Practice Exams 7.10.23 Flashcards
A company entered into a loan with a lender for $100,000 and pledged $120,000 of the company’s accounts receivable as collateral. The lender does not have the right to sell or repledge the accounts receivable. When the company receives the cash for the loan proceeds, what entry, if any, should be made to accounts receivable?
A. Credit accounts receivable $100,000.
B. Credit accounts receivable $20,000.
C. No entry is made to accounts receivable.
D. Credit accounts receivable $120,000.
C. No entry is made to accounts receivable.
A pledge is the use of receivables as collateral (security) for a loan. The borrower agrees to use collections of receivables to repay the loan. Only upon default can the lender sell the receivables to recover the loan proceeds. Because a pledge is a relatively informal arrangement, it is not reflected in the accounts.
Three years ago, Jameson Company purchased stock in Zebra, Inc., at a cost of $100,000. This stock was sold for $150,000 during the current fiscal year. The result of this transaction should be shown in the investing activities section of Jameson’s statement of cash flows as
A. $100,000
B. Zero.
C. $50,000
D. $150,000
D. $150,000
The statement of cash flows reports the cash effects of transactions. The accrual-basis gain on the stock is not relevant.
On January 1, Year 1, Evangel Company issued 9% bonds in the face amount of $100,000, which mature in 5 years. The bonds were issued for $96,207 to yield 10%. Evangel uses the effective interest method of amortizing bond discount. Interest is payable annually on December 31. What is the amount of interest expense that should be reported on Evangel’s Year 2 income statement?
A. $9,000
B. $9,559
C. $9,621
D. $9,683
D. $9,683
An amortization schedule for the first 2 years of Evangel’s bonds can be prepared as follows:
During Year 1, Fleet Co.’s trademark was licensed to Hitch Corp. for royalties of 10% of net sales of the trademarked items. Returns were estimated to be 1% of gross sales. On signing the licensing agreement, Hitch paid Fleet $75,000 as an advance against future royalty earnings. Gross sales of the trademarked items during the year were $600,000. What amount should Fleet report as royalty income for Year 1?
A. $54,000
B. $75,000
C. $60,000
D. $59,400
D. $59,400
Revenue for sales-based royalties from licensed intellectual property, such as a trademark, is recognized as the subsequent sales occur. Net sales for Year 1 equal $594,000 [$600,000 gross sales × (100% – 1%)]. Thus, royalty income is $59,400 ($594,000 × 10%). The remainder of the $75,000 advance is reported as deferred revenue. The entry is to debit cash ($75,000), credit earnings ($59,400), and credit deferred revenue ($15,600).
A corporation issuing stock should charge retained earnings for the fair value of the shares issued in a(n)
A. 2-for-1 stock split.
B. Purchase of the net assets of another entity.
C. 10% stock dividend.
D. Employee stock bonus.
C. 10% stock dividend.
A stock dividend in which the number of shares issued is fewer than 20 to 25% of those outstanding should be accounted for by debiting retained earnings for the fair value of the stock and crediting a capital stock account for the par value. Any excess of fair value over the par value is credited to an additional paid-in capital account. Hence, retained earnings decreases, but total equity does not change.
Brill Co. made the following expenditures during Year 1:
What amount of these expenditures should Brill report in its Year 1 income statement as research and development expenses?
A. $0
B. $75,000
C. $175,000
D. $100,000
A. $0
Costs of market research are not R&D costs. Furthermore, general and administrative costs not clearly related to R&D activities are not included as R&D costs. Thus, costs to develop software for the company’s own general management information system are also not R&D costs.
During Year 1, Gum Co. introduced a new product carrying a standard 2-year warranty against defects. The estimated warranty costs related to dollar sales are 2% within 12 months following the sale and 4% in the second 12 months following the sale. Sales and actual warranty expenditures for the years ended December 31, Year 1 and Year 2, are as follows:
What amount should Gum report as estimated warranty liability in its December 31, Year 2, balance sheet?
