Practice Exam 7.18.23

Question 1

In Year 3, a personal injury lawsuit was brought against Halsey Co. Based on counsel’s estimate, Halsey reported a $50,000 liability in its December 31, Year 3, balance sheet. In November Year 4, Halsey received a favorable judgment, requiring the plaintiff to reimburse Halsey for expenses of $30,000. The plaintiff has appealed the decision, and Halsey’s counsel is unable to predict the outcome of the appeal. In its December 31, Year 4, balance sheet, Halsey should report what amounts of asset and liability related to these legal actions?

Answer 1

C. $0 $0

Gain contingencies are not recognized until they are realized. This gain contingency should be disclosed; however, care should be taken to avoid misleading implications as to the likelihood of realization. Thus, no asset should be recorded. Also, given that Halsey received a favorable judgment and is no longer expected to owe $50,000 to the plaintiff, no amount should be recorded as a liability.

Question 2

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. $5,000
B. $7,500
C. $6,000
D. $3,500

Answer 2

C. $6,000

Question 3

During the current year, Haft Co. became involved in a tax dispute with the IRS. At December 31, Haft’s tax advisor believed that an unfavorable outcome was probable. A reasonable estimate of additional taxes was $200,000 but could be as much as $300,000. After the financial statements were issued, Haft received and accepted an IRS settlement offer of $275,000. What amount of accrued liability should Haft have reported in its December 31 balance sheet?

A. $275,000
B. $200,000
C. $250,000
D. $300,000

Answer 3

B. $200,000

A contingent loss is accrued when it is probable that, at the balance sheet date, an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. If the estimate is stated within a given range and no amount within that range appears to be a better estimate than any other, the minimum amount of the range should be accrued. Thus, Haft should report a $200,000 contingent liability.

Question 4

West Co. paid $50,000 for an intangible asset other than goodwill. Fair value of the asset is $55,000. West signed a contract to sell the asset for $10,000 in 10 years. What amount of amortization expense should West record each year?

A. $5,000
B. $4,000
C. $4,500
D. $5,500

Answer 4

B. $4,000

The amortizable amount of the intangible asset is $40,000 ($50,000 historical cost – $10,000 residual value), and the annual amortization expense is $4,000 ($40,000 amortizable amount ÷ 10 years).

Question 5

A firm’s ending inventory balance was overstated by $1,000. Which of the following statements is correct according to a periodic inventory system?

A. The gross margin was understated by $1,000.
B. The cost of goods available for sale was overstated by $1,000.
C. The retained earnings were overstated by $1,000.
D. The cost of goods sold was overstated by $1,000.

Answer 5

C. The retained earnings were overstated by $1,000.

Cost of goods sold (COGS) equals beginning inventory, plus purchases during the period, minus ending inventory. Thus, a $1,000 overstatement of the ending inventory results in a $1,000 understatement of cost of goods sold. The $1,000 understatement of COGS results in a $1,000 overstatement of gross profit, and $1,000 overstatement of retained earnings.

Question 6

Which of the following ratios is(are) useful in assessing a company’s ability to meet currently maturing or short-term obligations?

Answer 6

C. Yes No

The acid-test, or quick, ratio measures liquidity, which is the ability of a company to meet its short-term obligations. The debt-to-equity ratio is a leverage ratio. Leverage ratios measure the impact of debt on profitability and risk.

Question 7

Under a contract with another entity, a company will receive sales-based royalties from the assignment of a patent for 3 years. The royalties received should be reported as revenue

A. In the period received.
B. In the period earned as sales occur.
C. At the date of the royalty agreement.
D. Evenly over the life of the royalty agreement.

Answer 7

B. In the period earned as sales occur.

Assuming the entity satisfied the performance obligation to which the sales-based royalties relate, revenue for sales-based royalties from licensed intellectual property, such as a patent, is recognized as the subsequent sales occur.

Question 8

The objectives of financial reporting stem from which of the following sources?

A. Reporting on management’s consistency.
B. Reporting on management’s stewardship.
C. The need for conservatism.
D. The needs of the external users of the information.

