Mock Exam 2 (chatGPT)

Question 1

A company purchases equipment for €200,000. It incurs transportation costs of €10,000 and installation costs of €5,000. How should these costs be recorded in the journal entries according to IAS 16?

Answer 1

Dr. PPE (equipment) €215,000
Cr. Bank €215,000

Explanation: All costs directly attributable to bringing the asset to the location and condition necessary for it to operate are capitalized as part of the PPE.

Question 2

A company develops a new software internally. It incurs research costs of €50,000 and development costs of €200,000. How should these be treated according to IAS 38?

Answer 2

Research costs (€50,000): Expensed as incurred (but cannot be capitalized as an asset).

Development costs (€200,000): Capitalized as an intangible asset if certain criteria are met.

Explanation: Research costs cannot be capitalized, but development costs may be capitalized once technical feasibility and other criteria are demonstrated.

Question 3

A company discovers that its inventory, originally valued at €300,000, has a current replacement cost of €280,000. The estimated selling price is €290,000, with selling costs of €20,000. How should the inventory be valued at year-end?

Answer 3

€270,000

Explanation: According to the lower of cost and net realizable value (NRV), the NRV is €290,000 - €20,000 = €270,000. Since this is lower than the original cost of €300,000, the inventory should be written down to €270,000.

Question 4

A company buys a machine for €400,000 with an expected useful life of 10 years and a residual value of €20,000. What is the annual depreciation using the straight-line method?

Answer 4

Annual depreciation = (€400,000 - €20,000) / 10 = €38,000

Explanation: The straight-line method spreads the depreciable amount evenly over the asset’s useful life.

Question 5

A company performs an impairment test and finds that the carrying amount of its factory is €500,000, but the recoverable amount is only €450,000. How should the impairment loss be recorded?

Answer 5

Dr. Impairment loss €50,000
Cr. PPE €50,000

Explanation: The impairment loss is the difference between the carrying amount and the recoverable amount and should be recognized immediately.

Question 6

A company acquires another business and recognizes €1,000,000 in goodwill.

A year later, an impairment test shows that the recoverable amount of the cash-generating unit is only €900,000. What is the journal entry to record the impairment of goodwill?

Answer 6

Dr. Impairment loss €100,000
Cr. Goodwill €100,000

Explanation: Goodwill is impaired when the recoverable amount of the cash-generating unit is less than its carrying amount, and the impairment should be reflected in the financial statements.

Question 7

A company sets aside €150,000 for a warranty provision for a new product line. The actual costs incurred for warranty claims during the year amount to €50,000. What journal entries should be made at year-end?

Answer 7

Dr. Provision for warranties €50,000
Cr. Cash/Bank €50,000 (for the actual costs incurred)

Remaining provision: €150,000 - €50,000 = €100,000

Explanation: The provision is reduced by the amount of warranty costs incurred during the year, leaving a balance for future claims.

Question 8

A company reevaluates its provision for dismantling costs from €200,000 to €180,000 due to new information. How should the adjustment be recorded?

Answer 8

Dr. Provision for dismantling €20,000
Cr. PPE €20,000

Explanation: The reduction in the provision is recorded as a decrease in both the provision and the associated PPE asset.

Question 9

A company sells inventory for €500,000 on credit. The cost of the inventory was €300,000. What are the journal entries for the sale?

Answer 9

Dr. Accounts Receivable €500,000
Cr. Sales Revenue €500,000

Dr. Cost of Goods Sold €300,000
Cr. Inventory €300,000

Explanation: The sale and the corresponding cost of the inventory are recorded separately to reflect both the revenue and the expense.

Question 10

A company discovers that the carrying amount of its intangible asset is higher than its recoverable amount. What journal entries should be made to record the impairment?

Answer 10

Dr. Impairment loss (intangible asset) [Amount]
Cr. Intangible asset [Amount]

Explanation: Impairment of intangible assets is recorded similarly to impairment of PPE, by reducing the carrying amount to its recoverable value.

Question 11

What is the difference between an intangible asset and goodwill according to IAS 38 and IFRS 3?

Answer 11

Intangible asset: A non-monetary asset without physical substance that can be identified, such as patents or trademarks.

Goodwill: Arises from the acquisition of a business and represents future economic benefits from assets that cannot be individually identified or separately recognized.

Question 12

What are the criteria for recognizing development costs as an intangible asset under IAS 38?

Answer 12

Development costs can be capitalized if the entity can demonstrate:

-Technical feasibility
-Intention to complete and use/sell the asset
-Ability to use or sell the asset
-The asset will generate probable future economic benefits
-Availability of resources to complete the development
-Ability to measure costs reliably.

