealings with similar or related issues; second, the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework; and lastly, the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature, and accepted industry practices, to the extent that these do not conflict with IFRS or the Framework. IAS 8, para. 12.
How is an asset defined by the IASB’s Framework?
According to the IASB’s Framework, an asset is defined as “a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.” IASB Framework, para. 49.
T/F: Under the IASB Framework, the following assumptions underlie the preparation and presentation of the FS: Accrual basis and Going concern.
TRUE
T/F: The IASB has the right to enforce all regulations, accounting standards and procedures.
False. The IASB has no enforcement authority.
What are the two fundamental (primary) qualitative characteristics of useful financial information included in IASB’s Framework?
Relevance and faithful representation are the two fundamental qualitative characteristics of financial information (IASB Framework 5-18).
T/F: The IASB Framework treats expenses and losses as an expense, where the U.S. Framework treats expenses and losses as separate elements.
TRUE
T/F: The IASB Framework and US Framework identifies accrual accounting as a basic assumption.
FalseIASB = trueUS = false, (OCBOA)
How is retained earnings calculated?
Revenue - Expenses = NI before taxesSubtract income taxes to arrive at Net incomeAdd retained earning beginning of year balance to arrive at retained earnings end of year balance
Which financial statement would an analyst primarily use to assess the entity’s liquidity?
An entity’s liquidity is usually assessed from the Balance Sheet, by calculating the liquidity ratios, such as Current Ratio [(current assets) / (current liabilities)]; Quick Ratio [(cash + accounts receivable + short-term or marketable securities) / (current liabilities)]; and Cash Ratio [(cash + short-term or marketable securities) / (current liabilities)].
Which of the following accounts is a contra account? A. Accumulated depreciation, equipment. B. Depreciation expense, office equipment. C. Dividends. D. Unearned revenue.
A. Accumulated depreciation is a contra account. The asset account Equipment is reported on the Balance Sheet as the net of accumulated depreciation. As such, the accumulated depreciation account has a credit balance, reducing the Equipment account from its historical cost balance to its carrying or book value.
Y/N: Could a firm with an operating cycle of three years in duration report as current a liability due two years from the balance sheet date?
Yes. Operating cycle or one year, whichever is longer.
T/F: Account Form is the term applied to the balance sheet format that shows assets on the left and liabilities and equity on the right.
TRUE
T/F: Intraperiod tax allocation requires that cumulative effects of accounting principle changes be reported net of tax.
TRUE
T/F: Intraperiod tax allocation is the process that adjusts deferred tax accounts.
False. Intraperiod tax allocation pertains to the tax effects for only one year. It is the allocation of the total tax consequence for that year among income from continuing operations, Discontinued operations, Other comprehensive income items, Adjustment for retroactive accounting principle changes, and Prior period adjustments.
T/F: Gross margin is subject to Intraperiod tax allocation.
FalseIntraperiod tax allocation pertains to the tax effects for only one year. It is the allocation of the total tax consequence for that year among income from continuing operations, Discontinued operations, Other comprehensive income items, Adjustment for retroactive accounting principle changes, and Prior period adjustments.
Which of the following activities would Not be included in the company’s net income calculation?1 Gross sales 2 Cost of goods sold 3 Selling and administrative expense 4 Adjustment for a prior-year understatement of amortization expense 5 Sales returns 6 Gain on sale of available-for-sale securities 7 Gain on disposal of a discontinued business segment 8 Unrealized gain on available-for-sale securities
4 and 8 would Not be included in the company’s net income calculation.
In a multi-step Income Statement: A. Total expenses are subtracted from total revenues. B. Gross profit (margin) is shown as a separate item. C. Cost of sales and operating expense are subtracted from total revenues. D. Other income is added to revenue from sales.
B. In a multi-step Income Statement, gross profit (margin), operating profit (margin), and pretax income from continuing operations are determined. The focus is on the determination of operating profit rather than simply income from continuing operations. Gross profit (margin) is shown as a separate item.
Comprehensive income for a period is the: A. Sum of other comprehensive income items for the period. B. Change in total owners’ equity from all sources, other than from transactions with owners acting as owners. C. Sum of net income and other comprehensive income for the period. D. Change in total owners’ equity for the period.
