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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited. Page 1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test BankChapter 12 – Liabilities
1. Conceptually, liabilities constitute a present obligation as a result of a past event.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
2. Under IFRS, only legal obligations are recognized.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
3. A reasonable expectation on the part of a company’s stakeholders arising from a company’s past practices or behaviour may constitute a constructive obligation in certain instances.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 1
4. A contingency may become a provision if the likelihood of the contingent event greatly increases.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
5. For a small population, the best estimate for the amount of a provision that must be recognized is the expected value of the possible outcomes.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
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6. For a large population, the best estimate for the amount of a provision that must be recognized is the most likely outcome with respect to the expected value and cumulative probabilities.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
7. Discounting is not required when the time value of money is immaterial or if the amount and timing of cash flows is highly uncertain.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
8. For a small population, the best estimate for the amount of a provision that must be recognized is the expected value of the possible outcomes.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
9. Contingencies must be both accrued and disclosed.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
10. Under proposed changes to current standards, amounts currently classified as contingencies may need to be accrued rather than simply disclosed.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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11. An onerous contract is one where the unavoidable costs of meeting the contract may or may not exceed the benefits derived from the contract.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2, 3
12. A lawsuit in progress wherein the defendant will probably be found guilty would likely be accounted for as a provision.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
13. Warranties provisions may arise from legal or constructive obligations.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
14. Once a company has formally decided to restructure its operations, a provision must be made for the restructuring.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
15. Loyalty points are provided (accrued) for and reversed once the points are redeemed.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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16. Self-insurance costs for expected losses must never be provided for.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
17. Current liabilities are usually discounted.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
18. The carrying value of a bond from the issuing corporation’s standpoint will always move closer to its face value, regardless of whether the bond is issued at a premium or a discount.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
19. Under the effective interest method, interest expense is calculated by multiplying the market interest rate by the carrying value of the bonds.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
20. Assume that a company issues bonds at a discount. Under the effective interest method, the company will record progressively less interest with the passage of time.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
21. Transaction costs are usually included in the carrying value of any financial liabilities.
Ans: True
Difficulty: EasyLevel of Learning: KnowledgeTopic: LO4
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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22. Long-term financial liabilities will usually be carried at amortized cost.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
23. Adjustments to fair value relating to FVTPL liabilities will always flow through earnings.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
24. Loan guarantees must be provided for; the amount of the provision is the probability of payout multiplied by the fair value o the loan guarantee.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
25. When the market rate exceeds the stated or nominal rate, a bond’s carrying value will be less than its fair value.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4, 5
26. The stated rate of interest is the interest rate used to determine the amount of cash interest that will be paid on the principal.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4, 5
27. A short-term payable may be the current portion of a long-term liability, which arises when the next payment on such a debt will be made out of current assets.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4, 5
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28. Interest may be recognized on a note even though the note does not explicitly state an interest rate.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4, 5
29. The principal amount of a debt is the cash or cash equivalent amount borrowed.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4, 5
30. A company may reclassify a current financial liability to a long-term one only if there is a contractual agreement in place by the reporting date to replace the financing.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4, 5
31. Debt issue costs may be expensed or included in the cost of the debt.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4, 5
32. An administrative fee pertaining to a successful loan application is to be immediately expensed.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4, 5
33. An administrative fee pertaining to an unsuccessful loan application is to be immediately expensed.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4, 5
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34. Capitalization of borrowing costs on qualifying assets will continue even if work on the asset has temporarily ceased.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO6
35. Accounts payable should include only obligations directly related to the primary and continuing operations of an entity.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 2
36. Capitalization of borrowing costs on qualifying assets is mandatory under both IFRS andASPE.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6, 10
37. Use of the effective interest method for amortizing bond premiums and discounts is mandatory under IFRS but not under ASPE.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6, 10
38. Borrowing costs can only be capitalized on non-financial assets.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
39. The cost of any equity financing is included when calculating the cost of generalized borrowings.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
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40. Bonds are said to be redeemable when they can be prematurely retired at the discretion of the issuing company and retractable when they can be prematurely retired at the investor’s discretion.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO7
41. Under IRS, a loss contingency must be credited to a liability account only if the occurrence of the contingent event is probable and if the amount of loss can be reasonably estimated.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 3, 10
42. A gain contingency will usually not be recorded in the accounts and reported in the financial statements even though its occurrence is probable.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 3
43. Under ASPE, disclosure in the footnotes to the financial statements is the only way to properly report contingent losses.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 3, 10
44. When the maturity date of a bond issue is within one year or the operating cycle (whichever is longer) of the current balance sheet date, the bond liability should be reclassified as a current liability (assuming the payment will be made out of current assets).
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
45. Callable bonds are callable at the option of the investor.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
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46. A $1,000, 6%, 10-year bond purchased as a long-term investment at an effective rate at 7%, will pay the investor $70 cash interest each year.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
47. When bonds are sold at a discount, interest-method amortization results in a schedule of interest accruals, which increase in amount as maturity approaches.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
48. In-substance defeasance means that a debtor irrevocably places cash or other monetary assets in a trust fund to pay interest on an outstanding debt. In such situations, the debt is always recorded as paid when the trust fund is set up.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO7
49. Hedging is one method of minimizing foreign exchange risk.
Ans: True
Difficulty: EasyLevel of Learning: KnowledgeTopic: LO8
50. Under IFRS, a continuity schedule must be provided for both provisions and contingencies.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO9, 10
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51. (Appendix) Blended payments are payments where the interest rate is fixed at the beginning of the loan term and there are regular equal payments of principal and interest made.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO11, 12
52. A brewing company operating in an Ontario city experiencing water shortages received its water bill for December 1999, on December 31, 1999. The bill ($8,000) represents the cost of water used in December to make its product. The company will not publish the 1999 financial statements until February 2000. Therefore, the adjusting entry as of December 31, 1999 includes which of the following?A) cr. utilities payable $8,000B) cr. cash $8,000C) cr. utilities expense $8,000D) no adjusting entry needed because the bill will not be paid until January 2000
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO1
53. Bonds payable (due 5 years from the balance sheet date) should be classified as follows:A) A contingent liability.B) An element of the owners' equity.C) A long-term liability.D) A current liability.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
54. A short-term note payable may include all of the following except:A) Trade notes payable.B) Nontrade notes payable.C) A current portion of a long-term liability.D) Unearned revenue.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 9
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55. Which of the following statements is/are correct?A) Under IFRS, contingencies may be accrued, but not under ASPE.B) Litigation for which the company will probably be found guilty would normally be accrued
as a provision.C) Under IFRS, contingencies should be disclosed but not accrued.D) Both B & C are correct.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
56. A firm sold $100,000 worth of goods during 1999. The firm extends warranty coverage on these goods. Historically, warranty costs have averaged 2% of total sales. During 1999, the firm incurred $1,000 to service goods sold in 1998 and $200 to service goods sold in 1999. What is warranty expense for 1999?A) $200B) $1,200C) $2,000D) $3,200
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO1
57. You are an investor and have just purchased a bond on July 1 which pays interest every March 1 and September 1. When you receive your first interest cheque, you will receive and have earned how many months interest?
Received Earned1 6 62 6 23 2 24 4 45 6 4
A) Choice 1B) Choice 2C) Choice 3D) Choice 4E) Choice 5
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO5
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58. On November 7, 1999 local residents sued Brimley Corporation for excess chemical emissions that caused some of them to seek medical attention. The total lawsuit is $8,000,000. Brimley Corporation's lawyers believe that the lawsuit will be successful and that the amount to be paid to the residents will be $4,000,000. On its December 31, 1999 financial statements Brimley should:A) Accrue a provision loss of $8,000,000 with no financial statement disclosure necessary.B) Accrue a provision loss of $4,000,000 and note disclose.C) Do nothing as the lawsuit has not yet ended.D) Simply disclose the details regarding the lawsuit in a note.
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO1, 3
59. AB sold its 10-year bond at a discount. In reporting the bonds and the related discount on a balance sheet shortly thereafter, the discount should be:A) Added to the bonds.B) Recorded as expense in the period of sale.C) Reported as a deferred charge.D) Deducted from the bonds payable.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
60. JMR bought 15 Z Corporation $1,000 bonds for $15,270 total, on April 1, 2000, (five years prior to maturity). The bonds pay 8% annual interest on April 1 and October 1. On December 31, 2000, the bonds had a market value of $14,950 (not a permanent decline). JMR purchased these bonds at:A) Par.B) Par plus accrued interest.C) A premium.D) A discount.E) A discount plus accrued interest.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
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61. R Company was indebted to A Inc. at January 1, 2000. The note called for a $25,000 payment to be made on December 31, 2000 and also on December 31, 2001. The note was non-interest bearing yet 10% was the prevailing rate at the time the note was issued. What is the book value of the note on R's January 1, 2000 balance sheet?A) $47,727B) $47,500C) $43,389D) $50,000E) $38,962
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
62. $5,000 (face value) of bonds with a book value of $4,300 was retired 4 years and 9 months prior to maturity. The dollar amount (excluding interest) paid to retire the bonds was $4,700. The entry to record the retirement would include:A) dr. bonds payable $5,000B) cr. cash $4,300C) dr. bonds payable $4,700D) cr. unusual gain $400
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
63. ABC Inc has 50 pending lawsuits for which it may be found liable. The expected value (sum of the probabilities of the outcomes multiplied by their respective payouts) amounts to $100,000. However, the company’s controller believes that the most likely outcome will be a payout of $120,000. Which of the following statements pertaining to the accrual of the provision is correct?
A) There is a large population of lawsuits, so a provision of $100,000 must be accrued.B) There is a large population of lawsuits, so a provision of $120,000 must be accrued.C) There is a small population of lawsuits, so a provision of $100,000 must be accrued.D) There is a small population of lawsuits, so a provision of $120,000 must be accrued.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
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64. ER issued for $2,060,000, two thousand of its 9%, $1,000 callable bonds. The bonds are dated January 1, 1999, and mature many years from now. Interest is payable semi-annually on January 1 and July 1. The bonds can be called by the issuer at 102 on any interest payment date after December 31, 2003. The unamortized bond premium was $28,000 at December 31, 2001, and the market price of the bonds was 99 on this date. In its December 31, 2001, balance sheet, at what amount should GC report the carrying value of the bonds?A) $1,980,000B) $2,028,000C) $2,032,000D) $2,040,000E) Cannot answer; the bond term is not given
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
65. Gains or losses from the early extinguishment of debt, if material, should be:A) recognized in income as ordinary gains and losses or as unusual items.B) recognized as an extraordinary item in the period of extinguishment.C) amortized over the remaining original life of the extinguished issue.D) amortized over the life of the new issue.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
66. All of the following are true with respect to sinking funds except:A) A sinking fund is a cash fund that is restricted for retiring the debt of a company.B) A sinking fund may be handled by a trustee or by the individual company.C) A sinking fund may make the investment more attractive to investors.D) Once the sinking fund is established, the company has no more responsibility to the debt.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
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67. Which one of the following items is not a liability?A) Accrued estimated warranty costsB) Dividends payable in sharesC) Advances from customers on contractsD) The portion of long-term debt due within one year
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
68. Proposed changes to the IFRS definition of a liability include:A) The addition of the requirement that a liability relate to a past event.B) The removal of the requirement that a liability relate to a past event.C) The addition of the requirement that a liability be a present obligation.D) The addition of the requirement that a liability be a legal obligation.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
69. The rate of interest specified on the face of the debt is called the:A) Effective interest rate.B) Stated interest rate.C) Yield interest rate.D) Market interest rate.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
70. The rate of interest used to discount the future cash payments on a debt to the cash equivalent borrowed is least likely to be described by which of the following terms:A) Effective interest rate.B) Yield interest rate.C) Stated interest rate.D) Prevailing interest rate.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
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71. A company has commenced work on a non-cancellable fixed price construction contract in the amount of $6 million. Costs of $4 million have been incurred to date, and it is expected that $3.2 million in additional costs will have to be incurred to complete the contract. The company adheres to IFRS. Which of the following statements with respect to the contract are correct?A) There is a constructive obligation to finish the contract.B) The company will have recognized $3 million in profit on the contract to date.C) The company has a constructive obligation to accrue a loss of $1.2 million plus any
previously recognized profit.D) This is an onerous contract, so the company must accrue a loss of $1.2 million plus any
previously recognized profit.
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1, 3
72. Constructive obligations may arise from:A) Asset retirement obligationsB) Warranty obligations.C) Notes PayableD) Both A & B
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 3
73. A company is being sued by a competitor for $120,000. The company’s legal team estimates that there is a 20% chance that the company will be sued. Under the PROPOSED changes to current IFRS standards,A) No provision or note disclosure will be required.B) A provision of $24,000 will be required.C) A provision of $96,000 will be required.D) A provision of $120,000 will be required.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 3
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74. Long-term obligations (i.e., debts) that is callable for early payment:A) Must continue to be classified as a long-term liability by the debtor, if a provision of the
debt covenant has been violated.B) Must continue to be classified as a long-term liability in all situations.C) Must be reported as current liabilities by the debtor if callable on demand.D) Can be reported as current liabilities by the debtor only if callable because a provision of
the debt covenant has been violated.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
75. A company had sales of $1 million. Coupons in the amount of $1 per $10 in sales were given to paying customers. History has shown that 50% of all coupons are redeemed. Which of the following statements is correct?A) A provision for $50,000 must be recognized.B) A provision for $100,000 must be recognized.C) A provision for $1 million must be recognized.D) No provision is necessary.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 3
76. By law, a fleet of aircraft must be subject to a major overhaul every 5 years as part of its scheduled maintenance program. Which of the following statements is correct?A) An accrual should be made in each of the 5 years preceding the overhaul.B) The costs of the overhaul should be expensed as incurred.C) The cost of the overhaul should be deferred and amortized.D) The estimated cost of the overhaul should be disclosed as part of a continuity schedule in
the notes to the financial statements.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 3
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77. Which of the following statements is/are correct?A) For companies that are self-insured, a provision must be established for events taking place
prior to the reporting period but not for loss events that have happened during the year but are not yet known.
B) For companies that are self-insured, a provision must be established for events taking place prior to the reporting period and for loss events that have happened during the year but are not yet known.
C) Contingent assets are only recorded when it is virtually certain that the benefits relating to the contingent assets will be received.
D) Both A & C are correct.E) Both B & C are correct.
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 3
78. Information obtained prior to the issuance of the current period's financial statements of KG Company indicates that it is probable that, at the date of the financial statements, a liability will be incurred for obligations related to product warranties on products sold during the current period. During the past three years, product warranty costs have been approximately 1 1/2 percent of annual sales revenue. An estimated loss contingency should be:A) Neither accrued nor disclosed in the financial statements.B) Recognized as an appropriation of retained earnings.C) Accrued in the accounts and reported in the financial statements.D) Disclosed in the financial statements but not accrued.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 3
79. Contingent liabilities will or will not become actual liabilities depending on:A) Whether they are probable and estimableB) The degree of uncertaintyC) The present condition suggesting a liabilityD) The outcome of a future event
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 3
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80. Under IFRS, which of the following will only require only a note disclosure as a contingency?A) Cash discounts given for early payment by customers; almost always takenB) Remote chance of loss from a lawsuit in processC) Probable claim for an income tax refundD) Loss from an investment in equity securities that is certain
Ans: B
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 3
81. (Appendix) A Bank requires a client to maintain a certain debt-to-equity ratio, or else the client’s loan will become immediately repayable. This is an example of a(an):A) Debt covenant.B) Indenture.C) Contingency.D) Retraction.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO13
82. Which of the following contingencies should be accrued in the accounts and reported in the financial statements?A) The estimated expenses of a one-year product warrantyB) The company is forcefully contesting a personal injury suit and a loss is possible and
reasonably estimableC) An accommodation endorsement involving a remote lossD) It is probable that the company will receive $50,000 in settlement of a lawsuit
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 3
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83. KR Corporation was involved in a lawsuit with the Government alleging inadequate air pollution control facilities at its Glowworm plant site during 1999. At December 31, 2002, it appeared probable the Government would settle for approximately $150,000. This event should be recorded (i.e., recognized) in 2002 as a(n):A) Loss on the lawsuit (operating expense).B) Unusual gain.C) Prior period adjustment.D) Unusual loss.E) Disclosure of contingency loss only in a note.
Ans: A
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 3
84. Under IFRS, interest paid should be recorded on the Statement of Cash Flows as a(an): A) Operating activity.B) Financing Activity.C) Investing ActivityD) A or B
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
85. On January 1, 2000, DWW borrowed $400,000 cash and signed a one-year, 12 percent interest-bearing note payable. Assuming a 40 percent average income tax rate for DWW Corporation, the net effective interest rate on this note was:A) 4.8 percent.B) 6.0 percent.C) 7.2 percent.D) 12.0 percent.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
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86. XYZ borrowed $60,000 for one year and signed an 18 percent, interest-bearing note payable. Assuming XYZ has an income tax rate of 45 percent, the net effective rate was:A) 8.1 percent.B) 9.9 percent.C) 11.7 percent.D) 18 percent.
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO4, 5
87. On September 1, 1999, Company B signed a $7,392, two-year non-interest-bearing note payable in full on August 31, 2001. Company B received $6,000 cash. What was the yield or effective rate of interest?A) 11 percentB) 14 percentC) 18 percentD) 23 percent
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
88. VCR Company owed a $73,311 debt due on January 1, 2000. An agreement was reached to pay it off in three equal annual payments of $30,000 each, starting on December 31, 2002. The interest rate was 11 percent. The balance in the liability account of VCR Company on January 1, 2002 is:A) $27,027B) $51,875C) $73,321D) $90,000
Ans: ADifficulty: Medium
Level of Learning: ApplicationTopic: LO4, 5
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89. XY Company owed a $45,489 due on January 1, 2000. An agreement was reached to pay it off in five equal annual payments, starting on December 31, 2000. The interest rate was 10 percent. The total amount of interest paid under the terms of the agreement was (round annual payment to nearest $1):A) $25,000B) $22,745C) $14,511D) $ 6,000
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO4, 5
90. A firm sells products covered by a three-year warranty. From the past experience of the other firms in the industry, the firm expects to incur warranty costs equal to 1% of sales. Firm sales were $40,000 and $50,000 in 1999 and 2000 respectively. In 2000, the firm spent $200 to repair goods sold in 1999, and $300 to repair goods sold in 2000. The firm received no warranty servicing demands from customers in 1999, the firm's first year of operations. What is the balance in the warranty liability account on January 1, 2001?A) $400B) $500C) $300D) $0
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO1, 3
91. On January 1, 2000, JG purchased a machine and gave a $30,000 three-year, 8% note. The market or "going" interest rate was 12%. The annual interest payments are to be paid on each December 31. On January 1, 2000, JG should record the net liability amount determined as follows:A) Compute the present value of its face amount and the three $2,400 interest amounts by
using a discount rate of 8%.B) Compute the present value of its face amount and the three $2,400 interest amounts by
using a discount rate of 12%.C) Use its face amount, $30,000 plus the $7,200 interest.D) Use its face amount, $30,000 minus $7,200 interest.
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO4, 5
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92. KR issued bonds payable with a face amount of $200,000 and a maturity date ten years from date of issuance. If the bonds were issued at a premium, this indicated that:A) The effective and stated rates were the same.B) The stated rate of interest exceeded the effective rate.C) The stated rate and the market rate were the same.D) No necessary relationship exists between the two rates.E) The effective rate of interest exceeded the stated (nominal) rate.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
93. In theory (disregarding any other marketplace variables) the proceeds from the sale of a bond will be equal to:A) The face amount of the bond plus the present value of the interest payments made during
the life of the bond discounted at the prevailing market rate of interest.B) The sum of the face amount of the bond and the periodic interest payments.C) The present value of the principal amount due at the end of the life of the bond plus the
present value of the interest payments made during the life of the bond, each discounted at the stated rate of interest.
