P1SA2 Recognition, measurement, valuation and disclosure

Question 1

Ending Inventory when prices are rising

Answer 1

FIFO Higher

Question 2

Cost of Goods Sold when prices are rising

Answer 2

LIFO Higher

Question 3

Gross profit when prices are rising

Answer 3

FIFO Higher

Question 4

Ending Inventory when prices are falling

Answer 4

LIFO Higher

Question 5

Cost of Goods Sold when prices are falling

Answer 5

FIFO Higher

Question 6

Gross Profit when prices are falling

Answer 6

LIFO Higher

Question 7

Difference between periodic and the perpetual methods under FIFO

Answer 7

there’s no differences between the two methods because under FIFO, the oldest unit is sold. Both methods will give the same result.

Question 8

When using perpetual LIFO, it becomes slightly more difficult to calculate the ending inventory because LIFO perpetual method creates…

Answer 8

LIFO layer
- it arises when a company purchases more inventory before it sells all of its previous purchase of inventory

Question 9

Once a LIFO layer is created it will remain until the company reaches a period when it sells more units than it purchased. When the company sells more units than it has purchased, one or more LIFO layers may be eliminated. It is called

Answer 9

LIFO Liquidation
- The liquidated layer will be the newest, most recently formed layer

Question 10

In a period of rising prices, LIFO results in the ________ cost of goods sold and thus the _________ net income of all the methods

Answer 10

Highest COGS, Lowest net income

Question 11

In a period of __________ prices, FIFO results in the lowest cost of goods sold and the highest net income

Answer 11

Rising

Question 12

If prices are falling, _____ will result in the highest COGS and the lowest net income of all the methods., while ______ will result in the lowest COGS and the highest net income.

Answer 12

FIFO, LIFO

Question 13

The advantage of the last-in, first-out inventory method is based on the assumption that

Answer 13

the most recently incurred costs should be allocated to the cost of goods sold, while the earliest costs are allocated to ending inventory

Question 14

In a period of rising prices, which inventory methods usually provides the BEST matching of expenses against revenues?

Answer 14

Last-in, first-out (LIFO)

Because the cost allocated to sold units is the most recently incurred cost for each item of inventory

Question 15

Which of the following actions would result in a decrease in income?
a) Liquidating last-in, first-out layers of inventory when prices have been increasing
b) Changing from first-in, first-out to last-in, first-out inventory method when prices are decreasing
c) Accelerating purchases at the end of the year when using the last-in, first out inventory method in times of rising prices
d) Changing the number of last-in, first-out pools.

Answer 15

C

If more inventory is purchased at the end of the year when prices are rising and the last-in, first-out inventory cost flow assumption is being used, the cost of the sales that take place at year-end will be increased. The increase in cost of sales will result in a decrease in net income.

Question 16

In periods of rising costs, which inventory cash flow assumptions will result in higher cost of sales?

Answer 16

Last-in, first-out (LIFO)

Question 17

The inventory method that will yield the same inventory value and cost of goods sold whether a perpetual or periodic system is used is

Answer 17

first-in, first out (FIFO)

Question 18

Johnson company uses the allowance method to account for uncollectible accounts receivable. After recording the estimate of uncollectible accounts expense for the current year, Johnson decided to write off in the current year the $10,000 account of a customer who had filed for bankruptcy. What effect does this write off have on the company’s current net income and total current assets, respectively?

a) decrease, decrease
b) no effect, decrease
c) decrease, no effect
d) no effect, no effect

Answer 18

d) no effect, no effect

Writing off an account when the allowance method is used has no effect on either the income statement or on current assets. The entries to write off the account are a credit to AR and debit to the allowance account, so the net effect on net accounts receivable and on total current assets is zero. Furthermore, the writeoff does not affect any income statement account at all. An income statement account (bad debt expense) is debited when the allowance is booked, not when an account is written off.

Question 19

Based on the industry average, Davis Corp. estimates that its bad debts should average 3% of credit sales. The balance in the Allowance for Uncollectible Accounts at the beginning of Year 3 was $140,000. During Year 3, credit sales totaled $10,000,000, accounts of $100,000 were deemed to be uncollectible, and payment was received on $20,000 account that had previously been written off as uncollectible. The entry to record bad debt expense at the end of Year 3 would include a credit to the Allowance for Uncollectible Accounts of..

a) $300,000
b) $260,000
c) $240,000
d) $160,000

Answer 19

a) 300,000

A lot of unnecessary information is given in this problem. Davis Corp. uses the percentage of sales method to determine bad debt expense. Therefore, the entry to record bad debt expense is simply the percentage of current sales determined to be appropriate for bad debt expense, and that is 3%.+

Question 20

Traditionally, factoring is _______ recourse. It means that the factor assumes the risk of any inability to collect the receivables.