C. Comprehensive income is considered an overall measure of income and includes other comprehensive income. The latter is the net sum across four items: foreign currency adjustments, derivative gains and losses, unrealized gains and losses on securities available for sale, and certain pension adjustments. The latter four items are similar to income items but are not currently included in net income. Thus, comprehensive income is considered a broader and more inclusive measure of income than net income reported in the Income Statement.
Under FASB U.S. GAAP, which of the following items would cause earnings to differ from comprehensive income for an enterprise in an industry not having specialized accounting principles? A. Unrealized loss on investments in noncurrent marketable equity securities. B. Unrealized loss on investments in current marketable equity securities. C. Loss on exchange of similar assets. D. Loss on exchange of dissimilar assets.
A. Unrealized gains and losses on securities available for sale are among the few items that appear in comprehensive income but not in earnings. Only SAS can be noncurrent. Assuming the current securities are classified as trading securities, then that unrealized loss is included in earnings. This is a change in owners’ equity that is not included in earnings and is not the result of a transaction with owners. It is an “other” comprehensive income item. “Other” refers to other than net income, which is the largest component of comprehensive income. The remaining items are recognized in income.
What is the purpose of reporting comprehensive income? A. To summarize all changes in equity from nonowner sources. B. To reconcile the difference between net income and cash flows provided from operating activities. C. To provide a consolidation of the income of the firm’s segments. D. To provide information for each segment of the business.
A. The purpose of comprehensive income is to show all changes to equity, including changes that currently are not a required part of net income. Comprehensive income reflects all changes from owner and nonowner sources. The other comprehensive income items are: unrealized G/L on AFS securities, unrealized G/L on pension costs, foreign currency translation adjustments, and unrealized G/L on certain derivative transactions.
T/F: Comprehensive income is a required disclosure.
TRUE
The Statement of Changes in Equity: A. Is one of the required financial statements under U.S. GAAP B. Includes accounts such as the retained earnings and common share accounts but not other comprehensive income items. C. Is used only if a corporation frequently issues common shares D. Reconciles all of the beginning and ending balances in the equity accounts.
D. The Statement of Changes in Equity reconciles all of the beginning and ending balances in the equity accounts. The statement shows the opening balance then details all changes in the accounts, ending with the closing balance.
The Statement of Changes in Equity shows an increase in the common stock account of $2,000 and an increase in the additional paid-in capital account of $10,000. If the common stock has a par value of $2, and the only transactions affecting these accounts were these issues of common stock, what was the average issue price of the common stock during the year?
$12 If the par value of the stock is $2, and the increase in the common stock account is $2,000, then $2,000/$2 = 1,000 shares issued. The average issue price is the sum of the par value ($2) and the additional paid-in capital ($10,000/1,000 shares, or $10), which totals $12.
Bay Manufacturing Co. purchased a three-month U.S. Treasury bill. In preparing Bay’s Statement of Cash Flows, this purchase would: A. Have no effect. B. Be treated as an outflow from financing activities. C. Be treated as an outflow from investing activities. D. Be treated as an outflow from lending activities.
A. The three-month bill meets the definition of a cash equivalent. Three months is the maximum original maturity under the definition. Cash and cash equivalents are the reporting basis of the Statement of Cash Flows. Cash decreased but cash equivalents increased the same amount as a result of this purchase. Thus, there is no net effect on cash and cash equivalents. Therefore, there is nothing to report in the Statement of Cash Flows.
T/F: An investment in bonds which has been held for three years will likely be treated as a cash equivalent during the three months prior to its maturity.
FalseInvestments are usually considered cash equivalents only when their original maturity is three months or less.
T/F: Regardless of whether the direct or the indirect method is used to present “Cash Flows from Operating Activities” the remainder of the body of the Statement of Cash Flows will be the same.
TRUE
T/F: There is only one way to present “Cash Flows from Operating Activities” in the Statement of Cash Flows.
FalseThe “Cash Flows from Operating Activities” can be presented with either the Direct or the Indirect method.
T/F: In the body of the Statement of Cash Flows, only the “Cash Flows from Operating Activities” section can be different based on the method - direct or indirect - used.