D) The present value of the principal amount due at the end of the life of the bond plus the present value of the interest payments made during the life of the bond, each discounted at the prevailing market rate of interest.
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
94. AB Company sold and issued a $100,000, 10%, bond at 99. Therefore, the bond:A) was sold at a premium because the stated interest rate was higher than the yield rate.B) sold at a discount because the stated interest rate was lower than the market interest rate.C) sold at a premium because the $1,000 accrued interest is added to the $100,000 face
amount.D) was sold for $100,000 less $1,000 of accrued interest.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
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95. For bonds payable, the cash interest paid in each interest period is:A) The same amount regardless of whether the bond was sold at par, a discount, or a
premium.B) Different depending upon the date of sale.C) Not the same amount when the stated and yield interest rates are different.D) Dependent on the initial amount of accrued interest.
Ans: ADifficulty: Medium
Level of Learning: ApplicationTopic: LO4, 5
96. Straight-line amortization of bond premium or discount:A) Can be used as an optional method of amortization in all situations.B) Provides the same amounts of interest expense and interest revenue each interest period as
the effective interest method.C) Provides the same total amount of interest expense and interest revenue as the effective
interest method over the life of the bonds.D) is appropriate when the bond term is especially long.E) is appropriate for deep discount bonds.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
97. If a bond was sold at 108, the stated rate of interest was:A) Equal to market rate.B) Not related to market rate.C) Higher than market rate.D) Lower than market rate.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
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98. Bond A and Bond B both have a maturity value of $1,000 and pay annual interest of 9%. The market rate of interest is also 9%. Bond A matures in 4 years and Bond B matures in 5 years. Which of the following is correct?A) Both bonds sell for more than $1,000.B) Bond A will sell for more than Bond B.C) Both bonds sell for the same amount, $1,000.D) Bond B will sell for more than Bond A.E) There is not sufficient information to answer the question.
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO4, 5
99. Bonds payable should be reported as a long-term liability in the balance sheet of the issuer at:A) Current market price.B) lower-of-cost-or-market.C) Issue price, excluding any accrued interest at purchase date.D) Issue price less any unamortized bond premium or plus any unamortized discount.E) Issue price plus any unamortized bond premium or less any unamortized discount.
Ans: EDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
100. When the interest payment dates of a bond are May 31 and November 30, and a bond issue is sold on July 1, the amount of cash received by the issuer will be:A) Decreased by accrued interest from July 1 to November 30.B) Decreased by accrued interest from May 31 to July 1.C) Increased by accrued interest from May 31 to July 1.D) Increased by accrued interest from July 1 to November 30.E) Unaffected by accrued interest.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
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101. When the interest payment dates of a bond are May 31 and November 30, and a bond issue is sold on July 1, the price of the bond will be:A) Decreased by accrued interest from July 1 to November 30.B) Decreased by accrued interest from May 31 to July 1.C) Increased by accrued interest from May 31 to July 1.D) Increased by accrued interest from July 1 to November 30.E) Unaffected by accrued interest.
Ans: EDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
102. A firm retired a long-term note by in-substance defeasance. This meA) the creditors have been paidB) the debtor has been released of its legal responsibility for all remaining debt paymentsC) there is only a remote chance that the debtor will be required to make further payments on
the liabilityD) the debt is shown as an offset against the assets used to retire the debt, in the debtor's
balance sheetE) the debtor will continue to recognize interest expense on the debt but will make no more
payments
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO 5
103. There are two methods for amortizing premiums and discounts on the sale of bonds. The differences between the two methods are:A) Both methods charge a constant amount of interest to the financial statements each year;
however, the effective interest method charges a larger total amount of interest expense over the life of the bond.
B) The effective interest method charges a different interest expense each year while the straight-line method results in a different amount of annual interest expense as a percentage of beginning book value each year.
C) There are no differences between the twoD) None of these answers is correct
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
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104. In-substance defeasance is sometimes used as a method of bond retirement. Choose the correct statement about this practice.A) The bonds are legally retired as a resultB) The firm may invest in any investment-grade debt security to retire the bonds as long as the
investment securities are transferred irrevocably to a trusteeC) Neither the assets used to effect the defeasance, nor the bonds themselves, are reported in
the balance sheet, even though the bonds remain outstandingD) The process may require the company which issued the bonds to make substantial
payments in addition to the investments purchased for the defeasance
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
105. Which of the following is not one of the conditions that must be met to qualify as extinguishment of debt by in-substance defeasance?A) Trust must own monetary assets that are essentially risk free.B) Cash inflows into the trust must approximately coincide with required cash outflows.C) There is a reasonable possibility that the debtor will be called on to make additional
payments on the debt.D) The qualifying assets must not be used for trustee fees.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO5
106. The result of an effective interest rate that is higher than the stated rate on a debt security is the:A) Carrying value of the debt will decrease each interest period.B) Security will sell at a premium.C) Cash interest paid on each interest date will be changed.D) Dollar amount of interest expense reported on the income statement, assuming the interest
method is used, will increase each interest period.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
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107. Which of the following statements is true?A) If a bond is sold "at a discount," the effective interest rate on the bond is lower than the
stated interest rate.B) If a bond is sold between interest dates, it is necessary to record the interest accrued since
the last payment date before sale.C) If a bond is sold "at a premium," the effective interest rate on the bond is higher than the
stated interest rate.D) Bond price of 98 means that the yield rate is 98% of the stated rate.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
108. If bonds are issued initially at a discount and the straight-line method of amortization is used for the discount, interest expense in the earlier years will be:A) less than if the interest method is used.B) less than the amount of the interest payments.C) more than if the interest method is used.D) The same as if the interest method is used.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
109. VB owes a $200,000, 8%, five-year note payable dated January 1, 2000. It is the end of year 2000, and instead of making the interest payment now due, VB has made arrangements to pay the debt and the 2000 interest payment in four equal instalments based on the same interest rate. The first payment is to be made on January 1, 2001. The amount of the equal annual payments is (rounded to the nearest dollar):A) $54,000B) $60,384C) $55,912D) $65,214
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
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110. On January 1, 2000, ER signed a $120,000, 10%, three-year, note payable. The proceeds are to be used to purchase a computer and related software for the company. The lending institution advanced proceeds of $115,800 and took a mortgage on the computer. The note is payable in three equal annual instalments starting on December 31, 2000. The effective interest rate to use for this debt is (rounded to the nearest percent; do not interpolate):A) 10%.B) 11%.C) 12%.D) 13%.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
111. On November 1, 1999, WC purchased CX, 10-year, 7%, bonds with a face value of $100,000 for $96,000. The bonds are intended to be held to maturity. An additional $2,333 was paid for the accrued interest. Interest is payable semi-annually on January 1 and July 1. The bonds mature on July 1, 2006. WC uses the straight-line method of amortization. Ignoring income taxes, the amount of interest revenue reported in WC's 1999 income statement (year-end December 31) as a result of WC's long-term bond investment in CX was:A) $1,267B) $1,167C) $1,120D) $1,067
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
112. On March 1, 2000, WC issued 10% stated interest rate, 10 year debentures dated January 1, 2000, in the face amount of $1,000,000, with interest payable on January 1 and July 1. The debentures were sold to yield 12% plus accrued interest. How much should WC debit to cash on March 1, 2000?A) $ 901,963B) $ 903,003C) $1,016,667D) $1,033,333E) $ 902,336
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
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113. On September 1, 2000, ER issued 11%, 10 year bonds dated June 1, 2000, in the face amount of $140,000, with interest payable July 1 and December 31. The bonds were sold for $140,000. How much should ER debit to cash on September 1, 2000?A) $140,000B) $142,567C) $147,700D) Cannot be determined from the information given
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
114. Which of the following is true with respect to bond retirement?A) If interest rates increase, the issuer can retire bonds at a gain by buying them on the open
market.B) Gains and losses on bond retirements may be classified as ordinary gains and losses or
unusual gains and losses.C) On debt retirement all related accounts should be update.D) All of these answers are correct.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO 5
115. Ryan Company borrow $45,000 US when the exchange rate for US $1.00 is Cdn. $1.46. When the debt was repaid the exchange rate changes to US $1.00 = Cdn. $1.38. Ryan Company records the amount on the date of exchange as:A) A foreign exchange loss of $3,600B) A foreign exchange gain of $3,600C) A foreign exchange gain of $62,100D) A foreign exchange loss of $62,100
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO8
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116. ASPE and IFRS differ in their treatment of long-term Bonds Payable in that:A) Under IFRS, exchange gains and losses on short-term debt are recorded in the income
statement immediately.B) The straight-line method may be used under ASPE but not under IFRS..C) ASPE ignores foreign exchanges gains and losses.D) IFRS does not account for foreign exchange gains and losses on Bonds Payable.
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4, 10
117. Which of the following is not a required disclosure for Bonds Payable under IFRS?A) Interest rate risk.B) Credit risk.C) Transaction risk.D) Liquidity risk.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO9
118. On January 1, 1999, a company borrowed $20,000 on a 10% interest-bearing note, due on December 31, 2001. The interest is payable each December 31.
(a) The principal amount of the note is $__________(b) The face amount of the note is $__________(c) The maturity amount of the note is $__________(d) Total cash interest expense for the three years is $__________(e) The balance in the note payable account on January 1, 1999 is $__________(f) The balance in the note payable account on December 31, 19x2 is $__________
Ans: (a) $20,000, (b) $20,000, (c) $20,000, (d) $6,000, (e) $20,000, (f) $20,000Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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119. A company has been sued for damages as a result of illness caused to local residents due to the emission of highly toxic chemicals from its plant. The company's legal firm advises that it is probable that the company will lose the suit and that it probably will result in a judgment of $2 million to $10 million in damages. However, the legal firm believes that the most probable amount of the loss will be $6 million, and that the suit will be terminated about three years hence.The company has no other lawsuits pending.
(a) Should the company disclose this event in the year the suit was filed? (check one)_____ No; _____ Note only; _____ A loss in the income statement.
(b) If a loss should be reported, give the journal entry required:
Ans: (a) a loss in the income statement., (b) Loss-pollution (lawsuit pending) 6,000,000 Estimated liability pollution lawsuit 6,000,000
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120. A firm issued a 16%, $1,000 bond issued and dated Jan. 1/2000 maturingJan. 1, 2011 paying interest each June 30 and December 31, and yielding 14%. One bond is used for simplicity.Required:(a)Determine the price of the bond(b)All Year 2000 entries and balance sheet presentations for the bond after each interest date in Year A. Show the interest method and straight-line methods in parallel fashion.Ans:
(a)Price = $1,000(PV1,7%,20)(.25842) + $80(PVA,7%,20)(10.59401)= $1,105.94
(b) Interest SLJan. 1/00 Cash 1,105.94
(both methods) Bond premium 105.94Bonds payable 1,000.00
Balance sheet disclosure Jan. 1/00 (both methods)
Bonds payable $1,000.00Bond premium 105.94 Book value of bonds $1,105.94
June 30/00 Interest expense 77.42 74.70Bond premium 2.58 5.30 Cash 80.00 80.00
77.42 = $1,105.94(.07) 5.30 = $105.94/20
Balance sheet disclosure June 30/00
Bonds payable $1,000.00 $1,000.00Premium 103.36 100.64Book value of bonds $1,103.36 $1,100.64
Dec. 31/00 Interest expense 77.24 74.70Bond premium 2.76 5.30Cash 80.00 80.00
77.24 = $1,103.36(.07) 5.30 = $105.94/20
Balance sheet disclosure Dec. 31/00
Bonds payable $1,000.00 $1,000.00Premium 100.60 95.34Book value of bonds $1,100.60 $1,095.34
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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121. JV issued $10,000, 10% bonds payable (interest payable annually), which mature at the end of six years from issue date. The effective rate of interest at issue date was 12%. The sale price of the bonds was: $_________________.Ans:$10,000 x PV1, 12%, 6 (.50663) = $5,066$1,000 x PVA, 12%, 6 (4.11141) = 4,111
9,177
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
122. Match the "Characteristic" with the "Designation" by entering appropriate letters to the left.CharacteristicA. Bonds supported by a lien (mortgage) on specific assets.B. The entire bond issue matures at a single date.C. The investor has the option to turn in the bonds and receive in exchange other specified securities.D. Issuer has the option to retire them at a stated price before the obligatory maturity date.Designation___ 1. Ordinary bonds___ 2. Convertible bonds___ 3. Callable bonds___ 4. Secured bonds
Ans: 1:B, 2:C, 3:D, 4:ADifficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
123. RX issued $1,000,000, 10% bonds payable (interest payable annually), which mature at the end of five years from issue date. The effective rate of interest at issuance was 8%. The sale price of the bonds was: $_________________.Ans:
$1,000,000 x PV1, 8%, 5 (.68058)= $ 680,580$100,000 x PVA, 8%, 5 (3.99271)= 399,271Total $ 1,079,851
=========
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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124. A retail store has completed certain transactions that management believes may have caused current liabilities. Indicate by check mark whether the following items should be classified as current liabilities. Assume a December 31 year-end.
Classified as a Current LiabilityItems Yes No Unknown(a) Dividend issuable in stock of the company. ___ ___ ___(b) Interest for January through March, which is not payable until July 1 next year.
___ ___ ___
(c) Amounts withheld in January for income tax fromemployee pay cheques; amount not yet remitted.
___ ___ ___
(d) Bonds maturing in 11 months from the financial statement date for which inadequate sinking fund exists.
___ ___ ___
(e) Obligation to service warranted (one year) products sold with store's private label.
___ ___ ___
(f) Obligation on gift certificates redeemable during the upcoming year.
___ ___ ___
(g) Shipping cost for goods sold, in transit, shipped f.o.b. point of shipment.
___ ___ ___
Ans: (a) No, (b) Yes, (c) Yes, (d) No, (e) Yes, (f) Yes, (g) NoDifficulty: HardLevel of Learning: ApplicationTopic: LO1
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125. At the end of the current reporting period, a company which adheres to ASPE is involved in a number of contingencies. The company seeks your advice as to how each contingency should be recorded and reported. Below are listed four "Requirements for Recording and Reporting" and six "Contingencies." Match each situation with one appropriate requirement code.Requirements for Recording and Reporting:CodeA = Record with entryB = Disclosure note requiredC = Disclosure note permittedD = Disclosure not recommendedContingencies:___ 1. The company has substantial assets in a foreign country and their
expropriation is reasonably possible; the amount of the loss can be estimated reliably.
___ 2. The company is the defendant in a lawsuit wherein the plaintiff seeks damages; a loss is remote, however, if it does occur its amount can be estimated reliably.
___ 3. The company is the plaintiff in a lawsuit seeking damages; a gain is remote and the amount of the gain, should it occur, cannot be estimated reliably.
___ 4. The company is the defendant in a lawsuit wherein the plaintiff seeks damages; a loss is likely but the amount of it cannot be estimated reliably.
___ 5. The company gives a two-year warranty on all goods sold; the warranty cost can be estimated reliably.
___ 6. The company is the plaintiff in a lawsuit seeking damages; a gain is likely and the amount can be estimated reliably.
Ans: 1: B, 2: C, 3: D, 4: B, 5: A, 6: BDifficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
126. Indicate the correct financial statement treatment of each of the three situations listed below by entering the identifying letter in the space provided.Financial StatementA. Report as a current or long-term liability.B. Must report as a note to the financial statements.C. May report in a note to the financial statements.Situations___ 1. Short term obligation estimated amount.___ 2. Probable obligation estimated amount.___ 3. Short term obligation known amount.___ 4. Probable obligation known amount.___ 5. Reasonably possible obligation known amount.___ 6. Reasonably possible obligation unknown amount.___ 7. Remote obligation unknown amount.___ 8. Remote obligation known amount.
Ans: 1:A, 2:A, 3:A, 4:A, 5:B, 6:B, 7:C, 8:C
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Difficulty: HardLevel of Learning: ApplicationTopic: LO2 3
127. Use the identifying letters which appear below to classify the items listed.ClassificationA. Contingent liabilityB. Current liabilityC. Long-term liabilityD. Owners' equityE. None of these.
Items___ 1. Premium on bonds payable.___ 2. Dividends payable in stock of the company.___ 3. Accounts receivable assigned.___ 4. Income tax withheld from employees' salaries.___ 5. Revenue collected in advance.___ 6. Estimated premium claims payable (in connection with sales promotion offer
involving redemption of proof of purchase premiums).___ 7. Estimated income tax payable.
Ans: 1:C, 2:D, 3:E, 4:B, 5:B, 6:B, 7:BDifficulty: HardLevel of Learning: ApplicationTopic: LO1-8
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128. Match each of the following items with its appropriate financial statement classification by entering letters in the spaces provided.ClassificationA. Current liabilityB. Long-term liabilityC. Contingent liabilityD. Owners' equityE. None of these.Items___ 1. Sales taxes collected.___ 2. Deferred repairs.___ 3. Cash dividends payable.___ 4. Appropriated retained earnings for bond sinking fund.___ 5. Accrued wages.___ 6. Bonds payable.___ 7. Stock dividends issuable.___ 8. Unearned rent revenue.___ 9. Notes Payable (due in 6 months) discounted.___ 10. Premium on bonds payable.
Ans: 1:A, 2:A, 3:A, 4:D, 5:A, 6:B, 7:D, 8:A, 9:A, 10:BDifficulty: HardLevel of Learning: ApplicationTopic: LO1-8
129. Classify each of the items listed below by entering the appropriate letter. Assume that IFRS is adhered t.ClassificationA. Contingent liabilityB. Current liabilityC. Long-term liabilityD. Owners' equityE. Provision
Items___ 1. Unearned rent revenue.___ 2. Deferred interest revenue.___ 3. Accrued wages.___ 4. Cash dividends payable.___ 5. Bonds payable (due in five years).___ 6. Accommodation endorsement (probable and
estimable).___ 7. Stock dividend issuable.___ 8. Estimated taxes payable.
