Financial 1 - Standard Setting, Income Statement, and Reporting Requirements

Question 1

According to the FASB conceptual framework, which of the following attributes would not be used to measure inventory?

a. Historical cost.
b. Net realizable value.
c. Present value of future cash flows.
d. Replacement cost.

Answer 1

c. Present value of future cash flows.

The present value of future cash flows is used to measure long-term receivables or payables, not inventory, because inventory is a short-term asset, which has more immediate cash flows.

Question 2

According to the FASB conceptual framework, which of the following statements conforms to the realization concept?

a. Depreciated equipment was sold in exchange for a note receivable.
b. Cash was collected on accounts receivable.
c. Product unit costs were assigned to cost of goods sold when the units were sold.
d. Equipment depreciation was assigned to a production department and then to product unit costs.

Answer 2

a. Depreciated equipment was sold in exchange for a note receivable.

Revenues and gains are realized when assets are exchanged for cash or claims to cash.

Question 3

According to the FASB conceptual framework, certain assets are reported in financial statements
at the amount of cash or its equivalent that would have to be paid if the same or equivalent assets
were acquired currently. What is the name of the reporting concept?

a. Historical cost.
b. Current market value.
c. Net realizable value.
d. Replacement cost.

Answer 3

d. Replacement cost.

Replacement cost is defined as the amount of cash or its equivalent that would be paid to acquire or replace an asset currently. Replacement cost is an acquisition cost.

Question 4

Which of the following statements best describes an operating procedure for issuing FASB
Accounting Standards Update?

a. A new Accounting Standards Update can be rescinded by a majority vote of the AICPA
membership.
b. The exposure draft is modified per public opinion before issuing the discussion
memorandum.
c. An Accounting Standards Update is issued only after a majority vote by the members of
the FASB.
d. The emerging issues task force must approve a discussion memorandum before it is
disseminated to the public.

Answer 4

c. An Accounting Standards Update is issued only after a majority vote by the members of the FASB.

An Accounting Standards Update is issued only after a majority vote of the members of the FASB.

Question 5

Which of the following statements best describes an operating procedure for issuing a new International Financial Reporting Standard?

a. The IASB issues a required discussion paper as its first publication on the new topic.
b. Exposure drafts are only released to selected interested parties.
c. The IASB and IFRIC must jointly approve a new IFRS by majority vote.
d. An exposure draft is issued after approval by at least nine members of the IASB.

Answer 5

d. An exposure draft is issued after approval by at least nine members of the IASB.

Before an exposure draft is issued for public comment, it must be approved by at least nine members of the IASB.

Question 6

At December 31, Year 2, Off-Line Co. changed its method of accounting for demo costs from writing off the costs over two years to expensing the costs immediately. Off-Line made the change in recognition of an increasing number of demos placed with customers that did not result in sales. Off-Line had deferred demo costs of $500,000 at December 31, Year 1, $300,000 of which were to be written off in Year 2 and the remainder in Year 3. Off-Line’s income tax rate is 30%. In its Year 3 financial statements, what amount should Off-Line report as cumulative effect of change in accounting principle?

a. $200,000
b. $350,000
c. $500,000
d. $0

Answer 6

d. $0

A change in method of accounting for demo costs is a change in accounting principle inseparable from a change in estimate. When a change in accounting principle is considered inseparable from a change in estimate, the change is handled as a change in estimate - prospectively. No cumulative effect adjustment is made.

Question 7

How should the effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate be reported?

a. As a correction of an error.
b. By restating the financial statements of all prior periods presented.
c. By footnote disclosure only.
d. As a component of income from continuing operations.

Answer 7

d. As a component of income from continuing operations.

When the effect of a change in accounting principle is inseparable from the effect of a change in accounting estimate, the reporting treatment for the overall effect is as a change in estimate. Thus, the effect is reported prospectively as a component of income from continuing operations.