A. $2,500
B. $14,250
C. $11,250
D. $3,250
B. $14,250
A standard warranty against manufacturing defects is an assurance-type warranty. This warranty creates a loss contingency. A liability for warranty costs is recognized on the date the product is sold. Because this product is new, the beginning balance in the estimated warranty liability account at the beginning of Year 1 is $0. For Year 1, the estimated warranty costs related to dollar sales are 6% (2% + 4%) of sales, or $9,000 ($150,000 × 6%). For Year 2, the estimated warranty costs are $15,000 ($250,000 × 6%). These amounts are charged to warranty expense and credited to the estimated warranty liability account. This liability account is debited for expenditures of $2,250 and $7,500 in Year 1 and Year 2, respectively. Hence, the estimated warranty liability at 12/31/Year 2 is $14,250.
A seller-lessee and a buyer-lessor entered into a sale and leaseback transaction. The leaseback is classified as an operating lease, and the initial transfer meets the requirements for recognition of revenue from customers. When the transaction is not at fair value or based on market terms,
A. The seller-lessee recognizes a financial liability if the selling price exceeds the fair value of the asset.
B. The gain or loss on the initial transfer of the asset recognized by the seller-lessee is the difference between the selling price and the carrying amount of the asset.
C. The buyer-lessor recognizes interest income over the lease term if the selling price is lower than the fair value of the asset.
D. The initial transfer of the asset is not recognized as a sale by the parties.
A. The seller-lessee recognizes a financial liability if the selling price exceeds the fair value of the asset.
If the leaseback is classified as an operating lease, the initial transfer of the asset to the buyer-lessor can be accounted for as a sale of an asset if all the criteria for revenue recognition are met. When the sale and leaseback transaction is not at fair value or based on market terms, off-market adjustments are needed to recognize the sale at fair value. When the selling price of an asset (or leaseback payment) is greater than fair value (or market value), the difference is essentially additional financing received from the buyer-lessor. This additional financing should be accounted for separately from the lease liability. A financial liability is recognized by the seller-lessee for the off-market adjustment (e.g., the excess of the selling price of an asset over its fair value).
Certain balance sheet accounts of a foreign subsidiary of Rowan, Inc., at December 31, have been translated into U.S. dollars as follows:
The subsidiary’s functional currency is the currency of the country in which it is located. What total amount should be included in Rowan’s December 31 consolidated balance sheet for the above accounts?
A. $455,000
B. $495,000
C. $475,000
D. $450,000
C. $475,000
When the currency used to prepare a foreign entity’s financial statements is its functional currency, the current-rate method is used to translate the foreign entity’s financial statements into the reporting currency. This method applies the current exchange rate at the balance sheet date to assets and liabilities and historical rates to shareholders’ equity. The translation gains and losses arising from applying this method are reported in other comprehensive income in the consolidated statements and are not reflected in earnings. Because Rowan’s listed assets should be translated at current rates, $475,000 is the total amount that should be included in the consolidated balance sheet.
On January 2, Well Co. purchased 10% of Rea, Inc.’s outstanding common shares for $400,000, which equaled the carrying amount and the fair value of the interest purchased in Rea’s net assets. Well did not elect the fair value option. Because Well is the largest single shareholder in Rea, and Well’s officers are a majority on Rea’s board of directors, Well exercises significant influence over Rea. Rea reported net income of $500,000 for the year and paid dividends of $150,000. In its December 31 balance sheet, what amount should Well report as investment in Rea?
A. $400,000
B. $435,000
C. $450,000
D. $385,000
B. $435,000
The equity method should be used because Well Co. exercises significant influence over Rea. The investment in Rea equals $435,000 [$400,000 investment + ($500,000 net income × 10%) – ($150,000 of dividends × 10%)].