Answer 8

D. The needs of the external users of the information.

Financial statements are the primary method of communicating information to external parties about the results of operations, financial position, and cash flows. For general-purpose financial statements to be useful to external parties, they must be prepared in accordance with GAAP. Accordingly, the needs of the external users of the information is the source for the objectives of financial reporting.

Question 9

Which of the following examples would require restatement of prior years’ financial statements?

A. An intangible asset with a remaining estimated amortization period of 2 years, which is determined to be obsolete.
B. A change from the income tax basis of accounting to the accrual basis.
C. An insurance premium that was due in the prior year was not paid, and the policy lapsed.
D. A calculation change of warranty obligations based on updated claim information for the prior year.

Answer 9

B. A change from the income tax basis of accounting to the accrual basis.

Financial statements must be prepared under the accrual basis of accounting. A change to a generally accepted accounting principle from one that is not is an error correction, not an accounting change. Accordingly, a change from the income tax basis of accounting to the accrual basis of accounting is an error correction. Any error related to a prior period discovered after the financial statements are used must be reported as an error correction by restating the prior-period financial statements.

Question 10

Which of the following is the paramount objective of financial reporting by state and local governments?

A. Comparability.
B. Reliability.
C. Accountability.
D. Consistency.

Answer 10

C. Accountability.

Accountability is the paramount objective of governmental reporting. It is the objective from which all other financial reporting objectives flow. It requires that a government justify how it spends the resources it collects in pursuit of the goals citizens have set for it.

Question 11

The revenue recognition from contracts with customers standard (ASC 606) provides a <List> model that <List>.</List></List>

Answer 11

A. List A = Single principles-based
List B = Eliminates most current industry-specific guidance

The revenue recognition standard provides a single principles-based model (the five-step approach) that can be applied to all contracts with customers regardless of the industry-specific or transaction-specific fact pattern.

Question 12

Which of the following factors determines whether an identified segment of an entity should be reported in the entity’s financial statements?

A. Both I and II.
B. II only.
C. Neither I nor II.
D. I only.

Answer 12

D. I only.

A reportable segment is an operating segment that meets one of the following tests: (1) Reported revenue, including sales to external customers and intersegment sales or transfers, is at least 10% of the combined revenue of all operating segments; (2) assets are at least 10% of the combined assets of all operating segments; and (3) the absolute amount of reported profit or loss is at least 10% of the greater, in absolute amount, of either the combined reported profit of all operating segments that did not report a loss or the combined reported loss of all operating segments that did report a loss. A liabilities test is not stated.

Question 13

A company has a 22% investment in another company that it accounts for using the equity method. Which of the following disclosures should be included in the company’s annual financial statements?

A. The reason for the company’s decision to invest in the investee company.
B. The names and ownership percentages of the other stockholders in the investee company.
C. The company’s accounting policy for the investment.
D. Whether the investee company is involved in any litigation.

Answer 13

C. The company’s accounting policy for the investment.

A company is required to disclose its accounting policies for equity method investees. Disclosures for an investment accounted for under the equity method should also include (1) the names and company’s percentage of ownership in each investee; (2) the difference, if any, between the carrying amount of the investment and the underlying equity in the net assets of the investee; and (3) the accounting method applied to the difference.

Question 14

Nack City received a donation of a valuable painting. Nack planned to add the painting to its collection and display it in the protected exhibition area of city hall. Nack had a policy that if such donated art works were sold, the proceeds would be used to acquire new items for its collections. Which of the following would be correct regarding the donated painting?

A. Must be capitalized but not depreciated.
B. Must be capitalized and depreciated.
C. May be capitalized, but it is not required, and it must be depreciated.
D. May be capitalized, but it is not required, and depreciation is not required.

Answer 14

D. May be capitalized, but it is not required, and depreciation is not required.

Individual items or collections of works of art, historical treasures, and similar assets ordinarily must be capitalized. However, if a collection is (1) held in furtherance of public service and not for gain; (2) protected, preserved, cared for, and kept unencumbered; and (3) subject to a policy that sale proceeds are to be used for acquisitions of new collection items, the direct care of existing items, or both, capitalization is not required. If capitalized collections or individual items are exhaustible, for example, because their useful lives are reduced by display, educational, or research uses, they must be depreciated.

