2012 aicpa financial questions

2012 AICPA Newly Released Questions – Financial

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Following are multiple choice questions recently released by the AICPA. These

questions were released by the AICPA with letter answers only. Our editorial board has

provided the accompanying explanation.

Please note that the AICPA generally releases questions that it does NOT intend to use

again. These questions and content may or may not be representative of questions you

may see on any upcoming exams.


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1. A transaction that is unusual in nature or infrequent in occurrence should be reported as a(an):

a. Component of income from continuing operations, net of applicable income taxes. b. Extraordinary item, net of applicable income taxes. c. Component of income from continuing operations, but not net of applicable income taxes. d. Extraordinary item, but not net of applicable income taxes. Solution: Choice "c" is correct. Items of income or loss that are either unusual OR infrequent are not extraordinary. These items should be reported as part of income from continuing operations and not net of tax.

Choice "a" is incorrect. Items reported as part of continuing operations are not reported net of income taxes.

Choice "b" is incorrect. Items that are either unusual or infrequent are not extraordinary. Under U.S. GAAP, an extraordinary item is one that is both unusual in nature and infrequent in occurrence.

Choice "d" is incorrect. Items that are either unusual or infrequent are not extraordinary. Under U.S. GAAP, an extraordinary item is one that is both unusual in nature and infrequent in occurrence.


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2. Which of the following characteristics of accounting information primarily allows users of financial statements to generate predictions about an organization?

a. Reliability. b. Timeliness. c. Neutrality. d. Relevance. Solution: Choice "d" is correct. According to SFAC No.8, financial information is relevant if it is capable of making a difference in the decisions made by users and has predictive and/or confirming value.

Choice "a" is incorrect. Reliability, referred to as faithful representation in SFAC No. 8, requires completeness, neutrality and freedom from error.

Choice "b" is incorrect. Timeliness is an enhancing qualitative characteristic and means that information is available to users in time to be capable of influencing their decisions.

Choice "c" is incorrect. Neutrality is a component of faithful representation, not reliability.


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3. A company that is a large accelerated filer must file its Form 10-Q with the United States Securities and Exchange Commission within how many days after the end of the period?

a. 30 days. b. 40 days. c. 45 days. d. 60 days. Solution: Choice "b" is correct. Form 10-Q is a quarterly report filed within 40 days for large corporations and 45 days for small corporations after the end of the first three quarters of each fiscal year. It must contain reviews of interim financial information by an independent CPA.

Choice "a" is incorrect. There is no 30 day requirement. Form 10-Q is due 40 days after the end of the quarter for large corporations.

Choice "c" is incorrect. Form 10-Q is due 45 days after the end of the quarter for small corporations.

Choice "d" is incorrect. Form 10-K, an annual report, is due 60 days after the end of the fiscal year for large corporations.


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4. A company has the following items on its year-end trial balance:

Net sales $500,000 Common stock 100,000 Insurance expense 75,000 Wages 50,000 Cost of goods sold 100,000 Cash 40,000 Accounts payable 25,000 Interest payable 20,000

What is the company's gross profit?

a. $230,000 b. $275,000 c. $400,000 d. $500,000 Solution: Choice "c" is correct. Gross profit is calculated as sales less cost of goods sold.

Net sales $500,000 Cost of sales $100,000 Gross profit $400,000

Choice "a" is incorrect. Insurance expense, wages and liabilities are not subtracted to arrive at gross profit.

Choice "b" is incorrect. Insurance expense and wages are not part of cost of goods sold. $275,000 is the amount of net income.

Choice "d" is incorrect. Cost of sales is subtracted from sales to arrive at gross profit.


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5. Alta Co. spent $400,000 during the current year developing a new idea for a product that was patented during the year. The legal cost of applying for a patent license was $40,000. Also, $50,000 was spent to successfully defend the rights of the patent against a competitor. The patent has a life of 20 years. What amount should Alta capitalize related to the patent?

a. $40,000 b. $50,000 c. $90,000 d. $490,000 Solution: Choice "c" is correct. Development costs of a new product idea are a direct expense. Legal fees incurred to apply for a patent and to successfully defend the patent rights are capitalized as an asset.

Choice "a" is incorrect. The costs incurred to successfully defend the patent are capitalized.

Choice "b" is incorrect. The legal costs of applying for a patent license are capitalized.

Choice "d" is incorrect. The development costs of a new product idea are not capitalized.


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6. A retail store sold gift certificates that are redeemable in merchandise. The gift certificates lapse one year after they are issued. How would the deferred revenue account be affected by each of the following? Redemption of Lapse of certificates certificates a. Decrease Decrease b. Decrease No effect c. No effect Decrease d. No effect No effect Solution: Choice "a" is correct. Deferred revenue represents future income collected in advance. When the gift certificates are sold, deferred revenue is increased.

When the certificates are redeemed, the revenue is earned and shown in the income statement. Deferred revenue is decreased.

When the certificates lapse, the company has no further liability and revenue is earned. Deferred revenue is decreased.


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7. Brand Co. incurred the following research and development project costs at the beginning of the current year:

Equipment purchased for current and future projects $100,000 Equipment purchased for current projects only 200,000 Research and development salaries for current project 400,000

Equipment has a five-year life and is depreciated using the straight-line method. What amount should Brand record as depreciation for research and development projects at December 31?

a. $0 b. $20,000 c. $60,000 d. $140,000 Solution: Choice "b" is correct. Under U.S. GAAP, the only acceptable method of accounting for research and development is a direct charge to expense, except for materials, equipment, or facilities that have alternate future uses that are capitalized and depreciated over their useful lives. The equipment purchased for current projects only must be expensed as research and development cost. Only the equipment purchased for current and future projects will be capitalized and deprecated:

$100,000 / 5 years = $20,000.

Choice "a" is incorrect. The equipment purchased for current and future projects is depreciated over the useful life of the equipment of five years: $100,000 / 5 years = $20,000.

Choice "c" is incorrect. The equipment purchased for current projects is an immediate expense and is not depreciated.

Choice "d" is incorrect. The equipment purchased for current projects is an immediate expense and is not depreciated. Salaries are a direct expense and are not depreciated.


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8. How should NSB, Inc. report significant research and development costs incurred?

a. Expense all costs in the year incurred. b. Capitalize the costs and amortize over a five-year period c. Capitalize the costs and amortize over a 40-year period. d. Expense all costs two years before and five years after the year incurred. Solution: Choice "a" is correct. Under U.S. GAAP, the only acceptable method of accounting for research and development costs is a direct charge to expense, except for materials, equipment, or facilities that have alternate future uses that are capitalized and depreciated over their useful lives.

Choice "b" is incorrect. The only research and development costs that are capitalized under U.S. GAAP are materials, equipment, or facilities that have alternate future uses that are capitalized and depreciated over their useful lives (not necessarily a 5-year period).

Choice "c" is incorrect. The only research and development costs that are capitalized under U.S. GAAP are materials, equipment, or facilities that have alternate future uses that are capitalized and depreciated over their useful lives (not a 40-year period).

