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Showing posts with label Questions. Show all posts
Showing posts with label Questions. Show all posts

1 Financial Accounting and Accounting Standards QUESTIONS 1




QUESTIONS

1. Differentiate broadly between financial accounting and managerial accounting.
Answer:
1. Financial accounting measures, classifies, and summarizes in report form those activities and that
information which relate to the enterprise as a whole for use by parties both internal and external to a
business enterprise. Managerial accounting also measures, classifies, and summarizes in report
form enterprise activities, but the communication is for the use of internal, managerial parties, and
relates more to subsystems of the entity. Managerial accounting is management decision oriented
and directed more toward product line, division, and profit center reporting

2. Differentiate between “financial statements” and “financial reporting.”
Answer:
2. Financial statements generally refer to the four basic financial statements: balance sheet, income
statement, statement of cash flows, and statement of changes in owners’ or stockholders’ equity.
Financial reporting is a broader concept; it includes the basic financial statements and any other
means of communicating financial and economic data to interested external parties. Examples of
financial reporting other than financial statements are annual reports, prospectuses, reports filed with
the government, news releases, management forecasts or plans, and descriptions of an enterprise’s
social or environmental impact.

3. How does accounting help the capital allocation process?
Answer:
3. If a company’s financial performance is measured accurately, fairly, and on a timely basis, the right
managers and companies are able to attract investment capital. To provide unreliable and irrelevant
information leads to poor capital allocation which adversely affects the securities market.

4. What is the objective of financial reporting?
Answer:
4. The objective of general purpose financial reporting is to provide financial information about the
reporting entity that is useful to present and potential equity investors, lenders, and other creditors
in decisions about providing resources to the entity through equity investments and loans or other
forms of credit. Information that is decision-useful to capital providers (investors) may also be useful
to other users of financial reporting who are not investors.

5. Briefly explain the meaning of decision-usefulness in the context of financial reporting.
Answer:
5. Investors are interested in financial reporting because it provides information that is useful for
making decisions (referred to as the decision-usefulness approach). When making these decisions,
investors are interested in assessing the company’s (1) ability to generate net cash inflows and (2)
management’s ability to protect and enhance the capital providers’ investments. Financial
reporting should therefore help investors assess the amounts, timing, and uncertainty of
prospective cash inflows from dividends or interest, and the proceeds from the sale, redemption,
or maturity of securities or loans. In order for investors to make these assessments, the economic
resources of an enterprise, the claims to those resources, and the changes in them must be
understood.

6. Of what value is a common set of standards in financial accounting and reporting?
Answer:
6. A common set of standards applied by all businesses and entities provides financial statements
which are reasonably comparable. Without a common set of standards, each enterprise could, and
would, develop its own theory structure and set of practices, resulting in noncomparability among
enterprises.

7. What is the likely limitation of “general-purpose financial statements”?
Answer:
7. General-purpose financial statements are not likely to satisfy the specific needs of all interested
parties. Since the needs of interested parties such as creditors, managers, owners, governmental
agencies, and financial analysts vary considerably, it is unlikely that one set of financial statements
is equally appropriate for these varied uses.

8. In what way is the Securities and Exchange Commission concerned about and supportive of accounting principles and standards?
Answer:
8. The SEC has the power to prescribe, in whatever detail it desires, the accounting practices and
principles to be employed by the companies that fall within its jurisdiction. Because the SEC receives
audited financial statements from nearly all companies that issue securities to the public or are listed
on the stock exchanges, it is greatly interested in the content, accuracy, and credibility of the
statements. For many years the SEC relied on the AICPA to regulate the profession and develop
and enforce accounting principles. Lately, the SEC has assumed a more active role in the development
of accounting standards, especially in the area of disclosure requirements. In December 1973,
in ASR No. 150, the SEC said the FASB’s statements would be presumed to carry substantial
authoritative support and anything contrary to them to lack such support. It thereby supports the
development of accounting principles in the private sector.

9. What was the Committee on Accounting Procedure, and what were its accomplishments and failings?
Answer:
9. The Committee on Accounting Procedure was a special committee of the American Institute of CPAs
that, between the years of 1939 and 1959, issued 51 Accounting Research Bulletins dealing with
a wide variety of timely accounting problems. These bulletins provided solutions to immediate
problems and narrowed the range of alternative practices. But, the Committee’s problem-by-problem
approach failed to provide a well-defined and well-structured body of accounting theory that was so
badly needed. The Committee on Accounting Procedure was replaced in 1959 by the Accounting
Principles Board.

10. For what purposes did the AICPA create the Accounting Principles Board?
Answer:
10. The creation of the Accounting Principles Board was intended to advance the written expression
of accounting principles, to determine appropriate practices, and to narrow the differences and
inconsistencies in practice. To achieve its basic objectives, its mission was to develop an overall
conceptual framework to assist in the resolution of problems as they became evident and to do
substantive research on individual issues before pronouncements were issued.

11. Distinguish between Opinions of the Accounting Principles Board and Accounting Standards Updates.
Answer:
11. Accounting Research Bulletins were pronouncements on accounting practice issued by the
Committee on Accounting Procedure between 1939 and 1959; since 1964 they have been
recognized as accepted accounting practice unless superseded in part or in whole by an opinion of
the APB or an FASB standard. APB Opinions were issued by the Accounting Principles Board
during the years 1959 through 1973 and, unless superseded by FASB Statements, are recognized
as accepted practice and constitute the requirements to be followed by all business enterprises.
Accounting Standards Updates are pronouncements of the Financial Accounting Standards Board
that are incorporated into the FASB codification and therefore represent the accounting profession’s
authoritative pronouncements on financial accounting and reporting practices.

12. If you had to explain or define “generally accepted accounting principles or standards,” what essential characteristics would you include in your explanation?
Answer:
12. The explanation should note that generally accepted accounting principles or standards have
“substantial authoritative support.” They consist of accounting practices, procedures, theories,
concepts, and methods which are recognized by a large majority of practicing accountants as well
as other members of the business and financial community. Bulletins issued by the Committee on
Accounting Procedure, opinions rendered by the Accounting Principles Board, and statements
issued by the Financial Accounting Standards Board constitute “substantial authoritative support.”

13. In what ways was it felt that the pronouncements issued by the Financial Accounting Standards Board would carry greater weight than the opinions issued by the Accounting Principles Board?

14. How are FASB preliminary views and FASB exposure drafts related to FASB “statements”?

15. Distinguish between FASB Accounting Standards Updates and FASB Statements of Financial Accounting Concepts.

16. What is Rule 203 of the Code of Professional Conduct?

17. The chair of the FASB at one time noted that “the flow of standards can only be slowed if (1) producers focus less on quarterly earnings per share and tax benefits and more on quality products, and (2) accountants and lawyers rely less on rules and law and more on professional judgment and conduct.” Explain his comment.

18. Explain the role of the Emerging Issues Task Force in establishing generally accepted accounting principles.

19. What is the difference between the Codification and the Codification Research System?

20. What are the primary advantages of having a Codification of generally accepted accounting principles?

21. What are the sources of pressure that change and influence the development of GAAP?

22. Some individuals have indicated that the FASB must be cognizant of the economic consequences of its pronouncements. What is meant by “economic consequences”? What dangers exist if politics play too much of a role in the development of GAAP?

23. If you were given complete authority in the matter, how would you propose that GAAP should be developed and enforced?

24. One writer recently noted that 99.4 percent of all companies prepare statements that are in accordance with GAAP. Why then is there such concern about fraudulent financial reporting?

25. What is the “expectations gap”? What is the profession doing to try to close this gap?

26. The Sarbanes-Oxley Act was enacted to combat fraud and curb poor reporting practices. What are some key provisions of this legislation?

27. What are some of the major challenges facing the accounting profession?

28. How are financial accountants challenged in their work to make ethical decisions? Is technical mastery of GAAP not sufficient to the practice of financial accounting?