Ans: 1:B, 2:B, 3:B, 4:B, 5:C, 6:E, 7:D, 8:BDifficulty: HardLevel of Learning: ApplicationTopic: LO1-8
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130. On January 1, 2000, a company purchased a machine that had a list price of $23,500. The purchase terms agreed upon were: cash down payment $12,000 plus a 15% note payable of $9,132 (its present value). The note is payable in three equal annual instalments (interest plus principal) on each December 31. Round to the nearest dollar.Required:(a)Give the entry to record the acquisition of the machine.(b)Give the adjusting entry required on September 30, 20x2, for interest assuming this is the end of the accounting period.Ans:(a) Machine 21,132 Cash 12,000 Note payable 9,132(b) Interest expense 731 Interest payable (975 x 9/12) 731
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
131. On January 1, 2000, a corporation purchased a machine (10 year estimated useful life; no residual value; straight-line method) by paying cash $1,500 and signing a note payable with a face amount of $4,500, 8% interest payable each December 31. The maturity date is December 31, 2002. The going market rate of interest was 10%. Give all required entry (entries) at each of the following dates: January 1, 2000: December 31, 2000:Ans: January 1, 2000:Machine ($1,500 + $4,276) 5,776Cash (given) 1,500Note payable (net)* 4,276
* principal $4,500 x (PV1, 10%, 3) (.75131) 3,381* Interest $ 360 x (PVA, 10%, 3) (2.48685) 895
4,276December 31, 2000: =====
Depreciation expense ($5,776 ÷ 10 years) 578 Accumulated depreciation 578Interest expense ($4,276 x .10) 428 Cash ($4,500 x .08) 360 Note payable ($428 - 360) 68
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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132. On January 1, 1999, a company incurred a debt of $11,663, which is payable in four equal annual instalments of $3,600, starting on December 31, 1999.(a)The implicit interest rate is _______% (rounded to the nearest percent).(b)Give the journal entry to record the second annual payment (on December 31, 2000).Ans: (a) Implicit interest rate: 9%
$11,663 ÷ $3,600 = 3.23972, PVA for n = 4 shows 9%(b) December 31, 2000Liability 2,780Interest expense 820 Cash 3,600
Date Cash Interest Expense Principal Reduction Principal BalanceJan. 1/99 $11,663Dec.31/99 $ 3,600 $ 11,663 x.09 = $ 1,050 $3,600 - 1,050 = $ 2,550 9,113Dec.31/00 3,600 9,113 x.09 = 820 3,600 – 820 = 2,780 6,333
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
133. X owed a debt dated January 1, 2000, amounting to $91,330. Arrangements were made to pay the debt in three equal annual instalments, starting on December 31, 2000. The interest is 15% per annum.(a)Compute the amount of the annual cash payment to be made on each December 31.Payment $______________.(b)Prepare the related debt amortization schedule for the term of the debt.Ans:
(a)$91,330 ÷ (PVA, 15%, 3) (2.28323)= $40,000======
(b)
Date Cash – Interest Expense (15%) = PrincipalReduction
Principal Balance
Jan. 1/00 $91,330Dec.31/00 40,000 13,700 26,300 65,030Dec.31/01 40,000 9,755 30,245 34,785Dec.31/02 40,000 5,218 34,782*
_________*$3 difference due to rounding
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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134. On September 1, 2000, a company signed a $19,800, one-year, non-interest-bearing note payable and received $18,000 cash.(a)What was the yield rate of interest?_________(b)Give the entry required at September 1, 2000, in the accounts of the company (use the net method).(c)Give the adjusting entry required at the end of the accounting year for the company (December 31, 2000).(d)Give the entry required on the due date, August 31, 2001, assuming no reversing entries were made.Ans: (a) $19,800 - $18,000 = $1,800 ÷ $18,000 = 10%
(b)September 1, 2000Cash 18,000 Note payable 18,000
(c)December 31, 2000:Interest expense ($1,800 x 4/12) 600 Note payable 600
(d)August 31, 2001:Note payable 18,600Interest expense ($1,800 x 8/12) 1,200 Cash 19,800
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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135. On September 1, 2000, a company purchased a machine and paid for it by signing a two-year noninterest-bearing note, face $4,000. The note is payable August 31, 2002. The going rate of interest was 18% per year. The accounting period ends December 31.(a) Compute the cost of the machine.(b) Give all appropriate entries throughout the term of the note. Use the net method.Ans: (a) $4,000 x (PV1, 18%, 2) (.71818) = $2,873
(b) September 1, 2000Machine 2,873 Note payable 2,873
December 31, 2000Interest expense ($2,873 x .18 x 4/12) 172 Note payable 172
December 31, 2001Interest expense 548* Note payable 548
August 31, 2002Note payable ($2,873 + $172 + $548) 3,593Interest expense ($4,000 - $3,593) 407 Cash 4,000
*$2,873 x .18 = $517 x 8/12 = $345or ($2,873 + $172) x .18 = $548
====($2,873 + $517) x .18 = $610 x 4/12 = 203$548
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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136. On September 1, 2000, a company signed a $6,540, one-year, non-interest-bearing note payable and received $6,000 cash.(a)What was the imputed rate of interest?______________ % .(b)Give the entry required at September 1, 2000, to record the receipt of the cash (record on net basis).(c)Give the adjusting entry required at the end of the accounting year, December 31, 2000.(d)Give the entry required on the due date, August 31, 2001, assuming no reversing entries were made.Ans: (a) $6,540 - $6,000 = $540 ÷ $6,000 = 9%
(b) September 1, 2000Cash 6,000 Note payable 6,000(c) December 31, 2000Interest expense ($540 x 4/12) 180 Note payable 180(d) Note payable ($6,000 + $180) 6,180Interest expense ($540 x 8/12) 360 Cash 6,540
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
137. Quality 9000 International Inc., which began operations in 1996, sells 20,000 units of its product each year under the following warranty: defective units will be fixed free of charge during the calendar year of purchase and the next two calendar years. (This means it is best to buy from this company early in the year.) Only 1% of units sold have required warranty service in the past. The average cost has been $200 per unit for servicing. Units require service only once and the likelihood of a unit requiring service is the same during each year in the warranty period. What is the balance in the warranty liability account at December 31, 1999?Ans: As of Dec. 31/99, the warranty for 1996, 1997 units is expired;
Dec. 31/99 liability =For 1998 sales: 1/3(20,000)($200)(.01) = $13,333For 1999 sales: 2/3(20,000)($200)(.01) = 26,667Total liability at Dec. 31/99 $40,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO2
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138. A firm sells a remarkable product, which serves many household purposes. The firm is confident about its product and is so anxious to sell a large number of units that it grants a 3-year warranty. The warranty agreement specifies that any malfunction or other problem will be fixed at no cost to the customer, unless the customer has abused the product. Based on experience with other household products it has sold in the past, 3% of total units sold will require service over the warranty period at an average cost of $200 per unit. The following information relates to the first two years of the product's life:
Year 1 Year 2Unit sales 20,000 5,000Actual warranty costs incurred $ 35,000 $ 80,000
What is the balance of the warranty liability account at January 1, Year 3? Assume that the company did not revise its estimate of future warranty claims frequency.Ans: January 1, 20x3 warranty liability balance =
(20,000 + 25,000).03($200) - $35,000 - $80,000 = $155,000Difficulty: HardLevel of Learning: ApplicationTopic: LO3
139. At December 31, 1999 ABC Company has the following three separate lawsuits pending against it: Suit A-Plaintiffs seek damages of $40,000; Suit B-Plaintiff seeks damages of $200,000; and Suit C-Plaintiff seeks damages of $20,000.ABC management and legal counsel have made the assessments indicated below. For each suit, taking into account the assessment, you are to (a) give the accrual entry if it is required (if not, state why) and (b) indicate whether a disclosure note is required and explain the reason.CASE A-Remote that ABC will lose the suit.(a) Accrual entry:(b) Disclosure note: _______ Yes ______ No. Explanation:CASE B-Reasonably possible that ABC will lose; reasonable estimate of damages $4,000.(a) Accrual entry:(b) Disclosure note: ______ Yes _______ No. Explanation:CASE C-Probable that ABC will lose; reasonable estimate of damages $10,000.(a) Accrual entry:(b) Disclosure note: ______ Yes ______ No. Explanation:Ans: CASE A
(a) None permitted for remote loss contingencies(b) No (permissible but not required)CASE B(a) None(b) Yes (required for reasonably possible loss contingencies)CASE C
(a) Estimated loss-Damages from lawsuit 20,000Estimated liability-Damages from lawsuit 20,000
(b) Yes or no (Disclosure often required in addition to the journal entry) for full disclosure.Difficulty: HardLevel of Learning: ApplicationTopic: LO3
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140. BRIEFLY explain how the treatment of contingencies differs under IFRS and ASPE.
Ans: Contingencies may or may not be accrued under ASPE but are never accrued under IFRS. Both IFRS and ASPE require the disclosure of contingencies.
Difficulty: HardLevel of Learning: ApplicationTopic: LO3, 10
141. Match the following bond classifications with the appropriatestatement by entering the appropriate letters in the spaces provided:Bond ClassificationsA. Government bondsB. Corporate bondsC. Serial bondsD. Redeemable bondsE. Convertible bondsF. Callable bondsG. Income bondsH. Registered bondsI. Coupon bondsStatements___ 1. Bonds that may be turned in to issuer in exchange for other securities.___ 2. Issued by private companies.___ 3. Interest is paid only to owners of record as reflected in the accounts of the issuer.___ 4. Interest is paid only in years in which the issuer earns a profit.___ 5. Investor has the option of turning in the bond for retirement before maturity date.___ 6. Interest is paid only to investors who return a coupon.___ 7. Issued by public entities.___ 8. Principal paid off in steps (instalments).___ 9. Issuer has the option to pay off the bonds before maturity date.
Ans: 1:E, 2:B, 3:H, 4:G, 5:D, 6:I, 7:A, 8:C, 9:FDifficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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142. For each of the following, indicate the appropriate balance sheet classification by entering the applicable classification letter.ClassificationA. Current liabilityB. Long-term liabilityC. Contingent liabilityD. Owners' equityE. None of theseItem___ 1. Premium on bonds payable___ 2. Sales taxes collected___ 3. Repairs expense payable___ 4. Cash dividends payable___ 5. Bond sinking fund___ 6. Accrued wages payable___ 7. Bonds payable___ 8. Stock dividends declared___ 9. Rent received in advance
Ans: 1:B, 2:A, 3:A, 4:A, 5:E, 6:A, 7:B, 8:D, 9:ADifficulty: HardLevel of Learning: ApplicationTopic: LO1-8
143. On September 1, 2000, XYZ borrowed $100,000 on a 9%, two-year, note payable. Simple interest is payable on August 31, 2001 and 2002. XYZ's reporting year ends December 31 and the company does not use reversing entries for interest. The required entry on August 31, 2001, is:Ans:Interest Expense 6,000Interest Payable 3,000 Cash 9,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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144. A company wishes to finance a long-term construction project and in doing so, capitalize the related interest expense. The company requires $2 million in financing.
The company currently has the following debt and equity items on its December 31st, 2009 Balance Sheet:
Bonds Payable (8%, Issue at Par) $1,000,000Unsecured Line of Credit (6%) $3,000,000 Common Shares (Par Value $100) $1,000,000
There are 10,000 common shares outstanding which pay an annual dividend of $ 5 per share. The company can borrow a maximum of $5 million on its unsecured line of credit.
The company’s bank has indicated its willingness to extend an additional credit facility in the amount of $1.5 million at an annual rate of 5% as of March 31st, Year 6. These amounts remained outstanding throughout Year 6.
On March 1st, Year 6 the company borrowed $600,000. On April 1st, Year 6, and additional $1.4 million was wired to the company’s account, drawn on its new credit facility.
Determine the amount of interest that the company would be able to capitalize as per IFRS for Year 6.
Ans: The company requires $2 Million. $500,000 was drawn from the company’s unsecured line of credit – a generalized borrowing. The remainder was drawn on the purpose-specific credit facility.
It is necessary to calculate the company’s weighted average cost of capital for its general borrowings:
8%*$1 million + 6%*3 million =$260,000/ ($1 million + $3 million) = 6.5%.
The amount of interest to be capitalized would be adulated as follows:
Category Portion of Year Weighted Avg Borrowings Capitalized Interest
General 10/12 $600,000*10/12=$500,000*6.5% $32,500Specific 9/12 $1.4 million*9/12=$1,050,000*5% $52,500
Total $85,000
Thus, $85,000 of interest would be capitalized.
The journal entry to reflect the capitalization of interest would be as follows:
Interest Expense $85,000Construction-in-process $85,000
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Difficulty: HardLevel of Learning: ApplicationTopic: LO6
145. On July 1, 2000, RC sold two of its $10,000, 9%, bonds payable at an effective interest rate of 8%. Interest is paid each June 30 and the bond matures in six years on June 30, 2006. Round all amounts to the nearest dollar.(a)What was the amount of the premium $_____________ or discount $_______________________?(b)The income statement for the accounting year ended December 31, 2000, should report interest expense of, assuming:(1) Straight-line amortization, $_____________________.(2) Interest-method amortization, $___________________.Ans:
(a) $20,000 x PV1, 8%, 6 (.63017) $2,60 $1,800 x PVA, 8%, 6 (4.62288) 8,321 Cost 20,924 Par 20,000 Premium $924
======
(b) Straight-line amortization: $823, interest expense====
1,800 - ($924 ÷ 6 years = $154) = $1,646 x 6/12 = $823(2) Interest-method amortization: $837, interest expense
====$20,924 x 8% x 6/12 = $837
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
146. It is often necessary to compute the book value of a bond issue several years into its term. Rather than compute an amortization schedule for the entire term, it is possible to directly compute the net bond liability at any interest date under either the interest method or straight-line method. Assume that $100,000 of 8% bonds were issued to yield 10% on January 1, 2000, the bond date. The bonds pay interest each December 31 and are scheduled to mature in ten years. Answer the following questions without producing an amortization schedule.(a) What is the book value of the bonds on January 1, 2006 if the firm uses the straight-line method.(b) What is the book value of the bonds on January 1, 2006 if the firm uses the interest (effective interest) method.Ans: (a) Original issue price = $100,000(PV1,.10,10)(.38554) + $8,000(PVA,.10,10)(6.14457) =
$87,711. Original discount = $12,289. At Jan. 1/06, 4 years of term are left so BV = $100,000 -.4($12,289) = $95,084.(b) BV = 100,000(PV1,.10,4)(.68301) + $8,000(PVA,.10,4)(3.16987) = $93,660.
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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147. A firm has two bonds outstanding today, each with: (1) $1,000 face value, (2) a term of 5 years at issuance, (3) 3 years remaining to maturity, and (4) 10% yield rate at issuance. Bond A is a zero coupon bond; bond B pays 10% annually and just paid interest yesterday. The yield rate today on both bonds is 12%. Which bond has experienced the greatest percentage change in value since issuance?Ans: Bond A sold for 62: $1,000(PV1, .10, 5) (.62092).
Bond B sold for 100 as coupon and market rate were the same at issuance.Market value of Bond A today = 71 = $1,000(PV1, .12, 3)(.71178).Market value of Bond B today = 95 = $1,000(PV1, .12, 3) (.71178) +$100(PVA,.12,3)(2.40183)Bond A has increased 15% = (71 - 62)/62Bond B has decreased 5% = (100 - 95)/100 (generally the price of zeros is more volatile with interest rate changes)
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
148. On September 1, 2000, RC sold $10,000, 6% (payable semi-annually each March 1 and September 1), 10-year bonds dated September 1, 2000, to yield 8%. RC uses straight-line amortization. The accounting period ends December 31.(a) The sale price of the bond was $________________.(b) Interest expense for 2000, was $________________.Ans: (a)$10,000 x PV1, 4%, 20 (.45639) = $4,564
$300 x PVA, 4%, 20 (13.59033) = 4,077Sale price = $8,641
======(b)
$10,000 x 3% x 4/6 = $200$1,359 x 4/120 = 45Interest expense = 245
====
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
149. (Appendix) Discuss some of the sources of short-term financing.
Ans: The answer should include the ability to use promissory notes as financing. These notes can be interest or non-interest bearing. Companies can approach the banks for an operating line of credit. Large companies can issue commercial paper. Companies can also sell their receivables to a finance company.
Difficulty: HardLevel of Learning: ApplicationTopic: LO11
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150. On January 1, 2000, a company purchased a machine (an operational asset) with a list price of $4,000. $2,000 was paid in cash and a three-year, noninterest-bearing note was signed. The note was for $3,000 and required payment of equal amounts of $1,000 each December 31, 2000, 2001, and 2002. The going rate of interest was 12%. Using this information, complete the following requirements.(a) Give the entry on January 1, 2000, to record the purchase of the machine (show computations and round to the nearest dollar):(b) Prepare the related debt amortization schedule.(c) Give any adjusting entry related to the note payable required for 2001, assuming the accounting period ends March 31. If none is required, state the reason.(d) Assuming that the accounting period ends March 31 and there were no reversing entries, give the entry to record the annual payment made on December 31, 2001.Ans: (a)
January 1, 2000:Machinery 4,402 Cash Note payable
______*$1,000 x (PVA, 12%, 3) (2.40183) = 2,402
(b)Interest Principal Principal
Date Cash Expense Reduction BalanceJan. 1/00 $ 2,402Dec.31/00 $ 1,000 288 712 1,690Dec.31/01 1,000 203 797 893Dec.31/02 1,000 107 893 -0-
(c) March 31, 2001
Interest expense ($203 x 3/12) 51 Interest payable 51(d) Interest expense ($203 x 9/12) 152Interest payable 51 Note payable 797 Cash 1,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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151. AB owes a $100,000, 8%, five-year note payable dated January 1, 2000. It is the end of year 2000, and instead of making the interest payment now due, AB has made arrangements to pay the debt and the 2000 interest payment, in four equal instalments based on the same interest rate. The first payment is to be made on January 1, 2001. The amount of the equal annual payments, rounded to the nearest dollar, is:Ans: $100,000 + ($100,000 x .08) = $108,000 ÷ 3.57710 (PVAD, 8%, 4) =$30,192Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
152. The management of PT authorized an issue of $120,000 bonds payable, 6% (annual interest rate), dated January 1, 2000. The bonds mature on December 31, 2005 (5 years). Interest is payable each June 30 and December 31. The bonds were sold on May 1, 2000, at an effective (yield) rate of 8%.(a) The bonds were sold at a____________ premium; ____________discount (check one).(b) Give the entry for PT to record the sale of the bonds on May 1, 2000. Show computations for the issue price.Ans: (a) Discount, because the effective interest rate is higher than the stated rate.(b)Cash ($110,807* + $2,400) 113,207 Discount on bonds payable ($120,000 - $110,807) 9,193 Interest expense ($120,000 x 3% x 4/6) 2,400 Bonds payable 120,000
* To compute issue price on May 1:January 1, 2000:
Principal: $120,000 x PV1, 4%, 10 (.67556) = $81,067Interest: $3,600 x PVA, 4%, 10 (8.11090) = 29,199 Total = $110,266
========June 30, 2000:Principal: $120,000 x PV1, 4%, 9 (.70259) = $ 84,311Interest: $3,600 x PVA, 4%, 9 (7.43533) = 26,767 Total = $111,078
========Interpolation:($111,078 $110,266 = $812) x 2/6 =$271.00($111,078 $271) =$10,807
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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153. On April 1, 2000, the DEF sold a $2,000,000 bond issue dated January 1, 2000, to yield 9% per annum to maturity. The bonds were to be outstanding for twenty years from January 1, 2000, and the stated rate of interest was 8%. Interest is paid each January 1.(a) Give the entry to record the purchase of one-fourth of these bonds as a long-term investment by NOP. Assume effective interest amortization and contra/adjunct accounts.(b) Give the December 31, 2000, adjusting and closing entries for NOP.Ans:
(a) Investment in bonds ($2,000,000 x 1/4) 500,000 Interest revenue ($500,000 x 8% x 3/12) 10,000 Discount on bond investment 45,420 Cash (See computation below.) 464,580
(b) Interest receivable ($500,000 x 8%) 40,000 Discount on bond investment (892 -223)
669
Interest revenue 40,669
Interest revenue ($40,669 - $10,000) 30,669 Income summary 30,669
PV @ n=20; i=9:Prin. (500,000 x .17843 = 89,215) + Int. (40,000 x 9.12855 =365,142) = 454,357
PV @ n=19; i=9:Prin. (500,000 x .19449 = 97,245) + Int. (40,000 x 8.95011 =358,004) = 455,249
Difference 892======
PV @ Apr. 1/00: $454,357 + (892 x 1/4 = 223) = 454,580
plus accrued interest 10,000
Total Cash Paid 464,580======
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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Use the following to answer questions 154-155:
In August 2005, Cummings Corporation, a calendar-year corporation that records adjusting entries only once per year, issued bonds with the following characteristic:a. $50,000 total face valueb. 12% nominal ratec. 16% yield ratec. Interest dates are 1 February, 1 May, 1 August, and 1 Novembere. Bond date is 31 October 2004f. Maturity date is 1 November 2009 $1,000 of bond issue costs were incurred.