Albright Company uses the sum-of-the-years’-digits (SYD) method of depreciation. On January 1, the company purchased a machine for $50,000. It had an estimated life of 5 years and no residual value. Depreciation for the first year would b
A. $15,000
B. $10,000
C. $20,000
D. $16,667
D. $16,667
The SYD method multiplies a constant depreciable base (cost minus residual value) by a declining fraction. The numerator is the number of years of the useful life minus the years elapsed (5 – 0 = 5). The denominator is the sum of the digits of the years in the asset’s useful life (1 + 2 + 3 + 4 + 5). The first year’s depreciation expense is therefore $16,667 [$50,000 × (5 ÷ 15)].
Hunt Co. purchased merchandise for 300,000 British pounds from a vendor in London on November 30, Year 4. Payment in British pounds was due on January 30, Year 5. The exchange rates to purchase one pound were as follows:
In its December 31, Year 4, income statement, what amount should Hunt report as foreign currency transaction gain?
A. $12,000
B. $9,000
C. $0
D. $6,000
B. $9,000
Gains and losses from fluctuations in the exchange rate are ordinarily reflected in income when the rate changes. The foreign currency transaction gain is the difference between the spot rate on the date the transaction originates and the spot rate at year-end. Thus, the gain for Hunt Co. is $9,000 [300,000 British pounds × ($1.65 – $1.62)].
When Rolan County adopted its budget for the year ending June 30, Year 1, $20 million was recorded for estimated revenues control. Actual revenues for the year ended June 30, Year 1, amounted to $17 million. In closing the budgetary accounts at June 30, Year 1,
A. Estimated revenues control should be credited for $20 million.
B. Revenues control should be credited for $20 million.
C. Revenues control should be debited for $3 million.
D. Estimated revenues control should be debited for $3 million.
A. Estimated revenues control should be credited for $20 million.
Estimated revenues control is an anticipatory asset recognized by a debit upon the adoption of the budget. Revenues control is a nominal account in which revenues are credited when they meet the recognition criteria. At year end, both accounts are closed. Because no other entries are made to estimated revenues control, the closing entry credits the account for the initial amount.
Pine Corp.’s books showed pretax income of $800,000 for the year ended December 31. In the computation of federal income taxes, the following data were considered:
What amount should Pine report as its current federal income tax liability on its December 31 balance sheet?
A. $120,000
B. $65,000
C. $135,000
D. $50,000
D. $50,000
Current income tax expense equals taxable income times the enacted tax rate. Taxable income equals pretax accounting income adjusted for the items that are treated differently on the tax return and in the accounting records.
Because $70,000 has already been paid to the federal government in the form of estimated tax payments, the current federal income tax liability is $50,000 ($120,000 current income tax expense – $70,000 estimated tax payments).
On October 1, Year 1, Fleur Retailers signed a 4-month, 16% note payable to finance the purchase of holiday merchandise. At that date, there was no direct method of pricing the merchandise, and the note’s market rate of interest was 11%. Fleur recorded the purchase at the note’s face amount. All of the merchandise was sold by December 1, Year 1. Fleur’s Year 1 financial statements reported interest payable and interest expense on the note for 3 months at 16%. All amounts due on the note were paid February 1, Year 2. Fleur’s Year 1 cost of goods sold for the holiday merchandise was
A. Understated by the difference between the note’s face amount and the note’s October 1, Year 1, present value plus 16% interest for 2 months.
B. Overstated by the difference between the note’s face amount and the note’s October 1, Year 1, present value.
C. Overstated by the difference between the note’s face amount and the note’s October 1, Year 1, present value plus 11% interest for 2 months.
D. Understated by the difference between the note’s face amount and the note’s October 1, Year 1, present value.
D. Understated by the difference between the note’s face amount and the note’s October 1, Year 1, present value.
The general presumption when a note is exchanged for property, goods, or services in an arm’s-length transaction is that the rate of interest is fair and adequate. If the rate is not stated or the stated rate is unreasonable, the note and the property, goods, or services should be recorded at the fair value of the property, goods, or services or the market value of the note, whichever is more clearly determinable. In the absence of these values, the present value of the note should be used as the basis for recording both the note and the property, goods, or services. This present value is obtained by discounting all future payments on the note using an imputed rate of interest. If the market rate is the imputed rate, the note (and the purchase) will be recorded at a premium because the imputed rate (11%) is less than the nominal rate (16%). The face amount is the present value at the nominal rate. The face amount plus a premium is the present value at the (lower) market rate. Thus, recording the note and purchase at the face amount of the note understates the cost of the inventory sold.