Choice "d" is incorrect. Under U.S. GAAP, the only acceptable method of accounting for research and development costs is a direct charge to expense in the period incurred (except for materials, equipment, or facilities that have alternate future uses that are capitalized and depreciated over their useful lives).


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9. On June 19, Don Co., a U.S. company, sold and delivered merchandise on a 30-day account to Cologne GmbH, a German corporation, for 200,000 euros. On July 19, Cologne paid Don in full. Relevant currency exchange rates were:

June 19 July 19 Spot rate $.988 $.995 30-day forward rate .990 1.000

What amount should Don record on June 19 as an account receivable for its sale to Cologne?

a. $197,600 b. $198,000 c. $199,000 d. $200,000 Solution: Choice "a" is correct. A transaction denominated in a foreign currency is recorded at the spot rate on the date of the transaction: $200,000 x .988 = $197,600.

Choice "b" is incorrect. The transaction is not recorded at the forward exchange rate of .99.

Choice "c" is incorrect. The transaction is not originally recorded at the exchange rate when the invoice is paid. That amount would not be known at the date of the transaction. The difference between the spot rate on the transaction date and the settlement date is a foreign currency translation gain or loss. In this case, it is a gain that would be recognized on July 19.

Choice "d" is incorrect. The transaction is not recorded at the forward rate when the transaction is eventually settled. That amount would not be known at the time of the original transaction.


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10. Burns Corp. had the following items:

Sales revenue $45,000 Loss on early extinguishment of bonds 36,000 Realized gain on sale of available-for-sale securities 28,000 Unrealized loss on sale of available-for-sale securities 17,000 Loss on write-down of inventory 3,100

Which of the following amounts would the statement of comprehensive income report as other comprehensive income or loss?

a. $11,000 other comprehensive income. b. $16,900 other comprehensive income. c. $17,000 other comprehensive loss. d. $28,100 other comprehensive loss. Solution: Choice "c" is correct. Unrealized losses on available-for-sale securities are reported in other comprehensive income.

Choice "a" is incorrect. Realized gains on available-for-sale securities are reported on the income statement.

Choice "b" is incorrect. Only the unrealized losses on available-for-sale securities are reported in other comprehensive income. All of the other items listed are reported in the income statement.

Choice "d" is incorrect. Only the unrealized losses on available-for-sale securities are reported in other comprehensive income. The other gain and loss items would be reported on the income statement.


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11. On January 1 of the current year, Barton Co. paid $900,000 to purchase two-year, 8%, $1,000,000 face value bonds that were issued by another publicly-traded corporation. Barton plans to sell the bonds in the first quarter of the following year. The fair value of the bonds at the end of the current year was $1,020,000. At what amount should Barton report the bonds in its balance sheet at the end of the current year?

a. $900,000 b. $950,000 c. $1,000,000 d. $1,020,000 Solution: Choice "d" is correct. The bond investments are classified as trading securities because the bonds are held for the purpose of selling them in the near term. Trading securities are reported at fair value on the balance sheet.

Choice "a" is incorrect. Trading securities are not reported at the original cost of the bonds.

Choice "b" is incorrect. Trading securities are not reported at the amortized cost of the bonds.

Choice "c" is incorrect. Trading securities are not reported at the face value of the bonds.


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12. Tinsel Co.'s balances in allowance for uncollectible accounts were $70,000 at the beginning of the current year and $55,000 at year end. During the year, receivables of $35,000 were written off as uncollectible. What amount should Tinsel report as uncollectible accounts expense at year end?

a. $15,000 b. $20,000 c. $35,000 d. $50,000 Solution: Choice "b" is correct. The uncollectible (bad debts) expense is calculated as follows:

B Beginning balance, allowance for uncollectible accounts $70,000 A Uncollectible accounts expense Unknown S Accounts written off (35,000) E Ending balance, allowance for uncollectible accounts $55,000

The uncollectible account expense is $20,000.

Choice "a" is incorrect. Because there were write-offs during the year, the uncollectible accounts expense is not the difference between the beginning and end of year balances in the allowance account.

Choice "c" is incorrect. The accounts written off are specific accounts removed from the accounts receivable listing. The amount written off is not the uncollectible accounts expense because the direct write-off method is prohibited by GAAP.

Choice "d" is incorrect. When calculating the ending allowance, the uncollectible accounts expense must be added and the accounts written off must be subtracted.


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13. During the year, Hauser Co. wrote off a customer's account receivable. Hauser used the allowance method for uncollectable accounts. What impact would the write-off have on net income and total assets?

Net income Total assets a. Decrease Decrease b. Decrease No effect c. No effect Decrease d. No effect No effect Solution: Choice "d" is correct. The journal entry for a write off of a specific account receivable under the allowance method is as follows:

DR: Allowance for doubtful accounts $xxx CR: Accounts receivable $xxx

Since both accounts are asset accounts, there is no effect on net income or total assets.


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14. The original cost of an inventory item is above the replacement cost. The inventory item's replacement cost is above the net realizable value. Under the lower of cost or market method, the inventory item should be valued at:

a. Original cost. b. Replacement cost. c. Net realizable value. d. Net realizable value less normal profit margin. Solution: Choice "c" is correct. Inventory is reported at the lower of cost or market under U.S. GAAP. Market value is the middle value of an item's replacement cost, net realizable value, and net realizable value less a normal profit margin. In this problem, the cost is higher than replacement cost, which is higher than net realizable value, which is higher than net realizable value less normal profirm margin. From highest to lowest:

Cost Replacement cost Net realizable value <-- Market Net realizable value less normal profit margin

Therefore, market is equal to net realizable value and market is less than cost, so the inventory should be valued at net realizable value.

Choice "a" is incorrect. The inventory will not be reported at original cost because the cost of the item is higher than market.

Choice "b" is incorrect. The replacement cost is higher than both the net realizable value and the net realizable value less a normal profit margin. Therefore, market is net realizable value and market is less than cost, so the inventory should be valued at net realizable value.

Choice "d" is incorrect. The net realizable value less a normal profit margin is lower than both the replacement cost and net realizable value. Therefore, market is net realizable value and market is less than cost, so the inventory should be valued at net realizable value.


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15. Kauf Co. had the following amounts related to the sale of consignment inventory:

Cost of merchandise shipped to consignee $72,000 Sales value for two-thirds of inventory sold by consignee 80,000 Freight cost for merchandise shipped 7,500 Advertising paid for by consignee, to be reimbursed 4,500 10% commission due the consignee for the sale 8,000

What amount should Kauf report as net profit(loss) from this transaction for the year?

a. $(12,000) b. $8,000 c. $14,500 d. $32,000 Solution: Choice "c" is correct. Revenue is recognized when the goods are sold to a third party. Until the sale, the goods remain in the consigner's inventory. Freight is a cost of inventory and expensed when inventory is sold. Commissions and advertising are expenses.

Net sales $80,000 Cost of sales (2/3 x $72,000) (48,000) Freight (2/3 x $7,500) (5,000) Commissions (10% x $80,000) (8,000) Advertising (4,500)

Net Profit $14,500

Choice "a" is incorrect. Unsold inventory is not included as an expense.