 CONCEPTS FOR ANALYSIS
CA1-1 (FASB and Standard-Setting) Presented below are four statements which you are to identify as true or false. If false, explain why the statement is false.
1. GAAP is the term used to indicate the whole body of FASB authoritative literature.
2. Any company claiming compliance with GAAP must comply with most standards and interpretations but does not have to follow the disclosure requirements.
3. The primary governmental body that has influence over the FASB is the SEC.
4. The FASB has a government mandate and therefore does not have to follow due process in issuing a standard.


CA1-2 (GAAP and Standard-Setting) Presented below are four statements which you are to identify as true or false. If false, explain why the statement is false.
1. The objective of financial statements emphasizes a stewardship approach for reporting financial information.
2. The purpose of the objective of financial reporting is to prepare a balance sheet, an income statement, a statement of cash flows, and a statement of owners’ or stockholders’ equity.
3. Because they are generally shorter, FASB interpretations are subject to less due process, compared to FASB standards.
4. The objective of financial reporting uses an entity rather than a proprietary approach in determining what information to report.

CA1-3 (Financial Reporting and Accounting Standards) Answer the following multiple-choice questions.
1. GAAP stands for:
(a) governmental auditing and accounting practices.
(b) generally accepted attest principles.
(c) government audit and attest policies.
(d) generally accepted accounting principles.
2. Accounting standard-setters use the following process in establishing accounting standards:
(a) Research, exposure draft, discussion paper, standard.
(b) Discussion paper, research, exposure draft, standard.
(c) Research, preliminary views, discussion paper, standard.
(d) Research, discussion paper, exposure draft, standard.
3. GAAP is comprised of:
(a) FASB standards, interpretations, and concepts statements.
(b) FASB financial standards.
(c) FASB standards, interpretations, EITF consensuses, and accounting rules issued by FASB predecessor organizations.
(d) any accounting guidance included in the FASB Codification.
4. The authoritative status of the conceptual framework is as follows.
(a) It is used when there is no standard or interpretation related to the reporting issues under consideration.
(b) It is not as authoritative as a standard but takes precedence over any interpretation related to the reporting issue.
(c) It takes precedence over all other authoritative literature.
(d) It has no authoritative status.
5. The objective of financial reporting places most emphasis on:
(a) reporting to capital providers.
(b) reporting on stewardship.
(c) providing specific guidance related to specific needs.
(d) providing information to individuals who are experts in the field.
6. General-purpose financial statements are prepared primarily for:
(a) internal users.
(b) external users.
(c) auditors.
(d) government regulators.
7. Economic consequences of accounting standard-setting means:
(a) standard-setters must give first priority to ensuring that companies do not suffer any adverse effect as a result of a new standard.
(b) standard-setters must ensure that no new costs are incurred when a new standard is issued.
(c) the objective of financial reporting should be politically motivated to ensure acceptance by the general public.
(d) accounting standards can have detrimental impacts on the wealth levels of the providers of financial information.
8. The expectations gap is:
(a) what financial information management provides and what users want.
(b) what the public thinks accountants should do and what accountants think they can do.
(c) what the governmental agencies want from standard-setting and what the standard-setters provide.
(d) what the users of financial statements want from the government and what is provided.

CA1-4 (Financial Accounting) Omar Morena has recently completed his first year of studying accounting. His instructor for next semester has indicated that the primary focus will be the area of financial accounting.
Instructions
(a) Differentiate between financial accounting and managerial accounting.
(b) One part of financial accounting involves the preparation of financial statements. What are the financial statements most frequently provided?
(c) What is the difference between financial statements and financial reporting?

CA1-5 (Objective of Financial Reporting) Karen Sepan, a recent graduate of the local state university, is presently employed by a large manufacturing company. She has been asked by Jose Martinez, controller, to prepare the company’s response to a current
Preliminary Views published by the Financial Accounting Standards Board (FASB). Sepan knows that the FASB has a conceptual framework, and she believes that these concept statements could be used to support the company’s response to the
Preliminary Views. She has prepared a rough draft of the response citing the objective of financial reporting.
Instructions
(a) Identify the objective of financial reporting.
(b) Describe the level of sophistication expected of the users of financial information by the objective of financial reporting.


CA1-6 (Accounting Numbers and the Environment) Hardly a day goes by without an article appearing on the continuing fallout from the financial crisis of 2008. An overheated real estate market, fueled by home purchase incentives, poor lending practices, and securitization through high-risk, mortgage-backed securities, led to a near collapse of global capital markets. As a consequence, many have argued that if the financial institutions had been required to report their loans (and loan-backed investments) at fair value instead of cost, large losses would have been reported earlier. This would have signaled regulators to the problems in the mortgage markets and therefore minimized the losses to U.S. taxpayers.
Instructions
Explain how reported accounting numbers might affect an individual’s perceptions and actions. Cite two examples.


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2 Conceptual Framework for Financial Reporting QUESTIONS 2


QUESTIONS

1. What is a conceptual framework? Why is a conceptual framework necessary in financial accounting?
2. What is the primary objective of financial reporting?
3. What is meant by the term “qualitative characteristics of accounting information”?
4. Briefly describe the two fundamental qualities of useful accounting information.
5. How is materiality (or immateriality) related to the proper presentation of financial statements? What factors and measures should be considered in assessing the materiality of a misstatement in the presentation of a financial statement?
6. What are the enhancing qualities of the qualitative characteristics?
What is the role of enhancing qualities in the conceptual framework?
7. According to the FASB conceptual framework, the objective of financial reporting for business enterprises is based on the needs of the users of financial statements. Explain the level of sophistication that the Board assumes about the users of financial statements.
8. What is the distinction between comparability and consistency?
9. Why is it necessary to develop a definitional framework for the basic elements of accounting?
10. Expenses, losses, and distributions to owners are all decreases in net assets. What are the distinctions among them?
11. Revenues, gains, and investments by owners are all increases in net assets. What are the distinctions among them?
12. What are the four basic assumptions that underlie the financial accounting structure?
13. The life of a business is divided into specific time periods, usually a year, to measure results of operations for each such time period and to portray financial conditions at the end of each period.
(a) This practice is based on the accounting assumption that the life of the business consists of a series of time periods and that it is possible to measure accurately the results of operations for each period. Comment on the validity and necessity of this assumption.
(b) What has been the effect of this practice on accounting? What is its relation to the accrual system? What influence has it had on accounting entries and methodology?
14. What is the basic accounting problem created by the monetary unit assumption when there is significant inflation? What appears to be the FASB position on a stable monetary unit?
15. The chairman of the board of directors of the company for which you are chief accountant has told you that he has little use for accounting figures based on historical cost.
He believes that replacement values are of far more significance to the board of directors than “out-of-date costs.” Present some arguments to convince him that accounting data should still be based on historical cost.
16. What is the definition of fair value?
17. What is the fair value option? Explain how use of the fair value option reflects application of the fair value principle.
18. Briefly describe the fair value hierarchy.
19. Explain the revenue recognition principle.
20. What is a performance obligation, and how is it used to determine when revenue should be recognized?
21. What are the five steps used to determine the proper time to recognize revenue?
22. Selane Eatery operates a catering service specializing in business luncheons for large corporations. Selane requires customers to place their orders 2 weeks in advance of the scheduled events. Selane bills its customers on the tenth day of the month following the date of service and requires that payment be made within 30 days of the billing date. Conceptually, when should Selane recognize revenue related to its catering service?
23. Mogilny Company paid $135,000 for a machine. The Accumulated Depreciation—Equipment account has a balance of $46,500 at the present time. The company could sell the machine today for $150,000. The company president believes that the company has a “right to this gain.”
What does the president mean by this statement? Do you agree?
24. Three expense recognition methods (associating cause and effect, systematic and rational allocation, and immediate recognition) were discussed in the text under the expense recognition principle. Indicate the basic nature of each of these expense recognition methods and give two examples of each.
25. Statement of Financial Accounting Concepts No. 5 identifies four characteristics that an item must have before it is recognized in the financial statements. What are these four characteristics?
26. Briefly describe the types of information concerning financial position, income, and cash flows that might be provided (a) within the main body of the financial statements,
(b) in the notes to the financial statements, or (c) as supplementary information.
27. In January 2018, Janeway Inc. doubled the amount of its outstanding stock by selling on the market an additional 10,000 shares to finance an expansion of the business. You propose that this information be shown by a footnote on the balance sheet as of December 31, 2017. The president objects, claiming that this sale took place after December 31, 2017, and therefore should not be shown. Explain your position.
28. Describe the major constraint inherent in the presentation of accounting information.
29. What are some of the costs of providing accounting information?
What are some of the benefits of accounting information? Describe the cost-benefit factors that should be considered when new accounting standards are being proposed.
30. The treasurer of Landowska Co. has heard that conservatism is a doctrine that is followed in accounting and, therefore, proposes that several policies be followed that are conservative in nature. State your opinion with respect to each of the policies listed.
(a) The company gives a 2-year warranty to its customers on all products sold. The estimated warranty costs incurred from this year’s sales should be entered as an expense this year instead of an expense in the period in the future when the warranty is made good.
(b) When sales are made on account, there is always uncertainty about whether the accounts are collectible.
Therefore, the treasurer recommends recording the sale when the cash is received from the customers.
(c) A personal liability lawsuit is pending against the company. The treasurer believes there is an even chance that the company will lose the suit and have to pay damages of $200,000 to $300,000. The treasurer recommends that a loss be recorded and a liability created in the amount of $300,000.