154. Provide the entries required on 1 August 2007 under the effective interest method of amortization.Ans: 1 August 2007 - interest payment date
Interest expense 1,103 Discount on bonds payable 203 Cash 900
Bond issue expense 35 Bond issue cost 35
$1,103 = $27,567 x 4%$900 = $30,000 x 3%$35 = (60% of issue remaining) x ($1,000 / 17)
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
155. Provide the entries required on 1 August 2007 under the straight line method of amortization.Ans: Interest expense 1,115
Discount on bonds payable 215 Cash 900Bond issue expense 35 Bond issue cost 35
$215 = $358 x 60%
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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Use the following to answer questions 156-162:
Four year term loan, U.S. $500,000Funds borrowed 1 January 20X6; due 31 December 20X9Exchange rates:1 January 20X6 U.S. $1 = Cdn. $1.3531 December 20X6 U.S. $1 = Cdn. $1.4031 December 20X7 U.S. $1 = Cdn. $1.4231 December 20X8 U.S. $1 = Cdn. $1.3631 December 20X9 U.S. $1 = Cdn. $1.39
156. Based on the above information prepare entries to record receipt of loan proceeds for January 20X6.Ans: Cash ($500,000 x 1.35) $675,000
Long term debt $675,000Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
157. Based on the above information prepare entries to record the adjustment to spot rate for December 20X6.Ans: Exchange loss $25,000
Long term debt 500,000($1.35 - $1.40) $25,000Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
158. Based on the above information prepare entries to record adjustment to spot rate December 20X7Ans: Exchange loss $10,000
Long term debt 500,000($1.40 - $1.42) $10,000Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
159. Based on the above information prepare entries to record adjustment to spot rate December 20X8Ans: Long term debt 500,000($1.42 - $1.36) $30,000
Exchange gain $30,000Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
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160. Based on the above information prepare entries to record adjustment to spot rate December 20X9Ans: Exchange loss $15,000
Long term debt 500,000($1.36 - $1.39) $15,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
161. Based on the above information prepare entries to record repayment of loan December 20X9Ans: Long term debt 500,000($1.40 - $1.42) $695,000
Cash $695,000Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
162. Based on the above information calculate the total accounting recognition of loss.Ans: 20X6 $ 25,000 dr.
20X7 10,000 dr.20X8 30,000 cr. 20X9 15,000 dr.Total $ 20,000 dr.
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5
163. ABC Inc issued $10,000,000 worth of bonds on January 1st, 2008. The bonds mature on December 31st, 2017 and carry a coupon rate of 6% payable semi-annually on June 30th and December 31st of each year. A market interest rate of 8% was effective throughout 2008.
Required:
1) Were the bonds issued at a premium or a discount?2) Prepare all journal entries required during 2008.3) Assume that on January 1st 2009, ABC decided to retire half of the bonds for $4,800,000 in
cash. Prepare the required journal entry.
Ans:
1) The bonds were issued at a discount – market rate exceeds nominal (coupon) rate.
2) January 1st, 2008:
Cash $8,640,999Bond Discount $1,359,001
Bonds Payable $10,000,000
June 30th, 20X8
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Interest Expense $345,640Bond Discount $ 45,640Cash $300,000
Dec 31st, 20X8
Interest Expense $359,466Bond Discount $ 59,466Cash $300,000
3) Bonds Payable $5,000,000Loss on Bond Disposal $ 428,448
Bond Discount $ 628,448Cash $4,800,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5, 6
164. GHI Inc issued $5,000,000 worth of bonds on January 1st, 2008. The bonds mature on December 31st, 2017 and carry a coupon rate of 4% payable semi-annually on June 30th and December 31st
of each year. A market interest rate of 6% was effective throughout 2008.
Required:
1) Were the bonds issued at a premium or a discount?2) Prepare all journal entries required during 2008.3) Assume that on January 1st 2009, ABC decided to retire ALL of the bonds for $5,500,000 in
cash. Prepare the required journal entry.
Ans:
1) The bonds were issued at a premium – market rate is less than nominal (coupon) rate.
2) January 1st, 2008:
Cash $5,743,894Bond Premium $ 743,894Bonds Payable $5,000,000
June 30th, 20X8
Interest Expense $172,317Bond Premium $ 27,683
Cash $200,000
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Dec 31st, 20X8
Interest Expense $170,509Bond Premium $ 29,491
Cash $200,000
3) Bonds Payable $5,000,000Gain on Bond Disposal $ 186,720
Bond Premium $ 686,720Cash $5,500,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5, 6hzzled
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test BankChapter 13 – Shareholders’ Equity
1. Businesses engage in many transactions that are unaffected by the form of the business: proprietorship, partnership, or corporation.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
2. The primary sources of owners' equity must be separately identified in the accounts.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 1
3. Preferred shareholders normally have the same voting rights as common shareholders.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
4. Shareholders in a corporation usually have limited liability.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
5. The contributed capital accounts should be classified by source.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 1
6. Retained Earnings restrictions are usually imposed on a company by a third party.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 5
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7. Before a company can issue a property dividend in shares of another company, it must ensure that the shares are recorded at market value. The dividend is then paid out of the company’s contributed capital accounts rather than its retained earnings.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO21
8. Under IFRS, companies are required to disclose the components of their shareholders’ equity along with an explanation of any shareholder equity transactions during the year.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1, 9
9. Preferred shares generally have fewer voting rights than common shareholders but receive preferential treatment (relative to the common shareholders in the event of the company’s liquidation.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
10. All unrealized gains and losses, regardless of origin, flow through Other Comprehensive Income.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1, 9
11. Retained earnings, if not designated otherwise, represents the unappropriated portion of retained earnings.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
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12. Total retained earnings include both appropriated and unappropriated retained earnings.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 5
13. Property dividends are dividends that the corporation distributes in the form of noncash assets.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 6
14. All Contributed Capital accounts may carry either a debit or a credit balance, depending on the transactions from which the account balance originated.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 3
15. When a corporation declares a small stock dividend, it should capitalize the par value of the shares.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 7
16. A large stock split should be accounted for by capitalizing the current market value of the stock.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 7
17. A stock dividend and a stock split are identical in all respects for the corporation issuing the dividend or splitting the stock.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6, 7
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18. When stock rights are issued to current shareholders, it may require more than one such right to later acquire one additional share of the stock covered by the rights.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6, 7
19. Liquidating dividends are similar to stock dividends because neither one reduces total stockholders' equity.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO61
20. Dividends are paid when declared.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO61
21. Par value is typically set at a low amount so that the corporation can pay a minimum amount in dividends to the preferred shareholders.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 6
22. Only certain unrealized gains flow through Other Comprehensive Income – any realized gains flow through retained earnings.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO9
23. The shareholders of a corporation usually cannot be held legally liable for the debts of the corporation except to the extent that legal capital is impaired.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 2
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24. Legal capital is related directly to the total number of shares issued.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 2
25. Both preferred and common shares may be cumulative.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
26. A Statement of Changes in Shareholder Equity is mandatory under both IFRS and ASPE.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO8, 9
27. The position of common shareholders is less risky than the positions of both the creditors and preferred shareholders.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
28. Issuing a common stock dividend decreases common shares and increases retained earnings.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 6
29. Treasury shares held by management are considered to be issued but not outstanding.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 4
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30. The Treasury Share account is debited and credited at the cost of the shares repurchased.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 4
31. Common share subscriptions receivable should always be reported as a current asset.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 2
32. "Common shares subscribed" is credited in recording a common share subscription contract because the shares are usually issued at the time the contract is signed.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
33. If a corporation only has one class of shares, that class must be common shares.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 1
34. A bad debt loss is recognized when a subscriber to common shares defaults.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 2
35. Cumulative preferred shares usually carry the right, upon liquidation of the corporation, to dividends in arrears to the extent the corporation has retained earnings.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 2
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36. Convertible preferred shares are convertible (usually to common shares) at the option of the shareholder and not at the option of the corporation.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2, 3
37. The purchase of treasury stock reduces the number of outstanding shares, and if the treasury stock is subsequently resold, it is again classified as outstanding.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 4
38. Treasury shares cannot be voted, nor paid dividends, pending resale.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO41
39. The conversion of preferred shares into common shares results in no change in total shareholders' equity.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2, 3
40. When retained earnings are restricted, they must also be appropriated.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO5
41. When a company issues to its shareholders some shares of another corporation's stock that currently are held as an investment, the company is issuing a stock dividend.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 6, 7
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42. Dividends in arrears on cumulative preferred shares must be paid at the end of the accounting period if cash and retained earnings are available.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
43. Dividends in arrears on noncumulative preferred shares must be paid before dividends can be paid to the common shareholders.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO61
44. Dividends in arrears on cumulative preferred shares constitute a liability to the corporation that should be recorded (accrued).
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 6
45. The date of record for a cash dividend follows the date of payment and precedes the date of declaration.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 6
46. In accounting for dividends, the declaration date is the most important date because dividends are paid to whomever owns the shares on that date.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
47. A stock split results in the reduction of the par or stated value per share and a proportional increase in the number of shares outstanding.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO7
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48. In a stock split, only the content of contributed capital is changed, whereas in a stock dividend the amount of contributed capital is changed.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO7
49. The accounting treatment for ordinary and liquidating dividends differs. Ordinary dividends cause a debit to retained earnings and liquidating dividends cause a debit to contributed capital.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 6
50. Share issue costs may be charged to:A) Earnings.B) Share Capital.C) Retained Earnings.D) B or C.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
51. ABC Inc. issued 1,000 common shares and 3,000 preferred shares for a lump sum of $25,000. The fair market value of each share on the date of issue was $6 per common share and $8 per preferred share. How much of the proceeds received should be allocated to the preferred shares on the date of issue?A) $5,000B) $20,000C) $6,250D) $19,750
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
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52. The conversion from one type of share to another is accounted for at:A) Book Value.B) Fair Market Value.C) A or B.D) A discounted amount.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO 2
53. Preferred shares, which have the most restrictive features, are:A) Noncumulative, non-participating, nonvoting.B) Fully participating, nonvoting.C) Noncumulative, fully participating, nonvoting.D) Non-participating, cumulative, nonvoting.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO 2
54. Gains on sale of treasury stock should be credited to:A) Additional contributed capital.B) Other income.C) Share capital.D) Retained earnings.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO 4
55. Treasury shares are said to be:A) Issued.B) Outstanding.C) A and B.D) A or B.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO 4
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56. Ryan Corp. has the following share capital outstanding:Common, 10,000 sharesPreferred $1.80 noncumulative, non-participating, 10,000 sharesDividends are two years in arrears, excluding the current year. Total dividends of $90,000 will be paid for the current year. The total amounts that will be received by the preferred shareholders and common shareholders are:
Preferred Shareholders Common Shareholders1 $36,000 $54,0002 $18,000 $72,0003 $90,000 $04 $54,000 $36,000
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
57. The following owners' equity section of a firm's balance sheet relates to the current year (end-of-year data):8%, $100 par cumulative preferred shares $10,000$5 par common shares 40,000Contributed capital in excess of par-preferred shares 5,000Contributed capital in excess of par-common shares 20,000Retained earnings 60,000Treasury stock (10,000)Total owners' equity $125,000
========How many common shares are issued?A) 8,000B) 6,000C) 7,000D) There is insufficient information provided to answer the question.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
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58. LS issued 200 common shares to BH (last share transaction was a year prior when LS sold 10 shares at $4 per share), and received a patent in full payment. The patent had a current market value of $2,000 and was carried on the books of TX at $1,500. Under ASPE, common shares should be credited for:A) $800B) $1,500C) $1,800D) $2,000E) This transaction has no commercial substance, therefore no entry is required.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO 2, 9
59. SXC reported the following data on its 1999 statement of financial position:Common shares no par $202,000
Common shares subscribed 18,000Retained earnings 175,000
If the average price paid for all of the common shares sold and subscribed were $5.00, the total number of sold and subscribed shares was:A) $44,400B) $40,400C) $44,000D) $40,000E) None of these answers is correct
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
60. DWWR purchased its own common shares for $20,000 and debited the treasury stock account for the purchase price. The shares were subsequently sold for $17,000. The $3,000 difference between the cost and sale price should be recorded as a reduction of:A) Contributed capital from treasury stock transactions without regard as to whether or not
there have been previous net "gains" from sales or retirements of the same class of shares.B) Contributed capital from treasury stock transactions to the extent of previous net "gains"
from sales or retirements of the same class of shares; otherwise retained earnings should be reduced.
C) The beginning balance of retained earnings.D) Revenues on the income statement.
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO4
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61. XHC had only two share transactions. Initially, XHC issued 1,000 common shares, at $15 per share. XHC later bought back 200 shares at $16 per share. Under the single-transaction method, what is the amount that should be recorded in the treasury stock account?A) $2,000B) $3,000C) $3,200D) $3,600
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO 4
62. Identify the missing component (X) in the following equation: Retained earnings, ending balance = Net income to date + prior period adjustments to date - cash and property dividends to date - XA) Stock dividends and splits to date.B) Stock dividends to date.C) Stock splits to date.D) Net unrealized gain or loss on securities available for sale.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO 6
63. Cash dividends sometimes are declared in one reporting period and are payable in the next reporting period. The dividend should be recorded on the:A) Payment date.B) Declaration date.C) Record date.D) Either the declaration, record, or payment date, as preferred by the company.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO 6
64. A property dividend causes a debit to retained earnings equal to the ___________ of the property distributed:A) Book valueB) Fair market valueC) Original costD) Income tax basis
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO 6
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65. CB Corporation issued a 2 for 1 stock split. Which of the following is not a true statement concerning the effect of the split?A) The number of shares outstanding is increased.B) There is a transfer of retained earnings to contributed capital.C) A proportionate reduction in the par value per share occurs.D) There is a continuation of retained earnings with no reduction in its balance.
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO 7
66. On December 31, 1999, when JR Corporation's shares were selling at $44 per share, its shareholders' equity accounts were as follows:Common shares (no par value) 100,000
shares issued and outstanding $2,700,000Retained earnings (credit) 4,450,000
A 100 percent stock dividend was declared and issued. The effect of this dividend was:A) Total retained earnings did not change.B) Common shares increased to $5,600,000.C) Common shares increased to $6,460,000.D) Total shareholders' equity decreased.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO6
67. Which of the following dividends does not reduce retained earnings?A) Scrip dividend.B) Stock dividend.C) Cash dividend.D) Property dividend.E) Liquidating dividend.
Ans: EDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
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68. For dividends, the date of record is the date:A) The market price of the shares drops due to the dividend.B) On which the list of shareholders is prepared.C) The dividend is actually paid.D) The dividend is announced.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
69. Major factors contributing to the growth of the corporate form of business includes all of the following except:A) The facility to accumulate large amounts of resources.B) Limited liability of the shareholders.C) Easy transferability of ownership.D) The lack of government regulation.
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
70. Total equities of a corporation usually include:A) Assets plus contributed capital, and plus retained earnings.B) Contributed capital plus retained earnings.C) Contributed capital plus retained earnings, and plus creditors' interest.D) Total owners' equity less treasury stock at cost.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
71. Owners' equity must equal the:A) Total contributed capital plus retained earnings less liabilities.B) Sum of the share capital account balances plus the total contributed capital in excess of par
(or stated value).C) Total assets minus total liabilities.D) Total contributed capital plus total retained earnings.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
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72. ABC Inc. engages in a non-cash exchange with a third party whereby ABC Inc. issues common shares to the third party in exchange for some highly specialized Machinery & Equipment. The value of the shares issued was $15,000 while the appraised value of the Machinery & Equipment was $12,000. At what amount would this transaction be valued on ABC’s books?A) $12,000 under IFRS and $15,000 under ASPE.B) $15,000 under IFRS and $12,000 under ASPE.C) $12,000 under either ASPE or IFRS.D) $15,000 under either ASPE or IFRS.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO 9
73. Under IFRS, the treatment of any of a company’s foreign subsidiary is dependent upon:A) The functional currency of the subsidiary.B) The nature and extent of the parent company’s relationship with the subsidiary.C) A or B.D) Managerial judgement.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO 9
74. Which of the following is not a basic right of shareholders?A) To inspect the books of account and to insist upon an audit in the event of dissatisfaction
with results revealed by such inspectionB) To participate in the management of the corporation through taking part in and voting in
shareholders' meetingsC) To participate in the profits of the corporation through dividends declared by the board of
directorsD) To share in the distribution of assets of the corporation at liquidation or through liquidating
dividendsE) To sell shares in the corporation at a price exceeding its cost.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
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75. Ownership of shares usually entitles the holders to all of the following rights except:A) To elect the board of directors of the corporation.B) To control the day-to-day operations of the corporation.C) To purchase new shares when they are offered for sale.D) To share in the profits of the corporation.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
76. Authorized share capital refers to the total number of shares:A) Outstanding.B) Issued.C) That can be issued in conformity with the corporation's charter.D) Issued, less all treasury shares owned.
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO 2
77. Issued share capital refers to the number of shares:A) Outstanding.B) Outstanding less all shares held as treasury shares.C) Outstanding plus all shares held as treasury shares.D) That may be issued according to the corporate charter.
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO 2
78. Share capital may be classified primarily as:A) Par Value, Common; or Nopar, Preferred.B) Nopar, Common; or Par Value, Preferred.C) Par Value, Common; Nopar, Common; Par Value, Preferred; or Nopar, Preferred.D) Par Value, Common; Stated Value Common; or Nopar, Preferred.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
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79. At the date of the financial statements, common shares issued would exceed common shares outstanding as a result of the:A) Payment in full of subscribed shares.B) Declaration of a stock split.C) Declaration of a stock dividend.D) Purchase of treasury stock.
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO 2
80. Zygo sold 1,000 common shares (par $3) at $5 per share on a subscription basis. The entry to record this transaction included a credit to:A) Accounts receivable.B) Contributed capital in excess of par.C) Common shares.D) Subscriptions receivable.
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO 2
81. When a corporation sells some of its own common shares, all on credit, there should be a debit to the account:A) Subscriptions receivable, common.B) Accounts receivable.C) Cash.D) Notes receivable, common.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
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82. If preferred shares are noncumulative, then:A) The preferred shareholders are entitled to current dividends before common shareholders
can receive dividends.B) Cash dividends not declared in prior years are lost permanently.C) The preferred shareholders are only entitled to a specific percent of the cash dividends,
regardless of the amount declared.D) Prior years' cash dividends must be paid to the preferred shareholders before any dividends
may be paid to the common shareholders.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
83. If preferred shares are non-participating, then:A) Preferred shareholders are not entitled to vote.B) Preferred dividends for the year are limited to a specific rate.C) Preferred shareholders are not entitled to a prior year's dividend once that year has passed.D) Preferred shareholders may receive dividends in excess of a specific rate if common
stockholders receive more than that specific rate.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
84. The redemption privilege on preferred shares provides that the preferred shareholders can:A) Purchase treasury shares any time they become available.B) Purchase enough shares of any new issue, so that their percentage ownership remains the
same.C) Turn in the preferred shares for a specified cash price.D) Exchange the preferred shares for common shares.
