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Gleim 2015 | Part 1 | Online MCQs | Unit 001

A primary objective of external financial reporting is

A. Direct measurement of the value of a business enterprise.


B. Provision of information that is useful to present and potential investors,
creditors, and others in making rational financial decisions regarding the
enterprise.
Answer (B) is correct.
According to the FASBs Conceptual Framework, the objectives of
external financial reporting are to provide information that (1) is useful to
present and potential investors, creditors, and others in making rational
financial decisions regarding the enterprise; (2) helps those parties in
assessing the amounts, timing, and uncertainty of prospective cash
receipts from dividends or interest and the proceeds from sale,
redemption, or maturity of securities or loans; and (3) concerns the
economic resources of an enterprise, the claims thereto, and the effects of
transactions, events, and circumstances that change its resources and
claims thereto.
C. Establishment of rules for accruing liabilities.
D. Direct measurement of the enterprises stock price.

Question: 2

Notes to financial statements are beneficial in meeting the disclosure requirements of


financial reporting. The notes should not be used to

A. Describe significant accounting policies.


B. Describe depreciation methods employed by the company.
C. Describe principles and methods peculiar to the industry in which the
company operates, when these principles and methods are predominantly
followed in that industry.
D. Correct an improper presentation in the financial statements.
Answer (D) is correct.
Financial statement notes should not be used to correct improper
presentations. The financial statements should be presented correctly on
their own. Notes should be used to explain the methods used to prepare
the financial statements and the amounts shown. The first footnote
typically describes significant accounting policies.

Question: 3

An objective of financial reporting is

A. Providing information useful to investors, creditors, donors, and other users


for decision making.
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Answer (A) is correct.
The objective is to report financial information that is useful in making
decisions about providing resources to the reporting entity. Primary users
of financial information are current or prospective investors and creditors
who cannot obtain it directly. Their decisions depend on expected
returns.
B. Assessing the adequacy of internal control.
C. Evaluating management results compared with standards.
D. Providing information on compliance with established procedures.

Question: 4

The management of ABC Corporation is analyzing the financial statements of XYZ


Corporation because ABC is strongly considering purchasing a block of XYZ ordinary
shares that would give ABC significant influence over XYZ. Which financial statement
should ABC primarily use to assess the amounts, timing, and certainty of future cash flows
of XYZ Company?

A. Income statement.
B. Statement of changes in equity.
C. Statement of cash flows.
Answer (C) is correct.
A statement of cash flows provides information about the cash receipts
and cash payments of an entity during a period. This information helps
investors, creditors, and other users to assess the entitys ability to
generate cash and cash equivalents and the needs of the entity to use
those cash flows. Historical cash flow data indicate the amount, timing,
and certainty of future cash flows. It is also a means of verifying past
cash flow assessments and of determining the relationship between
profits and net cash flows and the effects of changing prices.
D. Statement of financial position.

Question: 5

An entity that sprays chemicals in residences to eliminate or prevent infestation of insects


requires that customers prepay for 3 months service at the beginning of each new quarter.
Select the term that appropriately describes this situation from the viewpoint of the entity.

A. Deferred income.
Answer (A) is correct.
The future inflow of economic benefits is not sufficiently certain given
that the entity has not done what is required to be entitled to those
benefits. Thus, the receipt of cash in anticipation of goods to be delivered
or services to be performed must be recognized as a liability, usually
called deferred (or unearned) revenue or deferred (or unearned) income.
B. Earned income.
C. Accrued income.
D. Prepaid expense.

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Question: 6

Which of the following is true regarding the comparison of managerial and financial
accounting?

A. Managerial accounting is generally more precise.


B. Managerial accounting has a past focus, and financial accounting has a
future focus.
C. The emphasis on managerial accounting is relevance, and the emphasis on
financial accounting is timeliness.
D. Managerial accounting need not follow generally accepted accounting
principles (GAAP), while financial accounting must follow them.
Answer (D) is correct.
Managerial accounting assists management decision making, planning,
and control. Financial accounting addresses accounting for an entitys
assets, liabilities, revenues, expenses, and other elements of financial
statements. Financial statements are the primary method of
communicating to external parties information about the entitys results
of operations, financial position, and cash flows. For general-purpose
financial statements to be useful to external parties, they must be
prepared in conformity with accounting principles that are generally
accepted in the United States. However, managerial accounting
information is primarily directed to specific internal users. Hence, it
ordinarily need not follow such guidance.

Question: 7

The financial statements included in the annual report to the shareholders are least useful
to which one of the following?

A.
B.
C.
D.

Stockbrokers.
Bankers preparing to lend money.
Competing businesses.
Managers in charge of operating activities.
Answer (D) is correct.
Accrual-basis amounts used in financial reporting are not useful to
managers making day-to-day operating decisions. The practice of
management accounting fulfills the needs of these users.

Question: 8

The accounting measurement that is not consistent with the going concern concept is

A.
B.
C.
D.

Historical cost.
Realization.
The transaction approach.
Liquidation value.
Answer (D) is correct.
Financial accounting principles assume that a business entity is a going
concern in the absence of evidence to the contrary. The concept justifies
the use of depreciation and amortization schedules, and the recording of

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assets and liabilities using attributes other than liquidation value.

Question: 9

The primary purpose of the statement of financial position is to reflect

A.
B.
C.
D.

The fair value of the firms assets at some moment in time.


The status of the firms assets in case of forced liquidation of the firm.
The success of a companys operations for a given amount of time.
Items of value, debt, and net worth.
Answer (D) is correct.
The balance sheet presents three major financial accounting elements:
assets (items of value), liabilities (debts), and equity (net worth).
According to the FASBs Conceptual Framework, assets are probable
future economic benefits resulting from past transactions or events.
Liabilities are probable future sacrifices of economic benefits arising
from present obligations as a result of past transactions or events. Equity
is the residual interest in the assets after deduction of liabilities.

Question: 10

Prepaid expenses are valued on the statement of financial position at the

A.
B.
C.
D.

Cost to acquire the asset.


Face amount collectible at maturity.
Cost to acquire minus accumulated amortization.
Cost less expired or used portion.
Answer (D) is correct.
Prepaid expenses, such as supplies, prepaid rent, and prepaid insurance,
are reported on the balance sheet at cost minus the expired or used
portion. These are typically current assets.

Question: 11

A statement of financial position allows investors to assess all of the following except the

A.
B.
C.
D.

Efficiency with which enterprise assets are used.


Liquidity and financial flexibility of the enterprise.
Capital structure of the enterprise.
Net realizable value of enterprise assets.
Answer (D) is correct.
Assets are usually measured at original historical cost in a statement of
financial position, although some exceptions exist. For example, some
short-term receivables are reported at their net realizable value. Thus, the
statement of financial position cannot be relied upon to assess NRV.

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Question: 12

The accounting equation (assets liabilities = equity) reflects the

A. Entity point of view.


B. Fund theory.
C. Proprietary point of view.
Answer (C) is correct.
The equation is based on the proprietary theory. Equity in an enterprise is
what remains after the economic obligations of the enterprise are
deducted from its economic resources.
D. Enterprise theory.

Question: 13

Long-term obligations that are or will become callable by the creditor because of the
debtors violation of a provision of the debt agreement at the balance sheet date should be
classified as

A. Long-term liabilities.
B. Current liabilities unless the debtor goes bankrupt.
C. Current liabilities unless the creditor has waived the right to demand
repayment for more than 1 year from the balance sheet date.
Answer (C) is correct.
Long-term obligations that are or will become callable by the creditor
because of the debtors violation of a provision of the debt agreement at
the balance sheet date normally are classified as current liabilities.
However, the debt need not be reclassified if the violation will be cured
within a specified grace period or if the creditor formally waives or
subsequently loses the right to demand repayment for a period of more
than a year from the balance sheet date (also, reclassification is not
required if the debtor expects and has the ability to refinance the
obligation on a long-term basis).
D. Contingent liabilities until the violation is corrected.

Question: 14

When classifying assets as current and noncurrent for reporting purposes,

A. The amounts at which current assets are carried and reported must reflect
realizable cash values.
B. Prepayments for items such as insurance or rent are included in an other
assets group rather than as current assets as they will ultimately be
expensed.
C. The time period by which current assets are distinguished from noncurrent
assets is determined by the seasonal nature of the business.
D. Assets are classified as current if they are reasonably expected to be
realized in cash or consumed during the normal operating cycle.
Answer (D) is correct.

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For financial reporting purposes, current assets consist of cash and other
assets or resources expected to be realized in cash, sold, or consumed
during the longer of 1 year or the normal operating cycle of the business.

Question: 15

Abernathy Corporation uses a calendar year for financial and tax reporting purposes and
has $100 million of mortgage bonds due on January 15, Year 2. By January 10, Year 2,
Abernathy intends to refinance this debt with new long-term mortgage bonds and has
entered into a financing agreement that clearly demonstrates its ability to consummate the
refinancing. This debt is to be

A. Classified as a current liability on the statement of financial position at


December 31, Year 1.
B. Classified as a long-term liability on the statement of financial position at
December 31, Year 1.
Answer (B) is correct.
Short-term obligations expected to be refinanced should be reported as
current liabilities unless the firm both plans to refinance and has the
ability to refinance the debt on a long-term basis. The ability to refinance
on a long-term basis is evidenced by a post-balance-sheet date issuance
of long-term debt or a financing arrangement that will clearly permit
long-term refinancing.
C. Retired as of December 31, Year 1.
D. Considered off-balance-sheet debt.

Question: 16

Lister Company intends to refinance a portion of its short-term debt in Year 2 and is
negotiating a long-term financing agreement with a local bank. This agreement would be
noncancelable and would extend for a period of 2 years. The amount of short-term debt that
Lister Company can exclude from its statement of financial position at December 31,
Year 1,

A. May exceed the amount available for refinancing under the agreement.
B. Depends on the demonstrated ability to consummate the refinancing.
Answer (B) is correct.
If an enterprise intends to refinance short-term obligations on a long-term
basis and demonstrates an ability to consummate the refinancing, the
obligations should be excluded from current liabilities and classified as
noncurrent. The ability to consummate the refinancing may be
demonstrated by a post-balance-sheet-date issuance of a long-term
obligation or equity securities, or by entering into a financing agreement
that meets certain criteria. These criteria are that the agreement does not
expire within 1 year, it is noncancelable by the lender, no violation of the
agreement exists at the balance sheet date, and the lender is financially
capable of honoring the agreement.
C. Is reduced by the proportionate change in the working capital ratio.
D. Is zero unless the refinancing has occurred by year end.

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Question: 17

A statement of financial position is intended to help investors and creditors

A. Assess the amount, timing, and uncertainty of prospective net cash inflows
of a firm.
B. Evaluate economic resources and obligations of a firm.
Answer (B) is correct.
The statement of financial position, or balance sheet, provides
information about an entitys resource structure (assets) and financing
structure (liabilities and equity) at a moment in time. According to the
FASBs Conceptual Framework, the statement of financial position does
not purport to show the value of a business, but it enables investors,
creditors, and other users to make their own estimates of value. It helps
users to assess liquidity, financial flexibility, profitability, and risk.
C. Evaluate economic performance of a firm.
D. Evaluate changes in the ownership equity of a firm.

Question: 18

A manufacturer receives an advance payment for special-order goods that are to be


manufactured and delivered within the next year. The advance payment should be reported
in the manufacturers current-year statement of financial position as a(n)

A. Current liability.
Answer (A) is correct.
The entity has not substantially completed what it must do to be entitled
to the benefits of the advance payment, and the receipt of future
economic benefits is not sufficiently certain to justify income
recognition. Accordingly, the receipt of cash in anticipation of goods to
be delivered or services to be performed must be recognized as a
liability, usually called deferred (or unearned) revenue or deferred (or
unearned) income. Because the manufacturer must deliver the goods
within the next year, this liability is current.
B. Noncurrent liability.
C. Contra asset amount.
D. Accrued revenue.

Question: 19

A cable television entity receives deposits from customers that are refunded when service is
terminated. The average customer stays with the entity 8 years. How should these deposits
be shown on the financial statements?

A.
B.
C.
D.

Operating revenue.
Other revenue.
Paid-in capital.
Liability.
Answer (D) is correct.
Liabilities are present obligations arising from past events, the settlement
of which is expected to result in an outflow of resources embodying
economic benefits. Customers deposits must be returned or credited to

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their accounts. The deposits should therefore be recorded as liabilities.

Question: 20

A company has outstanding accounts payable of $30,000 and a short-term construction


loan in the amount of $100,000 at year end. The loan was refinanced through issuance of
long-term bonds after year end but before issuance of financial statements. How should
these liabilities be recorded in the balance sheet?

A. Noncurrent liabilities of $130,000.


B. Current liabilities of $130,000.
C. Current liabilities of $30,000, noncurrent liabilities of $100,000.
Answer (C) is correct.
Accounts payable are properly classified as current liabilities because
they are for items entering into the operating cycle. Short-term debt that
is refinanced by a post-balance-sheet-date issuance of long-term debt
should be classified as noncurrent. (The ability to refinance on a longterm basis has been demonstrated.) Thus, the short-term construction
loan is classified as noncurrent. Accordingly, the entity records current
liabilities of $30,000 and noncurrent liabilities of $100,000.
D. Current liabilities of $130,000, with required footnote disclosure of the
refinancing of the loan.

Question: 21

A statement of financial position provides a basis for all of the following except

A.
B.
C.
D.

Computing rates of return.


Evaluating capital structure.
Assessing liquidity and financial flexibility.
Determining profitability and assessing past performance.
Answer (D) is correct.
The statement of financial position, also known as the balance sheet,
reports an entitys financial position at a moment in time. It is therefore
not useful for assessing past performance for a period of time. A balance
sheet can be used to help users assess liquidity, financial flexibility, and
risk.

Question: 22

Noncurrent debt should be included in the current section of the statement of financial
position if

A. It is to be converted into common stock before maturity.


B. It matures within the year and will be retired through the use of current
assets.
Answer (B) is correct.
Current liabilities include those obligations that are expected to be
satisfied by the (1) payment of cash, (2) use of current assets other than
cash, or (3) creation of new current liabilities within 1 year from the
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balance sheet date (or operating cycle, if longer).
C. Management plans to refinance it within the year.
D. A bond retirement fund has been set up for use in its scheduled retirement
during the next year.

Question: 23

Dixon Company has the following items recorded on its financial records:

Available-for-sale securities $200,000


Prepaid expenses

400,000

Treasury stock

100,000

The total amount of the above items to be shown as assets on Dixons statement of
financial position is

A. $400,000
B. $500,000
C. $600,000
Answer (C) is correct.
Available-for-sale securities (an investment) and prepaid expenses are
assets, but treasury stock is an equity item. The total of the assets
reported is therefore $600,000 ($200,000 + $400,000).
D. $700,000

Question: 24

A receivable classified as current on the statement of financial position is expected to be


collected within

A. The current operating cycle.


B. 1 year.
C. The current operating cycle or 1 year, whichever is longer.
Answer (C) is correct.
Current assets are reasonably expected to be realized in cash, sold, or
consumed during the normal operating cycle of the business or within 1
year, whichever is longer. The operating cycle is the time between the
acquisition of materials or services and the final cash realization from the
earning process.
D. The current operating cycle or 1 year, whichever is shorter.

Question: 25A company pays more than the fair value to acquire treasury stock. The difference
between the price paid to acquire the treasury stock and the fair value should be recorded as
A. An asset.
B. A liability.
C. Shareholders equity.
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Answer (C) is correct.
Apart from cash paid or received, a firm cannot recognize assets, liabilities, gains, or
losses from transactions in its own stock. Treasury stock is reported on the balance sheet
as a subtraction from equity.
D. An expense.

Question: 26

The purchase of treasury stock is recorded on the statement of financial position as a(n)

A.
B.
C.
D.

Increase in assets.
Decrease in liabilities.
Increase in shareholders equity.
Decrease in shareholders equity.
Answer (D) is correct.
The purchase of treasury stock is recorded on the statement of financial
position as a decrease in shareholders equity.

Question: 27

Current assets are reasonably expected to be realized in cash or sold or consumed during
the normal operating cycle of the business. Current assets most likely include

A.
B.
C.
D.

Intangible assets.
Purchased goodwill.
Organizational costs.
Trading securities.
Answer (D) is correct.
Current assets include, in descending order of liquidity, cash and cash
equivalents; certain individual trading, available-for-sale, and held-tomaturity securities; receivables; inventories; and prepaid expenses.
Trading securities are expected to be sold in the near term, so they are
likely to be classified as current.

Question: 28

Rice Co. was incorporated on January 1, Year 6, with $500,000 from the issuance of stock
and borrowed funds of $75,000. During the first year of operations, net income was
$25,000. On December 15, Rice paid a $2,000 cash dividend. No additional activities
affected equity in Year 6. At December 31, Year 6, Rices liabilities had increased to
$94,000. In Rices December 31, Year 6 balance sheet, total assets should be reported at

A. $598,000
B. $600,000
C. $617,000
Answer (C) is correct.
Total assets equal the sum of total liabilities and equity. Total liabilities
were $94,000 at year end, and equity amounted to $523,000 ($500,000
from issuance of stock + $25,000 net income $2,000 cash dividend).
Total assets are therefore $617,000 ($523,000 + $94,000).
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D. $692,000

Question: 29

Careful reading of an annual report will reveal that off-balance-sheet debt includes

A. Amounts due in future years under operating leases.


Answer (A) is correct.
Off-balance-sheet debt includes any type of liability for which the
company is responsible but that does not appear on the balance sheet.
The most common example is the amount due in future years on
operating leases. Under U.S. GAAP, operating leases are not capitalized;
instead, only the periodic payments of rent are reported when actually
paid. Capital leases (those similar to a purchase) must be capitalized and
reported as liabilities.
B. Transfers of accounts receivable without recourse.
C. Current portion of long-term debt.
D. Amounts due in future years under capital leases.

Question: 30

Which one of the following is not a form of off-balance-sheet financing?

A. Sale of receivables.
B. Foreign currency translations.
Answer (B) is correct.
Off-balance-sheet financing takes four principal forms: investments in
unconsolidated subsidiaries, special purpose entities, operating leases,
and factoring receivables with recourse.
C. Operating leases.
D. Special purpose entities.

Question: 31

In a multiple-step income statement for a retail company, all of the following are included in
the operating section except

A. Sales.
B. Cost of goods sold.
C. Dividend revenue.
Answer (C) is correct.
The operating section of a retailers income statement includes all
revenues and costs necessary for the operation of the retail establishment,
e.g., sales, cost of goods sold, administrative expenses, and selling
expenses. Dividend revenue, however, is classified under other revenues.
In a statement of cash flows, cash dividends received are considered an
operating cash flow.
D. Administrative and selling expenses.

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Question: 32

When reporting extraordinary items,

A. Each item (net of tax) is presented on the face of the income statement
separately as a component of net income for the period.
Answer (A) is correct.
Extraordinary items are reported net of tax after discontinued operations.
B. Each item is presented exclusive of any related income tax.
C. Each item is presented as an unusual item within income from continuing
operations.
D. All extraordinary gains or losses that occur in a period are summarized as
total gains and total losses, then offset to present the net extraordinary gain
or loss.

Question: 33

Which one of the following items is included in the determination of income from continuing
operations?

A.
B.
C.
D.

Discontinued operations.
Extraordinary loss.
Cumulative effect of a change in an accounting principle.
Unusual loss from a write-down of inventory.
Answer (D) is correct.
Certain items ordinarily are not to be treated as extraordinary gains and
losses. Rather, they are included in the determination of income from
continuing operations. These gains and losses include those from writedowns of receivables and inventories, translation of foreign currency
amounts, disposal of a business segment, sale of productive assets,
strikes, and accruals on long-term contracts. A write-down of inventory
is therefore included in the computation of income from continuing
operations.

Question: 34

Which one of the following would be shown on a multiple-step income statement but not on
a single-step income statement?

A. Loss from discontinued operations.


B. Gross profit.
Answer (B) is correct.
A single-step income statement combines all revenues and gains,
combines all expenses and losses, and subtracts the latter from the former
in a single step to arrive at net income. Gross profit, being the
difference between sales revenue and cost of goods sold, does not appear
on a single-step income statement.
C. Extraordinary gain.
D. Net income from continuing operations.
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Question: 35

The major segments of the statement of retained earnings for a period are

A. Dividends declared, prior period adjustments, and changes due to treasury


stock transactions.
B. Before-tax income or loss and dividends paid or declared.
C. Prior-period adjustments, before-tax income or loss, income tax, and
dividends paid.
D. Net income or loss, prior-period adjustments, and dividends paid or
declared.
Answer (D) is correct.
The statement of retained earnings is a basic financial statement.
Together with the income statement, the statement of retained earnings is
meant to broadly reflect the results of operations. The statement of
retained earnings consists of beginning retained earnings adjusted for any
prior period adjustment (net of tax), with further adjustments for income
(loss), dividends, and in certain other rare adjustments, e.g., quasireorganizations. The final figure is ending retained earnings.

Question: 36

Because of inexact estimates of the service life and the residual value of a plant asset, a
fully depreciated asset was sold in the current year at a material gain. This gain most likely
should be reported

A. In the other revenues and gains section of the current income statement.
Answer (A) is correct.
Revenues occur in the course of ordinary activities. Gains may or may
not occur in the course of ordinary activities. For example, gains may
occur from the sale of noncurrent assets. Thus, the gain on the sale of a
plant asset is not an operating item and should be classified in an income
statement with separate operating and nonoperating sections in the other
revenues and gains section.
B. As part of sales revenue on the current income statement.
C. In the extraordinary item section of the current income statement.
D. As an adjustment to prior periods depreciation on the statement of changes
in equity.

Question: 37

In recording transactions, which of the following best describes the relation between
expenses and losses?

A. Losses are extraordinary charges to income, whereas expenses are ordinary


charges to income.
B. Losses are material items, whereas expenses are immaterial items.
C. Losses are expenses that may or may not arise in the course of ordinary
activities.
Answer (C) is correct.
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Expenses are outflow or other usage of assets or incurrences of liability
(or both) from activities that qualify as ongoing major or central
operations. Losses are similar to expenses but generally do not occur in
ordinary activities. For example, losses may result from the sale of
noncurrent assets or from natural disasters.
D. Expenses can always be prevented, whereas losses can never be prevented.

Question: 38

An entity has a 50% gross margin, general and administrative expenses of $50, interest
expense of $20, and net income of $10 for the year just ended. If the corporate tax rate is
50%, the level of sales revenue for the year just ended was

A.
B.
C.
D.

$90
$135
$150
$180
Answer (D) is correct.
Net income equals sales minus cost of sales, G&A expenses, interest, and
tax. Given a 50% tax rate, income before tax must have been $20 [$10
net income (1.0 0.5 tax rate)]. Accordingly, income before interest
and tax must have been $40 ($20 income before tax + $20 interest), and
the gross margin (sales cost of sales) must have been $90 ($40 income
before interest and tax + $50 G&A expenses). If the gross margin is 50%
of sales, sales equals $180 ($90 gross margin 0.5).

Question: 39Assume that employees confessed to a $500,000 inventory theft but are not able to make
restitution. How should this material fraud be shown in the companys financial statements?
A. Classified as a loss and shown as a separate line item in the income statement.
Answer (A) is correct.
Losses may or may not occur in the course of ordinary activities. For example, they may
result from nonreciprocal transactions (e.g., theft), reciprocal transactions (e.g., a sale of
plant assets), or from holding assets or liabilities. Losses are typically displayed separately.
B. Initially classified as an accounts receivable because the employees are responsible for the
goods. Because they cannot pay, the loss would be recognized as a write-off of accounts
receivable.
C. Included in cost of goods sold because the goods are not on hand, losses on inventory
shrinkage are ordinary, and it would cause the least amount of attention.
D. Recorded directly to retained earnings because it is not an income-producing item.

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Question: 40

An entity had the following opening and closing inventory balances during the current year:

1/1

12/31

Finished goods

$ 90,000 $260,000

Raw materials

105,000

130,000

Work-in-progress

220,000

175,000

The following transactions and events occurred during the current year:
$300,000 of raw materials were purchased, of which $20,000

were

returned because of defects.


$600,000 of direct labor costs were incurred.
$750,000 of production overhead costs were incurred.
The cost of goods sold for the current year ended December 31 would be

A. $1,480,000
Answer (A) is correct.
Cost of goods sold equals cost of goods manufactured (COGM) adjusted
for the change in finished goods. COGM equals the sum of raw materials
used, direct labor costs, and production overhead, adjusted for the change
in work-in-progress. Raw materials used equals $255,000 ($105,000 BI +
$300,000 purchases $20,000 returns $130,000 EI). Thus, COGM
equals $1,650,000 ($255,000 RM + $600,000 DL + $750,000 OH +
$220,000 BWIP $175,000 EWIP), and COGS equals $1,480,000
($1,650,000 COGM + $90,000 BFG $260,000 EFG).
B. $1,500,000
C. $1,610,000
D. $1,650,000

Question: 41

The profit and loss statement of Madengrad Mining includes the following information for the
current fiscal year:

Sales

$160,000

Gross profit

48,000

Year-end finished goods inventory

58,300

Opening finished goods inventory

60,190

The cost of goods manufactured by Madengrad for the current fiscal year is

A. $46,110
B. $49,890
C. $110,110
Answer (C) is correct.
Madengrads cost of goods manufactured can be calculated as follows:
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Sales
Less: gross profit
Cost of goods sold
Add: ending finished goods
Goods available for sale

$160,000
(48,000)
$112,000
58,300
$170,300

Less: beginning finished goods (60,190)


Cost of goods manufactured

$110,110

D. $113,890

Question: 42

If the beginning balance for May of the materials inventory account was $27,500, the ending
balance for May is $28,750, and $128,900 of materials were used during the month, the
materials purchased during the month cost

A. $101,400
B. $127,650
C. $130,150
Answer (C) is correct.
Purchases equals usage adjusted for the inventory change. Hence,
purchases equals $130,150 ($128,900 used $27,500 BI + $28,750 EI).
D. $157,650

Question: 43

Given the following data for Scurry Company, what is the cost of goods sold?

Beginning inventory of finished goods $100,000


Cost of goods manufactured

700,000

Ending inventory of finished goods

200,000

Beginning work-in-process inventory

300,000

Ending work-in-process inventory

50,000

A. $500,000
B. $600,000
Answer (B) is correct.
Scurrys cost of goods sold can be calculated as follows:
Beginning inventory of finished goods $ 100,000
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Add: cost of goods manufactured
700,000
Less: ending inventory of finished goods (200,000)
Cost of goods sold

$ 600,000

C. $800,000
D. $950,000
Question: 44The following information was taken from last years accounting records of a
manufacturing company.
Inventory

January 1 December 31

Raw materials

$38,000 $ 45,000

Work-in-process

21,000

10,000

Finished goods

78,000

107,000

Other information
Direct labor

$236,000

Shipping costs on outgoing orders

6,500

Factory rent

59,000

Factory depreciation

18,700

Advertising expense

24,900

Net purchases of raw materials

115,000

Corporate administrative salaries

178,000

Material handling costs

35,800

On the basis of this information, the companys cost of goods manufactured and cost of goods sold
are
A. $460,500 and $489,500, respectively.
B. $468,500 and $439,500, respectively.
Answer (B) is correct.
This solution requires a series of computations.
Beginning raw materials

$ 38,000

Add: net purchases raw materials

$115,000

Materials available

$153,000

Less: ending materials


Materials used in production
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(45,000)
$108,000
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Direct labor

236,000

Manufacturing overhead
Factory rent

$59,000

Factory depreciation

18,700

Material handling costs

35,800

Total Manufacturing overhead


Total manufacturing costs
Add: beginning work-in-process
Less: ending work-in-process
Costs of Goods Manufactured
Add: beginning finished goods

113,500
$457,500
21,000
(10,000)
$468,500
78,000

Less: ending finished goods

(107,000)

Cost of Goods Sold

$439,500

C. $468,500 and $470,900, respectively.


D. $646,500 and $617,500, respectively.

Question: 45

Comprehensive income is best defined as

A. Net income excluding extraordinary gains and losses.


B. The change in net assets for the period including contributions by owners
and distributions to owners.
C. Total revenues minus total expenses.
D. The change in net assets for the period excluding owner transactions.
Answer (D) is correct.
Comprehensive income includes all changes in equity of a business
entity except those changes resulting from investments by owners and
distributions to owners. Comprehensive income includes two major
categories: net income and other comprehensive income (OCI). Net
income includes the results of operations classified as income from
continuing operations, discontinued operations, and extraordinary items.
Components of comprehensive income not included in the determination
of net income are included in OCI, for example, unrealized gains and
losses on available-for-sale securities (except those that are hedged items

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in a fair value hedge).

Question: 46

The financial statement that provides a summary of the firms operations for a period of time
is the

A. Income statement.
Answer (A) is correct.
The results of operations for a period of time are reported in the income
statement (statement of earnings) on the accrual basis using an approach
oriented to historical transactions.
B. Statement of financial position.
C. Statement of shareholders equity.
D. Statement of retained earnings.

Question: 47

The following information pertains to Maynard Corporations income statement for


the 12 months just ended. The company has an effective income tax rate of 40%.
Discontinued operations

$(70,000)

Extraordinary loss due to earthquake

(90,000)

Income from continuing operations (net of tax)

72,000

Cumulative effect of change in accounting principle 60,000


Maynards net income for the year is
A.
B.
C.
D.

$36,000
$12,000
$8,000
$(24,000)
Answer (D) is correct.
Maynards net income for the year is calculated as follows:
Income

Times:

Statement

Tax

As

Item

Effect

Reported

Income from continuing operations (net of


tax)
Discontinued operations
$(70,000)
Extraordinary loss due to earthquake
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(90,000)

(1.0
.40)
(1.0

$ 72,000
(42,000)
(54,000)

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.40)
Net income

Question: 48

$(24,000)

Which of the following items is not classified as other comprehensive income (OCI)?

A. Extraordinary gains from extinguishment of debt.


Answer (A) is correct.
Comprehensive income is divided into net income and other
comprehensive income (OCI). Under existing accounting standards, OCI
includes (1) unrealized gains and losses on available-for-sale securities
(except those that are hedged items in a fair value hedge); (2) gains and
losses on derivatives designated, qualifying, and effective as cash flow
hedges; (3) certain amounts associated with recognition of the funded
status of postretirement defined benefit plans; and (4) certain foreign
currency items, including foreign currency translations.
B. Foreign currency translation adjustments.
C. Prior service cost adjustment resulting from amendment of a defined
benefit pension plan.
D. Unrealized gains for the year on available-for-sale marketable securities.

Question: 49

Which of the following are acceptable formats for reporting comprehensive income?
I. In one continuous financial statement
II. In a statement of changes in equity
III. In a separate statement of net income
IV. In two separate but consecutive financial statements

A.
B.
C.
D.

I and II only.
I, II, and III only.
III and IV only.
I and IV only.
Answer (D) is correct.
If an entity that presents a full set of financial statements has items of
other comprehensive income (OCI), it must present comprehensive
income either (1) in a single continuous statement of comprehensive
income or (2) in two separate but consecutive statements (an income
statement and a statement of OCI).

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Question: 50

A company reports the following information as of December 31:

Sales revenue

$800,000

Cost of goods sold

600,000

Operating expenses

90,000

Unrealized holding gain on available-for-sale securities, net of tax

30,000

What amount should the company report as comprehensive income as of December 31?

A. $30,000
B. $110,000
C. $140,000
Answer (C) is correct.
Comprehensive income includes net income and other comprehensive
income. Net income equals $110,000 ($800,000 sales revenue
$600,000 COGS $90,000 operating expenses). Unrealized holding
gains on available-for-sale securities ($30,000) are included in other
comprehensive income. Thus, comprehensive income is $140,000
($110,000 + $30,000).
D. $200,000

Question: 51

Crawford Company is researching a future change to IFRS. Which one of the following
items reported on Crawfords income statement under U.S. GAAP is required to be changed
as a result of adopting IFRS?

A. Crawford values its merchandise inventory using average cost.


B. Crawford uses a multiple-step approach for its income statement.
C. Crawford uses historical cost to value its land, buildings, and intangible
assets even though the value of the land and building are greater than book
value.
D. Crawfords current-year income statement includes an extraordinary loss.
Answer (D) is correct.
Under U.S. GAAP, material transactions that are both unusual in nature
and infrequent in occurrence in the environment in which the company
operates are classified as extraordinary items. Extraordinary items are
reported individually in a separate section in the income statement, net of
tax. Under IFRS, no item is classified as extraordinary, and therefore it
would be recorded in the normal part of the income statement.

Question: 52

All of the following are defined as elements of an income statement except

A. Expenses.
B. Shareholders equity.
Answer (B) is correct.
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Equity of a business entity (or the net assets of a nonbusiness
organization) is a residual amount that reflects the basic accounting
equation: assets minus liabilities equals equity (or net assets). It is
reported on the statement of financial position.
C. Gains and losses.
D. Revenues.

Question: 53

Items reported as prior-period adjustments

A. Do not include the effect of a mistake in the application of accounting


principles, as this is accounted for as a change in accounting principle
rather than as a prior-period adjustment.
B. Do not affect the presentation of prior-period comparative financial
statements.
C. Do not require further disclosure in the body of the financial statements.
D. Are reflected as adjustments of the opening balance of the retained earnings
of the earliest period presented.
Answer (D) is correct.
Prior-period adjustments are made for the correction of errors. According
to SFAS 16, Prior Period Adjustments, the effects of errors on priorperiod financial statements are reported as adjustments to beginning
retained earnings for the earliest period presented in the retained earnings
statement. Such errors do not affect the income statement for the current
period.

