FAR1 50 Multiple Choice Questiona

FAR1 50 Multiple Choice Questions

1. A corporation issues quarterly interim financial statements and uses the lower of

cost or market method to value its inventory in its annual financial statements.

Which of the following statements is correct regarding how the corporation should

value its inventory in its interim financial statements?

A. Inventory losses generally should be recognized in the interim statements.

B. Gains from valuations in previous interim periods should be fully recognized.

C. Only the cost method of valuation should be used.

D. Temporary market declines should be recognized in the interim statements.

ANSWER: A

This answer is correct. The requirement is to identify the correct statement

regarding valuing inventory in interim financial statements. ASC Topic 270 provides

that inventory losses from market declines should be recognized in the interim

statements when the decline in value occurs. A temporary market decline need not be

recognized in the financial statements since no loss is expected to be incurred in

the fiscal year. Therefore this answer is correct.

2. As a result of differences between depreciation for financial reporting purposes

and tax purposes, the financial reporting basis of Noor Co.’s sole depreciable

asset, acquired in year 3, exceeded its tax basis by $250,000 at December 31, year

3. This difference will reverse in future years. The enacted tax rate is 30% for

year 3, and 40% for future years. Noor has no other temporary differences. In its

December 31, year 3 balance sheet, how should Noor report the deferred tax effect of

this difference?

A. As a liability of $75,000.

B. As a liability of $100,000.

C. As an asset of $100,000.

D. As an asset of $75,000.

ANSWER: B

This answer is correct. At 12/31/Y3, the financial reporting basis of the

depreciable asset exceeds its tax basis by $250,000. This means that in future years

tax depreciation will be less than book depreciation, resulting in future taxable

amounts. The existence of future taxable amounts requires recognition of a deferred

tax liability at 12/31/Y3 based on future enacted tax rates. Therefore, Noor should

report a 12/31/Y3 deferred tax liability of $100,000 ($250,000 x 40%). Note that the

deferred tax liability should reflect the future tax consequences of events which

have been recognized in the financial statements, so its computation is based on

current tax rates, unless future tax rates have been enacted and are different from

the current rate.

3. During year 1, an alumnus of Isabella College, a private not-for-profit college,

transferred $100,000 to the college with the stipulation that it be spent for

library acquisitions. However, the alumnus specified that none of the cash

transferred could be spent until the college had matched the entire amount


transferred with donations from other alumni by December 31, year 2. As of December

31, year 1, the college had received matching cash donations of only $5,000 from

other alumni, and the college estimated that it was reasonably possible that it

would not reach the goal of $100,000 by December 31, year 2. If the funds are not

matched by December 31, year 2, the cash will be returned to the alumnus. On the

college’s statement of financial position at December 31, year 1, the cash transfer

of $100,000 would be included in the amount reported for

A. Permanently restricted net assets.

B. Liabilities.

C. Temporarily restricted net assets.

D. Unrestricted net assets.

ANSWER:B

This answer is correct. A transfer of assets with a conditional promise to

contribute them shall be accounted for as a refundable advance until the conditions

have been substantially met. The conditions have been substantially met when the

possibility that they will not be met is remote. In this question, the chance that

the condition will not be met is reasonably possible, which is a higher level of

doubt than remote, and thus results in reporting the cash transfer as a liability at

December 31, year 1.

4. Brooklyn, Inc., had an explosion in its plant that destroyed most of its

inventory. Its records show that beginning inventory was $40,000. Brooklyn made

purchases of $480,000 and sales of $620,000 during the year. Its normal gross profit

percentage is 25%. It can sell some of its damaged inventory for $5,000. The

insurance company will reimburse Brooklyn for 70% of its loss. What amount should

Brooklyn report as loss from the explosion?

A. $18,000

B. $35,000

C. $15,000

D. $50,000

ANSWER:

This answer is correct. The requirement is to determine the amount that Brooklyn,

Inc. should report as loss from the explosion. To calculate the loss, you must

first determine an estimate of the inventory on hand, and information is provided to

estimate the inventory based on the gross profit method. If the gross profit

percent is 25% of sales, an estimate of the loss may be calculated as shown below:

Sales $620,000

COGS (75%) (465,000) Gross Profit 25% $155,000

Beginning inventory $ 40,000 + Purchases 480,000

Goods avail. for sale $520,000 – Cost of goods sold (estimated) (465,000)

Ending inventory (estimated) $ 55,000

FAR1 50 Multiple Choice Questions Ending inventory (estimated) $ 55,000

Less: sales value of damaged goods (5,000) Estimated loss $ 50,000

× 30% (not reimbursed) × 30% Amount of loss not reimbursed $ 15,000

Therefore, this is correct.

5. When goods which have been previously approved for purchase are received by a

governmental unit but not yet paid for, what account is credited?

A. Vouchers Payable.

B. Appropriations.

C. Reserve for Encumbrances.

D. Expenditures.

ANSWER: A

This answer is correct because when goods have been approved for purchase, an

“Encumbrances” account is debited and a Reserved for Encumbrances” account is

credited for the estimated cost of the goods. As the goods are received, the

following entries are recorded:

Reserved for Encumbrances xx Encumbrances xx

Expenditures xx Vouchers payable (cash) xx

The first entry records the receipt of the goods, and the second entry reverses the

original encumbrance that was set up when the goods were initially approved.

6. On September 22, year 2, Zoe Corp. purchased merchandise from an unaffiliated

foreign company for 10,000 units of the foreign company’s local currency. On that

date, the spot rate was $.55. Zoe paid the bill in full on March 20, year 3, when

the spot rate was $.65. The spot rate was $.70 on December 31, year 2. What amount

should Zoe report as a foreign currency transaction loss in its income statement for

the year ended December 31, year 2?