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO 2
85. If preferred shares are callable, then:A) The corporation may, at its option, purchase the preferred shares for a specified cash price.B) The preferred shareholder can turn the preferred shares in for a specified cash price.C) The shareholders can exchange the preferred shares owned for common shares.D) There cannot be dividends in arrears.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
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86. The order in which dividends are allocated to common and preferred shares depends upon the provisions in the respective stock contracts. Choose the correct statement regarding this allocation.A) When noncumulative preferred shares are fully participating, the rate of dividends
allocated to preferred shares is the ratio of total par of preferred shares outstanding to total par of both classes of shares outstanding
B) When noncumulative preferred shares are not participating, the rate of dividends to common shares are limited to the ratio of total par of common shares outstanding to total par of both classes of shares outstanding
C) When 8% cumulative preferred shares are participating to a total of 12%, any arrear dividends are ignored in the allocation since they pertain to a previous year
D) When 8% noncumulative preferred shares are participating to a total of 12%, the preferred shares must receive all arrear dividends and 12% of total preferred shares par outstanding prior to common shares receiving any dividends
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
87. As of January 1, 2011 there are 2 years of dividends in arrears on an issue of cumulative nonconvertible preferred shares. No dividends on preferred shares were declared in 2011. Therefore, under IFRS, on the Dec. 31, 2011 financial statements, the firm issuing the preferred shares:A) Reports a liability equal to 3 years of dividends on preferred sharesB) Reports a liability equal to 2 years of dividends on preferred sharesC) Subtracts 3 years of dividends on preferred shares from earnings when computing earnings
per share for 2011D) Discloses in a footnote to 2011's balance sheet that there are 3 years of dividends on
preferred shares in arrearsE) Discloses in a footnote to 2011's balance sheet that there are 2 years of dividends on
preferred shares in arrears
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO6, 9
88. The number of treasury shares held by a corporation equals:A) The difference between issued shares and outstanding shares.B) The difference between authorized shares and outstanding shares.C) All shares held by the treasurer of the corporation.D) All shares purchased by shareholders due to their pre-emptive right.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO4
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89. Under the single transaction method, the difference between the cost of treasury stock and a subsequent higher selling price of the treasury stock should be credited to:A) Retained earnings.B) Share capital.C) Gain from treasury stock transaction.D) Contributed capital.
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO4
90. How should a gain from the sale of treasury stock be reflected when using the single transaction method of recording treasury stock transactions?A) As an extraordinary item shown on the income statementB) As ordinary earnings shown on the income statementC) As contributed capital from treasury stock transactionsD) As an increase in the amount shown for common stock
Ans: C
Difficulty: MediumLevel of Learning: ApplicationTopic: LO4
91. Losses that a corporation suffers from dealing in its own stock may:A) Be recorded as a long-term loss.B) Be recorded in the retained earnings account.C) Be recorded as a loss from peripheral or incidental transactions (i.e., not from continuing
operations).D) Never be recorded in the retained earnings account.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
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92. Which of the following is NOT a true statement? Treasury stock is:A) Shares that cannot receive dividends nor vote.B) Shares that are held by the issuing company but has not been retired.C) Recorded in an equity account that has a debit balance.D) Shares that have been issued but are no longer outstanding.E) Shares that are included in earnings per share calculations.
Ans: EDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
93. When all of the preferred shares are purchased and formally retired by the issuing corporation for less than its original issue price, accounting for the retirement increases:A) Retained earnings.B) Contributed capital in excess of par, common stock.C) Net income for the period.D) Contributed capital from retirement of preferred shares.
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO 3
94. The owners' equity section of a firm's balance sheet reflects the following at the end of the current year:
$6 Preferred shares, 3,000 shares outstanding $300,000Common shares, 100,000 shares outstanding 500,000
(Matching dividend, if applicable, $.30)The preferred shares participate up to a maximum of $8 ($2 additional participation). There were two years of dividends in arrears on the preferred shares at the beginning of the current year. If the firm declares $110,000 in dividends at the end of the current year, what portion of that amount is distributed to the common shareholders?A) $50,000B) $30,000C) $54,000D) $60,000
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO 2, 6
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95. The increases in account balances of XYZ during 1999 are presented below:
Assets $456,000 Common Shares 240,000Liabilities 148,000 Other Contributed Capital 24,000
Assuming the only debit to retained earnings was for a dividend of $52,000, net income for 1999 was:A) $8,000B) $68,000C) $96,000D) $104,000
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
96. On December 31, 1999, TTX reported owners' equity of $150,000. During 2000, TTX declared and paid cash dividends of $30,000; reported a net loss of $15,000; issued additional common shares (nopar) for $70,000; and purchased treasury stock at a cost of $15,000 (cash), Therefore, the 2000 ending amount of shareholders' equity was:A) $160,000B) $170,000C) $215,000D) $230,000
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
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97. The following data is available for XAC:
Common shares, no par 10,000 shares authorized, 8,000 shares outstanding
$120,000
Common shares subscribed ?Subscriptions receivables (40% uncollected) 12,000
Find the number of shares subscribed and the subscription price per share?
Shares Outstanding Average Issue Price1 5,000 $25.002 5,000 $12.003 1,200 $25.004 1,200 $12.00
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
98. On January 1, 2000, DDB agreed to purchase 4,000 of CTC's common shares at $5 per share. Cash payment in full, including 10% interest, is to be paid one year later at which time the shares will be issued. The appropriate journal entry for CTC to record the transaction on January 1, 2000, would include a:A) Debit to Cash for $20,000.B) Credit to Common Shares Subscribed for $20,000.C) Credit to Cash $20,000.D) Debit to Subscriptions Receivable for $18,000.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
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99. During 1999, BV sold and issued the following shares for $20,000 cash:Common shares, 600 shares (current market price per share, $23.50).Preferred shares, 200 shares (no current market price available); original issue price, three years earlier, $22 per share.The total issue price of $20,000 that should be apportioned to the preferred shares is:A) $4,000B) $4,400C) $5,900D) $8,000
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO 2
100. ABC had 20,000 shares of treasury common stock, which it purchased for $7 per share. Until now, this was ABC's only treasury stock transaction. The shares were originally sold and issued at $5 per share. ABC uses the single-transaction method. ABC is now selling the treasury shares for $5 per share. The entry to record the resale would include a:A) Credit to Treasury stock for $100,000.B) Debit to Retained earnings for $40,000.C) Debit to common shares for $140,000.D) Credit to common shares for $100,000.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
101. TTSS Corporation had 1,000 common shares issued and outstanding (sold at $40 each). It then made its first-ever purchase of treasury stock by buying 200 of its own shares for $50 per share. Assume sufficient retained earnings. The entry to record this purchase using the single-transaction method would include:A) dr. common shares $8,000B) dr. common shares $10,000C) dr. contributed capital from treasury stock transactions $2,000D) dr. treasury stock $10,000
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
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102. When treasury stock accounted for by the single-transaction method is subsequently sold for more than its purchase price, the excess of the cash proceeds over the carrying value of the treasury stock should be recognized as:A) an unusual gain.B) Income from continuing operations.C) Increase in contributed capital.D) Increase in retained earnings.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
103. A restriction of retained earnings is most likely to be required by the:A) payment of last maturing series of a serial bond issue.B) amortization of intangible assets.C) purchase of treasury stock.D) exhaustion of potential benefits of the investment credit.
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO7
104. An appropriation of retained earnings of a significant amount:A) Means that specific assets actually have been set aside for a specific purpose.B) provides protection to the stockholders rather than to the creditors.C) Can have a significant impact on the total amount of retained earnings when recorded.D) Can be used to absorb extraordinary losses directly when of a significant amount.E) Should be reversed when the purpose of the appropriation has been achieved.
Ans: EDifficulty: MediumLevel of Learning: ApplicationTopic: LO 7
105. When noncash assets are issued as a dividend, those assets should be re-valued as of the:A) Announcement date.B) Recording date.C) Declaration date.D) Issuance date.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO 2, 6
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106. Which of the following represents the interest period for a scrip dividend?A) Record date to payment dateB) Declaration date to payment dateC) Record date to ex-dividend dateD) Declaration date to ex-dividend date
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
107. X Corporation owns 15% of the outstanding shares of Z Corporation. The Z stock is distributed to the shareholders of X Corporation as a dividend at its current market value. This is an example of a:A) scrip dividend.B) cash dividend.C) stock dividend.D) property dividend.
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO6
108. The declaration of a property dividend results in:A) a debit to retained earnings.B) a credit to retained earnings.C) either a debit or a credit to retained earnings.D) no effect on retained earnings.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO6
109. If a company desires to pay a cash dividend, but does not want to increase its liabilities, it can:A) pay the dividend only out of retained earnings.B) issue a scrip dividend.C) pay the dividend on declaration date.D) pay the dividend on the ex-dividend date.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
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110. The declaration and payment of a cash or property dividend requires:A) an appropriation of retained earnings.B) the distribution of a current asset.C) a reduction of both retained earnings and assets.D) a decrease in retained earnings and a change in contributed (paid-in) capital.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
111. On January 10, 1999, ZOE Corporation declared a cash dividend when the related shares were selling for $10 per share. ZOE prepared the list of shareholders on February 10, 1999 at which time the shares were still selling for $10 per share. However, on February 11, 1999 the shares were selling for $8 per share. The dividend was paid on March 1, 1999 when the shares were selling for $9 per share. The ex-dividend date must have been:A) January 10/99.B) February 10/99.C) February 11/99.D) March 1/99.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
112. Cash dividends usually are declared on one date and paid on a subsequent date to shareholders of record on some intermediate date. On which of the following dates should an accrual basis shareholder recognize investment revenue?A) Record dateB) Declaration dateC) Payment dateD) Either record date or declaration date
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO6
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113. The declaration and issuance of a common stock dividend:A) Does not change the internal content of retained earnings.B) Does not change assets, liabilities or total owners' equity.C) Decreases total owners' equity and increases the related common stock account.D) Decreases assets and decreases total owner's equity.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
114. A common stock dividend does not:A) Change a shareholder's proportionate interest in the corporation.B) Result in the shareholder receiving additional shares.C) Change the proportions among the different sources of shareholders' equity.D) Change the total amount in the related common shares account.
Ans: ADifficulty: Medium
Level of Learning: ApplicationTopic: LO6
115. Stock splits are often issued primarily to:A) Reduce the market price per share.B) Increase permanent capital.C) Decrease the liability for dividends in arrears.D) Give the shareholders more voting rights.
Ans: A
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
116. A stock dividend,A) If less than 20 to 25%, reduces retained earnings by the par value of shares distributed in
the dividendB) Increases the wealth of the recipient if the market value of the shares are unchanged by the
stock dividendC) Alters the par value of the common sharesD) If 100%, has no effect on the market value of the shares
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
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117. Choose the most correct statement regarding a 2-for-1 stock split and a 100% stock dividend.A) Neither affects par valueB) Both cause the same reduction in retained earningsC) Both double the number of shares outstandingD) Both cause a significant increase in the common share accountE) Only one affects contributed capital in excess of par on common shares
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
118. A 3-for-1 common stock split,A) Decreases retained earnings by the par value of shares distributed in the splitB) Will likely not affect the market value of the stockC) Has no effect on common share accountD) Will cause a change in the allocation of dividends to common stock relative to preferred
stock
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO6, 7
119. The effect of a stock dividend is to reduce:A) total stockholders' equity.B) retained earnings and the par value of each share.C) retained earnings and increase legal capital.D) total assets and reduce total stockholders' equity.
Ans: C
Difficulty: MediumLevel of Learning: ApplicationTopic: LO6
120. Which of the following statements concerning stock dividends is correct?A) The declaration of a stock dividend should not be recorded as a liability even though it has
not yet been issued.B) The issuance of a stock dividend increases total stockholders' equity.C) Courts generally have held that stock dividends, once declared, are irrevocable by the
board of directors; therefore, a stock dividend declared, but not yet issued is a liability.D) A stock dividend cannot use treasury stock.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO6
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121. XY Company: Common shares outstanding, 10,000; average issue price, $115; current market price, $140. Shares sold on a stock subscription basis are not issued until the subscription price is collected in full. Recording a declaration of a 10 percent stock dividend in conformity with generally accepted accounting principles would change retained earnings:A) On the basis of the market value of shares.B) By 10 percent of its balance before the dividend.C) On the basis of an arbitrary value of shares.D) On the basis of the average paid-in value of shares.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO6
122. Fractional share rights are usually issued:A) When a corporation issues a stock split.B) At the time a property dividend is declared.C) At the time a cash dividend is declared.D) At the time a stock dividend is declared.
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
123. When a corporation issues a dividend in excess of the balance of its retained earnings account, it is issuing a:A) Scrip dividend.B) Stock dividend.C) Property dividend.D) Liquidating dividend.
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO6
124. A dividend that constitutes a return of contributed capital rather than earnings is called a:A) Property dividend.B) Liability dividend.C) Liquidating dividend.D) Capital dividend.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
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125. If a corporation has dividends in arrears on preferred shares, they should also:A) Capitalize retained earnings for the dividends.B) Declare the dividends.C) Record a liability for the dividends.D) Report the dividends in arrears.
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
126. If a corporation has dividends in arrears of $25,000 on its cumulative preferred shares, it must:A) Set aside cash for the amount of the dividends.B) Pay the dividends in arrears before it can pay dividends to its common shareholders.C) Capitalize this amount as a part of permanent capital.D) Appropriate retained earnings for this amount.
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO6
127. XYZ reported the following on its December 31, 1999, balance sheet: common shares, nopar, $200,000; unappropriated retained earnings, $40,000; appropriation of retained earnings for bond sinking fund, $10,000; and reserve for possible future inventory losses, $5,000. Therefore, the last line on the retained earnings statement, total appropriated and unappropriated retained earnings should be:A) $55,000B) $15,000C) $40,000D) $10,000
Ans: ADifficulty: Medium
Level of Learning: ApplicationTopic: LO7
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128. A firm declares a property dividend to its shareholders. The assets to be distributed in the dividend have a combined book value of $40,000 and combined market value of $60,000. Before taxes, the net change in retained earnings as a result of this nonreciprocal transfer is:A) $40,000B) $60,000C) $20,000D) $0
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO6
129. You happen across the balance sheet of a firm, which discloses $40,000 of ending retained earnings, $10,000 of which is appropriated for plant expansion. This firm is not a natural resources firm. Therefore:A) the firm has $30,000 of cashB) the firm has $40,000 of cashC) the maximum allowable dividend cannot exceed $30,000D) the firm has never distributed a stock dividend
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO7
130. ABC declared a common stock dividend on March 10, at which time its shares were selling for $15 per share and 10,500 shares were outstanding. After the dividend, because only 13,650 were outstanding, some shareholders received fractional share rights. If the provisions of the dividend provided that one share was to be issued for each three shares previously owned, there must have been:A) 1,050 fractional share rights outstanding.B) 350 fractional share rights outstanding.C) 117 fractional share rights outstanding.D) Fractional shares outstanding not determinable based on the information given.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO6
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131. RST had the following shareholders and the shares owned by each on November 15:
Shareholder Shares Owneda 1,999b 1,555c 1,699d 2,132e 1,900Total 9,285
On that date, RST declared a 1 for 2 common stock dividend. The stock was selling for $10 per share. RST issued fractional share rights when necessary. RST had to issue the following number of fractional share rights:A) More than three.B) Three.C) Two.D) One.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
132. The December 31, 1999, the balance sheet of TXY reflected the following:
Total assets (market value $298,000) $252,000========
Total liabilities $70,000Preferred shares,$.10 cumulative, non-participating, liquidation preference $ 2.20per share, 20,000 shares outstanding 50,000
Common shares, nopar, 30,000 shares outstanding 120,000Retained earnings (no dividends were declared or paid in 1998 - 1999) 12,000 Total $252,000
=======
Assume the company sold all of the assets at December 31, 1999, at market value for cash; paid off the liabilities and distributed all of the remaining cash to the shareholders. The amount of cash per share that each common shareholder would receive would be:A) $4.47B) $5.93C) $6.00D) $8.27
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
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133. Effective April 8, 2000, the shareholders of Kim Corporation approved a 2 for 1 split of the company's common shares, and an increase in authorized common shares from 100,000 shares to 200,000 shares. Kim's shareholders' equity accounts immediately before issuance of the stock split shares were as follows:Common shares, 100,000 shares authorized;50,000 shares outstanding $2,250,000Retained earnings 2,150,000
What should be the balances in Bennett's common shares and retained earnings accounts immediately after the stock split?
Common Shares Retained Earnings 1 $ 2,300,000 $ 1,350,0002 $ 1,150,000 $ 200,0003 $ 2,300,000 $ 200,0004 $ 2,250,000 $ 2,150,000
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO6, 7
134. The dollar amount of total shareholders' equity remains the same for the:A) Issuance of preferred shares in exchange for convertible debentures.B) Issuance of nonconvertible bonds with detachable stock purchase warrants.C) Declaration of a cash dividend.D) Declaration of a stock dividend.
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO8
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135. On January 1, 2000, WVC split its common shares 4 for 1 when the market value was $80 per share. Prior to the split, WVC had 50,000 common shares issued and outstanding (average issue price $12 per share). After the split, the average issue price of the shares was reduced:A) By $3 per share.B) To $3 per share.C) To $4 per share.D) To $2.40 per share.E) No change in the par value.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO7
136. Accounting recognition must be given to common share subscriptions on the subscription date:A) to guarantee the receipt of dividends subsequent to the subscription date.B) because the dollar amount is usually large.C) because all events relating to the common share accounts must be disclosed.D) because a legal contract is involved.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
137. A company reacquires its own shares during the fiscal year and reports the transaction in the theoretically correct manner. What effect will this transaction have on shareholders' equity and earnings per share, respectively?A) Increase and decreaseB) Decrease and decreaseC) Decrease and increaseD) Increase and no effect
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO4
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138. XV Corporation has 1,000 shares of treasury stock (common shares). It was originally issued at $15 per share and was reacquired at $10 per share. XV Corporation has decided to formally retire these shares; the current market price is $9. The single-transaction method is used. The entry to record the retirement of the shares should include the following:A) Contributed capital from common share retirement, credit, $5,000.B) Gain on retirement of common shares, $5,000.C) Unusual gain, $5,000.D) Retained earnings credit, $5,000.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO4
139. The owners' equity section of a firm's balance sheet reflects the following at the end of the current year:$6 Preferred shares, 3,000 shares outstanding $300,000Common shares, 100,000 shares outstanding 500,000(Matching dividend, if applicable, $.30)The preferred shares participate up to a maximum of $8 ($2 additional participation). There were two years of dividends in arrears on the preferred shares at the beginning of the current year. If the firm declares $90,000 in dividends at the end of the current year, what portion of that amount is distributed to the preferred shareholders?A) $54,000B) $56,250C) $60,000D) $55,250
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
140. BX had the following shares outstanding:Preferred shares, $6, 2,000 shares $100,000Common shares, 2,000 shares $200,000
(Matching dividend, if applicable, $12)The preferred shares are cumulative, fully participating; dividends are three years in arrears, excluding the current year; dividends declared in the current year amount to $87,000. The total amount of dividends to which common shareholders are entitled is:A) $33,000B) $40,000C) $49,000D) $52,000
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO6
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141. DX had the following shares outstanding:Preferred shares, $3, 2,000 shares $100,000Common shares, 2,000 shares $200,000(Matching dividend, if applicable, $6)The preferred shares are cumulative, fully participating; dividends are three years in arrears, excluding the current year; dividends declared in the current year amount to $42,000. The total amount of dividends to which preferred shareholders are entitled is:A) $16,000B) $20,000C) $24,500D) $26,000
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
142. Lorella entered into a common share subscription contract for 1,000 shares at a subscription price of $20. She paid 20% of the total price as a down payment and also paid the next two 20% instalments (she paid 60% in all). Lorella then defaulted on the contract and refused to pay any more. Assuming the company must issue shares in proportion to the cash paid, the entry to record the default would include:A) dr. common shares $12,000B) dr. common shares subscribed $12,000C) dr. subscriptions receivable $8,000D) dr. common shares subscribed $20,000
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO2
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143. CRC reported the following on its 1995 balance sheet:$6 Preferred shares, no par $62,000Common shares, no par 320,000Retained earnings 240,000Given common shares outstanding, what is the average issue price per common share?
