Practice Exam 7.20.23

Question 1

Meen County uses an internal service fund to account for printing services provided to other departments. Meen County paid $200,000 for new printing equipment, a $5,000 fee for installation of new printing equipment, and $7,000 for ink. What amount should the internal service fund report as the cost of the new printing equipment on the proprietary funds statement of net position?

A. $205,000
B. $212,000
C. $200,000
D. $0

Answer 1

A. $205,000

The economic resources measurement focus and the accrual basis of accounting are required in the proprietary funds financial statements. Enterprise funds and internal service funds are proprietary funds. Capital assets of internal service funds are reported in the proprietary funds statement of net position on the same basis as business entities. The printing equipment therefore is reported at the cost of acquisition and installation, or $205,000 ($200,000 price + 5,000 cost of installation).

Question 2

On January 2, Year 1, Kine Co. granted Morgan, its president, fully vested share options to buy 1,000 shares of Kine’s $10 par common stock. The options have an exercise price of $20 per share and are exercisable for 3 years following the grant date. Morgan exercised the options on December 31, Year 1. The market price of the shares was $50 on January 2, Year 1, and $70 on the following December 31. Since the fair value of the options is not reasonably estimable at the grant date, the options are measured at intrinsic value. By what net amount will equity increase as a result of the grant and exercise of the options? (Ignore tax considerations.)

A. $70,000
B. $50,000
C. $20,000
D. $30,000

Answer 2

C. $20,000

The net effect on equity is an increase of $20,000 ($10,000 common stock + $60,000 additional paid-in capital – $50,000 compensation expense).

Question 3

An investor purchased a bond classified as a long-term investment between interest dates at a discount. At the purchase date, the carrying amount of the bond is more than the

Answer 3

B. Cash Paid to Seller = No
Face Amount of Bond = No

At the date of purchase, the carrying amount of the bond equals its face amount minus the discount. The cash paid equals the initial carrying amount plus accrued interest. Hence, the initial carrying amount is less than the cash paid by the amount of the accrued interest.

Question 4

Selected financial information for Floral company is as follows:

Floral’s net cash inflow from financing activities is:

A. $19,000
B. $8,000
C. $15,000
D. $10,000

Answer 4

C. $15,000

Cash inflows from financing activities include the cash received from issuance of stock of $45,000. Cash outflows from financing activities include the repayment of the loan for $18,000 and the cash dividends paid of $12,000. Therefore, net cash flow from financing activities is $15,000 ($45,000 – $18,000 – $12,000). Interest paid on the loan, dividends received, and the reduction of accounts payable are all operating activities.

Question 5

During the current year, a tornado completely destroyed a building belonging to Holland Corp. The building cost $100,000 and had accumulated depreciation of $48,000 at the time of the loss. Holland received a cash settlement from the insurance company and reported a loss of $21,000. In Holland’s current-year cash flow statement, the net change reported in the cash flows from investing activities section should be a

A. $21,000 decrease.
B. $10,000 increase.
C. $52,000 decrease.
D. $31,000 increase.

Answer 5

D. $31,000 increase.

Investing activities include the lending of money; the collection of those loans; and the acquisition, sale, or other disposal of (1) loans and other securities that are not cash equivalents and that have not been acquired specifically for resale and (2) property, plant, equipment, and other productive assets. The building had a carrying amount of $52,000 ($100,000 – $48,000), and the loss was $21,000. Hence, the cash inflow from the involuntary conversion (a disposal of property) must have been $31,000 ($52,000 – $21,000).

Question 6

On January 1 of the current year, Lean Co. made an investment of $10,000. The following is the present value of $1.00 discounted at a 10% interest rate:

What amount of cash will Lean accumulate in 2 years?

A. $16,250
B. $12,107
C. $27,002
D. $12,000

Answer 6

B. $12,107

The present value (PV) of an amount is the value today of some future payment. It equals the future payment times the present value of $1 (a factor found in a standard table) for the given number of periods and interest rate. The future payment (the future value of an amount) can therefore be determined by dividing the PV of an amount by the relevant interest factor. Consequently, the cash accumulated in 2 years will be $12,107 ($10,000 PV of an amount ÷ .826 PV of $1 for 2 years at 10%).