A. $1,000

B. $1,500

C. $0

D. $ 500

ANSWER: B

This answer is correct. A transaction has occurred for which settlement will be made

in a foreign currency. A foreign exchange transaction gain (loss) will result if the

spot rate on the settlement date is different than the rate on the transaction date.

A gain (loss) must be recognized at any intervening year-end date if there has been

a rate change. Thus, in year 2, Zoe would recognize a $1,500 foreign exchange


transaction loss [10,000 × ($.70 – $.55)]. Zoe would recognize a foreign exchange

transaction gain of $500 in year 3 [10,000 × ($.65 – $.70)].

7. According to the cost recovery method of accounting, gross profit on an

installment sale is recognized in income

A. In proportion to the cash collections.

B. On the date of sale.

C. After cash collections equal to the cost of sales have been received.

D. On the date the final cash collection is received.

ANSWER: C

This answer is correct. Installment methods of recognizing revenue are appropriate

only when "collection of the sale price is not reasonably assured." Under the cost

recovery method, gross profit is deferred and recognized only when the cumulative

receipts exceed the cost of the asset sold.

8. On January 1, year 2, Taylor Corp. acquired 50,000 shares of Riley Corp. stock

which represented 80% of Riley’s $10 par common stock for $19.50 per share. On the

date of acquisition, the fair value of the 12,500 shares representing the

noncontrolling interest in Riley was $18 per share. On this date, the carrying

amount of Riley’s net assets was $1,000,000. The fair values of Riley’s identifiable

assets and liabilities were the same as their carrying amounts. For the year ended

December 31, year 2, Riley had net income of $190,000 and paid cash dividends

totaling $125,000. In the December 31, year 2, consolidated balance sheet,

noncontrolling interest should be reported at

A. $233,000

B. $200,000

C. $225,000

D. $238,000

ANSWER: D

This answer is correct. The percentage of the acquiree’s stockholders’ equity not

owned by the acquirer company represents the noncontrolling interest. The

acquisition date noncontrolling interest is valued based on the fair value of the

shares, which is 12,500 (20% × 50,000) × $18 = $225,000. At 12/31/Y2 the

noncontrolling interest is computed below

1/1/Y2 noncontrolling interest $225,000 Year 2 net income (20% × $190,000) 38,000

Year 2 dividends (20% × $125,000) (25,000) Noncontrolling interest at 12/31/Y2 $238,000

9. Which of the following is not a type of foreign currency hedge?

A. A held-to-maturity security.


B. An unrecognized firm commitment.

C. A forecasted transaction.

D. A net investment in foreign operations.

ANSWER: A

This answer is correct. The four foreign currency hedges are (1) an unrecognized

firm commitment, (2) available-for-sale securities, (3) foreign currency denominated

forecasted transactions, and (4) net investments in foreign operations.

10. Under IFRS, a change in accounting estimate is accounted for

A. Prospectively in the period of change and future periods.

B. Retrospectively.

C. As a cumulative effect of an accounting change in the income statement.

D. Currently in the financial statements.

ANSWER: A

This answer is correct. Changes in accounting estimates are accounted for on a

prospective basis in the period of the change and in future periods.

11. On December 31, year 1, Trinity Corp. sold a machine to Diego and simultaneously

leased it back for 1 year. Pertinent information at this date follows:

Sales price $360,000 Carrying amount 330,000

Present value of reasonable rentals ($3,000 for 12 months @ 12%) 34,100 Estimated remaining useful life 12 years

In Trinity’s December 31, year 1 balance sheet, the deferred revenue from the sale

of this machine should be

A. $30,000

B. $34,100

C. $0

D. $ 4,100

ANSWER: C

This answer is correct. ASC Topic 840 generally treats a sale-leaseback as a single

financing transaction in which any profit on the sale is deferred and amortized by

the seller. However, ASC Topic 840 amends this general rule when either only a minor

part of the remaining use of the leased asset is retained (case 1), or when more

than a minor part but less than substantially all of the remaining use of the leased

asset is retained (case 2). Case 1 occurs when the PV of the lease payments is 10%

or less of the FV of the sale-leaseback property. Case 2 occurs when the leaseback

is more than minor but does not meet the criteria of a capital lease. This is an

example of case 1, because the PV of the lease payments ($34,100) is equal to or

less than 10% of the FV of the asset ($360,000). ASC Topic 840 specifies that under

these circumstances, the full gain ($360,000 – $330,000 = $30,000) is recognized,


and none is deferred.

12. The estimated current values of Madelyn’s personal assets at December 31, year

1, totaled $1,000,000, with tax bases aggregating $600,000. Included in these assets

was a vested interest in a deferred profit-sharing plan with a current value of

$80,000 and a tax basis of $70,000. The estimated current amounts of Madelyn’s

personal liabilities equaled their tax bases at December 31, year 1. Madelyn’s year

1 effective income tax rate was 30%. In Madelyn’s personal statement of financial

condition at December 31, year 1, what amount should be provided for estimated

income taxes relating to the excess of current values over tax bases?

A. $0

B. $120,000

C. $117,000

D. $ 3,000

ANSWER: B

This answer is correct. Per ASC Topic 274, estimated taxes that would be paid if all

the assets were converted to cash and all the liabilities were paid should be

included with the liabilities. Thus, $120,000 [($1,000,000 – $600,000) x .30] should

be provided for estimated income taxes relating to the excess of current values over

tax bases.

13. On January 16, Bailey Co. paid $60,000 in property taxes on its factory for the

current calendar year. On April 2, Bailey paid $240,000 for unanticipated major

repairs to its factory equipment. The repairs will benefit operations for the

remainder of the calendar year. What amount of these expenses should Bailey include

in its third quarter interim financial statements for the three months ended

September 30?