TRUE
T/F: The amount of “Cash Flows from Operating Activities” will be the same whether the direct of the indirect method is used.
TRUE
T/F: Under the indirect method of presenting “Cash Flows from Operating Activities,” the presentation begins with net income.
TrueThe indirect method is a reconciliation of net income and net operating cash flow.
T/F: When the direct method is used to present “Cash Flows from Operating Activities,” a separate reconciliation of net income with cash flow from operating activities must be provided.
TrueThe direct method reports the actual operating cash flows in the operating section. The reconciliation is provided in a separate schedule.
T/F: The Statement of Cash Flows discloses only information about cash flows.
False.The CF reports on info of net cash inflow/outflow of Operating Activities, Investing Activities, and Financing Activities; the Effects of Foreign Currency Translation; Reconciliation of net cash inflows/outflows; and Non-cash Investing and Financing Activities.
T/F: The direct method of presenting “Cash Flows from Operating Activities” requires different additional disclosures than the indirect method.
TrueThe direct method reports the actual operating cash flows in the operating section. The reconciliation is provided in a separate schedule.
A company acquired a building, paying a portion of the purchase price in cash and issuing a mortgage note payable to the seller for the balance. In a Statement of Cash Flows, what amount is included in investing activities for the above transaction?
The amounts paid to purchase plant assets and passive investments, such as stocks and bonds from other firms, are investing cash outflows. When part of the purchase price is financed, as in this question, ONLY THE CASH AMOUNT PAID is disclosed in the Statement of Cash Flows. The non-cash activity schedule would disclose the acquisition price and amount financed with the mortgage.
Polk Co. acquires a forklift from Quest Co. for $30,000. The terms require Polk to pay $3,000 down and finance the remaining $27,000. On March 1, year 1, Polk pays the $3,000 down and accepted delivery of the forklift. Polk signed a note that requires Polk to pay principal payments of $1,000 per month for 27 months beginning July 1, year 1. What amount should Polk report as an investing activity in the statement of cash flows for the year ended December 31, year 1?
$3,000Only actual cash inflows and outflows are presented on the statement of cash flows. In this case, Polk paid $3,000 in cash as a down payment for the forklift and financed the remainder of the purchase price. Therefore, the only cash outlay as an investing activity on the statement of cash flows is $3,000. The cash outflows associated with the payment on the note would be classified as a financing activity.
A company acquired a building, paying a portion of the purchase price in cash and issuing a mortgage note payable to the seller for the balance. In a Statement of Cash Flows for the purchasing company, what amount is included in financing activities for the above transaction?
ZEROThe cash payment is an investing cash outflow, not a financing cash flow. The transaction would show no entry in the financing section of the Statement of Cash Flows. The payment amount (only) would be reported in the investing activity section of the Statement of Cash Flows as an outflow.
Which of the following transactions is included in the operating activities section of a cash flow statement prepared using the indirect method? A. Gain on sale of plant asset. B. Sale of property, plant and equipment. C. Payment of cash dividend to the shareholders. D. Issuance of common stock to the shareholders.
A. The gain on the sale of a plant asset is a noncash item that is used to reconcile net income to cash flows from operations.
On December 31, 20x1, Deal, Inc. failed to accrue the December 20x1 sales salaries that were payable on January 6, 20x2. What is the effect of the failure to accrue sales salaries on working capital and cash flows from operating activities in Deal’s 20x1 financial statements?
Working Capital = OverstatedCash flows from operating activities = No effectFailure to accrue salaries at the end of 20x1 understates salaries payable, a current liability. Working capital equals current assets minus current liabilities. With current liabilities understated, working capital is overstated. The accrued salaries at the end of 20x1 would not have been paid in 20x1, even if they had been accrued correctly. Therefore, 20x1 operating cash flows are not affected by the failure to accrue the salaries.
T/F: Using the Direct Method, Operating Activities includes cash inflows: from customers, interest income or dividend income, and sale of trading investments.
TRUE
T/F: Using the Direct Method, Operating Activities includes cash outflows: to suppliers and employees, to government, purchase of trading investments, and for interest or other operational expenses.
TRUE
T/F: When using the indirect method of cash flows, you are essentially doing a reconciliation.