Question 15

Prior to the issuance of its December 31 financial statements, Stark Co. was named as a defendant in a lawsuit arising from an event that occurred in October. Stark’s legal counsel believes that it is reasonably possible that there will be an unfavorable outcome and that damages will range from $100,000 to $150,000. Which amount(s) should Stark accrue and/or disclose in its December 31 financial statements?

Answer 15

A.$0 $100,000 - $150,000

A material contingent loss must be accrued when (1) it is probable that, at a balance sheet date, an asset has been impaired or a liability has been incurred, and (2) the amount of the loss can be reasonably estimated. Because the probability of the loss is reasonably possible, and not probable, no accrual is required. The nature of the contingency and an estimate of the amount of the possible loss or the range of loss must be disclosed when the probability of the loss is reasonably possible. Thus, Stark is only required to disclose the range of the loss in the notes to the financial statements.

Question 16

On December 31, Year 2, Case, Inc., had 300,000 shares of common stock issued and outstanding. Case issued a 10% stock dividend on July 1, Year 3. On October 1, Year 3, Case purchased 24,000 shares of its common stock for its treasury and recorded the purchase by the cost method. What number of shares should be used in computing basic earnings per share for the year ended December 31, Year 3?

A. 324,000
B. 330,000
C. 309,000
D. 306,000

Answer 16

A. 324,000

When a stock dividend, stock split, or a reverse split occurs other than at the beginning of a year, a retroactive adjustment for the change in capital structure should be made as of the beginning of the earliest accounting period presented. For the first 9 months (Jan-Sept) of Year 3, Case is deemed to have had 330,000 shares outstanding [300,000 + (300,000 × 10%)]. After the treasury stock purchase, 306,000 shares (330,000 – 24,000) were outstanding for the last 3 months of the year. The weighted-average share calculation is shown below.

Question 17

According to the FASB’s conceptual framework, comprehensive income includes which of the following?

Answer 17

A. Yes No

Comprehensive income includes all changes in equity except those resulting from investments by owners and distributions to owners.

Question 18

Which of the following objectives of financial reporting is applicable to business entities, not to governmental entities? Provide information to

A. Assist in evaluating operating results.
B. Assist in assessing cash flow prospects.
C. Assist in assessing services provided.
D. Assist in public accountability.

Answer 18

B. Assist in assessing cash flow prospects.

Current and potential investors and creditors of a business entity want to assess their likelihood of receiving cash from (1) dividends or interest or (2) the proceeds from the sale, redemption, or maturity of securities or loans.

Question 19

Ole Corp. declared and paid a liquidating dividend of $100,000. This distribution resulted in a decrease in Ole’s

Answer 19

B. Yes No

The portion of a dividend that is liquidating results in a distribution in excess of the corporation’s retained earnings. Thus, by definition, declaration and payment of a liquidating dividend does not affect retained earnings.

Question 20

Assuming constant inventory quantities, which of the following inventory-costing methods will produce a lower inventory turnover ratio in an inflationary economy?

A. Weighted average.
B. FIFO (first-in, first-out).
C. LIFO (last-in, first-out).
D. Moving average.

Answer 20

B. FIFO (first-in, first-out).

The inventory turnover ratio equals cost of goods sold divided by the average of beginning and ending inventory. Under FIFO, ending inventory is assumed to contain the most recently purchased items, and cost of goods sold is assumed to contain the costs of the earliest purchased items. Under LIFO, the opposite assumptions are made. In an inflationary economy, costs are increasing. Thus, FIFO cost of goods sold is lower, and FIFO ending or average inventory is higher than under LIFO. The inventory methods based on average costs produce results that lie between those of FIFO and LIFO. Accordingly, inventory turnover is lowest under FIFO because the numerator is lower and the denominator is higher than under other methods.

Question 21

According to the FASB’s conceptual framework, the expected cash flow (ECF) approach to measuring present value

A. Uses a single set of estimated cash flows.
B. Determines the single most likely amount or best estimate.
C. Considers all possible estimated cash flows.
D. Is limited to assets and liabilities with contractual cash flows.