Question 7

Fact Pattern: Society is a nongovernmental not-for-profit organization. Recently, Food Company made an oral conditional promise to donate $20,000 to Society contingent upon its recognition as “best foundation of the year” by local government. The $20,000 is restricted to construction of a children’s library.

In Year 1, to help Society win recognition, Food Company gave $5,000 to Society in advance. How should the event be reported on Society’s statement of financial position for Year 1?

Answer 7

B. Assets = Increase
Liabilities = Increase
Net Assets with Donor Restrictions = No change

A donor-imposed condition is a barrier that must be overcome before the recipient is entitled to the assets. If it is not overcome, the contributor has a right of return of the assets or the promisor a right of release from its obligation. A conditional promise to give is not recognized until the condition is substantially met (i.e., the barrier is overcome). A transfer of assets before the condition is met is a conditional contribution. It is accounted for as a refundable advance (debit assets, credit a liability) until the condition is (1) substantially met or (2) explicitly waived by the donor. Accordingly, the amount of $5,000 should be recorded as a refundable advance (liability), and cash (asset) should be debited. No revenue is recognized. Net assets are not affected.

Question 8

Fact Pattern: The city of Lud formally integrates budgetary accounts into its general fund. Lud uses an internal service fund to account for the operations of its data processing center, which provides services to Lud’s other governmental units.

Lud’s current year expenditures from the general fund include payments for structural alterations to a firehouse and furniture for the mayor’s office.

To report the billing for data processing services provided to Lud’s other governmental units in the statement of revenues, expenses, and changes in fund net position, which of the following should be credited in the internal service fund?

A. Interfund transfers.
B. Data processing departmental expenses.
C. Interfund reimbursements.
D. Operating revenues.

Answer 8

D. Operating revenues.

The provision by an internal service fund of data processing services to other units of the same reporting entity is an interfund service provided and used. These services result in revenues to seller funds. Given that the principal purpose of the internal service fund is to provide data processing services to other subunits of the primary government, the revenues are classified as operating.

Question 9

Mann, Inc., had 300,000 shares of common stock issued and outstanding at January 1. On July 1, an additional 50,000 shares of common stock were issued for cash. Mann also had unexercised stock options to purchase 40,000 shares of common stock at $15 per share outstanding at the beginning and end of the year. The average market price of Mann’s common stock was $20 during the year. What is the number of shares that should be used in computing diluted earnings per share (DEPS) for the year ended December 31?

A. 325,000
B. 335,000
C. 365,000
D. 360,000

Answer 9

B. 335,000

The weighted average shares outstanding needs to be calculated. On July 1, 50,000 shares of common stock were issued. Hence, for the purpose of calculating Mann’s weighted-average number of shares, 300,000 shares should be considered outstanding for the first 6 months and 350,000 shares for the second 6 months. Therefore, the weighted average shares outstanding equals 325,000.
Dilutive call options and warrants are included in DEPS. These options are assumed to be exercised at the beginning of the period using the treasury stock method. This method assumes the options are exercised and the $600,000 of proceeds (40,000 options × $15) is used to repurchase shares. In the DEPS computation, the assumed repurchase price is the average market price for the period ($20), so 30,000 shares are assumed to be repurchased ($600,000 ÷ $20). The difference between the shares assumed to be issued and those repurchased (40,000 – 30,000 = 10,000) is added to the weighted average of common shares outstanding to determine the DEPS denominator. Thus, 335,000 (325,000 + 10,000) shares should be used in computing DEPS for the year ending December 31.

Question 10

Shipping costs incurred by a consignor on transfer of goods to a consignee should be considered as

A. Inventory cost to the consignee.
B. Inventory cost to the consignor.
C. Expense to the consignee.
D. Expense to the consignor.