Question 8

On April 30, Deer Corp. approved a plan to dispose of a component of its business. For the period January 1 through April 30, the component had revenues of $500,000 and expenses of $800,000. The assets of the component were sold on October 15 at a loss. In its income statement for the year ended December 31, how should Deer report the component’s operations from January 1 to April 30?

a. $300,000 should be reported as part of the loss on disposal of a component and included as part of continuing operations.
b. $300,000 should be reported as a loss from operations of a component and included in loss from discontinued operations.
c. $300,000 should be reported as an extraordinary loss.
d. $500,000 and $800,000 should be included with revenues and expenses, respectively, as part of continuing operations.

Answer 8

b. $300,000 should be reported as a loss from operations of a component and included in loss from discontinued operations.

Once the decision has been made to dispose of a component of a business and that component meets the criteria to be classified as held for sale, the operating results of the component for the period reported on, and any gain or loss from the disposal, should be reported separately from continuing operations, net of tax. In this question, the component was classified as held for sale and was sold in the same year.

Question 9

In open market transactions, Gold Corp. simultaneously sold its long-term investment in Iron Corp. bonds and purchased its own outstanding bonds. The broker remitted the net cash from the two transactions. Gold’s gain on the purchase of its own bonds exceeded its loss on the sale of the Iron bonds. Assume the transaction to purchase its own outstanding bonds is unusual in nature and has occurred infrequently. Under U.S. GAAP, Gold should report the:

a. Effect of its own bond transaction gain in income before extraordinary items, and report the Iron bond transaction as an extraordinary loss.
b. Effect of its own bond transaction as an extraordinary gain, and report the Iron bond transaction loss in income before extraordinary items.
c. Net effect of the two transactions in income before extraordinary items.
d. Net effect of the two transactions as an extraordinary gain.

Answer 9

b. Effect of its own bond transaction as an extraordinary gain, and report the Iron bond transaction loss in income before extraordinary items.

These are two separate transactions because Gold Corp. (1) sold Iron Corp. bonds (an investment) for a loss, and, (2) bought back its own (Gold) Corp. bonds (a debt) for a gain.

This is not a “refinancing” (where one would sell new bond debt to buy back old bond debt outstanding). The gain from the purchase of its own bonds is an “extraordinary gain” because it is both unusual in nature and infrequently occurring. The Iron Corp. transaction is a loss in “income before extraordinary items” under U.S. GAAP.

Question 10

The following question is based on the following:
Vane Co.’s trial balance of income statement accounts for the year ended December 31, Year 1, included the following:

In Vane’s Year 1 multiple-step income statement, what amount should Vane report as income from continuing operations?

a. $129,500
b. $147,000
c. $126,000
d. $140,000

Answer 10

d. $140,000

Question 11

Per U.S. GAAP, which of the following statements is correct regarding accounting changes that result in financial statements that are, in effect, the statements of a different reporting entity?

a. No restatements or adjustments are required if the changes involve the cost or equity methods of accounting for investments.
b. The financial statements of all prior periods presented should be restated.
c. Cumulative-effect adjustments should be reported as separate items on the income statement in the year of change.
d. No restatements or adjustments are required if the changes involve consolidated methods of accounting for subsidiaries.

Answer 11

b. The financial statements of all prior periods presented should be restated.

Financial statements of all prior periods presented should be restated when there is a “change in entity” such as resulting from:

1. Changing companies in consolidated financial statements.
2. Consolidated financial statements vs. Previous individual financial statements.

Question 12

The cumulative effect of a change in accounting estimate should be shown separately:

a. On the income statement after income from continuing operations and before extraordinary items.
b. On the retained earnings statement as an adjustment to the beginning balance.
c. It should not be recorded separately on any financial statement.
d. On the income statement above income from continuing operations.

Answer 12

c. It should not be recorded separately on any financial statement.

A change in estimate is handled prospectively. No cumulative effect adjustment is made and no separate line item presentation is made on any financial statement. If a material change is being made, appropriate footnote disclosure is necessary.

Question 13

Inventory costs include what?

Answer 13

1. Purchase price
2. Freight in

Question 14

Selling expense includes what?