Shares Outstanding Average Issue Price1 200,000 $1.412 100,000 $2.823 50,000 $6.404 40,000 $8.805 None of these
A) Choice 1B) Choice 2C) Choice 3D) Choice 4E) Choice 5
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
144. YTC sold and issued 200 of its common shares, true no-par, at $12 per share. Assuming no specific legal requirements, the common share account should be credited for:A) $200B) $240C) $2,000D) $2,400
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO2
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145. ABC made the following entry to record the issuance of a dividend:
Retained earnings 40,000 Common shares 40,000ABC must have declared a:A) stock split.B) Property dividend.C) Large stock dividend.D) Small stock dividend.
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
146. MNO declared a stock dividend when it had 40,000 shares outstanding. After issuing the dividend, 7,200 additional shares and 4,000 fractional share rights were outstanding. If it requiredfive fractional share rights to acquire a new share, this dividend must have been a:A) 5 percent stock dividend.B) 10 percent stock dividend.C) 15 percent stock dividend.D) 20 percent stock dividend.
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO6
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147. BAX declared a stock dividend, which provided that each shareholder would receive one share for each ten shares currently owned. Fractional share rights were issued to each shareholder for the number of shares issuable. The rights can be bought and sold, but must be exercised within 3 months. The equity accounts had the following balances on the declaration date:Common shares (market price $15) $ 25,000Treasury stock, single-transaction method (400 shares) 4,000Retained earnings 140,000Assuming an entry is made on declaration date, BAX would properly record the declaration as follows:
1 Retained earnings 2,100 Common stock dividend issuable 2,100 2 Retained earnings 3,150 Common stock dividend issuable 3,150 3 Retained earnings 2,500 Common stock dividend issuable 2,500 4 Retained earnings 3,750 Common stock dividend issuable 3,750
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
148. Match the following terms with the appropriate definitions.A. Contributed capitalB. Legal capitalC. Shareholders' equityD. Total equity___ 1. The investment made by the entrepreneurs; that is, the total amount "invested" by all
parties other than creditors.___ 2. The total equity at any given time of the legal owners of the enterprise. It is the total of
the proprietorship equity including both contributed capital and subsequent accretions thereto.
___ 3. Represents the total claims of all parties in the assets of the business. It is the sum of the liabilities and owners' equity.
___ 4. hat portion of corporate capital required by statute to be retained in the business for protection of creditors.
Ans: 1: A, 2: C, 3: D, 4: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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149. XAC received a share subscription from J. Doe for 100 of its common shares, issue price $15; one-third cash down payment. Provide the entry to record the subscription and partial payment.Ans:Cash ($1,500 x 1/3) 500Subscription receivable, common ($1,500 x 2/3) 1,000 Common shares subscribed (100 shares x $10) 1,500
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
150. YTC issued 200 of its preferred shares and 1,000 of its common shares, for a total cash consideration of $15,000. The current market prices for its shares were: Preferred, $25; Common, $20. The issue entry for the preferred and common shares combined would be as follows:Ans: The total consideration paid equals the sum of the market values of the individual
securities sold; therefore no allocation is necessary.Cash (given) 15,000 Preferred shares (20%) 3,000 Common shares (80%) 12,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
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151. Indicate the principle effects of a cash dividend (declared and paid), a stock dividend issued, and a stock split issued, on the financial statements of the issuing corporation. Respond as follows: I-for increase; D-for decrease; and N-no effect. Assume no stock warrants and no reverse stock splits.Stock
Cash Stock StockFinancial Statement Item Dividend Dividend Split(a) Contributed capital(exclusive of retained earnings) ____ ____ ____(b) Par value per share outstanding ____ ____ ____(c) Total amount of shares outstanding ____ ____ ____(d) Retained earnings (at year-end) ____ ____ ____(e) Number of shares outstanding ____ ____ ____(f) Net income (for the year of issuance) ____ ____ ____(g) Earnings per share (for the year of issuance) ____ ____ ____(h) Total assets (at year-end) ____ ____ ____(i) Total liabilities (at year end) ____ ____ ____(j) Total shareholders' equity(at year-end) ____ ____ ____Ans:
Cash Stock StockDividend Dividend Split
a) N I Nb) N N Dc) N I Nd) D D Ne) N I If) N N Ng) N D Dh) D N Ni) N N Nj) D N N
Difficulty: MediumLevel of Learning: ApplicationTopic: LO5, 6, 7
152. On July 1, 1999, NTC had outstanding 10,000 common shares, (originally sold at $12); the quoted market price currently is $16. The company declared and issued a 10% common stock dividend. Give the entry.Ans:Retained earnings (1,000 sh. x $16) 16,000 Common shares 16,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO6
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153. Match the following terms and definitions by entering the appropriate letters to the left.TermsA. Stock dividendB. Liability dividendC. Property dividendD. Cash dividendE. None of these.Definitions___ 1. Issuance of additional shares to each shareholder at no cost.___ 2. Issuance of a dividend that decreases both retained earnings and noncash assets.___ 3. Issuance of a stock split.___ 4. A dividend that does not change total assets, liabilities, or shareholders' equity.___ 5. A dividend that decreases cash and shareholders' equity when declared and paid.___ 6. A dividend that decreases retained earnings and increases contributed capital.
Ans: 1: A, 2: C, 3: E, 4: A, 5: D, 6: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO5, 6, 7
154. Several types of dividends and other items are identified below by letter. Match the type of dividends with its characteristic by entering letters in the spaces provided.Type of ItemA. Cash dividendB. Liquidating dividendC. Property dividendD. Stock dividendE. Stock splitF. Stock dividend and stock splitG. None of theseCharacteristic___ 1. Increases the number of shares outstanding by decreasing the book value per share
proportionately.___ 2. Creates a current liability and decreases retained earnings when declared (no gain or
loss recorded).___ 3. Decreases retained earnings and increases contributed capital accounts.___ 4. Decreases retained earnings and noncash assets.___ 5. Results in no change to assets, debt, or total shareholders' equity.___ 6. Represents a return of capital rather than a distribution of earnings.
Ans: 1: E, 2: A, 3: D, 4: C, 5: F, 6: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
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155. Several years ago, a corporation set up a reserve for storm losses in the amount of $300,000 as an appropriation of retained earnings. During the current year, the company suffered a $85,000 hurricane loss that was not covered by insurance. The firm reduces appropriations when their purpose has been fulfilled. Give the entry(s) to record the loss and provide any appropriate explanation.Ans:Casualty loss 85,000 Plant 85,000Retained earnings, appropriated 85,000 Retained earnings 85,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
156. Propertee, Inc. declared a dividend on May 1 payable in shares of Milly, Inc. (original cost: $4 per share, acquired at the beginning of the current year) to Propertee shareholders of record on June 1. The payment date is July 1. The dividend requires 20,000 shares of Milly to be distributed. Market prices of Milly/share were: May 1: $6; June 1: $8; July 1: $9. Provide the entry at declaration of the dividend.Ans:Retained earnings 120,000 $6(20,000)Investment 40,000 ($6-$4)(20,000) Property dividend payable 120,000 Gain on investment 40,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO6
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157. On October 1, 1999, XBC declared a dividend to its common shareholders by issuing one share of YTC, preferred share, $.60 nopar (held as a long-term investment) for each of the 15,000 common shares of XBC. On declaration date, the YTC shares were selling at $7 per share. The YTC shares originally were purchased by XBC at $9 per share; they were transferred to the XBC shareholders on January 30, 2000, when their quoted market price was $7.50 per share. Give the following entries for XBC:(a) At date of declaration:(b) At date of payment:Ans: (a)At date of declaration: Retained earnings (15,000 sh. x $7) 105,000 Loss on disp. of investment 30,000 Investment in YTC preferred shares 30,000 Prop. dividend payable 105,000
(b)At date of payment: Prop. div. payable 105,000 Investment in YTC preferred shares 105,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO6
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158. ATC's balance sheet on December 31, 20x1, showed the following:
Cash $30,000 Current liabilities $90,000Other current assets. 70,000 Long-term liabilities 170,000Operational assets (net) 200,000 Common shares, 5000Other assets 100,000 shares outstanding 100,000
Retained earnings 40,000$400,000 $400,000
======== ========
Using this information, answer the following questions:
(a) What is the absolute maximum amount of cash dividends that can be paid immediately?_________________________________________.(b) What is the book value per common share? $_________________.(c) Assuming a $10,000 cash dividend is declared, what entries would be made on each of the following dates:(1) Declaration date:(2) Date of record:(3) Date of payment:Ans: (a) $30,000 (cash balance).
(b) $140,000 ÷ 5,000 = $28
(c)(1)Retained earnings 10,000 Dividends payable 10,000
(2) None
(3) Dividends payable 10,000 Cash 10,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO6
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159. On July 1, 1999, NDC had outstanding 20,000 common shares, (originally sold at $5 per share); the current quoted market price is $7 per share. The company declared and issued a 10% common stock dividend; however, stock rights for 100 fractional shares were issued (10 shares). The rights currently had a quoted market price of $.80 each. Give the entry to record the dividend.Ans:Retained Earnings (2,000 sh. x $7) 14,000 Common shares (1,990 sh. x $7) 13,930 Common stock warrants outstanding (100 ÷ 10) x $7 70
Difficulty: MediumLevel of Learning: ApplicationTopic: LO3
160. On July 1, 1999, the Board of Directors of BXC declared a stock dividend that required the issuance of 5,000 common shares. The common shares had a market value at this date of $18 per share. Retained earnings amounted to $900,000. Give the entry to record the stock dividend (the shares were issued), assuming:The 5,000 shares represented 10% of the previously outstanding shares.Ans:Retained earnings 90,000 Common shares (5,000 x $18 par value) 90,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO3
161. During December 1999, BRC declared and issued a 1 for 5 stock dividend on its 100,000 outstanding common shares. The per share amounts were: original average issue price $16; current market price (end 1999) $13; and the average market price for 1999, $15. Give the required journal entry to record the simultaneous declaration and issuance of the stock dividend.Ans: Small stock dividend-Use market value:Retained earnings (100,000 sh. ÷ 5) x $13 260,000 Common shares 260,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO3
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162. Match the following terms with the appropriate definitions.TermsA. Common sharesB. Preferred sharesC. Preferred shares, non-participatingD. Par value sharesE. Preferred shares, cumulativeF. No-par sharesG. No-par, stated value sharesH. Shares purchased on creditDefinitions___ 1 The basic issue of shares.___ 2. Shares on which dividends in arrears must be paid before current dividends can be paid.___ 3. No-par shares with an assigned "value," but not usually specified in the charter.___ 4. Shares with specified differences from the basic shares.___ 5. Shares with a minimum "value" always specified in the charter.___ 6. Subscribed shares.___ 7. Shares that are limited to a specified dividend rate per year.___ 8. Shares that have no minimum amount that must be paid in at first sale.
Ans: 1:A, 2:E, 3:G, 4:B, 5:D, 6:H, 7:C, 8:F
Difficulty: MediumLevel of Learning: ApplicationTopic: LO1
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163. Match the following terms with the appropriate definitions.
TermsA. Treasury sharesB. Convertible sharesC. Subscribed sharesD. Callable sharesE. Authorized sharesF. Unissued sharesG. Redeemable sharesH. Cumulative shares
Definitions___ 1. Shares that have been sold under contract, but not yet issued because collection has not been
made.___ 2. The difference between total shares issued and total shares outstanding.___ 3. Shares on which dividends in arrears must be paid prior to payment of any current
dividends.___ 4. Shares that may, at the option of the holder, be turned in for another security.___ 5. Shares that have been issued, repurchased, and held.___ 6. Shares that, at the option of the issuer, may be called in and paid off.___ 7. The difference between authorized and issued shares.___ 8. Shares which, at the option of the shareholder, may be surrendered for a specified amount of
cash.
Ans: 1: C, 2: A, 3: H, 4: B, 5: A, 6: D, 7: F, 8: GDifficulty: MediumLevel of Learning: ApplicationTopic: LO1
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164. DXC has the following outstanding shares:$5 Preferred, 2,000 shares issued at $100 per share common, no-par value, 5,000 shares issued at $60 per share(Matching dividend, if applicable $3)Compute the amount of dividends per share payable to each class of shares for each independent case. Show computations.
Per SharePreferred Stock Provisions Preferred Common
(a) Preferred is noncumulative and non-participating. Dividends declared, $40,000
$_________ $_________
(b) Preferred is cumulative and non-participating; in arrears three years (in addition to the current year). Dividends declared, $65,000
$_________ $_________
(c) Preferred is cumulative, in arrears three years (in addition to the current year); fully participating. Dividends declared, $75,000.
$_________ $_________
Ans:Share capital common = $300,000 (60
preferred = $200,000 (40%)total = $500,000 (100%)
=======
(a) Preferred: $2,000 x $5 = $10,000 ÷ 2,000 shares = $5.00Common: $40,000 - $10,000 = $30,000 ÷ 5,000 shares = $6.00
(b) Preferred: $30,000 + $10,000 = 40,000 ÷ 2,000 shares = $20.00Common: $65,000 - $40,000 = $25,000 ÷ 5,000 shares = $5.00
(c) Preferred: $30,000 + $10,000 + $8,000(ii) = $48,000 ÷ 2,000 = $24.00Common: $15,000(i) + $12,000(iii) = $27,000 ÷ 5,000 = $5.40
(i) 5,000 x $3(ii) 75,000 - (30,000 - 10,000) - 15,000 = 20,000; 20,000 x
(200,000 ÷ [200,000 + 300,000]) = 8,000(iii) 20,000 x (300,000 ÷ [200,000 + 300,000]) = $12,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO6
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165. SXC reported income during four successive years as follows: $1,000, $2,000, $3,000, and $11,000. The share capital outstanding consisted of 3,000 common shares issued at $20 each, and 5,000, $.50 preferred shares issued at $10 each. (Matching common dividend, if applicable, $1). If income in full were declared as dividends each year, determine the amount that would be paid on each class of shares for each of the four years assuming:
Year Common Preferred(a) Preferred is noncumulative and 1 $________ $________
non-participating. 2 $________ $________3 $________ $________4 $________ $________
(b) Preferred is cumulative and 1 $________ $________non-participating. 2 $________ $________
3 $________ $________4 $________ $________
(c) Preferred is noncumulative and 1 $________ $________fully participating. 2 $________ $________
3 $________ $________4 $________ $________
(d) Preferred is cumulative and 1 $________ $________fully participating. 2 $________ $________
3 $________ $________4 $________ $________
Ans: Annual preferred dividend = $2,500 (5,000 x $.50)Common Preferred
(a) Year 1 $None $1,000Year 2 $None $2,000Year 3 $500 $2,500Year 4 $8,500 $2,500
(b) Year 1 $None $1,000Year 2 $None $2,000Year 3 $None $3,000Year 4 $7,000 $4,000
(c) Year 1 $None $1,000Year 2 $None $2,000Year 3 $500 $2,500Year 4 $6,000 $5,000
(d) Year 1 $None $1,000Year 2 $None $2,000Year 3 $None $3,000Year 4 $5,182 $5,818*
C P* arrear dividends = 3($2,500) - $6,000 = $1,500
current year $3,000 2,500remaining for participation: $4,000$4,000 x (60,000 ÷ [60,000 + 50,000]) 2,182$4,000 x (50,000 ÷ [60,000 + 50,000]) 1,818$5,182 $5,818====== ======
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Difficulty: MediumLevel of Learning: ApplicationTopic: LO6
166. On January 1, 1999, the accounts of CXC reflected the following:
The single-transaction method is used. On February 1, 1999, CXC purchased 5,000 of its own shares at $2.10 per share. Later, onDecember 1, 1999, CXC sold 2,000 of these treasury shares at $1.50 per share. Give the journal entry on December 1, 1999, to record this sale of treasury stock.
Common shares, 40,000 shares outstanding. $80,000Contributed capital from treasury stock transactions. 1,500Retained earnings. 50,000Ans:Cash (2,000 x $1.50) 3,000Contributed capital from T.S. transactions 1,200 Treasury stock (2,000 x $2.10) 4,200
Difficulty: MediumLevel of Learning: ApplicationTopic: LO4
167. Explain the options available to a corporation that issues share subscriptions where partial payment has been received but the subscriber defaults on the balance.Ans: A corporation has three options available. They may issue shares in proportion to the cash
received. They may also return all payments to the subscriber and issue no shares. Finally, the corporation may retain the money received. The third option is not common; however, legislation does not prohibit it.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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168. Brimley Corp. issued 5,000 common shares, no par, and 800 preferred shares. At the time of issue the common shares were selling at $30 per share and the preferred at $25. Total cash received was $162,000. Prepare the journal entry to record the issuance of the shares.Ans: Since market prices are known the proportional method can be used.Market value of common (5,000 shares x $30) $150,000 (88% of total)Market value of preferred (800 shares x $25) 20,000 (12% of total) Total market value $170,000
Allocation of lump-sum sale price of $162,000Common ($162,000 x 88%) $142,560Preferred ($162,000 x 12%) 19,440
$162,000
Journal Entry:Dr. Cash 162,000 Cr. Common shares 142,560 Cr. Preferred shares 19,440
Difficulty: MediumLevel of Learning: ApplicationTopic: LO6
169. Brimley Corp. issued 5,000 common shares, no par, and 800 preferred shares. At the time of issue the common shares were selling at $30 per. There is no current market value for the preferred shares. Total cash received was $162,000. Prepare the journal entry to record the issuance of the shares.Ans: Since market values for preferred shares are not known, the incremental method should be
used.
Journal Entry:Dr. Cash 162,000 Cr. Common shares (5,000 shares $150,000 Cr. Preferred shares 12,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
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170. Explain what is meant by share issue costs and how they are treated for accounting purposes.Ans: Share issue costs include legal fees, accounting fees, underwriting costs, printing, clerical
and other costs associated with the share issue. There are three methods to deal with share issue costs:
Offset Method: Record the costs as a reduction in the amount received from the sale of the shares as they are argued to be one-time costs. Share costs are debited to the share capital account.
Retained earnings method: Share issue costs are charged directly to retained earnings.Deferred Charge Method: Less common method. Costs are recorded as a deferred charge and amortized over a reasonable time period.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2
171. Explain why companies may want to reacquire their own shares?Ans: (1) To increase earnings per share
(2) To provide cash flow to shareholders in lieu of dividends(3) To acquire shares when they appear to be undervalued(4) To reduce the possibility of a takeover bid(5) To reduce future dividend payments (i.e. less shares outstanding)
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO3, 4
Use the following to answer questions 172-178:
On 2 January 20X4, GHI Corporation was incorporated in the province of Ontario. It was authorized to issue an unlimited number of no-par value common shares, and 10,000 shares of no-par, $8, cumulative and non-participating preferred. During 20X4, the firm completed the following transactions:8 Jan. Accepted subscription for 40,000 common shares at $12 per share. Down payment on the
subscribed shares totalled $150,000.30 Jan Issued 4,000 preferred shares in exchange for the following assets:
Machinery With a fair market value of $35,000, a factory with a fair market value of $110,000, and land with an appraised value of $295,000.
15 Mar. Machinery with a fair market value of $55,000 was donated to the company.25 Apr. Collected the balance of the subscriptions receivable and issued common Shares.30 Jun. Purchased 2,200 common shares at $18. per share. The shares were retired.31 Dec. Declared sufficient cash dividends to allow a $1. Per share dividend for Outstanding
common shares. The dividend is payable on 10 January 20X2, To shareholders of record on 5 January 20X2.