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3 The Accounting Information System QUESTIONS 3


QUESTIONS

1. Give an example of a transaction that results in:
(a) A decrease in an asset and a decrease in a liability.
(b) A decrease in one asset and an increase in another asset.
(c) A decrease in one liability and an increase in another liability.
2. Do the following events represent business transactions?
Explain your answer in each case.
(a) A computer is purchased on account.
(b) A customer returns merchandise and is given credit on account.
(c) A prospective employee is interviewed.
(d) The owner of the business withdraws cash from the business for personal use.
(e) Merchandise is ordered for delivery next month.
3. Name the accounts debited and credited for each of the following transactions.
(a) Billing a customer for work done.
(b) Receipt of cash from customer on account.
(c) Purchase of office supplies on account.
(d) Purchase of 15 gallons of gasoline for the delivery truck.
4. Why are revenue and expense accounts called temporary or nominal accounts?
5. Andrea Pafko, a fellow student, contends that the double entry system means that each transaction must be recorded twice. Is Andrea correct? Explain.
6. Is it necessary that a trial balance be taken periodically?
What purpose does it serve?
7. Indicate whether each of the following items is a real or nominal account and whether it appears in the balance sheet or the income statement.
(a) Prepaid Rent.
(b) Salaries and Wages Payable.
(c) Inventory.
(d) Accumulated Depreciation—Equipment.
(e) Equipment.
(f) Service Revenue.
(g) Salaries and Wages Expense.
(h) Supplies.
8. Employees are paid every Saturday for the preceding work week. If a balance sheet is prepared on Wednesday,
December 31, what does the amount of wages earned during the first three days of the week (12/29, 12/30,
12/31) represent? Explain.
9. (a) How are the components of revenues and expenses different for a merchandising company? (b) Explain the income measurement process of a merchandising company.
10. What differences are there between the trial balance before closing and the trial balance after closing with respect to the following accounts?
(a) Accounts Payable.
(b) Expense accounts.
(c) Revenue accounts.
(d) Retained Earnings account.
(e) Cash.
11. What are adjusting entries and why are they necessary?
12. What are closing entries and why are they necessary?
13. Jay Hawk, maintenance supervisor for Boston Insurance Co., has purchased a riding lawnmower and accessories to be used in maintaining the grounds around corporate headquarters. He has sent the following information to the accounting department.
Compute the amount of depreciation expense (related to the mower and accessories) that should be reported on Boston’s December 31, 2017, income statement. Assume straight-line depreciation.
14. Midwest Enterprises made the following entry on December 31, 2017.
Interest Expense 10,000
Interest Payable 10,000
(To record interest expense due on loan from Anaheim National Bank)
What entry would Anaheim National Bank make regarding its outstanding loan to Midwest Enterprises? Explain why this must be the case.
15. Distinguish between cash-basis accounting and accrual-basis accounting. Why is accrual-basis accounting acceptable for most businesses and the cash-basis unacceptable in the preparation of an income statement and a balance sheet?
16. When salaries and wages expense for the year is computed, why are beginning accrued salaries and wages subtracted from, and ending accrued salaries and wages added to, salaries and wages paid during the year?
17. List two types of transactions that would receive different accounting treatment using (a) strict cash-basis accounting, and (b) a modified cash basis.
18. What are reversing entries, and why are they used?
19. “A worksheet is a permanent accounting record, and its use is required in the accounting cycle.” Do you agree? Explain.



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4 Income Statement and Related Information QUESTIONS 4