Answer 21

C. Considers all possible estimated cash flows.

The traditional approach to calculating present value uses one set of estimated cash flows and one interest rate. This approach is expected to continue to be used in many cases, for example, when contractual cash flows are involved. However, according to the FASB’s conceptual framework, the ECF approach is applicable in more complex circumstances, such as when no market or no comparable item exists for an asset or liability. The ECF results from multiplying each possible estimated amount by its probability and adding the products. The ECF approach emphasizes explicit assumptions about the possible estimated cash flows and their probabilities. The traditional method merely includes those uncertainties in the choice of interest rate. Moreover, by allowing for a range of possibilities, the ECF approach permits the use of present value when the timing of cash flows is uncertain.

Question 22

During fiscal year 2019, Meen County issued $1,000,000 of bonds to purchase trucks. Accumulated depreciation on the trucks was $180,000, and $200,000 of the principal of the bonds has been paid. How much should Meen County include in net investment in capital assets when it reports its government-wide statement of net position?

A. $20,000
B. $820,000
C. $1,000,000
D. $800,000

Answer 22

A. $20,000

Net position includes (1) net investment in capital assets, (2) restricted net position, and (3) unrestricted net position. Net investment in capital assets includes capital assets, net of accumulated depreciation, reduced by outstanding debt related to acquiring, constructing, or improving the assets. Related deferred inflows and outflows of resources also are included. The amount of $20,000 is the effect on net investment in capital assets.

Question 23

Park Corp.’s equity accounts at December 31, Year 4, were as follows:

All shares of common stock outstanding at December 31, Year 4, were issued in Year 1 for $26 a share. On January 4, Year 5, Park reacquired 20,000 shares of its common stock at $24 a share and retired them. Immediately after the shares were retired, the balance in additional paid-in capital was

A. $2,590,000
B. $2,430,000
C. $2,470,000
D. $2,510,000

Answer 23

C. $2,470,000

The 20,000 shares of common stock that were reacquired and retired were originally issued for $520,000 (20,000 shares × $26). Of this amount, $400,000 (20,000 shares × $20 par) should have been credited to common stock, with the remaining $120,000 ($520,000 – $400,000) credited to additional paid-in capital. The 20,000 shares were reacquired for $480,000 (20,000 shares × $24). To record the purchase and retirement, $400,000 should be debited to the common stock account, with the remaining $80,000 ($480,000 – $400,000) debited to additional paid-in capital. Thus, the additional paid-in capital following the retirement of the shares should be $2,470,000 ($2,550,000 – $80,000).

Question 24

Vanity Corporation holds investments in debt securities. These investments were acquired last year and have been properly classified as available-for-sale (AFS) securities. During the current year, the company sold some of the AFS securities at a loss. At year end, the remaining portfolio of AFS securities had appreciated in total value compared with the value at the end of last year. Based on these facts, which one of the following should Vanity report in its financial statements at the end of the current year?

Answer 24

D. Income Stmnt = Realized loss on sale of AFS securities & Balance Sheet = Unrealized holding gain on appreciation of AFS securities

AFS debt securities are measured at fair value at each balance sheet date. Realized losses on the sale of available-for-sale securities are included in the calculation of current period earnings. However, unrealized holding gains on available-for-sale securities are excluded from earnings and are reported as components of other comprehensive income.

Question 25

Andro Co. has a $10 million note payable that is due 3 months after year end. The note payable was refinanced when long-term bonds were issued 1 month after year end for $11 million. The December 31 financial statements were issued 2 months after year end. How should Andro classify and disclose the note?

Answer 25

D. Classificationof liability = Noncurrent & Note disclosure required = Yes

An obligation may be reclassified from current liabilities to noncurrent when an entity intends to refinance it on a noncurrent basis and demonstrates an ability to consummate the refinancing. Since the note payable was refinanced prior to the issuance of the balance sheet, the note payable should be classified as a noncurrent liability. Notes to the financial statements should include a general description of the financing agreement and the terms of any new obligation incurred or securities issued.