A. $75,000

B. $95,000

C. $0

D. $15,000

ANSWER: B

This answer is correct. The requirement is to determine the amount of expenses that

should be included in the third quarter interim financial statements. ASC Topic 270

states that expenditures which clearly benefit more than one interim period may be

allocated among the periods benefited. The major repairs were paid in the second

quarter and benefited three quarters, the current and the next two. Therefore, the

repairs expense of $80,000 ($240,000/3) should be allocated to the current quarter.

Property taxes of $60,000 are allocated to four quarters at $15,000 ($60,000/4) per

quarter. Therefore, the correct answer is $95,000 ($80,000 + $15,000) to be

allocated to the third quarter.


14. Jaxon Corp. has an effective tax rate of 30%. On January 1, year 2, Jaxon

purchased equipment for $100,000. The equipment has a useful life of 10 years. What

amount of current tax benefit will Jaxon realize during year 2 by using the 150%

declining balance method of depreciation for tax purposes instead of the

straight-line method?

A. $3,000

B. $5,000

C. $4,500

D. $1,500

ANSWER: D

This answer is correct because the additional $5,000 in depreciation on the tax

return by using the 150% declining balance method would result in a tax savings or

current tax benefit of $1,500 ($5,000 x 30%). If Jaxon used the straight-line method

of depreciation for tax purposes, depreciation for year year 2 would have been

$10,000 ($100,000/ 10 years). If Jaxon uses the 150% declining balance method for

tax purposes, depreciation would be $15,000 ($100,000 x 1/10 x 1.5 = $15,000).

15. When an investor uses the cost adjusted for fair value method to account for

investments in common stock held in either a trading or available-for-sale

portfolio, cash dividends received by the investor from the investee should normally

be recorded as

A. Dividend income.

B. A deduction from the investment account.

C. An addition to the investor’s share of the investee’s profit.

D. A deduction from the investor’s share of the investee’s profit.

ANSWER: A

This answer is correct because using the cost adjusted for fair value method, cash

dividends are normally recorded as dividend income.

16. The equity method of accounting for an investment in the common stock of another

company should be used when the investment

A. Is obtained by an exchange of stock for stock.

B. Is composed of common stock and it is the investor’s intent to vote the common

stock.

C. Enables the investor to exercise significant influence over the investee.

D. Ensures a source of supply such as raw materials.

ANSWER: C

This answer is correct because the equity method should be used in those cases in

which "an investor has the ability to exercise significant influence over an

investee"

17. In determining diluted earnings per share, a potentially dilutive security was


antidilutive in year 1 and dilutive in year 2. The common stock equivalent would be

included in the computation for

year 1 year 2 A. Yes Yes B. No Yes C. No No D. Yes No

A. D

B. B

C. C

D. A

ANSWER: B

This answer is correct. In computing diluted EPS, only dilutive common stock

equivalents are included. Furthermore, the determination of whether a potentially

dilutive security is dilutive must be made at every reporting date. A situation may

arise in which a potentially dilutive security may be dilutive at one reporting date

and antidilutive the next. In this circumstance, the potentially dilutive security

should only be included in the diluted EPS calculation on the date on which it is

dilutive. Therefore, the potentially dilutive security would be included in the year

2 computation but not the year 1 computation.

18. Max Co. reported the following items in its year-end financial statements:

Capital expenditures $1,000,000 Capital lease payments 125,000

Income taxes paid 325,000 Dividends paid 200,000

Net interest payments 220,000

What amount should Max report as supplemental disclosures in its statement of cash

flows prepared using the indirect method?

A. $1,870,000

B. $ 545,000

C. $ 745,000

D. $1,125,000

ANSWER: B

This answer is correct. ASC Topic 230 (SFAS 95, par. 29) requires that if the

indirect method is used to prepare the statement of cash flows, supplemental

disclosures are required to report the amount of interest paid and the amount of

income taxes paid during the period. This answer is correct because the total amount

of supplemental disclosures are $325,000 + $220,000 = $545,000.


19. Genesis Co. discovered that in the prior year, it failed to report $40,000 of

depreciation related to a newly constructed building. The depreciation was computed

correctly for tax purposes. The tax rate for the current year was 40%. What was the

impact of the error on Genesis’s financial statements for the prior year?

A. Understatement of accumulated depreciation of $40,000.

B. Understatement of net income of $24,000.

C. Understatement of depreciation expense of $24,000.

D. Understatement of accumulated depreciation of $24,000.

ANSWER: A

This answer is correct. The requirement is to determine the impact of the error. The

result of this error would have been an understatement of depreciation by $40,000

and understatement of accumulated depreciation by $40,000 and an overstatement of

net income by $24,000 [$40,000 x (1 - .4)].

20. Under IFRS reporting, how is presentation currency defined?

A. The currency of the primary economic environment in which the entity operates.

B. A currency other than the functional currency.

C. The currency in which financial statements are presented.

D. The currency that uses the current rate.

ANSWER: C

This answer is correct because currency in which financial statements are presented

is the definition of the presentation currency.

21. Kennedy Company leased equipment from Howe, Inc. on December 31, year 1, for a

10-year period (the useful life of the asset) expiring December 30, year 11. Equal

annual payments under the lease are $100,000 and are due on December 31 of each

year. The first payment was made on December 31, year 1, and the second payment was

made on the due date. The present value at December 31, year 1, of the minimum lease

payments over the lease term discounted at 10% (the implicit rate computed by Howe

and known by Kennedy) was $676,000. Kennedy’s incremental borrowing rate was 12% at

December 31, year 1. The lease is appropriately accounted for as a capital lease by

Kennedy. What should be the balance in Kennedy’s liability under capital lease

account at December 31, year 2?