Answer 20

Without recourse

If a sold receivable proves to be uncollectible, the purchaser has no recourse against the seller

Question 21

Woody Company sold $150,000 of its accounts receivable without recourse. The purchaser assessed a finance charge of 5%. Woody should record

a) interest expense of $7,500
b) a credit to liability on transferred accounts receivable of $150,000
c) a credit to accounts receivable of $150,000
d) a debit to cash of $150,000

Answer 21

c) a credit to accounts receivable of $150,000

Because the receivables were sold without recourse, the receivables need to be completely written off the books. This is done with a credit to accounts receivable for $

Question 22

Under FIFO, ending inventory is valued at current cost, and cost of goods sold is reported at an older, historical cost. Therefore, the ________ has “current” figures on it because the inventory is valued at the current cost.

Answer 22

Balance sheet

Question 23

Under LIFO, cost of goods sold is valued at the current cost of the inventory. Inventory is recorded on the balance sheet at an older, historical cost. Therefore, the _________ has “current” figures on it because cost of goods sold is valued at the current costs

Answer 23

Income statement

Question 24

formula to calculate cost of goods sold

Answer 24

Beginning inventory + purchases - ending inventory = cost of goods sold

Question 25

formula to calculate ending inventory

Answer 25

Beginning inventory + purchases - Cost of goods sold

Question 26

Holly Company’s inventory is overstated at December 31 of this year. The result will be

a) understated income this year
b) understated retained earnings this year
c) understated retained earnings next year
d) understated income next year

Answer 26

d) understated income next year

Net income next year will be understated because net income this year will be overstated. Income this year will be overstated because cost of goods sold this year will be understated.

If ending inventory is overstated at the end of this year, cost of goods sold will be understated for this year. Because ending inventory is overstated at the end of this year, beginning inventory for next year will also be overstated. The result will be that cost of goods sold will be overstated next year, and so net income next year will be understated.

Question 27

which one of the following errors will result in the overstatement of net income?

a) overstatement of beginning inventory
b) overstatement of ending inventory
c) overstatement of goodwill amortization
d) overstatement of bad debt expense

Answer 27

b) overstatement of ending inventory

because of the way cost of goods sold is calculated, if ending inventory is overstated, cost of goods sold will be understated. If cost of goods sold is understated, net income will be overstated.

Question 28

If COGS is overstated, then what is understated?

Answer 28

then profits are understated

Question 29

If COGS is understated, then what’s overstated?

Answer 29

then profits are overstated

Question 30

Formula to calculate net realizable value (ceiling)

Answer 30

net realizable value or ceiling = selling price - cost to complete and dispose

Question 31

Formula to calculate floor

Answer 31

Floor = net realizable value (the ceiling) - normal profit amount

Question 32

On January 2, Rio Corp. bought machinery under a contract that required a down payment of $10,000, plus 24 monthly payments of $5,000 each, for total cash payments of $130,000. The cash equivalent price of the machinery is $110,000. The machinery has an estimated useful life of 10 years and an estimated salvage value of $5,000. Rio uses straight-line depreciation. In its income statement for the year ended December 31, what amount should Rio report as depreciation expense for this machinery?

a) $10,500
b) $11,000
c) $12,500
d) $13,000

Answer 32

a) $10,500

This is actually two questions in one. Not only is it a basic depreciation question, but it also tests if you know what cost to use for an asset that is purchased on an installment basis. The asset should be recorded at the cash price cost, which in this problem is $110,000. (The additional amount paid over time is interest expense on the financing for the asset.) Since straight-line depreciation is being used, we need to subtract the salvage value from the cost to get the depreciable amount. With a salvage value of $5,000 the depreciable amount is $105,000. $105,000 is then divided by the estimated useful life of 10 years to determine the depreciation expense per year of $10,500.