TRUE
T/F: Investing Activities, cash inflows: sale of PPE. sale of debt or equity securities of other entities, collection of loan principal. Cash outflows: Purchase of PPE, Purchase of debt or equity securities of other entities.
TRUE
Financing Activities, cash inflows: from sale of the entity’s own equity securities, from issuance of debt (bonds and notes). Cash outflows: to stockholders as dividends, to redeem LT debt, and to reacquire capital stock.
TRUE
Y/N: Are the amounts of operating cash flows generally the same as the related amounts of accrual basis revenues and expenses?
No.
T/F: Cash payments for income tax is a cash outflow from operating activities.
True.
T/F: The sale of marketable securities Held for Trading would be a source of cash flow for operations if the purchaser intends to hold the securities only for a short time.
TRUE
In a Statement of Cash Flows, if used equipment is sold at a loss, the amount shown as a cash inflow from investing activities equals the carrying amount of the equipment: A. Less the loss and plus the amount of tax attributable to the loss. B. Less both the loss and the amount of tax attributable to the loss. C. Less the loss. D. With no addition or subtraction.
C. A journal entry helps to visualize the transaction: Cash dr. xxx Loss dr. xxx Asset (book value) cr. xxx The investing cash inflow is the book value of the asset less the loss. In actuality, this amount equals the amount of cash received on the sale. Any tax effects are accounted for in income tax payments, an operating cash outflow.
Rory Co.’s prepaid insurance was $50,000 at December 31, 2005 and $25,000 at December 31, 2004. Insurance expense was $20,000 for 2005 and $15,000 for 2004. What amount of cash disbursements for insurance should be reported in Rory’s 2005 net cash flows from operating activities presented on a direct basis?
The prepaid insurance account is analyzed to determine insurance payments during the year. Beg. prepaid insurance + insurance payments - insurance expense = end. prepaid insurance $25,000 + insurance payments - $20,000 = $50,000 insurance payments = $45,000
In its cash flow statement for the current year, Ness Co. reported cash paid for interest of $70,000. Ness did not capitalize any interest during the current year. Changes occurred in several balance sheet accounts as follows: Accrued interest payable $17,000 decrease Prepaid interest 23,000 decrease What amount of interest expense for the current year will Ness report in its income statement?
A summary journal entry is helpful to sort out what happened with interest during the period: dr. Interest expense 76,000 dr. Accrued interest payable 17,000 cr. Prepaid interest 23,000 cr. Cash 70,000 The interest expense amount for the year is the derived amount in the entry. Also, a more verbal approach works: (1) accrued interest payable decreased implying that $17,000 more cash was paid in interest than was recognized in expense, and (2) prepaid interest decreased implying that $23,000 less cash was paid in interest than was recognized in expense. The net of these two yields $6,000 less cash paid in interest than was recognized in expense. With $70,000 cash paid for interest, $76,000 must have been expensed. Interest expense of $76,000 = cash interest paid of $70,000 - accrued payable decrease of $17,000 + prepaid interest decrease $23,000.
Which of the following should not be disclosed in an enterprise’s Statement of Cash Flows that is prepared using the indirect method? A. Interest paid, net of amounts capitalized. B. Income taxes paid. C. Cash flow per share. D. Dividends paid on preferred stock.
C. Cash flow per share is not an accepted disclosure. The reason is that there might be confusion with earnings per share, and investors might believe that the amount of cash flow per share would be available for dividends.
When calculating the cash paid for goods to be sold, what are the two accounts related to COGS?
Inventory and Accounts PayableCost of goods sold $250,000 Less decrease in inventory (this represents an increase to cost of goods sold for inventory not purchased in the current period. Thus, the cash paid for inventory is less than cost of goods sold by this amount). (16,000) Less increase in accounts payable (this represents an increase in purchases and, therefore, cost of goods sold that was not paid for in the current period. Thus, the cash paid for inventory is less than cost of goods sold by this amount). ( 7,500) Equals cash paid for inventory
In a Statement of Cash Flows, if used equipment is sold at a gain, the amount shown as a cash inflow from investing activities equals the carrying amount of the equipment: A. Plus the gain. B. Plus the gain and less the amount of tax attributable to the gain. C. Plus both the gain and the amount of tax attributable to the gain. D. With no addition or subtraction.