QUESTIONS

1. What kinds of questions about future cash flows do investors and creditors attempt to answer with information in the income statement?
2. How can information based on past transactions be used to predict future cash flows?
3. Identify at least two situations in which important changes in value are not reported in the income statement.
4. Identify at least two situations in which application of different accounting methods or accounting estimates results in difficulties in comparing companies.
5. Explain the transaction approach to measuring income.
Why is the transaction approach to income measurement preferable to other ways of measuring income?
6. What is earnings management?
7. How can earnings management affect the quality of earnings?
8. Why should caution be exercised in the use of the net income figure derived in an income statement? What are the objectives of generally accepted accounting principles in their application to the income statement?
9. A Wall Street Journal article noted that Apple reported higher income than its competitors by using a more aggressive policy for recognizing revenue on future upgrades to its products. Some contend that Apple’s quality of earnings is low. What does the term “quality of earnings” mean?
10. What is the major distinction (a) between revenues and gains and (b) between expenses and losses?
11. What are the advantages and disadvantages of the single-step income statement?
12. What is the basis for distinguishing between operating and nonoperating items?
13. Distinguish between the modified all-inclusive income statement and the current operating performance income statement. According to present generally accepted accounting principles, which is recommended? Explain.
14. How should correction of errors be reported in the financial statements?
15. Discuss the appropriate treatment in the financial statements of each of the following.
(a) Gain on sale of investment securities.
(b) A profit-sharing bonus to employees computed as a percentage of net income.
(c) Additional depreciation on factory machinery because of an error in computing depreciation for the previous year.
(d) Rent received from subletting a portion of the office space.
(e) A patent infringement suit, brought 2 years ago against the company by another company, was settled this year by a cash payment of $725,000.
(f) A reduction in the Allowance for Doubtful Accounts balance because the account appears to be considerably in excess of the probable loss from uncollectible receivables.
16. Indicate where the following items would ordinarily appear on the financial statements of Boleyn, Inc. for the year 2017.
(a) The service life of certain equipment was changed from 8 to 5 years. If a 5-year life had been used previously, additional depreciation of $425,000 would have been charged.
(b) In 2017, a flood destroyed a warehouse that had a book value of $1,600,000. Floods are rare in this locality.
(c) In 2017, the company wrote off $1,000,000 of inventory that was considered obsolete.
(d) In 2014, a supply warehouse with an expected useful life of 7 years was erroneously expensed.
(e) Boleyn, Inc. changed from weighted-average to FIFO inventory pricing.
17. Indicate the section of a multiple-step income statement in which each of the following is shown.
(a) Loss on inventory write-down.
(b) Loss from strike.
(c) Bad debt expense.
(d) Loss on disposal of a discontinued operation.
(e) Gain on sale of machinery.
(f) Interest revenue.
(g) Depreciation expense.
(h) Material write-offs of notes receivable.
18. Perlman Land Development, Inc. purchased land for $70,000 and spent $30,000 developing it. It then sold the land for $160,000. Sheehan Manufacturing purchased land for a future plant site for $100,000. Due to a change in plans, Sheehan later sold the land for $160,000. Should these two companies report the land sales, both at gains of $60,000, in a similar manner?
19. You run into Greg Norman at a party and begin discussing financial statements. Greg says, “I prefer the singlestep income statement because the multiple-step format generally overstates income.” How should you respond to Greg?
20. Santo Corporation has eight expense accounts in its general ledger which could be classified as selling expenses.
Should Santo report these eight expenses separately in its income statement or simply report one total amount for selling expenses?
21. Cooper Investments reported an unusual gain from the sale of certain assets in its 2017 income statement. How does intraperiod tax allocation affect the reporting of this unusual gain?
22. Discuss the appropriate treatment in the income statement for the following items:
(a) Loss on discontinued operations.
(b) Noncontrolling interest allocation.
(c) Earnings per share.
(d) Gain on sale of equipment.
23. Lebron Co. owns most but not all of the shares of its subsidiary
Bryant Inc. Lebron reported net income of $124,700. The amount to be attributed to the noncontrolling interest in Bryant is $30,000. Indicate how Lebron will report the noncontrolling interest in its income statement.
24. What effect does intraperiod tax allocation have on reported net income?
25. Neumann Company computed earnings per share as follows.
Neumann has a simple capital structure. What possible errors might the company have made in the computation?
Explain.
26. Qualls Corporation reported 2017 earnings per share of $7.21. In 2018, Qualls reported earnings per share as follows.
On income from continuing operations $6.40
On discontinued operations 1.88
On net income $8.28
Is the increase in earnings per share from $7.21 to $8.28 a favorable trend?
27. What is meant by “tax allocation within a period”? What is the justification for such practice?
28. When does tax allocation within a period become necessary?
How should this allocation be handled?
29. During 2017, Liselotte Company reported income of $1,500,000 before income taxes and realized a gain of $450,000 on the disposal of assets related to a discontinued operation. The criteria for classification as a discontinued operation is appropriate for this sale. The income is subject to income taxation at the rate of 34%. The gain on the sale of the plant is taxed at 30%. Indicate an appropriate presentation of these items in the income statement.
30. On January 30, 2016, a suit was filed against Frazier Corporation under the Environmental Protection Act. On
August 6, 2017, Frazier Corporation agreed to settle the action and pay $920,000 in damages to certain current and former employees. How should this settlement be reported in the 2017 financial statements? Discuss.
31. Linus Paper Company decided to close two small pulp mills in Conway, New Hampshire, and Corvallis, Oregon.
These two closings do not represent a major shift in strategy for the company. Would these closings be reported in a separate section entitled “Discontinued operations after income from continuing operations”?
Discuss.
32. What major types of items are reported in the retained earnings statement?
33. Generally accepted accounting principles usually require the use of accrual accounting to “fairly present” income. If the cash receipts and disbursements method of accounting will “clearly reflect” taxable income, why does this method not usually also “fairly present” income?
34. State some of the more serious problems encountered in seeking to achieve the ideal measurement of periodic net income. Explain what accountants do as a practical alternative.
35. What is meant by the terms elements and items as they relate to the income statement? Why might items have to be disclosed in the income statement?
36. What are the two ways that other comprehensive income may be displayed (reported)?
37. How should the disposal of a component of a business be disclosed in the income statement?

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5 Balance Sheet and Statement of Cash Flows QUESTIONS 5

QUESTIONS

1. How does information from the balance sheet help users of the financial statements?
2. What is meant by solvency? What information in the balance sheet can be used to assess a company’s solvency?
3. A recent financial magazine indicated that the airline industry has poor financial flexibility. What is meant by financial flexibility, and why is it important?
4. Discuss at least two situations in which estimates could affect the usefulness of information in the balance sheet.
5. Perez Company reported an increase in inventories in the past year. Discuss the effect of this change on the current ratio (current assets ÷ current liabilities). What does this tell a statement user about Perez Company’s liquidity?
6. What is meant by liquidity? Rank the following assets from one to five in order of liquidity.
(a) Goodwill. (d) Short-term investments.
(b) Inventory. (e) Accounts receivable.
(c) Buildings.
7. What are the major limitations of the balance sheet as a source of information?
8. Discuss at least two items that are important to the value of companies like Intel or IBM but that are not recorded in their balance sheets. What are some reasons why these items are not recorded in the balance sheet?
9. How does separating current assets from property, plant, and equipment in the balance sheet help analysts?
10. In its December 31, 2017, balance sheet Oakley Corporation reported as an asset, “Net notes and accounts receivable, $7,100,000.” What other disclosures are necessary?
11. Should available-for-sale securities always be reported as a current asset? Explain.
12. What is the relationship between current assets and current liabilities?
13. The New York Knicks, Inc. sold 10,000 season tickets at $2,000 each. By December 31, 2017, 16 of the 40 home games had been played. What amount should be reported as a current liability at December 31, 2017?
14. What is working capital? How does working capital relate to the operating cycle?
15. In what section of the balance sheet should the following items appear, and what balance sheet terminology would you use?
(a) Treasury stock (recorded at cost).
(b) Checking account at bank.
(c) Land (held as an investment).
(d) Sinking fund.
(e) Unamortized premium on bonds payable.
(f) Copyrights.
(g) Pension fund assets.
(h) Premium on common stock.
(i) Long-term investments (pledged against bank loans payable).
16. Where should the following items be shown on the balance sheet, if shown at all?
(a) Allowance for doubtful accounts.
(b) Merchandise held on consignment.
(c) Advances received on sales contract.
(d) Cash surrender value of life insurance.
(e) Land.
(f) Merchandise out on consignment.
(g) Franchises.
(h) Accumulated depreciation of equipment.
(i) Materials in transit—purchased f.o.b. destination.
17. According to generally accepted accounting principles, what is the balance sheet valuation of each of the following assets?
(a) Trade accounts receivable.
(b) Land.
(c) Inventories.
(d) Trading securities (common stock of other companies).
(e) Prepaid expenses.
18. Refer to the definition of assets on page 204. Discuss how a leased building might qualify as an asset of the lessee
(tenant) under this definition.
19. Kathleen Battle says, “Retained earnings should be reported as an asset, since it is earnings which are reinvested in the business.” How would you respond to Battle?
20. The creditors of Chester Company agree to accept promissory notes for the amount of its indebtedness with a proviso that two-thirds of the annual profits must be applied to their liquidation. How should these notes be reported on the balance sheet of the issuing company? Give a reason for your answer.
21. What is the purpose of a statement of cash flows? How does it differ from a balance sheet and an income statement?
22. The net income for the year for Genesis, Inc. is $750,000, but the statement of cash flows reports that the net cash provided by operating activities is $640,000. What might account for the difference?
23. Net income for the year for Carrie, Inc. was $750,000, but the statement of cash flows reports that net cash provided by operating activities was $860,000. What might account for the difference?
24. Differentiate between operating activities, investing activities, and financing activities.
25. Each of the following items must be considered in preparing a statement of cash flows. Indicate where each item is to be reported in the statement, if at all. Assume that net income is reported as $90,000.
(a) Accounts receivable increased from $34,000 to $39,000 from the beginning to the end of the year.
(b) During the year, 10,000 shares of preferred stock with a par value of $100 per share were issued at $115 per share.
(c) Depreciation expense amounted to $14,000, and bond premium amortization amounted to $5,000.
(d) Land increased from $10,000 to $30,000.
26. Sergey Co. has net cash provided by operating activities of $1,200,000. Its average current liabilities for the period are $1,000,000, and its average total liabilities are $1,500,000.
Comment on the company’s liquidity and financial flexibility, given this information.
27. Net income for the year for Tanizaki, Inc. was $750,000, but the statement of cash flows reports that net cash provided by operating activities was $860,000. Tanizaki also reported capital expenditures of $75,000 and paid dividends in the amount of $30,000. Compute Tanizaki’s free cash flow.
28. What is the purpose of a free cash flow analysis?
29. What are some of the techniques of disclosure for the balance sheet?
30. What is a “Summary of Significant Accounting Policies”?
31. What types of contractual obligations must be disclosed in great detail in the notes to the balance sheet? Why do you think these detailed provisions should be disclosed?
32. What is the profession’s recommendation in regard to the use of the term “surplus”? Explain.