Foley Co. is preparing the electronic spreadsheet below to amortize the discount on its 10-year, 6%, $100,000 bonds payable. Bonds were issued on December 31 to yield 8%. Interest is paid annually. Foley uses the effective interest method to amortize bond discounts.
Which formula should Foley use in cell E3 to calculate the bonds’ carrying amount at the end of Year 2?
A. E2 + D3.
B. E2 + C3.
C. E2 – D3.
D. E2 – C3.
A. E2 + D3.
Bond discount amortization equals the excess of interest expense (C3) (carrying amount × effective interest rate) over the nominal interest paid (B3). Discount amortization for Year 2 (D3) increases the carrying amount of the bond (E2). The amount of amortization is $926 [($86,580 × 8%) – $6,000 paid].
On December 31, Year 1, a building owned by Pine Corp. was totally destroyed by fire. The building had fire insurance coverage up to $500,000. Other pertinent information as of December 31, Year 1, follows:
During January Year 2, before the Year 1 financial statements were issued, Pine received insurance proceeds of $500,000. On what amount should Pine base the determination of its loss on involuntary conversion?
A. $520,000
B. $530,000
C. $550,000
D. $560,000
B. $530,000
Gain or loss must be recognized on an involuntary conversion. For Pine Corp. the determination of the loss on involuntary conversion is based on the $520,000 carrying amount of the building plus the $10,000 of removal and cleanup costs, a total of $530,000. Given $500,000 of insurance proceeds, Pine Corp. should recognize a loss of $30,000 on this involuntary conversion.
A nongovernmental not-for-profit entity discovered that equipment purchased on January 1, Year 1, for $650,000 was incorrectly expensed instead of capitalized. The equipment should have been depreciated (straight-line method) over 5 years with no salvage value. What amount should be recorded as equipment at January 1, Year 5, when the error was discovered?
A. $0
B. $520,000
C. $650,000
D. $130,000
C. $650,000
Any error related to a prior period discovered after the statements are available to be used must be reported as an error correction by restating the prior period statements. The carrying amounts of (1) assets, (2) liabilities, and (3) net assets at the beginning of the first period reported are restated for the cumulative effect of the error on the prior periods. Corrections of prior period errors must not be included in the change in net assets from operations for the current year. Equipment should be debited and unrestricted net assets should be credited for $650,000 for the purchase of the equipment. Also, accumulated depreciation should be credited and net assets without donor restrictions should be debited for $520,000 [($650,000 ÷ 5 years) × 4 years], the total accumulated depreciation that should have been recorded for Years 1 through 4.
Invern, Inc., has a self-insurance plan. Each year, retained earnings is appropriated for contingencies in an amount equal to insurance premiums saved less recognized losses from lawsuits and other claims. As a result of a Year 4 accident, Invern is a defendant in a lawsuit in which it will probably have to pay damages of $190,000. What are the effects of this lawsuit’s probable outcome on Invern’s Year 4 financial statements?
A. An increase in both expenses and liabilities.
B. An increase in expenses and no effect on liabilities.
C. No effect on expenses and an increase in liabilities.
D. No effect on either expenses or liabilities.
A. An increase in both expenses and liabilities.
A loss contingency is an existing condition, situation, or set of circumstances involving uncertainty as to the impairment of an asset’s value or the incurrence of a liability as of the balance sheet date. Resolution of the uncertainty depends on the occurrence or nonoccurence of one or more future events. A loss should be debited and either an asset valuation allowance or a liability credited when the loss contingency is both probable and reasonably estimable. Thus, the company should accrue a loss and a liability.