Choice "b" is incorrect. Total sales less total inventory is not considered to be the net income.

Choice "d" is incorrect. Freight, commissions and advertising are expenses used to calculate the net income.


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16. A manufacturer has the following per-unit costs and values for its sole product:

Cost $10.00 Current replacement cost 5.50 Net realizable value 6.00 Net realizable value less normal profit margin 5.20

In accordance with IFRS, what is the per-unit carrying value of inventory in the manufacturer's statement of financial position?

a. $5.20 b. $5.50 c. $6.00 d. $10.00 Solution: Choice "c" is correct. IFRS requires inventory to be reported at the lower of cost or net realizable value.

Choice "a" is incorrect. Net realizable value less normal profit margin is not recognized under IFRS. U.S. GAAP sets this as the market floor.

Choice "b" is incorrect. The current replacement cost is not recognized by IFRS in determining the lower of cost or market.

Choice "d" is incorrect. The net realizable value is lower than the cost and is the carrying value of inventory according to IFRS.


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17. At the beginning of the year, Cann Co. started construction on a new $2 million addition to its plant. Total construction expenditures made during the year were $200,000 on January 2, $600,000 on May 1, and $300,000 on December 1. On January 2, the company borrowed $500,000 for the construction at 12%. The only other outstanding debt the company had was a 10% interest rate, long-term mortgage of $800,000, which had been outstanding the entire year. What amount of interest should Cann capitalize as part of the cost of the plant addition?

a. $140,000 b. $132,000 c. $72,500 d. $60,000 Solution: Choice "c" is correct. Construction period interest is capitalized based on the weighted average of accumulated construction expenditures. The interest rate paid on borrowings specifically for asset construction is used first to determine the amount of interest cost capitalized. If the average accumulated expenditures outstanding exceed the amount of the specific new borrowing, interest on the excess is computed based on the interest rate for other borrowings of the company.

Average expenditures: $200,000 4/12 (Jan-Apr) $ 66,667 $800,000 7/12 (May-Nov) 466,667 $1,100,000 1/12 (Dec) 91,666

Average Expenditures $625,000

Capitalized Interest Expense: Construction loan $500,000 x 12% $60,000 Excess Expenditures $125,000 x 10% 12,500

Capitalized interest $72,500

Choice "a" is incorrect. Only the interest related to construction expenditures is capitalized. The entire amount of interest is not capitalized.

Choice "b" is incorrect. The capitalized interest is based on the weighted average construction expenditures during the year and the rates of interest for specific borrowings. It is not calculated as the year end amount of expenditures at the construction loan rate.

Choice "d" is incorrect. The capitalized interest is not based simply on the construction loan interest paid. It is based on the average expenditures and the interest rates paid by the company.


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18. Hudson Corp. operates several factories that manufacture medical equipment. The factories have a historical cost of $200 million. Near the end of the company's fiscal year, a change in business climate related to a competitor's innovative products indicated to Hudson's management that the $170 million carrying amount of the assets of one of Hudson's factories may not be recoverable. Management identified cash flows from this factory and estimated that the undiscounted future cash flows over the remaining useful life of the factory would be $150 million. The fair value of the factory's assets is reliably estimated to be $135 million. The change in business climate requires investigation of possible impairment. Which of the following amounts is the impairment loss?

a. $15 million b. $20 million c. $35 million d. $65 million Solution: Choice "c" is correct. A fixed asset is first tested for impairment. If the sum of the undiscounted expected future cash flows is less than the carrying amount, an impairment loss needs to be recognized. In this problem, the carrying value is $170 million and the undiscounted future cash flows are estimated to be $150 million. Therefore, an impairment loss must be recorded.

The amount of the impairment loss is the amount by which the carrying amount exceeds the fair value of the asset:

$170 million carrying amount – $135 million fair value of assets = $35 million impairment loss.

Choice "a" is incorrect. The impairment loss is not calculated by taking the difference between the undiscounted expected cash flows and the fair value of the assets.

Choice "b" is incorrect. The impairment loss is not the difference between the carrying value and the expected cash flows. But, this calculation is used to determine whether there is an impairment loss.

Choice "d" is incorrect. The carrying amount of the asset, not the original cost, is used to calculate the impairment loss.


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19. On January 2, Vole Co. issued bonds with a face value of $480,000 at a discount to yield 10%. The bonds pay interest semiannually. On June 30, Vole paid bond interest of $14,400. After Vole recorded amortization of the bond discount of $3,600, the bonds had a carrying amount of $363,600. What amount did Vole receive upon issuing the bonds?

a. $360,000 b. $367,200 c. $476,400 d. $480,000 Solution: Choice "a" is correct. The unamortized discount on bonds payable is a contra to bonds payable. It is presented on the balance sheet as a direct reduction from the face value of the bonds to arrive at the bond's carrying amount. As the discount is amortized, the carrying value of the bond decreases. The carrying amount is $363,600 after recording amortization of $3,600. Therefore, the carrying amount before amortization is $360,000.

Choice "b" is incorrect. Amortization of a discount increases, not decreases, the carrying amount of the bond. Amortization of the discount or premium always moves the carrying value closer to the face value.

Choice "c" is incorrect. Amortization is calculated on the carrying amount of the bond, not the face value of the bond.

Choice "d" is incorrect. The face value of the bond is received if there was no discount or premium.


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20. What type of bonds mature in installments?

a. Debenture. b. Term. c. Variable rate. d. Serial. Solution: Choice "d" is correct. Serial bonds are pre-numbered bonds that the issuer may call and redeem a portion by serial number.

Choice "a" is incorrect. Debentures are unsecured bonds.

Choice "b" is incorrect. Term bonds are bonds that have a single fixed maturity date.

Choice "c" is incorrect. Variable rate bonds have interest rates that change.


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21. Bondholders of Balm Co. converted their bonds into 90,000 shares of $5 par value common stock. In Balm's accounting records, the bonds had a par value of $775,000 and unamortized discount of $23,000 at the time of conversion. What amount of additional paid-in capital from the conversion should Balm record?

a. $302,000 b. $325,000 c. $348,000 d. $798,000 Solution: Choice "a" is correct. No gain or loss is recognized at conversion. At conversion, the bond payable and discount are written off and common stock is credited at par. Additional paid in capital is credited for the excess of the bond's carrying value over the stock's par value.

DR: Bond Payable $775,000 CR: Unamortized discount $ 23,000 CR: Common stock – par value 450,000 CR: Additional paid in capital 302,000

Choice "b" is incorrect. The unamortized discount needs to be subtracted from the amount of bonds payable.

Choice "c" is incorrect. The unamortized discount needs to be subtracted, not added, to the amount of bonds payable.

Choice "d" is incorrect. The stock amount needs to be split between common stock and additional paid in capital and the unamortized discount should be subtracted, not added.