A. $545,120

B. $800,000

C. $533,600

D. $607,960

ANSWER: C

This answer is correct. The first payment (paid on the date the lease is signed)

contains no interest and is, therefore, all reduction of principal. The second

payment includes interest of $57,600 (10% x $576,000) and principal of $42,400

($100,000 – $57,600). Note that because Howe’s implicit interest rate of 10% is

known by Kennedy and is lower than Kennedy’s incremental rate, it is used to compute


the interest payment.

Date Cash payment 10% Interest Reduction of principal

Lease liability 12/31/Y1

$676,000 12/31/Y1 $100,000

576,000 12/31/Y2 100,000 $57,600 $42,400

533,600

Therefore, Kennedy should report a liability under capital lease as of 12/31/Y2 of

$533,600.

22. On January 1, year 1, Weaver Company purchased as a long-term investment

$500,000 face value of Park Corporation’s 8% bonds for $456,200. The bonds were

purchased to yield 10% interest. The bonds mature on January 1, year 7, and pay

interest annually on January 1. Weaver intends to hold the bonds until their

scheduled maturity. Weaver uses the interest method of amortization and does not

elect the fair value option for reporting financial assets. What amount should

Weaver report on its December 31, year 1 balance sheet as long-term investment?

A. $466,200

B. $456,200

C. $450,580

D. $461,820

ANSWER: D

This answer is correct. Held-to-maturity investments should be reported at

amortized cost on the balance sheet. The carrying value of long-term investments on

December 31, year 1, will be the carrying value on January 1, year 1, plus the

discount amortization. Discount amortization is the difference between interest

revenue and interest receivable. Interest revenue is the book value of the bonds

times the yield rate of interest ($456,200 × .10 = $45,620). Interest receivable is

the face value of the bonds times the face rate of interest ($500,000 × .08 =

$40,000). The adjusting entry on December 31, year 1, will be

Interest receivable 40,000 Kennedy investment (long-term) 5,620

Interest revenue 45,620

Thus, the carrying value of the bonds on December 31, year 1, is $461,820 ($456,200

+ $5,620). The above entry assumes that the bonds were recorded net when purchased.

If a discount of $43,800 was recorded, the $5,620 debit would be to the discount

account.


23. Mackenzie Company is in its first year of operations. Mackenzie estimates its

annual warranty expense at 2% of net annual sales. Mackenzie provides its customers

with a three-year warranty plan. Expected warranty expense is shown below:

Year Expected warranty expense Present value discounted at 8% year 1 $40,000 $37,037 year 2 10,000 8,573 year 3 10,000 7,938

Total $60,000 $53,548

The current borrowing rate for Mackenzie is 8%. Mackenzie can contract with a third

party to provide the warranty work. The cost for a contract to settle the warranties

is $57,000. If Mackenzie elects the fair value option to report warranty

obligations, at what amount will the warranty liability be recorded on the balance

sheet?

A. $0

B. $53,548

C. $60,000

D. $57,000

ANSWER: D

This answer is correct. ASC Topic 825 provides that a company can elect the fair

value option to record its warranties if the warranty liability can be satisfied by

contracting with a third party. ASC Topic 820 provides that the fair value is the

exchange price in an orderly transaction between market participants to sell the

asset or transfer the liability in the principal or most advantageous market.

Therefore, if the fair value option is elected, the fair value of the warranty

liability is the cost to settle or transfer the liability in the market.

24. On June 30, year 2, a fire in Brooke Company’s plant caused a total loss to a

production machine. The machine had a book value of $80,000 at December 31, year 1,

and was being depreciated at an annual rate of $10,000. The machine had a fair

value of $110,000 at the date of the fire, and Brooke received insurance proceeds of

$100,000 in October year 2. The same month Brooke purchased a replacement machine

for $130,000. Ignoring income taxes, what amount should Brooke report on its year 2

income statement as involuntary conversion gain or loss?

A. $10,000 loss.

B. $20,000 gain.

C. $25,000 gain.

D. $0.

ANSWER: C

This answer is correct. Per ASC 605-40-45-1, a gain (loss) on such conversions

should be recognized as the difference between the proceeds and the book value of

the converted asset, regardless of whether or not the proceeds are reinvested.

Proceeds $100,000

FAR1 50 Multiple Choice Questions Book value ($80,000 -$5,000) 75,000

Gain $ 25,000

The book value of $80,000 is decreased by a half-year’s depreciation (1/2 × $10,000

= $5,000) for 12/31/Y1 to 6/30/Y2.

25. Scarlett Inc. specializes in real estate transactions other than retail land

sales. On January 1, year 1, Scarlett consummated a sale of property to Cole Ltd.

The amount of profit on the sale is determinable and Scarlett is not obligated to

perform any additional activities to earn the profit. Cole’s initial and continuing

investments were adequate to demonstrate a commitment to pay for the property.

However, Scarlett’s receivable may be subject to future subordination. Scarlett

should account for the sale using the

A. Cost recovery method.

B. Reduced profit method.

C. Deposit method.

D. Full accrual method.

ANSWER: A

This answer is correct. The problem states that the sale has been consummated and

that Cole’s initial and continuing investments are adequate to demonstrate a

commitment to pay for the property. However, the fact that Scarlett’s receivable is

subject to future subordination precludes recognition of the profit in full.

Instead, the cost recovery method must be used to account for the sale.

26. Harper Corp. entered into a troubled debt restructuring agreement with National

Bank. National agreed to accept land with a carrying amount of $75,000 and a fair

value of $100,000 in exchange for a note with a carrying amount of $150,000.

Disregarding income taxes, what amount should Harper report as a gain on

restructuring the debt?

A. $75,000

B. $50,000

C. $25,000

D. $0

ANSWER: B

This answer is correct. The gain on restructuring the debt would be the difference

between the carrying amount of the note received and the FMV of the land given. The

amount that Harper should report as gain in its income statement is

$150,000 CV of note – 100,000 FMV of land --------- $ 50,000 Gain on restructuring the debt


27. During year 1 London Company sold a parcel of land used as a plant site. The

amount London received was $100,000 in excess of the land’s carrying amount.