Answer 14

1. Freight out
2. Salaries and commissions
3. Advertising

Question 15

General & Administrative include what?

Answer 15

1. Officer’s salaries
2. Accounting & legal
3. Insurance

Question 16

Non operating include what?

Answer 16

1. Auxiliary activities
2. Interest expense

Question 17

A segment of Ace Inc. was discontinued during Year 1. Ace’s loss from discontinued operations should not:

a. Include operating losses of the current period up to the date the decision to dispose of the segment was made.
b. Include additional pension costs associated with the decision to dispose.
c. Exclude operating losses from the date the decision to dispose of the segment was made until the end of Year 1.
d. Include employee relocation costs associated with the decision to dispose.

Answer 17

c. Exclude operating losses from the date the decision to dispose of the segment was made until the end of Year 1.

Ace’s loss on discontinued operations should not exclude operating losses from the date the decision to dispose of the segment was made until the end of Year 1. All Year 1 operating losses should be included.

Question 18

On December 31, Year 1, the Board of Directors of Maxy Manufacturing, Inc. committed to a plan to discontinue the operations of its Alpha division. Maxy estimated that Alpha’s Year 2 operating loss would be $500,000 and that the fair value of Alpha’s facilities was $300,000 less than their carrying amounts. Alpha’s Year 1 operating loss was $1,400,000, and the division was actually sold for $400,000 less than its carrying amount in Year 2. Maxy’s effective tax rate is 30%.

In its Year 1 income statement, what amount should Maxy report as loss from discontinued operations?

a. $980,000
b. $1,190,000
c. $1,400,000
d. $1,700,000

Answer 18

b. $1,190,000

Since the fair value of Alpha’s facilities was $300,000 less than its carrying value, there has been an impairment loss, and that loss should be recognized in Year 1. That $300,000 impairment loss plus the $1,400,000 Year 1 operating loss would be recognized in Year 1 net of tax. The total loss would be $1,700,000 x 70% (100% - 30%) or $1,190,000.

Question 19

On December 31, Year 1, the Board of Directors of Maxy Manufacturing, Inc. committed to a plan to discontinue the operations of its Alpha division. Maxy estimated that Alpha’s Year 2 operating loss would be $500,000 and that the fair value of Alpha’s facilities was $300,000 less than their carrying amounts. The estimate for Year 2 turned out to be correct. Alpha’s Year 1 operating loss was $1,400,000, and the division was actually sold for $400,000 less than its carrying amount. Maxy’s effective tax rate is 30%.

In its Year 2 income statement, what amount should Maxy report as loss from discontinued operations?

a. $500,000
b. $350,000
c. $420,000
d. $600,000

Answer 19

c. $420,000

The Year 2 loss from discontinued operations would include both the Year 2 operating loss of $500,000 (which turned out to be a correct estimate) and the “additional” loss (on disposal) of $100,000, net of tax, for a total of $600,000 x 0.70 or $420,000.

Question 20

Midway Co. had the following transactions during the current year:

• $1,200,000 pretax loss on foreign currency exchange due to a major unexpected devaluation by the foreign government.
• $500,000 pretax loss from discontinued operations of a division.
• $800,000 pretax loss on equipment damaged by a hurricane. This was the first hurricane ever to strike in Midway’s area. Midway also received $1,000,000 from its insurance company to replace a building, with a carrying value of $300,000 that had been destroyed by the hurricane.

What amount should Midway report in its year-end income statement as extraordinary loss before income taxes under U.S. GAAP?

a. $1,800,000
b. $100,000
c. $1,300,000
d. $2,500,000

Answer 20

b. $100,000

Foreign currency devaluations and losses from discontinued operations are not extraordinary items. The hurricane is an extraordinary item and the loss, net of insurance, is $100,000:

Equipment loss $ 800,000
Building loss 300,000
Insurance proceeds (1,000,000)
Hurricane loss $100,000

Question 21

Which of the following is not a criteria for recognizing a liability associated with exit or disposal activities?

a. The entity has no discretion to avoid the future transfer of assets.
b. A commitment to an exit plan.
c. The occurrence of an obligating event.
d. The existence of a present obligation to transfer assets in the future.