31 Dec. Closed the income summary to retained earnings. The income for the period. Was $98,000.
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172. Prepare Journal entries to record the subscription of common sharesAns: Cash $ 150,000
Stock subscription receivable $ 330,000 Common shares subscribed (40,000 shares) $ 480,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
173. Prepare Journal entries to record the issuance of preferred shares in exchange for assets; recorded at fair market value of the assets in the absence of a value for the preferred shares.Ans: Machinery $ 35,000
Factory $ 110,000Land $ 295,000 Preferred shares (4,000 shares) $440,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
174. Prepare Journal entries to record the receipt of donated assets.Ans: Machinery $ 55,000
Contributed capital – donations $55,000Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
175. Prepare Journal entries to record the receipt of cash for subscribed shares and issuance of shares.Ans: Cash $ 330,000
Stock subscription receivable $ 330,000Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
176. Prepare Journal entries to record the acquisition and retirement of common shares.Ans: Common Shares ($480,000 / 40,000) x 2,200 26,400
Retained Earnings 13,200 Cash ($18 x 2,200) 39,600
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
177. Prepare Journal entries to record dividends declared.Ans: Retained Earnings 69,800
Dividends payable, preferred shares 32,000 Dividends payable, common shares 37,800Preferred dividend: 4,000 shares x 8 Common dividend: 37,800 shares x $1
Difficulty: MediumLevel of Learning: ApplicationTopic: LO6
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178. Prepare Journal entries to record the closing of the income summary account.Ans: Income Summary 98,000
Retained earnings 98,000Difficulty: MediumLevel of Learning: ApplicationTopic: LO6
179. On December 31st, 2011, JKL Inc. had the following account balances:
Common Shares(No par, 10,000 shares issued, 8,000 shares outstanding) $100,000
Preferred Shares($1, non-cumulative, 10,000 shares issued and outstanding) $ 50,000
Retained Earnings $180,000Treasury Shares (2,000 shares) ($20,000)Total $310,000
During 2012, the following took place:
▫ JKL Inc. had a total Comprehensive Income of $150,000.▫ During 2012, JKL Inc. bought 2,000 shares of MNO Inc. for $45 per share. On December
31st, 2012, these shares were trading at $60 per share. These shares, which were all on hand at the end of 2012, were designated by management as FVTOCI.
▫ Half of the treasury shares held by management at the start of 2012 were sold during the year for $15,000.
▫ JKL declared at total of $30,000 in dividends, which included a common stock dividend valued at $10,000.
Required:A) Prepare a Statement of Changes in Equity for JKL Inc. as per IFRS as at December 31st,
2012.B) Briefly explain how JKL Inc’s reporting requirements would differ if it complied with ASPE
instead of IFRS.
Ans:
A)
JKL Inc.
Statement of Changes in Equity
For the year ended December 31st, 2012
Common Stock
Preferred Shares
Retained Earnings
Cumulative OCI
Treasury Shares
Contributed Surplus-Treasury Shares Total
Balances, January 1, 2012 100,000
50,000
180,000
- 20,000
310,000
Comprehensive Income 120,000
30,000
150,000
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Treasury Share - resale 10,000
5,000
15,000
Dividends: -
Cash- 20,000
- 20,000
Common Stock Dividend 10,000
- 10,000
-
Balances, December 31st, 2012 110,000
50,000
270,000
30,000
- 10,000
5,000
455,000
B) Had JKL Inc. been following ASPE, only a Statement of Retained Earnings would be required, not a Statement of Changes in Equity. Moreover, there is no Comprehensive Income under ASPE. This would mean that the shares in MNO Inc. could not be designated as FVTOCI. These shares would be designated as FVTPL.
Difficulty: HardLevel of Learning: ApplicationTopic: LO8, 9hzzled
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test BankChapter 14 – Complex Debt and Equity Instruments
1. The accounting classification of a financial instrument is determined by its tax status.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
2. Induced conversions of convertible debt arise when the debtor offers a "sweetener" to encourage the creditor to promptly convert the debt.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 2
3. When stock rights are issued to current shareholders, it may require more than one such right to later acquire one additional share of the stock covered by the rights.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
4. The measurement date of a compensatory stock option must precede the date of grant.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 3
5. General debt carries a firm commitment to interest payments and repayment of capital at maturity.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
6. Options are ONLY for the purpose of buying or selling financial instruments.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 7
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7. If a financial instrument is an equity instrument in substance, but its legal form is debt, any periodic payments made to investors will be accrued on the company’s financial statements as interest expense.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
8. If cash payments to investors are dependent on one or more future events, the instrument in question would be considered equity.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
9. When interest is repayable to investors at a fixed amount per share, the financial instrument in question would be considered debt.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
10. Retractable preferred shares are those which can be redeemed at the investor’s discretion.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
11. When preferred shares are classified as debt, their dividends are deducted from Retained Earnings, thus bypassing earnings.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 2
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12. Securities issued as debt, but intended by the issuing corporation to be exchanged for shares by the investors at some time prior to maturity, are known as "hybrid securities".
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1, 2
13. Perpetual Debt is accounted for as equity.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 2
14. Management of a company that has convertible bonds outstanding would likely force conversion of its bonds of the fair market value of the shares upon conversion exceeds the fair value of the bonds.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 2
15. The conversion option attached to convertible bonds, which have a floating conversion price per share, has an intrinsic value which is based on the fair market value of the shares at the time.
Ans: False
Difficulty: EasyLevel of Learning: KnowledgeTopic: LO 3, 4
16. A financial instrument is any contract that gives rise to a financial asset of one party and a financial liability or equity instrument of another party.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
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17. Stock options have no intrinsic value when the market price of the share exceeds its conversion price.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 2
18. The proceeds of any bonds sold with detachable stock warrants must be pro-rated between the bonds and the warrants.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO5
19. Share-based payments to suppliers are valued at the value of the goods or services received.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
20. Assume that a company wishes to grant stock options to a supplier in exchange for services rendered. The company chose to value this exchange at the going market rate charged by the suppliers’ competitors. This is an example of a Level 2 Fair Value Hierarchy application.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 6
21. Under ASPE, preferred shares must be classified as equity while shareholder loans must be classified as debt.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO 9
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22. Under ASPE, convertible debt must always be treated as debt in its entirety.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3, 4, 9
23. Under ASPE, forfeitures which occur under a stock-based compensation structure are accrued throughout the vesting period.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 6, 9
24. Cash flow hedges do not exist under ASPE.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 8, 9
25. Embedded derivatives are those that can be detached and separately sold from their host contracts.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO7
26. Under IFRS, forfeitures which occur under a stock-based compensation structure are accrued throughout the vesting period.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6, 9
27. The crucial aspect of debt is that the creditors can demand payment.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
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28. An instrument may be classified as equity even though the investor can demand payment.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
29. One of the most common forms of hybrid security is convertible debt.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 2, 3, 4
30. The conversion ratio for convertible bonds can be expressed either in the number of shares per bond, or in a price per share.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3, 4
31. Even if the underlying share value of a convertible bond never reaches the conversion price, management can still force conversion.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3, 4
32. Once the market price of shares rises above the conversion price on convertible bonds, the bond ceases to trade as debt, and effectively is traded as equity.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3, 4
33. In splitting the bonds and the conversion feature, either the incremental or the proportional method may be used.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3, 4
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34. With respect to convertible bonds, whose conversion is mandatory, only the interest stream is valued as debt; the bond principal and conversion features are considered equity.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
35. When bonds are converted, it is first necessary to update any accounts relating to bond premium or discount, accrued interest, and foreign exchange gains and losses on foreign currency denominated debt.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3, 4
36. If it is the company's option to repay the debentures through the issuance of common shares, the principal component of the bonds is debt.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3, 4
37. To be classified as retractable preferred shares, the cash repayment must either be contractually required or at the option of the investor.
Ans: True
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Difficulty: EasyLevel of Learning: KnowledgeTopic: LO2
38. When a bond matures, an investor will convert if the market price of the convertible bond is higher than the conversion price of the bond.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
39. When a bond matures, an investor will cash it in if the market price of the convertible bond is higher than the conversion price of the bond.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3, 4
40. An equity item is classified as debt in the financial statements and dividend payments were shown on the financial statements. For income tax purposes, the amounts will not be tax deductible.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 2
41. Hedge accounting is often performed to minimize any accounting mismatch between the hedged and hedging items and is strictly voluntary.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO7
42. If a company issues debt that is convertible at the corporation's option, in substance, the debt is equity.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
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43. The fair value of a company’s share is equal to its intrinsic value.
Ans: False
Difficulty: EasyLevel of Learning: KnowledgeTopic: LO6
44. On January 1st, 20x2, ABC Inc. had invoiced a client in New York for $10,000 US for services rendered that day. ABC did not hedge this receivable. The receivable is due in 60 days. On January 1st, 20x2, the spot rate was $1US=$1.02CDN. On January 31st, 20x2, the spot rate was $1US=$1.05CDN. What is the effect of the above information on ABC’s January financial statements?
A) A $300 foreign exchange gain.B) A $300 foreign exchange loss.C) A $300 credit to OCI.D) A $300 debit to OCI.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO7
45. S Corporation created a stock option plan for its two top executives. The plan provided that each executive would receive 1,000 options, which would enable him or her to purchase 100 shares at 75 percent of the market price on the date the options became exercisable. The options were exercisable in two years. At the date of granting the options, the market price of the shares was $12 per share. The date of measurement for the stock option plan was the:A) date of grant.B) end of the first year.C) end of the second year.D) date the employees' exercise their options.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
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46. JKC initiated a stock option plan for its three top executives. The plan provided that each executive would receive 6,000 options that would enable each one to purchase 600 shares at the option price.
The option price was set at 10 percent below market price at the first exercise date. The options could be exercised after the executives remained as employees of the company for 3 more years. The market price of the shares on the date that the options were granted was $10 per share. The amount of compensation expense the company incurred for the three executives due to the option plan was:A) $8,100B) $3,000C) $600D) $0E) Cannot be determined from the information provided.
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47. Compensatory stock options were granted to executives on January 1, 20x3, with a measurement date of June 30, 20x4, for services to be rendered during 20x3, 20x4, and 20x5. The excess of the market value of the shares over the option price at the measurement date was reasonably estimable at the date of grant. The stock option was exercised on October 31, 20x5. Compensation expense should be recognized in the income statement in which of the following years?
20x3 20x4 20x51 No No Yes2 No Yes Yes3 Yes No No4 Yes Yes Yes
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO6
48. Which of the following are requirements for hedge accounting?A) An existing risk management strategy involving hedging.B) Designation and documentation of the hedging relationship.C) Reasonable expectation of hedge effectiveness.D) all of the above
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
49. ABC Inc. enters and interest rate swap agreement with a third party whereby the company agrees to “swap” its variable interest debt on its $100,000 debt issue. In doing so, the company opted for fixed annual interest payments of $8,000 per year. Assuming that the variable rate throughout the last year was 6%, this would mean that:A) ABC must pay $6,000 to the other party in the swap agreement.B) ABC must pay $8,000 to the other party in the swap agreement.C) ABC must pay $2,000 to the other party in the swap agreement.D) ABC will receive $2,000 from the other party in the swap agreement.
Ans: CDifficulty: MediumLevel of Learning: Knowledge/ApplicationTopic: LO7
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50. Preferred shares are likely to be classified as debt if any of the following conditions exist except:A) Redemption is contractually requiredB) Redemption can be forced by the investorC) Terms of the shares are such that redemption is essentially forced, even if the entity is
financially soundD) all of the above
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
51. Perpetual debt is issued for the following reason:A) Cash flowB) Income tax reasonsC) Redemption clausesD) None of the above
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
52. A stock option plan is a compensatory plan if:A) The employee must have worked for the company for one year.B) The employee must report the option on the employee's current tax return.C) The employee must work for the company until retirement.D) It involves a cost to the grantor.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
53. $10,000 (face value) of bonds was sold with a total of 200 detachable stock warrants attached. Each warrant conveys the right to purchase one common share at a specified price during a specified time period. The market immediately valued the warrants at $2 each. The issue sold for 102. The entry to record the bond issuance would include:A) dr. bond premium $200B) dr. an owners' equity account for $400C) cr. bonds payable $10,200D) dr. bond discount $200
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO5
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54. All of the following are examples of derivative instruments except:A) Foreign exchange forward contractsB) Interest rate swapsC) Currency swapsD) Retractable preferred shares
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
55. Which of the following is an example of a financial asset?A) InventoryB) accounts receivableC) Capital assetsD) Prepaid expenses
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
56. In order to determine if, in substance, a complex financial instrument is debt, the answer should be yes to all of the following except:A) Is the periodic return on capital obligatory?B) Is the debtor legally obligated to repay the principal at a fixed rate?C) Is the amount convertible into common shares?D) Is the debtor legally obligated to repay the principal at the option of the creditor?
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
57. In order to determine if, in substance, a complex financial instrument is equity, the answer should be no to all of the following except:A) Is the periodic return on capital obligatory?B) Is the debtor legally obligated to repay the principal at a fixed rate?C) Is the amount convertible into common shares?D) Is the debtor legally obligated to repay the principal at the option of the creditor?
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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58. All of the following are common reasons for a company to issue convertible bonds except:A) The company prefers to issue shares, but is unsure of the present stock market and the
timing.B) The bonds are issued to controlling shareholders so that they can receive interest payments
in preference to other shareholders.C) A bond that has a favourable component such as a conversion privilege, can carry a lower
interest rate than a "straight" bond.D) All of the above.
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
59. General characteristics of convertible bonds that will be converted include all of the following except:A) management fully intends that the conversion privilege will eventually be attractive to the
investorsB) the investors will convert at or before maturity dateC) the company will no longer have to repay the principal amount of the bondsD) the market price of the shares will drop below the conversion price
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
60. Why would a corporation issue retractable preferred share in a private placement rather than a normal debt arrangement?A) Cash flowB) Income minimizationC) The tax treatment of intercorporate dividendsD) none of the above
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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61. Why would a corporation issue retractable preferred share in a private placement rather than a normal debt arrangement?A) Cash flowB) Income minimizationC) The debt-to-equity ratioD) None of the above
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
62. Silo Corp. granted to Donna, its superstar accountant, the option to purchase Silo common shares for $10, on Jan. 1, 20x1. The market price of the shares on that date was $20. The options can be exercised during the period Jan. 1, 20x4 through Jan. 1, 20x6. The number of shares under option is determined by a formula based on Silo earnings each year. The number of shares actually under option will be the formula value on Dec. 31, 20x3. That formula estimated the following number of shares under option at the end of years: 20x1, 200; 20x2, 300. The formula determined the number of shares at Dec. 31, 20x3 to be 400.The market prices for Silo shares at the end of years: 20x1, $25;
20x2, $40, 20x3, $50. What is the recorded compensation expense for 20x2, for Donna?A) $7,250B) $3,000C) $4,000D) $4,500E) $5,000
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO 6
63. A non-compensatory stock option plan means that:A) Any employee can purchase shares at a discount from the prevailing market priceB) Top executives are given shares in the companyC) No shares are given but shareholders are allowed to purchased on the open marketD) None of the above
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
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64. All of the following are characteristics of stock rights except:A) The warrants are usually detachableB) Stock warrants never expireC) Stock warrants can be exercised without having to trade in the bondD) Stock warrants can be exercised without having to redeem the bond
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
65. JMR Ltd. Issued $300,000 of 7%, 8 year, non-convertible bond with detachable stock purchase warrants. KER Corp. purchased the entire issue. Each $1,000 bond carries 20 warrants. Each warrant entitles KER to purchase one common share for $20. The bond issue sells for 104 exclusive of accrued interest. Shortly after issuance, the warrants trade for $5 each and the bonds were quoted at 103 ex-warrants. The market value of the bonds and warrants using the proportional method was:A) $339,000B) $321,000C) $605,000D) $350,000
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO5
66. JMR Ltd. issued $100,000 of 8%, 8 year, non-convertible bond with detachable stock purchase warrants. KER Corp. purchased the entire issue. Each $1,000 bond carries 10 warrants. Each warrant entitles KER to purchase one common share for $20. The bond issue sells for 104 exclusive of accrued interest. Shortly after issuance, the warrants trade for $5 each and the bonds were quoted at 103 ex-warrants. The market value of the bonds and warrants using the proportional method was:A) $107,000B) $321,000C) $605,000D) $108,000
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO5
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67. JMR Ltd. Issued $100,000 of 8%, 8 year, non-convertible bond with detachable stock purchase warrants. KER Corp. purchased the entire issue. Each $1,000 bond carries 10 warrants. Each warrant entitles KER to purchase one common share for $20. The bond issue sells for 104 exclusive of accrued interest. Shortly after issuance, the warrants trade for $5 each and the bonds were quoted at 103 ex-warrants. The allocation of the proceeds to bonds using the proportional method was:A) $107,000B) $99,185C) $100,000D) $108,000
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO5
68. JMR Ltd. Issued $300,000 of 7%, 8 year, non-convertible bond with detachable stock purchase warrants. KER Corp. purchased the entire issue. Each $1,000 bond carries 20 warrants. Each warrant entitles KER to purchase one common share for $20. The bond issue sells for 104 exclusive of accrued interest. Shortly after issuance, the warrants trade for $5 each and there was no market value for the bond. In the journal entry, the amount of the payable for the bond is:A) $339,000B) $321,000C) $300,000D) $350,000
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO5
69. An option is:A) An obligation to buy something in the futureB) An obligation to sell something in the futureC) A debt instrumentD) The right to buy something in the future
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
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70. An option is:A) An obligation to buy something in the futureB) An obligation to sell something in the futureC) The right to sell something in the futureD) A debt instrument
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
71. A forward contract is:A) An obligation to buy or sell something in the futureB) The right to sell something in the futureC) A derivative instrumentD) Bothe A and C
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO7
72. A forward contract is:A) A debt instrumentB) The right to sell something in the futureC) An obligation to sell something in the futureD) The right to buy something in the future
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO7
73. A derivative has all of the following characteristics except:A) a derivative is a secondary financial instrument whose value is lined to a primary financial
instrumentB) a derivative is an optionC) a derivative is a forward contractD) a derivative is an option and a forward contractE) all of the above
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
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74. For each type of financial instrument, the reporting enterprise should disclose:A) The extent and nature of the financial instrumentsB) Significant termsC) Significant conditionsD) all of the above
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO8
75. Stock Appreciation Rights (SARS) earned by employees may be settled by issuing:A) CashB) SharesC) Promissory notesD) A or B
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
76. Securities issued as debt but intended by the issuing company to be exchanged for shares by the investor prior to maturity are called:A) Hybrid securitiesB) Discount bondsC) optionsD) convertible debt
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
77. Primary securities that have both debt and equity characteristics are called:A) Hybrid securitiesB) Discount bondsC) optionsD) convertible debt
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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78. VB Ltd. raises $150,000 by issuing a financial instrument that pays interest at a rate of 8% per year to the investor. At the end of the fourth year, the financial instrument is retired for $155,000. If the financial instrument is treated as debt:A) The repayment will decrease owners' equityB) The interest payment decreases retained earningsC) Retained earning is reduced as the interest payment is treated as a dividend distributionD) Shareholders' equity is increased at issuance
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
79. VB Ltd. raises $150,000 by issuing a financial instrument that pays interest at a rate of 8% per year to the investor. At the end of the fourth year, the financial instrument is retired for $155,000. If the financial instrument is treated as equity:A) The repayment will decrease owners' equityB) The interest payment decreases retained earningsC) If premium on repayment was not known, it is recorded as a loss on the income statementD) Long-term liabilities is increased at issuance
Ans: A
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
80. On the statement of cash flows, a hybrid financial instrument should be:A) Reported as an operating activityB) Reported as a financial activityC) Reported as an investing activityD) Reported according to its individual components
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO8
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81. The crucial aspect of debt is:A) The legal agreementB) The interest paymentsC) That the creditors can demand paymentD) The maturity date
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
82. A company issues a convertible bond. Management can essentially force conversion as long as:A) The share price is higher than the conversion priceB) The share price is lower than the conversion priceC) The share price is equal to the conversion priceD) None of the above
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
83. The incremental method to accounting for convertible bonds means that:A) The proceeds of the bond are allocated on the basis of the relative market values of the
straight bond and imbedded stock optionB) The stock option is valued at the difference between the total proceeds of the bond issue
and the market value of an equivalent straight bond issueC) Any of the aboveD) None of the above
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3, 4
84. The incremental method to accounting for convertible bonds means that:A) The proceeds of the bond are allocated on the basis of the relative market values of the
straight bond and imbedded stock optionB) The stock option is valued at the difference between the total proceeds of the bond issue
and the market value of an equivalent straight bond issueC) Any of the aboveD) None of the above
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO3, 4
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85. When convertible bonds are submitted for conversion, all of the following must be updated except:A) Bond premium or discountB) Accrued interestC) CashD) Foreign exchange gains and losses on foreign currency denominated debt
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3, 4
86. If a company issues debt that is convertible at the corporation's option, in substance, the debt is:A) DebtB) EquityC) An AssetD) Subordinated
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3, 4
87. Credit risk is an issue for financial instruments because:A) the company may default on its loanB) the company may not have enough cash flow to pay suppliersC) the other parties to financial instruments may not perform their obligationsD) the company may not perform their obligations
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3, 4
88. Derivatives are:A) Legal contractsB) Promissory notesC) Common sharesD) Executory contracts
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
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89. Derivatives are often used to reduce risk. All of the following risks can be covered by a derivative contract except:A) Retractable preferred sharesB) Exchange contractsC) Currency swapsD) all of the above
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
90. At the end of 20x2, interest on a perpetual loan is paid to the holder. The perpetual debt is shown as an equity instrument. Based on the above the interest is:A) Deducted on the statement of retained earningsB) Added to the statement of retained earningsC) Deducted for income tax purposesD) Added for income tax purposes
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO1, 2
91. At the end of 20x2, interest on a perpetual loan is paid to the holder. The perpetual debt is shown as an equity instrument. Based on the above the interest is:A) Deducted on the income statementB) Added to the income statementC) Deducted for income tax purposesD) Added for income tax purposes
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
92. Which of the following forms part of the definition of a financial liability?A) CashB) An equity instrument of another entityC) To deliver cash or another financial asset to another partyD) A contractual right to receive cash or another financial asset from another party
Ans: C
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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93. A financial asset has any of the following characteristics except:A) An equity instrument of another entityB) A debt instrument of another entityC) CashD) A contractual right to exchange financial instruments with another party under conditions
that are potentially favourable
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
94. The president of XBC was granted a stock option for 1,000 common shares. On the grant date, the option price was $40 and the market value was $38 per share. Give the entry to record the option at the date of the grant.Ans: No entry is required because the option price exceeds the market price.Difficulty: MediumLevel of Learning: Knowledge/ApplicationTopic: LO5
95. A company issues a financial instrument for $40,000 paying interest of $4,000 per year. How would the interest be treated if the instrument was determined to be equity?Ans: If the financial instrument was classified as equity, the interest payment would be treated
as a dividend distribution and retained earnings would be reduced. There is no impact on the income statement.
