II. Select Financial Statement Accounts

Question 1

77. Introduction to Inventory

Is freight out considered in calculating cost of goods sold?

Answer 1

No, freight out is not a manufacturing cost but is a distribution cost

Question 2

88. Inventory and IFRS

Under IFRS, inventory is reported at what?

Answer 2

The lower of cost or net realizable value

Question 3

101. Impairment—Assets for Use and Held-for-Sale
     Restorations of carrying value for long-lived assets are permitted if an asset’s fair value increases subsequent to recording an impairment loss for which of the following?
     Held for use
     Held for disposal

Answer 3

Held for use: No
Held for disposal: Yes

If an asset is held for disposal, previous losses can be recovered. The logic is that the recovery will be realized in the near future if the asset is in the process of being disposed. In contrast, an asset held for use CANNOT recover previous impairment because there is no certainty regarding the ultimate realization of those losses.

Question 4

106.No Commercial Substance

When a transaction lacks commercial substance and cash is paid, how is the new asset recorded?

Answer 4

When a transaction lacks commercial substance and cash is paid, the new asset is recorded at the book value of the old asset plus any cash given.

Question 5

153.Stock Dividends and Splits

What is the purpose of stock dividends?

Answer 5

Stock dividends are distributed to reduce the market price of the firm’s stock (often because the stock price has become too high for potential investors) and also to reduce demand by shareholders for cash dividends.

Question 6

153.Stock Dividends and Splits

What is the effect of stock dividends?

Answer 6

The effect of a stock dividend is to increase the number of shares issued and outstanding.

Earnings per share is decreased by a stock dividend.

Question 7

105. Commercial Substance
     Treatment of Cash: What is the FV of the new asset?
106. If cash is paid:
107. If cash is received:

Answer 7

1. FV of new asset = FV of old asset + cash paid

2. FV of new asset = FV of old asset - cash received

Question 8

105. Commercial Substance

What does commercial substance mean?

Answer 8

1. The CF from the new asset will be significantly different from those of the old asset in terms of amount, timing, risk

or

2. The use of the new asset to the firm is significantly different from that of the old asset

Question 9

105. Commercial Substance

If neither asset’s FV can be determined, do we recognize gain/loss? How would we record the incoming asset on our books?

Answer 9

No gain loss is recognized

The incoming asset is recorded at the BV of the outgoing asset + cash paid or - cash received

Question 10

106. No Commercial Substance

Exception: If a loss is evident:

Answer 10

Record the loss and the new asset is at FV (same as with commercial substance) Doesn’t matter if cash is paid or received.

Question 11

106. No Commercial Substance

If a gain is evident and cash is paid:

Answer 11

No gain recognized and the new asset is the sum of BV of asset exchanged + cash paid

Question 12

106. No Commercial Substance

If a gain is evident and cash is received < 25% of the total consideration:

Answer 12

Recognize the gain in proportion to the cash received and the new asset is at FV less the unrecognized portion of the gain

Question 13

106. No Commercial Substance

If a gain is evident and cash is received > 25% of the total consideration:

Answer 13

Recognize the full gain and record the new asset at FV

Question 14

106. No Commercial Substance

General Rule: When there is no commercial substance, the value of the asset acquired is?

Answer 14

the book value of the asset given

Question 15

110.Introduction—Equity and Debt Investments

Is preferred stock considered a debt or equity security?

Answer 15

Equity

Question 16

110.Introduction—Equity and Debt Investments

Is redeemable preferred stock considered a debt or equity security?

Answer 16

Debt

Question 17

111. Equity Investments at Fair Value

Are transactions considered when determining most advantageous market?

Answer 17

YES

Question 18

112.Equity Investments at Cost

How do we measure impairment?

Answer 18

Impairment loss is the difference between the carrying value and the FV of the investment

FV becomes the new cost basis

Question 19

113.Equity Method Accounting

Are dividends income under equity method accounting?

Answer 19

NO

Question 20

113.Equity Method Accounting

Steps:

Answer 20

1. Record equity investment at cost
2. Increase equity investment for investor’s share of the investee’s net income
3. Decrease equity investment for investor’s share of the investee’s dividends
4. Remeasure investee’s BV to FV at date of investment (amortize this difference as a reduction in the equity investment and the income from the equity investment)

Question 21

114.Debt Investments at Fair Value

How would Debt Investments Trading be classified on the Statement of cash flows?

Answer 21

Operating

Question 22

152. Dividends

Property Dividends are recorded at the assets fair value at what date?

Answer 22

Declaration Date

Question 23

Is deferred tax liability arising from depreciation a current or noncurrent liability?

Answer 23

noncurrent - for depreciation, the related asset account is a noncurrent asset

Question 24

What is factoring of AR?

Answer 24

In a factoring, the transferor (original creditor) transfers the receivables to a factor (transferee, a financial institution) immediately as a normal part of business.

Question 25

What is assignment of AR?

Answer 25

When accounts receivable are assigned, the borrower assigns rights to specific accounts receivable as collateral for a loan. The lender has the right to seek payment from these receivables should the borrower (original creditor for the accounts receivable) default on the loan. The borrower reclassifies the receivables as accounts receivable assigned, a subcategory of total accounts receivable. The borrower maintains the receivable records, and as cash is received, it is remitted to the lender in payment of the loan. The loan and the receivables are not offset on the borrower’s balance sheet. When the loan is repaid, any remaining accounts receivable assigned are returned to ordinary accounts receivable status.