Answer 21

b. A commitment to an exit plan.

An entity’s commitment to an exit or disposal plan, by itself, is not enough to result in liability recognition. A liability is only recognized when all of the following criteria are met:

1. An obligating event has occurred.
2. The event results in a present obligation to transfer assets or to provide services in the future.
3. The entity has little or no discretion to avoid the future transfer of assets or providing of services.

Question 22

An entity’s commitment to an exit or disposal plan, by itself, is not enough to result in liability recognition. A liability is only recognized when all of the following criteria are met:

Answer 22

1. An obligating event has occurred.
2. The event results in a present obligation to transfer assets or to provide services in the future.
3. The entity has little or no discretion to avoid the future transfer of assets or providing of services.

Question 23

On June 15 of the current year, Solid Co. decided to change from moving average inventory system to the FIFO inventory system. Solid uses IFRS, is on a calendar year basis, and complies with IFRS minimum comparative reporting requirements. The cumulative effect of the change is shown as an adjustment to beginning retained earnings on the balance sheet for:

a. June 15 of the current year.
b. January 1 of the prior year.
c. December 31 of the current year.
d. January 1 of the current year.

Answer 23

b. January 1 of the prior year.

Under IFRS, when an entity records a change in accounting principle, the entity must (at a minimum) present three balance sheets (end of current period, end of prior period, and beginning of prior period) and two of each other financial statement (current period and prior period). The cumulative effect adjustment is shown as an adjustment to beginning retained earnings on the balance sheet for the beginning of the prior period, which would be January 1 of the prior year.

Question 24

In Dart Co.’s Year 2 single-step income statement, as prepared by Dart’s controller, the section titled “Revenues” consisted of the following:

Sales $ 250,000
Purchase discounts 3,000
Recovery of accounts written off 10,000
Total revenues $ 263,000

In its Year 2 single-step income statement, what amount should Dart report as total revenues?

a. $263,000
b. $253,000
c. $260,000
d. $250,000

Answer 24

d. $250,000

The single-step income statement will include in total revenues all sales of goods, services, and rentals. Purchase discounts are not included in revenue, but instead reduce cost of goods sold. The recovery of accounts written off does not hit the revenue account.

Question 25

Which of the following transactions qualify as a discontinued operation?

a. Disposal of part of a line of business.
b. Changes related to technological improvements.
c. Phasing out of a production line.
d. Planned and approved sale of a segment.

Answer 25

d. Planned and approved sale of a segment.

The planned and approved sale of a segment qualifies as a discontinued operation. Because a segment is a component of the entity. Segments may be functional in nature, like a major product category or service division, or they can be geographical as well.

Question 26

Which of the following is a component of other comprehensive income?

a. Minimum accrual of vacation pay.
b. Cumulative currency-translation adjustments.
c. Unrealized gain or loss on trading securities.
d. Changes in market value of inventory.

Answer 26

b. Cumulative currency-translation adjustments.

Cumulative currency translation adjustments are reported in other comprehensive income.

Question 27

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. Composition of sales by segment.
c. Future minimum lease payments in the aggregate and for each of the five succeeding fiscal years.
d. Depreciation expense.

Answer 27

a. Basis of profit recognition on long-term construction contracts.

The summary of significant accounting policies should disclose policies. The only policy in this question is the “basis” of profit recognition on long-term construction contracts. The other disclosures are accounting details and would be disclosed in other footnotes, but not in the summary of significant accounting policies.

Question 28

Which of the following must be included in a company’s summary of significant accounting policies in the notes to the financial statements?

a. Summary of long-term debt outstanding.
b. Revenue recognition policies.
c. Description of current year equity transactions.
d. Schedule of fixed assets.

Answer 28

b. Revenue recognition policies.

The summary of significant accounting policies should include “policies.” The only policy in the choices listed is the revenue recognition policies.