Answer 10

B. Inventory cost to the consignor.

Inventoriable costs include all costs of making the inventory ready for sale. Costs incurred by a consignor on the transfer of goods to a consignee are costs necessary to prepare the inventory for sale. Because goods on consignment remain in the inventory of the consignor, the shipping costs should be debited to consignment-out (the account in which the consignor records consignment-related transactions).

Question 11

Pear Co.’s income statement for the year ended December 31, as prepared by Pear’s controller, reported income before taxes of $125,000. The auditor questioned the following amounts that had been included in income before taxes:

Pear owns 40% of Cinn’s common stock, and no acquisition differentials are relevant. Pear’s December 31 income statement should report income before taxes of

A. $85,000
B. $152,000
C. $120,000
D. $117,000

Answer 11

B. $152,000

Under the equity method, the investor’s share of the investee’s net income is accounted for as an addition to, and losses and dividends are reflected as reductions of, the carrying amount of the investment. Consequently, the equity in earnings of Cinn Co. was correctly included in income, but the dividends received should have been excluded. In addition, error corrections related to earlier periods are treated as prior-period adjustments and are not included in net income. Thus, income before taxes should have been $152,000 ($125,000 – $8,000 dividends + $35,000 depreciation error).

Question 12

Which of the following is not valid as it applies to inventory costing methods?

A. When a firm using the LIFO method fails to maintain its usual inventory position (reduces stock on hand below customary levels), there may be a matching of old costs with current revenue.
B. LIFO tends to smooth out the net income pattern since it matches current cost of goods sold with current revenue when inventories remain at constant quantities.
C. The use of FIFO permits some control by management over the amount of net income for a period through controlled purchases, which is not true with LIFO.
D. If inventory quantities are to be maintained, part of the earnings must be invested (plowed back) in inventories when FIFO is used during a period of rising prices.

Answer 12

C. The use of FIFO permits some control by management over the amount of net income for a period through controlled purchases, which is not true with LIFO.

Under LIFO, the most recent purchases are included in cost of goods sold. Management could affect net income with an end-of-period purchase that would immediately alter cost of goods sold. A last-minute FIFO purchase included in the ending inventory would have no such effect.

Question 13

How should unconditional pledges received by a nongovernmental not-for-profit entity that will be collected over more than one year be reported?

A. Deferred revenue, valued at present value.
B. Pledges receivable, valued at their present values.
C. Long-term pledges receivable, valued at the expected collection amount.
D. Pledges receivable, valued at the amount pledged.

Answer 13

B. Pledges receivable, valued at their present values.

A promise to give is an oral or written agreement to contribute assets to another entity. It is unconditional if it depends only upon the passage of time or a demand by the promisee for performance. Consequently, the promise is unconditional. It should be reported as contributions or pledges receivable. It is treated as an increase in net assets with donor-imposed restrictions. Also, the fair value of unconditional promises to give cash expected to be collected in 1 year or more is the present value of the estimated future cash flows.

Question 14

Murphy Co. had 200,000 shares outstanding of $10 par common stock on March 30 of the current year. Murphy reacquired 30,000 of those shares at a cost of $15 per share and recorded the transaction using the cost method on April 15. Murphy reissued the 30,000 shares at $20 per share and recognized a $50,000 gain on its income statement on May 20. Which of the following statements is correct?

A. Murphy’s net income for the current year is understated.
B. Murphy should have recognized a $50,000 loss on its income statement for the current year.
C. Murphy’s net income for the current year is overstated.
D. Murphy’s comprehensive income for the current year is correctly stated.

Answer 14

C. Murphy’s net income for the current year is overstated.

The cost method debits cash and credits treasury stock and paid-in capital from treasury stock transactions when a reissuance of shares is made for an amount in excess of cost. The credit to treasury stock is $450,000 (30,000 shares × $15), and the credit to paid-in capital from treasury stock transactions is $150,000 [$600,000 cash (debit) – $450,000 treasury stock (credit)]. The reason for the latter credit (an equity account) instead of a gain is that the effects of transactions in the entity’s own stock are always excluded from net income or the results of operations. Thus, recognizing a gain on the reissuance of treasury stock overstates current net income.