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6 Accounting and the Time Value of Money QUESTIONS 6

QUESTIONS

1. What is the time value of money? Why should accountants have an understanding of compound interest, annuities, and present value concepts?
2. Identify three situations in which accounting measures are based on present values. Do these present value applications involve single sums or annuities, or both single sums and annuities? Explain.
3. What is the nature of interest? Distinguish between “simple interest” and “compound interest.”
4. What are the components of an interest rate? Why is it important for accountants to understand these components?
5. The following are a number of values taken from compound interest tables involving the same number of periods and the same rate of interest. Indicate what each of these four values represents.
(a) 6.71008. (c) .46319.
(b) 2.15892. (d) 14.48656.
6. Jose Oliva is considering two investment options for a $1,500 gift he received for graduation. Both investments have 8% annual interest rates. One offers quarterly compounding; the other compounds on a semiannual basis.
Which investment should he choose? Why?
7. Regina Henry deposited $20,000 in a money market certificate that provides interest of 10% compounded quarterly if the amount is maintained for 3 years. How much will Regina have at the end of 3 years?
8. Will Smith will receive $80,000 5 years from now, from a trust fund established by his father. Assuming the appropriate interest rate for discounting is 12% (compounded semiannually), what is the present value of this amount today?
9. What are the primary characteristics of an annuity? Differentiate between an “ordinary annuity” and an “annuity due.”
10. Kehoe, Inc. owes $40,000 to Ritter Company. How much would Kehoe have to pay each year if the debt is retired through four equal payments (made at the end of the year), given an interest rate on the debt of 12%? (Round to two decimal places.)
11. The Kellys are planning for a retirement home. They estimate they will need $200,000 4 years from now to purchase this home. Assuming an interest rate of 10%, what amount must be deposited at the end of each of the 4 years to fund the home price? (Round to two decimal places.)
12. Assume the same situation as in Question 11, except that the four equal amounts are deposited at the beginning of the period rather than at the end. In this case, what amount must be deposited at the beginning of each period? (Round to two decimals.)
13. Explain how the future value of an ordinary annuity interest table is converted to the future value of an annuity due interest table.
14. Explain how the present value of an ordinary annuity interest table is converted to the present value of an annuity due interest table.
15. In a book named Treasure, the reader has to figure out where a 2.2 pound, 24 kt gold horse has been buried. If the horse is found, a prize of $25,000 a year for 20 years is provided. The actual cost to the publisher to purchase an annuity to pay for the prize is $245,000. What interest rate (to the nearest percent) was used to determine the amount of the annuity? (Assume end-of-year payments.)
16. Alexander Enterprises leases property to Hamilton,
Inc. Because Hamilton is experiencing financial difficulty,
Alexander agrees to receive five rents of $20,000 at the end of each year, with the rents deferred 3 years.
What is the present value of the five rents discounted at 12%?
17. Answer the following questions.
(a) On May 1, 2017, Goldberg Company sold some machinery to Newlin Company on an installment contract basis. The contract required five equal annual payments, with the first payment due on May 1, 2017. What present value concept is appropriate for this situation?
(b) On June 1, 2017, Seymour Inc. purchased a new machine that it does not have to pay for until June 1, 2019.
The total payment on June 1, 2019, will include both principal and interest. Assuming interest at a 12% rate, the cost of the machine would be the total payment multiplied by what time value of money concept?
(c) Costner Inc. wishes to know how much money it will have available in 5 years if five equal amounts of $35,000 are invested, with the first amount invested immediately. What interest table is appropriate for this situation?
(d) Megan Hoffman invests in a “jumbo” $200,000, 3-year certificate of deposit at First Wisconsin Bank.
What table would be used to determine the amount accumulated at the end of 3 years?
18. Recently, Glenda Estes was interested in purchasing a
Honda Acura. The salesperson indicated that the price of the car was either $27,600 cash or $6,900 at the end of each of 5 years. Compute the effective-interest rate to the nearest percent that Glenda would pay if she chooses to make the five annual payments.
19. Property/casualty insurance companies have been criticized because they reserve for the total loss as much as 5 years before it may happen. The IRS has joined the debate because it says the full reserve is unfair from a taxation viewpoint. What do you believe is the IRS position?





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7 Cash and Receivables QUESTIONS 7

QUESTIONS

1. What may be included under the heading of “cash”?
2. In what accounts should the following items be classified?
(a) Coins and currency.
(b) U.S. Treasury (government) bonds.
(c) Certificate of deposit (matures in 5 months).
(d) Cash in a bank that is in receivership.
(e) NSF check (returned with bank statement).
(f) Deposit in foreign bank (exchangeability limited).
(g) Postdated checks.
(h) Cash to be used for retirement of long-term bonds.
(i) Deposits in transit.
(j) 100 shares of HP stock (intention is to sell in one year or less).
(k) Savings and checking accounts.
(l) Petty cash.
(m) Stamps.
(n) Travel advances.
3. Define a “compensating balance.” How should a compensating balance be reported?
4. Springsteen Inc. reported in a recent annual report “Restricted cash for debt redemption.” What section of the balance sheet would report this item?
5. What are the reasons that a company gives trade discounts?
Why are trade discounts not recorded in the accounts like cash discounts?
6. What are two methods of recording accounts receivable transactions when a cash discount situation is involved?
Which is more theoretically correct? Which is used in practice more of the time? Why?
7. Discuss the accounting for sales allowances and how they relate to the concept of variable consideration.
8. What are the basic problems that occur in the valuation of accounts receivable?
9. What is the theoretical justification of the allowance method as contrasted with the direct write-off method of accounting for bad debts?
10. Indicate how the percentage-of-receivables method, based on an aging schedule, accomplishes the objectives of the allowance method of accounting for bad debts.
What other methods, besides an aging analysis, can be used for estimating uncollectible accounts?
11. Of what merit is the contention that the allowance method lacks the objectivity of the direct write-off method? Discuss in terms of accounting’s measurement function.
12. Explain how the accounting for bad debts can be used for earnings management.
13. Because of calamitous earthquake losses, Bernstein Company, one of your client’s oldest and largest customers, suddenly and unexpectedly became bankrupt.
Approximately 30% of your client’s total sales have been made to Bernstein Company during each of the past several years. The amount due from Bernstein Company— none of which is collectible—equals 22% of total accounts receivable, an amount that is considerably in excess of what was determined to be an adequate provision for doubtful accounts at the close of the preceding year. How would your client record the write-off of the Bernstein Company receivable if it is using the allowance method of accounting for bad debts? Justify your suggested treatment.
14. What is the normal procedure for handling the collection of accounts receivable previously written off using the direct write-off method? The allowance method?
15. On January 1, 2017, Lombard Co. sells property for which it had paid $690,000 to Sargent Company, receiving in return Sargent’s zero-interest-bearing note for $1,000,000 payable in 5 years. What entry would Lombard make to record the sale, assuming that Lombard frequently sells similar items of property for a cash sales price of $640,000?
16. What is “imputed interest”? In what situations is it necessary to impute an interest rate for notes receivable?
What are the considerations in imputing an appropriate interest rate?
17. What is the fair value option? Where do companies that elect the fair value option report unrealized holding gains and losses?
18. Indicate three reasons why a company might sell its receivables to another company.
19. When is the financial components approach to recording the transfers of receivables used? When should a transfer of receivables be recorded as a sale?
20. Moon Hardware is planning to factor some of its receivables.
The cash received will be used to pay for inventory purchases. The factor has indicated that it will require “recourse” on the sold receivables. Explain to the controller of Moon Hardware what “recourse” is and how the recourse will be reflected in Moon’s financial statements after the sale of the receivables.
21. Horizon Outfitters Company includes in its trial balance for December 31 an item for Accounts Receivable $789,000. This balance consists of the following items:
Illustrate how these items should be shown in the balance sheet as of December 31.
22. What is the accounts receivable turnover, and what type of information does it provide?
23. You are evaluating Woodlawn Racetrack for a potential loan. An examination of the notes to the financial statements indicates restricted cash at year-end amounts to $100,000. Explain how you would use this information in evaluating Woodlawn’s liquidity.
*24. Distinguish among the following: (1) a general checking account, (2) an imprest bank account, and (3) a lockbox account.
*25. What are the general rules for measuring and recognizing gain or loss by both the debtor and the creditor in an impairment?
*26. Describe the estimation of the allowance, based on expected cash flows.