In Year 2, Ajax, Inc., reported taxable income of $400,000 and pretax financial statement income of $300,000. The difference resulted from $60,000 of nondeductible premiums on Ajax’s officers’ life insurance and $40,000 of rental income received in advance. Rental income is taxable when received. Ajax’s effective tax rate is 30%. In its Year 2 income statement, what amount should Ajax report as income tax expense – current portion?
A. $102,000
B. $90,000
C. $120,000
D. $108,000
C. $120,000
Current income tax expense or benefit is the amount of taxes paid or payable (or refundable) for the year based on enacted tax law applied to taxable income (or excess of deductions over revenues). Thus, current income tax expense is $120,000 ($400,000 × 30%).
The following information pertains to property taxes levied by Oak City for calendar Year 6:
What amount should Oak report for Year 6 net property tax revenues?
A. $700,000
B. $690,000
C. $600,000
D. $500,000
C. $600,000
Property taxes are recognized in the period for which they are levied if the availability criterion is met. (Property taxes generally are accounted for in governmental funds, which use the modified accrual basis.) For property tax purposes, “available” means collected within the current period or expected to be collected soon enough thereafter to be used to pay current liabilities. Moreover, “soon enough thereafter” means within 60 days. Accordingly, the $500,000 of Year 6 collections plus the $100,000 expected to be collected in the first 60 days of Year 7 are recognized as Year 6 property tax revenue.
Martin Corporation has the following data related to its operating segments.
Based on the revenue criterion only, which of Martin’s segments is (are) reportable?
A. Segments A and D only.
B. Segments A, B, C, D, and E.
C. Segment E only.
D. Segments A, B, D, and E only.
D. Segments A, B, D, and E only.
An operating segment of a business is considered reportable if its reported revenue, including sales to external customers and intersegment sales or transfers, is at least 10% of the combined revenue of all operating segments.
Accordingly, only Segment C is not reportable based on the revenue criterion.
Program revenues reported in the government-wide statement of activities do not include
A. Program-specific capital grants and contributions.
B. Charges for services.
C. All taxes.
D. Program-specific operating grants and contributions.
C. All taxes.
Components of program revenues on the statement of activities include (1) charges for services, (2) program-specific operating grants and contributions, and (3) program-specific capital grants and contributions. General revenues are not required to be reported as program revenues. They are reported separately after total net (expense) revenue for all functions. All taxes, including those levied for a special purpose, are general revenues. General revenues are reported at the bottom of the statement of activities to determine the change in net position for the period.
Fact Pattern:
Selected information from the separate and consolidated balance sheets and income statements of Mussel, Inc., and its subsidiary, Shel Co., as of December 31, Year 4, and for the year then ended, is presented below.
Additional information:
During Year 4, Mussel sold goods to Shel at the same markup on cost that Mussel uses for all sales.
At December 31, Year 4, what was the amount of Shel’s payable to Mussel for intraentity sales?
A. $64,000
B. $6,000
C. $58,000
D. $12,000
D. $12,000
In a consolidated balance sheet, reciprocal balances, such as receivables and payables, between a parent and a consolidated subsidiary are eliminated in their entirety. Given that $12,000 ($52,000 Mussel A/R + $38,000 Shel A/R – $78,000 consolidated A/R) of accounts receivable was eliminated, $12,000 of accounts payable on Shel’s books also must have been eliminated.
Cyan Corp. issued 20,000 shares of $5 par common stock at $10 per share. On December 31, Year 3, Cyan’s retained earnings were $300,000. In March Year 4, Cyan reacquired 5,000 shares of its common stock at $20 per share. In June Year 4, Cyan sold 1,000 of these shares to its corporate officers for $25 per share. Cyan uses the cost method to record treasury stock. Net income for the year ended December 31, Year 4 was $60,000. At December 31, Year 4, what amount should Cyan report as retained earnings?