Question 26

A lessee incurred costs to construct office space in a leased warehouse. The estimated useful life of the office is 10 years. The remaining term of the nonrenewable lease is 15 years. The costs should be

A. Capitalized as leasehold improvements and amortized over 10 years.
B. Capitalized as leasehold improvements and amortized over 15 years.
C. Expensed as incurred.
D. Capitalized as leasehold improvements and expensed in the year in which the lease expires.

Answer 26

A. Capitalized as leasehold improvements and amortized over 10 years.

General improvements to leased property should be capitalized as leasehold improvements and amortized in accordance with the straight-line method over the shorter of their expected useful life or the lease term. The 10-year useful life is shorter than the 15-year remaining lease term.

Question 27

Which of the following is a criterion for a lease to be classified as a finance lease in the books of a lessee?

A. The lease contains a purchase option that the lessee is reasonably certain to exercise.is equal to 65% or more of the estimated useful life of the leased property.
B. The lease term
C. The present value of the minimum lease payments is 70% or more of the fair market value of the leased property.
D. The lease does not transfer ownership of the property to the lessee.

Answer 27

A. The lease contains a purchase option that the lessee is reasonably certain to exercise.

It’s a finance lease if any of the following five criteria is satisfied:

(1) the lease transfers ownership of the leased asset to the lessee by the end of the lease term.
(2) the lease includes an option to purchase the leased asset that the lessee is reasonably certain to exercise.
(3) the lease term is for the major part (generally is considered to be at least 75%) of the remaining economic life of the leased asset.
(4) the present value of the sum of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all (generally is considered to be at least 90%) of the fair value of the leased asset.
(5) the leased asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

Question 28

Ahm Corp. owns 90% of Bee Corp.’s common stock and 80% of Cee Corp.’s common stock. The remaining common shares of Bee and Cee are owned by their respective employees. Bee sells exclusively to Cee, Cee buys exclusively from Bee, and Cee sells exclusively to unrelated companies. Selected information for Bee and Cee for the year follows:

What amount should be reported as gross profit in Bee and Cee’s combined income statement for the year ended December 31?

A. $26,000
B. $56,000
C. $41,000
D. $47,800

Answer 28

C. $41,000

Cee buys exclusively from Bee. Thus, Cee’s cost of sales equals the sales price charged by Bee, which represented a 30% [($130,000 – $100,000) ÷ $100,000] markup on the cost to the combined entity. Consequently, the gross profit of the combined entity on sales to unrelated companies should include Bee’s markup as well as Cee’s gross profit. Because Bee’s sales were 130% of its cost, the cost to the entity of Cee’s sales was $50,000 ($65,000 cost of sales ÷ 130%). The gross profit in the combined income statement was therefore $41,000 ($91,000 – $50,000).

Question 29

Jonn City entered into a lease for equipment during the year. How should the asset obtained through the lease be reported in Jonn City’s government-wide statement of net position?

A. General capital asset.
B. Expenditure.
C. Other financing use.
D. Not reported.

Answer 29

A. General capital asset.

The only possible correct answer is that the lease is a general capital asset. Other financing sources and uses and expenditures are not reported in the government-wide statements.

Question 30

Simm Co. has determined its December 31 inventory on a LIFO basis to be $400,000. Information pertaining to the inventory follows:

At December 31, what should be the amount of Simm’s inventory?

A. $328,000
B. $400,000
C. $388,000
D. $390,000

Answer 30

C. $388,000

Inventory accounted for using the LIFO or retail inventory method must be written down to market if its utility is less than its cost. Market is the current cost to replace inventory, subject to limitations. Market should not (1) exceed a ceiling equal to net realizable value (NRV) or (2) be less than a floor equal to NRV reduced by an allowance for an approximately normal profit margin. NRV is the estimated selling price in the ordinary course of business minus reasonably predictable costs of completion, disposal, and transportation.
Cost ($400,000 LIFO basis) exceeds market ($390,000 current replacement cost). But market exceeds the ceiling ($408,000 estimated selling price – $20,000 estimated cost of disposal = $388,000 NRV) and the floor ($388,000 NRV – $60,000 normal profit margin = $328,000). Inventory therefore is $388,000, and the loss on write-down is $12,000 ($400,000 cost – $388,000 market ceiling).