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8 Valuation of Inventories: A Cost-Basis Approach QUESTIONS 8

QUESTIONS

1. In what ways are the inventory accounts of a retailing company different from those of a manufacturing company?
2. Why should inventories be included in (a) a statement of financial position and (b) the computation of net income?
3. What is the difference between a perpetual inventory and a physical inventory? If a company maintains a perpetual inventory, should its physical inventory at any date be equal to the amount indicated by the perpetual inventory records? Why?
4. Mishima, Inc. indicated in a recent annual report that approximately $19 million of merchandise was received on consignment. Should Mishima, Inc. report this amount on its balance sheet? Explain.
5. What is a repurchase agreement (product financing) arrangement? How should a product repurchase agreement be reported in the financial statements?
6. Where, if at all, should the following items be classified on a balance sheet?
(a) Goods out on approval to customers.
(b) Goods in transit that were recently purchased f.o.b. destination.
(c) Land held by a realty firm for sale.
(d) Raw materials.
(e) Goods received on consignment.
(f) Manufacturing supplies.
7. Define “cost” as applied to the valuation of inventories.
8. Distinguish between product costs and period costs as they relate to inventory.
9. Ford Motor Co. is considering alternate methods of accounting for the cash discounts it takes when paying suppliers promptly. One method suggested was to report these discounts as financial income when payments are made. Comment on the propriety of this approach.
10. Zonker Inc. purchases 500 units of an item at an invoice cost of $30,000. What is the cost per unit? If the goods are shipped f.o.b. shipping point and the freight bill was $1,500, what is the cost per unit if Zonker Inc. pays the freight charges? If these items were bought on 2/10, n/30 terms and the invoice and the freight bill were paid within the 10-day period, what would be the cost per unit?
11. Specific identification is sometimes said to be the ideal method of assigning cost to inventory and to cost of goods sold. Briefly indicate the arguments for and against this method of inventory valuation.
12. FIFO, average-cost, and LIFO methods are often used instead of specific identification for inventory valuation purposes. Compare these methods with the specific identification method, discussing the theoretical propriety of each method in the determination of income and asset valuation.
13. How might a company obtain a price index in order to apply dollar-value LIFO?
14. Describe the LIFO double-extension method. Using the following information, compute the index at December 31, 2017, applying the double-extension method to a LIFO pool consisting of 25,500 units of product A and 10,350 units of product B. The base-year cost of product A is $10.20 and of product B is $37.00. The price at December 31, 2017, for product A is $21.00 and for product B is $45.60. (Round to two decimal places.)
15. As compared with the FIFO method of costing inventories, does the LIFO method result in a larger or smaller net income in a period of rising prices? What is the comparative effect on net income in a period of falling prices?
16. What is the dollar-value method of LIFO inventory valuation?
What advantage does the dollar-value method have over the specific goods approach of LIFO inventory valuation? Why will the traditional LIFO inventory costing method and the dollar-value LIFO inventory costing method produce different inventory valuations if the composition of the inventory base changes?
17. Explain the following terms.
(a) LIFO layer.
(b) LIFO reserve.
(c) LIFO effect.
18. On December 31, 2016, the inventory of Powhattan Company amounts to $800,000. During 2017, the company decides to use the dollar-value LIFO method of costing inventories. On December 31, 2017, the inventory is $1,053,000 at December 31, 2017, prices. Using the December 31, 2016, price level of 100 and the December 31, 2017, price level of 108, compute the inventory value at December 31, 2017, under the dollar-value LIFO method.
19. In an article that appeared in the Wall Street Journal, the phrases “phantom (paper) profits” and “high LIFO profits” through involuntary liquidation were used. Explain these phrases.
20. At the balance sheet date, Clarkson Company held title to goods in transit amounting to $214,000. This amount was omitted from the purchases figure for the year and also from the ending inventory. What is the effect of this omission on the net income for the year as calculated when the books are closed? What is the effect on the company’s financial position as shown in its balance sheet? Is materiality a factor in determining whether an adjustment for this item should be made?



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9 Inventories: Additional Valuation Issues QUESTIONS 9

QUESTIONS

1. Where there is evidence that the utility of inventory goods, as part of their disposal in the ordinary course of business, will be less than cost, what is the proper accounting treatment?
2. Why are inventories valued at the lower-of-cost-or-net realizable value (LCNRV)? What are the arguments against the use of the LCNRV method of valuing inventories?
3. What approaches may be employed in applying the LCNRV procedure? Which approach is normally used and why?
4. In some instances, accounting principles require a departure from valuing inventories at cost alone. Determine the proper unit inventory price in the following cases using LCNRV.
…
5. What method(s) might be used in the accounts to record a loss due to a price decline in the inventories? Discuss.
6. Explain the rationale for the ceiling and floor in the lower-of-cost-or-market method of valuing inventories.
7. In some instances, accounting principles require a departure from valuing inventories at cost alone. Determine the proper unit inventory price in the following cases, under the lower-of-cost-or-market rule.
…
8. What factors might call for inventory valuation at sales prices (net realizable value or market price)?
9. Under what circumstances is relative sales value an appropriate basis for determining the price assigned to inventory?
10. At December 31, 2017, Ashley Co. has outstanding purchase commitments for 150,000 gallons, at $6.20 per gallon, of a raw material to be used in its manufacturing process. The company prices its raw material inventory at cost or market, whichever is lower. Assuming that the market price as of December 31, 2017, is $5.90, how would you treat this situation in the accounts?
11. What are the major uses of the gross profit method?
12. Distinguish between gross profit as a percentage of cost and gross profit as a percentage of sales price. Convert the following gross profit percentages based on cost to gross profit percentages based on sales price: 25% and 331/3%. Convert the following gross profit percentages based on sales price to gross profit percentages based on cost: 331/3% and 60%.
13. Adriana Co., with annual net sales of $5 million, maintains a markup of 25% based on cost. Adriana’s expenses average 15% of net sales. What is Adriana’s gross profit and net profit in dollars?
14. A fire destroys all of the merchandise of Assante Company on February 10, 2017. Presented below is information compiled up to the date of the fire.
…
What is the approximate inventory on February 10, 2017?
15. What conditions must exist for the retail inventory method to provide valid results?
16. The conventional retail inventory method yields results that are essentially the same as those yielded by the lower-of-cost-or-market method. Explain. Prepare an illustration of how the retail inventory method reduces inventory to market.
17. (a) Determine the ending inventory under the conventional retail method for the furniture department of Mayron Department Stores from the following data…
(b) If the results of a physical inventory indicated an inventory at retail of $295,000, what inferences would you draw?
18. Deere and Company reported inventory in its balance sheet as follows.
Inventories $1,999,100,000
What additional disclosures might be necessary to present the inventory fairly?
19. Of what significance is inventory turnover to a retail store?
* 20. What modifications to the conventional retail method are necessary to approximate a LIFO retail flow?