Question 13

Under IAS 2, what costs can be included in the valuation of inventory?

Answer 13

Inventory can be valued by including:

• Costs of purchase (purchase price, import duties, taxes)
• Costs of conversion (direct labor, manufacturing overheads)
• Other costs incurred in bringing the inventories to their present location and condition.
  Excludes: Abnormal costs, storage costs (unless necessary), and selling costs.

Question 14

When should an impairment test be performed for an asset according to IAS 36?

Answer 14

An impairment test should be performed when:

• There are indicators of impairment (e.g., market decline, technological obsolescence)
• For intangible assets with indefinite life, like goodwill, it must be tested for impairment at least annually.

Question 15

How is the recoverable amount of an asset determined under IAS 36?

Answer 15

The recoverable amount is the higher of:

Fair value less costs of disposal
Value in use (the present value of future cash flows expected to be derived from the asset).

Question 16

What is the difference between provisions and contingent liabilities under IAS 37?

Answer 16

Provision: A liability of uncertain timing or amount, recognized when a present obligation exists, and it’s probable that an outflow of resources will be required.

Contingent liability: A possible obligation that arises from past events and is dependent on uncertain future events; not recognized but disclosed unless the chance of an outflow is remote.

Question 17

According to IAS 16, how should a revaluation surplus be treated in financial statements?

Answer 17

When PPE is revalued upwards, the surplus is credited to a revaluation reserve under equity.

It is not recognized in profit or loss but may be transferred to retained earnings as the asset is used (e.g., through depreciation).

Question 18

What is the “useful life” of an asset under IAS 16, and what factors influence its determination?

Answer 18

Useful life is the period over which an asset is expected to be available for use by the entity. Factors include:

-Expected usage
-Physical wear and tear
-Technical or commercial obsolescence
-Legal or similar limits on the asset’s use

Question 19

Under IAS 38, can a company recognize internally generated brands, customer lists, or similar items as intangible assets?

Answer 19

No. IAS 38 prohibits the recognition of internally generated brands, customer lists, and similar items as intangible assets because they do not meet the recognition criteria of being identifiable or reliably measurable.

Question 20

How does IAS 2 define net realizable value (NRV), and how is it used to value inventories?

Answer 20

NRV is the estimated selling price in the ordinary course of business, less the estimated costs of completion and the estimated costs necessary to make the sale.

Inventories are valued at the lower of cost and NRV to ensure that inventory is not overstated on the balance sheet.

Question 21

What is the dominant principle in Continental European accounting systems, and how does it influence financial reporting?

Answer 21

The dominant principle is the prudence principle, which leads to conservative reporting. This often results in understatement of assets and overstatement of liabilities to protect creditors and align with tax regulations.

Question 22

What are the three valuation techniques used to determine fair value under IFRS 13?

Answer 22

Market approach: Uses prices from market transactions involving identical or comparable assets or liabilities.

Cost approach: Reflects the amount that would be required to replace the service capacity of an asset.

Income approach: Converts future amounts (e.g., cash flows) into a present value.

Question 23

What is the “fair-value hierarchy” under IFRS 13, and what are its levels?

Answer 23

The fair-value hierarchy prioritizes the inputs used in valuation:

Level 1: Observable, quoted prices in active markets for identical assets or liabilities.
Level 2: Observable inputs other than Level 1, such as prices for similar assets or liabilities.
Level 3: Unobservable inputs based on company-specific information.

Question 24

What are the recognition criteria for an intangible asset according to IAS 38?

Answer 24

An intangible asset is recognized if:

It is identifiable (either separable or arises from contractual/legal rights).
The entity has control over the asset.
It is expected to provide future economic benefits.
Its cost can be measured reliably.

Question 25

How does IAS 38 differentiate between research and development expenditures?

Answer 25

Research costs: Expensed as incurred -> they do not meet the recognition criteria for assets!

Development costs: Can be capitalized if specific criteria are met (e.g., technical feasibility, intention to complete, ability to use or sell).
(Oil rig example)

Question 26

Under IAS 16, what is included in the cost of an item of property, plant, and equipment (PPE)?

Answer 26

Purchase price, including import duties and non-refundable taxes.

Directly attributable costs (e.g., site preparation, delivery, installation).

Initial estimates of the cost of dismantling and removing the asset and restoring the site.

Question 27

What are provisions under IAS 37, and when should they be recognized?

Answer 27

Provisions are liabilities of uncertain timing or amount. They should be recognized when:

There is a present obligation (!) resulting from a past event.
It is probable (!) that an outflow of resources will be required.
A reliable estimate of the obligation can be made.