A. $365,000
B. $380,000
C. $375,000
D. $360,000
D. $360,000
Under the cost method, the treasury stock account should be debited for the purchase price. When this stock is subsequently reissued for an amount greater than the acquisition cost, the excess should be credited to additional paid-in capital, not the retained earnings account. Thus, retained earnings is $360,000 ($300,000 + $60,000).
A transaction was reported as a nonmonetary exchange of assets. Under which of the following circumstances should the exchange be measured based on the reported amount of the nonmonetary asset surrendered?
A. When the entity’s future cash flows are expected to change as a result of the exchange.
B. When the transaction lacks commercial substance.
C. When the timing of future cash flows of the asset received differs significantly from the configuration of the future cash flows of the asset transferred.
D. When the transaction has commercial substance.
B. When the transaction lacks commercial substance.
When the exchange lacks commercial substance because it is not expected to change the entity’s cash flows significantly, the accounting for a nonmonetary exchange is based on the carrying amount of the assets given up.
The following information was obtained from Smith Co.:
Smith’s gross margin is 20%. What amount represents Smith purchases?
A. $208,000
B. $202,000
C. $232,000
D. $220,000
A. $208,000
Gross margin equals sales minus cost of goods sold. If it is 20% of sales, cost of goods sold equals $220,000 [$275,000 × (1.0 – .20)]. Cost of goods sold equals beginning inventory, plus purchases, minus ending inventory. Thus, purchases equals $208,000 ($220,000 COGS – $30,000 BI + $18,000 EI).
On January 1, Year 1, a company has capitalized software costs of $1,200,000 related to software that it intends to begin selling in Year 1. The company estimates that the software has an economic life of 4 years and will generate $3,000,000 of sales and leasing revenue over the next 4 years. In Year 1, the company earned $1,000,000 in sales and leasing revenue related to the software. What amount of expense should be recognized from amortizing the software costs for the year ended December 31, Year 1?
A. $400,000
B. $350,000
C. $300,000
D. $1,200,000
A. $400,000
For computer software sold to external customers, the amortization of capitalized software costs is the greater of (1) total capitalized cost times the revenue ratio (annual gross software revenue ÷ total projected gross revenue) of $400,000 [$1,200,000 × ($1,000,000 ÷ $3,000,000)], or (2) straight-line amortization of $300,000 ($1,200,000 ÷ 4 years). Thus, the amortization expense reported for the year ended December 31, Year 1, is $400,000.
On January 2 of the current year, Peace Co. paid $310,000 to purchase 75% of the voting shares of Surge Co. Surge held no shares in Peace. Peace reported retained earnings of $80,000, and Surge reported contributed capital of $300,000 and retained earnings of $100,000. The purchase differential was attributed to depreciable assets with a remaining useful life of 10 years. Peace used the equity method in accounting for its investment in Surge. Surge reported net income of $20,000 and paid dividends of $8,000 during the current year. Peace reported income, exclusive of its income from Surge, of $30,000 and paid dividends of $15,000 during the current year. What amount will Peace report as dividends declared and paid in its current year’s consolidated statement of changes in equity?
A. $15,000
B. $23,000
C. $17,000
D. $8,000
C. $17,000
Peace acquired a greater than 50% share of the voting interests in Surge. Accordingly, Peace must consolidate Surge unless it does not have control. Moreover, the equity method is not appropriate except in parent-only statements. The consolidated statements should report only dividends paid to parties outside the consolidated entity. Because Peace acquired only 75% of the voting shares of Surge, a 25% noncontrolling interest exists. Thus, 25% of Surge’s dividends were paid to parties outside the consolidated entity. Furthermore, all of Peace’s dividends were paid to parties outside of the consolidated entity. Accordingly, consolidated dividends paid are calculated as follows:
A local government’s utility sells part of its output to the primary government. The utility is accounted for in an enterprise fund. In the comprehensive annual financial report, the sale of the utility’s output most likely is accounted for as
A. An interfund transfer.
B. Expenditures in the general fund.
C. An elimination in the government-wide statement of activities.
D. Interfund receivables and payables in the government-wide statement of net position.
B. Expenditures in the general fund.
Interfund services provided and used are sales and purchases of goods and services between funds for a price approximating external exchange value. They should be reported as revenues in seller funds and expenditures or expenses in purchaser funds. Unpaid amounts should be reported as interfund receivables and payables in the fund statements. Thus, the enterprise fund (seller) reports revenues and the general fund (a governmental fund purchaser using the modified accrual basis of accounting) reports expenditures.