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10 Acquisition and Disposition of Property, Plant, and Equipment QUESTIONS 10

QUESTIONS

1. What are the major characteristics of plant assets?
2. Mickelson Inc. owns land that it purchased on January 1, 2000, for $450,000. At December 31, 2017, its current value is $770,000 as determined by appraisal. At what amount should Mickelson report this asset on its December 31, 2017, balance sheet? Explain.
3. Name the items, in addition to the amount paid to the former owner or contractor, that may properly be included as part of the acquisition cost of the following plant assets.
(a) Land.
(b) Machinery and equipment.
(c) Buildings.
4. Indicate where the following items would be shown on a balance sheet.
(a) A lien that was attached to the land when purchased.
(b) Landscaping costs.
(c) Attorney’s fees and recording fees related to purchasing land.
(d) Variable overhead related to construction of machinery.
(e) A parking lot servicing employees in the building.
(f) Cost of temporary building for workers during construction of building.
(g) Interest expense on bonds payable incurred during construction of a building.
(h) Assessments for sidewalks that are maintained by the city.
(i) The cost of demolishing an old building that was on the land when purchased.
5. Two positions have normally been taken with respect to the recording of fixed manufacturing overhead as an element of the cost of plant assets constructed by a company for its own use:
(a) It should be excluded completely.
(b) It should be included at the same rate as is charged to normal operations.
What are the circumstances or rationale that support or deny the application of these methods?
6. The Buildings account of Postera Inc. includes the following items that were used in determining the basis for depreciating the cost of a building.
(a) Organization and promotion expenses.
(b) Architect’s fees.
(c) Interest and taxes during construction.
(d) Interest revenue on investments held to fund construction of a building.
Do you agree with these charges? If not, how would you deal with each of the items above in the corporation’s books and in its annual financial statements?
7. Burke Company has purchased two tracts of land. One tract will be the site of its new manufacturing plant, while the other is being purchased with the hope that it will be sold in the next year at a profit. How should these two tracts of land be reported in the balance sheet?
8. One financial accounting issue encountered when a company constructs its own plant is whether the interest cost on funds borrowed to finance construction should be capitalized and then amortized over the life of the assets constructed. What is the justification for capitalizing such interest?
9. Provide examples of assets that do not qualify for interest capitalization.
10. What interest rates should be used in determining the amount of interest to be capitalized? How should the amount of interest to be capitalized be determined?
11. How should the amount of interest capitalized be disclosed in the notes to the financial statements? How should interest revenue from temporarily invested excess funds borrowed to finance the construction of assets be accounted for?
12. Discuss the basic accounting problem that arises in handling each of the following situations.
(a) Assets purchased by issuance of common stock.
(b) Acquisition of plant assets by gift or donation.
(c) Purchase of a plant asset subject to a cash discount.
(d) Assets purchased on a long-term credit basis.
(e) A group of assets acquired for a lump sum.
(f) An asset traded in or exchanged for another asset.
13. Magilke Industries acquired equipment this year to be used in its operations. The equipment was delivered by the suppliers, installed by Magilke, and placed into operation.
Some of it was purchased for cash with discounts available for prompt payment. Some of it was purchased under long-term payment plans for which the interest charges approximated prevailing rates. What costs should Magilke capitalize for the new equipment purchased this year? Explain.
14. Schwartzkopf Co. purchased for $2,200,000 property that included both land and a building to be used in operations. The seller’s book value was $300,000 for the land and $900,000 for the building. By appraisal, the fair value was estimated to be $500,000 for the land and $2,000,000 for the building. At what amount should
Schwartzkopf report the land and the building at the end of the year?
15. Pueblo Co. acquires machinery by paying $10,000 cash and signing a $5,000, 2-year, zero-interest-bearing note payable. The note has a present value of $4,208, and
Pueblo purchased a similar machine last month for $13,500. At what cost should the new equipment be recorded?
16. Stan Ott is evaluating two recent transactions involving exchanges of equipment. In one case, the exchange has commercial substance. In the second situation, the exchange lacks commercial substance. Explain to Stan the differences in accounting for these two situations.
17. Crowe Company purchased a heavy-duty truck on July
1, 2014, for $30,000. It was estimated that it would have a useful life of 10 years and then would have a trade-in value of $6,000. The company uses the straight-line method. It was traded on August 1, 2018, for a similar truck costing $42,000; $16,000 was allowed as trade-in value (also fair value) on the old truck and $26,000 was paid in cash. A comparison of expected cash flows for the trucks indicates the exchange lacks commercial substance.
What is the entry to record the trade-in?
18. Once equipment has been installed and placed in operation, subsequent expenditures relating to this equipment are frequently thought of as repairs or general maintenance and, hence, chargeable to operations in the period in which the expenditure is made. Actually, determination of whether such an expenditure should be charged to operations or capitalized involves a much more careful analysis of the character of the expenditure. What are the factors that should be considered in making such a decision? Discuss fully.
19. What accounting treatment is normally given to the following items in accounting for plant assets?
(a) Additions.
(b) Major repairs.
(c) Improvements and replacements.
20. New machinery, which replaced a number of employees, was installed and put in operation in the last month of the fiscal year. The employees had been dismissed after payment of an extra month’s wages, and this amount was added to the cost of the machinery. Discuss the propriety of the charge. If it was improper, describe the proper treatment.
21. To what extent do you consider the following items to be proper costs of the fixed asset? Give reasons for your opinions.
(a) Overhead of a business that builds its own equipment.
(b) Cash discounts on purchases of equipment.
(c) Interest paid during construction of a building.
(d) Cost of a safety device installed on a machine.
(e) Freight on equipment returned before installation, for replacement by other equipment of greater capacity.
(f) Cost of moving machinery to a new location.
(g) Cost of plywood partitions erected as part of the remodeling of the office.
(h) Replastering of a section of the building.
(i) Cost of a new motor for one of the trucks.
22. Neville Enterprises has a number of fully depreciated assets that are still being used in the main operations of the business. Because the assets are fully depreciated, the president of the company decides not to show them on the balance sheet or disclose this information in the notes.
Evaluate this procedure.
23. What are the general rules for how gains or losses on retirement of plant assets should be reported in income?



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11 Depreciation, Impairments, and Depletion QUESTIONS 11