Question: 54

An appropriation of retained earnings by the board of directors of a corporation for bonded


indebtedness will result in

A. The establishment of a sinking fund to retire bonds when they mature.


B. A decrease in cash on the balance sheet with an equal increase in the
investment and funds section of the balance sheet.
C. A decrease in the total amount of retained earnings presented on the
balance sheet.
D. The disclosure that management does not intend to distribute assets, in the
form of dividends, equal to the amount of the appropriation.
Answer (D) is correct.
The appropriation of retained earnings is a transfer from one retained
earnings account to another. The only practical effect is to decrease the
amount of retained earnings available for dividends. An appropriation of
retained earnings is purely for disclosure purposes.

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Question: 55

When treasury stock is accounted for at cost, the cost is reported on the balance sheet as
a(n)

A.
B.
C.
D.

Asset.
Reduction of retained earnings.
Reduction of additional paid-in-capital.
Unallocated reduction of equity.
Answer (D) is correct.
Treasury stock is a corporations own stock that has been reacquired but
not retired. In the balance sheet, treasury stock recorded at cost is
subtracted from the total of the capital stock balances, additional paid-in
capital, retained earnings, and accumulated other comprehensive income.

Question: 56

The statement of shareholders equity shows a

A. Reconciliation of the beginning and ending balances in shareholders


equity accounts.
Answer (A) is correct.
The statement of shareholders equity (changes in equity) presents a
reconciliation in columnar format of the beginning and ending balances
in the various shareholders equity accounts. A statement of changes in
equity may include, for example, columns for (1) totals,
(2) comprehensive income, (3) retained earnings, (4) accumulated OCI
(but the components of OCI are presented in another statement), (5)
common stock, and (6) additional paid-in capital.
B. Listing of all shareholders equity accounts and their corresponding dollar
amounts.
C. Computation of the number of shares outstanding used for earnings per
share calculations.
D. Reconciliation of net income to net operating cash flow.

Question: 57

Unless the shares are specifically restricted, a holder of common stock with a preemptive
right may share proportionately in all of the following except

A. The vote for directors.


B. Corporate assets upon liquidation.
C. Cumulative dividends.
Answer (C) is correct.
Common stock does not have the right to accumulate unpaid dividends.
This right is often attached to preferred stock.
D. New issues of stock of the same class.

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Question: 58

Which one of the following statements is correct regarding the effect preferred stock has on
a company?

A. The firms after-tax profits are shared equally by common and preferred
shareholders.
B. Control of the firm is now shared by the common and preferred
shareholders, with preferred shareholders having greater control.
C. Preferred shareholders claims take precedence over the claims of common
shareholders in the event of liquidation.
Answer (C) is correct.
Preferred stockholders have preference over common stockholders with
respect to dividend and liquidation rights, but payment of preferred
dividends, unlike bond interest is not mandatory. In exchange for these
preferences, the preferred stockholders give up the right to vote.
Consequently, preferred stock is a hybrid of debt and equity.
D. Nonpayment of preferred dividends places the firm in default, as does
nonpayment of interest on debt

Zinc Co.s adjusted trial balance at December 31, Year 6, includes the following account
balances:

Common stock, $3 par


Additional paid-in capital
Treasury stock, at cost
Question: 59

$600,000
800,000
50,000

Net unrealized holding loss on


available-for-sale securities

20,000

Retained earnings: appropriated for


uninsured earthquake losses

150,000

Retained earnings: unappropriated

200,000

What amount should Zinc report as total equity in its December 31, Year 6, balance sheet?

A. $1,680,000
Answer (A) is correct.
Total credits to equity equal $1,750,000 ($600,000 common stock at par
+ $800,000 additional paid-in capital + $350,000 retained earnings). The
treasury stock recorded at cost is subtracted from (debited to) total
equity, and the unrealized holding loss on available-for-sale securities is
debited to other comprehensive income, a component of equity. Because
total debits equal $70,000 ($50,000 cost of treasury stock + $20,000
unrealized loss on available-for-sale securities), total equity equals

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$1,680,000 ($1,750,000 $70,000).
B. $1,720,000
C. $1,780,000
D. $1,820,000

Question: 60

A retained earnings appropriation can be used to

A.
B.
C.
D.

Absorb a fire loss when a company is self-insured.


Provide for a contingent loss that is probable and reasonable.
Smooth periodic income.
Restrict earnings available for dividends.
Answer (D) is correct.
Transfers to and from accounts properly designated as appropriated
retained earnings (such as general purpose contingency reserves or
provisions for replacement costs of fixed assets) are always excluded
from the determination of net income. However, appropriation of
retained earnings is permitted if it is displayed within the equity section
and is clearly identified. The effect of the appropriation is to restrict the
amount of retained earnings available for dividends, not to set aside
assets.

Question: 61

Which one of the following statements regarding treasury stock is correct?

A. It is unretired but no longer outstanding, yet it has all the rights of


outstanding shares.
B. It is an asset representing shares that can be sold in the future or otherwise
issued in stock option plans or in effectuating business combinations.
C. It is unable to participate in the liquidation proceeds of the firm but able to
participate in regular cash dividend distributions as well as stock dividends
and stock splits.
D. It is reflected in shareholders equity as a contra account.
Answer (D) is correct.
Treasury stock recorded at cost is a reduction of total equity. Treasury
stock recorded at par is a direct reduction of the pertinent contributed
capital balance, e.g., common stock or preferred stock.

Question: 62

Tyler Corporation purchased 10,000 shares of its own $5 par-value common stock for $25
per share. This stock originally sold for $28 per share. Tyler used the cost method to record
this transaction. If the par-value method had been used rather than the cost method, which
of the following accounts would show a different dollar amount?

A. Treasury stock and total shareholders equity.


B. Additional paid-in capital and retained earnings.
C. Paid-in capital from treasury stock and retained earnings.
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D. Additional paid-in capital and treasury stock.
Answer (D) is correct.
Under the cost method, the treasury stock account was debited for the
full market price of the shares; had the par-value method been used,
treasury stock would only have been debited for the par value of the
shares. Under the cost method, the additional paid-in capital account was
not affected; had the par-value method been used, additional paid-in
capital would have been debited for the excess of the market price of the
shares over par.

Question: 63

On December 1, Noble Inc.s Board of Directors declared a property dividend, payable in


stock held in the Multon Company. The dividend was payable on January 5. The investment
in Multon stock had an original cost of $100,000 when acquired 2 years ago. The market
value of this investment was $150,000 on December 1, $175,000 on December 31, and
$160,000 on January 5. The amount to be shown on Nobles statement of financial position
at December 31 as property dividends payable would be

A. $100,000
B. $150,000
Answer (B) is correct.
When a property dividend is declared, the property is remeasured at its
fair value as of the declaration date. This amount is then reclassified from
retained earnings to property dividends payable.
C. $160,000
D. $175,000

Question: 64

Garland Corporation, a public company, has declared a property dividend of one share of its
investment in Marlowe, Inc., for every 10 shares of its common stock outstanding. The
Marlowe shares were originally purchased by Garland for $50 per share; on the date the
dividend was declared, the market value was $75 per share. As a result of this declaration,
Garland should recognize

A. A loss of $25 per share to be distributed.


B. A gain of $25 per share to be distributed.
Answer (B) is correct.
When a property dividend is declared, the property is remeasured at its
fair value as of the declaration date ($75 $50 = $25).
C. No gain or loss.
D. An appropriate gain or loss based on the market value on the date of
distribution.

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Question: 65

Grand Corporation has 10,000,000 shares of $10 par-value stock authorized, of which
2,000,000 shares are issued and outstanding. The Board of Directors of Grand declared a
2-for-1 stock split on November 30 to be issued on December 30. The stock was selling for
$30 per share on the date of declaration. In addition, the Board has amended the articles of
incorporation to allow for a proportional increase in the number of authorized shares. The
par-value information appearing in the shareholders equity section of Grands statement of
financial position at December 31 will be

A. $5
Answer (A) is correct.
As a result of the 2-for-1 stock split, the par value of Grands shares is
halved to $5.
B. $10
C. $15
D. $30

Question: 66

Fox Company has 1,000,000 shares of common stock authorized, of which 100,000 shares
are held as treasury shares; the remainder are held by the company shareholders. On
November 1, the Board of Directors declared a cash dividend of $.10 per share to be paid
on January 2. At the same time, the Board declared a 5% stock dividend to be issued on
December 31. On the date of the declaration, the stock was selling for $10 a share, and no
fractional shares were to be issued. The total amount of these declarations to be shown as
current liabilities on Foxs statement of financial position as of December 31 is

A. $90,000
Answer (A) is correct.
Cash dividends are only paid on outstanding shares. Thus, the dividend
payable at December 31 is $90,000 (900,000 $.10). Stock dividends
distributable are reported in equity, not current liabilities.
B. $100,000
C. $540,000
D. $600,000

Question: 67

Bertram Company had a balance of $100,000 in retained earnings at the beginning of the
year and of $125,000 at the end of the year. Net income for this time period was $40,000.
Bertrams statement of financial position indicated that the dividends payable account had
decreased by $5,000 throughout the year, despite the fact that both cash dividends and a
stock dividend were declared. The amount of the stock dividend was $8,000. When
preparing its statement of cash flows for the year, Bertram should show cash paid for
dividends as

A. $20,000
B. $15,000
C. $12,000
Answer (C) is correct.
The amount of total dividends declared during the year can be calculated
as follows:

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Beginning retained earnings

$100,000

Net income for the year

40,000

Ending retained earnings

(125,000)

Dividends declared during the year $ 15,000


Since $8,000 is the amount of stock dividends declared, the amount of
cash dividends declared this year is $7,000 ($15,000 $8,000). The
amount of cash dividends paid during the year can be calculated as
follows:
Decrease in the cash dividends payable account during the
period

$ 5,000

Cash dividends declared during the year


Cash paid for dividends during the year

7,000
$12,000

NOTE: Stock dividends declared does not affect the dividends payable
account.
D. $5,000

Question: 68

How would a stock split affect the par value of the stock and the companys shareholders
equity?

Par Value Shareholders Equity


A. Decrease Increase
B. Decrease No change
Answer (B) is correct.
A stock split reduces the par value of the stock and increases the number
of shares outstanding, making it more attractive to investors. As with a
stock dividend, each shareholders proportionate interest in the company
and total book value remain unchanged.
C. Increase Decrease
D. Increase No change

Question: 69

An undistributed stock dividend declared by the Board of Directors should be reported as


a(n)

A.
B.
C.
D.
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Current liability.
Long-term liability.
Footnote to the financial statements.
Item in the shareholders equity section.
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Answer (D) is correct.
In accounting for a stock dividend, the fair value of the additional shares
issued is reclassified from retained earnings to capital stock and the
difference to additional paid in capital. Stock dividend distributable is an
item of shareholders equity and not a liability.

Question: 70

Which one of the following statements regarding dividends is correct?

A. A stock dividend of 15% of the outstanding common shares results in a


debit to retained earnings at the par value of the stock distributed.
B. At the declaration date of a 30% stock dividend, the carrying value of
retained earnings will be reduced by the fair market value of the stock
distributed.
C. The declaration of a cash dividend will have no effect on book value per
share.
D. The declaration and payment of a 10% stock dividend will result in a
reduction of retained earnings at the fair market value of the stock.
Answer (D) is correct.
When a small stock dividend is declared (less than 20% to 25% of the
previously outstanding common shares), retained earnings is debited for
the fair value of the stock.

Question: 71

Which one of the following transactions does not affect the balance of retained earnings?

A. Declaration of a stock dividend.


B. A quasi-reorganization.
C. Declaration of a stock split.
Answer (C) is correct.
In a stock split, no journal entry is recorded and no retained earnings are
reclassified.
D. Declaration of a property dividend.

Question: 72

Underhall, Inc.s common stock is currently selling for $108 per share. Underhall is planning
a new stock issue in the near future and would like to stimulate interest in the company. The
Board, however, does not want to distribute capital at this time. Therefore, Underhall is
considering whether to offer a 2-for-1 common stock split or a 100% stock dividend on its
common stock. The best reason for opting for the stock split is that

A. It will not decrease shareholders equity.


B. It will not impair the companys ability to pay dividends in the future.
Answer (B) is correct.
A 2-for-1 stock split doubles the number of shares outstanding; retained
earnings is not affected. Under a stock dividend, however, a portion of
retained earnings is reclassified as common stock. Since dividends are
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restricted by the amount of available retained earnings, a stock dividend,
but not a stock split, will impair the firms ability to pay dividends in the
future.
C. The impact on earnings per share will not be as great.
D. The par value per share will remain unchanged.

Question: 73

When preparing the statement of cash flows, companies are required to report separately
as operating cash flows all of the following except

A.
B.
C.
D.

Interest received on investments in bonds.


Interest paid on the companys bonds.
Cash collected from customers.
Cash dividends paid on the companys stock.
Answer (D) is correct.
In general, the cash flows from transactions and other events that enter
into the determination of income are to be classified as operating. Cash
receipts from sales of goods and services, from interest on loans, and
from dividends on equity securities are from operating activities. Cash
payments to suppliers for inventory; to employees for wages; to other
suppliers and employees for other goods and services; to governments
for taxes, duties, fines, and fees; and to lenders for interest are also from
operating activities. However, distributions to owners (cash dividends on
a companys own stock) are cash flows from financing, not operating,
activities.

Question: 74

A statement of cash flows is intended to help users of financial statements

A. Evaluate a firms liquidity, solvency, and financial flexibility.


Answer (A) is correct.
The primary purpose of a statement of cash flows is to provide
information about the cash receipts and payments of an entity during a
period. If used with information in the other financial statements, the
statement of cash flows should help users to assess the entitys ability to
generate positive future net cash flows (liquidity), its ability to meet
obligations (solvency) and pay dividends, the need for external financing,
the reasons for differences between income and cash receipts and
payments, and the cash and noncash aspects of the investing and
financing activities.
B. Evaluate a firms economic resources and obligations.
C. Determine a firms components of income from operations.
D. Determine whether insiders have sold or purchased the firms stock.

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Question: 75

Which of the following items is specifically included in the body of a statement of cash
flows?

A. Operating and nonoperating cash flow information.


Answer (A) is correct.
All noncash transactions are excluded from the body of the statement of
cash flows to avoid undue complexity and detraction from the objective
of providing information about cash flows. Information about all noncash
financing and investing activities affecting recognized assets and
liabilities shall be reported in related disclosures.
B. Conversion of debt to equity.
C. Acquiring an asset through a capital lease.
D. Purchasing a building by giving a mortgage to the seller.

Question: 76

With respect to the content and form of the statement of cash flows, the

A. Pronouncements covering the cash flow statement encourage the use of the
indirect method.
B. Indirect method adjusts ending retained earnings to reconcile it to net cash
flows from operations.
C. Direct method of reporting cash flows from operating activities includes
disclosing the major classes of gross cash receipts and gross cash
payments.
Answer (C) is correct.
The FASB encourages use of the direct method of reporting major
classes of operating cash receipts and payments, but the indirect method
may be used. The minimum disclosures of operating cash flows under
the direct method are cash collected from customers, interest and
dividends received, other operating cash receipts, cash paid to employees
and other suppliers of goods or services, interest paid, income taxes paid,
and other operating cash payments.
D. Reconciliation of the net income to net operating cash flow need not be
presented when using the direct method.

Question: 77

Depreciation expense is added to net income under the indirect method of preparing a
statement of cash flows in order to

A. Report all assets at gross carrying amount.


B. Ensure depreciation has been properly reported.
C. Reverse noncash charges deducted from net income.
Answer (C) is correct.
The indirect method begins with net income and then removes the effects
of past deferrals of operating cash receipts and payments, accruals of
expected future operating cash receipts and payments, and net income
items not affecting operating cash flows (e.g., depreciation).

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D. Calculate net carrying amount.

Question: 78

All of the following should be classified under the operating section in a statement of cash
flows except a

A.
B.
C.
D.

Decrease in inventory.
Depreciation expense.
Decrease in prepaid insurance.
Purchase of land and building in exchange for a long-term note.
Answer (D) is correct.
Operating activities include all transactions and other events not
classified as investing and financing activities. Operating activities
include producing and delivering goods and providing services. Cash
flows from such activities are usually included in the determination of
net income. However, the purchase of land and a building in exchange
for a long-term note is an investing activity. Because this transaction
does not affect cash, it is reported in related disclosures of noncash
investing and financing activities.

Question: 79

Which one of the following transactions should be classified as a financing activity in a


statement of cash flows?

A. Purchase of equipment.
B. Purchase of treasury stock.
Answer (B) is correct.
Financing activities are defined to include the issuance of stock, the
payment of dividends, the receipt of donor-restricted resources to be used
for long-term purposes, treasury stock transactions (purchases or sales),
the issuance of debt, the repayment of amounts borrowed, obtaining and
paying for other resources obtained from creditors on long-term credit.
C. Sale of trademarks.
D. Payment of interest on a mortgage note.

Question: 80

Kelli Company acquired land by assuming a mortgage for the full acquisition cost. This
transaction should be disclosed on Kellis statement of cash flows as a(n)

A.
B.
C.
D.

Financing activity.
Investing activity.
Operating activity.
Noncash financing and investing activity.
Answer (D) is correct.
The exchange of debt for a long-lived asset does not involve a cash flow.
It is therefore classified as a noncash financing and investing activity.

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Question: 81

Which one of the following transactions should not be classified as a financing activity in the
statement of cash flows?

A.
B.
C.
D.

Issuance of common stock.


Purchase of treasury stock.
Payment of dividends.
Income tax refund.
Answer (D) is correct.
Financing activities include obtaining resources from owners and
providing them with a return on, and a return of, their investment. Cash
inflows from financing activities include proceeds from issuing equity
instruments. Cash outflows include outlays to reacquire the enterprises
equity instruments, and outlays to pay dividends. However, an income
tax refund is an operating activity.

Question: 82

All of the following should be classified as investing activities in the statement of cash
flows except

A. Cash outflows to purchase manufacturing equipment.


B. Cash inflows from the sale of bonds of other entities.
C. Cash outflows to lenders for interest.
Answer (C) is correct.
Investing activities include the lending of money and the collecting of
those loans; the acquisition, sale, or other disposal of debt or equity
instruments; and the acquisition, sale, or other disposition of assets
(excluding inventory) that are held for or used in the production of goods
or services. Investing activities do not include acquiring and disposing of
certain loans or other debt or equity instruments that are acquired
specifically for resale. Cash outflows to lenders for interest are cash from
an operating, not an investing, activity.
D. Cash inflows from the sale of a manufacturing plant.

Question: 83

All of the following should be included in the reconciliation of net income to net operating
cash flow in the statement of cash flows except a(n)

A. Decrease in inventory.
B. Decrease in prepaid insurance.
C. Purchase of land and building in exchange for a long-term note.
Answer (C) is correct.
The purchase of land and a building in exchange for a long-term note is a
noncash investing activity that does not affect net income. Thus, it is
reported in the related disclosures section of the cash flow statement but
is not a reconciling item.
D. Increase in income tax payable.

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Question: 84

In preparing a statement of cash flows, an item included in determining net cash flow from
operating activities is the

A. Amortization of a bond premium.


Answer (A) is correct.
The debtor (issuer) on a bond sold at a premium debits or reduces the
bond premium for the excess of cash interest paid over interest expense
recognized under the effective interest method. The lender (buyer)
likewise reduces the bond premium (by a credit) for the excess of cash
interest received over interest income recognized. Interest paid (received)
is a cash outflow (inflow) from an operating activity. In a reconciliation
of net income to net cash flow from operating activities, both the issuer
of the bond and the purchaser must make an adjustment for the
difference between the cash flow and the effect on net income. Because
the issuers cash outflow exceeded interest expense, it must deduct the
difference (premium amortization) from net income in performing the
reconciliation. The purchasers cash inflow is greater than interest
income, so it must add the difference (premium amortization) to net
income to arrive at net cash flow from operating activities.
B. Proceeds from the sale of equipment for cash.
C. Cash dividends paid.
D. Purchase of treasury stock.

Question: 85

The information reported in the statement of cash flows should help investors, creditors, and
others to assess all of the following except the

A.
B.
C.
D.

Amount, timing, and uncertainty of prospective net cash inflows of a firm.


Companys ability to pay dividends and meet obligations.
Companys ability to generate future cash flows.
Management of the firm with respect to the efficient and profitable use of
its resources.
Answer (D) is correct.
The statement of cash flows is not designed to provide information with
respect to the efficient and profitable use of the firms resources.
Financial reporting provides information about an enterprises
performance during a period when it was under the direction of a
particular management but does not directly provide information about
that managements performance. Financial reporting does not try to
separate the impact of a particular managements performance from the
effects of prior management actions, general economic conditions, the
supply and demand for an enterprises inputs and outputs, price changes,
and other events.

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Question: 86

To calculate cash flows using the indirect method, which one of the following items must be
added back to net income?

A. Revenue.
B. Marketing expense.
C. Depreciation expense.
Answer (C) is correct.
The indirect method begins with accrual-basis net income or the change
in net assets and removes items that did not affect operating cash flow.
Depreciation is a non-cash item and thus does not affect the cash flows.
This amount must be added back to net income because it decreased net
income even though it had no cash effect.
D. Interest income.

Question: 87

The net income for Cypress, Inc., was $3,000,000 for the year ended December 31.
Additional information is as follows:

Depreciation on fixed assets

$1,500,000

Gain from cash sale of land

200,000

Increase in accounts payable

300,000

Dividends paid on preferred stock

400,000

The net cash provided by operating activities in the statement of cash flows for the year
ended December 31 should be

A. $4,200,000
B. $4,500,000
C. $4,600,000
Answer (C) is correct.
Net operating cash flow may be determined by adjusting net income.
Depreciation is an expense not directly affecting cash flows that should
be added back to net income. The increase in accounts payable is added
to net income because it indicates that an expense has been recorded but
not paid. The gain on the sale of land is an accrual-basis item affecting
net income and thus should be subtracted. The dividends paid on
preferred stock are cash outflows from financing, not operating, activities
and do not require an adjustment. Thus, net cash flow from operations is
$4,600,000 ($3,000,000 + $1,500,000 $200,000 + $300,000).
D. $4,800,000

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Fact Pattern: Royce Company had the following transactions during the fiscal year ended December 31,
Year 2:
Accounts receivable decreased from $115,000 on December
Sold a truck with a net
31, Year 1, to $100,000 on December 31, Year 2.
carrying amount of $7,000
for $5,000 cash, reporting a
Royces board of directors declared dividends on December
loss of $2,000.
31, Year 2, of $.05 per share on the 2.8 million shares
outstanding, payable to shareholders of record on January 31,
Year 3. The company did not declare or pay dividends for
fiscal Year 1.

Question: 88

Paid interest to bondholders


of $780,000.
The cash balance was
$106,000 on December 31,
Year 1, and $284,000 on
December 31,

Royce Company uses the direct method to prepare its statement of cash flows at December
31, Year 2. The interest paid to bondholders is reported in the

A. Financing section, as a use or outflow of cash.


B. Operating section, as a use or outflow of cash.
Answer (B) is correct.
Payment of interest on debt is considered a cash outflow from an
operating activity, although repayment of debt principal is a financing
activity.
C. Investing section, as a use or outflow of cash.
D. Debt section, as a use or outflow of cash.

Fact Pattern: Royce Company had the following transactions during the fiscal year ended December 31,
Year 2:
Accounts receivable decreased from $115,000 on December
Sold a truck with a net
31, Year 1, to $100,000 on December 31, Year 2.
carrying amount of $7,000
for $5,000 cash, reporting a
Royces board of directors declared dividends on December
loss of $2,000.
31, Year 2, of $.05 per share on the 2.8 million shares
outstanding, payable to shareholders of record on January
31, Year 3. The company did not declare or pay dividends for
fiscal Year 1.

Question: 89

Paid interest to bondholders


of $780,000.
The cash balance was
$106,000 on December 31,
Year 1, and $284,000 on
December 31, Year 2.

Royce Company uses the indirect method to prepare its Year 2 statement of cash flows. It
reports a(n)

A. Source or inflow of funds of $5,000 from the sale of the truck in the
financing section.
B. Use or outflow of funds of $140,000 in the financing section, representing
dividends.
C. Deduction of $15,000 in the operating section, representing the decrease in
year-end accounts receivable.
D. Addition of $2,000 in the operating section for the $2,000 loss on the sale
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of the truck.
Answer (D) is correct.
The indirect method determines net operating cash flow by adjusting net
income. Under the indirect method, the $5,000 cash inflow from the sale
of the truck is shown in the investing section. A $2,000 loss was
recognized and properly deducted to determine net income. This loss,
however, did not require the use of cash and should be added to net
income in the operating section.

Fact Pattern: Royce Company had the following transactions during the fiscal year ended December 31,
Year 2:
Accounts receivable decreased from $115,000 on December
Sold a truck with a net
31, Year 1, to $100,000 on December 31, Year 2.
carrying amount of $7,000
for $5,000 cash, reporting a
Royces board of directors declared dividends on December
loss of $2,000.
31, Year 2, of $.05 per share on the 2.8 million shares

Paid interest to bondholders


of $780,000.

outstanding, payable to shareholders of record on January


31, Year 3. The company did not declare or pay dividends for
fiscal Year 1.

Question: 90

The cash balance was


$106,000 on December 31,
Year 1, and $284,000 on
December 31, Year 2.

The total of cash provided (used) by operating activities plus cash provided (used) by
investing activities plus cash provided (used) by financing activities is

A. Cash provided of $284,000.


B. Cash provided of $178,000.
Answer (B) is correct.
The total of cash provided (used) by the three activities (operating,
investing, and financing) should equal the increase or decrease in cash
for the year. During Year 2, the cash balance increased from $106,000 to
$284,000. Thus, the sources of cash must have exceeded the uses by
$178,000.
C. Cash used of $582,000.
D. Equal to net income reported for fiscal year ended December 31, Year 2.

Question: 91

The following information was taken from the accounting records of Oak Corporation for the
year ended December 31:

Proceeds from issuance of preferred stock F $4,000,000


Dividends paid on preferred stock F
400,000
Bonds payable converted to common stock 2,000,000
Payment for purchase of machinery
500,000
Proceeds from sale of plant building
1,200,000
2% stock dividend on common stock
300,000
Gain on sale of plant building
200,000
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The net cash flows from investing and financing activities that should be presented on Oaks
statement of cash flows for the year ended December 31 are, respectively,

A. $700,000 and $3,600,000.


Answer (A) is correct.
The relevant calculations are as follows:
Proceeds from sale of plant building $1,200,000
Payment for purchase of machinery (500,000)
Net cash provided by investing activities $ 700,000
Proceeds from issuance of preferred stock $4,000,000
Dividends paid on preferred stock (400,000)
Net cash provided by financing activities $3,600,000
B. $700,000 and $3,900,000.
C. $900,000 and $3,900,000.
D. $900,000 and $3,600,000.

Question: 92

Zip Company entered into the following transactions during the year:
Purchased stock for $200,000
Purchased electronic equipment for use on the manufacturing floor for $300,000
Paid dividends to shareholders of Zip Company in the amount of $800,000
The amount to be reported in the investing activities section of Zips statement of cash flows
would be

A. $200,000
B. $500,000
Answer (B) is correct.
The statement of cash flows classifies an enterprises cash flows into
three categories. Investing activities typically include the purchase and
sale of securities of other entities and the purchase and sale of property,
plant, and equipment. Thus, the amount to be reported in the investing
activities section of Zips statement of cash flows is $500,000 ($200,000
+ $300,000).
C. $800,000
D. $1,300,000

Question: 93

When using the statement of cash flows to evaluate a companys continuing solvency,
the most important factor to consider is the cash

A. Balance at the end of the period.


B. Flows from (used for) operating activities.
Answer (B) is correct.
Solvency is the ability of an entity to pay its noncurrent debts as they
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become due. A statement of cash flows provides information about,
among other things, an entitys activities in generating cash through
operations (operating activities) to (1) repay debt, (2) distribute
dividends, or (3) reinvest to maintain or expand operating capacity. Thus,
cash flows from operating activities (net operating cash inflows), which
are generated by an entitys ongoing major or central activities, are the
best indicator of its ability to remain solvent over the long term.
C. Flows from (used for) investing activities.
D. Flows from (used for) financing activities.

Question: 94

Dividends paid to shareholders are shown on the statement of cash flows as

A.
B.
C.
D.

Operating cash inflows.


Operating cash outflows.
Cash flows from investing activities.
Cash flows from financing activities.
Answer (D) is correct.
The payment of dividends is a cash outflow from a financing activity.
The receipt of dividends, however, is generally considered a cash inflow
from an operating activity.

Question: 95

All of the following are classifications on the statement of cash flows except

A. Operating activities.
B. Equity activities.
Answer (B) is correct.
The three classifications used on the statement of cash flows are
operating activities, investing activities, and financing activities.
C. Investing activities.
D. Financing activities.

Question: 96The sale of available-for-sale securities should be accounted for on the statement of cash
flows as a(n)
A. Operating activity.
B. Investing activity.
Answer (B) is correct.
Investing activities include acquiring and disposing of debt or equity instruments.
C. Financing activity.
D. Noncash investing and financing activity.

Question: 97

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several balance sheet accounts during the current year as follows:

Investment in Videogold, Inc., stock, all of which was acquired in the


previous year, carried on the equity basis
$5,500 increase
Accumulated depreciation, caused by major repair to projection
equipment
2,100 decrease
Premium on bonds payable
1,400 decrease
Deferred income tax liability (long-term)
1,800 increase
In Metros current year cash flow statement, the reported net cash provided by operating
activities should be

A. $150,400
B. $148,300
C. $144,900
Answer (C) is correct.
The increase in the equity-based investment reflects the investors share
of the investees net income after adjustment for dividends received.
Hence, it is a noncash revenue and should be subtracted in the
reconciliation of net income to net operating cash inflow. A major repair
provides benefits to more than one period and therefore should not be
expensed. One method of accounting for a major repair is to charge
accumulated depreciation if the useful life of the asset has been extended,
with the offsetting credit to cash, a payable, etc. However, the cash
outflow, if any, is from an investing activity. The item has no effect on
net income and no adjustment is necessary. Amortization of bond
premium is a noncash income statement item that reduces accrual-basis
expenses and therefore must be subtracted from net income to arrive at
net cash flow from operating activities. The increase in the deferred tax
liability is a noncash item that reduces net income and should be added in
the reconciliation. Accordingly, net cash provided by operations is
$144,900 ($150,000 $5,500 $1,400 + $1,800).
D. $142,800

Question: 98

Hauschka Company reported net income for the year of $1,050,000. During the year,
accounts receivable decreased $300,000, prepaid expenses increased $150,000, accounts
payable for merchandise decreased $150,000, and liabilities for other expenses increased
$100,000. Administrative expenses include depreciation expense of $50,000, and the
company reported a loss on the sale of obsolete equipment of $10,000. Calculate
Hauschkas net cash flows from operating activities during the year.

A. $1,790,000
B. $1,690,000
C. $1,210,000
Answer (C) is correct.
Net operating cash flow may be determined by adjusting net income. The
depreciation expense, decrease in accounts receivable, increase in
liabilities, and loss on the sale of obsolete equipment must be added
back. The increase in prepaid expense and decrease in accounts payable
must be subtracted from net income. Thus, net cash flow from operations
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is $1,210,000 ($1,050,000 net income + $50,000 depreciation + $300,000
accounts receivable + $100,000 liabilities + $10,000 loss $150,000
prepaid expenses $150,000 accounts payable).
D. $1,110,000

Question: 99

Garnett Companys year-end income statement shows the following:

Revenues

$5,000,000

Selling and general expenses (including depreciation expense of


$200,000)

3,800,000

Interest expense

50,000

Gain on sale of equipment

40,000

Income tax expense (including deferred tax expense of $30,000)


Net income

320,000
$ 870,000

During the year, Garnetts noncash current assets rose by $100,000, and current liabilities
increased by $150,000. On its statement of cash flows, Garnett would report cash provided
by operating activities of

A. $1,080,000
B. $1,110,000
Answer (B) is correct.
Net operating cash flow may be determined by adjusting net income. Net
income of $870,000 is decreased by the increase in current assets of
$100,000, increased by the increase in current liabilities of $150,000,
increased by depreciation expense of $200,000, decreased by the gain on
sale of equipment of $40,000, and increased by the deferred tax liability.
Thus, cash provided by operating activities would be $1,110,000.
C. $1,160,000
D. $1,190,000

Question: 100

An accountant with Nasbo Enterprises, Inc., has gathered the following information to
prepare the statement of cash flows for the current year. Net income of $456,900 includes a
deduction of $45,600 for depreciation expense. The company issued $300,000 of dividends
this year and purchased one new building for $275,000. The balance sheets from the
current period and prior period included the following balances:

Prior Year Current Year


Accounts receivable, net $ 56,860 $ 45,300
Accounts payable
Inventory

12,900

10,745

186,700

194,320

Using the indirect method, what is the amount of cash provided by operating activities?