On December 1, Boyd Co. purchased a $400,000 tract of land for a factory site. Boyd razed an old building on the property and sold the materials it salvaged from the demolition. Boyd incurred additional costs and realized salvage proceeds during December as follows:
In its December 31 balance sheet, Boyd should report a balance in the land account of
A. $442,000
B. $464,000
C. $460,000
D. $422,000
B. $464,000
When land is acquired as a factory site, the cost of the land should include the purchase price of the land and such additional expenses as legal fees, title insurance, recording fees, subsequent assumption of encumbrances on the property, and the costs incurred in preparing the property for its intended use. Because the land was purchased as a factory site, the cost of razing the old building, minus any proceeds received from the sale of salvaged materials, should be capitalized as part of the land account. Thus, the amount to be reported as land is $464,000 ($400,000 + $10,000 + $12,000 + $50,000 – $8,000).
The UNO Company was formed on January 2, Year 1, to sell a single product. Over a 2-year period, UNO’s costs increased steadily. Inventory quantities equaled 3 months’ sales at December 31, Year 1, and zero at December 31, Year 2. Assuming the periodic system and no accounting changes, the inventory cost method that reports the highest amount for each of the following is
D. FIFO FIFO
In a period of rising prices, FIFO inventory is higher than LIFO inventory. FIFO assumes that the latest and therefore the highest priced goods purchased are in inventory. But LIFO assumes that these goods were the first to be sold. Accordingly, the inventory at December 31, Year 1 (beginning inventory for Year 2), is higher for FIFO than LIFO. Given zero inventory at December 31, Year 2, the units sold in Year 2 must have equaled the sum of Year 2 purchases and beginning inventory. Because beginning inventory for Year 2 is reported at a higher amount under FIFO than LIFO, the result is a higher cost of goods sold under FIFO.
At the beginning of the current year, Paxx County’s enterprise fund had a $125,000 balance for accrued compensated absences. At the end of the year, the balance was $150,000. During the year, Paxx paid $400,000 for compensated absences. What amount of compensated absences expense should Paxx County’s enterprise fund report for the year?
A. $425,000
B. $400,000
C. $550,000
D. $375,000
A. $425,000
Enterprise funds use the accrual method of accounting. Thus, the expense is calculated using the same method used for business entities. The entity paid $400,000 for compensated absences, and the balance for accrued compensated absences (a liability) increased by $25,000. Accordingly, it must report an expense for compensated absences of $425,000.
Ace Corp. entered into a troubled debt restructuring agreement with National Bank. National agreed to accept land with a carrying amount of $75,000 and a fair value of $100,000 in exchange for a note with a carrying amount and fair value of $150,000. Disregarding income taxes, what amount should Ace report as a gain in its income statement?
A. $25,000
B. $75,000
C. $50,000
D. $0
B. $75,000
The debtor must recognize a gain as a result of the extinguishment of debt because the carrying amount of the debt is greater than the carrying amount of the asset given. Accordingly, Ace should recognize a total gain of $75,000 equal to the sum of (1) the $25,000 gain on appreciation of the land recognized on its disposal ($100,000 fair value –$75,000 carrying amount) and (2) the $50,000 gain on restructuring for the excess of the carrying amount of the debt over the fair value of the land ($150,000 – $100,000).
During the current year, Ace Co. amortized a bond discount. Ace prepares its statement of cash flows using the indirect method. In which section of the statement should Ace report the amortization of the bond discount?