Question 15

On December 15, Year 4, Far-Lap Co. paid $200,000 cash for 40% of the outstanding common shares of Dunwunder, Inc. On that date, Far-Lap intended to sell all of these shares soon after the close of its fiscal year on December 31, Year 4. Far-Lap’s equity stake permitted it to exercise significant influence over Dunwunder. For the period March 1 through December 15, Year 4, Dunwunder reported $5,600 in net income. Which of the following is the best reason for Far-Lap not to use the equity method to account for its investment in Dunwunder?

A. Far-Lap classified the investment as held for sale.
B. The purchase did not result in recognition of goodwill.
C. Far-Lap held no previous equity stake in Dunwunder before the purchase date.
D. Far-Lap’s equity stake is only 40%.

Answer 15

A. Far-Lap classified the investment as held for sale.

The equity method is not required if the investment is classified as held for sale.

Question 16

Which of the following items is considered a permanent book to tax difference?

A. Tax penalties paid to tax authorities.
B. Warranty payable.
C. Prepaid insurance.
D. Sale of inventory under the installment method for tax purposes.

Answer 16

A. Tax penalties paid to tax authorities.

Permanent differences are never reversed. Therefore, they have no deferred tax consequences. Fines resulting from a violation of law are subtracted in calculating net income but not taxable income.

Question 17

The transaction price from contracts with customers generally should not be adjusted for the effect of the time value of money when

A. A substantial amount of the consideration is contingent on a future event that is not within the control of the seller.
B. The selling price of the product and the consideration promised in the contract differ significantly.
C. The transfer of goods is at the discretion of the seller.
D. The time between the payment and the delivery of the promised goods in the contract to the customer is 18 months.

Answer 17

A. A substantial amount of the consideration is contingent on a future event that is not within the control of the seller.

The transaction price should not be adjusted for the effect of the time value of money if:

1. The time between the payment and the delivery of the promised good or service to the customer is 1 year or less.
2. The transfer of goods or services is at the discretion of the customer (e.g., a bill-and-hold contract in which the seller provides storage services for goods it sold to the buyer).
3. A substantial amount of the consideration promised is variable, and its amount or timing varies on the basis of future circumstances that are not within the control of the entity or the customer. An example is a sales-based royalty contract in which the amount of consideration depends on sales by the customer to third parties.

Question 18

A reporting entity makes an award of share-based employee compensation in the form of share options classified as equity. To account for this award, the entity

A. Credits other comprehensive income.
B. Recognizes changes in estimated total cost by retrospective application to prior periods affected.
C. Recognizes no cost for an award with a performance condition until the condition is satisfied.
D. Recognizes total compensation cost based on the number of equity instruments for which the requisite service was performed.

Answer 18

D. Recognizes total compensation cost based on the number of equity instruments for which the requisite service was performed.

Compensation cost for an award classified as equity is recognized over the requisite service period. This period is the period during which employees must perform services. It is most often the vesting period. The requisite service period begins at the service inception date. The service required is called the requisite service. Total compensation cost at the end of the requisite service period is determined by the number of equity instruments for which the requisite service was completed and their grant-date fair value. The entity must estimate this number when initial accruals are made. The credit is usually to paid-in capital.

Question 19

Deck Co. had 120,000 shares of common stock outstanding at January 1. On July 1, it issued 40,000 additional shares of common stock. Outstanding all year were 10,000 shares of nonconvertible cumulative preferred stock. What is the number of shares that Deck should use to calculate basic earnings per share?

A. 150,000
B. 170,000
C. 160,000
D. 140,000

Answer 19

D. 140,000

The weighted-average number of common shares outstanding relates the portion of the period that the shares were outstanding to the total time in the period. Consequently, the number of shares used to calculate BEPS is 140,000 {120,000 shares outstanding throughout the period + [40,000 shares × (6 months ÷ 12 months)]}.