A. $202,500
B. $405,205
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C. $504,285
Answer (C) is correct.
Net operating cash flow may be determined by adjusting net income.
Depreciation is an expense not directly affecting cash flows that should
be added back to net income. The decrease in accounts payable is
subtracted from net income because it indicates that an expense has been
paid, while the decrease in accounts receivable should be added to net
income. The increase in inventory should be subtracted from net income
because cash was used to purchase the inventory. The dividends paid on
preferred stock are cash outflows from financing, not operating, activities
and do not require an adjustment. Thus, net cash flow from operations is
$504,285 ($456,900 + $45,600 + $11,560 $2,155 $7,620).
D. $521,405

Question: 100

An accountant with Nasbo Enterprises, Inc., has gathered the following information to
prepare the statement of cash flows for the current year. Net income of $456,900 includes a
deduction of $45,600 for depreciation expense. The company issued $300,000 of dividends
this year and purchased one new building for $275,000. The balance sheets from the
current period and prior period included the following balances:

Prior Year Current Year


Accounts receivable, net $ 56,860 $ 45,300
Accounts payable
Inventory

12,900

10,745

186,700

194,320

Using the indirect method, what is the amount of cash provided by operating activities?

A. $202,500
B. $405,205
C. $504,285
Answer (C) is correct.
Net operating cash flow may be determined by adjusting net income.
Depreciation is an expense not directly affecting cash flows that should
be added back to net income. The decrease in accounts payable is
subtracted from net income because it indicates that an expense has been
paid, while the decrease in accounts receivable should be added to net
income. The increase in inventory should be subtracted from net income
because cash was used to purchase the inventory. The dividends paid on
preferred stock are cash outflows from financing, not operating, activities
and do not require an adjustment. Thus, net cash flow from operations is
$504,285 ($456,900 + $45,600 + $11,560 $2,155 $7,620).
D. $521,405

Question: 101

Which one of the following would result in a decrease in cash flow measured under the
indirect method of preparing a statement of cash flows?

A. Amortization expense.
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B. Decrease in income taxes payable.
Answer (B) is correct.
The indirect method reconciles accrual-basis net income to net operating
cash flow. A decrease in income taxes payable implies an operating cash
outflow not reflected in net income. Thus, the reconciling adjustment is a
subtraction from net income. The result is a lower measure of net
operating cash flow.
C. Proceeds from the issuance of common stock.
D. Decrease in inventories.

Question: 102

A statement of cash flows prepared using the indirect method would have cash activities
listed in which one of the following orders?

A.
B.
C.
D.

Financing, investing, operating.


Investing, financing, operating.
Operating, financing, investing.
Operating, investing, financing.
Answer (D) is correct.
A statement of cash flows prepared using either the direct or the indirect
method lists the categories of cash flows in the following order:
operating, investing, and financing.

Question: 103

Which one of the following should be classified as a cash flow from an operating activity on
the statement of cash flows?

A. A decrease in accounts payable during the year.


Answer (A) is correct.
Operating activities are all transactions and other events that are not
financing or investing activities. In general, operating activities involve
the production and delivery of goods and the provision of services. Their
effects normally are reported in earnings. A decrease in accounts payable
indicates a cash outflow to the entitys suppliers in payment for goods or
services.
B. An increase in cash resulting from the issuance of previously authorized
common stock.
C. The payment of cash for the purchase of additional equipment needed for
current production.
D. The payment of a cash dividend from money arising from current
operations.

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Question: 104

The most commonly used method for calculating and reporting a companys net cash flow
from operating activities on its statement of cash flows is the

A. Direct method.
B. Indirect method.
Answer (B) is correct.
The FASB has expressed a preference for the direct method. However, if
the direct method is used, a separate reconciliation based on the indirect
method must be provided in a separate schedule. For this reason, most
entities use the indirect method. The same net operating cash flow is
reported under both methods.
C. Single-step method.
D. Multiple-step method.

Question: 105

The presentation of the major classes of operating cash receipts (such as receipts from
customers) minus the major classes of operating cash disbursements (such as cash paid for
merchandise) is best described as the

A. Direct method of calculating net cash provided or used by operating


activities.
Answer (A) is correct.
The direct method converts the accrual-basis amounts in the income
statement to the cash basis. It then reports the separate categories of gross
cash receipts and disbursements. Net cash flow from operating activities
is the difference between total cash receipts and total cash disbursements.
B. Cash method of determining income in conformity with generally accepted
accounting principles.
C. Format of the statement of cash flows.
D. Indirect method of calculating net cash provided or used by operating
activities.

Question: 106

Larry Mitchell, Bailey Companys controller, is gathering data for the statement of cash flows
for the most recent year end. Mitchell is planning to use the direct method to prepare this
statement and has made the following list of cash inflows for the period:
Collections of $100,000 for goods sold to customers
Securities purchased for investment purposes with an original cost of $100,000 sold
for $125,000
Proceeds from the issuance of additional company stock totaling $10,000
The correct amount to be shown as cash inflows from operating activities is

A. $100,000
Answer (A) is correct.
Cash flows from operating activities are those generated by the firms
major and ongoing activities. They include cash flows from all activities
not classified as investing or financing. Only the $100,000 of collections
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on sales to customers qualifies.
B. $135,000
C. $225,000
D. $235,000

Question: 107

During the year, Deltech, Inc., acquired a long-term productive asset for $5,000 and also
borrowed $10,000 from a local bank. These transactions should be reported on Deltechs
statement of cash flows as

A. Outflows for investing activities, $5,000; inflows from financing activities,


$10,000.
Answer (A) is correct.
The acquisition and disposal of property, plant, equipment, and other
productive assets are investing activities. Borrowing money is a
financing activity. Deltechs transactions should therefore be reported on
its statement of cash flows as a $5,000 outflow for investing activities
and a $10,000 inflow from financing activities.
B. Inflows from investing activities, $10,000; outflows for financing activities,
$5,000.
C. Outflows for operating activities, $5,000; inflows from financing activities,
$10,000.
D. Outflows for financing activities, $5,000; inflows from investing activities,
$10,000.

Question: 108

Atwater Company has recorded the following payments for the current period:

Purchase Trillium stock

$300,000

Dividends paid to Atwater shareholders 200,000


Repurchase of Atwater Company stock 400,000
The amount to be shown in the investing activities section of Atwaters statement of cash
flows should be

A. $300,000
Answer (A) is correct.
Financing activities include paying dividends and treasury stock
transactions. Investing activities include acquiring and disposing of debt
and equity instruments. Thus, the amount to be shown in the investing
activities section of Atwaters statement of cash flows is $300,000.
B. $500,000
C. $700,000
D. $900,000

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Question: 109

Carlson Company has the following payments recorded for the current period:

Dividends paid to Carlson shareholders $150,000


Interest paid on bank loan

250,000

Purchase of equipment

350,000

The total amount of the above items to be shown in the operating activities section of
Carlsons statement of cash flows should be

A. $150,000
B. $250,000
Answer (B) is correct.
Cash flows from operating activities include cash flows from all
activities not classified as investing or financing. Their effects normally
are reported in earnings. Operating cash flows include the payment and
collection of interest, dividends paid are a financing cash outflow, and
the purchase of equipment is an investing activity. Thus, the total amount
to be reported in the operating activities section of the statement of cash
flows is $250,000.
C. $350,000
D. $750,000

Question: 110

Barber Company has recorded the following payments for the current period:

Interest paid on bank loan

$300,000

Dividends paid to Barber shareholders 200,000


Repurchase of Barber stock

400,000

The amount to be shown in the financing activities section of Barbers statement of cash
flows should be

A. $300,000
B. $500,000
C. $600,000
Answer (C) is correct.
The payment and collection of interest are treated as cash flows from
operating activities. Financing activities include paying dividends and
treasury stock transactions. Thus, the amount to be reported in the
financing activities section of the statement of cash flows is $600,000
($200,000 + $400,000).
D. $900,000

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Fact Pattern: Selected financial information for Kristina Company for the year just ended is shown below.
Net income

$2,000,000

Increase in net accounts receivable

300,000

Decrease in inventory

100,000

Increase in accounts payable

200,000

Depreciation expense

400,000

Gain on the sale of available-for-sale securities

700,000

Cash receivable from the issue of common stock

800,000

Cash paid for dividends

80,000

Cash paid for the acquisition of land

1,500,000

Cash received from the sale of available-for-sale securities 2,800,000

Question: 111

Kristinas cash flow from financing activities for the year is

A. $(80,000)
Answer (A) is correct.
Cash flows from financing activities for the year consist of the $80,000
outflow for dividends paid. The issue of common stock is a financing
activity, but the $800,000 of proceeds have not yet been received.
B. $720,000
C. $800,000
D. $3,520,000
Fact Pattern: Selected financial information for Kristina Company for the year just ended is shown below.
Net income
Increase in net accounts receivable

300,000

Decrease in inventory

100,000

Increase in accounts payable

200,000

Depreciation expense

400,000

Gain on the sale of available-for-sale securities

700,000

Cash receivable from the issue of common stock

800,000

Cash paid for dividends


Cash paid for the acquisition of land

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$2,000,000

80,000
1,500,000

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Cash received from the sale of available-for-sale securities 2,800,000

Question: 112

Kristinas cash flow from investing activities for the year is

A. $(1,500,000)
B. $1,220,000
C. $1,300,000
Answer (C) is correct.
Cash flows from investing activities for the year include the $2,800,000
inflow from the sale of available-for-sale securities and the $1,500,000
cash outflow for the purchase of land ($2,800,000 $1,500,000 =
$1,300,000 net cash inflow).
D. $2,800,000

Question: 113

For the fiscal year just ended, Doran Electronics had the following results:

Net income
Depreciation expense

$920,000
110,000

Increase in accounts payable

45,000

Increase in net accounts receivable

73,000

Increase in deferred income tax liability

16,000

Dorans net cash flow from operating activities is

A. $928,000
B. $986,000
C. $1,018,000
Answer (C) is correct.
The following is the net cash flow from operating activities calculated
using the indirect method:
Net income

$ 920,000

Add: increase in accounts payable

45,000

Add: increase in deferred tax liability

16,000

Add: depreciation expense

110,000

Minus: increase in net accounts receivable

(73,000)

Net cash provided by operating activities $1,018,000

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The adjustment from cost of goods sold (an accrual accounting amount
used to calculate net income) to cash paid to suppliers requires two steps:
(1) from cost of goods sold to purchases and (2) from purchases to cash
paid to suppliers. An increase in inventory is subtracted from net income.
It indicates that purchases were greater than cost of goods sold. A
decrease in inventory is added to net income. It indicates that purchases
were less than cost of goods sold. However, the change in inventory is
not given, so it is assumed to be zero. The increase in accounts payable is
added to net income. It indicates that cash paid to suppliers was $45,000
less than purchases. Thus, the net effect of the changes in inventory and
accounts payable is that cash paid to suppliers was $45,000 ($0 +
$45,000) less than the accrual basis cost of goods sold. The increase in a
deferred income tax liability (debit income tax expense, credit deferred
liability) is a noncash item. The adjustment is a $16,000 addition to net
income. Depreciation ($110,000) also is a noncash item that is added to
net income. The net accounts receivable balance increased by $73,000,
implying that cash collections were less than sales. If sales, collections,
write-offs, and recognition of bad debt expense were the only relevant
transactions, $73,000 should be subtracted from net income. Use of the
change in net accounts receivable as a reconciliation adjustment is a
short-cut method. It yields the same net adjustment to net income as
separately including the effects of the change in gross accounts
receivable, bad debt expense (a noncash item resulting in an addition),
and bad debt write-offs (reflecting that write-offs did not result in
collections).
D. $1,074,000

Question: 114

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 Jamesons statement of cash flows as

A.
B.
C.
D.

Zero.
$50,000
$100,000
$150,000
Answer (D) is correct.
The statement of cash flows reports the cash effects of transactions. The
accrual-basis gain on the stock is not relevant.

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Question: 115

Madden Corporations controller has gathered the following information as a basis for
preparing the statement of cash flows. Net income for the current year was $82,000. During
the year, old equipment with a cost of $60,000 and a net carrying amount of $53,000 was
sold for cash at a gain of $10,000. New equipment was purchased for $100,000. Shown
below are selected closing balances for last year and the current year.

Last Year

Current Year

$ 39,000

$ 85,000

Accounts receivable net

43,000

37,000

Inventories

93,000

105,000

Equipment

360,000

400,000

70,000
22,000
100,000
250,000
93,000

83,000
19,000
100,000
250,000
175,000

Cash

Accumulated depreciation -- equipment


Accounts payable
Notes payable
Common stock
Retained earnings

Maddens net cash flow from operating activities for the current year is

A. $63,000
B. $73,000
C. $83,000
Answer (C) is correct.
The net operating cash flow may be determined by reconciling it with net
income.
Net income

$ 82,000

Add: decrease in receivables

6,000

Add: depreciation expense

20,000

Minus: increase in inventories

(12,000)

Minus: decrease in payables

(3,000)

Minus: gain on sale of equipment

(10,000)

Net cash provided by operating activities $ 83,000


The net accounts receivable balance declined by $6,000 ($43,000
$37,000), implying that cash collections exceeded sales. Assuming that
sales, collections, write-offs, and recognition of bad debt expense were
the only relevant transactions, $6,000 should be added to net income.
Use of the change in net accounts receivable as a reconciliation
adjustment is a short-cut method. It yields the same net adjustment to net
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income as separately including the effects of the change in gross
accounts receivable, bad debt expense (a noncash item), and bad debt
write-offs.
Equipment costing $60,000 and having a carrying amount of $53,000
was sold on January 1, Year 6, for $63,000 in cash. Thus, the debit to
accumulated depreciation must have been $7,000 ($60,000 $53,000).
During the year, Madden must have recognized $20,000 of depreciation
[$83,000 acc. dep. year end ($70,000 acc. dep. begin. of yr. $7,000
acc. dep. on sold equip.)]. The depreciation should be added to net
income because it is included in net income but had no cash effect.
The adjustment from cost of goods sold (an accrual accounting amount
used to calculate net income) to cash paid to suppliers requires two steps:
(1) from cost of goods sold to purchases and (2) from purchases to cash
paid to suppliers. The $12,000 ($105,000 $93,000) increase in
inventory is subtracted from net income. It indicates that purchases were
$12,000 greater than cost of goods sold. The decrease in accounts
payable is subtracted from net income. It indicates that cash paid to
suppliers was $3,000 greater than purchases. Thus, the net effect of the
changes in inventory and accounts payable is that cash paid to suppliers
was $15,000 ($12,000 + $3,000) less than the accrual basis cost of goods
sold. The $10,000 gain on the sale of equipment is subtracted from net
income because it is a cash inflow from an investing, not an operating,
activity.
D. $93,000

Fact Pattern: Selected financial information for Kristina Company for the year just ended is shown below.
Net income

$2,000,000

Increase in net accounts receivable

300,000

Decrease in inventory

100,000

Increase in accounts payable

200,000

Depreciation expense

400,000

Gain on the sale of available-for-sale securities

700,000

Cash receivable from the issue of common stock

800,000

Cash paid for dividends


Cash paid for the acquisition of land

80,000
1,500,000

Cash received from the sale of available-for-sale securities 2,800,000

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Question: 116

Assuming the indirect method is used, Kristinas cash flow from operating activities for the
year is

A. $1,700,000
Answer (A) is correct.
The following is the net cash flow from operating activities calculated
using the indirect method:
Net income

$2,000,000

Add: decrease in inventory

100,000

Add: increase in accounts payable

200,000

Add: depreciation expense

400,000

Minus: increase in net accounts receivable

(300,000)

Minus: gain on sale of securities

(700,000)

Net cash provided by operating activities $1,700,000

The adjustment from cost of goods sold (an accrual accounting amount
used to calculate net income) to cash paid to suppliers requires two steps:
(1) from cost of goods sold to purchases and (2) from purchases to cash
paid to suppliers. The $100,000 decrease in inventory is added to net
income. It indicates that purchases were $100,000 less than cost of goods
sold. The $200,000 increase in accounts payable is added to net income.
It indicates that cash paid to suppliers was $200,000 less than purchases.
Thus, the net effect of the changes in inventory and accounts payable is
that cash paid to suppliers was $300,000 ($100,000 + $200,000) less than
the accrual basis cost of goods sold. Depreciation expense ($300,000) is
a noncash item included in net income. Hence, it is subtracted from net
income. The net accounts receivable balance increased by $300,000,
implying that cash collections were less than sales. If sales, collections,
write-offs, and recognition of bad debt expense were the only relevant
transactions, $300,000 should be subtracted from net income. Use of the
change in net accounts receivable as a reconciliation adjustment is a
short-cut method. It yields the same net adjustment to net income as
separately including the effects of the change in gross accounts
receivable, bad debt expense (a noncash item resulting in an addition),
and bad debt write-offs (a subtraction to reflect that write-offs did not
result in collections). The sale of securities is an investing activity. It also
is subtracted from net income.
B. $2,000,000
C. $2,400,000
D. $3,100,000

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Question: 117

ABC operates a catering service that specializes in business luncheons for large
corporations. ABC requires customers to place their orders 2 weeks in advance of the
scheduled events. ABC bills its customers on the 10th day of the month following the date of
service and requires that payment be made within 30 days of the billing date. Conceptually,
ABC should recognize revenue from its catering services at the date when a

A. Customer places an order.


B. Luncheon is served.
Answer (B) is correct.
Revenues should be recognized when (1) realized or realizable and (2)
earned. The most common time at which these two conditions are met is
when goods are delivered or services are rendered.
C. Billing is mailed.
D. Customers payment is received.

Question: 118

A company provides fertilization, insect control, and disease control services for a variety of
trees, plants, and shrubs on a contract basis. For $50 per month, the company will visit the
subscribers premises and apply appropriate mixtures. If the subscriber has any problems
between the regularly scheduled application dates, the companys personnel will promptly
make additional service calls to correct the situation. Some subscribers elect to pay for an
entire year because the company offers an annual price of $540 if paid in advance. For a
subscriber who pays the annual fee in advance, the company should recognize the related
revenue

A. When the cash is collected.


B. Evenly over the year as the services are performed.
Answer (B) is correct.
Revenues should be recognized when (1) realized or realizable and (2)
earned. The most common time at which these two conditions are met is
when goods are delivered or services are rendered. In the situation
presented, the performance of the service (monthly spraying) is so
significant to creating a sufficient probability of a flow of future
economic benefits that it should be the triggering event for revenue
recognition.
C. At the end of the contract year after all of the services have been
performed.
D. At the end of the fiscal year.

Question: 119

On February 1, Year 1, a computer software firm agrees to program a software package.


Twelve payments of $10,000 on the first of each month are to be made, with the first
payment March 1, Year 1. The software is accepted by the client June 1, Year 2. How much
Year 1 revenue should be recognized?

A. $0
Answer (A) is correct.
Revenues should be recognized when (1) realized or realizable and (2)
earned. Because the software firm has not substantially fulfilled its
obligation, the earning process has not been substantially completed in
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Year 1. Accordingly, a liability should be recognized because the entity
has a current obligation arising from a past event that will require an
outflow of economic benefits, that is, to deliver the software or to refund
the customers money. Thus, a liability for $100,000 and revenue of $0
should be recognized for Year 1.
B. $100,000
C. $110,000
D. $120,000

Question: 120

An airline should recognize revenue from airline tickets in the period when

A.
B.
C.
D.

Passenger reservations are booked.


Passenger reservations are confirmed.
Tickets are issued.
Related flights occur.
Answer (D) is correct.
Revenues should be recognized when (1) realized or realizable and (2)
earned. Although the benefits of the service rendered are reliably
measurable on the date the reservations are booked, the earning process
is not substantially completed until the airline has fulfilled its obligation,
that is, when the related flights occur.

Question: 121

A department store sells gift certificates that may be redeemed for merchandise. Each
certificate expires 3 years after issuance. The revenue from the gift certificates should be
recognized

A.
B.
C.
D.

Evenly over 3 years from the date of issuance.


In the period the certificates are sold.
In the period the certificates expire.
In the period the certificates are redeemed or in the period they expire if
they are allowed to lapse.
Answer (D) is correct.
Revenues should be recognized when (1) realized or realizable and (2)
earned. These criteria are met when the certificates are redeemed or
expire.

Question: 122

To comply with the matching principle, the cost of labor services of an employee who
participates in the manufacturing of a product normally should be charged to the income
statement in the period in which the

A.
B.
C.
D.
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Work is performed.
Employee is paid.
Product is completed.
Product is sold.
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Answer (D) is correct.
The matching principle states that expenses should be recognized in the
same period as the revenues that those expenses helped produce.
Revenues related to the employees labor are not recognized until the
goods are sold.

Question: 123

Revenues of an entity are usually measured by the exchange values of the assets or
liabilities involved. Recognition of revenue does not occur until

A. The revenue is realizable.


B. The revenue is realized and earned.
Answer (B) is correct.
According to the FASBs conceptual framework, revenues should be
recognized when they are realized or realizable and earned. Revenues are
realized when products, merchandise, or other assets are exchanged for
cash or claims to cash. Revenues are realizable when related assets
received or held are readily convertible to known amounts of cash or
claims to cash. Revenues are earned when the entity has substantially
accomplished what it must do to be entitled to the benefits represented by
the revenues.
C. Products or services are exchanged for cash or claims to cash.
D. The entity has substantially accomplished what it agreed to do.

Question: 124

Robin Gavaskar, who recently founded a company that produces baseball bats and balls,
wants to determine her companys policy for revenue recognition. According to the revenue
recognition principle, the mostappropriate time to recognize revenue would be when

A. The sale occurs.


Answer (A) is correct.
Revenues are normally recognized when they are realized or realizable
and earned. Revenues are realized (or realizable) when goods or services
have been exchanged for cash or claims to cash (assets readily
convertible to cash). Revenues are earned when the earning process is
substantially complete, and the entity is entitled to the resulting benefits
or revenues. The revenue recognition criteria are ordinarily met at the
point of sale (time of delivery of goods or services).
B. Cash is received.
C. Production is completed.
D. Quarterly financial statements are prepared.

Question: 125

For financial statement purposes, the installment method of accounting may be used if the

A. Collection period extends over more than 12 months.


B. Installments are due in different years.
C. Ultimate amount collectible is indeterminate.
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Answer (C) is correct.
Profits from sales in the ordinary course of business usually should be
recognized at the time of sale unless collection of the sales price is not
reasonably assured. When receivables are collected over an extended
period and, because of the terms of the transaction or other conditions, no
reasonable basis exists for estimating the degree of collectibility, the
installment method or the cost-recovery method of accounting may be
used.
D. Percentage-of-completion method is inappropriate.

Question: 126

It is proper to recognize revenue prior to the sale of merchandise when


I. The revenue will be reported as an installment sale.
II. The revenue will be reported under the cost-recovery method.

A.
B.
C.
D.

I only.
II only.
Both I and II.
Neither I nor II.
Answer (D) is correct.
The installment method recognizes income on a sale as the related
receivable is collected. Under the cost-recovery method, profit is
recognized only after collections exceed the cost of the item sold.

Question: 127

Several of Fox, Inc.s customers are having cash flow problems. Information pertaining to
these customers for the years ended March 31, Year 7 and Year 8 follows:

3/31/Yr 7 3/31/Yr 8
Sales

$10,000 $15,000

Cost of sales

8,000

9,000

on Year 7 sales

7,000

3,000

on Year 8 sales

--

Cash collections

12,000

If the cost-recovery method is used, what amount would Fox report as gross profit from
sales to these customers for the year ended March 31, Year 8?

A. $2,000
B. $3,000
C. $5,000
Answer (C) is correct.
The cost-recovery method recognizes profit only after collections exceed
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the cost of the item sold, that is, when the full cost has been recovered.
Subsequent amounts collected are treated entirely as revenue (debit cash
and deferred gross profit, credit the receivable and realized gross profit).
The sum of collections in excess of costs to be recognized as gross profit
is $5,000 {[$3,000 Year 8 collections on Year 7 sales ($8,000 cost
$7,000 Year 7 collections on Year 7 sales)] + ($12,000 collections on
Year 8 sales $9,000 cost)}.
D. $15,000

Question: 128

Paulson Company uses the percentage-of-completion method to account for long-term


construction contracts. The following information relates to a contract that was awarded at a
price of $700,000. The estimated costs were $500,000, and the contract duration was 3
years.

Year 1
Cumulative cost to date

Year 2

Year 3

$300,000 $390,000 $530,000

Costs to complete at year end 250,000 130,000


-Progress billings
325,000 220,000 155,000
Collections on account
300,000 200,000 200,000
Assuming that $65,000 was recognized as gross profit in Year 1, the amount of gross profit
Paulson recognized in Year 2 was

A. $35,000
B. $70,000
Answer (B) is correct.
Determining the annual recognized gross profit requires calculation of
the estimated total gross profit.
Year 1
Contract price

Year 2

$700,000 $700,000

Minus: estimated total costs


Costs to date

$300,000 $390,000

Estimated costs to complete 250,000 130,000


Estimated total costs

$550,000 $520,000

Estimated total gross profit $150,000 $180,000


The completion percentage for Year 2 is the ratio of costs incurred to
date to estimated total costs ($390,000 $520,000 = 75%). The
cumulative gross profit recognized at the end of Year 2 is therefore
$135,000 ($180,000 75%). Because $65,000 was recognized in Year 1,
the amount recognized in Year 2 is $70,000 ($135,000 $65,000).
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C. $135,000
D. $170,000

Question: 129

The calculation of the income recognized in the third year of a 5-year construction contract
accounted for using the percentage-of-completion method includes the ratio of

A.
B.
C.
D.

Costs incurred in Year 3 to total billings.


Costs incurred in Year 3 to total estimated costs.
Total costs incurred to date to total billings.
Total costs incurred to date to total estimated costs.
Answer (D) is correct.
The percentage-of-completion method recognizes gross profit or revenue
based on the ratio of costs to date to estimated total costs. (This
relationship is the recommended but not the only basis for determining
progress.)

Question: 130

A company appropriately uses the completed-contract method to account for a long-term


construction contract. Revenue is recognized when progress billings are

Recorded Collected
A. No Yes
B. Yes Yes
C. Yes No
D. No No
Answer (D) is correct.
GAAP require that revenue be recognized when it is realized or
realizable and earned. Under the completed-contract method, revenue
recognition is appropriate only at the completion of the contract. Neither
the recording nor the collection of progress billings affects this
recognition.

Question: 131

A building contractor has a fixed-price contract to construct a large building. It is estimated


that the building will take 2 years to complete. Progress billings will be sent to the customer
at quarterly intervals. Which of the following describes the preferable point for revenue
recognition for this contract if the outcome of the contract can be estimated reliably?

A. After the contract is signed.


B. As progress is made toward completion of the contract.
Answer (B) is correct.
Under the percentage-of-completion method, revenues and expenses are
recognized based on the stage of completion at the balance sheet date if
the outcome of the contract can be estimated reliably. For a fixed-price
contract, the outcome can be estimated reliably if (1) total revenue can be
measured reliably, (2) it is probable that the economic benefits of the
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contract will flow to the enterprise, (3) contract costs to complete and
stage of completion can be measured reliably, and (4) contract costs can
be clearly identified and measured reliably so that actual and estimated
costs can be compared.
C. As cash is received.
D. When the contract is completed.

Question: 132

How should the balances of progress billings and construction in progress be shown at
reporting dates prior to the completion of a long-term contract?

A. Progress billings as deferred income, construction in progress as a deferred


expense.
B. Progress billings as income, construction in progress as inventory.
C. Net, as a current asset if debit balance and current liability if credit balance.
Answer (C) is correct.
The difference between construction in progress (costs and recognized
gross profit) and progress billings to date must be reported as a current
asset if construction in progress exceeds total billings, and as a current
liability if billings exceed construction in progress. Separate recognition
is required for each project.
D. Net, as gross profit from construction if credit balance, and loss from
construction if debit balance.

Question: 133

During Year 1, Tidal Co. began construction on a project scheduled for completion in Year
3. At December 31, Year 1, an overall loss was anticipated at contract completion. What
would be the effect of the project on Year 1 operating income under the percentage-ofcompletion method and the completed-contract method?

Percentage-ofCompletion Completed-Contract
A. No effect No effect
B. No effect Decrease
C. Decrease No effect
D. Decrease Decrease
Answer (D) is correct.
When the current estimate of total contract costs indicates a loss, an
immediate provision for the entire loss should be made regardless of
method. Thus, under either method, Year 1 operating income is
decreased by the projected loss.

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Question: 134

A company began work on a long-term construction contract in Year 1. The contract price
was $3,000,000. Year-end information related to the contract is as follows:

Year 1

Year 2

Year 3

Estimated total cost $2,000,000 $2,000,000 $2,000,000


Cost incurred

700,000

900,000

400,000

Billings

800,000

1,200,000

1,000,000

Collections

600,000

1,200,000

1,200,000

Under the percentage-of-completion method, the gross profit to be recognized in Year 1 is

A.
B.
C.
D.

$(100,000)
$100,000
$200,000
$350,000
Answer (D) is correct.
The percentage-of-completion method recognizes revenue based on the
stage of completion of the contract. One typical method for estimating
the stage of completion is the calculation of ratio of the contract costs
incurred to date to the estimated total costs. The percentage-ofcompletion at year-end on the cost-to-cost basis is 35% ($700,000
$2,000,000). The gross profit for Year 1 is the anticipated gross profit on
the contract times the completion percentage. Thus, profit for Year 1 is
$350,000 [($3,000,000 $2,000,000) 35%].



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Question: 135

The measurement basis most often used to report a long-term payable representing a
commitment to pay money at a determinable future date is

A.
B.
C.
D.

Historical cost.
Current cost.
Net realizable value.
Present value of future cash flows.
Answer (D) is correct.
The measurement basis most commonly adopted by entities in preparing
their financial statements is historical cost. However, it is usually
combined with other measurement bases (attributes). The attribute used
to measure a long-term receivable or payable is the present or discounted
value of its future cash flows.

Question: 136

Statements of financial position on December 31, Year 1, and December 31, Year 2, are
presented below:

Dec. 31,
Year 1

Dec. 31,
Year 2

$ 50,000

$ 60,000

Assets:
Cash
Accounts receivable
Allowance for uncollectible accounts
Inventory
Property, plant, and equipment
Accumulated depreciation

95,000
(4,000)
120,000
295,000
(102,000)

89,000
(3,000)
140,000
340,000
(119,000)

Total Assets

$ 454,000

$ 507,000

Liabilities and equity:


Trade accounts payable
Interest payable
Bonds payable
Unamortized bond discount
Equity

$ 62,000
8,000
200,000
(15,000)
199,000

$ 49,000
11,000
200,000
(10,000)
257,000

Total liabilities and equity

$ 454,000

$ 507,000

Additional information for Year 2:


1.

Sales revenue was $338,000.

2.

$3,000 of accounts receivable was written off.

Cash collections from customers in Year 2 were

A. $341,000

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Answer (A) is correct.
Cash collections from customers equals beginning accounts receivable,
plus sales revenue, minus accounts written off, minus ending accounts
receivable. In Year 2, cash collections from customers were $341,000
($95,000 + $338,000 $3,000 $89,000).
B. $338,000
C. $344,000
D. $335,000

Question: 137

An analysis of an entitys $150,000 accounts receivable at year end resulted in a $5,000


ending balance for its allowance for uncollectible accounts and a bad debt expense of
$2,000. During the past year, recoveries on bad debts previously written off were correctly
recorded at $500. If the beginning balance in the allowance for uncollectible accounts was
$4,700, what was the amount of accounts receivable written off as uncollectible during the
year?

A. $1,200
B. $1,800
C. $2,200
Answer (C) is correct.
Under the allowance method, uncollectible accounts are written off by a
debit to the allowance and a credit to accounts receivable. The $500 of
recovered bad debts is accounted for by a debit to accounts receivable
and a credit to the allowance. The $2,000 bad debt expense is also
credited to the allowance. The amount of accounts receivable written off
can be calculated as follows:
Beginning allowance $4,700
Bad debt expense
Recoveries

2,000
500

Ending allowance

(5,000)

A/R written off

$2,200

D. $2,800

Question: 138

The following information applies to Nichola Manufacturing Company, which has a 6-month
operating cycle:

Cash sales

$100,000

Credit sales during the sixth month with net 30 days terms
Credit sale during the fifth month with special terms of net 9 months
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Interest earned and accrued on an investment that matures during month 3
of the next cycle

2,000

The total of Nicholas trade accounts receivable at the end of the current cycle is

A. $152,000
B. $160,000
Answer (B) is correct.
A receivable classified as current on the statement of financial position is
expected to be collected within the current operating cycle or 1 year,
whichever is longer. The total of the trade accounts receivable at the end
of the current cycle is therefore $160,000 ($150,000 + $10,000).
C. $260,000
D. $262,000

Question: 139

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

Net Income Total Current Assets


A. Decrease Decrease
B. No effect Decrease
C. Decrease No effect
D. No effect No effect
Answer (D) is correct.
Johnson uses the allowance method. Thus, when a specific amount is
written off, the journal entry is
Allowance for doubtful accounts $10,000
Accounts receivable

$10,000

The write-off of a bad debt has no effect on expenses, net income, and
total current assets.