A. Financing activities.
B. Supplemental disclosures.
C. Operating activities.
D. Investing activities.
C. Operating activities.
The indirect method reconciles the net income of a business with the net operating cash flow. The indirect method removes the effects of (1) all deferrals of past operating cash receipts and payments, (2) all accruals of estimated future operating cash receipts and payments, and (3) all items not affecting operating cash flows to arrive at the net cash flow from operating activities. Hence, the amortization of the discount on bonds payable is added to net income in the reconciliation because it represents a noncash increase in interest expense (a decrease in net income).
The reporting entity may elect the fair value option (FVO) for
A. An interest in a variable interest entity (VIE) if the reporting entity is the primary beneficiary.
B. Most financial assets and liabilities.
C. Its obligation for pension and other postretirement employee benefits.
D. An investment consisting of more than 50% of the outstanding voting interests of another entity.
B. Most financial assets and liabilities.
An entity may elect the FVO for most recognized financial assets and liabilities.
During Year 2, Pipp Co. incurred the following costs to develop and produce a routine, low-risk computer software product:
In Pipp’s December 31, Year 2, balance sheet, what amount should be capitalized as software cost?
A. $10,000
B. $59,000
C. $44,000
D. $25,000
C. $44,000
Accounting for the costs of developing or obtaining computer software depends on whether the software is (1) sold to external customers or (2) used internally. The costs of software to be marketed may be expensed as incurred, capitalized as computer software costs, or included in inventory. For computer software products (intended to be sold to external customers), costs incurred before technological feasibility is established (coding, testing, etc.) are expensed as incurred. Costs incurred after technological feasibility is established are capitalized as computer software costs. Technological feasibility is established when either a detailed program design is complete or the entity has created a working model. Costs incurred to prepare the product for sale (duplication of software, training materials, packaging) are capitalized as inventory. Costs for coding and testing and for the completion of detailed program design are incurred before technological feasibility is established. They should thus be expensed as incurred. The other coding and testing costs ($44,000) after establishing technological feasibility, but not for preparing the product for sale, should be capitalized as computer software costs.
Lorraine Co. has determined its fiscal year-end inventory on a LIFO basis to be $400,000. Information pertaining to that inventory follows:
Lorraine records losses that result from applying the lower-of-cost-or-market (LCM) rule. At its year end, what should be the net carrying value of Lorraine’s inventory?
A. $388,000
B. $360,000
C. $328,000
D. $400,000
B. $360,000
Inventory accounted for using LIFO or the retail inventory method is measured at the lower of cost or market. Under the LCM method, market is current replacement cost subject to a maximum (ceiling) equal to net realizable value and a minimum (floor) equal to net realizable value minus a normal profit. NRV equals selling price minus costs of completion and disposal. Here, original cost is $400,000 and replacement cost is $360,000. The LCM method uses the lower of the two, $360,000, to measure inventory. However, the inventory measure cannot exceed the NRV of $388,000 ($408,000 selling price – $20,000 cost of disposal). Furthermore, the inventory carrying amount cannot be lower than NRV minus normal profit, or $328,000 ($388,000 NRV – $60,000 normal profit). Because the lower of cost or market ($360,000) is between $388,000 (ceiling) and $328,000 (floor), the net carrying amount is $360,000.
Linden Corporation is a defendant in a lawsuit in which the plaintiff is seeking $1,000,000 in damages. The company had terminated the plaintiff, George Russell, from his position with Linden after Russell allegedly sold specifications for one of Linden’s new products to a competitor. Linden’s attorney believes that it is quite possible Linden will lose the case and that, if so, damages could range from $100,000 to $200,000.
Regardless of the outcome of the case, Linden’s accountants estimate the company will incur an additional $5,000 in unemployment costs because of Russell’s termination. The amount that Linden should accrue because of the contingency in this situation is
A. $5,000
B. $100,000
C. $0
D. $200,000
C. $0
Loss contingencies are accrued when the loss is probable. The $5,000 in unemployment costs that will probably be incurred are a routine cost of doing business.