A. The carrying amount plus the gain equals the cash proceeds received. The proper disclosure is something along the lines of the following journal entry: dr. Proceeds from sale of equipment $xxxxxx. cr. Gain xxxxx cr. Equipment (book value) xxxxx
During 20x1, Teb, Inc. had the following activities related to its financial operations: Payment for the early retirement of long-term bonds payable (carrying value $740,000) $750,000 Distribution in 20x1 of cash dividends declared in 20x0 to preferred shareholders 62,000 Carrying value of convertible preferred stock in Teb, converted into common shares 120,000 Proceeds from the sale of treasury stock (carrying value at cost, $86,000) 95,000 In Teb’s 20x1 Statement of Cash Flows, net cash used in financing activities should be:
$717,000Payment for the early retirement of long-term bonds payable ($750,000) Distribution in 20x1 of cash dividend declared in 20x0 to preferred shareholders (62,000) Proceeds from the sale of treasury stock 95,000 Net cash used in financing activities ($717,000) The conversion of preferred stock is a non-cash activity, not a cash flow.
The summary of significant accounting policies should disclose the A. Pro forma effect of retroactive application of an accounting change. B. Basis of profit recognition on long-term construction contracts. C. Adequacy of pension plan assets in relation to vested benefits. D. Future minimum lease payments in the aggregate and for each of the five succeeding fiscal years.
B. The summary of significant accounting policies conveys information regarding the important accounting methods and policies chosen by the firm, when a choice is available. Knowledge of the methods is critical to an understanding of the amounts disclosed in the financial statements. The method of accounting for long-term contracts may be the percentage of completion or completed contract method. Disclosure of this method assists the user in understanding the meaning of reported revenue and gross profit.The other answer alternatives give data on specific accounts or the result of applying specific accounting principles. They do not indicate what choices the firm has made for accounting and reporting.
Which of the following should be disclosed in a summary of significant accounting policies?I. Management’s intention to maintain or vary the dividend payout ratio.II. Criteria for determining which investments are treated as cash equivalents.III. Composition of the sales order backlog by segment.
Only II. is an accounting policy. Accounting policies include the choice of accounting methods made by the firm, the principles and methods specific to an industry, and any unusual or innovative applications of GAAP. I. and III. are data regarding specific accounts or statements of management intention. They are not descriptions of methods of measurement or recognition used by the firm disclosed for the purpose of assisting users in understanding the amounts reported in the financial statements.
Which of the following should be disclosed in a summary of significant accounting policies? A. Basis of profit recognition on long-term construction contracts. B. Future minimum lease payments in the aggregate and for each of the five succeeding fiscal years. C. Depreciation expense. D. Composition of sales by segment.
A. GAAP allows many choices. In the long-term construction contracts area, GAAP allows both the completed contract and percentage of completion methods. The result of applying each method significantly affects both the Income Statement and Balance Sheet.
Where in its financial statements should a company disclose information about its concentration of credit risks? A. No disclosure is required. B. The notes to the financial statements. C. Supplementary information to the financial statements. D. Management’s report to shareholders.
B. GAAP requires disclosure of all significant concentrations of credit risk from receivables and other financial instruments in the notes. A concentration of credit risk occurs when receivables from different sources reflect common economic risks (for example, a group of receivables from several firms within the same industry).
Brad Corp. has unconditional purchase obligations associated with product financing arrangements. These obligations are reported as liabilities on Brad’s balance sheet, with the related assets also recognized.In the notes to Brad’s financial statements, the aggregate amount of payments for these obligations should be disclosed for each of how many years following the date of the latest balance sheet? A. 0 B. 1 C. 5 D. 10
C. The payments for the five years following the balance sheet date must be disclosed. This question requires memorization of a relatively obscure piece of information. However, there are other cases for which data must be disclosed for the five years following the balance sheet date. Few, if any disclosures are required for a full ten years after the balance sheet date.
Which type of material related-party transactions require disclosure? A. Only those not reported in the body of the financial statements. B. Only those that receive accounting recognition. C. Those that contain possible illegal acts. D. All those other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business.