Question: 140

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

A. $300,000

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Answer (A) is correct.
Bad debt expense is based on the income statement approach. It treats
bad debt expense as a function of sales on account. Thus, it is projected
to be $300,000 ($10,000,000 3%). The entry to record bad debt
expense is
Bad debt expense

$300,000

Allowance for doubtful accounts

$300,000

B. $260,000
C. $240,000
D. $160,000

Question: 141

The following information has been compiled by Able Manufacturing Company:


Sale of company products for the period to customers with net 30-day terms
amounting to $150,000.
Sale of company products for the period to a customer, supported by a note for
$25,000, with special terms of net 180 days.
Balance of trade receivables at the end of the last period was $300,000.
Collections of open trade receivables during the period was $200,000.
Rental income for the period, both earned and accrued but not yet collected, from
the Able Employees Credit Union for use of company facilities was $2,000.
The open trade receivables balance to be shown on the statement of financial position
for the period is

A. $250,000
Answer (A) is correct.
The open trade receivables balance is calculated as follows:
Previous ending balance

$300,000

Add: sales to customers (terms net 30) 150,000


Minus: collections during period
Open trade receivables reported

(200,000)
$250,000

B. $252,000
C. $275,000
D. $277,000

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Question: 142

The following information relates to Jay Co.s accounts receivable for the year just ended:

Accounts receivable, 1/1

$ 650,000

Credit sales for the year

2,700,000

Sales returns for the year

75,000

Accounts written off during the year

40,000

Collections from customers during the year 2,150,000


Estimated future sales returns at 12/31

50,000

Estimated uncollectible accounts at 12/31

110,000

What amount should Jay report for accounts receivable, before allowances for sales returns
and uncollectible accounts, at December 31?

A. $1,200,000
B. $1,125,000
C. $1,085,000
Answer (C) is correct.
The ending balance in accounts receivable consists of the $650,000
beginning debit balance, plus debits for $2,700,000 of credit sales, minus
credits for $2,150,000 of collections, $40,000 of accounts written off,
and $75,000 of sales returns.
Accounts Receivable (in 000s)
1/1
$ 650
Credit sales 2,700
12/31

75 Sales returns
2,150 Collections
40 Write-offs

$1,085

The $110,000 of estimated uncollectible receivables and the $50,000 of


estimated sales returns are not relevant because they affect the allowance
accounts but not gross accounts receivable.
D. $925,000

Question: 143

A shoe retailer allows customers to return shoes within 90 days of purchase. The company
estimates that 5% of sales will be returned within the 90-day period. During the month, the
company has sales of $200,000 and returns of sales made in prior months of $5,000. What
amount should the company record as net sales revenue for new sales made during the
month?

A. $185,000
B. $190,000

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Answer (B) is correct.
The company has $200,000 of sales and estimates that 5% of sales will
be returned. Thus, the company will recognize $10,000 ($200,000 5%)
for sales returns (contra revenue) and for a corresponding allowance for
sales returns (contra asset). This amount is subtracted from total sales to
find net sales revenue of $190,000 ($200,000 $10,000).
C. $195,000
D. $200,000

Question: 144

An internal auditor is deriving cash flow data based on an incomplete set of facts. Bad debt
expense was $2,000. Additional data for this period follows:

Credit sales

$100,000

Gross accounts receivable -- beginning balance

5,000

Allowance for bad debts -- beginning balance

(500)

Accounts receivable written off

1,000

Increase in net accounts receivable (after subtraction of allowance for bad


debts)

30,000

How much cash was collected this period on credit sales?

A. $64,000
B. $68,000
Answer (B) is correct.
The beginning balance of gross accounts receivable (A/R) was $5,000
(debit). Thus, net beginning A/R was $4,500 ($5,000 $500 credit in the
allowance for bad debts). The allowance was credited for the $2,000 bad
debt expense. Accordingly, the ending allowance (credit) was $1,500
($500 $1,000 write-off + $2,000). Given a $30,000 increase in net A/R,
ending net A/R must have been $34,500 ($4,500 beginning net A/R +
$30,000), with ending gross A/R of $36,000 ($34,500 + $1,500).
Collections were therefore $68,000 ($5,000 beginning gross A/R
$1,000 write-off + $100,000 credit sales $36,000 ending gross A/R).
Gross A/R
$

5,000 Beg. Bal. $ 1,000 Write-off

100,000 Cr. Sales

68,000 Collections

$ 36,000 End. Bal.

C. $68,500
D. $70,000
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Question: 145

Marr Co. had the following sales and accounts receivable balances, prior to any
adjustments at year end:

Credit sales
Accounts receivable
Allowance for uncollectible accounts

$10,000,000
3,000,000
50,000

Marr uses 3% of accounts receivable to determine its allowance for uncollectible accounts
at year end. By what amount should Marr adjust its allowance for uncollectible accounts at
year end?

A. $0
B. $40,000
Answer (B) is correct.
The entity uses the percentage of accounts receivable method to estimate
the allowance. The year-end balance should be $90,000 ($3,000,000 A/R
3%). Hence, the year-end adjustment is $40,000 ($90,000 $50,000)
unadjusted balance.
C. $90,000
D. $140,000

Question: 146

When the allowance method of recognizing uncollectible accounts is used, the entry to
record the write-off of a specific account

A. Decreases both accounts receivable and the allowance for uncollectible


accounts.
Answer (A) is correct.
When an account receivable is written off, both accounts receivable and
the allowance for uncollectible accounts are decreased. If an account
previously written off is collected, the account must be reinstated by
increasing both accounts receivable and the allowance. The account
receivable is then decreased by the amount of cash collected.
B. Decreases accounts receivable and increases the allowance for
uncollectible accounts.
C. Increases the allowance for uncollectible accounts and decreases net
income.
D. Decreases both accounts receivable and net income.

Question: 147

Wren Company had the following account balances at December 31:

Accounts receivable

$ 900,000

Allowance for uncollectible accounts


(before any provision for the year
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uncollectible accounts expense)

16,000

Credit sales for the year

1,750,000

Wren is considering the following methods of estimating uncollectible accounts expense for
the year:
Based on credit sales at 2%
Based on accounts receivable at 5%
What amount should Wren charge to uncollectible accounts expense under each method?

Percentage of
Percentage of
Credit Sales Accounts Receivable
A. $51,000 $45,000
B. $51,000 $29,000
C. $35,000 $45,000
D. $35,000 $29,000
Answer (D) is correct.
Uncollectible accounts expense is estimated in two ways. One
emphasizes asset valuation, while the other emphasizes income
measurement. The first is based on an aging of the receivables to
determine the balance in the allowance for uncollectible accounts. Bad
debt expense is the amount necessary to adjust the allowance account to
this estimated balance. The second recognizes bad debt expense as a
percentage of sales. The corresponding credit is to the allowance for
uncollectible accounts. Under the first method, if uncollectible accounts
are estimated to be 5% of gross accounts receivable, the allowance
account should have a balance of $45,000 ($900,000 5%), and the
entry is to debit uncollectible accounts expense and credit the allowance
for $29,000 ($45,000 $16,000 existing balance). Under the second
method, bad debt expense is $35,000 ($1,750,000 2%).

Question: 148

On March 31, Vale Co. had an unadjusted credit balance of $1,000 in its allowance for
uncollectible accounts. An analysis of Vales trade accounts receivable at that date revealed
the following:

Estimated
Age

Amount

0-30 days $60,000

Uncollectible
5%

31-60 days

4,000

10%

Over 60 days

2,000

70%

What amount should Vale report as allowance for uncollectible accounts in its March 31
balance sheet?

A. $4,800
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Answer (A) is correct.
The aging schedule determines the balance in the allowance for
uncollectible accounts. Of the accounts that are no more than 30 days
old, the amount uncollectible is $3,000 ($60,000 5%). Accounts that
are 31-60 days old and over 60 days old have estimated uncollectible
balances of $400 ($4,000 10%) and $1,400 ($2,000 70%),
respectively. Hence, the amount recorded in the allowance for
uncollectible accounts is $4,800 ($3,000 + $400 + $1,400). The $1,000
balance already in the account is disregarded because the aging schedule
determines the balance that should be in the account.
B. $4,000
C. $3,800
D. $3,000

Question: 149

Which method of recording uncollectible accounts expense is consistent with accrual


accounting?

Allowance Direct Write-Off


A. Yes Yes
B. Yes No
Answer (B) is correct.
The allowance method attempts both to match the expense with the
related revenue and to determine the NRV of the accounts receivable.
This method is acceptable under GAAP. The direct write-off method
debits expense and credits accounts receivable at the time uncollectibility
is established. This method does not match revenue and expense or state
receivables at NRV. It is not acceptable under GAAP.
C. No Yes
D. No No
Question: 150

Under the allowance method of recognizing uncollectible accounts, the entry to write-off an
uncollectible account

A. Increases the allowance for uncollectible accounts.


B. Has no effect on the allowance for uncollectible accounts.
C. Has no effect on net income.
Answer (C) is correct.
The entry to record bad debt expense under the allowance method is to
debit bad debt expense and credit the allowance account. When a specific
account is then written off, the allowance is debited and accounts
receivable credited. Net income is affected when bad debt expense is
recognized, not at the time of the write-off. Because accounts receivable
and the allowance account are decreased by the same amount, a write-off
of an account also has no effect on the net amount of accounts
receivable.

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D. Decreases net income.

Question: 151

The following accounts were abstracted from Roxy Co.s unadjusted trial balance at
December 31:

Debit
Accounts receivable

Credit

$1,000,000

Allowance for uncollectible accounts

8,000

Net credit sales

$3,000,000

Roxy estimates that 3% of the gross accounts receivable will become uncollectible. After
adjustment at December 31, the allowance for uncollectible accounts should have a credit
balance of

A.
B.
C.
D.

$90,000
$82,000
$38,000
$30,000
Answer (D) is correct.
The allowance for uncollectible accounts at year end should have a credit
balance of $30,000. This amount is equal to the $1 million of accounts
receivable multiplied by the 3% that are estimated to become
uncollectible.

Question: 152

Mill Co.s allowance for uncollectible accounts was $100,000 at the end of Year 2 and
$90,000 at the end of Year 1. For the year ended December 31, Year 2, Mill reported bad
debt expense of $16,000 in its income statement. What amount did Mill debit to the
appropriate account in Year 2 to write off actual bad debts?

A. $6,000
Answer (A) is correct.
When uncollectible accounts are written off, a debit is made to the
allowance and a credit to accounts receivable. The beginning balance in
the allowance account is $90,000, the ending balance is $100,000, and
the bad debt expense is $16,000. Because write-offs equal the beginning
balance, plus the bad debt expense, minus the ending balance, $6,000 of
accounts must have been written off.
Allowance
Write-offs $6,000

$ 90,000 12/31/Yr 1
16,000 Bad debt expense
$100,000 12/31/Yr 2

B. $10,000
C. $16,000
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D. $26,000

Question: 153

DEF is the consignee for 1,000 units of product X for ABC Company. ABC should recognize
the revenue from these 1,000 units when

A.
B.
C.
D.

The agreement between DEF and ABC is signed.


ABC ships the goods to DEF.
DEF receives the goods from ABC.
DEF sells the goods and informs ABC of the sale.
Answer (D) is correct.
Under a consignment arrangement, the consignor ships goods to the
consignee, who acts as sales agent for the consignor. The goods are in the
physical possession of the consignee but remain the property of the
consignor and are included in the consignors inventory. Revenue and the
related cost of goods sold from consigned goods are recognized by the
consignor only when the merchandise is sold and delivered to the final
customer. Accordingly, recognition occurs when notification is received
that the consignee has sold the goods.

Question: 154

An entity had the following account balances in the pre-closing trial balance:

Opening inventory $100,000


Closing inventory

150,000

Purchases

400,000

Transportation-in

6,000

Purchase discounts

40,000

Purchase allowances

15,000

Returned purchases

5,000

The entity had net purchases for the period of

A. $340,000
B. $346,000
Answer (B) is correct.
Purchase discounts, allowances, and returns are subtractions from
purchases because they are reductions of cost. Transportation-in is an
addition because it increases cost. Thus, net purchases equals $346,000
($400,000 + $6,000 $40,000 $15,000 $5,000).
C. $370,000
D. $376,000

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Question: 155

A physical inventory count showed an entity had inventory costing $1,000,000 on hand at
December 31, Year 1. Excluded from this amount were the following:
Goods costing $82,000, shipped to a customer free on board (FOB) shipping point
on December 28, Year 1. They were expected to be received by the customer on
January 4, Year 2.
Goods costing $122,000, shipped to a customer free on board (FOB) destination
December 30, Year 1. They were expected to be received by the customer on
January 5, Year 2.
Compute the correct ending inventory to be reported on the shippers statement of
financial position at December 31, Year 1.

A. $1,000,000
B. $1,082,000
C. $1,122,000
Answer (C) is correct.
The goods shipped FOB shipping point should be counted in the buyers,
not the sellers, inventory because title and risk of loss pass at the time
and place of shipment. These goods were properly excluded from ending
inventory. The goods shipped FOB destination were improperly excluded
from the sellers ending inventory. The title and risk of loss did not pass
until the time and place where the goods reached their destination and
were duly tendered. Thus, the correct ending inventory is $1,122,000
($1,000,000 beginning balance + $122,000 goods shipped FOB
destination).
D. $1,204,000

Question: 156

The following selected data from statements of financial position on December 31, Year 1,
and December 31, Year 2, are presented below:

12/31/Year 1 12/31/Year 2
Inventory

$120,000

$140,000

62,000

49,000

Trade accounts payable


Additional information for Year 2:
1.

Cash payments to suppliers of merchandise were $180,000.

Cost of goods sold in Year 2 was

A. $147,000
Answer (A) is correct.
Cost of goods sold equals beginning inventory, plus purchases, minus
ending inventory. To determine cost of goods sold, purchases must be
calculated. Purchases equal $167,000 ($49,000 ending accounts payable
+ $180,000 payments to suppliers $62,000 beginning accounts

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payable). Thus, cost of goods sold equals $147,000 ($120,000 beginning
inventory + $167,000 purchases $140,000 ending inventory).
B. $160,000
C. $167,000
D. $180,000

Question: 157

An entity with a December 31 year end purchased $2,000 of inventory on account. The
seller was responsible for delivery to the shipping point, with freight of $50 paid at
destination by the buyer. The invoice date was December 27, Year 1, and the goods arrived
on January 3, Year 2.
Now assume the terms required the seller to deliver to the destination instead of the
shipping point. What is the correct amount of inventory and freight-in relating to this
purchase on the Year 1 financial statements?

Inventory Freight-In
A. $0 $0
Answer (A) is correct.
Title and risk of loss passed to the buyer at the destination, and the seller
incurred the expense of delivery to that point. The goods did not arrive
until after year end, so they should not be included in Year 1 inventory.
Freight-in should also not be recorded until Year 2.
B. $2,050 $0
C. $0 $50
D. $2,000 $50

Question: 158

A retail entity maintains a markup of 25% based on cost. The entity has the following
information for the current year:

Purchases of merchandise $690,000


Freight-in on purchases
Sales

25,000
900,000

Ending inventory

80,000

Beginning inventory was

A. $40,000
B. $85,000
Answer (B) is correct.
Cost of goods sold for a period equals beginning inventory, plus
purchases, plus freight-in, minus ending inventory. Given that sales
reflect 125% of cost, cost of goods sold must equal $720,000 ($900,000

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sales 1.25). Consequently, the beginning inventory must have been
$85,000 ($720,000 COGS + $80,000 EI $690,000 purchases $25,000
freight-in).
C. $110,000
D. $265,000

Fact Pattern: An entity had the following opening and closing inventory balances during the current year:
1/1

12/31

Finished goods

$ 90,000

$260,000

Raw materials

105,000

130,000

Work-in-progress

220,000

175,000

The following transactions and events occurred during the current year:
$300,000 of raw materials were purchased, of which $20,000 were returned because of defects.
$600,000 of direct labor costs were incurred.
$750,000 of production overhead costs were incurred

Question: 159

If the entitys raw materials inventory as of December 31 of the current year (ending
inventory) was miscounted and the true figure was higher than $130,000, one effect on the
year-end financial statements would be that

A. Profit is overstated.
B. Cost of goods sold is overstated.
Answer (B) is correct.
If the ending inventory of raw materials is understated, raw materials
used is overstated, cost of goods produced is overstated, and cost of
goods sold is overstated.
C. Working capital is overstated.
D. Cost of goods produced is understated.

Question: 160

The following information is available for an entity for the quarter ended March 31, of the
current year:

Merchandise inventory, as of
January 1 of the current year $ 30,000
Sales

200,000

Purchases

190,000

The gross profit margin is normally 20% of sales. What is the estimated cost of the
merchandise inventory at March 31, of the current year?

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A. $20,000
B. $40,000
C. $60,000
Answer (C) is correct.
Using the gross profit method, cost of goods sold for the quarter is
estimated to be $160,000 [$200,000 sales (1.0 0.2)]. Goods available
for sale was $220,000 ($30,000 beginning inventory + $190,000
purchases). Estimated ending inventory is therefore $60,000 ($220,000
goods available for sale $160,000 estimated cost of goods sold).
D. $180,000

Question: 161

An internal auditor performs an analytical procedure to compare the gross margins of


various divisional operations with those of other divisions and with the individual divisions
performance in previous years. The internal auditor notes a significant increase in the gross
margin at one division. The internal auditor does some preliminary investigation and also
notes that there were no changes in products, production methods, or divisional
management during the year. The most likely cause of the increase in gross margin is

A. An increase in the number of competitors selling similar products.


B. A decrease in the number of suppliers of the material used in
manufacturing the product.
C. An overstatement of year-end inventory.
Answer (C) is correct.
An overstatement of year-end inventory results in an understatement of
cost of goods sold, which overstates gross margin.
D. An understatement of year-end accounts receivable.

Question: 162

If certain goods owned by an entity were not recorded as a purchase and were not counted
in ending inventory, in error, then

A.
B.
C.
D.

Cost of goods sold for the period will be understated.


Cost of goods sold for the period will be overstated.
Net income for the period will be understated.
There will be no effect on cost of goods sold or profit for the period.
Answer (D) is correct.
The effects of the errors on cost of goods sold are offsetting. Purchases,
which increase cost of goods sold, and ending inventory, which
decreases cost of goods sold, are understated by the same amount.
Neither cost of goods sold nor net income is affected.

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Question: 163

What is the cost of ending inventory given the following factors?

Beginning inventory $ 5,000


Total production costs 60,000
Cost of goods sold

55,000

Direct labor

40,000

A. $5,000
B. $10,000
Answer (B) is correct.
Beginning inventory, plus purchases (or other inventory additions),
minus cost of goods sold, equals ending inventory. Thus, ending
inventory equals $10,000 ($5,000 + $60,000 $55,000). Direct labor is
included in total production costs.
C. $45,000
D. $50,000

Question: 164

Holly Companys inventory is overstated at December 31 of this year. The result will be

A.
B.
C.
D.

Understated income this year.


Understated retained earnings this year.
Understated retained earnings next year.
Understated income next year.
Answer (D) is correct.
Cost of goods sold equals beginning finished goods, plus cost of goods
manufactured for a manufacturer or purchases for a retailer, minus
ending finished goods. Overstated ending inventory therefore results in
understated cost of goods sold, overstated net income, and overstated
retained earnings in the period of the error. When these errors reverse in
the following period, beginning inventory and cost of goods sold will be
overstated, and net income will be understated. Retained earnings will be
correct.

Question: 165

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

A. Overstatement of beginning inventory.


B. Overstatement of ending inventory.
Answer (B) is correct.
Cost of goods sold equals beginning finished goods, plus cost of goods
manufactured for a manufacturer or purchases for a retailer, minus
ending finished goods. Overstated ending inventory therefore results in
understated cost of goods sold, overstated net income, and overstated

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retained earnings in the period of the error.
C. Overstatement of goodwill amortization.
D. Overstatement of bad debt expense.

Question: 166

The following information applies to the income statement of Addison Company:

Gross sales

$1,000,000

Net sales

900,000

Freight-in

10,000

Ending inventory
Gross profit margin

200,000
40%

Addisons cost of goods available for sale is

A. $550,000
B. $560,000
C. $740,000
Answer (C) is correct.
The gross profit (gross margin) method calculates ending inventory at a
given time by subtracting an estimated cost of goods sold from the sum
of beginning inventory and purchases (or cost of goods manufactured).
The estimated cost of goods sold equals sales minus the gross profit. The
gross profit equals sales multiplied by the gross profit percentage, an
amount ordinarily determined on a historical basis. Given that the gross
margin percentage is 40% of net sales, cost of goods sold must be 60% of
net sales, or $540,000 ($900,000 60%). Goods available for sale equals
cost of goods sold plus ending inventory ($540,000 + $200,000 =
$740,000).
D. $800,000

Question: 167

An entity started in Year 1 with 200 scented candles on hand at a cost of $3.50 each. These
candles sell for $7.00 each. The following schedule represents the purchases and sales of
candles during Year 1:

Transaction Quantity

Unit Quantity

Number Purchased Cost

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Sold

---

---

150

250

$3.30

---

---

---

100

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4

200

3.10

---

---

---

200

350

3.00

---

---

---

300

If the entity uses periodic FIFO inventory pricing, the gross profit for Year 1 would be

A. $2,755
B. $2,805
Answer (B) is correct.
The FIFO method assumes that the first goods purchased are the first
goods sold and that ending inventory consists of the latest purchases.
Moreover, whether the inventory system is periodic or perpetual does not
affect FIFO measurement. The cost of goods sold is $2,445 {beginning
inventory (200 units $3.50) + purchases [(250 units $3.30) + (200
units $3.10) + (350 units $3.00)] ending inventory (250 units
$3.00)}. Thus, the gross profit for Year 1 using FIFO is $2,805 [sales
(750 units $7.00) cost of goods sold of $2,445].
C. $2,854
D. $2,920

Question: 168

The cost of materials has risen steadily over the year. Which of the following methods of
estimating the ending balance of the materials inventory account will result in the highest
profit, assuming all other variables remain constant?

A. Last-in, first-out (LIFO).


B. First-in, first-out (FIFO).
Answer (B) is correct.
Profit will be higher when cost of goods sold is lower, other factors held
constant. Cost of goods sold equals beginning inventory, plus purchases,
minus ending inventory. Accordingly, cost of goods sold will be lowest
when the ending inventory is highest. In an inflationary environment,
ending inventory is highest under FIFO because the older, less expensive
items are deemed to have been sold, leaving the more expensive items in
the ending inventory.
C. Weighted average.
D. Specific identification.

Question: 169

When a right of return exists, an entity may recognize revenue from a sale of goods at the
time of sale only if

A. The amount of future returns can be reliably estimated.

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Answer (A) is correct.
One condition for recognition of revenue from the sale of goods is the
transfer of the significant risks and rewards of ownership. Retention of
significant risk may occur when, for example, the buyer may rescind the
purchase for a reason stipulated in the contract, and the buyer is uncertain
about the probability of return. However, if the entity can reliably
estimate future returns and recognizes a liability for returns based on
experience and other pertinent information, revenue may be recognized
at the time of sale if the other conditions for revenue recognition also are
met.
B. The seller retains the risks and rewards of ownership.
C. The buyer resells the goods.
D. The seller believes returns will not be material.

Fact Pattern: Illustrated below is a perpetual inventory card for the current year.
Date
Units Purchased Units Sold Units Balance
January 1
January 12

0
300

March 15
May 5

1,000

1,000 @ $2.00
500 @ $2.20

July 8

700
1,200

500

700

November 24 1,000 @ $1.65


1,700
Additional information:
The entity had no opening inventory.
The items sold on March 15 were purchased on January 12.
The items sold on July 8 were purchased on May 5.

Question: 170

The ending inventory balance under the first-in, first-out (FIFO) method of inventory
valuation is

A. $3,050
B. $3,150
Answer (B) is correct.
Under the FIFO method, the 1,700 units of ending inventory are valued
at the most recent prices. Ending inventory is assumed to include 1,000
units purchased November 24, 500 units purchased May 5, and 200 units
purchased January 12. Hence, the ending inventory is $3,150 [(1,000
$1.65) + (500 $2.20) + (200 $2.00)].
C. $3,230
D. $3,430

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Fact Pattern: Illustrated below is a perpetual inventory card for the current year.
Date
Units Purchased Units Sold Units Balance
January 1
January 12

0
300

March 15
May 5

1,000

1,000 @ $2.00
500 @ $2.20

July 8

700
1,200

500

700

November 24 1,000 @ $1.65


1,700
Additional information:
The entity had no opening inventory.
The items sold on March 15 were purchased on January 12.
The items sold on July 8 were purchased on May 5.

Question: 171

The cost of goods sold under the specific identification method of inventory valuation is

A.
B.
C.
D.

$1,320
$1,520
$1,600
$1,700
Answer (D) is correct.
Of the 800 units sold during the period, the 300 units sold on March 15
were purchased on January 12 at a cost of $2.00 per unit. The remaining
500 units were purchased on May 5 at a cost of $2.20 per unit. The cost
of goods sold under the specific identification method is therefore $1,700
[(300 units $2.00) + (500 units $2.20)].

Fact Pattern: Illustrated below is a perpetual inventory card for the current year.
Date
Units Purchased Units Sold Units Balance
January 1
January 12

0
300

March 15
May 5
July 8

1,000

1,000 @ $2.00
500 @ $2.20

700
1,200

500

700

November 24 1,000 @ $1.65


1,700
Additional information:
The entity had no opening inventory.
The items sold on March 15 were purchased on January 12.
The items sold on July 8 were purchased on May 5.

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Question: 172

A merchandising company had the following inventory related transactions in its first year of
operations:

Date
Jan. 1

Purchases

Sales in

Balance

in Units

Units

in Units

10,000 @ $5

10,000

March 1 6,000 @ $6

16,000

May 1
July 1

3,000 13,000
8,000 @ $6.25

21,000

Sept. 1
Nov. 1

12,000
5,000 @ $7

9,000
14,000

Dec. 1

2,000 12,000

If the company uses the first-in-first-out (FIFO) method of inventory valuation, its ending
inventory balance (rounded) will be

A. $62,000
B. $70,759
C. $78,750
Answer (C) is correct.
The first-in-first-out (FIFO) method treats the oldest units as being sold
first and the newest units remain in inventory. Because the company has
12,000 units remaining, ending inventory equals $78,750 [(5,000 $7) +
(7,000 $6.25)].
D. $84,000

Question: 173

An entity has 8,000 units in inventory on January 1, valued at 10 per unit. During the year,
the entity sold 25,000 units and purchased inventory as follows:

Quantity
Date

Purchased Unit Price

April 1

15,000 units

$8

July 1

10,000 units

October 1 12,500 units

10

If the entity uses the weighted-average method of inventory valuation, cost of goods sold for
the period will be

A. $186,978
B. $197,000
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C. $228,023
Answer (C) is correct.
Under the weighted-average method, the weighted-average cost per unit
is multiplied by the number of units sold to determine the cost of goods
sold for the period. The total units available for sale equaled 45,500
(8,000 + 15,000 + 10,000 + 12,500). The total cost of all units available
for sale was $415,000 [(8,000 $10) + (15,000 $8) + (10,000 $9) +
(12,500 $10)]. Thus, the weighted-average cost per unit of inventory
was $9.1209 ($415,000 45,500), and cost of goods sold was $228,023
(25,000 $9.1209).
D. $235,000

Question: 174

On January 1, a company has no opening inventory balance. The following purchases are
made during the year:

Units

Unit

Purchased

Cost

January 1

5,000

$10.00

April 1

5,000

9.00

July 1

5,000

8.00

October 1

5,000

7.50

There are 10,000 units in inventory on December 31.


If the company uses the first-in, first-out (FIFO) method of inventory valuation, the ending
inventory balance will be

A. $77,500
Answer (A) is correct.
Under first-in, first-out (FIFO) inventory valuation, the 10,000 units in
ending inventory are assumed to have been the most recent items
purchased. The cost of the most recent 10,000 units purchased is: (5,000
units $7.50) + (5,000 units $8) = $77,500.
B. $85,000
C. $86,250
D. $95,000

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Question: 175

Which inventory pricing method generally approximates current cost for each of the
following?

Ending
Cost of
Inventory Goods Sold
A. FIFO FIFO
B. LIFO FIFO
C. FIFO LIFO
Answer (C) is correct.
FIFO assigns the most recent acquisition costs to ending inventory and
the earliest acquisition costs to cost of goods sold. LIFO assigns the
earliest acquisition costs to ending inventory (it is permitted by
U.S. GAAP but not by IFRS). Thus, FIFO approximates current cost for
ending inventory, and LIFO approximates current cost of goods sold.
D. LIFO LIFO

Question: 176

Which of the following changes in accounting policies resulting from a significant change in
the expected pattern of economic benefit will increase profit?

A. A change from FIFO to LIFO inventory valuation when costs are rising.
B. A change from FIFO to weighted-average inventory valuation when costs
are falling.
Answer (B) is correct.
In a period of falling costs, FIFO results in higher cost of goods sold than
the weighted-average method. FIFO includes the higher, earlier costs in
cost of goods sold, and the weighted-average method averages the later,
lower costs with the higher, earlier costs. Thus, a change from FIFO to
weighted-average costing reduces cost of goods sold and increases
reported profit.
C. A change from accelerated to straight-line depreciation in the later years of
the depreciable lives of the assets.
D. A change from straight-line to accelerated depreciation in the early years of
the depreciable lives of the assets.

Question: 177

On January 1, a company has no opening inventory balance. The following purchases are
made during the year:

Units
Unit
Purchased Cost
January 1 5,000 $10.00
April 1
5,000
9.00
July 1
5,000
8.00
October 1 5,000
7.50
There are 10,000 units in inventory on December 31.

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If the company uses the last-in, first-out (LIFO) method of inventory valuation, cost of goods
sold for the year will be:

A. $77,500
Answer (A) is correct.
A total of 20,000 units was available for sale (0 beginning inventory +
20,000 purchased during year). Since 10,000 remain in ending inventory,
10,000 were sold (20,000 available 10,000 remaining). Under the LIFO
method, the units sold were those purchased in July and October. Cost of
goods sold for the year thus equaled $77,500 [(5,000 units x $8.00 July)
+ (5,000 units x $7.50 October)].
B. $86,250
C. $87,500
D. $95,000

Question: 178

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

A. The most recently incurred costs should be allocated to the cost of goods
sold.
Answer (A) is correct.
Under the LIFO method, the most recent costs of acquiring or producing
inventory are expensed as part of cost of goods sold. Given inflation, this
method results in the highest cost of goods.
B. Costs should be charged to revenue in the order in which they are incurred.
C. Costs should be charged to cost of goods sold at average cost.
D. Current costs should be based on representative or normal conditions of
efficiency and volume of operations.

Question: 179

Which inventory cost flow method is prohibited according to IFRS?

A.
B.
C.
D.

First-in, first-out (FIFO) method.


Specific identification method.
Weighted average cost method.
Last-in, first-out (LIFO) method.
Answer (D) is correct.
The last-in, first-out (LIFO) method is prohibited by IFRS. This method
is based on the assumption that the newest items are sold first. Its effect
is to include current prices in cost of goods sold. But the LIFO
assumption ordinarily does not match actual inventory use.

Question: 180

The inventory method yielding the same inventory measurement and cost of goods sold
whether a perpetual or periodic system is used is

A. Average cost.
B. First-in, first-out.
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Answer (B) is correct.
A perpetual inventory system will result in the same dollar amount of
ending inventory as a periodic inventory system assuming a FIFO cost
flow. Under both perpetual and periodic systems, the same units are
deemed to be in ending inventory.
C. Last-in, first-out.
D. Either first-in, first-out or last-in, first-out.

Question: 181

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

A. Weighted average.
B. First-in, first-out.
C. Last-in, first-out.
Answer (C) is correct.
A significant advantage of the LIFO method is its matching of current
revenues with the most recent product costs. When prices are rising
(which is most of the time), the most recent costs are the highest costs,
resulting in higher cost of goods sold and lower net income. The lower
net income means lower taxes.
D. Specific identification.

Question: 182

Which one of the following actions would result in a decrease in income?

A. Liquidating last-in, first-out layers of inventory when prices have been


increasing.
B. Changing from first-in, first-out to last-in, first-out inventory method when
prices are decreasing.
C. Accelerating purchases at the end of the year when using last-in, first-out
inventory method in times of rising prices.
Answer (C) is correct.
Under the LIFO method, the most recent costs of acquiring or producing
inventory are expensed as part of cost of goods sold. In a time of rising
prices, charging newer, higher-priced goods against current revenues
decreases income.
D. Changing the number of last-in, first-out pools.

Question: 183

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

A. First-in, first-out.
B. Last-in, first-out.

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Answer (B) is correct.
A significant advantage of the LIFO method is its matching of current
revenues with the most recent product costs. When prices are rising
(which is most of the time), the most recent costs are the highest costs,
resulting in higher cost of goods sold and lower net income. The lower
net income means lower taxes.
C. Weighted average.
D. Moving average.

Fact Pattern: During January, Metro Co., which maintains a perpetual inventory system, recorded the
following information pertaining to its inventory:
Units
Unit Total

On

Units Cost Cost Hand


Balance on 1/1

1,000 $1 $1,000 1,000

Purchased on 1/7

600

Sold on 1/20

900

Purchased on 1/25 400

Question: 184

1,800 1,600
700

2,000 1,100

Under the moving-average method, what amount should Metro report as inventory at
January 31?