Question 20

On December 1, Year 4, Tigg Mortgage Co. gave Pod Corp. a $200,000, 12% loan. Pod received proceeds of $194,000 after the deduction of a $6,000 nonrefundable loan origination fee. Principal and interest are due in 60 monthly installments of $4,450, beginning January 1, Year 5. The repayments yield an effective interest rate of 12% at a present value of $200,000 and 13.4% at a present value of $194,000. What amount of accrued interest receivable should Tigg include in its December 31, Year 4, balance sheet?

A. $4,450
B. $2,000
C. $2,166
D. $0

Answer 20

B. $2,000

Accrued interest receivable is always equal to the face amount times the nominal rate for the period of the accrual. Thus, the accrued interest receivable is $2,000 [$200,000 × 12% × (1 ÷ 12)].

Question 21

Which of the following information about threatened litigation should not be considered to determine whether an accrual is appropriate prior to an issuance of a company’s financial statements?

A. The ability to make a reasonable estimate of the amount of loss.
B. The period in which the threatened litigation became known to management.
C. The degree of probability of an unfavorable outcome.
D. The period in which the underlying cause of the threatened litigation occurred.

Answer 21

B. The period in which the threatened litigation became known to management.

A material contingent loss must be accrued (debit a loss and credit a liability) when (1) it is probable that an asset has been impaired or a liability has been incurred and (2) the amount of the loss can be reasonably estimated. Subsequent events are events or transactions that occur after the balance sheet date and prior to the issuance of the financial statements. The accrual is appropriate when the subsequent event provides additional evidence about conditions that existed at the date of the balance sheet. Thus, the period in which the underlying cause of the threatened litigation occurred is considered in determining whether to accrue a liability before the issuance of the financial statements. Therefore, the only information that is not considered is when threatened litigation became known to management.

Question 22

The following information pertains to Pine City’s general fund for Year 1:

After Pine City’s general fund accounts were closed at the end of Year 1, the fund balance increased by

A. $2,500,000
B. $3,000,000
C. $1,000,000
D. $1,500,000

Answer 22

A. $2,500,000

The change in the fund balance during the period is determined by the changes in the operating account balances. Appropriations is a budgetary control account, the balance of which usually does not change except when it is established and closed. Revenues of $8,000,000, plus other financing sources of $1,500,000, equal $9,500,000 of total credits. Thus, the increase in fund balance was $2,500,000 ($9,500,000 – $5,000,000 expenditures – $2,000,000 other financing uses).

Question 23

Fact Pattern: Flax Corp. uses the direct method to prepare its statement of cash flows. Flax’s trial balances at December 31, Year 6 and Year 5, are as follows:

What amount should Flax report in its statement of cash flows for the year ended December 31, Year 6, for cash paid for income taxes?

A. $15,000
B. $19,700
C. $25,800
D. $20,400

Answer 23

C. $25,800

To reconcile income tax expense to cash paid for income taxes, a two-step adjustment is needed. The first step is to add the decrease in income taxes payable. The second step is to subtract the increase in deferred income taxes. Hence, cash paid for income taxes equals $25,800 [$20,400 + ($27,100 – $21,000) – ($5,300 – $4,600)].

Question 24

When the direct method of preparing a statement of cash flows is used, an enterprise should provide a reconciliation of net income to net cash flows from which activity?

A. Investing.
B. Operating.
C. Financing.
D. No reconciliation should be provided.

Answer 24

B. Operating.

If the direct method is used, a reconciliation of net income and net cash flows from operating activities is required to be provided in a separate schedule.

Question 25

The LIFO inventory cost flow method may be applied to which of the following inventory systems?

Answer 25

C. Periodic = Yes
Perpetual = Yes

In a periodic system, a purchases account is used, and the beginning inventory remains unchanged during the accounting period. Cost of goods sold is determined at year-end. It is the difference between the goods available for sale (beginning inventory + purchases) and ending inventory.

In a perpetual system, purchases are directly recorded in the inventory account. Cost of goods sold is determined as the goods are sold. LIFO may be applied to both a periodic and a perpetual system, but the amount of cost of goods sold may vary with the system chosen.