Question 33

Sydney Co. purchased a machine that was installed and placed into service on January 1, 20X8, at a cost of $480,000. Salvage value is estimated to be $80,000, and the machine is being depreciated over 10 years using the double declining balance method. For the year ended December 31, 20X9, what amount of depreciation expense should Sydney report?

a) $96,000
b) $76,800
c) $64,000
d) $61,440

Answer 33

b) $76,800

This is a double declining balance depreciation question in which we need to calculate the depreciation expense for Year 2. Since double declining balance is being used, we will need to calculate the depreciation expense for the first year (20X8) before we can calculate the depreciation for the second year (20X9). Double declining balance depreciation expense is calculated as twice the straight-line percentage multiplied by the book balance at the beginning of the year. Because the useful life is 10 years, we would take 10% of the amount each year under straight-line. As this is double declining balance we will use 20% of the beginning book value to calculate the depreciation expense. In 20X8, depreciation expense is $96,000 ($480,000 x 20%). This will mean that at the beginning of 20X9, the book value will be $384,000 ($480,000 — $96,000). $384,000 is multiplied by 20% to get 20X9 depreciation expense of $76,800.

Note that in this question the salvage value is given. The salvage value is not needed for double declining balance until the very end of its useful life when we need to make sure that we do not depreciate the asset below its salvage value.

Question 34

In Joan Co.’s review of long-lived assets to be held and used, an asset with a cost of $10,000 and accumulated depreciation of $5,500 was determined to have a fair value of $3,500. Determine the amount of impairment loss to be recognized if the expected future cash flow is (a) $5,000 or (b) $3,000.

a)
b)

Answer 34

a) $0
b) $1,000

To determine if a fixed asset has been impaired, we compare the book value with the cash value of future cash flows. In question a) the future cash flows are greater than the book value of the asset so it is not impaired and no impairment loss needs to be recognized. In question b), however, the asset is impaired since the future cash flows are less than the book value. In this case the asset needs to be written down from its book value ($4,500) to its fair value ($3,500), or a $1,000 impairment loss.

Question 35

East Corp. manufactures stereo systems that carry a two-year warranty against defects. Based on past experience, warranty costs are estimated at 4% of sales for the warranty period. During 20X9, stereo system sales totaled $3,000,000 and warranty costs of $67,500 were incurred. In its income statement for the year ended December 31, 20X9, East should report warranty expense of:

a) $52,500
b) $60,000
c) $67,500
d) $120,000

Answer 35

d) 120,000

The calculation of warranty expense is simply the total value of the sales multiplied by the estimated future warranty costs at 4% of sales for the warranty period: $3,000,000 x 4% = $120,000.

Question 36

Which of the following represents a temporary difference that would be deductible on the tax return after it has been recognized in financial income?

a) Subscription revenue received by a magazine publisher
b) Warranty liabilities
c) Payment of an insurance premium
d) A deposit received from a customer by a contractor

Answer 36

b) Warranty liabilities

Estimated liabilities for warranties are recognized in financial income as sales take place. The liabilities are an expense for financial reporting purposes but are not deductible for tax reporting purposes until the expense to fulfill the warranties is actually incurred.

Question 37

On December 31, 20X8, HomeTheater Company received a $20,000 deposit from a customer for a home theater installation to be completed in 20X9. HomeTheater included the $20,000 in the revenue reported on its 20X8 tax return but it reported the receipt as a liability (unearned revenue) on its 20X8 financial statements. The enacted tax rates are 35% for 20X8 and 38% for 20X9. What amount of deferred tax asset or liability did HomeTheater report on its balance sheet for financial reporting purposes at the end of 20X8?

a) $7,000 deferred tax asset
b) $7,000 deferred tax liability
c) $7,600 deferred tax asset
d) $7,600 deferred tax liability

Answer 37

c) $7,600 deferred tax asset

HomeTheater reported the $20,000 as income on its 20X8 tax return and paid tax on it. In 20X9, HometTheater will include that amount in its revenue for the installation but HomeTheater will not pay income tax on the $20,000 in 20X9 because the company already paid the tax on it in 20X8. The enacted tax rate for 20X9 is 38%. HomeTheater’s deferred tax asset is 38% of $20,000, or $7,600.