A. $2,640
B. $3,225
Answer (B) is correct.
The moving-average system is only applicable to perpetual inventories. It
requires that a new weighted average be computed after every purchase.
This moving average is based on remaining inventory held and the new
inventory purchased. Based on the calculations below, the movingaverage cost per unit for the 1/20 sale is $1.75, and the cost of goods sold
(COGS) for January is $1,575 (900 units sold $1.75). Thus, ending
inventory is $3,225 ($1,000 beginning balance + $1,800 purchase on 1/7
$1,575 COGS on 1/20 + $2,000 purchase on 1/25).
Moving-Average
Units

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Cost/Unit

Total Cost

Balance 1/1 1,000

$1.00

$1,000

Purchase 1/7 600

3.00

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1,600

$1.75

$2,800

C. $3,300
D. $3,900

Question: 185

The weighted average for the year inventory cost flow method is applicable to which of the
following inventory systems?

Periodic Perpetual
A. Yes Yes
B. Yes No
Answer (B) is correct.
The weighted-average method determines an average cost only once (at
the end of the period) and is therefore applicable only to a periodic
system. In contrast, the moving-average method requires determination
of a new weighted-average cost after each purchase and thus applies only
to a perpetual system.
C. No Yes
D. No No

Question: 186

In accounting for inventories, generally accepted accounting principles require departure


from the historical cost principle when the utility of inventory has fallen below cost. This rule
is known as the lower-of-cost-or-market rule. The term market as defined here means

A. Original cost minus allowance for obsolescence.


B. Original cost plus normal profit margin.
C. Replacement cost of the inventory.
Answer (C) is correct.
Market is the replacement cost of the inventory as determined in the
market in which the entity buys its inventory, not the market in which it
sells to customers. Market is limited to a ceiling amount equal to net
realizable value and a floor amount equal to net realizable value minus a
normal profit margin.
D. Original cost minus cost to dispose.
Fact Pattern: The data below concern items in Stockholm Co.s inventory.
Per Unit

Gear

Historical cost

$190.00 $106.00 $53.00

Selling price
Cost to complete and sell

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Stuff

Wickets

217.00 145.00 73.75


19.00

8.00

2.50

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Current replacement cost 203.00 105.00 51.00
Normal profit margin

Question: 187

32.00

29.00 21.25

Under IFRS, what amount should Stockholm Co. compare with historical cost to measure
the amount at which the wickets should be measured?

A. $51.00
B. $50.00
C. $71.25
Answer (C) is correct.
Inventory is recorded at cost. However, inventory must be written down
if its utility is no longer as great as its cost. To make this determination
under IFRS, historical cost is compared with the inventorys net
realizable value (NRV). NRV is the estimated selling price in the
ordinary course of business minus estimated costs of completion and
sale. NRV for the wickets is $71.25 ($73.75 selling price $2.50
estimated costs of completion and sale).
D. $73.75

Question: 188

An entity that prepares its financial statements using IFRS reported the following selected
per-unit data relating to work-in-process:

Selling price

$100

Completion costs

10

Historical cost

91

Replacement cost
Normal gross profit
Selling cost

108
20
5

In comparison with historical cost, what will be the per-unit effect on gross profit of
measuring ending inventory?

A. No effect.
B. Reduction of $6.
Answer (B) is correct.
Under IFRS, inventories are measured subsequent to acquisition at the
lower of cost or net realizable value (NRV). NRV equals selling price
minus estimated completion and selling costs. Given that historical cost
is $91 and NRV is $85 ($100 selling price $10 completion cost $5
selling cost), the effect on per-unit gross profit is a reduction of $6. This
amount is expensed.
C. Reduction of $26.
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D. Increase of $5.

Question: 189

The following data apply to a unit of inventory:

Selling price

$22

Selling cost

Normal profit margin

Replacement cost

10

Using the lower of cost or market (LCM) method of measuring inventory, what is the market
amount for this unit of inventory?

A. $10.00
B. $15.00
Answer (B) is correct.
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 margin. NRV equals
selling price minus costs of completion and disposal. Thus, the maximum
market amount is the $20 NRV ($22 selling price $2 selling cost), and
the minimum is $15 ($20 NRV $5 normal profit margin). Because the
minimum exceeds the $10 replacement cost, it is the market amount.
C. $17.50
D. $20.00

Question: 190

Based on a physical inventory taken on December 31, Chewy Co. determined its chocolate
inventory on a FIFO basis at $26,000 with a replacement cost of $20,000. Chewy estimated
that, after further processing costs of $12,000, the chocolate could be sold as finished
candy bars for $40,000. Chewys normal profit margin is 10% of sales. Under the lower-ofcost-or-market rule, what amount should Chewy report as chocolate inventory in its
December 31 balance sheet?

A. $28,000
B. $26,000
C. $24,000
Answer (C) is correct.
Market equals current replacement cost subject to maximum and
minimum values. The maximum is NRV, and the minimum is NRV
minus normal profit. When replacement cost is within this range, it is
used as market. Cost is given as $26,000. NRV is $28,000 ($40,000
selling price $12,000 additional processing costs), and NRV minus a
normal profit equals $24,000 [$28,000 ($40,000 10%)]. Because the
lowest amount in the range ($24,000) exceeds replacement cost
($20,000), it is used as market. Because market value ($24,000) is less

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than cost ($26,000), it is also the inventory amount.
D. $20,000

Question: 191

The lower-of-cost-or-market rule for inventories may be applied to total inventory, to groups
of similar items, or to each item. Which application generally results in the lowest inventory
amount?

A.
B.
C.
D.

All applications result in the same amount.


Total inventory.
Groups of similar items.
Separately to each item.
Answer (D) is correct.
Applying the LCM rule to each item of inventory produces the lowest
amount for each item and therefore the lowest and most conservative
measurement for the total inventory. The reason is that aggregating items
results in the inclusion of some items at amounts greater than LCM. For
example, if item A (cost $2, market $1) and item B (cost $3, market $4)
are aggregated for LCM purposes, the inventory measurement is $5. If
the rule is applied separately to A and B, the LCM measurement is $4.

Question: 192

Under the lower-of-cost-or-market method, the replacement cost of an inventory item would
be used as the designated market value

A. When it is below the net realizable value less the normal profit margin.
B. When it is below the net realizable value and above the net realizable value
less the normal profit margin.
Answer (B) is correct.
Market is current replacement cost subject to maximum and minimum
values. The maximum is net realizable value, and the minimum is net
realizable value less normal profit. When replacement cost is within this
range, it is used as the market amount.
C. When it is above the net realizable value.
D. Regardless of net realizable value.

Question: 193

Ward Distribution Company has determined its December 31 inventory on a FIFO basis at
$200,000. Information pertaining to that inventory follows:

Estimated selling price

$204,000

Estimated cost of disposal

10,000

Normal profit margin

30,000

Current replacement cost

180,000

Ward records losses that result from applying the lower-of-cost-or-market rule. At December

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31, the loss that Ward should recognize is

A.
B.
C.
D.

$0
$6,000
$14,000
$20,000
Answer (D) is correct.
As indicated below, the $180,000 replacement cost falls between the
$194,000 ceiling and the $164,000 floor. Hence, it will be used as market
in the LCM determination. Because the $180,000 market value is
$20,000 lower than the $200,000 historical cost, the inventory should be
valued at $180,000 and a $20,000 loss recognized.
NRV ($204,000 $10,000)

$194,000

Replacement cost

$180,000

NRV Normal profit ($194,000 $30,000) $164,000

Question: 194

The replacement cost of an inventory item is below the net realizable value and above the
net realizable value less the normal profit margin. The original cost of the inventory item is
below the net realizable value less the normal profit margin. Under the lower-of-cost-ormarket (LCM) method, the inventory item should be valued at

A. Net realizable value.


B. Net realizable value less the normal profit margin.
C. Original cost.
Answer (C) is correct.
When replacement cost is below the NRV and above the NRV less the
normal profit margin, market equals replacement cost. Given that the
original cost of the inventory item is below market, the original cost
should be used to measure the inventory item under the LCM method.
D. Replacement cost.

Question: 195

Lorraine Co. has determined its fiscal year-end inventory on a FIFO basis to be $400,000.
Information pertaining to that inventory follows:

Estimated selling price

$408,000

Estimated cost of disposal

20,000

Normal profit margin

60,000

Current replacement cost

360,000

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 Lorraines inventory?

A. $400,000
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B. $388,000
C. $360,000
Answer (C) is correct.
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.
D. $328,000

Question: 196

Which of the following is true regarding inventory adjustments under IFRS?

A. IFRS do not require inventory adjustments.


B. Reversals of adjustments are allowed in a subsequent period.
Answer (B) is correct.
Both IFRS and U.S. GAAP require the cost of inventory to be written
down if the utility of the goods is impaired. Under IFRS, inventories are
measured subsequent to initial recognition at the lower of cost and net
realizable value (NRV), with NRV assessed each period. Moreover,
unlike U.S. GAAP, IFRS permit inventory to be written up to the lower
of cost and NRV if previously written down. The reversal is permissible
only to the extent of the prior write-down.
C. A reversal of a previous write-down may be higher than the previous writedown.
D. Adjustments may not be reversed in a subsequent period.

Question: 197

A company determined the following information for its inventory at the end of an interim
period on June 30, Year 2:

Historical cost

$80,000

Net realizable value (NRV) 77,000


Current replacement cost
Normal profit margin

76,000
2,000

The company expects that on December 31, Year 2, the inventorys NRV reduced by a
normal profit margin will be at least $81,000. What amount of inventory should the company
report in its interim financial statements under IFRS and under U.S. GAAP on June 30, Year

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2?

IFRS

U.S. GAAP

A. $77,000 $80,000
Answer (A) is correct.
Under U.S. GAAP, inventory is reported at its historical cost of $80,000
because no write-down of inventory is reasonably anticipated for the
year. Under IFRS, the inventory is measured at the lower of cost
($80,000) and NRV ($77,000) for each interim reporting period. Whether
a market decline is expected to be reversed by the end of the annual
period is not considered. Thus, the inventory is not reported at its NRV
of $77,000.
B. $77,000 $76,000
C. $80,000 $80,000
D. $80,000 $81,000

Question: 198

Investments classified as held-to-maturity are measured at

A. Fair value, with unrealized gains and losses reported in net income.
B. Fair value, with unrealized gains and losses reported in other
comprehensive income (OCI).
C. Replacement cost, with no unrealized gains or losses reported.
D. Amortized cost, with no unrealized gains or losses reported.
Answer (D) is correct.
Assuming the fair value option has not been elected, held-to-maturity
securities are reported at amortized cost, with no unrealized gains or
losses reported.

Question: 199

King Company has the following investment portfolio:

Cost

Fair Value

Trading securities:
Quill Company common stock $140,000 $150,000
Barton, Inc., common stock

125,000

110,000

Delta, Inc., 8% bonds

225,000

240,000

80,000

84,000

180,000

210,000

Securities to be held to maturity:


Armand, Inc., 9% bonds
Port City municipal bonds

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Available-for-sale securities:
Knox Co. common stock

45,000

51,000

Vernon, Inc., preferred stock

97,000

109,000

The total amount of these investments to be reported on Kings statement of financial


position is

A. $892,000
B. $902,000
C. $920,000
Answer (C) is correct.
Trading securities and available-for-sale securities are reported at their
fair values at each balance sheet date. Held-to-maturity securities are
reported at amortized cost. The total amount of these investments to be
reported on Kings statement of financial position is therefore calculated
as follows:
Trading securities:
Quill Company common stock $150,000
Barton, Inc., common stock

110,000

Delta, Inc., 8% bonds

240,000

Securities to be held to maturity:


Armand, Inc., 9% bonds
Port City municipal bonds

80,000
180,000

Available-for-sale securities:
Knox Co. common stock
Vernon, Inc., preferred stock
Total

51,000
109,000
$920,000

D. $954,000

Question: 200

Which one of the following statements with regard to marketable securities is incorrect?

A. In the trading portfolio of marketable equity securities, unrealized gains


and losses are recorded on the income statement.
B. In the available-for-sale portfolio of marketable equity securities,
unrealized gains and losses are recorded on the income statement.

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Answer (B) is correct.
Assuming the fair value option has not been elected, unrealized holding
gains and losses on available-for-sale securities are reported in other
comprehensive income. (But all or part of unrealized holding gains and
losses on available-for-sale securities designated and qualifying as
hedged items in a fair value hedge are recognized in earnings.)
C. The held-to-maturity portfolio consists only of debt securities.
D. Securities may be transferred from the held-to-maturity to the available-forsale portfolio.

Question: 201

Securities held primarily for sale in the near term to generate income on short-term price
differences are known as

A.
B.
C.
D.

Available-for-sale securities.
Equity securities.
Held-to-maturity securities.
Trading securities.
Answer (D) is correct.
Trading securities are bought and held primarily for sale in the near term.
They are purchased and sold frequently. They are initially recorded at
cost but are remeasured at fair value at each balance sheet date, with the
unrealized holding gains or losses recognized in earnings.

Question: 202

Unrealized gains and losses on trading securities should be presented in the

A. Statement of financial position.


B. Income statement.
Answer (B) is correct.
Unrealized holding gains and losses on trading securities are included in
earnings and are therefore reported in the income statement.
C. Notes to the financial statements.
D. Statement of retained earnings.

Question: 203

Vanity Corporation holds investments in equity 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?

Income Statement

Balance sheet

A. Unrealized loss on sale of


AFS securities
B. Realized loss on sale of
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Unrealized holding gain on appreciation


of AFS securities
Unrealized holding gain on appreciation
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AFS securities

of AFS securities

Answer (B) is correct.


Realized losses on the sale of available-for-sale securities are included in
the calculation of current period earnings. However, unrealized holding
gains and losses on available-for-sale securities, including those
classified as current assets, are excluded from earnings and are reported
as components of other comprehensive income.
C. Unrealized holding gain on
Unrealized loss on sale of
appreciation of AFS securities
AFS securities.
D. Realized loss on sale of AFS securities and
Unrealized holding
unrealized holding gain on appreciation of
gains/losses not
AFS securities
reported he

Question: 204

Kale Co. purchased bonds at a discount on the open market as an investment and has the
intent and ability to hold these bonds to maturity. Absent an election of the fair value option,
Kale should account for these bonds at

A. Cost.
B. Amortized cost.
Answer (B) is correct.
Absent an election of the fair value option, investments in debt securities
must be classified asheld-to-maturity and measured at amortized cost in
the balance sheet if the reporting entity has the positive intent and ability
to hold them to maturity.
C. Fair value.
D. Lower of cost or market.

Question: 205

At year end, Rim Co. held several investments with the intent of selling them in the near
term. The investments consisted of $100,000, 8%, 5-year bonds, purchased for $92,000,
and equity securities purchased for $35,000. At year end, the bonds were selling on the
open market for $105,000, and the equity securities had a market value of $50,000. What
amount should Rim report as trading securities in its year-end balance sheet?

A.
B.
C.
D.

$50,000
$127,000
$142,000
$155,000
Answer (D) is correct.
Trading securities are debt securities not classified as held to maturity
and equity securities with readily determinable fair values that are bought
and held primarily for sale in the near term. Hence, the bonds and the
equity securities are trading securities. They are initially recorded at cost
but are subsequently measured at fair value at each balance sheet date.
Quoted market prices in active markets are the best evidence of fair

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value. Based on market quotes at year end, the bonds had a fair value of
$105,000, and the equity securities had a fair value of $50,000. The total
is $155,000.

Question: 206

An entity should report the marketable equity securities that it has classified as trading at

A. Lower of cost or market, with holding gains and losses included in


earnings.
B. Lower of cost or market, with holding gains included in earnings only to
the extent of previously recognized holding losses.
C. Fair value, with holding gains included in earnings only to the extent of
previously recognized holding losses.
D. Fair value, with holding gains and losses included in earnings.
Answer (D) is correct.
Trading securities are those held principally for sale in the near term.
They are classified as current and consist of debt securities and equity
securities with readily determinable fair values. Unrealized holding gains
and losses on trading securities are reported in earnings. On a statement
of financial position, these securities are reported at fair value.

Question: 207

On December 31, Ott Co. had investments in trading securities as follows:

Fair
Cost
Man Co.

Value

$10,000 $ 8,000

Kemo, Inc.

9,000 11,000

Fenn Corp. 11,000

9,000

$30,000 $28,000
Otts December 31 balance sheet should report the trading securities as

A. $26,000
B. $28,000
Answer (B) is correct.
Trading securities are reported at fair value, and unrealized holding gains
and losses are included in earnings. Consequently, the securities should
be reported as $28,000.
C. $29,000
D. $30,000

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Question: 208

Nola Co. has a portfolio of marketable equity securities that it does not intend to sell in the
near term. How should Nola classify these securities, and how should it report unrealized
gains and losses from these securities?

Classify as

Report in

A. Trading securities A component of income from continuing operations


B. Available-for-sale securities Other comprehensive income (OCI)
Answer (B) is correct.
Marketable equity securities may be classified as either trading or
available-for-sale (assuming no election of the fair value option). Equity
securities that are not expected to be sold in the near term should be
classified as available-for-sale. These securities should be reported at fair
value, with unrealized holding gains and losses (except those on
securities designated as being hedged in a fair value hedge) excluded
from earnings and reported in OCI.
C. Trading securities Other comprehensive income (OCI)
D.
Available-for-sale
A component of income from continuing
securities
operations

Question: 209

The following information pertains to Lark Corp.s available-for-sale securities:

December 31
Year 2
Cost

Year 3

$100,000 $100,000

Fair value

90,000 120,000

Differences between cost and fair values are considered to be temporary. The decline in fair
value was properly accounted for at December 31, Year 2. Ignoring tax effects, by what
amount should other comprehensive income (OCI) be credited at December 31, Year 3?

A.
B.
C.
D.

$0
$10,000
$20,000
$30,000
Answer (D) is correct.
Unrealized holding gains and losses on available-for-sale securities,
including those classified as current assets, are not included in earnings
but ordinarily are reported in OCI, net of tax effects (ignored in this
question). At December 31, Year 2 (assuming the securities are not
designated as being hedged in a fair value hedge), OCI should have been
debited for $10,000 for the excess of cost over fair value to reflect an
unrealized holding loss. At December 31, Year 3, OCI should be credited
to reflect a $30,000 unrealized holding gain ($120,000 fair value at

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12/31/Year 3 $90,000 fair value at 12/31/Year 2).

Question: 210

The following information was extracted from Gil Co.s December 31 balance sheet:

Debit Balance
Noncurrent assets:
Available-for-sale securities (carried at fair value)
Equity:
Accumulated other comprehensive income (OCI)
Unrealized gains and losses on available-for-sale securities

$96,450

19,800

Historical cost of the available-for-sale securities was

A.
B.
C.
D.

$63,595
$76,650
$96,450
$116,250
Answer (D) is correct.
The existence of an equity account with a debit balance signifies that the
available-for-sale securities are reported at fair value that is less than
historical cost. The difference is the net unrealized loss balance. Hence,
historical cost must have been $116,250 ($96,450 available-for-sale
securities at fair value + $19,800 net unrealized loss).

Question: 211

When the fair value of an investment in debt securities exceeds its amortized cost, how
should each of the following debt securities be reported at the end of the year, given no
election of the fair value option?

Debt Securities Classified As


Held-to-Maturity Available-for-Sale
A. Amortized cost Amortized cost
B. Amortized cost Fair value
Answer (B) is correct.
Investments in debt securities must be classified as held-to-maturity and
measured at amortized cost in the balance sheet if the reporting entity has
the positive intent and ability to hold them to maturity. Investments in
equity securities are classified as either trading or available-for-sale.
Equity securities that are not expected to be sold in the near term should
be classified as available-for-sale. These securities should be reported at
fair value, with unrealized holding gains and losses (except those on
securities designated as being hedged in a fair value hedge) excluded
from earnings and reported in OCI.
C. Fair value Fair value
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D. Fair value Amortized cost

Question: 212

Reed, Inc., began operations on January 1. The following information pertains to Reeds
December 31 securities:

Trading Available-for-Sale
Cost

$360,000

$550,000

320,000

450,000

304,000

420,000

Fair value
Lower of cost or fair value
applied to each security

If the declines are judged to be temporary, what amounts should Reed report for its trading
and available-for-sale securities in the assets section of its December 31 balance sheet?

Trading Available-for-Sale
A. $360,000 $550,000
B. $360,000 $450,000
C. $320,000 $450,000
Answer (C) is correct.
Fair value accounting applies to both trading and available-for-sale
securities. The difference in treatment is that the unrealized holding gains
and losses are included in earnings for trading securities and in other
comprehensive income for available-for-sale securities, assuming the
latter are not designated as being hedged in a fair value hedge. Thus,
these securities should be reported in the assets section of the balance
sheet at their fair values of $320,000 and $450,000, respectively.
D. $304,000 $420,000

Question: 213

Beach Co. determined that the decline in the fair value (FV) of an investment was below the
amortized cost and permanent in nature. The investment was classified as available-for-sale
on Beachs books. The controller would properly record the decrease in FV by including it in
which of the following?

A. Other comprehensive income section of the income statement only.


B. Earnings section of the income statement and writing down the cost basis
to FV.
Answer (B) is correct.
The amortized cost basis is used to calculate the amount of any
impairment. The amortized cost basis should be distinguished from fair
value, which equals the cost basis plus or minus the net unrealized
holding gain or loss. If a decline in fair value of an individual availablefor-sale security below its amortized cost basis is other than temporary,

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the amortized cost basis is written down to fair value as a new cost basis.
The write-down is deemed to be a realized loss and is included in
earnings.
C. Extraordinary items section of the income statement, net of tax, and writing
down the cost basis to FV.
D. Other comprehensive income section of the income statement, and writing
down the cost basis to FV.

Question: 214

On January 2, Year 1, Adam Co. purchased as a long-term investment 10,000 shares of Mill
Corp.s common stock for $40 a share. These securities were properly classified as
available-for-sale. On December 31, Year 1, the market price of Mills stock was $35 a
share, reflecting a temporary decline in market price. On January 28, Year 2, Adam sold
8,000 shares of Mill stock for $30 a share. For the year ended December 31, Year 2, Adam
should report a realized loss on disposal of a long-term investment of

A. $100,000
B. $80,000
Answer (B) is correct.
A realized loss or gain is recognized when an individual security is sold
or otherwise disposed of. The investment was acquired for $40 per share.
Because the shares were purchased as a long-term investment, they
should be classified as available-for-sale securities. Thus, the temporary
decline in fair value at 12/31/Year 1 was debited to other comprehensive
income and was not included in earnings. Accordingly, the realized loss
included in earnings at 12/31/Year 2 was $80,000 [8,000 shares ($40
$30)].
C. $60,000
D. $40,000

Question: 215

A corporation acquires a 30% voting interest in another corporation. In this situation, the
long-term investment is generally accounted for on the investor corporations books using
which of the following reporting methods?

A.
B.
C.
D.

Lower-of-cost-or-market.
Cost.
Consolidated.
Equity.
Answer (D) is correct.
If an investor can exercise significant influence over an investee, the
investment should be accounted for by the equity method. When a
corporation owns 20% or more of the voting power of the investee, the
ability to exercise significant influence is presumed.

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Question: 216

Johnstone Company owns 10,000 shares of Breva Corporations stock; Breva currently has
40,000 shares outstanding. During the year, Breva had net income of $200,000 and paid
$160,000 in dividends. At the beginning of the year, there was a balance of $150,000 in
Johnstones equity method investment in Breva Corporation account. At the end of the year,
the balance in this account should be

A. $110,000
B. $150,000
C. $160,000
Answer (C) is correct.
Johnstone holds 25% (10,000 40,000) of Brevas voting common
stock. Under the equity method, (1) an investor recognizes its share of
the investees net income as an increase in the investment account:
Investment in Breva ($200,000 25%) $50,000
Income -- equity-method investee
$50,000
(2) a dividend from the investee is treated as a return of an investment:
Cash ($160,000 25%)

$40,000

Investment in Breva

$40,000

Thus, at the end of the year, the balance in the investment in Breva
account is $160,000 ($150,000 + $50,000 $40,000).
D. $240,000

Question: 217

An investor uses the equity method to account for an investment in common stock. The
investors equity in the earnings of the investee is affected by

A Change in Fair
Cash Dividends Value of the Investees
from Investee
Common Stock
A. No Yes
B. No No
Answer (B) is correct.
Under the equity method, an investor debits an investment and credits
revenue for its share of the investees earnings. The receipt of a cash
dividend from the investee is treated as a return of an investment. Thus, it
is credited to the investment but does not affect equity-based earnings. A
change in fair value has no effect on an investment in securities
accounted for under the equity method.
C. Yes No
D. Yes Yes

Question: 218

An investor uses the equity method to account for an investment in common stock. After the
date of acquisition, the investment account of the investor is

A. Not affected by its share of the earnings or losses of the investee.


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B. Not affected by its share of the earnings of the investee, but is decreased by
its share of the losses of the investee.
C. Increased by its share of the earnings of the investee, but is not affected by
its share of the losses of the investee.
D. Increased by its share of the earnings of the investee, and is decreased by
its share of the losses of the investee.
Answer (D) is correct.
After the date of acquisition, an equity-based investment in common
stock account of an investor is increased by its share of the earnings of
the investee, decreased by its share of the losses of the investee, and
decreased by its share of cash dividends received from the investee.

Question: 219

On January 1, Dyer Co. acquired as a long-term investment a 20% common stock interest
in Eason Co. Dyer paid $700,000 for this investment when the fair value and carrying
amount of Easons net assets was $3.5 million. Dyer can exercise significant influence over
Easons operating and financial policies. For the year ended December 31, Eason reported
net income of $400,000 and declared and paid cash dividends of $160,000. How much
revenue from this investment should Dyer report for the year?

A. $32,000
B. $48,000
C. $80,000
Answer (C) is correct.
Because the investor can exercise significant influence over the
investees operating and financial policies, the investment should be
accounted for using the equity method. The $700,000 paid for the
investment is equal to 20% of the $3.5 million fair value. Moreover, the
carrying amount and fair value of the net assets were the same. Thus, no
goodwill impairment or other acquisition differential that might require
adjustment of Dyers share of the investees net income is associated
with this investment. Under these circumstances, revenue from the
investment is 20% of the reported net income of $400,000, or $80,000.
The cash dividend does not affect the amount of income to be reported.
D. $112,000

Question: 220

Peel Co. received a cash dividend from a common stock investment. Should Peel report an
increase in the investment account if it uses the fair value method or the equity method of
accounting?

Fair Value Equity


A. No No
Answer (A) is correct.
Under the fair value method and the cost method, (used only if the fair
value method and the equity method are not applicable), dividends from

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an investee should be accounted for by the investor as dividend income
unless a liquidating dividend is received. Thus, assuming that the
dividend is not liquidating, it has no effect on the investment account
under the fair value method. Under the equity method, the investor
recognizes its equity in the undistributed earnings of the investee.
Consequently, cash dividends decrease the investment account because
the dividend is considered to be a return of investment.
B. Yes Yes
C. Yes No
D. No Yes

Question: 221

When an investor uses the equity method to account for investments in common stock, the
investment account will be increased when the investor recognizes

A. A proportionate interest in the net income of the investee.


Answer (A) is correct.
Under the equity method, the investors share of the investees net
income is accounted for as an addition to the carrying amount of the
investment on the investors books. Losses and dividends are reflected as
reductions of the carrying amount.
B. A cash dividend received from the investee.
C. Periodic amortization of the goodwill related to the purchase.
D. Depreciation related to the excess of fair value over the carrying amount of
the investees depreciable assets at the date of purchase by the investor.

Question: 222

Green Corp. owns 30% of the outstanding common stock and 100% of the outstanding
noncumulative nonvoting preferred stock of Axel Corp. In Year 1, Axel declared dividends of
$100,000 on its common stock and $60,000 on its preferred stock. Green exercises
significant influence over Axels operations and uses the equity method to account for the
investment in the common stock. What amount of dividend revenue should Green report in
its income statement for the year ended December 31, Year 1?

A. $0
B. $30,000
C. $60,000
Answer (C) is correct.
Under the equity method, the receipt of a cash dividend from the investee
should be credited to the investment account. It is a return of, not a return
on, the investment. However, the equity method is not applicable to
preferred stock. Thus, Green should report $60,000 of revenue when the
preferred dividends are declared.
D. $90,000

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Question: 223

On July 1, Year 1, Denver Corp. purchased 3,000 shares of Eagle Co.s 10,000 outstanding
shares of common stock for $20 per share but did not elect the fair value option. On
December 15, Year 1, Eagle paid $40,000 in dividends to its common shareholders. Eagles
net income for the year ended December 31, Year 1, was $120,000, earned evenly
throughout the year. In its Year 1 income statement, what amount of income from this
investment should Denver report?

A. $36,000
B. $18,000
Answer (B) is correct.
Denver Corp.s purchase of 30% of Eagle presumably allows it to
exercise significant influence. Hence, it should apply the equity method.
The investors share of the investees income is a function of the
percentage of ownership and the length of time the investment was held.
The income from this investment was therefore $18,000 [$120,000
30% (6 months 12 months)].
C. $12,000
D. $6,000

Question: 224

Entity A acquires all of the voting shares of Entity B for $1,000,000. At the time of the
acquisition, the net fair value of the identifiable assets acquired and liabilities assumed had
a carrying amount of $900,000 and a fair value of $800,000. The amount of goodwill Entity
A will record on the acquisition date is

A. $0
B. $100,000
C. $200,000
Answer (C) is correct.
Given no prior equity interest or noncontrolling interest, goodwill equals
the excess of the fair value of the consideration transferred over the fair
value of the net of the identifiable assets acquired and liabilities assumed.
Consequently, goodwill is $200,000 ($1,000,000 $800,000).
D. $300,000

Question: 225

A conglomerate entity acquired 100% of the net assets of a target entity for $900 cash. The
target entitys statement of financial position just prior to the acquisition is presented below.

Target Entity (as of acquisition date)

Cash

Carrying

Fair

Amount

Value

$ 100

$100

Receivables

200

200

Inventory

150

200

Property, plant,
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and equipment (net)

600

400

Total assets

$1,050

$900

Current liabilities

$ 200

$200

Share capital

200

Retained earnings

650

Total liabilities and equity

$1,050

The amount of goodwill to be recorded by the conglomerate entity related to its purchase of
the target entity is

A. $(200)
B. $50
C. $200
Answer (C) is correct.
Given no prior equity interest and no noncontrolling interest, goodwill is
the excess of the fair value of the consideration transferred over the net
of the fair values of the identifiable net assets acquired. This net fair
value equals the sum of cash, receivables, inventory, and PPE, minus
liabilities. Hence, the net fair value acquired is $700, and goodwill is
$200 ($900 fair value of the consideration transferred $700).
D. None of the answers are correct.

Question: 226

Entity X owns 90% of Entity Y. Early in the year, X lent Y $1,000,000. No payments have
been made on the debt by year end. Proper accounting at year end in the consolidated
financial statements would

A. Eliminate 100% of the receivable, the payable, and the related interest.
Answer (A) is correct.
In a consolidated statement of financial position, reciprocal balances,
such as receivables and payables, between a parent and a consolidated
subsidiary should be eliminated in their entirety regardless of the portion
of the subsidiarys shares held by the parent. Thus, all effects of the
$1,000,000 loan should be eliminated in the preparation of the year-end
consolidated statement of financial position.
B. Eliminate 100% of the receivable and the payable but not any related
interest.
C. Eliminate 90% of the receivable, the payable, and the related interest.
D. Eliminate 90% of the receivable and the payable but not any related
interest.

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Question: 227

Costs incurred in completing a business combination are listed below.

General administrative costs

$240,000

Consulting fees

120,000

Direct cost to register and issue equity securities

80,000

The amount charged to the expenses of the business combination is

A.
B.
C.
D.

$80,000
$120,000
$240,000
$360,000
Answer (D) is correct.
Acquisition-related costs, such as finders fees, professional and
consulting fees, and general administrative costs, are expensed as
incurred. But direct issue costs of equity (underwriting, legal, accounting,
tax, registration, etc.) are debited to additional paid-in capital.
Accordingly, the amount expensed is $360,000 ($240,000 + $120,000).

Question: 228

Alton Corporation purchased 100% of the shares of Jones Corporation for $600,000.
Financial information for Jones Corporation is provided below.

Jones Corporation ($000)


Carrying
Amount

Fair
Value

$ 50

$ 50

Accounts receivable

100

100

Inventory

150

100

300

250

500

600

$800

$850

$150

$150

200

200

350

350

Common stock

150

150

Paid-in capital

80

80

Cash

Total current assets


Property, plant, and equipment (net)
Total assets
Current liabilities
Long-term debt
Total liabilities

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Retained earnings
Total shareholders equity
Total liabilities and shareholders equity

220
450
$800

The amount of goodwill resulting from this purchase, if any, would be

A. $200,000
B. $150,000
C. $100,000
Answer (C) is correct.
Goodwill is the excess of (1) the sum of the acquisition-date fair values
of (a) the consideration transferred ($600,000), (b) any noncontrolling
interest in the acquiree ($0), and (c) the acquirers previously held equity
interest in the acquiree ($0) over (2) the net of the acquisition-date fair
values of the identifiable assets acquired ($850,000) and liabilities
assumed ($350,000). The amount of goodwill is calculated as follows:
Consideration transferred

$600,000

Acquisition-date fair value of net assets acquired ($850,000


$350,000)
(500,000)
Goodwill

$100,000

D. $0

Question: 229

How should the acquirer recognize a bargain purchase in a business acquisition?