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22. On June 1 of the current year, a company entered into a real estate lease agreement for a new building. The lease is an operating lease and is fully executed on that day. According to the terms of the lease, payments of $28,900 per month are scheduled to begin on October 1 of the current year and to continue each month thereafter for 56 months. The lease term spans five years. The company has a calendar year end. What amount is the company's lease expense for the current calendar year?

a. $86,700 b. $161,838 c. $188,813 d. $202,300 Solution: Choice "c" is correct. If free or reduced rent is part of the lease package, the lessee must take the total rent expense to be paid for the entire term of the lease and divide it evenly over each period.

Rent to be paid per month $ 28,900 Rent payments 56 Total rent to be paid $1,618,400 Months in lease 60 Monthly rent expense $ 26,973 Months in current year 7 Rent expense for current year $ 188,813

Choice "a" is incorrect. The rent expense is not the amount of cash paid in the current year. Rent expense must be recognized evenly over the life of the lease.

Choice "b" is incorrect. The rent expense for the current year is 7 months, not 6 months.

Choice "d" is incorrect. The rent expense is not calculated at the payment amount for seven months.


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23. Each of the following is a component of the changes in the net assets available for benefits of a defined benefit pension plan trust, except:

a. The net change in fair value of each significant class of investments. b. The net change in the actuarial present value of accumulated plan benefits. c. Contributions from the employer and participants. d. Benefits paid to participants. Solution: Choice "b" is correct. The statement of changes in net assets available for benefits shows the appreciation in the fair value of investments, any other investment income, investment expenses, contributions, benefits paid, and administrative expenses to arrive at the net increase or decrease in net assets available for benefits during the period. The change in actuarial present value of accumulated plan benefits is shown on the statement of changes in accumulated plan benefits.

Choice "a" is incorrect. The net change in fair value is reported on the statement of changes in net assets available for benefits.

Choice "c" is incorrect. Contributions to the plan, whether from the employer or participants, are reported on the statement of changes in net assets available for benefits.

Choice "d" is incorrect. Benefits paid are reported on the statement of changes in net assets available for benefits.


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24. The funded status of a defined benefit pension plan for a company should be reported in

a. The income statement. b. The statement of cash flows. c. The statement of financial position. d. The notes to the financial statements only. Solution: Choice "c" is correct. Companies are required to report the funded status of their pension plan on the statement of financial position as an asset or liability (or both). The statement of financial position is also known as the balance sheet. The funded status of a pension plan is the fair value of plan assets less the projected benefit obligation.

Choice "a" is incorrect. The funded status of a pension plan is not shown in the income statement.

Choice "b" is incorrect. The funded status of a pension plan is not shown in the statement of cash flows.

Choice "d" is incorrect. The funded status of a pension plan is explained in the notes to the financial statements and also shown on the statement of financial position.


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25. Baler Co. prepared its statement of cash flows at year-end using the direct method. The following amounts were used in the computation of cash flows from operating activities:

Beginning inventory $200,000 Ending Inventory 150,000 Cost of goods sold 1,200,000 Beginning accounts payable 300,000 Ending accounts payable 200,000

What amount should Baler report as cash paid to suppliers for inventory purchases?

a. $1,200,000 b. $1,250,000 c. $1,300,000 d. $1,350,000 Solution: Choice "b" is correct. Cash paid to suppliers is calculated as follows:

Cost of goods sold $1,200,000 Minus: Decrease in inventory (50,000) Plus: Decrease in accounts payable 100,000 Cash paid to suppliers $1,250,000

Choice "a" is incorrect. Cost of goods sold is an accrual basis amount. Adjustments for the decreases in inventory and accounts payable must be made to calculate the amount of cash actually paid.

Choice "c" is incorrect. The decrease in inventory must be subtracted from the cost of sales to get the amount of cash paid to suppliers.

Choice "d" is incorrect. The decrease in inventory must be subtracted from the cost of sales (not added) to get the amount of cash paid to suppliers. Since the overall inventory level decreased, purchases during the period were less than the cost of sales.


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26. Which of the following transactions is included in the operating activities section of a cash flow statement prepared using the indirect method?

a. Gain on sale of plant asset. b. Sale of property, plant and equipment. c. Payment of cash dividend to the shareholders. d. Issuance of common stock to the shareholders. Solution: Choice "a" is correct. Gains on the sale of plant assets are an adjustment to net income in the operating section of a cash flow statement since they are included in net income but do not affect operating cash receipts and disbursements.

Choice "b" is incorrect. The sale of property, plant and equipment is an investing activity.

Choice "c" is incorrect. The payment of cash dividends is a financing activity.

Choice "d" is incorrect. Issuance of common stock is a financing activity.


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27. Balm Co. had 100,000 shares of common stock outstanding as of January 1. The following events occurred during the year:

4/1 Issued 30,000 shares of common stock. 6/1 Issued 36,000 shares of common stock. 7/1 Declared a 5% stock dividend. 9/1 Purchased as treasury stock 35,000 shares of its common stock. Balm used the cost method

to account for the treasury stock.

What is Balm's weighted average of common stock outstanding at December 31?

a. 131,000 b. 139,008 c. 150,675 d. 162,342 Solution: Choice "b" is correct.

Total Shares x Period Outstanding x Adjustment for split = Weighted Avg. 100,000 3/12(Jan-Mar) 1.05 26,250 130,000 2/12(Apr-May) 1.05 22,750 166,000 3/12(June-Aug) 1.05 43,575 139,300 4/12(Sept-Dec) 46,433

Weighted Average 139,008

Choice "a" is incorrect. The 5% stock dividend must be treated as though it occurred at the beginning of the year. The shares outstanding before the stock dividend must be restated for the portion of the year before the stock dividend.

Choice "c" is incorrect. The purchase of treasury stock reduces the amount of shares outstanding.

Choice "d" is incorrect. The purchase of treasury stock is a reduction, not an addition to the amount of shares outstanding.


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28. The stockholders of Meadow Corp. approved a stock-option plan that grants the company's top three executives options to purchase a maximum of 1,000 shares each of Meadow's $2 par common stock for $19 per share. The options were granted on January 1 when the fair value of the stock was $20 per share. Meadow determined that the fair value of the compensation is $300,000 and the vesting period is three years. What amount of compensation expense from the options should Meadow record in the year the options were granted?

a. $20,000 b. $60,000 c. $100,000 d. $300,000 Solution:

Choice "c" is correct. Compensation expense is calculated at the grant date of the option and allocated over the vesting period: $300,000 / 3 years = $100,000 per year.

Choice "a" is incorrect. Compensation expense is not recorded at the total par value of the stock divided by the vesting period.

Choice "b" is incorrect. Compensation expense is not recorded at the total par value of the stock.

Choice "d" is incorrect. Compensation expense is not recorded in full in the year the options are issued when the vesting period is three years. Compensation expense is recognized equally over the vesting period.


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29. Jones Co. had 50,000 shares of $5 par value common stock outstanding at January 1. On August 1, Jones declared a 5% stock dividend followed by a two-for-one stock split on September 1. What amount should Jones report as common shares outstanding at December 31?

a. 105,000 b. 100,000 c. 52,500 d. 50,000 Solution: Choice "a" is correct. The common shares outstanding at year-end are calculated as follows:

50,000 shares outstanding at the beginning of the year x 1.05 (stock dividend) x 2 (stock split) = 105,000

Choice "b" is incorrect. Shares are increased 5% on 8/1 as a result of the 5% stock dividend.