Question 38

Griffey Corp. declared a 7% stock dividend on its 10,000 issued and outstanding shares of $3 par value common stock, which had a fair value of $6 per share before the stock dividend was declared. This stock dividend was distributed 90 days after the declaration date. By what amount did Griffey’s current liabilities increase as a result of the stock dividend declaration?

a) $0
b) $700
c) $2,100
d) $4,200

Answer 38

a) $0

When a stock dividend is declared but not immediately paid, this future stock dividend is not recorded as a dividend payable but rather as “Common Shares - Issuable as a Dividend.” As such, when the dividend is declared, no liability is recorded.

Question 39

The following information was abstracted from the accounts of the Moore Corp. at year-end:

Total income since incorporation $840,000
Total cash dividends paid 60,000
Fair value of a 20% stock dividend distributed 60,000
Excess of proceeds over cost of treasury stock sold 140,000

What should be the current balance of retained earnings?

a) $520,000
b) $580,000
c) $610,000
d) $660,000

Answer 39

a) $520,000

If we take total income since incorporation of $840,000 and subtract the cash dividend of $260,000 and the small stock dividend $60,000, we get a balance of $520,000. We also know that retained earnings can be increased only by the transfer of net income in the year-end close. Of the choices b, c and d, all are greater than $520,000. Therefore, we can select choice a without needing to worry about how the last item given is treated.

Question 40

Do you include goods held on consignment in inventory?

Answer 40

no, goods held on consignment is excluded in inventory

Question 41

Do you include goods out on consignment in inventory?

Answer 41

yes, goods out on consignment is included in inventory

Question 42

Do you include Goods in transit with FOB shipping point in inventory

Answer 42

yes, goods in transit with FOB shipping point is included

Question 43

Do you include Goods in transit with FOB destination point in inventory

Answer 43

no, goods in transit with FOB destination point is excluded

Question 44

What are the four general types of inventory valuations or inventory cost assumption methods?

Answer 44

1. Specific Identification
2. Moving Average Method (Weighted Average Method)
3. First in First Out Method (FIFO)
4. Last In First Out Method (LIFO)

Question 45

In a period of rising prices, what will be the effect of the FIFO valuation on cost of goods sold and net income?

Answer 45

In the period of rising prices, the FIFO method will report the lowest cost of goods because cheaper items are sold first. It will also lead to the highest net income.

Question 46

In a period rising prices, what will be the effect of the LIFO valuation on cost-of-goods sold and net income?

Answer 46

In the period of rising prices, the LIFO method provides the highest cost of goods sold since higher priced items are sold first. It will result in the lowest net income.

Question 47

what will be the effect to net income for the current period if the beginning inventory is understated?

Answer 47

cost of goods sold will be understated and net income will be overstated

Question 48

what is market value in terms of inventory?

Answer 48

the market value can be equal to current replacement cost but must neither exceed the net realizable value nor be less than the net realizable value less normal profit margin

(net realizable value - normal profit margin) < Market Value < Net Realizable Value

Question 49

what will be the effect to net income for the current period if the beginning inventory is overstated?

Answer 49

cost of goods sold will be overstated and net income will be understated

Question 50

what will be the effect to net income for the current period if the ending inventory is understated?

Answer 50

cost of goods sold will be overstated and net income will be understated

Question 51

what will be the effect to net income for the current period if the ending inventory is overstated?

Answer 51

cost of goods sold will be understated and net income will be overstated

Question 52

what will be the effect to net income for the current period if purchases are understated?

Answer 52

cost of goods sold will be understated
net income will be overstated
accounts payable will be understated or cash will be overstated related to the purchase transaction

Question 53

what will be the effect to net income for the current period if purchases are overstated?

Answer 53

cost of goods sold is overstated
net income will be understated
accounts payable will be overstated
cash will be understated related to the purchase transaction

Question 54

what are some advantages of specific identification method?

Answer 54

theoretically accurate due to specific assignment of costs

Question 55

what are some advantages of average cost method?

Answer 55

neutralize fluctuations in inventory cost when prices are unpredictable

simple and a fairly objective method

Question 56

what are some advantages of first in, first out method?

Answer 56

inventory approximates the current replacement cost

lower income tax from lower net income when prices are constantly falling

Question 57

what are some advantages of last in, first out method?

Answer 57

lower income tax from lower net income when prices are constantly rising

Question 58

what are some disadvantages of last in, first out method?

Answer 58

higher income tax from higher net income when prices are constantly falling

inventory is reported at prices which may not substantially reflect the current price

not permitted by IFRS

Question 59

what are some disadvantages of first in, first out method?