QUESTIONS

1. Distinguish among depreciation, depletion, and amortization.
2. Identify the factors that are relevant in determining the annual depreciation charge, and explain whether these factors are determined objectively or whether they are based on judgment.
3. Some believe that accounting depreciation measures the decline in the value of fixed assets. Do you agree? Explain.
4. Explain how estimation of service lives can result in unrealistically high carrying values for fixed assets.
5. The plant manager of a manufacturing firm suggested in a conference of the company’s executives that accountants should speed up depreciation on the machinery in the finishing department because improvements were rapidly making those machines obsolete, and a depreciation fund big enough to cover their replacement is needed. Discuss the accounting concept of depreciation and the effect on a business concern of the depreciation recorded for plant assets, paying particular attention to the issues raised by the plant manager.
6. For what reasons are plant assets retired? Define inadequacy, supersession, and obsolescence.
7. What basic questions must be answered before the amount of the depreciation charge can be computed?
8. Workman Company purchased a machine on January 2, 2017, for $800,000. The machine has an estimated useful life of 5 years and a salvage value of $100,000. Depreciation was computed by the 150% declining-balance method. What is the amount of accumulated depreciation at the end of December 31, 2018?
9. Silverman Company purchased machinery for $162,000 on January 1, 2017. It is estimated that the machinery will have a useful life of 20 years, salvage value of $15,000, production of 84,000 units, and working hours of 42,000. During 2017, the company uses the machinery for 14,300 hours, and the machinery produces 20,000 units. Compute depreciation under the straight-line, units-of-output, working hours, sum-of-the-years’-digits, and double-declining-balance methods.
10. What are the major factors considered in determining what depreciation method to use?
11. Under what conditions is it appropriate for a business to use the composite method of depreciation for its plant assets? What are the advantages and disadvantages of this method?
12. If Remmers, Inc. uses the composite method and its composite rate is 7.5% per year, what entry should it make when plant assets that originally cost $50,000 and have been used for 10 years are sold for $14,000?
13. A building that was purchased on December 31, 2003, for $2,500,000 was originally estimated to have a life of 50 years with no salvage value at the end of that time. Depreciation has been recorded through 2017. During 2018, an examination of the building by an engineering firm discloses that its estimated useful life is 15 years after 2017.
What should be the amount of depreciation for 2018?
14. Charlie Parker, president of Spinners Company, has recently noted that depreciation increases cash provided by operations and therefore depreciation is a good source of funds. Do you agree? Discuss.
15. Andrea Torbert purchased a computer for $8,000 on July 1, 2017. She intends to depreciate it over 4 years using the double-declining-balance method. Salvage value is $1,000. Compute depreciation for 2018.
16. Walkin Inc. is considering the write-down of its longterm plant because of a lack of profitability. Explain to the management of Walkin how to determine whether a write-down is permitted.
17. Last year, Wyeth Company recorded an impairment on an asset held for use. Recent appraisals indicate that the asset has increased in value. Should Wyeth record this recovery in value?
18. Toro Co. has equipment with a carrying amount of $700,000. The expected future net cash flows from the equipment are $705,000, and its fair value is $590,000.
The equipment is expected to be used in operations in the future. What amount (if any) should Toro report as an impairment to its equipment?
19. Explain how gains or losses on impaired assets should be reported in income.
20. It has been suggested that plant and equipment could be replaced more quickly if depreciation rates for income tax and accounting purposes were substantially increased. As a result, business operations would receive the benefit of more modern and more efficient plant facilities. Discuss the merits of this proposition.
21. Neither depreciation on replacement cost nor depreciation adjusted for changes in the purchasing power of the dollar has been recognized as generally accepted accounting principles for inclusion in the primary financial statements. Briefly present the accounting treatment that might be used to assist in the maintenance of the ability of a company to replace its productive capacity.
22. List (a) the similarities and (b) the differences in the accounting treatments of depreciation and cost depletion.
23. Describe cost depletion and percentage depletion. Why is the percentage depletion method permitted?
24. In what way may the use of percentage depletion violate sound accounting theory?
25. In the extractive industries, businesses may pay dividends in excess of net income. What is the maximum permissible? How can this practice be justified?
26. The following statement appeared in a financial magazine: “RRA—or Rah-Rah, as it’s sometimes dubbed— has kicked up quite a storm. Oil companies, for example, are convinced that the approach is misleading.
Major accounting firms agree.” What is RRA? Why might oil companies believe that this approach is misleading?
27. Shumway Oil uses successful-efforts accounting and also provides full-cost results as well. Under fullcost,
Shumway Oil would have reported retained earnings of $42 million and net income of $4 million.
Under successful-efforts, retained earnings were $29 million, and net income was $3 million. Explain the difference between full-costing and successful-efforts accounting.
28. Wal-Mart Stores, Inc. in 2014 reported net income of $16.4 billion, net sales of $482.2 billion, and average total assets of $204.2 billion. What is Wal-Mart’s asset turnover? What is Wal-Mart’s return on assets?
*29. What is a modified accelerated cost recovery system (MACRS)? Speculate as to why this system is now required for tax purposes.






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12 Intangible Assets QUESTIONS 12

QUESTIONS

1. What are the two main characteristics of intangible assets?
2. If intangibles are acquired for stock, how is the cost of the intangible determined?
3. Intangibles have either a limited useful life or an indefinite useful life. How should these two different types of intangibles be amortized?
4. Why does the accounting profession make a distinction between internally created intangibles and purchased intangibles?
5. In 2017, Ghostbusters Corp. spent $420,000 for “goodwill” visits by sales personnel to key customers. The purpose of these visits was to build a solid, friendly relationship for the future and to gain insight into the problems and needs of the companies served. How should this expenditure be reported?
6. What are factors to be considered in estimating the useful life of an intangible asset?
7. What should be the pattern of amortization for a limitedlife intangible?
8. Columbia Sportswear Company acquired a trademark that is helpful in distinguishing one of its new products.
The trademark is renewable every 10 years at minimal cost. All evidence indicates that this trademarked product will generate cash flows for an indefinite period of time. How should this trademark be amortized?
9. Romo Company spent $190,000 developing a new process, $45,000 in legal fees to obtain a patent, and $91,000 to market the process that was patented, all in the year 2017. How should these costs be accounted for in 2017?
10. Izzy Inc. purchased a patent for $350,000 which has an estimated useful life of 10 years. Its pattern of use or consumption cannot be reliably determined. Prepare the entry to record the amortization of the patent in its first year of use.
11. Explain the difference between artistic-related intangible assets and contract-related intangible assets.
12. What is goodwill? What is a bargain purchase?
13. Under what circumstances is it appropriate to record goodwill in the accounts? How should goodwill, properly recorded on the books, be written off in order to conform with generally accepted accounting principles?
14. In examining financial statements, financial analysts often write off goodwill immediately. Comment on this procedure.
15. Braxton Inc. is considering the write-off of a limited-life intangible because of its lack of profitability. Explain to the management of Braxton how to determine whether a write-off is permitted.
16. Last year, Zeno Company recorded an impairment on an intangible asset held for use. Recent appraisals indicate that the asset has increased in value. Should Zeno record this recovery in value?
17. Explain how losses on impaired intangible assets should be reported in income.
18. Simon Company determines that its goodwill is impaired.
It finds that its implied goodwill is $360,000 and its recorded goodwill is $400,000. The fair value of its identifiable assets is $1,450,000. What is the amount of goodwill impaired?
19. What is the nature of research and development costs?
20. Research and development activities may include (a) personnel costs, (b) materials and equipment costs, and
(c) indirect costs. What is the recommended accounting treatment for these three types of R&D costs?
21. Which of the following activities should be expensed currently as R&D costs?
(a) Testing in search for or evaluation of product or process alternatives.
(b) Engineering follow-through in an early phase of commercial production.
(c) Legal work in connection with patent applications or litigation, and the sale or licensing of patents.
22. Indicate the proper accounting for the following items.
(a) Organization costs. (c) Operating losses.
(b) Advertising costs.
23. In 2016, Austin Powers Corporation developed a new product that will be marketed in 2017. In connection with the development of this product, the following costs were incurred in 2016: research and development costs $400,000, materials and supplies consumed $60,000, and compensation paid to research consultants $125,000. It is anticipated that these costs will be recovered in 2019.
What is the amount of research and development costs that Austin Powers should record in 2016 as a charge to expense?
24. Recently, a group of university students decided to incorporate for the purposes of selling a process to recycle the waste product from manufacturing cheese. Some of the initial costs involved were legal fees and office expenses incurred in starting the business, state incorporation fees, and stamp taxes. One student wishes to charge these costs against revenue in the current period. Another wishes to defer these costs and amortize them in the future. Which student is correct?
25. An intangible asset with an estimated useful life of 30 years was acquired on January 1, 2007, for $540,000.
On January 1, 2017, a review was made of intangible assets and their expected service lives, and it was determined that this asset had an estimated useful life of 30 more years from the date of the review. What is the amount of amortization for this intangible in 2017?



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