Choice "c" is incorrect. Shares are increased by the two-for-one stock split on 9/1.

Choice "d" is incorrect. Shares have increased during the year due to the stock dividend and stock split.


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30. Polk Co. acquires a forklift from Quest Co. for $30,000. The terms require Polk to pay $3,000 down and finance the remaining $27,000. On March 1, year 1, Polk pays the $3,000 down and accepted delivery of the forklift. Polk signed a note that requires Polk to pay principal payments of $1,000 per month for 27 months beginning July 1, year 1. What amount should Polk report as an investing activity in the statement of cash flows for the year ended December 31, year 1? a. $3,000 b. $9,000 c. $12,000 d. $30,000 Solution: Choice "a" is correct. Only the cash down payment is considered to be a cash flow from the purchase of noncurrent assets. The remaining $27,000 note is a non-cash investing and financing activity, disclosed separately and not considered as a cash flow. The $9,000 in principal payments on the note are financing activities since they are payments on a debt obligation.

Choice "b" is incorrect. The $9,000 in principal payments on the note are financing activities since they are payments on a debt obligation.

Choice "c" is incorrect. The $9,000 in principal payments on the note are financing activities since they are payments on a debt obligation.

Choice "d" is incorrect. Only the actual cash down payment of $3,000 is considered to be a cash flow from investing activities. The remaining $27,000 note is a non-cash investing and financing activity, disclosed separately and not considered as a cash flow. The $9,000 in principal payments on the note are financing activities since they are payments on a debt obligation.


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31. Wood Co.'s dividends on noncumulative preferred stock have been declared but not paid. Wood has not declared or paid dividends on its cumulative preferred stock in the current or the prior year and has reported a net loss in the current year. For the purpose of computing basic earnings per share, how should the income available to common stockholders be calculated?

a. The current-year dividends and the dividends in arrears on the cumulative preferred stock should be added to the net loss, but the dividends on the noncumulative preferred stock should not be included in the calculation.

b. The dividends on the noncumulative preferred stock should be added to the net loss, but the current-year dividends and the dividends in arrears on the cumulative preferred stock should not be included in the calculation.

c. The dividends on the noncumulative preferred stock and the current-year dividends on the cumulative preferred stock should be added to the net loss.

d. Neither the dividends on the noncumulative preferred stock nor the current-year dividends and the dividends in arrears on cumulative preferred stock should be included in the calculation.

Solution: Choice "c" is correct. Income available to common shareholders is determined by deducting dividends declared in the period on non-cumulative preferred stock (regardless of whether they have been paid) and dividends accumulated in the period on cumulative preferred stock (regardless of whether they have been declared).

Choice "a" is incorrect. Dividends on noncumulative preferred stock are added to the net loss since the dividend was declared in the current period. Additionally, only the current period dividends and not the dividends in arrears on the cumulative preferred stock are added to the net loss. Dividends in arrears were subtracted from income in the year that they first were an obligation of the company.

Choice "b" is incorrect. Current year dividends on cumulative preferred stock are added to the net loss since the company is obligated to pay these dividends before distributions are made to common shareholders. Dividends in arrears were subtracted from income in the year that they first were an obligation of the company.

Choice "d" is incorrect. Income available to common shareholders is determined by deducting dividends declared in the period on non-cumulative preferred stock (regardless of whether they have been paid) and dividends accumulated in the period on cumulative preferred stock (regardless of whether they have been declared).


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32. Which of the following funds would be reported as a fiduciary fund in Pine City's financial statements?

a. Special revenue. b. Permanent. c. Private-purpose trust. d. Internal service. Solution: Choice "c" is correct. Fiduciary funds include Private Purpose Funds. Fund structure is generally defined using the following framework / mnemonic (GRSPP SE PAPI).

Governmental funds Proprietary funds Fiduciary funds General Internal Service Pension Special Revenue Enterprise Agency Debt Service Private Purpose Capital Projects Investment Trust Permanent

Choice "a" is incorrect. Special Revenue funds are governmental funds.

Choice "b" is incorrect. Permanent funds are governmental funds.

Choice "d" is incorrect. Internal service funds are proprietary funds.


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33. On January 1, Fonk City approved the following general fund resources for the new fiscal period:

Property taxes $5,000,000 Licenses and permits 400,000 Intergovernmental revenues 150,000 Transfers in from other funds 350,000

What amount should Fonk record as estimated revenues for the new fiscal year?

a. $5,400,000 b. $5,550,000 c. $5,750,000 d. $5,900,000 Solution: Choice "b" is correct. Revenues include property taxes, licenses and intergovernmental revenues. Transfers would be considered estimated other financing sources. Estimated revenues are:

Property taxes $5,000,000 Licenses and permits 400,000 Intergovernmental revenues 150,000 Total estimated revenues $5,550,000

Choice "a" is incorrect. Total estimated revenues are computed above. The proposed solution incorrectly excludes intergovernmental revenue.

Choice "c" is incorrect. Total estimated revenues are computed above. The proposed solution incorrectly excludes intergovernmental revenue and includes transfers, a resource inflow classified as other financing sources, not revenue.

Choice "d" is incorrect. Total estimated revenues are computed above. The proposed solution incorrectly includes transfers, resources inflow classified as other financing sources, not revenue.


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34. Kenn City obtained a municipal landfill and passed a local ordinance that required the city to operate the landfill so that the costs of operating the landfill, as well as the capital costs, are to be recovered with charges to customers. Which of the following funds should Kenn City use to report the activities of the landfill?

a. Enterprise. b. Permanent. c. Special revenue. d. Internal service. Solution: Choice "a" is correct. Kenn City should account for the landfill as an enterprise fund. Activities are required to be reported as enterprise funds if any one of the following criteria are met:

a. The activity is financed with debt that is secured solely by a pledge of the net revenue from fees and charges

b. Laws and regulations require that the cost of providing services be recovered through fees

c. The pricing policies of the activity establish fees and charges designed to recover its costs

The local ordinance adopted by the city requires it to operate the landfill so that the costs of operating the landfill, as well as the capital costs, be recovered with charges to customers. The landfill is an enterprise fund.

Choice "b" is incorrect. Permanent funds should be used to report resources that are legally restricted to the extent that only earnings and not principal may be used for the purposes that support the reporting government's programs. The landfill operations are not restricted in this manner.

Choice "c" is incorrect. Special revenue funds account for expenditures that are legally restricted or committed for specific purposes other than debt service or capital projects. Typically sales taxes, gasoline taxes or grant funds are accounted for in special revenue funds. The landfill is a fee based enterprise that fully defrays operating and capital costs.

Choice "d" is incorrect. Although the question does not specifically state that the landfill will serve external customers, that's a safe assumption. Landfills will generally provide waste disposal services to citizens of a region, not the departments of government.