Question 26

What is pledging of AR?

Answer 26

Pledging of accounts receivable is less formal than assignment. Rights to specific receivables are not noted as collateral, and accounts receivable are not reclassified. Neither the accounting for the receivables nor the loan is affected by the pledge. Receivables in bulk are transferred to a trustee and can be used for payment of the loan in the event of default by the borrower (original creditor for the accounts receivable). The cash flows from the receivables are used to pay the loan. Footnote disclosure of the pledge is required.

Question 27

What is double-extension method?

Answer 27

This process illustrates that DV LIFO uses price-level indices to measure the inventory increase first in base-year cost, and then expresses each year’s layer at current cost through the conversion index. The result is a DV LIFO ending inventory that is the sum of layers measured in current dollars for the period the layers were added. This method is called the double-extension method because the ending inventory is extended at both base-year cost and ending current-year cost.

Question 28

What is the Conversion Index formula?

Answer 28

Ending inventory at CY cost / Ending inventory at BY cost

Question 29

troubled debt restructure (TDR)

Answer 29

The creditor granted a concession in the expectation that more ultimately will be received from the debtor compared with other strategies, such as forcing the debtor into bankruptcy.
The debtor is in financial difficulty, which means that without the concession, it is likely that the debtor will default.

In all TDR cases, the present value of the consideration paid under the restructured agreement is less than the carrying value of the debt (including any unpaid interest) at date of restructure.
If the debt is settled, the fair value of consideration transferred is less than the carrying value of the debt at date of restructure (creditor grants a concession).
If the debt is modified, the present value of the restructured cash flows (computed using the original interest rate) is less than the carrying value of the debt at date of restructure (creditor grants a concession).

Question 30

How would the amortization of premium on bonds payable affect each of the following?

Carrying Value of Bond
Net income

Answer 30

This answer is correct. When the premium on bonds payable is amortized, the following entry is made:

Premium on bonds payable xxx
Interest expense xxx

This entry has several effects. First, it reduces the amount of the premium. Because the carrying value of the bonds is the face value of the bonds plus the unamortized premium, amortization of the premium serves to reduce the carrying value. Second, amortization of the premium decreases interest expense, thus increasing net income.

Question 31

Derby Co. incurred costs to modify its building and to rearrange its production line. As a result, an overall reduction in production costs is expected. However, the modifications did not increase the building’s market value, and the rearrangement did not extend the production line’s life.

Should the building modification costs and the production line rearrangement costs be capitalized?

Answer 31

Yes, Yes
The criterion for capitalizing post-acquisition costs is not whether the market value of the overall asset is increased. Rather, the criteria are (1) increase in useful life or (2) increase in productivity or efficiency including cost reduction.

An overall reduction in production costs meets the second criterion. Therefore, both costs are capitalized rather than immediately expensed.

Question 32

Contingent Loss: Probability of future events decide how a contingent loss is reported.
Probable
Reasonably possible
Remote

When is an estimate loss reported on the BS?

Answer 32

Probable—Based on professional judgment, the probability of occurrence is considered very high or a near certainty.
Reasonably possible—Based on professional judgment, the probability of occurrence is neither very high nor remote. In other words, when probability of occurrence is considered along a spectrum of possibilities, the probability of occurrence is not at either end of the spectrum, but is in the large middle section of the spectrum.
Remote—Based on professional judgment, the probability of occurrence is considered to be very low, or as the title implies, remote.

The Loss Contingency is Probable and Can be Reasonably Estimated at the Balance Sheet Date—GAAP requires that if a contingent loss is both probable and estimable, then an estimated loss and estimated liability is recognized—actually recorded in the accounts in the amount estimated.

Question 33

Under cash basis of accounting: what is the sales formula?

Answer 33

Sales equals cash collected from customers.
AR, beginning 
\+ Sales
- Write offs
- customer collections
= AR, ending

Question 34

How should a guarantee be treated of likelihood of default is remote?

Answer 34

Since this is a contingent liability where the possibility of loss is remote.

Loss contingencies are accrued when they are probable and reasonably estimable.

All others are disclosed unless remote. However, some contingencies, such as guarantees of others’ debts, standby letters of credit by banks, and agreements to repurchase receivables, are disclosed even if remote. Eagle’s contingent liability is not accrued, because it is not probable. It is disclosed for two reasons: it is a guarantee of other’s debt, and it is a related-party transaction.

Question 35

What are the advantages of Dollar Value LIFO?

Answer 35

Reduces the Effect of the Liquidation Problem—The dollar-value LIFO conversion technique takes a company’s ending inventory in FIFO dollars (usually) and converts them to LIFO dollars. In doing so, the impact of the liquidation problem is reduced.

Allows Companies to Use FIFO Internally—Most companies prefer to use FIFO for internal management reports and internal operating decisions. dollar-value LIFO allows companies an opportunity to do so.

Reduces Clerical Costs—As mentioned earlier, most LIFO companies prefer LIFO for external reporting purposes and prefer FIFO for internal purposes.
Through the use of Dollar-Value LIFO, a company can maintain a FIFO system for internal purposes, and then convert those results to LIFO for external purposes. Please note that through the use of dollar-value LIFO, a company must maintain only a single inventory system (FIFO) during the accounting period, thus reducing clerical costs.

Question 36

What is the Conversion Index?

Answer 36

Conversion Index = Ending Inventory in Current-Year Dollars / Ending Inventory in Base-Year Dollars