A. As negative goodwill in the statement of financial position.


B. As goodwill in the statement of financial position.
C. As a gain in earnings at the acquisition date.
Answer (C) is correct.
A bargain purchase is recognized in the consolidated financial statements
as an ordinary gain at the acquisition date. A bargain purchase occurs
when the net of the acquisition-date fair values of identifiable assets
acquired and liabilities assumed exceeds the sum of the acquisition-date
fair values of the consideration transferred, any noncontrolling interest
recognized, and any previously held equity interest in the acquiree.
D. As a deferred gain that is amortized into earnings over the estimated future
periods benefited.

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Question: 230

Par Corp. owns 60% of Sub Corp.s outstanding capital stock. On May 1, Par advanced Sub
$70,000 in cash, which was still outstanding at December 31. What portion of this advance
should be eliminated in the preparation of the December 31 consolidated balance sheet?

A. $70,000
Answer (A) is correct.
In a consolidated balance sheet, reciprocal balances, such as receivables
and payables, between a parent and a consolidated subsidiary should be
eliminated in their entirety regardless of the portion of the subsidiarys
stock held by the parent. Thus, the entire $70,000 advance should be
eliminated in the preparation of the year-end consolidated balance sheet.
B. $42,000
C. $28,000
D. $0

Question: 231

Shep Co. has a receivable from its parent, Pep Co. Should this receivable be separately
reported in Sheps balance sheet and in Peps consolidated balance sheet.

Sheps
Peps Consolidated
Balance Sheet Balance Sheet
A. Yes No
Answer (A) is correct.
In a consolidated balance sheet, reciprocal balances, such as receivables
and payables, between a parent and a consolidated subsidiary are
eliminated in their entirety, regardless of the portion of the subsidiarys
stock held by the parent. However, intraentity transactions should not be
eliminated from the separate financial statements of the entities.
B. Yes Yes
C. No No
D. No Yes

Question: 232

Water Co. owns 80% of the outstanding common stock of Fire Co. On December 31, Year
3, Fire sold equipment to Water at a price in excess of Fires carrying amount but less than
its original cost. On a consolidated balance sheet at December 31, Year 3, the carrying
amount of the equipment should be reported at

A. Waters original cost.


B. Fires original cost.
C. Waters original cost minus Fires recorded gain.
Answer (C) is correct.
In consolidated financial statements, the effects of intraentity transactions
should be eliminated. The original amount recorded for the acquisition
by Water Co. of the equipment from Fire Co. was the carrying amount on
Fires balance sheet plus the gain on the sale. In the consolidated

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financial statements, the equipment should be reported at the amount
previously recorded on Fires balance sheet. This amount is the original
cost recorded by Water minus the gain recognized by Fire when the
transaction took place.
D. Waters original cost minus 80% of Fires recorded gain.

Question: 233

Vadis Co. sells appliances that include a 3-year warranty. Service calls under the warranty
are performed by an independent mechanic under a contract with Vadis. Based on
experience, warranty costs are estimated at $30 for each machine sold. When should Vadis
recognize these warranty costs?

A.
B.
C.
D.

Evenly over the life of the warranty.


When the service calls are performed.
When payments are made to the mechanic.
When the machines are sold.
Answer (D) is correct.
Under the accrual method, a provision for warranty costs is made when
the related revenue is recognized.

Question: 234

East Corp. manufactures stereo systems that carry a 2-year warranty against defects.
Based on past experience, warranty costs are estimated at 4% of sales for the warranty
period. During the year, stereo system sales totaled $3 million, and warranty costs of
$67,500 were incurred. In its income statement for the year ended December 31, East
should report warranty expense of

A.
B.
C.
D.

$52,500
$60,000
$67,500
$120,000
Answer (D) is correct.
Warranty expense equals 4% of sales for the period, or $120,000
($3,000,000 4%).

Question: 235

During Year 3, Rex Co. introduced a new product carrying a 2-year warranty against
defects. The estimated warranty costs related to dollar sales are 2% within 12 months
following sale and 4% in the second 12 months following sale. Sales and actual warranty
expenditures for the years ended December 31, Year 3 and Year 4, are as follows:

Actual Warranty
Sales

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Year 3 $ 600,000

$ 9,000

Year 4 1,000,000

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$1,600,000

$39,000

At December 31, Year 4, Rex should report an estimated warranty liability of

A. $0
B. $39,000
C. $57,000
Answer (C) is correct.
Because this product is new, the beginning balance in the estimated
warranty liability account at the beginning of Year 3 is $0. For Year 3,
the estimated warranty costs related to dollar sales are 6% (2% + 4%) of
sales or $36,000 ($600,000 6%). For Year 4, the estimated warranty
costs are $60,000 ($1,000,000 sales 6%). These amounts are charged to
warranty expense and credited to the estimated warranty liability
account. This liability account is debited for expenditures of $9,000 and
$30,000 in Year 3 and Year 4, respectively. Hence, the estimated
warranty liability at 12/31/Yr 4 is $57,000.
Estimated Warranty Liability
$
Year 3 expenditures $ 9,000
Year 4 expenditures 30,000

0
36,000
60,000

$57,000

1/1/Yr 3
Year 3 expense
Year 4 expense
12/31/Yr 4

D. $96,000

Question: 236

On April 1, Ash Corp. began offering a new product for sale under a 1-year warranty. Of the
5,000 units in inventory at April 1, 3,000 had been sold by June 30. Based on its experience
with similar products, Ash estimated that the average warranty cost per unit sold would be
$8. Actual warranty costs incurred from April 1 through June 30 were $7,000. At June 30,
what amount should Ash report as estimated warranty liability?

A. $9,000
B. $16,000
C. $17,000
Answer (C) is correct.
If 3,000 units were sold at an estimated $8 per unit warranty cost, the
total credits to the liability account equaled $24,000 (3,000 $8). Given
that actual warranty costs of $7,000 were debited to the account, the
ending balance must have been $17,000 ($24,000 $7,000).
D. $33,000

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Question: 237

A corporation entered into a purchase commitment to buy inventory. At the end of the
accounting period, the current market value of the inventory was less than the fixed
purchase price by a material amount. Which of the following accounting treatments
is most appropriate?

A. Describe the nature of the contract in a note to the financial statements,


recognize a loss in the income statement, and recognize a liability for the
accrued loss.
Answer (A) is correct.
A commitment to acquire goods in the future is not recorded at the time
of the agreement, e.g., by debiting an asset and crediting a liability. But
recognition in earnings of a loss on goods subject to a firm purchase
commitment is required if the market price of these goods declines below
the commitment price. The reason for current loss recognition is the
same as that for inventory on hand. A decrease (not an increase) in the
future benefits of the commitment should be recognized when it occurs.
Thus, the lower of cost or market rule is followed. If material losses are
expected to arise from firm, noncancelable, and unhedged commitments
for the future purchase of inventory, they should be measured in the same
way as inventory losses, and, if material, recognized and separately
disclosed in the income statement. The entry is to debit unrealized
holding loss-earnings and to credit liability-purchase commitment.
Furthermore, certain disclosures are required for unconditional purchase
obligations that are unrecorded. They include the nature and term of the
obligation.
B. Describe the nature of the contract and the estimated amount of the loss in
a note to the financial statements, but do not recognize a loss in the income
statement.
C. Describe the nature of the contract in a note to the financial statements,
recognize a loss in the income statement, and recognize a reduction in
inventory equal to the amount of the loss by use of a valuation account.
D. Neither describe the purchase obligation nor recognize a loss on the income
statement or balance sheet.

Question: 238

Net losses on firm purchase commitments to acquire goods for inventory result from a
contract price that exceeds the current market price. If a firm expects that losses will occur
when the purchase occurs, expected losses, if material,

A. Should be recognized in the accounts and separately disclosed as losses on


the income statement of the period during which the decline in price takes
place.
Answer (A) is correct.
A loss is accrued in the income statement on goods subject to a firm
purchase commitment if the market price of these goods declines below
the commitment price. This loss should be measured in the same manner
as inventory losses. Disclosure of the loss is also required.
B. Should be recognized in the accounts and separately disclosed as net
unrealized losses on the balance sheet at the end of the period during which
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the decline in price takes place.
C. Should be recognized in the accounts and separately disclosed as net
unrealized losses on the balance sheet at the end of the period during which
the contract is executed.
D. Should not be recognized in the accounts until the contract is executed and
need not be separately disclosed in the financial statements.

Question: 239

A liability arising from a loss contingency should be recorded if the

A. Amount of the loss can be reasonably estimated.


B. Contingent future events have a reasonably possible chance of occurring.
C. Contingent future events have a reasonably possible chance of occurring
and the amount of the loss can be reasonably estimated.
D. Contingent future events will probably occur and the amount of the loss
can be reasonably estimated.
Answer (D) is correct.
A material contingent loss must be accrued when the following two
conditions are met:
1.
It is probable that, at the balance sheet date, an asset has
been impaired or a liability has been incurred.
2.
The amount of the loss can be reasonably estimated.

Question: 240

Which one of the following loss contingencies would be accrued as a liability rather than
disclosed in the notes to the financial statement?

A. A guarantee of the indebtedness of another.


B. A dispute over additional income taxes assessed for prior years (now in
litigation).
C. A pending lawsuit with an uncertain outcome.
D. Liabilities for service or product warranties made as a regular part of
business.
Answer (D) is correct.
Similarly to the guidelines for loss contingencies, a liability for future
warranty costs should be accrued if (1) the incurrence of the expense is
probable and (2) the amount can be reasonably estimated.

Question: 241

Linden Corporation is a defendant in a lawsuit where 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 Lindens new products to a
competitor. Lindens 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, Lindens accountants estimate the company will
incur an additional $5,000 in unemployment costs because of Russells termination. The

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amount that Linden should accrue because of the contingency in this situation is

A.
B.
C.
D.

$200,000
$100,000
$5,000
$0
Answer (D) is correct.
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.

Question: 242

Ichabod Company is the plaintiff in two lawsuits. The first suit involves a competitor who has
made an exact copy of one of Ichabods products, and Ichabod is suing for patent
infringement. The attorneys estimate a $5,000,000 award for Ichabod; however, it is
anticipated that the case will be in litigation for 2 to 3 years before final resolution.
The second case also involves patent infringement; however, in this instance, the attorneys
do not believe Ichabod has a strong case. It is estimated that the company has a 50%
chance of winning and the award, if any, would be in the $250,000 to $1,000,000 range.
The most appropriate amount to be recorded as a gain contingency is

A. $0
Answer (A) is correct.
Gain contingencies are not recorded; they are recognized only when
realized. A gain contingency must be adequately disclosed.
B. $5,000,000
C. $5,125,000
D. $5,250,000

Question: 243

Warren Company is being sued in a wrongful discharge suit for $500,000. The company
attorney has advised Warren that the probability of the plaintiff prevailing and receiving the
full amount is about 80%. The attorney also indicated that the case would likely be tied up in
the courts for 2 to 3 years. The most appropriate financial statement presentation for this
loss contingency would be to

A. Record $500,000 as a loss contingency.


Answer (A) is correct.
A liability arising from a loss contingency should be recorded if the
contingent future event will probably occur and the amount of the loss
can be reasonably estimated.
B. Record $400,000 as a loss contingency.
C. Disclose the loss contingency in the footnotes.
D. Not record or footnote the loss contingency.

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Question: 244

In May Year 1, Caso Co. filed suit against Wayne, Inc., seeking $1.9 million in damages for
patent infringement. A court verdict in November Year 4 awarded Caso $1.5 million in
damages, but Waynes appeal is not expected to be decided before Year 6. Casos counsel
believes it is probable that Caso will be successful against Wayne for an estimated amount
in the range between $800,000 and $1.1 million, with $1 million considered the most likely
amount. What amount should Caso record as income from the lawsuit in the year ended
December 31, Year 4?

A. $0
Answer (A) is correct.
Gain contingencies are not recognized until they are realized. Because
the appeal is not expected to be decided before Year 6, Caso should not
record any revenue from the lawsuit in the Year 4 income statement. This
gain contingency should be disclosed; however, care should be taken to
avoid misleading implications as to the likelihood of realization.
B. $800,000
C. $1,000,000
D. $1,500,000

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Question: 245

Which of the following is not an appropriate basis for measuring the cost of property, plant,
and equipment?

A. The purchase price, freight costs, and installation costs of a productive


asset should be included in the assets cost.
B. Proceeds obtained in the process of readying land for its intended purpose,
such as from the sale of cleared timber, should be recognized immediately
as income.
Answer (B) is correct.
Accordingly, items of property, plant, and equipment (PPE) that meet the
recognition criterion are initially measured at cost. The cost includes the
purchase price (minus trade discounts and rebates, plus purchase taxes)
and the directly attributable costs of bringing the assets to working
condition for their intended use. Directly attributable costs include site
preparation, installation, initial delivery and handling, architect and
equipment fees, costs of removing the assets and restoring the site, etc.
Accordingly, the cost of land includes the cost of obtaining the land and
readying it for its intended uses, but it is inappropriate to recognize the
proceeds related to site preparation immediately in profit or loss. They
should be treated as reductions in the price of the land.
C. The costs of improvements to equipment incurred after its acquisition
should be added to the assets cost if they increase future service potential.
D. All costs incurred in the construction of a plant building, from excavation
to completion, should be considered as part of the assets cost.

Question: 246

An entity installed an assembly line in Year 1. Four years later, $100,000 was invested to
automate the line. The automation increased the market value and productive capacity of
the assembly line but did not affect its useful life. Proper accounting for the cost of the
automation should be to

A. Report it as an expense in Year 5.


B. Establish a separate account for the $100,000.
C. Allocate the cost of automation between the asset and accumulated
depreciation accounts.
D. Debit the cost to the property, plant, and equipment account.
Answer (D) is correct.
Subsequent costs are added to the carrying amount of an item of PPE if it
is probable that, as a result, future economic benefits will be received,
and the costs are reliably measurable. An extended useful life, improved
output quantity or quality, and reduced operating costs are all future
economic benefits.

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Question: 247

The selected data from statements of financial position on December 31, Year 1, and
December 31, Year 2, is presented below:

12/31/Year 12/31/Year Additional information for Year 2:


1
2
Property,
plant,
and
equipment

$295,000

$340,000

1.
Equipment was acquired
for $65,000.
2.
Depreciation expense was
$30,000.

Accumulated
depreciation

(102,000)

(119,000)

The carrying amount (cost minus accumulated depreciation) of property, plant, and
equipment disposed of in Year 2 was

A. $7,000
Answer (A) is correct.
The Year 2 beginning carrying amount is $193,000 ($295,000
$102,000), and the Year 2 ending carrying amount is $221,000
($340,000 $119,000). The carrying amount of PPE disposed of is
$7,000 ($193,000 beginning balance + $65,000 acquired during Year 2
$30,000 depreciation expense $221,000 ending balance).
B. $17,000
C. $20,000
D. $32,000

Question: 248

A theme park purchased a new, exciting ride and financed it through the manufacturer. The
following facts pertain:

Purchase price

$800,000

Delivery cost

50,000

Installation cost

70,000

Cost of trial runs

40,000

Interest charges for first year

60,000

The straight-line method is to be used. Compute the depreciation on the equipment for the
first year assuming an estimated service life of 5 years.

A. $160,000
B. $184,000
C. $192,000

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Answer (C) is correct.
Under the straight-line method, the annual depreciation expense for an
asset equals the assets amount (cost residual value) divided by the
assets estimated useful life. The cost of the asset includes its price and
the directly attributable costs of bringing it to working condition for
intended use. Thus, the depreciation expense is $192,000 [($800,000
purchase price + $50,000 delivery cost + $70,000 installation cost +
$40,000 trial-run cost) 5-year estimated service life]. Borrowing costs
incurred after the asset is prepared for its intended use are expensed even
if the allowed alternative treatment of such costs is followed, and the
asset otherwise satisfies the criteria for capitalization of such expenses.
D. $204,000

Question: 249

Which of the following is not an appropriate basis for measuring the historical cost of
property, plant, and equipment?

A. Delivery and handling costs and installation costs of a productive asset


should be included in the assets cost.
B. The cost should include the purchase price without a deduction for trade
discounts.
Answer (B) is correct.
An asset classified under property, plant, and equipment is measured
initially at cost. This amount includes the purchase price and any directly
attributable costs of bringing the asset to working condition for its
intended use. Directly attributable costs include costs of, for example,
site preparation, initial delivery and handling, installation, professional
fees (e.g., those of architects and engineers), and dismantling and
removing the asset and restoring the site. The purchase price is
determined by adding any import fees and nonrefundable purchase taxes
and subtracting any trade discounts and rebates.
C. The costs of improvements to equipment incurred after its acquisition
should be added to the assets cost if they provide future economic benefits
exceeding the originally assessed standard of performance.
D. All costs incurred in the construction of a plant building, from excavation
to completion, should be considered as part of the assets cost.

Question: 250

In making a cash flow analysis of property, plant, and equipment (PPE), the internal auditor
discovered that depreciation expense for the period was $10,000. PPE with a cost of
$50,000 and related accumulated depreciation of $30,000 was sold for a gain of $1,000. If
the carrying amount of PPE increased by $80,000 during the period, how much PPE was
purchased this period?

A. $91,000
B. $100,000
C. US $110,000

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Answer (C) is correct.
The carrying amount of the PPE account, net of accumulated
depreciation, is increased by the cost of purchases and decreased by the
carrying amount of items of PPE sold and depreciation. The net PPE
decreased by the carrying amount of items sold, or $20,000 ($50,000 cost
$30,000 accumulated depreciation), and by the $10,000 of
depreciation. If PPE still increased by $80,000, $110,000 ($30,000 total
decrease + $80,000 increase) of equipment must have been purchased.
D. $119,000

Question: 251

On January 1, Year 1, an entity purchased an abandoned quarry for $1,200,000 to be used


as a landfill to service its trash collection contracts with nearby cities for the next 20 years.
The entity depletes the quarry using the units-of-production method based on a surveyors
measurements of volume of the quarrys pit. This amount was 500,000 cubic yards when
purchased and 350,000 cubic yards at year-end Year 5. What is the net amount that should
be shown on the entitys December 31, Year 5, statement of financial position for the
quarry?

A. $1,200,000
B. $900,000
C. $840,000
Answer (C) is correct.
The units-of-production method allocates cost based on output. The net
amount reported as an asset for the quarry using this method is $840,000
[(350,000 cubic yards 500,000 total cubic yards) $1,200,000].
D. $360,000

Question: 252

A new machine has an initial cost of $300,000, an estimated useful life of 2,000 hours of
use over a 3-year period, and an estimated residual value of $70,000. Usage rates are
estimated as 500 hours in the first year, 700 hours in the second year, and 800 hours in the
third year. Depreciation expense in Year 2 under the units-of-production method of
depreciation will be

A. $57,500
B. $75,000
C. $80,500
Answer (C) is correct.
Depreciation expense equals cost minus residual value, times the
estimated hours of use in Year 2 divided by the total estimated hours of
use. Thus, depreciation expense is $80,500 [($300,000 $70,000) (700
hours 2,000 hours)].
D. $105,000

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Question: 253

A company uses straight-line depreciation for financial reporting purposes, but uses
accelerated depreciation for tax purposes. Which of the following account balances would
be lower in the financial statements used for tax purposes than it would be in the general
purpose financial statements?

A. Accumulated depreciation.
B. Cash.
C. Retained earnings.
Answer (C) is correct.
Because the tax basis uses an accelerated method, depreciation expense
and accumulated depreciation will be greater. Moreover, taxable income
will be lower than financial net income. Consequently, tax-basis retained
earnings will be less than that in the general purpose financial statements.
D. Gross property, plant, and equipment.

Question: 254All of the following would be included as part of the cost of a depreciable
asset except the
A. Costs to level land to make it usable for the companys purposes.
Answer (A) is correct.
Site preparation costs [clearing, draining, filling, leveling the property, and razing existing
buildings, minus any proceeds (such as timber sales)] are costs of the land, not of the
building to be constructed on the land.
B. Freight costs to ship new equipment to the companys facility.
C. Actual interest costs incurred during the construction of a new building.
D. Costs to construct a driveway on the companys property.

Question: 255

The board of directors of Ingold Industries, Inc., authorized Don Burger, president of Ingold,
to pay as much as $90,000 to purchase a tract of land adjacent to the main factory. Burger
negotiated a price of $75,800 for the land, and legal fees for closing costs amounted to
$820. A contractor cleared, filled, and graded the land for $6,800, and dug the foundation
for a new building for $4,300. A prefabricated building was erected at a cost of $181,000.
The building has an estimated useful life of 20 years with no residual value. The contractors
bill indicated that the cost of the parking lot and driveways was $7,060. The parking lot and
the driveways will need to be replaced in 15 years. The proper amount to be recorded in
Ingolds land account is

A. $76,620
B. $83,420
Answer (B) is correct.
The cost of acquiring and preparing land for its expected use is
capitalized. The amount to be recorded in the land account is $83,420,
consisting of the $75,800 purchase price, the $820 closing costs, and the
$6,800 site preparation costs.
C. $87,720
D. $90,480

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Question: 256Basic Brick, Inc., purchased manufacturing equipment for $100,000, with an estimated
useful life of 10 years and a salvage value of $15,000. The second years depreciation for this
equipment using the double-declining balance method is
A. $8,500
B. $13,600
C. $16,000
Answer (C) is correct.
Under the double-declining balance method, the full cost of the asset, or $100,000, is
depreciated, but not below salvage value. Because the straight-line rate for a 10-year asset
is 10% (100% 10), the double-declining balance rate is 20% (10% 2). The first years
depreciation is $20,000 ($100,000 20%), leaving a carrying amount for the second year
of $80,000 ($100,000 $20,000). The second years depreciation is thus $16,000 ($80,000
20%).
D. $20,000

Question: 257

Which one of the following characteristics is not required for an asset to be properly
described as property, plant, and equipment?

A. Held for use and not for investment.


B. Newly purchased.
Answer (B) is correct.
These assets are known variously as property, plant, and equipment;
fixed assets; or plant assets.
1.
PPE are tangible. They have physical existence.
2.
PPE may be either personal property (something movable,
e.g., equipment) or real property (such as land or a building).
3.
PPE are used in the ordinary operations of an entity and
are not held primarily for investment, resale, or inclusion in
another product. But they are often sold.
4.
PPE are noncurrent. They are not expected to be used up
within 1 year or the normal operating cycle of the business,
whichever is longer.
However, an asset need not be newly purchased to be properly described
as property, plant, and equipment.
C. Expected life of more than 1 year.
D. Tangible.

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Question: 258

Equipment bought by Wilson Steam Generating Company 3 years ago was charged to
equipment expense in error. The cost of the equipment was $100,000, with no expected
salvage value and a 10-year estimated life. Wilson uses the straight-line depreciation
method on similar equipment. The error was discovered at the end of Year 3 prior to the
issuance of Wilsons financial statements. After correction of the error, the correct carrying
value of the equipment will be

A. $30,000
B. $70,000
Answer (B) is correct.
The straight-line depreciation that should have been charged to the
equipment had it been properly capitalized is $30,000 [$100,000 (3
10 years)]. Thus, after correction of the error, the carrying amount of the
equipment will be $70,000 ($100,000 $30,000).
C. $80,000
D. $100,000

Question: 259

The types of assets that qualify for interest capitalization are

A. Assets that are being used in the earning activities of the reporting entity.
B. Assets that are ready for their intended use in the activities of the reporting
entity.
C. Assets that are constructed for the reporting entitys own use.
Answer (C) is correct.
Interest should be capitalized for (1) assets constructed or otherwise
produced for an entitys own use, including those constructed or
produced by others; (2) assets intended for sale or lease that are
constructed or produced as discrete projects (e.g., ships); and (3) certain
equity-based investments. An asset constructed for an entitys own use
qualifies for capitalization of interest if (1) relevant expenditures have
been made, (2) activities necessary to prepare the asset for its intended
use are in progress, and (3) interest is being incurred. The investee must
have activities in progress necessary to commence its planned principal
operations and be expending funds to obtain qualifying assets for its
operations.
D. Inventories that are manufactured in large quantities on a continuing basis.
Question: 260

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Wellington Industries has owned its present facilities since 1981, and Mary Dunlap, CEO,
has authorized various expenditures to repair and improve the building during the current
year. The building was beginning to sag, and without repair, the building would only last
another 8 years. To correct the problem, the foundation was reinforced, and several
columns were added in the basement area at a cost of $47,200. As a result, engineers
estimate that the building will have a remaining useful life of 20 years. To install a new
computer local area network (LAN) and be ready for the next generation of computers, the
phone lines and electrical systems were updated at a cost of $81,300. Wellington engineers
estimate that these improvements should last 25 years. The offices and open work spaces
were rearranged to reduce exposure to electronic emissions at a material cost of $31,000.
The purchase and installation of the computers and software for the LAN cost $102,700.
The LAN hardware and software will have to be replaced in 6 years, but further
rearrangement of the offices and work spaces will not be necessary. After the above
improvements were completed, the entire building was painted inside and outside at a cost

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of $9,450.
As controller of Wellington Industries, which one of the following actions would you
recommend to be in conformity with generally accepted accounting principles?

A. Treat all expenditures as expenses in the current year except the cost of
rearrangement ($31,000), which should be amortized over a period not to
exceed 20 years.
B. Capitalize all expenditures because they represent additions, improvements,
and rearrangements.
C. Capitalize all costs with the exception of the upgrade to the phone and
electrical systems and the painting because they represent maintenance
expenses.
D. Capitalize all costs with the exception of the painting because it represents
maintenance expense.
Answer (D) is correct.
Expenditures on capital assets that improve the assets performance or
extend its useful life are capitalized as part of the assets cost.
Accordingly, the building repairs are capitalized. The substitution of a
better computer system is classified as an improvement, and the costs
also should be capitalized. Moreover, the entity capitalizes the costs of a
rearrangement of the configurations of the offices and open work spaces
that (1) requires material outlays, (2) is separable from recurring
expenses, and (3) provides probable future benefits. However,
expenditures that merely maintain the asset at an acceptable level of
productivity are expensed as they are incurred. Thus, the costs of
painting the building are routine, minor outlays that should be expensed
immediately.

Question: 261

Lakeside Electric purchased a truck for $38,600 to transport equipment to various job sites.
For this purpose, storage bins were welded to the truck bed at a cost of $1,700. Doug
Lombardi, controller of Lakeside, estimates the useful life of the truck to be 5 years and the
residual value to be $1,000. Using the double-declining balance method, the depreciation
expense on the truck for its second year of use is

A.
B.
C.
D.

$9,024
$9,264
$9,432
$9,672
Answer (D) is correct.
Under the double-declining balance method, the full cost of the asset, or
$40,300 ($38,600 + $1,700), is depreciated, but not below salvage value.
Because the straight-line rate for a 5-year asset is 20% (100% 5), the
double-declining balance rate is 40% (20% 2). The first years
depreciation is $16,120 ($40,300 40%), leaving a carrying amount for
the second year of $24,180 ($40,300 $16,120). The second years
depreciation is thus $9,672 ($24,180 40%).

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Question: 262

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 be

A. $10,000
B. $15,000
C. $16,667
Answer (C) is correct.
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 assets useful life
(1 + 2 + 3 + 4 + 5). The first years depreciation expense is therefore
$16,667 [$50,000 (5 15)].
D. $20,000

Question: 263

When a fixed plant asset with a 5-year estimated useful life is sold during the second year,
how would the use of an accelerated depreciation method instead of the straight-line
method affect the gain or loss on the sale of the fixed plant asset?

Gain

Loss

A. Increase Increase
B. Increase Decrease
Answer (B) is correct.
An accelerated method reduces the carrying amount of the asset more
rapidly in the early years of the useful life than does the straight-line
method. Hence, the effect of an early sale is to increase the gain or
decrease the loss that would have been recognized under the straight-line
method.
C. Decrease Increase
D. Decrease Decrease

Question: 264

Which one of the following methods of depreciation will result in the lowest reported net
income in the early life of a depreciable asset?

A.
B.
C.
D.

Composite depreciation method.


Group depreciation method.
Straight-line depreciation method.
Sum-of-the-years-digits depreciation method.
Answer (D) is correct.
Sum-of-the-years-digits depreciation has the highest depreciation
expense in the early years of an assets life, resulting in lower net

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income.

Question: 265

Silken, Inc., a distributor of silk goods, is in its first year of operation. The company has
purchased ten computers at $3,500 each with an estimated life of 6 years; five desks at
$500 each with an estimated life of 10 years; and two word processors at $300 each, with
an estimated life of 4 years. No residual value is anticipated for any of these assets. Silken
wants to adopt a depreciation method that will be easy to use and reflect an appropriate
depreciation expense for the business each accounting period. The most appropriate
method would be

A. Composite depreciation.
Answer (A) is correct.
Group and composite depreciation methods use the straight-line
technique for an aggregate of assets. The composite method is used for
dissimilar assets.
B. Group depreciation.
C. Inventory method.
D. Replacement method.

Question: 266

In which of the following situations is the units-of-production method of


depreciation most appropriate?

A. An assets service potential declines with use.


Answer (A) is correct.
The units-of-production depreciation method allocates asset cost based
on the level of production. As production varies, so will the credit to
accumulated depreciation. Consequently, when an assets service
potential declines with use, the units-of-production method is the most
appropriate method.
B. An assets service potential declines with the passage of time.
C. An asset is subject to rapid obsolescence.
D. An asset incurs increasing repairs and maintenance with use.

Question: 267

Under IFRS, according to the revaluation model, an item of property, plant, and equipment
must be carried at

A. Cost minus any accumulated depreciation.


B. Cost minus residual value.
C. Fair value minus any subsequent accumulated depreciation and impairment
losses.
Answer (C) is correct.
Under the revaluation model, if the fair value of an item of property,
plant, and equipment can be reliably measured, it must be carried

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subsequent to initial recognition at a revalued amount. This amount is
fair value at the date of the revaluation minus any subsequent
accumulated depreciation and impairment losses. The revaluation model
is permitted by IFRS, not U.S. GAAP.
D. The lower of cost or net realizable value.

Question: 268

Merry Co. purchased a machine costing $125,000 for its manufacturing operations and paid
shipping costs of $20,000. Merry spent an additional $10,000 testing and preparing the
machine for use. What amount should Merry record as the cost of the machine?

A. $155,000
Answer (A) is correct.
The amount to be recorded as the acquisition cost of a machine includes
all costs necessary to prepare it for its intended use. Thus, the cost of a
machine used in the manufacturing operations of a company includes the
cost of testing and preparing the machine for use and the shipping costs.
The acquisition cost is $155,000 ($125,000 + $20,000 + $10,000).
B. $145,000
C. $135,000
D. $125,000

Question: 269

According to IFRS, which accounting policy may an entity apply to measure investment
property in periods subsequent to initial recognition?

A. Cost model or revaluation model.


B. Cost model or fair value model.
Answer (B) is correct.
An entity may choose either the cost model or the fair value model as its
accounting policy. But it must apply that policy to all of its investment
property. Under the cost model, investment property is carried at its cost
minus any accumulated depreciation and impairment losses. Under the
fair value model, investment property is measured at fair value, and gain
or loss from a change in its fair value is recognized immediately in profit
or loss.
C. Fair value model only.
D. Fair value model or revaluation model.

Question: 270

An expenditure to install an improved electrical system is a

Capital Expenditure Revenue Expenditure


A. No Yes
B. No No
C. Yes No
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Answer (C) is correct.
A betterment (improvement) occurs when a replacement asset is
substituted for an existing asset, and the result is increased productivity,
capacity, or expected useful life. If the improvement benefits future
periods, it should be capitalized.
D. Yes Yes

Question: 271

Brown Systems began operating January 1 and spent $900,000 in the first month of
operations on the following items:

January advertising campaign $ 40,000


Computer equipment

280,000

12-month insurance policy

120,000

January building rent

60,000

January salaries

340,000

Office supplies

10,000

Automobile

30,000

January utilities

20,000

Total

$ 900,000

The total cash expenditures that should be capitalized as property, plant, and equipment is

A. $80,000
B. $310,000
Answer (B) is correct.
The assets purchased that are capitalized as property, plant, and
equipment (PPE) are the computer equipment and automobile. Therefore,
PPE is $310,000 ($280,000 + $30,000).
C. $370,000
D. $440,000

Question: 272

An entity sells a piece of machinery, for cash, prior to the end of its estimated useful life.
The sale price is less than the carrying amount of the asset on the date of sale. The entry
that the entity uses to record the sale is

A.

Cash
Accumulated depreciation -- machinery
Loss on disposal of machinery
Machinery
Answer (A) is correct.

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Cash is debited for the amount of the sale proceeds. Machinery and the
related accumulated depreciation are eliminated by a credit and a debit,
respectively. Because the sale price was less than the carrying amount of
the asset on the date of sale, a loss on disposal should be recognized in
net income or loss.
B.

Cash
Accumulated depreciation -- machinery
Gain on disposal of machinery
Machinery

C.

Cash
Expense -- disposal of machinery
Accumulated depreciation -- machinery
Machinery

D.