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35. At the beginning of the current year, Paxx County's enterprise fund had a $125,000 balance for accrued compensated absences. At the end of the year, the balance was $150,000. During the year, Paxx paid $400,000 for compensated absences. What amount of compensated absences expense should Paxx County's enterprise fund report for the year?

a. $375,000 b. $400,000 c. $425,000 d. $550,000 Solution: Choice "c" is correct. The amount of the expense associated with compensated absences can be derived from the change in liability account as follows:

Beginning (balance of liability) $125,000 Add (accrued compensated absence expenses) 425,000 (Squeeze) Subtract (payments) (400,000) Ending (balance of liability) $150,000

Choice "a" is incorrect. The proposed answer is backwards, it reverses the beginning and ending balances from the fact pattern in arriving at $375,000.

Choice "b" is incorrect. The amount of the expense is not equal to the payments.

Choice "d" is incorrect. The amount of the payments plus the ending balance of the liability is not the amount of the expense. This computation ignores the effect of the beginning balance.


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36. A government makes a contribution to its pension plan in the amount of $10,000 for year 1. The actuarially-determined annual required contribution for year 1 was $13,500. The pension plan paid benefits of $8,200 and refunded employee contributions of $800 for year 1. What is the pension expenditure for the general fund for year 1?

a. $8,200 b. $9,000 c. $10,000 d. $13,500 Solution: Choice "c" is correct. The general fund would record an expenditure equal to $10,000, the amount that it paid toward its contribution to pension funding. A governmental fund's payments to a pension fund are accounted for as a fund expenditure. Any actuarially determined contribution requirement is accounted for as part of pension fund reporting.

Choice "a" is incorrect. A governmental fund's payments to a pension fund are accounted for as the fund expenditure. The governmental fund expenditure is not the amount paid to beneficiaries, $8,200, as suggested by this answer.

Choice "b" is incorrect. A governmental fund's payments to a pension fund are accounted for as the fund expenditure. The governmental fund expenditure is not the amount paid to beneficiaries, $8,200 plus the $800 in refunded contributions totaling $9,000, as suggested by this answer.

Choice "d" is incorrect. The $13,500 in actuarially determined contributions would not be the general fund expenditure as proposed by this solution. The general fund would record an expenditures equal to $10,000, the amount that it paid toward its contribution to pension funding. A governmental fund's payments to a pension fund are accounted for as the fund expenditure. Any actuarially determined contribution requirement is accounted for as part of pension fund reporting.


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37. Which of the following is one of the three standard sections of a governmental comprehensive annual financial report?

a. Investment. b. Actuarial. c. Statistical. d. Single audit. Solution: Choice "c" is correct. A comprehensive annual financial report (CAFR) includes a statistical section. A CAFR is divided into three sections;

1. Introductory

2. Financial (which includes both basic financial statements and required supplementary information as required by GASB #34)

3. Statistical

Neither the introductory section nor the statistical section is audited.

Choice "a" is incorrect. The term "investment section" is not used to define CAFR sections.

Choice "b" is incorrect. The term "actuarial section" is not used to define CAFR sections.

Choice "d" is incorrect. The term "single audit section" is not used to define CAFR sections.


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38. Which of the following financial categories are used in a nongovernmental not-for-profit organization's statement of financial position?

a. Net assets, income, and expenses. b. Income, expenses, and unrestricted net assets. c. Assets, liabilities, and net assets. d. Changes in unrestricted, temporarily restricted, and permanently restricted net assets. Solution: Choice "c" is correct. A not-for-profit organization classifies balances in its statement of financial position as assets, liabilities, and net assets.

Choice "a" is incorrect. A not-for-profit organization classifies balances in its statement of financial position as assets, liabilities, and net assets, not net assets, income, and expenses. The statement of activities generally uses income and expense classifications along with net assets.

Choice "b" is incorrect. A not-for-profit organization classifies balances in its statement of financial position as assets, liabilities, and net assets. The statement of activities generally uses income and expense classifications along with net assets by classification, including unrestricted net assets.

Choice "d" is incorrect. A not-for-profit organization classifies balances in its statement of financial position as assets, liabilities, and net assets. The statement of activities generally accounts for changes in all classifications of net assets.


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39. In year 2, the Nord Association, a nongovernmental not-for-profit organization, received a $100,000 contribution to fund scholarships for medical students. The donor stipulated that only the interest earned on the contribution be used for the scholarships. Interest earned in year 2 of $15,000 was used to award scholarships in year 3. What amount should Nord report as temporarily restricted net assets at the end of year 2?

a. $115,000 b. $100,000 c. $15,000 d. $0 Solution: Choice "c" is correct. At the end of year 2, Nord Association has temporarily restricted net assets of $15,000, the amount of unspent earnings stipulated by the donor to be used for a specific purpose, scholarships. The fact pattern notes that this amount was not used until year 3.

Choice "a" is incorrect. At the end of year 2, Nord Association has temporarily restricted net assets of $15,000, the amount of unspent earnings stipulated by the donor to be used for scholarships. The $100,000 received by the Nord Association and subject to a donor restriction that allows only for earnings to be used for specified purposes (a contribution with restrictions that can never be removed), is classified as permanently restricted.

Choice "b" is incorrect. The $100,000 received by the Nord Association and subject to a donor restriction that allows only for earnings to be used for specified purposes (a contribution with restrictions that can never be removed) is classified as permanently restricted.

Choice "d" is incorrect. At the end of year 2, Nord Association has temporarily restricted net assets of $15,000, the amount of unspent earnings stipulated by the donor to be used for scholarships.


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40. On January 1, Read, a nongovernmental not-for-profit organization, received $20,000 and an unconditional pledge of $20,000 for each of the next four calendar years to be paid on the first day of each year. The present value of an ordinary annuity for four years at a constant interest rate of 8% is 3.312. What amount of restricted net assets is reported in the year the pledge was received?

a. $66,240 b. $80,000 c. $86,240 d. $100,000 Solution: Choice "a" is correct. Read would display temporarily restricted net assets of $66,240. Multiyear pledges are recorded at their net present value at the date the pledge is made. Thus, multiyear pledges should be discounted. Multiyear pledges have an implied time restriction and are temporarily restricted.

The question requires that we presume that the discount rate given is appropriate and reasonable so the net present value of a four year annuity beginning on the first of the next year (end to the current year) discounted at 8% using the ordinary annuity factor is:

$20,000 x 3.312 = $66,240

Choice "b" is incorrect. The proposed response of $80,000 does not discount the annuity in error. The cash receipts should be discounted to the net present value.

Choice "c" is incorrect. The proposed solution appears to compound the annuity rather than discount it to its present value in error.

Choice "d" is incorrect. The proposed solution appears to consider the annuity for a five year period instead of four and, furthermore, does not discount the income stream in error.


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41. Belle, a nongovernmental not-for-profit organization, received funds during its annual campaign that were specifically pledged by the donor to another nongovernmental not-for-profit health organization. How should Belle record these funds?

a. Increase in assets and increase in liabilities. b. Increase in assets and increase in revenue. c. Increase in assets and increase in deferred revenue. d. Decrease in assets and decrease in fund balance. Solution: Choice "a" is correct. Belle would account for the monies pledged by the donor to another not-for-profit organization as an asset and as a liability to that other organization. Recipients (like Belle) that do not have variance power (do not have any latitude with regard to use of the funds received) would recognize the asset received as a liability to the beneficiary.