Question 29

Which of the following is not a disclosure requirement related to risks and uncertainties under U.S. GAAP?

a. Disclosure of an entity’s major products or services and its principle markets.
b. Disclosure of significant estimates when it is probable that the estimate will change in the near term, even if the effect of the change will be immaterial.
c. Disclosure of concentrations when it is reasonably possible that a concentration could cause a severe impact in the near term.
d. Disclosure of the use of estimates in the preparation of the financial statements.

Answer 29

b. Disclosure of significant estimates when it is probable that the estimate will change in the near term, even if the effect of the change will be immaterial.

Significant estimates should be disclosed when it is reasonably possible (not probable) that the estimate will change in the near term and that the effect of the change will be material. Immaterial items are not disclosed.

Question 30

Due to a decline in market price in the second quarter, Petal Co. incurred an inventory loss. The market price is expected to return to previous levels by the end of the year. At the end of the year the decline had not reversed. When should the loss be reported in Petal’s interim income statements?

a. In the second quarter only.
b. In the fourth quarter only.
c. Ratably over the third and fourth quarters.
d. Ratably over the second, third, and forth [sic] quarters.

Answer 30

b. In the fourth quarter only.

When the loss is probable and estimable, the expected loss must be recorded in full. This loss becomes such at the end of the fourth quarter. Therefore, the inventory must be valued on the year-end at the lower of cost or market, recognizing the loss at that time.

Question 31

During the first quarter of the calendar year, Worth Co. had income before taxes of $100,000, and its effective income tax rate was 15%. Worth’s effective annual income tax rate for the previous year was 30%. Worth expects that its effective annual income tax rate for the current year will be 25%. The statutory tax rate for the current year is 35%. In its first quarter interim income statement, what amount of income tax expense should Worth report?

a. $15,000
b. $25,000
c. $30,000
d. $35,000

Answer 31

b. $25,000

When preparing interim financial statements, income tax expense is estimated each quarter using the effective tax rate expected to apply to the entire year.

Question 32

A corporation issues quarterly interim financial statements and uses the lower cost or market method to value its inventory in its annual financial statements. Which of the following statements is correct regarding how the corporation should value its inventory in its interim financial statements?

a. Temporary market declines should be recognized in the interim statements.
b. Inventory losses generally should be recognized in the interim statements.
c. Only the cost method of valuation should be used.
d. Gains from valuations in previous interim periods should be fully recognized.

Answer 32

b. Inventory losses generally should be recognized in the interim statements.

Permanent declines in inventory market value should be reflected in interim financial statements in the period incurred.

Question 33

On January 16, Tree Co. paid $60,000 in property taxes on its factory for the current calendar year. On April 2, Tree paid $240,000 for unanticipated major repairs to its factory equipment. The repairs will benefit operations for the remainder of the calendar year. What amount of these expenses should Tree include in its third quarter interim financial statements for the three months ended September 30?

a. $75,000
b. $0
c. $15,000
d. $95,000

Answer 33

d. $95,000

For interim reporting purposes, costs that benefit multiple periods should be allocated equally to those periods. The $60,000 in property taxes will benefit the entire calendar year and therefore must be allocated equally to each calendar quarter:

$60,000 / 4 quarters = $15,000 per quarter

The $240,000 in equipment repairs will benefit the company from April - December and therefore should be allocated equally to each the three quarters contained in that period:

$240,000 / 3 quarters = $80,000 per quarter

Therefore, the total of these expenses to be recognized in the quarter ended September 30 is $95,000 ($15,000 allocated property taxes + $80,000 allocated equipment repairs).

Question 34

Bard Co., a calendar-year corporation, reported income before income tax expense of $10,000 and income tax expense of $1,500 in its interim income statement for the first quarter of the year. Bard had income before income tax expense of $20,000 for the second quarter and an estimated effective annual rate of 25%. What amount should Bard report as income tax expense in its interim income statement for the second quarter?

a. $7,500
b. $3,500
c. $5,000
d. $6,000

Answer 34

d. $6,000

In order to calculate income tax expense on an interim statement, the appropriate methodology is to multiply year to date income by the effective tax rate and subtract from that the income tax expense recorded in the previous quarter. The total income for both quarters is $30,000 and the effective tax rate estimated as of the second quarter is 25%. Total tax expense is then estimated as $7,500 for both quarters, and with $1,500 already booked in the first quarter, that will leave $6,000 for the second quarter.