Question 26

A nongovernmental not-for-profit entity reported cost of goods sold for its publications of $200,000 for the current year. Additional information is as follows:

What amount should be reported as cash paid to suppliers in the current-year statement of cash flows (direct method)?

A. $182,000
B. $268,000
C. $150,000
D. $132,000

Answer 26

B. $268,000

To reconcile cost of goods sold to cash paid to suppliers, a two-step adjustment is needed. First, purchases is calculated by adding the increase in inventory to cost of goods sold. Second, cash paid for goods sold is calculated by adding the decrease in accounts payable to purchases. Thus, cash paid for goods sold equals $268,000 [$200,000 + ($100,000 – $50,000) + ($28,000 – $10,000)].

Question 27

After an impairment loss is recognized, the adjusted carrying amount of the intangible asset shall be its new accounting basis. Which of the following statements about subsequent reversal of a previously recognized impairment loss is correct?

A. It is prohibited.
B. It is required when the reversal is considered permanent.
C. It must be disclosed in the notes to the financial statements.
D. It is encouraged but not required.

Answer 27

A. It is prohibited.

When an impairment of an intangible asset is recognized, the previous carrying amount of the asset is reduced by the impairment loss. The adjusted carrying amount is the new accounting basis. Thus, it cannot be increased subsequently for a change in fair value. This rule applies whether the intangible asset has a finite or an indefinite useful life.

Question 28

Pubco is a public company that uses a calendar year and has a complex capital structure. Pubco reported in the first quarter income from continuing operations (net of tax) of $1 million and a loss on discontinued operations (net of tax) of $1.2 million.
The average market price of Pubco’s common stock for the first quarter was $25, the shares outstanding at the beginning of the period equaled 300,000, and 12,000 shares were issued on March 1.

At the beginning of the quarter, Pubco also had outstanding 120,000 shares of preferred stock paying a dividend of $.10 per share at the end of each quarter and convertible to common stock on a one-to-one basis. Holders of 60,000 shares of preferred stock exercised their conversion privilege on February 1.

The BEPS amount for Pubco’s net income or loss available to common shareholders for the first quarter is

A. $(0.60)
B. $(3.49)
C. $2.89
D. $(0.58)

Answer 28

A. $(0.60)

The weighted-average number of shares used in the BEPS denominator is 344,000 {300,000 + [12,000 × (1 ÷ 3)] + [60,000 × (2 ÷ 3)]}. The numerator equals net income or loss minus preferred dividends. Thus, it equals $(206,000) [$1,000,000 income from continuing operations – $1,200,000 loss on discontinued operations – (60,000 × $0.1) preferred dividends]. The BEPS amount for the net income or loss available to common shareholders is $(0.60) [$(206,000) ÷ 344,000 shares].

Question 29

A state or local government’s reporting includes required supplementary information (RSI) (other than management’s discussion and analysis). Which of the following is not RSI other than MD&A?

A. Budgetary comparison schedules.
B. Information about infrastructure assets reported using the modified approach.
C. Statement of net position.
D. Statistical data.

Answer 29

C. Statement of net position.

RSI other than MD&A is presented in a separate section of the annual comprehensive financial report following the notes to the basic financial statements. RSI other than MD&A includes (1) schedules, (2) statistical data, (3) budgetary comparison schedules, and (4) other information that is an essential part of financial reporting. It should be presented with, but not as a part of, the basic financial statements of a governmental entity. But the government-wide statement of net position (or the proprietary funds statement of net position) is a basic financial statement, not RSI.

Question 30

The following revenues were among those reported by Ariba Township in the current year:

What amount of the foregoing items should be accounted for in Ariba’s governmental funds?

A. $6,040,000
B. $6,140,000
C. $6,000,000
D. $6,100,000

Answer 30

C. $6,000,000

The parking garage is accounted for in an enterprise fund, which is a proprietary fund. Investments held for employees’ retirement benefits are accounted for in a pension (or other employee benefit) trust fund, which is a fiduciary fund. Thus, only the property taxes should be recorded in the governmental funds.