London’s income tax rate for year 1 was 30%. In its year 1 income statement, London

should report a gain on sale of land of

A. $ 30,000

B. $100,000

C. $0

D. $ 70,000

ANSWER: B

This answer is correct. Generally, gains and losses on the sale of land are not

accorded special treatment. The entire $100,000 gain should, therefore, be included

in income before taxes. The gain is not reported as an extraordinary item because it

does not meet the criteria of unusual and infrequent.

28. The capital accounts of the partnership of Grayson, Payton, and Cameron on June

1, year 1, are presented below with their respective profit and loss ratios.

Grayson $139,200 1/2 Payton 208,800 1/3

Cameron 96,000 1/6 ---------

$444,000

On June 1, year 1, Lauren was admitted to the partnership when he purchased, for

$132,000, a proportionate interest from Grayson and Payton in the net assets and

profits of the partnership. As a result of this transaction, Lauren acquired a

one-fifth interest in the net assets and profits of the firm. Assuming that implied

goodwill is not to be recorded, what is the combined gain realized by Grayson and

Payton upon the sale of a portion of their interests in the partnership to Lauren?

A. $62,400

B. $0

C. $82,000

D. $43,200

ANSWER: D

This answer is correct. Under the bonus method, the excess of a new partner’s

contribution over that partner’s purchased share (percent of equity) is allocated to

the original partners’ capital accounts as if they had been paid a bonus. The book

value of 1/5 of the partnership purchased by Lauren is $88,800 ($444,000 ÷ 5). Thus

the gain to be recognized is $43,200 ($132,000 selling price – $88,800 book value).

Note there is no need to allocate gains or losses and capital balances between

Grayson and Payton, as the requirement is in terms of the combined gain.


29. On December 31, year 1, Serenity Township paid a contractor $2,000,000 for the

total cost of a new firehouse built in year 1 on Township-owned land. Financing was

by means of a $1,500,000 general obligation bond issue sold at face value on

December 31, year 1, with the remaining $500,000 transferred from the general fund.

What should be reported on Serenity’s year 1 financial statements for the Capital

Project Fund?

A. Revenues, $1,500,000; Expenditures, $1,500,000.

B. Revenues, $1,500,000; Other financing sources, $500,000; Expenditures,

$2,000,000.

C. Other financing sources, $2,000,000; Expenditures, $2,000,000.

D. Revenues, $2,000,000; Expenditures, $2,000,000.

ANSWER: C

This answer is correct because per Section 1800 of the GASB Codification, neither

proceeds from a general obligation bond nor transfers from the general fund are

revenues. Rather they are recognized as "other financing sources" when they become

measurable and available as net current assets. Section 1600 states that

expenditures of Governmental Funds are generally recognized in the accounting period

in which the fund liability is incurred, which is the current year in this question.

30. The following data were available from Xavier Co.’s records on December 31, year

2:

Finished goods inventory, 1/1/Y2 $120,000 Finished goods inventory, 12/31/Y2 110,000

Cost of goods manufactured 520,000 Loss on sale of plant equipment 50,000

The cost of goods sold for year 2 was

A. $580,000

B. $520,000

C. $530,000

D. $510,000

ANSWER: C

This answer is correct. For a manufacturing company, cost of goods sold is computed

as follows:

Finished goods inv., 1/1/Y2 $120,000 Cost of goods manufactured 520,000

Cost of goods available for sales 640,000 Less finished goods inv., 12/31/Y2 110,000

Cost of goods sold $530,000

Note that the above computation is very similar to the computation of cost of goods

sold for a merchandising firm. For a merchandising firm, merchandise inventory is

used instead of finished goods inventory and cost of goods purchased is used instead


of cost of goods manufactured. In either case, a loss on sale of equipment

($50,000) would not affect the computation.

31. Which of the following qualifies as an operating segment?

A. Corporate headquarters, which oversees $1 billion in sales for the entire

company.

B. Eastern Europe segment, which reports its results directly to the manager of the

European division, and has 20% of the company’s assets, 12% of revenues, and 11% of

profits.

C. North American segment, whose assets are 12% of the company’s assets of all

segments, and management reports to the chief operating officer.

D. South American segment, whose results of operations are reported directly to the

chief operating officer, and has 5% of the company’s assets, 9% of revenues, and 8%

of the profits.

ANSWER: C

This answer is correct. The requirement is to identify the business unit that

qualifies as an operating segment. This answer is correct because the North American

segment has revenue that is at least 10% of combined revenue and its management

reports to the chief operating officer.

32. Parker-Hunter Partnership was formed on January 2, year 1. Under the partnership

agreement, each partner has an equal initial capital balance accounted for under the

goodwill method. Partnership net income or loss is allocated 60% to Parker and 40%

to Hunter. To form the partnership, Parker originally contributed assets costing

$30,000 with a fair value of $60,000 on January 2, year 1, while Hunter contributed

$20,000 in cash. Drawings by the partners during year 1 totaled $3,000 by Cor and

$9,000 by Hunter. Parker-Hunter’s year 1 net income was $25,000. Parker’s share of

Parker-Hunter’s year 1 net income is

A. $15,000

B. $12,500

C. $ 7,800

D. $12,000

ANSWER: A

This answer is correct. The partnership agreement states that partnership income or

loss will be allocated 60% to Parker and 40% to Hunter. Thus, Parker’s share of year

1 income is $15,000 ($25,000 x 60%). Note that the relative capital balances of

Parker and Hunter have nothing to do with the allocation of income and loss since

the allocation percentages are explicitly stated in the partnership agreement.