Choice "b" is incorrect. Belle would recognize revenues if it had variance power (discretion) over the funds received. Since Belle does not have variance power, they would not recognize revenue, they would recognize a liability.

Choice "c" is incorrect. Belle would potentially recognize deferred revenue if the receipts could be earned, however, Belle does not have variance power so there is no deferral of revenue, there is a liability to the beneficiary.

Choice "d" is incorrect. Receipts owed to another entity would not be a direct entry to equity. Regardless, equity accounts in not for profit entities are titled net assets and not fund balance.


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42. Ragg Coalition, a nongovernmental not-for-profit organization, received a gift of treasury bills. The cost to the donor was $20,000, with an additional $500 for brokerage fees that were paid by the donor prior to the transfer of the treasury bills. The treasury bills had a fair value of $15,000 at the time of the transfer. At what amount should Ragg report the treasury bills in its statement of financial position?

a. $15,000 b. $15,500 c. $20,000 d. $20,500 Solution: Choice "a" is correct. Ragg would report the treasury bills at their fair value of $15,000 on the statement of financial position. All debt securities that have readily determinable fair values are measured at fair value in the statement of financial position.

Donated items are valued at fair value upon receipt. Securities are marked to market and valued at fair value at the balance sheet date. The question is silent as to the receipt date and the value at year end, so we are left to assume that the value on the statement of financial position is the last fair value provided, $15,000.

Choice "b" is incorrect. The fair value plus brokerage costs is not the valuation used by the recipient. The recipient would purely use the fair value.

Choice "c" is incorrect. The donor's basis is not the valuation used by the recipient. The recipient would use the fair value.

Choice "d" is incorrect. The donor's basis plus brokerage costs is not the valuation used by the recipient. The recipient would use the fair value.


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43. At the beginning of the year, the carrying value of an asset was $1,000,000 with 20 years of remaining life. The fair value of the liability for the asset retirement obligation was $100,000. At year end, the carrying value of the asset was $950,000. The risk-free interest rate was 5%. The credit-adjusted risk-free interest rate was 10%. What was the amount of accretion expense for the year related to the asset retirement obligation?

a. $10,000 b. $50,000 c. $95,000 d. $100,000 Solution: Choice "a" is correct. Accretion expense is the increase in the ARO liability due to the passage of time. The credit adjusted interest rate is used to calculate the ARO, as follows:

Beginning ARO x Risk-adjusted rate = $100,000 x 10% = $10,000

Choice "b" is incorrect. Accretion expense is not equal to the carrying value of the asset times the risk-free rate. Accretion expense is the increase in the ARO liability due to the passage of time. Accretion expense is beginning asset retirement obligation times the appropriate accretion rate, in this case the credit-adjusted rate.

Choice "c" is incorrect. Accretion expense is not equal to the ending carrying value of the asset times the risk-adjusted rate. Accretion expense is the increase in the ARO liability due to the passage of time. Accretion expense is beginning asset retirement obligation times the appropriate accretion rate, in this case the credit-adjusted rate.

Choice "d" is incorrect. Accretion expense is not equal to the asset retirement obligation. Accretion expense is the increase in the ARO liability due to the passage of time. Accretion expense is beginning asset retirement obligation times the appropriate accretion rate, in this case the credit-adjusted rate.


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44. Blythe Corp. is a defendant in a lawsuit. Blythe's attorneys believe it is reasonably possible that the suit will require Blythe to pay a substantial amount. What is the proper financial statement treatment for this contingency?

a. Accrued and disclosed. b. Accrued but not disclosed. c. Disclosed but not accrued. d. No disclosure or accrual. Solution: Choice "c" is correct. A financial statement disclosure only, not an accrual, shall be made when there is a reasonable possibility that a loss may have occurred.

Choice "a" is incorrect. Accrual and disclosure would occur when a loss contingency is considered to be probable.

Choice "b" is incorrect. A loss contingency that is required to be disclosed (probable) would also need to be adequately disclosed.

Choice "d" is incorrect. No disclosure or accrual is necessary when a loss contingency is considered to be remote.


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45. Giaconda, Inc. acquires an asset for which it will measure the fair value by discounting future cash flows of the asset. Which of the following terms best describes this fair value measurement approach?

a. Market. b. Income. c. Cost. d. Observable inputs. Solution: Choice "b" is correct. The income approach converts future amounts, including cash flows or earnings to a single discounted amount to measure fair value.

Choice "a" is incorrect. The market approach uses prices and other relevant information from identical or comparable market transactions to measure fair value.

Choice "c" is incorrect. The cost approach uses current replacement cost to measure fair value.

Choice "d" is incorrect. Observable inputs is not a fair value measurement approach. Observable inputs are inputs other than quoted market values that are directly or indirectly observable for the asset or liability.


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46. A company owns a financial asset that is actively traded on two different exchanges (market A and market B). There is no principal market for the financial asset. The information on the two exchanges is as follows:

Quoted price of asset Transaction costs Market A $1,000 $75 Market B 1,050 150

What is the fair value of the financial asset?

a. $900 b. $925 c. $1,000 d. $1,050 Solution: Choice "c" is correct. The price in the most advantageous market is used if there is no principal market. The most advantageous market is the market with the best price after considering transaction costs:

Market A = $1,000 - $75 = $925

Market B = $1,050 - $150 = $900

Market A is the most advantageous market. Although transaction costs are used to determine the most advantageous market, transaction costs are not included in the final fair value measurement, so the fair value is the $1,000 quoted market price in Market A.

Choice "a" is incorrect. Transaction costs are not included in the final fair value measurement. Additionally, Market A is the most advantageous market because it has the best price after considering transaction costs.

Choice "b" is incorrect. Transaction costs are not included in the final fair value measurement.

Choice "d" is incorrect. The most advantageous market is the market with the best price after considering transaction costs. Although transaction costs are used to determine the most advantageous market, transaction costs are not included in the final fair value measurement.


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47. Martin Pharmaceutical Co. is currently involved in two lawsuits. One is a class-action suit in which consumers claim that one of Martin's best selling drugs caused severe health problems. It is reasonably possible that Martin will lose the suit and have to pay $20 million in damages. Martin is suing another company for false advertising and false claims against Martin. It is probable that Martin will win the suit and be awarded $5 million in damages. What amount should Martin report on its financial statements as a result of these two lawsuits?

a. $0 b. $5 million income. c. $15 million expense. d. $20 million expense. Solution: Choice "a" is correct. The likelihood of loss on the drug lawsuit is reasonably possible and is disclosed on the financial statement notes but not accrued on the financial statements.

The false advertising lawsuit is a gain contingency and gain contingencies are not recorded because to do so may cause recognition of revenue prior to its realization.

Choice "b" is incorrect. The false advertising lawsuit is a gain contingency and gain contingencies are not recorded because to do so may cause recognition of revenue prior to its realization.