Question: 273

Cash
Machinery
Accumulated depreciation -- machinery
Gain on disposal of machinery

An entity purchased a machine for $700,000. The machine was depreciated using the
straight-line method and had a residual value of $40,000. The machine was sold on
December 31, Year 1. The accumulated depreciation related to the machine was $495,000
on that date. The entity reported a gain on the sale of the machine of $75,000 in its income
statement for the fiscal year ending December 31, Year 1. The selling price of the machine
was

A. $280,000
Answer (A) is correct.
The selling price minus the carrying amount of the machine equals the
gain or loss on disposal. The carrying amount equals $205,000 ($700,000
historical cost $495,000 accumulated depreciation). Thus, the selling
price was $280,000 ($205,000 + $75,000 gain).
B. $240,000
C. $205,000
D. $115,000

Question: 274

What is the journal entry recorded upon the sale of an item of property, plant, and
equipment (PPE) that was sold for cash in excess of its carrying amount?

A. No journal entry is required.


B. Debit cash
Debit accumulated depreciation
Debit income on disposal of PPE
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Credit PPE
C. Debit cash
Debit PPE
Credit accumulated depreciation
Credit income on disposal of PPE
D. Debit cash
Debit accumulated depreciation
Credit PPE
Credit income on disposal of PPE
Answer (D) is correct.
The journal entry to record the sale of an item of PPE for cash in excess
of its carrying amount should debit the cash account to record the sale
proceeds received. Accumulated depreciation should be eliminated by
debiting an amount equal to depreciation accumulated up to the start of
the current accounting period plus any depreciation that has accumulated
between the start of the current period and the date of disposal. Finally,
the PPE account should be credited to eliminate the original cost of the
asset. The gain should be recorded as a credit and recognized as income
on the income statement.

Question: 275

An entity sold a depreciable asset in the middle of the fifth year of its estimated 10-year
useful life. The original cost of the asset was $100,000, and it was being depreciated on the
straight-line basis. If the asset was sold for $80,000, the gain on the sale will be

A. $20,000
B. $25,000
Answer (B) is correct.
The gain on the sale is the difference between the sale proceeds and the
carrying amount of the asset (its remaining undepreciated cost).
Depreciation must be taken up to the time of sale. Assuming that residual
value is $0, annual depreciation is $10,000 ($100,000 10 years). Thus,
the gain is $25,000 {$80,000 sale proceeds [$100,000 historical cost
($10,000 4.5 years)]}.
C. $30,000
D. $35,000

Question: 276

To determine whether to recognize the impairment of a depreciable fixed asset, a company


must compare the

A. Carrying amount of the asset and the present value of the future cash flows
expected to be generated by the asset.
B. Original cost of the asset and the fair value of the asset.
C. Carrying amount of the asset and the undiscounted future cash flows
expected to be generated by the asset.

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Answer (C) is correct.
A long-lived asset (asset group) is impaired when its carrying amount is
greater than its fair value. However, a loss equal to this excess is
recognized for the impairment only when the carrying amount is not
recoverable. The carrying amount is not recoverable when it exceeds the
sum of the undiscounted cash flows expected from the use and
disposition of the asset (asset group).
D. Original cost of the asset and the carrying amount of the asset.

Fact Pattern: Blake Corporation has determined that one of its machines has experienced an impairment in
value. However, the company expects to continue to use the asset for another 3 full years because no active
market exists for this machine. Selected information on the impaired asset (on the date that impairment was
determined to exist) is provided below.
Original cost of the machine

Question: 277

$22,000

Carrying amount of the machine

20,000

Undiscounted future cash flows expected to be generated by the machine

15,000

Fair value of the machine (determined by calculating the present value of the future
cash flows expected to be generated by the machine)

12,000

After recognition of the impairment loss, Blakes carrying amount of the impaired asset will
be

A. $0
B. $12,000
Answer (B) is correct.
A long-lived asset (asset group) is impaired when its carrying amount is
greater than its fair value. However, a loss equal to this excess is
recognized for the impairment only when the carrying amount is not
recoverable. The carrying amount is not recoverable when it exceeds the
sum of the undiscounted cash flows expected from the use and
disposition of the asset (asset group).
The asset is impaired because its carrying amount ($20,000) exceeds its
fair value ($12,000). This loss ($20,000 $12,000 = $8,000) is
recognized in full because the carrying amount ($20,000) exceeds the
undiscounted cash flows from the asset ($15,000). Thus, the carrying
amount is reduced to $12,000.
C. $14,000
D. $15,000

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Fact Pattern: Blake Corporation has determined that one of its machines has experienced an impairment in
value. However, the company expects to continue to use the asset for another 3 full years because no active
market exists for this machine. Selected information on the impaired asset (on the date that impairment was
determined to exist) is provided below.
Original cost of the machine

Question: 278

$22,000

Carrying amount of the machine

20,000

Undiscounted future cash flows expected to be generated by the machine

15,000

Fair value of the machine (determined by calculating the present value of the future
cash flows expected to be generated by the machine)

12,000

What is the amount of the impairment loss to be recorded by Blake?

A.
B.
C.
D.

$3,000
$5,000
$7,000
$8,000
Answer (D) is correct.
The impairment loss is the difference between the carrying amount and
fair value of the asset ($20,000 $12,000 = $8,000).

Question: 279

An entity purchased a machine on January 1, Year 1, for $1,000,000. The machine had an
estimated useful life of 9 years and a residual value of $100,000. The company uses
straight-line depreciation. On December 31, Year 4, the machine was sold for $535,000.
The gain or loss that should be recorded on the disposal of this machine is

A. $35,000 gain.
B. $65,000 loss.
Answer (B) is correct.
The accumulated depreciation was $400,000 {[($1,000,000 historical
cost $100,000 residual value) 9 years estimated useful life] 4
years}, so the carrying amount was $600,000 ($1,000,000 $400,000).
Thus, the loss was $65,000 ($600,000 carrying amount $535,000 sales
price).
C. $365,000 loss.
D. $465,000 loss.

Question: 280

Which of the following statements is true regarding impairment of long-lived assets?

A. U.S. GAAP requires a one-step impairment test, and IFRS requires a twostep impairment test.
B. Both IFRS and U.S. GAAP permit reversal of an impairment loss in
subsequent periods.
C. Both IFRS and U.S. GAAP prohibit reversal of an impairment loss in
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subsequent periods.
D. Under U.S. GAAP, but not IFRS, reversal of an impairment loss in
subsequent periods is prohibited.
Answer (D) is correct.
Under IFRS, an impairment loss on an asset may be reversed in
subsequent periods if a change in the estimates used to measure the
recoverable amount has occurred. But an impairment loss recognized for
goodwill must not be reversed. Under U.S. GAAP, a previously
recognized impairment loss must not be reversed.

Question: 281

An entity applies IFRS. On December 31, Year 1, it estimates the following information
regarding its headquarters building:

Fair value

$100,000

Cost to sell

$15,000

Value in use

$90,000

Residual value

$17,000

Net realizable value $82,000


According to the information above, what is the recoverable amount of the headquarters
building on December 31, Year 1?

A. $85,000
B. $90,000
Answer (B) is correct.
The recoverable amount of an asset is the higher of its fair value minus
costs to sell and its value in use. Thus, the recoverable amount is $90,000
[$90,000 value in use > ($100,000 $15,000) FV minus costs to sell].
C. $100,000
D. $82,000

Question: 282

Testing for possible impairment of a long-lived asset (asset group) that an entity expects to
hold and use is required

A.
B.
C.
D.

At each interim and annual balance sheet date.


At annual balance sheet dates only.
Periodically.
Whenever events or changes in circumstances indicate that its carrying
amount may not be recoverable.
Answer (D) is correct.
A long-lived asset (asset group) is tested for recoverability whenever

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events or changes in circumstances indicate that its carrying amount may
not be recoverable. The carrying amount is not recoverable when it
exceeds the sum of the undiscounted cash flows expected to result from
the use and disposition of the asset (asset group). If the carrying amount
is not recoverable, an impairment loss is recognized equal to the excess
of the carrying amount over the fair value.

Question: 283

A company has a long-lived asset with a carrying value of $120,000, expected future cash
flows of $130,000, present value of expected future cash flows of $100,000, and a market
value of $105,000. What amount of impairment loss should be reported?

A. $0
Answer (A) is correct.
An impairment loss is recognized when a long-lived assets carrying
amount exceeds the sum of its undiscounted cash flows. Because the sum
of the undiscounted cash flows ($130,000) exceeds the carrying amount
($120,000), the carrying amount is recoverable. Thus, no impairment is
recognized.
B. $5,000
C. $15,000
D. $20,000

Question: 284

An impairment loss on a long-lived asset (asset group) to be held and used is reported by a
business enterprise in

A.
B.
C.
D.

Discontinued operations.
Extraordinary items.
Other comprehensive income.
Income from continuing operations.
Answer (D) is correct.
An impairment loss is included in income from continuing operations
before income taxes by a business enterprise (income from continuing
operations in the statement of activities by a not-for-profit organization).
When a subtotal for income from operations is reported, the
impairment loss is included.

Question: 285

Last year, Katt Co. reduced the carrying amount of its long-lived assets used in operations
from $120,000 to $100,000, in connection with its annual impairment review. During the
current year, Katt determined that the fair value of the same assets had increased to
$130,000. Under U.S. GAAP, what amount should Katt record as restoration of previously
recognized impairment loss in the current years financial statements?

A. $0
Answer (A) is correct.
A previously recognized impairment loss may not be reversed under U.S.
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GAAP. Under IFRS, an impairment loss (carrying amount > recoverable


amount) on an asset (except goodwill) may be reversed if a change in the
estimates used to measure the recoverable amount has occurred.
Furthermore, IFRS permit an item of property, plant, and equipment to
be carried at a revalued amount if its fair value can be measured reliably.
Thus, an increase in excess of the prior carrying amount is permitted by
IFRS.
B. $10,000
C. $20,000
D. $30,000

Question: 286

Under IFRS, an asset is impaired when its carrying amount exceeds its recoverable
amount. The recoverable amount of an asset is

A.
B.
C.
D.

The lower of its fair value plus cost to sell or value in use.
The greater of its fair value plus cost to sell or value in use.
The lower of its fair value minus cost to sell or value in use.
The greater of its fair value minus cost to sell or value in use.
Answer (D) is correct.
The recoverable amount of an asset is the greater of its fair value minus
cost to sell or value in use. Value in use is the present value of the assets
expected cash flows. The recognized impairment loss is the excess of the
assets carrying amount over its recoverable amount.

Question: 287

Which of the following is not considered to be an intangible asset?

A. Goods on consignment.
Answer (A) is correct.
An intangible asset is an identifiable nonmonetary (nonfinancial) asset
without physical substance. Inventory is a tangible asset. Thus, goods on
consignment are not intangible assets.
B. Patents.
C. Copyrights.
D. Trademarks.

Question: 288

A recognized intangible asset is amortized over its useful life

A. Unless the pattern of consumption of the economic benefits of the asset is


not reliably determinable.
B. If that life is determined to be finite.
Answer (B) is correct.

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A recognized intangible asset is amortized over its useful life if that
useful life is finite, that is, unless the useful life is determined to be
indefinite. The useful life of an intangible asset is indefinite if no
foreseeable limit exists on the period over which it will contribute,
directly or indirectly, to the reporting entitys cash flows.
C. Unless the precise length of that life is not known.
D. If that life is indefinite but not infinite.

Question: 289

Hansen, Inc., purchased a patent at the beginning of Year 1 for $22,100 that was to be
amortized over 17 years. On July 1 of Year 8, Hansen incurred legal costs of $11,400 to
successfully defend the patent. The amount of amortization expense that Hansen should
record for Year 8 is

A. $2,500
B. $1,971
C. $1,900
Answer (C) is correct.
Hansen will amortize the cost of the patent on a straight-line basis at the
rate of $1,300 per year ($22,100 17). The costs of a successful legal
defense of a patent are capitalized and amortized over the shorter of the
remaining legal life or the estimated useful life of the patent. Because the
legal costs to defend the patent were incurred when the patent had
9.5 years of life remaining, they will be amortized at a rate of $1,200 per
year ($11,400 9.5). Because Year 8 only includes a half years
depreciation for the legal costs, total amortization expense for that year is
$1,900 ($1,300 + $600).
D. $1,300

Question: 290

Which of the following costs associated with an internally developed patent should be
capitalized?

Research and Patent


Development Registration
A. No Yes
Answer (A) is correct.
R&D costs must be expensed as they are incurred. Legal fees and
registration fees are excluded from the definition of R&D. Thus, the
patent registration fees should be capitalized as a cost associated with an
internally developed patent. The patents R&D costs should have been
expensed as they were incurred.
B. No No
C. Yes No
D. Yes Yes

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Question: 291

On July 1, Broadstreet Corporation acquired a patent on its new manufacturing process,


which streamlines its production operation. The cost of the patent was $17,000, and
Broadstreet expects that the useful life of the new process will be 10 years, although the
legal life of the patent is 17 years. Broadstreet is a calendar-year corporation and is
preparing its December 31 Statement of Financial Position. At which amount should the
patent be reported at December 31 of the year of acquisition?

A. $15,300
B. $16,000
C. $16,150
Answer (C) is correct.
A patent is amortized over the shorter of its useful life or legal life, so
annual amortization on this patent is $1,700 ($17,000 10 years). The
depreciation expense for the year of acquisition is $850 [$1,700 (6 12
months)]. The patent should therefore be reported at December 31 at
$16,150 ($17,000 $850).
D. $16,500

Question: 292

Which of the following expenditures qualifies for asset capitalization?

A.
B.
C.
D.

Cost of materials used in prototype testing.


Costs of testing a prototype and modifying its design.
Salaries of engineering staff developing a new product.
Legal costs associated with obtaining a patent on a new product.
Answer (D) is correct.
Patents may be purchased or developed internally. The initial capitalized
cost of a purchased patent is normally the fair value of the consideration
given, that is, its purchase price plus incidental costs, such as registration
and attorneys fees. Internally developed patents are less likely to be
capitalized because related R&D costs must be expensed when incurred.
Thus, only relatively minor costs can be capitalized, for example, patent
registration fees and legal fees.

Question: 293

During the year just ended, Jase Co. incurred research and development costs of $136,000
in its laboratories relating to a patent that was granted on July 1. Costs of registering the
patent equaled $34,000. The patents legal life is 20 years, and its estimated economic life
is 10 years. In its December 31 balance sheet, what amount should Jase report for the
patent, net of accumulated amortization?

A. $32,300
Answer (A) is correct.
R&D costs are expensed as incurred. However, legal work in connection
with patent applications or litigation and the sale or licensing of patents
are specifically excluded from the definition of R&D. Hence, the legal
costs of filing a patent should be capitalized. The patent should be
amortized over its estimated economic life of 10 years. Amortization for

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the year equals $1,700 [($34,000 10) (6 12)]. Thus, the reported
amount of the patent at year end equals $32,300 ($34,000 $1,700).
B. $33,150
C. $161,500
D. $165,000

Question: 294

A purchased patent has a remaining legal life of 15 years. It should be

A. Expensed in the year of acquisition.


B. Amortized over 15 years regardless of its useful life.
C. Amortized over its useful life if less than 15 years.
Answer (C) is correct.
The amortization period for an intangible asset distinct from goodwill is
the shorter of its useful life or the legal life remaining after acquisition.
D. Amortized over 40 years.

Question: 295

Under IFRS, an entity that acquires an intangible asset may use the revaluation model for
subsequent measurement only if

A. The useful life of the intangible asset can be reliably determined.


B. An active market exists for the intangible asset.
Answer (B) is correct.
An intangible asset is carried at cost minus any accumulated amortization
and impairment losses, or at a revalued amount. The revaluation model is
similar to that for items of PPE (initial recognition of an asset at cost).
However, fair value must be determined based on an active market.
C. The cost of the intangible asset can be measured reliably.
D. The intangible asset is a monetary asset.

Question: 296

Legal fees incurred by a company in defending its patent rights should be capitalized when
the outcome of litigation is

Successful Unsuccessful
A. Yes Yes
B. Yes No
Answer (B) is correct.
Legal fees incurred in the successful defense of a patent should be
capitalized as part of the cost of the patent and then amortized over its
remaining useful life because that useful life is finite. Legal fees incurred
in an unsuccessful defense should be expensed as the costs are incurred.
C. No No

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D. No Yes

Question: 297

Gray Co. was granted a patent on January 2, Year 5, and appropriately capitalized $45,000
of related costs. Gray was amortizing the patent over its estimated useful life of 15 years.
During Year 8, Gray paid $15,000 in legal costs in successfully defending an attempted
infringement of the patent. After the legal action was completed, Gray sold the patent to the
plaintiff for $75,000. Grays policy is to take no amortization in the year of disposal. In its
Year 8 income statement, what amount should Gray report as gain from sale of patent?

A. $15,000
B. $24,000
Answer (B) is correct.
The patent was capitalized at $45,000 in Year 5. Annual amortization of
$3,000 ($45,000 15 years) for Year 5, Year 6, and Year 7 reduced the
carrying amount to $36,000. The $15,000 in legal costs for successfully
defending an attempted infringement may be capitalized, which increases
the carrying amount of the patent to $51,000 ($36,000 + $15,000).
Accordingly, the gain from the sale is $24,000 ($75,000 $51,000).
C. $27,000
D. $39,000

Question: 298

Which of the following assets, if any, acquired this year in an exchange transaction is(are)
potentially amortizable?

Goodwill Trademarks
A. No No
B. No Yes
Answer (B) is correct.
Goodwill is tested for impairment at least annually but is never
amortized. Trademarks, however, may be amortized but only if they have
finite useful lives.
C. Yes Yes
D. Yes No

Question: 299

Goodwill should be tested for value impairment at which of the following levels?

A. Each identifiable long-term asset.


B. Each reporting unit.
Answer (B) is correct.
The cost of an acquired entity minus the net amount assigned to assets
acquired and liabilities assumed is goodwill. Goodwill is not amortized.
However, goodwill is assigned to a reporting unit that benefited from the
business combination for the purpose of testing impairment. Testing

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occurs each year at the same time, but different reporting units may be
tested at different times. Furthermore, additional testing also may be
indicated. Potential impairment of goodwill is deemed to exist only if the
carrying amount (including goodwill) of a reporting unit is greater than
its fair value. Thus, accounting for goodwill is based on the units of the
combined entity into which the acquired entity was absorbed. A reporting
unit is an operating segment or one of its components, that is, one level
below an operating segment. A component qualifies as a reporting unit if
(1) it is a business for which discrete financial information is available,
and (2) segment management regularly reviews its operating results.
However, similar components are aggregated. These provisions,
including the determination of operating segments, apply even if the
reporting entity is not required to report segment information.
C. Each acquisition unit.
D. Entire business as a whole.

Question: 300

A company should recognize goodwill in its balance sheet at which of the following points?

A. Costs have been incurred in the development of goodwill.


B. Goodwill has been created in the purchase of a business.
Answer (B) is correct.
Goodwill can be recognized only in a business combination. Goodwill is
an asset representing the future economic benefits arising from other
assets acquired in a business combination that are not individually
identified and separately recognized.
C. The company expects a future benefit from the creation of goodwill.
D. The fair market value of the companys assets exceeds the book value of
the companys assets.

Question: 301

Which one of the following statements is correct about the reconciliation of U.S. GAAP and
International Financial Reporting Standards (IFRS)?

A. The costs of development must be expensed under U.S. GAAP, but are
capitalized under IFRS if they meet specific criteria.
Answer (A) is correct.
Under IFRS, (1) costs incurred during the research phase of an internal
project are expensed as incurred since the company cannot demonstrate
that an intangible asset exists that will generate probable future economic
benefits; and (2) costs incurred during the development phase of an
internal project can be capitalized and recognized as an intangible asset
if, and only if, the company can demonstrate all of the following:
1.

The technical feasibility to complete the intangible asset

2.

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3.
Its intention to complete and use or sell the intangible
asset
4.
Its ability to sell or use the intangible asset
5.
Availability of resources to complete and use or sell the
intangible asset
6.
The way in which the asset will generate probable future
economic benefits
7.
Its ability to reliably measure expenditures attributable to
the asset
B. The costs of research must be expensed under U.S. GAAP, but are
capitalized under IFRS if they meet specific criteria.
C. All costs of research and development must be expensed under both U.S.
GAAP and IFRS.
D. Internally generated goodwill may not be capitalized under U.S. GAAP,
but it may be capitalized under IFRS.

Question: 302

Howell Corporation, a publicly traded corporation, is the lessee in a leasing agreement with
Brandon, Inc. to lease land and a building. If the lease contains a bargain purchase option,
Howell should record the land and the building as a(n)

A.
B.
C.
D.

Operating lease and capital lease, respectively.


Capital lease and operating lease, respectively.
Capital lease but recorded as a single unit.
Capital lease but separately classified.
Answer (D) is correct.
A lessee records a lease as a capital lease if it meets any one of four
criteria. Existence of a bargain purchase option is one of these criteria. If
a lease involving land and a building contains a bargain purchase option
or if the lease transfers ownership to the lessee at the end of its term, the
lessee separately capitalizes the land and the building.

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Fact Pattern:

Lessor
On January 1, Plantation Restaurant is planning to enter
as the lessee into the two lease agreements described
in the columns to the right. Each lease is noncancelable,
and Plantation does not receive title to either leased
property during or at the end of the lease term. All
payments required under these agreements are due on
January 1 each year.

Question: 303

Hadaway,
Inc.

Type of property
Yearly rental
Lease term
Economic life
Purchase option
Renewal option
Fair market value
at
inception of lease
Unguaranteed
residual value
Lessees
incremental
borrowing rate
Executory costs
paid by
Annual executory
costs
Present value
factor at
10% (of an
annuity due)

Cutter
Electronics

Oven
$15,000
10 years
15 years
None
None

Computer
$4,000
3 years
5 years
$3,000
None

$125,000

$10,200

None

$2,000

10%
Lessee

10%
Lessor

$800

$500

6.76

2.74

Plantation Restaurant should treat the lease agreement with Hadaway, Inc. as a(n)

A. Capital lease with an initial asset value of $101,400.


B. Operating lease, charging $14,200 in rental expense and $800 in executory
costs to annual operations.
C. Operating lease, charging the present value of the yearly rental expense to
annual operations.
D. Operating lease, charging $15,000 in rental expense and $800 in executory
costs to annual operations.
Answer (D) is correct.
The Hadaway lease is an operating lease with a $15,000 annual rental
expense with annual executory costs of $800 to be paid by the lessee. An
operating lease does not transfer the rights and risks of ownership to the
lessee. The Hadaway lease is nothing more than a rental arrangement. If
any one of the following criteria is met, the lease is a capital lease: the
lease transfers title to the lessee, the lease has a bargain purchase option,
the lease term is 75% or more of the useful life of the leased asset, or the
present value of the minimum lease payments is 90% or more of the

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assets fair value. The Hadaway lease meets none of these four criteria.

Fact Pattern:

Lessor
On January 1, Plantation Restaurant is planning to enter
as the lessee into the two lease agreements described
in the columns to the right. Each lease is noncancelable,
and Plantation does not receive title to either leased
property during or at the end of the lease term. All
payments required under these agreements are due on
January 1 each year.

Question: 304

Hadaway,
Inc.

Type of property
Yearly rental
Lease term
Economic life
Purchase option
Renewal option
Fair market value
at
inception of lease
Unguaranteed
residual value
Lessees
incremental
borrowing rate
Executory costs
paid by
Annual executory
costs
Present value
factor at
10% (of an
annuity due)

Cutter
Electronics

Oven
$15,000
10 years
15 years
None
None

Computer
$4,000
3 years
5 years
$3,000
None

$125,000

$10,200

None

$2,000

10%
Lessee

10%
Lessor

$800

$500

6.76

2.74

Plantation Restaurant should treat the lease agreement with Cutter Electronics as a(n)

A. Capital lease with an initial asset value of $10,960.


B. Capital lease with an initial asset value of $10,200.
C. Operating lease, charging $3,500 in rental expense and $500 in executory
costs to annual operations.
D. Capital lease with an initial asset value of $9,590.
Answer (D) is correct.
A capital lease is one in which many of the benefits and risks of
ownership are transferred to the lessee. For accounting purposes, the
lessee treats a capital lease as similar to the purchase of an asset. If the
present value of the minimum lease payments (excluding executory
costs) is 90% or more of the assets fair value, the lease should be
accounted for as a capital lease. Given that the executory costs associated
with the lease are to be paid by the lessor, a portion of the lease rental

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price is for those costs, not for the asset. Executory costs include
insurance, maintenance, and similar expenses. Consequently, the annual
minimum lease payment equals the annual payment minus the executory
costs, or $3,500 ($4,000 yearly rental $500). The present value of the
minimum lease payments is therefore $9,590 ($3,500 2.74), which is
greater than 90% of the fair value of the asset. Thus, the lease should be
capitalized. The appropriate amount of the initial asset value is the
present value of the minimum lease payments calculated above.

Question: 305

Which of the following statements about a capital lease is false?

A. The lessor capitalizes the net investment in the lease.


B. The lessor records the leased item as an asset.
Answer (B) is correct.
When a lease is capitalized, the lessor derecognizes the leased item and
records lease payments receivable. The lessee records and depreciates the
leased item.
C. The lessee records depreciation or capital cost allowance on the leased
asset.
D. The lease arrangement represents a form of financing.

Question: 306

If a company uses off-balance-sheet financing, assets have been acquired

A. For cash.
B. With operating leases.
Answer (B) is correct.
With an operating lease, no long-term liability need be reported on the
face of the balance sheet.
C. With financing leases.
D. With a line of credit.

Question: 307

Which one of the following statements with respect to leases is correct?

A. An operating lease is treated like a rental contract between the lessor and
lessee.
Answer (A) is correct.
An operating lease is a transaction in which the lessee rents the right to
use the lessors assets without acquiring a substantial portion of the
benefits and risks of ownership. Thus, an operating lease is treated like a
rental contract between the lessor and lessee.
B. A lease that does not transfer ownership from the lessor to the lessee by the
end of the lease is automatically an operating lease.
C. Sales and direct financing leases pertain more to lessees than lessors.
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D. Unpredictability of lease revenues or expenses can transform what would
otherwise be a capital lease for the lessee into an operating lease for the
lessee.

Fact Pattern: Neary Company has entered into a contract to lease computers from Baldwin Company
starting on January 1, Year 1. Relevant information pertaining to the lease is provided below.
Lease term

4 Years

Useful life of computers

5 Years

Present value of future lease payments

$100,000

Fair value of leased asset on date of lease 105,000


Baldwins implicit rate

10%

At the end of the lease term, ownership of the asset transfers from Baldwin to Neary. Neary has properly
classified this lease as a capital lease on its financial statements and uses straight -line depreciation on
comparable assets.
Question: 308

At January 1, Year 1, the lease would be reported on Nearys books as a(n)

A. Asset only.
B. Asset and a liability.
Answer (B) is correct.
The lease is classified as a capital lease, since the ownership of the leased
asset is transferred to the lessee at the end of the lease term. The lessee
must record a capital lease as an asset and as an obligation at an amount
equal to the present value of the minimum lease payments.
C. Liability only.
D. Expense and a liability.

Fact Pattern: Neary Company has entered into a contract to lease computers from Baldwin Company
starting on January 1, Year 1. Relevant information pertaining to the lease is provided below.
Lease term

4 Years

Useful life of computers

5 Years

Present value of future lease payments

$100,000

Fair value of leased asset on date of lease 105,000


Baldwins implicit rate

10%

At the end of the lease term, ownership of the asset transfers from Baldwin to Neary. Neary has properly
classified this lease as a capital lease on its financial statements and uses straight -line depreciation on
comparable assets.

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Question: 309

What is the annual depreciation expense that Neary will record on the leased computers?

A. $20,000
Answer (A) is correct.
Under a capital lease, the lessee recognizes a leased asset at an amount
equal to the present value of the minimum lease payments ($100,000).
Since the lease provides for the transfer of ownership, Neary should
depreciate the computers using the straight-line method over their
estimated useful life (5 years). Annual depreciation expense on the
computers is $20,000 ($100,000 5 years).
B. $21,000
C. $25,000
D. $26,250

Question: 310

On January 1, Rosewater Company leased a computer for 4 years at a monthly rent of $80,
payable at the end of each month. Due to the rate of technical change, the computer is
expected to become obsolete within 5 years. At the inception of the lease, the computer
was retailing for $3,450. Had Rosewater chosen to purchase the computer instead of
leasing it, they could have borrowed the funds at 10%. At a 10% interest rate, the present
value of the lease payments is $3,154. Rosewater does not know the rate implicit in the
lease. For the month of January, Rosewater should report (to the closest dollar) interest
expense of

A. $26 and depreciation expense of $66.


Answer (A) is correct.
Interest expense will be recognized in the amount of $26 [$3,154 10%
(1 12 months)]. Since Rosewater does not know the lessors implicit
rate, it is appropriate to use Rosewaters own incremental borrowing rate
to determine whether the lease should be classified as a capital lease.
Since the present value of the lease payments is greater than 90% of the
fair value of the computer ($3,154 $3,450 = 91.4%), the lease is
appropriately classified as a capital lease and Rosewater will recognize
depreciation expense. Since the lease agreement neither provides for
transfer of ownership nor contains a bargain purchase option, the
computers are depreciated over the lease term (4 years). Monthly
depreciation expense will be $66 ($3,154 48 months).
B. $0 and rent expense of $80.
C. $29 and depreciation expense of $58.
D. $29 and rent expense of $80.

Question: 311

Keller Corporation signed a 3-year lease for an automobile on December 1. The automobile
had a list price of $17,000 and an estimated useful life of 8 years. The lease called for
payments of $500 per month for 36 months. The present value of the $500 payments was
$15,054 at Kellers incremental borrowing rate and $15,496 at the lessors implicit rate,
which is known to the lessee. Based on the above information, Keller should record the
lease as a(n)

A. Capital lease.
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Answer (A) is correct.
A lessee must report a lease as a capital lease if the present value of the
minimum lease payments (MLP) is at least 90% of the fair value of the
asset. If the lessors implicit rate is known to the lessee, that is the
appropriate rate for discounting the MLP. Dividing the present value of
the MLP by the list price of the automobile yields a result > 90%
($15,496 $17,000 = 91.2%). Thus, this lease must be classified by
Keller as a capital lease.
B. Operating lease.
C. Sale-leaseback.
D. Sales-type lease.

Question: 312

Lease M does not contain a bargain purchase option, but the lease term is equal to 90% of
the estimated economic life of the leased property. Lease P does not transfer ownership of
the property to the lessee by the end of the lease term, but the lease term is equal to 75% of
the estimated economic life of the leased property. How should the lessee classify these
leases?

Lease M

Lease P

A. Capital lease
B. Capital lease

Operating lease
Capital lease

Answer (B) is correct.


For a lease to be classified as a capital lease by the lessee, any one of
four criteria must be met. One of these criteria is that the lease term equal
75% or more of the estimated remaining economic life of the leased
property. Both leases meet the 75% criterion and should be properly
classified as capital leases.
C. Operating lease
D. Operating lease

Question: 313

Capital lease
Operating lease

Bain Co. entered into a 10-year lease agreement for a new piece of equipment worth
$500,000. At the end of the lease, Bain will have the option to purchase the equipment.
Which of the following would require the lease to be accounted for as a capital lease?

A. The lease includes an option to purchase stock in the company.


B. The estimated useful life of the leased asset is 12 years.
Answer (B) is correct.
A lease is classified as a capital lease by the lessee if, at its inception, any
of the following four criteria are satisfied: (1) the lease provides for the
transfer of ownership of the leased property, (2) the lease contains a
bargain purchase option, (3) the lease term is 75% or more of the
estimated economic life of the leased property, or (4) the present value of
the minimum lease payments is at least 90% of the fair value of the
leased property to the lessor. Because the lease is for 83 1/3% (10 12)

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of the estimated economic life of the leased property, Bain must
capitalize the lease.
C. The present value of the minimum lease payments is $400,000.
D. The purchase option at the end of the lease is at fair market value.

Question: 314

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

A. The lease contains a bargain purchase option.


Answer (A) is correct.
A lease is classified as a capital lease by the lessee if, at its inception, any
of the following four criteria is satisfied: (1) the lease provides for the
transfer of ownership of the leased property, (2) the lease contains a
bargain purchase option, (3) the lease term is 75% or more of the
estimated economic life of the leased property, or (4) the present value of
the minimum lease payments (excluding executory costs) is at least 90%
of the fair value of the leased property to the lessor.
B. The lease does not transfer ownership of the property to the lessee.
C. The lease term is equal to 65% or more of the estimated useful life of the
leased property.
D. The present value of the minimum lease payments is 70% or more of the
fair market value of the leased property.

Question: 315

Which of the following is a characteristic of a capital lease?

A. The lease term is substantially less than the estimated economic life of the
leased property.
B. The lease contains a bargain-purchase option.
Answer (B) is correct.
A lessee capitalizes a lease that contains a BPO. A lessor capitalizes a
lease that contains a BPO if (1) collectibility of the remaining payments
is reasonably predictable and (2) no material uncertainties exist regarding
unreimbursable costs to be incurred by the lessor.
C. The present value of the minimum lease payments at the beginning of the
lease term is 75% or more of the fair value of the property at the inception
of the lease.
D. The future obligation does not appear in the balance sheet of the lessee.