33. While preparing its year 3 financial statements, Austin Corp. discovered

computational errors in its year 2 and year 1 depreciation expense. These errors

resulted in overstatement of each year’s income by $25,000, net of income taxes. The


following amounts were reported in the previously issued financial statements:

year 2 year 1 ---------- --------

Retained earnings, 1/1 $700,000 $500,000 Net income 150,000 200,000

Retained earnings, 12/31 $850,000 $700,000

Austin’s year 3 income is correctly reported at $180,000. Which of the following

amounts should be adjusted to retained earnings and presented for net income in

Austin’s year 3 and year 2 comparative financial statements?

Year Retained earnings Net income A. year 2 -- 150,000

year 3 ($50,000) 180,000 B. year 2 ($50,000) $150,000

year 3 -- 180,000 C. year 2 ($50,000) $125,000

year 3 -- 180,000 D. year 2 -- $125,000

year 3 -- 180,000

A. D

B. C

C. A

D. B

ANSWER: B

This answer is correct. ASC Topic 250 requires that items of profit or loss related

to the correction of an error in the financial statements of a prior period be

accounted for and reported as prior period adjustments and excluded from the

determination of net income for the current period. When comparative financial

statements are prepared, it is necessary to adjust net income, its components,

retained earnings balances, and other affected balances for all of the periods

presented to reflect retroactive application of prior period adjustments. Hence,

the amounts for each period must be stated in the comparative statements as if the

errors had not occurred. Thus, both year 1 and year 2 net income and retained

earnings would be retroactively reduced by $25,000 to reflect the correct amounts

for each period. After these adjustments are made, the amounts for year 3 will be

correctly stated. Note that this retroactive treatment is only used for

presentation purposes in the comparative financial statements. The actual journal

entry made to correct retained earnings at 1/1/Y3 is

Retained earnings 50,000 Accumulated depreciation 50,000


34. On October 1, year 1, Savannah Retailers signed a 4-month, 16% note payable to

finance the purchase of holiday merchandise. At that date, there was no direct

method of pricing the merchandise, and the note’s market rate of interest was 11%.

Savannah recorded the purchase at the note’s face amount. All of the merchandise was

sold by December 1, year 1. Savannah’s year 1 financial statements reported interest

payable and interest expense on the note for 3 months at 16%. All amounts due on the

note were paid February 1, year 2. Savannah’s year 1 cost of goods sold for the

holiday merchandise was

A. Understated by the difference between the note’s face amount and the note’s

October 1, year 1 present value.

B. Overstated by the difference between the note’s face amount and the note’s

October 1, year 1 present value plus 11% interest for 2 months.

C. Overstated by the difference between the note’s face amount and the note’s

October 1, year 1 present value.

D. Understated by the difference between the note’s face amount and the note’s

October 1, year 1 present value plus 16% interest for 2 months.

ANSWER: A

This answer is correct. Per ASC Topic 835, when a note is exchanged for property,

goods, or services, the stated interest rate is presumed to be fair unless (1)

interest is not stated, (2) the stated rate is unreasonable, or (3) the current cash

price of the property, goods, or services is materially different from the market

value of the note. In these circumstances, the note and the cost of the property,

goods, or services should be recorded at the fair value of the property, goods, or

services or the market value of the note, whichever is more clearly determinable.

The note signed by Savannah bears an unreasonable interest rate of 16% as compared

to the market rate of 11%.

If the note payable had been for more than 1 year, the correct entry would have

recorded the inventory at the market value of the note, since at the time of the

transaction there was no direct method of pricing the merchandise. A premium on the

note payable would have been recorded (since the stated rate was greater than the

market rate) and the premium would have been subsequently amortized over the term of

the note payable.

However, since the term of the note is less than 1 year (4 months), Savannah’s

recording of the inventory purchase and the note payable at the face amount of the

note is appropriate accounting treatment per ASC Topic 835.

Because the entry records inventory at the face amount of the note rather than at

its present value, and the inventory was all sold prior to December 31, year 1, cost

of goods sold would already be recorded appropriately. However, since that is not

an option for the solution, the best answer would be that the cost of goods sold

would be understated by the difference between the face value of the note and the

present value of the note. (If the market rate of 11% had been used to value the

note, the purchases would have been recorded at a higher amount.)


35. In a troubled debt restructuring, when the fair value option is not elected, if

a noncash asset is exchanged to settle the debt:

A. The noncash asset is revalued to fair value, with a gain or loss recognized on

the asset.

B. Noncash assets cannot be exchanged to settle debt.

C. The noncash asset is revalued to fair value, with no gain or loss recognized on

the asset.

D. The noncash asset is not revalued to fair value.

ANSWER: A

This answer is correct because when a noncash asset is exchanged to settle debt, it

must be revalued to fair value with a gain or loss recognized on the asset.

36. Connor Co. reported a total asset retirement obligation of $257,000 in last

year’s financial statements. This year, Connor acquired assets subject to

unconditional retirement obligations measured at undiscounted cash flow estimates of

$110,000 and discounted cash flow estimates of $68,000. Connor paid $87,000 toward

the settlement of previously recorded asset retirement obligations and recorded an

accretion expense of $26,000. What amount should Connor report for the asset

retirement obligation in this year’s balance sheet?

A. $306,000

B. $264,000

C. $280,000

D. $238,000

ANSWER: B

This answer is correct. The asset retirement obligation (ARO) is recorded at its

fair value in the period in which it is incurred. Subsequently, it is adjusted for

revisions in estimates and the passage of time. The beginning balance in the asset

retirement obligation account is $257,000. The fair value of the additional

unconditional retirement obligations incurred during the year was $68,000 and

increases the ARO. The $87,000 paid toward the settlement of obligations decreases

the ARO. The $26,000 accretion expense is the expense recognized on the ARO due to

the passage of time and will increase the ARO. ($257,000 + $68,000 — $87,000 +

$26,000 = $264,000).