Choice "c" is incorrect. The likelihood of loss on the drug lawsuit is reasonably possible and is disclosed on the financial statement notes but not accrued on the financial statements.

The false advertising lawsuit is a gain contingency and gain contingencies are not recorded because to do so may cause recognition of revenue prior to its realization.

Choice "d" is incorrect. The likelihood of loss on the drug lawsuit is reasonably possible and is disclosed on the financial statement notes but not accrued on the financial statements.


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48. The fair value for an asset or liability is measured as:

a. The appraised value of the asset or liability. b. The price that would be paid to acquire the asset or received to assume the liability in an orderly

transaction between market participants. c. The price that would be received when selling an asset or paid when transferring a liability in an

orderly transaction between market participants. d. The cost of the asset less any accumulated depreciation or the carrying value of the liability on the

date of the sale. Solution: Choice "c" is correct. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal market at the measurement date under market conditions.

Choice "a" is incorrect. Fair value measurements are not based on the appraised value of an asset or liability.

Choice "b" is incorrect. Fair value is an exit price, not an entrance price (i.e., sell an asset, not acquire an asset).

Choice "d" is incorrect. Fair value is not based on the carrying amount or book value of an asset or liability.


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49. On January 1, year 1, Peabody Co. purchased an investment for $400,000 that represented 30% of Newman Corp.'s outstanding voting stock. For year 1, Newman reported net income of $60,000 and paid dividends of $20,000. At year end, the fair value of Peabody's investment in Newman was $410,000. Peabody elected the fair value option for this investment. What amount should Peabody recognize in net income for year 1 attributable to the investment?

a. $6,000 b. $10,000 c. $16,000 d. $18,000 Solution: Choice "c" is correct. Entities may elect the fair value option for recognized financial assets and liabilities. An entity can choose to measure at fair value an investment that would otherwise be accounted for using the equity method. Under the fair value option, income is calculated as the amount of the dividend received of $6,000 ($20,000 x 30%) plus the appreciation for the year of $10,000.

Choice "a" is incorrect. Both the dividend income and the appreciation of the investment must be recorded in earnings under the fair value option.

Choice "b" is incorrect. Both the dividend income and the appreciation of the investment must be recorded in earnings under the fair value option.

Choice "d" is incorrect. Because the entity opted to use the fair value option, the entity will not record equity method income of $18,000 ($60,000 Newman net income x 30%).


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50. On March 21, year 2, a company with a calendar year end issued its year 1 financial statements. On February 28, year 2, the company's only manufacturing plant was severely damaged by a storm and had to be shut down. Total property losses were $10 million and determined to be material. The amount of business disruption losses is unknown. How should the impact of the storm be reflected in the company's year 1 financial statements?

a. Provide no information related to the storm losses in the financial statements until losses and expenses become fully known.

b. Accrue and disclose the property loss with no accrual or disclosure of the business disruption loss. c. Do not accrue the property loss or the business disruption loss, but disclose them in the notes to the

financial statements. d. Accrue and disclose the property loss and additional business disruption losses in the financial

statements. Solution: Choice "c" is correct. Subsequent events that provide information about conditions that occurred after the balance sheet date and did not exist at the balance sheet date are nonrecognized subsequent events. This type of subsequent event is not recognized in the financial statements; but, is disclosed in the notes to the financial statements.

Choice "a" is incorrect. A nonrecognized subsequent event is disclosed in the notes to the financial statements.

Choice "b" is incorrect. Neither situation is accrued in the financial statements since the situation is a nonrecognized subsequent event.

Choice "d" is incorrect. Neither the property loss nor the business disruption is accrued in the financial statements because they are nonrecognized subsequent events. Both situations are disclosed.

AICPA Newly Released FAR Simulations Task 3038_01

AJE #1

Dr. Prepaid expenses $5,000 Cr. Rent expense $5,000

The rent expense attributable to year 3 that has been paid in year 2 is a prepaid item as of December 31, year 2.

AJE#2

Dr. Depreciation expense $1,500 Cr. Accumulated depreciation – pp&e $1,500

Depreciation is calculated on the original cost of $20,000, less salvage value of $5,000 over a 10 year useful life.

AJE#3

Dr. Bad debt expense $750 Cr. Allowance for doubtful accounts $750

Bad debt expense is estimated to be .25% of the Sales amount of $300,000.

AJE#4

Dr. Allowance for doubtful accounts $855 Cr. Accounts receivable $855

When a specific account is written off, the allowance account is reduced (debit) and the receivable is removed from Accounts receivable (credit).

AJE#5

Dr. Insurance expense $650 Cr. Prepaid expenses $650

Insurance expense for the year ended December 31, year 2 that has been posted to Prepaid expenses needs to be adjusted to an expense account.

AJE#6

Dr. Interest receivable $300 Cr. Interest income $300

Interest income that has been earned in Year 2 is shown as income even though it has not as yet been received (accrual concept).

AJE#7

Dr. Tax expense $2,000 Cr. Taxes payable $2,000

Income tax expense for the year of $3,000 for Year 2 is shown as an expense for the year. Since the amount in the expense and payable account is $1,000, an additional $2,000 is needed to adjust the amount to the balance at year end. It would appear that JRM Co. made a tax accrual of $1,000 earlier in the year.

Task 3042_01

Explanation:

Apri 1, year 1

DR Patents $50,000 CR Cash $50,000

The cost of purchasing a patent from an outside source for $50,000 is capitalized as an intangible asset. The $35,000 in development costs incurred by DD Co. is research and development which is a direct charge to expense.

July 1, year 1

DR Equipment $79,000 CR Cash $79,000

Research and development costs are a direct charge to income EXCEPT for materials or equipment that have alternate future uses. Because the equipment qualifies under this rule, the amount capitalized is the original cost plus any expenditure directly related to the acquisition of the asset.

October 1, year 1

DR Legal Expense $25,000 CR Cash $25,000

Legal fees for an unsuccessful defense of a trademark are an expense. Legal fees for a successful defense of the trademark are added to the asset value of the trademark.

December 31, year 1

DR Amortization Expense $3,750 CR Accumulated Amortization - Patent $3,750

A patent is amortized over the shorter of its estimated useful life or its remaining useful life. Amortization is on a straight line basis: $50,000/10 years x 9/12.

December 31, year 1

DR Reseach and Development Expense $7,900 CR Accumulated Depreciation $7,900

Depreciation expense is calculated on the capitalized amount of $79,000. Depreciation is on the straight line basis: 79,000/5 years x 6/12. Because the equipment is currently used for research and development, the depreciation is charged to reseach and development expense.

December 31, year 1

No entry required

Goodwill amortization is a two step process. First, since the carrying value of the identifiable net assets exceeds the fair value, there is a potential for impairment. Second, the amount of goodwill loss is measured by comparing the implied fair value of the goodwill to the carrying amount of that goodwill. If the implied fair value is less than its carrying amount, a goodwill loss is recognized. In this case, the implied fair value is higher so no goodwill impairment is recognized.

Task 4465_01

Key words:

Share purchase plan, compensation expense

2012 aicpa financial questions

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