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Question: 316

The present value of minimum lease payments should be used by the lessee in determining
the amount of a lease liability under a lease classified by the lessee as a(n)

Capital Lease Operating Lease


A. Yes Yes
B. Yes No
Answer (B) is correct.
The lessee must record a capital lease as an asset and an obligation at an
amount equal to the present value of the minimum lease payments.
Under an operating lease, the lessee records no liability except for rental
expense accrued at the end of an accounting period. The accrual is at
settlement value rather than present value.
C. No No
D. No Yes

Question: 317

Koby Co. entered into a capital lease with a vendor for equipment on January 2 for 7 years.
The equipment has no guaranteed residual value. The lease required Koby to pay $500,000
annually on January 2, beginning with the current year. The present value of an annuity due
for seven years was 5.35 at the inception of the lease. What amount should Koby capitalize
as leased equipment?

A. $500,000
B. $825,000
C. $2,675,000
Answer (C) is correct.
The lessee records a capital lease as an asset and an obligation at the
present value of the minimum lease payments. These payments include
the initial payment at the inception of the lease. Thus, the annual
payments constitute an annuity due. In the absence of a bargain purchase
option, guaranteed residual value, or nonrenewal penalty, the amount
capitalized as leased equipment is $2,675,000 ($500,000 annual payment
5.35 present value of an annuity due for 7 years).
D. $3,500,000

Question: 318

Quick Companys lease payments are made at the end of each period. Quicks liability for a
capital lease will be reduced periodically by the

A. Minimum lease payment less the portion of the minimum lease payment
allocable to interest.
Answer (A) is correct.
The lease liability consists of the present value of the minimum lease
payments. The lease liability is reduced by the portion of the lease
payment attributable to the lease liability. This amount is the lease
payment less the interest component of the payment. Thus, the liability is
decreased by the minimum lease payment each period less the portion of

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the payment allocable to interest.
B. Minimum lease payment plus the amortization of the related asset.
C. Minimum lease payment less the amortization of the related asset.
D. Minimum lease payment.

Question: 319

On January 1, Year 4, Harrow Co., as lessee, signed a 5-year noncancelable equipment


lease with annual payments of $100,000 beginning December 31, Year 4. Harrow treated
this transaction as a capital lease. The five lease payments have a present value of
$379,000 at January 1, Year 4, based on interest of 10%. What amount should Harrow
report as interest expense for the year ended December 31, Year 4?

A. $37,900
Answer (A) is correct.
Under the effective-interest method, interest expense for the first year is
$37,900 ($379,000 lease obligation 10% effective interest rate).
B. $27,900
C. $24,200
D. $0

Question: 320

On January 2, Cole Co. signed an 8-year noncancelable lease for a new machine, requiring
$15,000 annual payments at the beginning of each year. The machine has a useful life of 12
years with no salvage value. Title passes to Cole at the lease expiration date. Cole uses
straight-line depreciation for all of its plant assets. Aggregate lease payments have a
present value on January 2 of $108,000, based on an appropriate rate of interest. For the
current year, Cole should record depreciation (amortization) expense for the leased
machine at

A. $0
B. $9,000
Answer (B) is correct.
This lease qualifies as a capital lease because title passes to the lessee at
the end of the lease term. When a lease is capitalized because title passes
to the lessee at the end of the lease term or because the lease contains a
bargain purchase option, the depreciation (amortization) period is the
estimated economic life of the asset. The asset should be depreciated
(amortized) in accordance with the lessees normal depreciation policy
for owned assets. Cole normally uses the straight-line method. Thus,
depreciation (amortization) expense is $9,000 [($108,000 leased asset
$0 salvage value) 12-year economic life].
C. $13,500
D. $15,000

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Question: 321

Leases should be classified by the lessee as either operating leases or capital leases.
Which of the following statements best characterizes operating leases?

A. The benefits and risks of ownership are transferred from the lessor to the
lessee.
B. The lessee records leased property as an asset and the present value of the
lease payments as a liability.
C. Operating leases transfer ownership to the lessee, contain a bargain
purchase option, are for more than 75% of the leased assets useful life, or
have minimum lease payments with a present value in excess of 90% of the
fair value of the leased asset.
D. The lessor records lease revenue, asset depreciation, maintenance, etc., and
the lessee records lease payments as rental expense.
Answer (D) is correct.
Operating leases are transactions whereby lessees rent the right to use
lessor assets without acquiring a substantial portion of the benefits and
risks of ownership of those assets.

Question: 322

Which one of the following temporary differences will result in a deferred tax asset?

A. Use of the straight-line depreciation method for financial statement


purposes and the Modified Accelerated Cost Recovery System (MACRS)
for income tax purposes.
B. Installment sale profits accounted for on the accrual basis for financial
statement purposes and on a cash basis for income tax purposes.
C. Advance rental receipts accounted for on the accrual basis for financial
statement purposes and on a cash basis for tax purposes.
Answer (C) is correct.
A deferred tax asset records the deferred tax consequences attributable to
deductible temporary differences and carryforwards. Advance rental
receipts accounted for on the accrual basis for financial statement
purposes and on a cash basis for tax purposes would give rise to a
deferred tax asset. The financial statements would report no income and
no related tax expense because the rental payments apply to future
periods. The tax return, however, would treat the rent as income when
the cash was received, and a tax would be due in the year of receipt.
Because the tax is paid prior to recording the income for financial
statement purposes, it represents an asset that will be recognized as an
expense when income is finally recorded.
D. Investment gains accounted for under the equity method for financial
statement purposes and under the cost method for income tax purposes.

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Fact Pattern:
Bearings Manufacturing Company, Inc. purchased a new
machine on January 1, Year 1, for $100,000. The company uses
the straight-line depreciation method with an estimated
equipment life of 5 years and a zero salvage value for financial
statement purposes, and uses the 3-year, Modified Accelerated
Cost Recovery System (MACRS) with an estimated equipment
life of 3 years for income tax reporting purposes. Bearings is
subject to a 35% marginal income tax rate.

Assume that the deferred tax liability at


the beginning of the year is zero and that
Bearings has a positive earnings tax
position. The MACRS depreciation rates
for 3-year equipment are shown below.

Year Rate
1 33.33%
2 44.45
3 14.81
4 7.41

Question: 323

What is the deferred tax liability at December 31, Year 1 (rounded to the nearest whole
dollar)?

A.
B.
C.
D.

$7,000
$33,330
$11,666
$4,666
Answer (D) is correct.
For financial reporting purposes, the reported amount (cost
accumulated depreciation) of the machine at year-end, assuming straightline depreciation and no salvage value, will be $80,000 [$100,000 cost
($100,000 5 years)]. The tax basis of this asset will be $66,670
[$100,000 ($100,000 33.33%)]. A taxable temporary difference has
arisen because the excess of the reported amount over the tax basis will
result in a net future taxable amount over the recovery period. A taxable
temporary difference requires recognition of a deferred tax liability.
Assuming the 35% rate applies during the assets entire life, the deferred
tax liability equals the applicable enacted tax rate times the temporary
difference, or $4,666 [($80,000 $66,670) 35%].

Question: 324

On a statement of financial position, all of the following should be classified as current


liabilities except

A. Advances from customers for services to be performed.


B. Salaries payable for work performed during the previous month.
C. Deferred income taxes for differences based on depreciation methods.
Answer (C) is correct.
Deferred tax amounts are classified as current or noncurrent based on the
classification of the related asset or liability (assuming such an asset or
liability exists). Because depreciable assets are noncurrent, a deferred tax
liability for differences based on depreciation methods is noncurrent.
D. Accounts payable for inventory items to be shipped on consignment.
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Question: 325

A liability that represents the accumulated difference between the income tax expense
reported on the firms books and the income tax actually paid is

A. Capital gains tax.


B. Deferred taxes.
Answer (B) is correct.
Deferred tax liabilities arise when temporary differences in book and
taxable income result in future taxable amounts. Deferred tax assets arise
when temporary differences in book and taxable income result in future
deductible amounts.
C. Taxes payable.
D. Value-added taxes.

Question: 326

Harrison Corporation entered into a 3-year contract, using the percentage-of-completion


method for financial income and the completed contract method for taxable income.
Harrison expected the project to be profitable throughout the construction period. The effect
on Harrisons financial statements for the third year of this contract would be a(n)

A. Decrease in the deferred tax asset account.


B. Decrease in the deferred tax liability account.
Answer (B) is correct.
For the first two years of the contract, Harrison reports more revenue for
financial reporting purposes than for tax purposes, giving rise to a
deferred tax liability. Upon completion of the contract, Harrison reports
all the revenue on its tax return, thereby decreasing the deferred tax
liability.
C. Increase in the deferred tax asset account.
D. Increase in the deferred tax liability account.

Question: 327

A tax rate other than the current tax rate may be used to calculate the deferred income tax
amount on the statement of financial position if a(n)

A. Future tax rate has been enacted into law.


Answer (A) is correct.
A tax rate other than the current tax rate may be used to calculate the
deferred income tax amount on the statement of financial position if a
future tax rate has been enacted into law.
B. Future tax rate change is considered more likely than not to occur.
C. Election has been made to apply past tax rates.
D. Net operating loss carryback exists.

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Question: 328

Selected financial information for Windham, Inc., for the year just ended is shown below.

Pretax income

$5,000,000

Interest received on municipal bonds

600,000

Gain on the sale of land reported this


year but not taxable until next year
Tax rate for all years

1,000,000
40%

Beginning balances:
Income taxes payable

-0-

Deferred tax liability

$50,000

The total income tax expense reported on Windhams income statement for the year just
ended should be

A. $960,000
B. $1,360,000
C. $1,760,000
Answer (C) is correct.
Taxable income consists of pretax income adjusted for those items that
give rise to tax differences. Taxable income is therefore $3,400,000
($5,000,000 $600,000 $1,000,000), and current tax expense is
$1,360,000 ($3,400,000 40%). The interest on municipal bonds is a
permanent difference because it is tax-exempt, i.e., it is recognized in
GAAP income but never in taxable income. Permanent differences have
no deferred tax effects. However, the gain on the sale of land is a
temporary difference because it is included in GAAP income this year
and is included in taxable income in the future. This temporary
difference gives rise to a future taxable amount, specifically, a $400,000
deferred tax liability ($1,000,000 40%). This credit to the deferred tax
liability account is balanced by a debit to income tax expense. Total
income tax expense for the year is therefore $1,760,000 ($1,360,000
current portion + $400,000 deferred portion).
D. $2,640,000

Fact Pattern: Lucas Company computed the following deferred tax balances for the 2 most recent years.
Deferred tax assets are considered fully realizable.
Year 1 Year 2
Current deferred tax assets

$3,000 $10,000

Noncurrent deferred tax assets

6,000

7,000

Current deferred tax liabilities

8,000

9,000

Noncurrent deferred tax liabilities 5,000 14,000

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Question: 329

If Lucas calculates taxable income of $1,000,000 for Year 2 and is taxed at an effective
income tax rate of 40%, how much income tax expense will be reported on Lucass income
statement for Year 2?

A. $400,000
B. $402,000
Answer (B) is correct.
Deferred tax expense or benefit is the net change during the year in the
entitys deferred tax liabilities and assets. It is aggregated with the
current tax expense or benefit to determine total income tax expense for
the year. The amount of income taxes payable (current tax expense) is
$400,000 ($1,000,000 40%). The deferred tax assets increased by
$8,000 ($10,000 $3,000 + $7,000 $6,000) and the deferred tax
liabilities increased by $10,000 ($9,000 $8,000 + $14,000 $5,000).
Thus, Lucass income tax expense for Year 2 is $402,000 ($400,000
current tax expense $8,000 increase in the deferred tax assets +
$10,000 increase in the deferred tax liabilities).
C. $404,000
D. $406,000

Fact Pattern: Lucas Company computed the following deferred tax balances for the 2 most recent years.
Deferred tax assets are considered fully realizable.
Year 1 Year 2
Current deferred tax assets

$3,000 $10,000

Noncurrent deferred tax assets

6,000

7,000

Current deferred tax liabilities

8,000

9,000

Noncurrent deferred tax liabilities 5,000 14,000

Question: 330

What deferred tax amounts will appear on Lucass statement of financial position at the end
of Year 2?

Assets

Liabilities

Current Noncurrent Current Noncurrent


A. $0 $1,000 $5,000 $0
B. $7,000 $1,000 $1,000 $9,000
C. $1,000 $0 $0 $7,000
Answer (C) is correct.
Current deferred tax amounts are netted for financial reporting purposes.
Likewise, noncurrent amounts are also netted. At the end of Year 2,

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Lucas nets its $10,000 of current deferred tax assets and $9,000 of
current deferred tax liabilities for a reported current deferred tax asset of
$1,000. Similarly, the $7,000 of noncurrent deferred tax assets and
$14,000 of noncurrent deferred tax liabilities are netted to produce a
reported noncurrent deferred tax liability of $7,000.
D. $10,000 $7,000 $9,000 $14,000

Question: 331

At the end of its first year in business, Pebbles Corporation reported pretax financial
statement income of $50,000. Included in pretax income were $10,000 of revenue from
installment sales and depreciation expense of $12,000. On the tax return, $5,000 of
installment sales revenue was reported, and depreciation expense of $16,000 was
deducted. The income tax rate was 40%. Pebbles reports installment sales receivables as
current assets. On its year-end statement of financial position, Pebbles should report
deferred tax balances of

A. $2,000 as a current liability and $1,600 as a current asset.


B. $4,000 as a current asset and $5,000 as a noncurrent asset.
C. $2,000 as a current liability and $1,600 as a noncurrent liability.
Answer (C) is correct.
Temporary differences arise when the GAAP basis and the tax basis of
an item of income or expense differ. Of the installment sales, all $10,000
was recognized for financial reporting, but only $5,000 was recognized
for tax purposes, producing a temporary difference of $5,000. Since this
amount will be recognized later for tax purposes than for financial
reporting, it constitutes a deferred tax liability in the amount of $2,000
($5,000 40%). The depreciation expense will also result in a deferred
tax liability; since more expense was recognized for tax purposes than for
GAAP reporting ($16,000 $12,000 = $4,000), a deferred tax liability of
$1,600 ($4,000 40%) results. A deferred tax asset or liability is
classified as current or noncurrent depending on the classification of the
related asset or liability. The installment revenue is thus properly
classified as current and, since depreciation expense relates to property,
plant, and equipment, it is classified as noncurrent.
D. $4,000 as a noncurrent liability and $5,000 as a current liability.

Question: 332

Moore Corporations income tax computations gave rise to the following accounts.

Deferred tax asset -- current

$20,000

Deferred tax asset -- noncurrent

30,000

Deferred tax liability -- current

10,000

Deferred tax liability -- noncurrent 80,000


The account(s) relating to Moores taxes that should appear on the statement of financial
position is (are)

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A. A noncurrent deferred tax liability of $40,000.
B. A noncurrent deferred tax liability of $90,000 and a noncurrent deferred tax
asset of $50,000.
C. A current deferred tax asset of $10,000 and a noncurrent deferred tax
liability of $50,000.
Answer (C) is correct.
Current deferred tax amounts are netted for financial reporting purposes.
Likewise, noncurrent amounts are also netted. At the end of the year,
Moore nets its $20,000 of current deferred tax assets and $10,000 of
current deferred tax liabilities for a reported current deferred tax asset of
$10,000. Similarly, the $30,000 of noncurrent deferred tax assets and
$80,000 of noncurrent deferred tax liabilities are netted to produce a
reported noncurrent deferred tax liability of $50,000.
D. A current deferred tax asset of $20,000, a noncurrent deferred tax asset of
$30,000, a current deferred tax liability of $10,000, and a noncurrent
deferred tax liability of $80,000.

Question: 333Intraperiod income tax allocation arises because


A. Items included in the determination of taxable income may be presented in different sections
of the financial statements.
Answer (A) is correct.
To provide a fair presentation, GAAP require that income tax expense for the period be
allocated among continuing operations, discontinued operations, extraordinary items, other
comprehensive income, and items debited or credited directly to equity.
B. Income taxes must be allocated between current and future periods.
C. Certain revenues and expenses appear in the financial statements either before or after they
are included in taxable income.
D. Certain revenues and expenses appear in the financial statements but are excluded from
taxable income.

Question: 334

Income-tax-basis financial statements differ from those prepared under GAAP because they

A. Do not include nontaxable revenues and nondeductible expenses in


determining income.
B. Include detailed information about current and deferred income tax
liabilities.
C. Contain no disclosures about capital and operating lease transactions.
D. Recognize certain revenues and expenses in different reporting periods.
Answer (D) is correct.
Financial statements prepared under the income tax basis of accounting
and financial statements prepared under GAAP differ when the tax basis
of an asset or a liability and its reported amount in the GAAP-based

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financial statements are not the same. The result will be taxable or
deductible amounts in future years when the reported amount of the asset
is recovered or the liability is settled. Thus, certain revenues and
expenses are recognized in different periods. An example is subscriptions
revenue received in advance, which is recognized in taxable income
when received and recognized in financial income when earned in a later
period. Another example is a warranty liability, which is recognized as
an expense in financial income when a product is sold and recognized in
taxable income when the expenditures are made in a later period.

Question: 335

Temporary differences arise when expenses are deductible for tax purposes

After They Are Before They Are


Recognized in Recognized in
Financial Income Financial Income
A. No No
B. No Yes
C. Yes Yes
Answer (C) is correct.
A temporary difference exists when (1) the reported amount of an asset
or liability in the financial statements differs from the tax basis of that
asset or liability, and (2) the difference will result in taxable or deductible
amounts in future years when the asset is recovered or the liability is
settled at its reported amount. A temporary difference may also exist
although it cannot be identified with a specific asset or liability
recognized for financial reporting purposes. Temporary differences most
commonly arise when either expenses or revenues are recognized for tax
purposes either earlier or later than in the determination of financial
income.
D. Yes No

Question: 336

When accounting for income taxes, a temporary difference occurs in which of the following
scenarios?

A. An item is included in the calculation of net income but is neither taxable


nor deductible.
B. An item is included in the calculation of net income in one year and in
taxable income in a different year.
Answer (B) is correct.
A temporary difference results when the GAAP basis and the tax basis of
an asset or liability differ. The effect is that a taxable or deductible
amount will occur in future years when the asset is recovered or the
liability is settled. But some temporary differences are not related to an

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asset or liability for financial reporting. Thus, temporary differences
occur when revenues or gains, or expenses or losses, are used to calculate
net income under GAAP in a year before or after being used to calculate
taxable income.
C. An item is no longer taxable due to a change in the tax law.
D. The accrual method of accounting is used.

Question: 337

The best advantage of a zero-coupon bond to the issuer is that the

A. Bond requires a low issuance cost.


B. Bond requires no interest income calculation to the holder or issuer until
maturity.
C. Interest can be amortized annually by the APR method and need not be
shown as an interest expense to the issuer.
D. Interest can be amortized annually on a straight-line basis but is a noncash
outlay.
Answer (D) is correct.
Zero-coupon bonds do not pay periodic interest. The bonds are sold at a
discount from their face value, and the investors do not receive interest
until the bonds mature. The issuer does not have to make annual cash
outlays for interest. However, the discount must be amortized annually
and reported as interest expense.

Fact Pattern: On January 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%, resulting in a bond discount of $3,793.
Evangel uses the effective interest method of amortizing bond discount. Interest is payable annually on
December 31.
Question: 338

What is the amount of interest Evangel will pay at the end of the first year?

A. $8,659
B. $9,000
Answer (B) is correct.
The annual cash payment is the face amount of the bonds times the stated
rate ($100,000 9% = $9,000).
C. $9,621
D. $10,000

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Question: 339

A premium on bonds payable arises when

A. The semiannual bond interest becomes due.


B. The prevailing interest rate after the bond issuance falls below the nominal
rate of the bonds.
C. The amount received from sale of the bonds at issuance exceeds the face
value of the bonds.
Answer (C) is correct.
A premium on bonds payable arises when the amount received from sale
of the bonds at issuance exceeds the face value of the bonds. This
situation occurs if, at the time the bonds are sold, their stated rate is
greater than the current market rate.
D. The cost of issuing the bonds is capitalized.

Fact Pattern: On January 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%, resulting in a bond discount of $3,793.
Evangel uses the effective interest method of amortizing bond discount. Interest is payable annually on
December 31.
Question: 340

What is the amount of interest expense that should be reported on Evangels income
statement for the second year?

A.
B.
C.
D.

$8,779
$9,000
$9,559
$9,683
Answer (D) is correct.
An amortization schedule for the first 2 years of Evangels bonds can be
prepared as follows:
Beginning Times: Equals:
Carrying Effective Interest
Year Amount
Rate
Expense

Minus:
Equals:
Ending
Cash
Discount Carrying
Paid Amortized Amount

$96,207

10%

$9,621

$9,000

$621

$96,828

96,828

10%

9,683

9,000

683

97,510

Fact Pattern: On January 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%, resulting in a bond discount of $3,793.
Evangel uses the effective interest method of amortizing bond discount. Interest is payable annually on
December 31.

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Question: 341

What is the amount of Evangels unamortized bond discount at the end of the first year?

A. $621
B. $2,452
C. $3,172
Answer (C) is correct.
Total interest expense for the year equals the carrying amount of the
bonds times the effective rate (yield), or $9,621 ($96,207 10%).
Subtracting the cash interest payment from this leaves the amount of
discount amortized, or $621 ($9,621 $9,000). Subtracting this amount
from the previous unamortized discount ($3,793) leaves a remaining
unamortized discount at the end of Year 1 of $3,172.
D. $3,793

Fact Pattern: On January 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%, resulting in a bond discount of $3,793.
Evangel uses the effective interest method of amorti zing bond discount. Interest is payable annually on
December 31.
Question: 342

The net carrying amount of Evangels bonds payable at the end of the first year is

A. $94,866
B. $95,586
C. $96,828
Answer (C) is correct.
Total interest expense for the year equals the carrying amount of the
bonds times the effective rate (yield), or $9,621 ($96,207 10%).
Subtracting the cash interest payment from this leaves the amount of
discount amortized ($9,621 $9,000 = $621). Subtracting this amount
from the previous unamortized discount ($3,793) leaves a remaining
unamortized discount at the end of Year 1 of $3,172. Subtracting this
amount from the face amount of the bonds ($100,000) provides a
carrying amount of $96,828.
D. $97,548

Fact Pattern: On Januar y 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%, resulting in a bond discount of $3,793.
Evangel uses the effective interest method of amortizing bond discount. Interest is payable annually on
December 31.
Question: 343

What is the amount of interest expense that should be reported on Evangels income
statement at the end of the first year?

A. $8,659
B. $9,000
C. $9,621

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Answer (C) is correct.
Total interest expense for the year equals the carrying amount of the
bonds times the effective rate (yield), or $9,621 ($96,207 10%).
D. $10,000

Question: 344

On January 1, bonds with a face amount of $200,000, an 8% annual effective yield, and a
7% annual coupon rate were sold by Thomas Dynamics, Inc., for $180,000. The bonds pay
interest on January 1 and July 1. Using the effective interest method, the companys interest
expense for the first 6 months ended July 1 will be

A. $7,000
B. $7,200
Answer (B) is correct.
Total interest expense for the year equals the carrying amount of the
bonds times the effective rate (yield), or $14,400 ($180,000 8%). Half
of this amount is $7,200.
C. $14,000
D. $14,400

Question: 345

Debentures are

A. Income bonds that require interest payments only when earnings permit.
B. Subordinated debt and rank behind convertible bonds.
C. Bonds secured by the full faith and credit of the issuing firm.
Answer (C) is correct.
Debentures are unsecured bonds. Although no assets are mortgaged as
security for the bonds, debentures are secured by the full faith and credit
of the issuing firm. Debentures are a general obligation of the borrower.
Only companies with the best credit ratings can issue debentures because
only the companys credit rating and reputation secure the bonds.
D. A form of lease financing similar to equipment trust certificates.

Question: 346

Which one of the following characteristics distinguishes income bonds from other bonds?

A. The bondholder is guaranteed an income over the life of the security.


B. By promising a return to the bondholder, an income bond is junior to
preferred and common stock.
C. Income bonds are junior to subordinated debt but senior to preferred and
common stock.
D. Income bonds pay interest only if the issuing company has earned the
interest.
Answer (D) is correct.
An income bond is one that pays interest only if the issuing company has
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earned the interest, although the principal must still be paid on the due
date. Such bonds are riskier than normal bonds.

Question: 347

Serial bonds are attractive to investors because

A. All bonds in the issue mature on the same date.


B. The yield to maturity is the same for all bonds in the issue.
C. Investors can choose the maturity that suits their financial needs.
Answer (C) is correct.
Serial bonds have staggered maturities; that is, they mature over a period
(series) of years. Thus, investors can choose the maturity date that meets
their investment needs. For example, an investor who will have a child
starting college in 16 years can choose bonds that mature in 16 years.
D. The coupon rate on these bonds is adjusted to the maturity date.

Question: 348

A construction company has signed $1,000,000 in new contracts. During the current year,
10% of the required work for these contracts was performed. Historically, the controller has
recognized revenue when the contract work was completed using the completed contract
method. This year, the companys auditors are requiring the new contracts to be recognized
under the percentage of completion method. The change in revenue recognition methods
will result in a revenue change of

A. $0
B. $(900,000)
C. $100,000
Answer (C) is correct.
When the outcome of a transaction involving the rendering of services
(e.g., a construction project) cannot be estimated reliably, revenue must
be recognized only to the extent of the expenses recognized that are
recoverable. If it is probable that the entity will recover the transaction
costs incurred, revenue is recognized only to the extent of those costs that
are expected to be recoverable. Thus, $100,000, 10% of the $1,000,000
contract, should be recognized as revenue compared with $0 of revenue
recognized under the completed contract method, since the contract is not
fully completed.
D. $1,000,000

Question: 349

Visor Co. maintains a defined benefit pension plan for its employees. The service cost
component of Visors pension expense is measured using the

A. Unfunded accumulated benefit obligation.


B. Unfunded vested benefit obligation.
C. Projected benefit obligation.

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Answer (C) is correct.
Service cost is the actuarial present value of benefits attributed by the
pension benefit formula to services rendered during the accounting
period. It is a component of the projected benefit obligation (PBO). The
PBO as of a date is equal to the actuarial present value of all benefits
attributed by the pension benefit formula to employee service rendered
prior to that date. The PBO is measured using assumptions as to future
salary levels.
D. Expected return on plan assets.

Question: 350

Which of the following components must be included in the calculation of pension expense
recognized for a period by an employer sponsoring a defined benefit pension plan?

Expected Return
Interest Cost on Plan Assets
A. Yes No
B. Yes Yes
Answer (B) is correct.
The required minimum pension expense consists of the following
elements:
+ Service cost
+ Interest cost
Expected return on plan assets
Amortization of net gain or loss
Amortization of prior service cost of credit
Pension expense
Thus, both interest cost and expected return on plan assets are
components of pension expense.
C. No Yes
D. No No

Question: 351

The following information pertains to Gali Co.s defined benefit pension plan for Year 1:

Fair value of plan assets, beginning of year


Fair value of plan assets, end of year
Employer contributions
Benefits paid

$350,000
525,000
110,000
85,000

In computing pension expense, what amount should Gali use as actual return on plan
assets?

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A. $65,000
B. $150,000
Answer (B) is correct.
The actual return on plan assets is based on the fair value of plan assets at
the beginning and end of the accounting period adjusted for contributions
and payments during the period. The actual return for Gali is $150,000
($525,000 $350,000 $110,000 + $85,000).
C. $175,000
D. $260,000

Question: 352

Interest cost included in the pension expense recognized for a period by an employer
sponsoring a defined benefit pension plan represents the

A. Shortage between the expected and actual return on plan assets.


B. Increase in the projected benefit obligation resulting from the passage of
time.
Answer (B) is correct.
The interest cost component of pension expense is defined as the increase
in the PBO resulting from the passage of time.
C. Increase in the fair value of plan assets resulting from the passage of time.
D. Amortization of the discount on prior service cost.

Fact Pattern: Selected financial information for Jory Company for the current year ended December 31 is
shown below.
Plan assets at January 1

$6,000,000

Projected benefit obligation at January 1

5,000,000

Accumulated benefit obligation at January 1

4,000,000

Interest cost

400,000

Service cost

700,000

Actual return on plan assets

500,000

Expected return on plan assets

500,000

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Employers contribution

800,000

Benefits paid to retirees

300,000

Accrued pension cost at January 1

Question: 353

-0-

Jorys net pension expense for the year ended December 31 is

A. $600,000
Answer (A) is correct.
Jorys net pension expense for the year ended December 31 can be
calculated as follows:
Current service cost
Interest cost

$700,000
400,000

Expected return on plan assets (500,000)


Net periodic pension cost $600,000
B. $900,000
C. $1,600,000
D. $1,900,000

Fact Pattern: Selected financial information for Jory Company for the current year ended December 31 is
shown below.
Plan assets at January 1

Projected benefit obligation at January 1

$6,000,000

5,000,000

Accumulated benefit obligation at January 1 4,000,000

Interest cost

400,000

Service cost

700,000

Actual return on plan assets

500,000

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Expected return on plan assets

500,000

Employers contribution

800,000

Benefits paid to retirees

300,000

Accrued pension cost at January 1

Question: 354

-0-

The plan assets at December 31 for Jory should be valued at

A. $6,500,000
B. $6,800,000
C. $7,000,000
Answer (C) is correct.
The fair value of Jorys plan assets at December 31 can be calculated as
follows:
Fair value, January 1

$6,000,000

Add: Actual return

500,000

Add: Employer contribution

800,000

Less: Retirement benefits paid

(300,000)

Fair value, December 31 $7,000,000


D. $7,300,000

Fact Pattern: Selected financial information for Jory Company for the current year ended December 31 is
shown below.
Plan assets at January 1

Projected benefit obligation at January 1

$6,000,000

5,000,000

Accumulated benefit obligation at January 1 4,000,000

Interest cost

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Service cost

700,000

Actual return on plan assets

500,000

Expected return on plan assets

500,000

Employers contribution

800,000

Benefits paid to retirees

300,000

Accrued pension cost at January 1

Question: 355

-0-

Jorys projected benefit obligation at December 31 is

A. $5,400,000
B. $5,700,000
C. $5,800,000
Answer (C) is correct.
Jorys projected benefit obligation at December 31 can be calculated as
follows:
PBO, January 1

$5,000,000

Add: Current service cost

700,000

Add: Interest cost

400,000

Less: Retirement benefits paid

(300,000)

PBO, December 31

$5,800,000

D. $6,100,000

Fact Pattern: Brown Industries operates a defined benefit pension plan. Information received from the
actuary and the trustee related to the Year 2 pension plan includes the following:
Projected benefit obligation, January 1, Year 2

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$1,889,000

Service cost

105,000

Interest cost

190,000

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Retirement benefits paid

182,000

Employer contribution

155,000

Actual return on plan assets

215,000

Amortization of prior service cost

122,000

Amortization of prior-year net pension loss

37,000

Fair value -- pension plan assets, December 31, Year 1 1,825,000

Question: 356

Browns Year 2 net pension cost is

A. $190,000
B. $239,000
Answer (B) is correct.
Assuming that the actual return on plan assets is equal to the expected
return, the calculations are:
Current service cost

$105,000

Interest cost

190,000

Actual return on plan assets

(215,000)

Amortization of prior service cost

122,000

Amortization of prior-year net pension loss


Net periodic pension cost

37,000
$239,000

C. $454,000
D. $299,000

Fact Pattern: Brown Industries operates a defined benefit pension plan. Information received from the
actuary and the trustee related to the Year 2 pension plan includes the following:
Projected benefit obligation, January 1, Year 2

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$1,889,000

Service cost

105,000

Interest cost

190,000

Retirement benefits paid

182,000

Employer contribution

155,000

Actual return on plan assets

215,000

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Amortization of prior service cost
Amortization of prior-year net pension loss

122,000
37,000

Fair value -- pension plan assets, December 31, Year 1 1,825,000

Question: 357 The fair value of Browns plan assets at December 31, Year 2, is
A.
B.
C.
D.

$1,790,000
$1,798,000
$2,005,000
$2,013,000
Answer (D) is correct.
The calculations are:
Fair value, Dec. 31, Year 1

$1,825,000

Add: Actual return

215,000

Add: Employer contribution

155,000

Less: Retirement benefits paid

(182,000)

Fair value, Dec. 31, Year 2 $2,013,000

Fact Pattern: Brown Industries operates a defined benefit pension plan. Information received from the
actuary and the trustee related to the Year 2 pension plan includes the following:
Projected benefit obligation, January 1, Year 2

$1,889,000

Service cost

105,000

Interest cost

190,000

Retirement benefits paid

182,000

Employer contribution

155,000

Actual return on plan assets

215,000

Amortization of prior service cost

122,000

Amortization of prior-year net pension loss

37,000

Fair value -- pension plan assets, December 31, Year 1 1,825,000

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Question: 358

Browns projected benefit obligation at December 31, Year 2, is

A. $1,787,000
B. $1,969,000
C. $2,002,000
Answer (C) is correct.
The calculations are:
PBO, Jan. 1, Year 2

$1,889,000

Add: Current service cost

105,000

Add: Interest cost

190,000

Less: Retirement benefits paid

(182,000)

PBO, Dec. 31, Year 2

$2,002,000

D. $2,029,000

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