37. Aubree uses IFRS to prepare its financial statements. During year 4, Aubree

voluntarily changes its accounting method because the new method will provide more

reliable and relevant information. Aubree can estimate the effects of the change.

How should Aubree treat the change in accounting principle?

A. By a cumulative adjustment on the income statement.

B. On a retrospective basis.

C. On a prospective basis.

D. By restating the financial statements.

ANSWER: B

This answer is correct because IFRS requires changes in accounting principles to be


reported by giving retrospective application to the earliest period presented.

38. On July 1, year 1, Trinity Corporation issued for $960,000, 1,000 of its 9%,

$1,000 callable bonds. The bonds are dated July 1, year 1, and mature on July 1,

year 11. Interest is payable semiannually on January 1 and July 1. Trinity uses the

straight-line method of amortizing bond discount. The bonds can be called by the

issuer at 101 at any time after June 30, year 6. On July 1, year 7, Trinity called

in all of the bonds and retired them. How much loss should Trinity report on this

early extinguishment of debt for the year ended December 31, year 7?

A. $10,000

B. $26,000

C. $34,000

D. $50,000

ANSWER: B

This answer is correct. The loss on early extinguishment of debt is the difference

between cash paid and the carrying amount. The bonds payable ($1,000,000) were

issued at a discount of $40,000 on 7/1/Y1. The bonds are called at 101 6 years later

on 7/1/Y7. Since the bonds were due in 10 years, 6/10 of the discount (6/10 ×

$40,000, or $24,000) would have been amortized by 7/1/Y7. Therefore, the balance in

the bond discount account is $16,000 ($40,000 — $24,000), and the carrying amount of

the debt is $984,000 ($1,000,000 — $16,000). The loss on the retirement is the

difference between the $1,010,000 cash paid ($1,000,000 × 1.01) and the $984,000

carrying amount, or $26,000.

39. Harper Co. exchanged similar nonmonetary assets with Dale Co. No cash was

exchanged. The carrying amount of the asset surrendered by Harper exceeded both the

fair value of the asset received and Dale’s carrying amount of that asset. If the

transaction lacks commercial substance, Harper should recognize the difference

between the carrying amount of the asset it surrendered and

A. Dale’s carrying amount of the asset it received as a loss.

B. The fair value of the asset it received as a gain.

C. Dale’s carrying amount of the asset it received as a gain.

D. The fair value of the asset it received as a loss.

ANSWER: D

This answer is correct. Per ASC Topic 845, exchanges that lack commercial substance

are accounted for at book value. Although ASC Topic 845 prohibits recognition of a

gain on these exchanges, it requires the recognition of any loss. Since the carrying

value of the asset surrendered by Harper exceeds the fair market value of the asset

received, Harper realized a loss on this exchange. Harper should value the asset

received at its fair market value. The difference between the carrying amount of the

asset surrendered and its fair market value (measured by the fair market value of

the asset received in this case) should be recognized as a loss.


40. Personal financial statements should include which of the following statements?

Financial condition Changes in net worth Cash flows A. No Yes Yes B. Yes No No C. Yes Yes No D. Yes Yes Yes

A. D

B. B

C. A

D. C

ANSWER: D

This answer is correct. Per ASC Topic 274, personal financial statements consist of

(1) a statement of financial condition, and (2) a statement of changes in net worth.

A statement of cash flows is not required.

41. Which of the following is an appropriate market approach for determining fair

value measurements?

A. Using the undiscounted cash flows from the asset.

B. Using the current replacement cost of the asset.

C. Using present value techniques to discount cash flows.

D. Using relevant information from recent transactions.

ANSWER: D

This answer is correct. Relevant information from recent transactions is a market

approach to determining fair value measurement.

42. A nongovernmental not-for-profit organization’s statement of activities is

similar to which of the following for-profit financial statements?

A. Statement of retained earnings.

B. Balance sheet.

C. Statement of cash flows.

D. Income statement.

ANSWER: D

This answer is correct because a statement of activities reports revenues and

expenses for the government. The requirement is to identify the for-profit financial

statement that is similar to a statement of activities.

43. A loan is granted in the amount of $500,000 with a stated interest rate of 10%.

The lender incurs direct loan origination costs of $10,000 and charges the borrower

a 3-point nonrefundable fee. The effective interest rate to the lender will be


A. Greater than 9% but less than 10%.

B. Greater than 10%

C. 10%

D. Less than 10%

ANSWER: B

This answer is correct. The lender has a carrying amount of $495,000. This reflects

the $500,000 less the $15,000 nonrefundable fee plus the $10,000 loan origination

costs. A carrying amount less than the face amount will yield an effective interest

rate greater than the stated interest rate of 10%.

44. In financial reporting for segments of a business enterprise, segment data may

be aggregated

A. Before performing the 10% tests if a majority of the aggregation criteria are

met.

B. Before performing the 10% tests if all of the aggregation criteria are met.

C. If any one of the aggregation criteria is met.

D. If the segments do not meet the 10% tests but meet some of the aggregation

criteria.

ANSWER: B

This answer is correct. Per ASC Topic 280, two or more operating segments may be

aggregated into a single operating segment if all of the aggregation criteria are

met, or if after performing the 10% test a majority of the aggregation criteria are

met.

45. Wyatt Corp., a company whose stock is publicly traded, provides a

noncontributory defined benefit pension plan for its employees. The company’s

actuary has provided the following information for the year ended December 31, year

5:

Projected benefit obligation $400,000 Accumulated benefit obligation 350,000

Plan assets (fair value) 410,000 Service cost 120,000

Interest on projected benefit obligation 12,000 Amortization of unrecognized prior service cost 30,000

Expected and actual return on plan assets 41,000

The market-related asset value equals the fair value of plan assets. Prior

contributions to the defined benefit pension plan equaled the amount of net periodic

pension cost accrued for the previous year-end. No contributions have been made for

year 5 pension cost. In its December 31, year 5 balance sheet, Wyatt should report

a pension asset of

A. $0


B. $121,000

C. $203,000

D. $ 10,000

ANSWER: D

This answer is correct. Since prior contributions equaled the amount of net pension

cost previously accrued, there is no pension asset/liability at 1/1/Y5. Year 5

pension expense is $121,000, as computed below.