Answer 59

higher income tax from higher net income when prices are constantly rising

Question 60

what is the formula to calculate the dividend yield ratio?

Answer 60

stock share price

Question 61

three methods for investment valuation

Answer 61

• fair value method
• the equity method
• the consolidated method

Question 62

what are trading securities?

Answer 62

debt securities that are purchased and held with the intention of selling them in the short term

it is reported at fair value on the balance sheet

Question 63

what are available for sale securities?

Answer 63

securities that are neither classified as trading securities nor held to maturity securities.

they are reported at fair value on the balance sheet

Question 64

what are held-to-maturity securities?

Answer 64

debt securities that are acquired with the positive intention and ability to hold them in the future

they are reported at amortized cost on the balance sheet

Question 65

what are four key components found in corporate bond debt securities?

Answer 65

• coupon rate
• maturity date
• par value
• yield

Question 66

coupon rate

Answer 66

the fixed interest rate based on the initial issue price of the bond

Question 67

maturity date

Answer 67

the date at which the bond’s principal (par value) is due for repayment

Question 68

par value

Answer 68

the “face value”, or the initial price of the bond. This is the amount to be repaid at the maturity date

Question 69

yield

Answer 69

the coupon rate divided by the current bond price

Question 70

relationship between the current price of a corporate bond to the investor’s cost of capital

Answer 70

the current price of a bond is inversely related to the investor’s cost of capital

As current/future interest rate increases, the price of existing bonds fall. Bonds yield adjust to match yields of bonds issued more recently.

Question 71

formula to calculate the straight line depreciation method

Answer 71

estimated useful life

Question 72

formula to calculate the double declining balance depreciation method

Answer 72

(2 / estimated useful life) X asset’s book vale at the beginning of the year)

Question 73

formula to calculate the sum-of-years digits (SYD) depreciation method

Answer 73

n(n+1) / 2

n=estimated asset life in years

You multiply the SYD fraction by the asset’s depreciable cost.

So for a 5 year asset, year 1 would multiply the asset’s depreciable cost by 5/15ths

year 2 would be 4/15ths, year 3 would be 3/15ths, year 4 would be 2/15ths and year 5 would be 1/15th.

The underlying assumption with this method is that the asset is more valuable in its earlier years and less towards the end of its economic life.

Question 74

Which one of the following statement reflects a disadvantage of the LIFO inventory valuation method?

A. It rarely approximates the physical flow of inventory
B. Current costs are not matched to the current revenues
C. It often can cause acceleration of income tax impacts
D. It can negatively impact a company’s cash flow

Answer 74

A. It rarely approximates the physical flow of inventory

Question 75

A corporation’s common stock has a market price that is greater than its par value. The corporation is considering a small stock dividend, a large stock dividend, or a stock split. Which of the following would change additional paid-in-capital on the balance sheet?

A. The stock split only
B. The small stock dividend and the stock split only
C. The large stock dividend and the stock split only
D. The small stock dividend only

Answer 75

D. The small stock dividend only

Question 76

Giaconda, Inc. acquires an asset for which it will measure the fair value by discontinuing 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

Answer 76

b. income

Using present value technique to discount the cash flows or earnings is called the income approach.

Option A is incorrect because market approach uses prices and relevant information from market transactions for identical or comparable assets/liabilities.

Option C is incorrect because cost approach uses current replacement cost.

Option D is incorrect because observable inputs are the inputs for FV valuation and not a valuation technique.

Question 77

Regal Department Store sells gift certificates, redeemable for store merchandise, that expire one year after their issuance. Regal has the following information pertaining to its gift certificates sales and redemptions:

*Unredeemed at 12/31 of prior year: $75,000
*Current year sales: 250,000
*Redemptions of prior year sales: 25,000
*Redemptions of current year sales: 175,000

Regal’s experience indicates that 10% of gift certificates sold will not be redeemed. In its current year December 31 balance sheet, what amount should Regal report as unearned revenue?

Answer 77

$50,000

Of the $250,000 of gift certificates sold in the current year, only $225,000 (i.e., $250,000 x 90%) are expected to be redeemed. Since $175,000 of the gift certificates sold in the current year were redeemed in the current year, $50,000 should be reported as unearned revenue at 12/31 of the current year. (At 12/31 of the current year there is not liability for unredeemed gift certificates sold in the prior year because the certificates expire one year after their issuance.)