Reading 19: understanding balance sheets

Question 1

Which of the following is most likely an essential characteristic of an asset?
An asset is tangible.
An asset is obtained at a cost.
An asset provides future benefits.

Answer 1

An asset is a future economic benefit obtained or controlled as a result of past transactions. Some assets are intangible (e.g., goodwill), and others may be donated. (Module 19.1, LOS 19.a)

Question 2

Which of the following statements about analyzing the balance sheet is most accurate?
The value of the firm’s reputation is reported on the balance sheet at amortized cost.
Shareholders’ equity is equal to the intrinsic value of the firm.
The balance sheet can be used to measure the firm’s capital structure.

Answer 2

The balance sheet lists the firm’s assets, liabilities, and equity. The capital structure is measured by the mix of debt and equity used to finance the business. (Module 19.2, LOS 19.b)

Question 3

Century’s balance sheet presentation is known as:

a classified balance sheet.
a liquidity-based balance sheet.
an account form balance sheet.

Answer 3

A classified balance sheet groups together similar items (e.g., current and noncurrent assets and liabilities) to arrive at significant subtotals. (Module 19.2, LOS 19.c)

Question 4

Which of the following would most likely result in a current liability?
Possible warranty claims.
Recognizing impairment of PP&E.
Estimated income taxes for the current year.

Answer 4

Estimated income taxes for the current year are likely reported as a current liability. To recognize the warranty expense, it must be probable, not just possible. Recognizing impairment of PP&E does not create a liability. (Module 19.3, LOS 19.d)

Question 5

How should the proceeds received from the advance sale of tickets to a sporting event be treated by the seller, assuming the tickets are nonrefundable?
Unearned revenue is recognized to the extent that costs have been incurred.
Revenue is recognized to the extent that costs have been incurred.
Revenue is deferred until the sporting event is held.

Answer 5

The ticket revenue should not be recognized until it is earned. Even though the tickets are nonrefundable, the seller is still obligated to hold the event. (Module 19.3, LOS 19.e)

Question 6

Which of the following inventory valuation methods is required by the accounting standard-setting bodies?
Lower of cost or net realizable value.
Weighted average cost.
First-in, first-out.

Answer 6

Inventories are required to be valued at the lower of cost or net realizable value (or “market” under U.S. GAAP). FIFO and average cost are two of the inventory cost flow assumptions among which a firm has a choice. (Module 19.3, LOS 19.e)

Question 7

Under IFRS, a firm may report the value of property, plant, and equipment using:
only the cost model.
the cost model or the fair value model.
the cost model or the revaluation model.

Answer 7

IFRS permits either the cost model or the revaluation model for property, plant, and equipment. (Module 19.4, LOS 19.d, 19.e)

Question 8

SF Corporation has created employee goodwill by reorganizing its retirement benefit package. An independent management consultant estimated the value of the goodwill at $2 million. In addition, SF recently purchased a patent that was developed by a competitor. The patent has an estimated useful life of five years. Should SF report the goodwill and patent on its balance sheet?

goodwill patent
yes no
no yes
no no

Answer 8

Goodwill developed internally is expensed as incurred. The purchased patent is reported on the balance sheet. (Module 19.5, LOS 19.e)

Question 9

At the beginning of the year, Parent Company purchased all 500,000 shares of Sub Incorporated for $15 per share. Just before the acquisition date, Sub’s balance sheet reported net assets of $6 million. Parent determined the fair value of Sub’s property and equipment was $1 million higher than reported by Sub. What amount of goodwill should Parent report as a result of its acquisition of Sub?
$0.
$500,000.
$1,500,000.

Answer 9

Purchase price of $7,500,000 [$15 per share × 500,000 shares] – fair value of net assets of $7,000,000 [$6,000,000 book value + $1,000,000 increase in property and equipment] = goodwill of $500,000. (Module 19.5, LOS 19.e)

Question 10

At the beginning of the year, Company P purchased $80,000 face value of Company S corporate bonds for $77,000. Company P intends to hold these bonds for several years but sell them before they mature. At the end of the year, the market value of the bonds was $75,000. What amount should Company P report on its balance sheet at year-end for the investment in Company S bonds?
$75,000
$77,000
$80,000

Answer 10

A Debt securities acquired with the intent to sell before maturity are reported on the balance sheet at their fair values. (Module 19.6, LOS 19.e)

Question 11

Miller Corporation has 160,000 shares of common stock authorized. There are 92,000 shares issued and 84,000 shares outstanding. How many shares of treasury stock does Miller own?
8,000.
68,000.
76,000.

Answer 11

The difference between the issued shares and the outstanding shares is the treasury shares. (LOS 19.f)

Question 12

A vertical common-size balance sheet expresses each category of the balance sheet as a percentage of:
assets.
equity.
revenue.

Answer 12

Each category of the balance sheet is expressed as a percentage of total assets. (LOS 19.g)

Question 13

Which of the following ratios are used to measure a firm’s liquidity and solvency?

liquidity solvency
current ratio quick ratio
debt to equity ratio financial leverage r
cash ratio total debt ratio

Answer 13

The current ratio, quick ratio, and cash ratio measure liquidity. Debt-to-equity, the total debt ratio, and the financial leverage ratio measure solvency. (LOS 19.h)