Service cost $120,000 Interest on PBO 12,000

Amort. of unrec. PSC 30,000 Return on plan assets (41,000)

Pension cost $121,000

Although no year 5 contributions have been made, there is no liability at 12/31/Y5

because the plan assets exceed the PBO. Therefore, a pension plan asset of $10,000

is recognized.

46. The following items relate to the preparation of a statement of cash flows:

year 2 year 1 year 2 Cash $150,000 $100,000 Net sales $3,200,000

Dividends payable 35,000 0 CGS (2,500,000) Common stock 600,000 450,000 Expenses (500,000)

Retained earnings 280,000 165,000 Net income $ 200,000

Capital stock was sold to provide additional working capital. Under financing

activities, cash dividend payments during year 2 amounted to

A. $ 50,000

B. $ 85,000

C. $ 35,000

D. $115,000

ANSWER: A

This answer is correct. Retained earnings increased $115,000 ($280,000 – $165,000)

even though net income was $200,000 for year 2. This indicates that dividends

declared during this period amounted to $85,000 ($200,000 – $115,000). However,

$35,000 of this represents a liability at the end of year 2. Therefore, cash

dividend payments for year 2 is $50,000 ($85,000 – $35,000).

47. The functional currency of Max, Inc.’s subsidiary is the Swiss franc. Max

borrowed Swiss francs as a partial hedge of its investment in the subsidiary. In

preparing consolidated financial statements, Max’s translation loss on its

investment in the subsidiary exceeded its exchange gain on the borrowing. How should


the effects of the loss and gain be reported in Max’s consolidated financial

statements?

A. The translation loss less the exchange gain is reported in the income statement.

B. The translation loss is reported in the income statement and the exchange gain is

reported as "other comprehensive income" and in the stockholders’ equity section of

the balance sheet.

C. The translation loss is reported separately as "other comprehensive income" and

in the stockholders’ equity section of the balance sheet and the exchange gain is

reported in the income statement.

D. The translation loss less the exchange gain is reported as "other comprehensive

income" under one of three alternatives and "accumulated other comprehensive income"

in the stockholders’ equity section of the balance sheet.

ANSWER: D

This answer is correct. According to ASC Topic 830, translation adjustments

resulting from the translation of foreign currency statements should be reported

separately as a component of "other comprehensive income" under one of three

alternatives and in "accumulated other comprehensive income" in stockholders’

equity. Additionally, gains and losses on certain foreign currency transactions

should be reported in the same manner. Those gains and losses which should be

excluded from net income and instead reported in "other comprehensive income" and as

a component of stockholders’ equity include foreign currency transactions designated

as economic hedges of a net investment in a foreign entity. Thus, both the

translation loss and the exchange gain are to be reported as "other comprehensive

income" and in the stockholders’ equity section of the balance sheet.

48. For purposes of computing the weighted-average number of shares outstanding

during the year, a midyear event that must be treated as occurring at the beginning

of the year is the

A. Issuance of stock warrants.

B. Declaration and payment of stock dividend.

C. Sale of additional common stock.

D. Purchase of treasury stock.

ANSWER: B

This answer is correct because a stock dividend is considered to have occurred on

the first day of the year when computing the weighted-average number of shares

outstanding.

49. Colton, Inc. owns 80% of Bentley, Inc.’s outstanding common stock. Bentley, in

turn, owns 10% of Colton’s outstanding common stock. What percentage of the common

stock cash dividends declared by the individual companies should be reported as

dividends declared in the consolidated financial statements?

Dividends declared by Colton Dividends declared by Bentley A. 90% 0%

FAR1 50 Multiple Choice Questions B. 90% 20% C. 100% 0% D. 100% 20%

A. C

B. D

C. B

D. A

ANSWER: D

This answer is correct because of the reciprocal ownership relationship that exists

between the two companies. Colton (the acquirer) owns 80% of Bentley (the acquiree),

and Bentley owns 10% of Colton. When Colton declares a cash dividend, 90% of it is

distributed to outside parties and 10% goes to Bentley. Because Bentley is part of

the consolidated entity, its 10% share is eliminated; thus, only 90% of dividends

declared by Colton are reported in the consolidated statements. When Bentley

declares a dividend, 80% is distributed to Colton and 20% to outside parties.

Colton’s 80% share is eliminated as an intercompany transaction and the remaining

20% is also excluded because, from the acquirer’s point of view, acquiree dividends

do not represent dividends of the consolidated entity and must be eliminated.

50. Carter Company adopted a defined benefit pension plan on January 1, year 4.

Carter amortizes the prior service cost over 16 years and funds prior service cost

by making equal payments to the fund trustee at the end of each of the first 10

years. The service (normal) cost is fully funded at the end of each year. The

following data are available for year 4:

Service (normal) cost for year 4 $110,000 Prior service cost:

Amortized 41,700 Funded 57,200

Carter’s pension asset/liability at December 31, year 4, is

A. $57,200

B. $41,700

C. $0

D. $15,500

ANSWER: D

This answer is correct. Pension asset (liability) is the excess of the amount

funded over the amount recorded as pension expense. The amount funded is $167,200

($110,000 service cost + $57,200 funding of prior service cost). Pension expense is

$151,700 ($110,000 service cost + $41,700 amortization of prior service cost).

Therefore, pension asset/liability is $15,500 ($167,200 – $151,700).

FAR1 50 Multiple Choice Questiona

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