D. Material related party transactions must be disclosed unless they are ordinary business transactions, such as payment of employees and other routine transactions.
T/F: Companies must disclose the future maturities on their borrowing for five years following the balance sheet date.
True.
T/F: U.S. and International GAAP require disclosure of the amount of dividends proposed or declared before the statements were authorized for issue.
False.Companies are required to provide the following info related to capital structure:1. Rights and privileges of outstanding securities2. Number of shares issued during the annual fiscal period and any subsequent interim period3. Liquidation preference of preferred stock4. If there is a considerable excess of par value or stated value of preferred stock, this info should be disclosed in the equity section of BS5. Other preferred stock disclosures6. Redeemable preferred stock
On December 30, 2004, Solomon Co. had a current ratio greater than 1:1 and a quick ratio less than 1:1. On December 31, 2004, all cash was used to reduce accounts payable. How did these cash payments affect the ratios?
Current Ratio = IncreaseQuick Ratio = DecreaseCash is both a current and a quick asset (an asset immediately available to pay debts). Accounts payable is a current liability. Thus, the numerator and denominator of both ratios have decreased. The current ratio was greater than 1.0 before the transaction. Therefore, the denominator decreased a greater percentage than the numerator causing the ratio to increase. The quick ratio was less than 1.0 before the transaction. Therefore, the numerator decreased a greater percentage than the denominator causing the ratio to decrease.
Assuming constant inventory quantities, which of the following inventory-costing methods will produce a lower inventory turnover ratio in an inflationary economy? A. FIFO (first in, first out). B. LIFO (last in, first out). C. Moving average. D. Weighted average.
A. FIFOInventory turnover ratio is Cost of Goods Sold/Average Inventory. Therefore, to produce the lowest inventory turnover ratio, we need the highest value of ending inventory. The method that produces the highest value of ending inventory in an inflationary economy (prices are rising) is FIFO.
What effect would the sale of a company’s trading securities at their carrying amounts for cash have on each of the following ratios?Current RatioQuick Ratio
Current Ratio = No effectQuick Ratio = No effectThe current ratio equals current assets divided by current liabilities. The quick ratio equals quick assets divided by current liabilities. Quick assets include cash, cash equivalents, trading securities, accounts receivable and other current assets readily convertible to cash. Quick assets exclude inventories and prepaids. Trading securities are included in both current assets and quick assets because they are, by definition, immediately marketable. The sale of trading securities at book value has no effect on current assets or quick assets because the cash received equals the reduction in the trading securities account. Thus, neither ratio is affected by such a sale.
T/F: If the cost of goods sold increases while average inventory remains constant, there has been a more efficient use of inventory.
True.
T/F: The accounts receivable turnover ratio shows the relationship between total sales and average accounts receivable on the books.
False.Measures the # of times that AR turns over during a period. Indicates the quality of credit policies and the efficiency of collection procedures.AR turnover = (net) credit sales / avg. (net) AR
T/F: If the working capital ratio is more or less than 1.00, equal changes in the current assets and current liabilities will change the working capital ratio.
True.WCR = Current Assets / Current Liabilities
T/F: The defensive-interval ratio is a measure of how long available cash and other highly liquid assets could support normal cash requirements.
True.Securities Defensive-interval ratios = (cash + (net) AR + Marketable Securities) / Avg. Daily cash expenditures
T/F: In computing the interest earned ratio, interest expense and income tax expense have to be added back to net income.
TrueMeasures the ability of current earnings to cover interest payments for a period.Times Interest Earned Ratio = (NI + Interest Exp. + Income Tax) / Interest Exp.
T/F: The price-earnings ratio is computed only for common stock.
True.Measures the price of a share of CS relative to its latest earnings per share (EPS). Indicates a measure of how the market values the stock, especially when compared with other stocks.Price-earnings ratio = market price for a CS / EPS
Accounts Receivable Turnover =
(Net) Credit Sales / Average (Net) Accounts Receivable (e.g. (Beginning + Ending)/2) Measures the number of times that accounts receivable turnover (are incurred and collected) during a period. Indicates the quality of credit policies (and the resulting receivables) and the efficiency of collection procedures.