Question 35

How are discontinued operations and extraordinary items that occur at midyear initially reported?

a. Disclosed only in the notes to the year-end financial statements.
b. Included in net income and disclosed in the notes to interim financial statements.
c. Included in net income and disclosed in the notes to the year-end financial statements.
d. Disclosed only in the notes to interim financial statements.

Answer 35

b. Included in net income and disclosed in the notes to interim financial statements.

To adequately capture the impact of discountinued operations and extraordinary items, both should be included (prorated) in net income and disclosed in the interim financial statement notes.

Question 36

What information should a public company present about revenues from its reporting segments?

a. No disclosure of revenues from foreign operations need be reported.
b. Disclose separately the amount of sales to unaffiliated customers and the amount of intracompany sales.
c. Disclose as a combined amount sales to unaffiliated customers and intracompany sales between geographic areas.
d. Disclose separately the amount of sales to unaffiliated customers but not the amount of intracompany sales between geographic areas.

Answer 36

b. Disclose separately the amount of sales to unaffiliated customers and the amount of intracompany sales.

Unaffiliated customers sales and intracompany sales must be disclosed separately.

Question 37

A company is required to file quarterly financial statements with the United States Securities and Exchange Commission on Form 10-Q. The company operates in an industry that is not subject to seasonal fluctuations that could have a significant impact on its financial condition. In addition to the most recent quarter end, for which of the following periods is the company required to present balance sheets on Form 10-Q?

a. The end of the preceding fiscal year and the end of the prior two fiscal years.
b. The end of preceding fiscal year.
c. The end of the corresponding fiscal quarter of the preceding fiscal year.
d. The end of the preceding fiscal year and the end of the corresponding fiscal quarter of the preceding fiscal year.

Answer 37

b. The end of preceding fiscal year.

Due to the absence of seasonal fluctuations, the end of the preceding fiscal year is the appropriate period to include in addition to the most recent quarter end.

Question 38

Under Regulation S-X, an entity’s interim financial statements filed with the SEC should include all of the following, except:

a. An income statement for the cumulative 12 month period ending during the most recent fiscal quarter.
b. A balance sheet as of the end of the preceding fiscal year.
c. A statement of cash flows for the most recent fiscal quarter.
d. An income statement for the period between the end of the preceding fiscal year and the end of the most recent fiscal quarter.

Answer 38

c. A statement of cash flows for the most recent fiscal quarter.

Interim financial statements filed with the SEC would not include a statement of cash flows for the most recent fiscal quarter, but should include statements of cash flows for the period between the end of the preceding fiscal year and the end of the most recent fiscal quarter, and for the corresponding period for the preceding fiscal year. The financial statements may also present statements of cash flows for the cumulative 12 month period ended during the most recent fiscal quarter and for the corresponding preceding period.

Question 39

An entity has modified liability for its interactive data (XBRL) exhibits for a period:

a. Of 30 days after the earlier of the due date or filing date of the related report or registration statement.
b. Ending on June 15, 2011.
c. Of 24 months from the time the filer first is required to submit interactive data files.
d. Ending on October 31, 2014.

Answer 39

c. Of 24 months from the time the filer first is required to submit interactive data files.

XBRL exhibits submitted to the SEC are subject to modified liability for 24 months from the time the filer first is required to submit interactive data files. The modified liability provision will terminate completely on October 31, 2014, but will end sooner than this date for most entities.

Question 40

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?

a. 40 days.
b. 45 days.
c. 60 days.
d. 30 days.

Answer 40

a. 40 days.

Form 10-Q is a quarterly report filed within 40 days for large corporations and 45 days for small corporations after the end of the first three quarters of each fiscal year. It must contain reviews of interim financial information by an independent CPA.