Difficulty: MediumLevel of Learning: ApplicationTopic: LO1
96. A company issues a financial instrument for $40,000 paying interest of $4,000 per year. How would the repayment of the financial instrument be treated if it was determined to be debt?Ans: If the financial instrument was classified as debt, the repayment of the instrument would
decrease liabilities.
Difficulty: MediumLevel of Learning: ApplicationTopic: LO1
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97. What are hybrid securities?Ans: Hybrid securities have the characteristics of both debt and equity. Their use is gaining
popularity as companies look for more innovative ways to raise funds/minimize their cost of capital.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
98. Match the brief description with the terms by entering the appropriate letters in the blank spaces provided.
Brief DescriptionA. Inventory, capital assets, prepaid expensesB. Accounts receivable, loan receivableC. Warranty liabilities, unearned revenueD. Accounts payable, loans payableTerm___ 1. Financial Asset___ 2. Financial Liability___ 3. Non-financial Asset___ 4. Non-financial Liability
Ans: 1: B, 2: D, 3: A, 4: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
99. An investor purchases a $10,000 bond convertible into common shares at a price of $50. How many shares are available for conversion?Ans: 10,000/50=200 sharesDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3, 4
100. In substance, a complex financial instrument will be treated as debt if the answer is yes to two basic criteria. What are they?Ans: 1. Are there periodic returns on capital? (Interest payments)2. Is the borrower required to
repay the principal?Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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101. Elizabeth Corp. owned a major business building in a small Canadian city. The building has a $1,345,000 mortgage that is held by a Canadian financial institution (FI). Elizabeth Corp. has had recent cash flow problems, in part, due to the low vacancy rates in the business buildings. Interest is 15 months in arrears and totals $145,000. After discussions with the FI, they agree to a financial reorganization in that they accept $50 preferred shares at a value of $1,490,000, retractable in 15 years time at book value. The shares have first claim on the proceeds of the business building, should it be sold.
Required:Prepare the journal entry to record the exchange.Ans:Mortgage payable 1,345,000Interest payable 145,000 Preferred shares, $20 1,490,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
102. Amanda Corp. owned a major business building in a small Canadian city. The building has a $1,555,000 mortgage that is held by a Canadian financial institution (FI). Amanda Corp. has had recent cash flow problems, in part, due to the low vacancy rates in the business buildings. Interest is 15 months in arrears and totals $132,000. After discussions with the FI, they agree to a financial reorganization in that they accept $50 preferred shares at a value of $1,490,000, retractable in 15 years time at book value. The shares have first claim on the proceeds of the business building, should it be sold.Required:Prepare the journal entry to record the exchange.Ans:Mortgage payable 1,555,000Interest payable 132,000 Preferred shares, $20 1,490,000 Gain on financial reorganization 197,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
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103. KIM Corp. owned a major business building in a small Canadian city. The building has a $1,155,000 mortgage that is held by a Canadian financial institution (FI). KIM Corp. has had recent cash flow problems, in part, due to the low vacancy rates in the business buildings. Interest is 15 months in arrears and totals $132,000. After discussions with the FI, they agree to a financial reorganization that results in the FI accepting $800,000 from the shareholders who agree to inject this amount of cash into the business.Required:Prepare the journal entry to record the exchange. What is this called?Ans:Cash 800,000 Common shares 800,000Mortgage payable 1,155,000Interest payable 132,000 Cash 800,000 Gain on financial reorganization 487,000This is called settlement of debt, as the loan will no longer exist after the transaction.Difficulty: MediumLevel of Learning: ApplicationTopic: LO 2
104. List the criteria determining whether an asset is a financial asset. Give an example of a financial asset and a non-financial asset.Ans: 1. cash
2. A contractual right to receive cash or another financial asset from another party3. A contractual right to exchange financial instruments with another party under conditions that are potentially favourable 4. An equity instruments of another entity financial asset: accounts receivable non-financial asset: inventory
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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105. Match the brief description with the terms by entering the appropriate letters in the blank spaces provided.
Brief DescriptionA. A type of derivative instrument.B. A firm commitment to interest payments and repayment of capital at maturity.C. A nonmonetary asset.D. A loan that never has to be repaid.E. A residual interest in net assets with rights only to dividends.F. Securities that have both debt and equity characteristics.G. Bonds stripped of interest as issued by the issuer.H. At maturity the debt is settled by paying it in silver.Term
___ 1. Equity___ 2. Hybrid investment___ 3. Commodity-Linked debt___ 4. Zero coupon bonds___ 5. Inventory___ 6. Perpetual debt___ 7. Stock right___ 8. Debt
Ans: 1:E, 2:F, 3:H, 4:G, 5:C, 6:D, 7:A, 8:BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1-8
123. List the criteria determining whether liability is a financial liability. Give an example of a financial liability and a non-financial liability.Ans: A financial liability is any liability that is a contractual obligation:
1) To deliver cash or another financial asset to another party2) To exchange financial instruments with another party under conditions that are potentially unfavourableFinancial liability: accounts payableNon-financial liability: unearned revenue
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO6
107. If a financial instrument is determined to be in substance equity, what are the reporting implications?Ans: Any interest payments will be treated as dividend payments with retained earnings being
reduced – in other words the interest does not flow through the income statement. The original proceeds will be recorded as equity.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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108. What is convertible debt? Why would a company issue convertible debt?Ans: Convertible debt can be exchanged for shares, generally at a specified price. The issuing
company is hoping that the debt will be converted before maturity so that they will not have to repay the loan. In order for conversion to happen, the market price of the shares must be higher than the conversion price. The company is generally able to issue the debt with a lower interest rate as there is a conversion feature attached. In some cases, when the company is risky, the conversion feature is needed to entice investors. The stock market may be slow and the company does not want to issue shares.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO3, 4
109. JMR Ltd. purchased $100,000 of bonds convertible into common shares at a price of $50. The bonds have a maturity date of 20x4. On the maturity date, the market price of the common shares is $55. Assuming that JMR Ltd. is a knowledgeable investor, what will the company do?Ans: The company will convert the bonds to common shares as the market price is greater than
the conversion price. JMR Ltd. will get 2,000 shares.
Difficulty: MediumLevel of Learning: Knowledge/ApplicationTopic: LO3, 4
110. JMR Ltd. purchased $100,000 of bonds convertible into common shares at a price of $50. The bonds have a maturity date of 20x4. On the maturity date, the market price of the common shares is $45. Assuming that JMR Ltd. is a knowledgeable investor, what will the company do?Ans: The company will take the money from the bond (i.e. cash the bond in for $100,000) as the
market price is below the conversion price.Difficulty: MediumLevel of Learning: Knowledge/ApplicationTopic: LO3, 4
111. DWWR Ltd. issues a $150,000, 6%, five-year debenture at par, repayable at maturity in common shares at DWWR's option. Interest is repayable annually in cash. Prepare the journal entry at issuance.Ans:
$150,000 (pv,5,6%) = 150,000x0.74726= $112,089$9,000 (pva,5,6%) = 9,000x4.21236= $37,911
$150,000=======
Cash 150,000 Interest liability 37,911 Share equity – debenture 112,089
Difficulty: MediumLevel of Learning: ApplicationTopic: LO1, 2
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112. WB Ltd. issues a $200,000, 6%, five-year debenture at par, repayable at maturity in common shares at DWWR's option. Interest is repayable annually in cash. Prepare the journal entry at issuance.Ans:
$200,000 (pv,5,6%) = 200,000x0.74726 = $149,452$12,000 (pva,5,6%) = 12,000x4.21236 = $ 50,548
$200,000=======
Cash 200,000 Interest liability 50,548 Share equity – debenture 149,452
Difficulty: MediumLevel of Learning: ApplicationTopic: LO1, 2
113. JMR Ltd. issues a $150,000, 7%, five-year debenture at par, repayable at maturity in common shares at DWWR's option. Interest is repayable annually in cash. Prepare the journal entry at issuance.Ans:
$150,000 (pv,5,7%) = 150,000x0.71299 = $106,949$10,500 (pva,5,7%) = 10,500x4.10020 = $ 43,051
$150,000=======
Cash 150,000 Interest liability 43,051 Share equity – debenture 106,949
Difficulty: MediumLevel of Learning: ApplicationTopic: LO1, 2
114. Why do companies issue retractable preferred shares?Ans: There are two basic reasons why corporations issue retractable preferred shares. In some
cases, corporations want or need to keep a positive debt-to-equity ratio. In other situations, corporations are attempting to structure their instruments for tax purposes. Therefore, they issue retractable preferred shares due to the tax treatment of intercorporate dividends.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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115. KER Corp. issued 150,000 rights allowing the holder to acquire common shares in 3 years' time at an acquisition price of $30 per share – the current market price. It takes 5 rights to acquire each share. The corporation received $40,000 for the rights. Assuming all rights are exercised when the market price was $35, prepare journal entries at: announcement date, issuance date and exercise dateAns: No entry on announcement date
Issuance date:Cash 40,000 Stock rights outstanding 40,000
Exercise date:Cash 900,000Stock rights outstanding 40,000 Common shares 940,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO5
116. KER Corp. issued 150,000 rights allowing the holder to acquire common shares in 3 years' time at an acquisition price of $25 per share – the current market price. It takes 10 rights to acquire each share. The corporation received $30,000 for the rights. Assuming 100,000 rights are exercised when the market price was $30 and the balance expire, prepare journal entries at: announcement date, issuance date, exercise date and expiration date.Ans: 1. Announcement Date: No entry
2. Issuance DateCash 30,000 Stock rights outstanding 30,000
3. Exercise dateCash 250,000Stock rights outstanding 20,000 Common shares 270,000
4. Stock rights outstanding 10,000 Contributed capital, lapse of rights 10,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO5
117. What is a "poison pill"?Ans: Corporations may try to make it difficult for others to take them over (i.e. takeover bid). At
times they will issue rights that will make it very expensive and very difficult for someone to obtain control. Generally the rights are issued to existing shareholders for no consideration.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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118. JMR Corp. grants their top executive an option for 1,000 shares. The option price is $30 per share. Prepare the journal entry if the current market price is $40 per share. What would happen if instead the market price was $25?Ans: Market price=$40Compensation expense (40-30)x1000 shares 10,000 Common share options outstanding 10,000Market price=$25No entry when option granted as the market price is less than the option price
Difficulty: MediumLevel of Learning: ApplicationTopic: LO5
119. JMR Ltd. sold $350,000 of 5 %( annual interest payments) convertible 5 year bonds at par. The market interest rate on the sale date was 7%. Each $1,000 bond was convertible into 20 shares of KER Ltd. no-par value common shares on any interest date after the end of the first year from the date of issuance. Using IFRS, prepare the journal entry at issuance using the proportional method. Assume that the option pricing model placed a value of $73,675 for the conversion feature.Ans: PV of bond:
350,000x(pv,5,0.07)=350,000x0.71299= $249,547(350,000x0.05)x(pva,5,0.07)=$17,500x4.10020= $ 71,754
$321,301=======
Mkt value Proportion AllocationLiability comp. $321,301 81.3% $284,500Stock option $ 73,675 18.7% $ 65,450
$394,976 100.0% $350,000
Cash(350,000x1.01) $350,000Discount on Bond $ 65,450 Bonds payable $350,000 Common stock conversion rights $65,450
Difficulty: MediumLevel of Learning: ApplicationTopic: LO3, 4
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120. JMR Ltd. sold $350,000 of 5 %( annual interest payments) convertible 5 year bonds at 101. The market interest rate on the sale date was 7%. Each $1,000 bond was convertible into 20 shares of KER Ltd. no-par value common shares on any interest date after the end of the first year from the date of issuance. Using IFRS, prepare the journal entry at issuance using the incremental method.Ans: PV of bond:
350,000x(pv,5,0.07)=350,000x0.71299= $249,547(350,000x0.05)x(pva,5,0.07)=$17,500x4.10020= $ 71,754
$321,301=======
Cash(350,000x1.01) $353,500Discount on Bond $28,699 Bonds payable $350,000 Common stock conversion rights $32,199
Difficulty: MediumLevel of Learning: ApplicationTopic: LO3, 4
121. Explain why a company would want to classify a financial instrument as debt instead of equity?Ans: Many companies want to classify financial instruments as equity and not debt in order to
improve their debt-to-equity. By recording certain items as equity, they will avoid possible loan covenant problems. In addition income is affected by the retirement and interest payments if the item is classified as debt.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
Use the following to answer questions 122-125:
On January 20X2, ABC Corporation issued $1,000,000 face amount of 8%, five year, convertible debentures. Interest is payable semi-annually on 30 June and 31 December. The debentures are convertible at the holder's option at the rate of 20 common shares for each $1,000 bond. The market rate of interest for non-convertible bonds of similar risk and maturity is 6%. The net proceeds received by ABC Corporation amounted to $1,250,000.
122. Prepare a Journal entry to record the issuance of the bonds on 1 January 20X2.Ans: Cash 10,000,000
Interest liability on subordinated debentures [$800,000(P/A, 8%, 10) 5,368,064 Share equity – subordinated debentures 4,631,936
Difficulty: MediumLevel of Learning: ApplicationTopic: LO1, 2
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123. Prepare a Journal entry for interest expense on 30 June 20X2 and 31 December 20X2. Assume that ABC uses straight-line amortization for bond premium and discount.Ans: June 30 20x2
Interest expense 31,470Premium on Bonds payable($85,298/10 periods) 8,350Cash $40,000
Dec. 31 20x2Interest expense 31,470Premium on Bonds payable 8,350Cash $40,000
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
124. Indicate how all amounts relating to the bonds will be shown on ABC financial statements for the year ending 31 December 20X2.Ans: Income statement
Interest expense $62,940Balance SheetLong term debt Bonds payable 1,000,000 Premium on bonds payable (85,298 x 4/5) 68,238
Shareholders equity Common share conversion rights 164,702
Cash flow statementFinancing activities Proceeds from issuance of convertible bonds 1,250,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO3, 4, 8
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125. Assume that the holders of $300,000 face value bonds exercise their conversion privilege on 1 January 20X5, when market value of the common shares is $65. Prepare the journal entry to record the conversion, using the book value method.Ans: Bonds Payable 300,000
Premium on bonds payable 10,236Common share conversion rights (164,702 x 3/10) 49,411 Common shares 359,647
Difficulty: HardLevel of Learning: ApplicationTopic: LO3, 4
Use the following to answer questions 126-127:
On January 1, 2004, ABC Incorporated issued $10,000,000 face amount of 8%, 10 year, subordinated convertible debentures at face value in a private placement. The debentures payinterest annually, in cash, on 31 December. The bonds are convertible into 50 common shares for each $1,000 of the bonds’ face value. At maturity, ABC Incorporated has the option of issuing common shares to redeem the bonds instead of paying cash.
126. Prepare Journal entries to record the issuance of the bonds on January 1, 2004. Ans: Cash 10,000,000
Interest Liability on subordinated debentures (800,000 x (PA, 8%, 10) 5,368,064Share equity – subordinated debentures 4,631,936
Difficulty: HardLevel of Learning: ApplicationTopic: LO 4
127. Prepare Journal entry to record the interest payment on the first interest date of 31 December 20X4. Also record the related equity transfer.Ans: Interest expense (5,368,064 x 8%) 429,445
Interest liability on subordinated debentures 429,445
Interest liability on subordinated debentures 800,000 Cash ($10,000,000 x 8%) 800,000
Retained earnings ($4,631,936 x 8%) 370,555 Share equity – subordinated debentures 370,555Difficulty: HardLevel of Learning: ApplicationTopic: LO 4
For questions 128 to 132 inclusively, assume the same information as questions 126 and 127 above, except that the share conversion is not mandatory, the bonds were issued for $12 million, and that the market rate was 6%:
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128. Prepare Journal entries to record the issuance of the bonds on January 1, 2004.
Ans:
The carrying value of the bonds on the date of issue must be calculated, with the balance going to equity:
Interest Liability on subordinated debentures (800,000 x (PA, 6%, 10) 5,888,072
Principal on subordinated debentures (10,000,000 x (PV, 6%, 10) 5,583,950
Present Value of Bonds: $11,472,022
Cash 12,000,000Bonds Payable 10,000,000Bond Premium 1,472,022Share equity – subordinated debentures 527,978
Difficulty: HardLevel of Learning: ApplicationTopic: LO 4
129. Prepare Journal entry to record the interest payment on the first interest date of 31 December 20X4. Ans: Interest expense (11,472,022 x6%) 688,321
Bond Premium 111,679 Interest liability on subordinated debentures 800,000
Interest liability on subordinated debentures 800,000 Cash ($10,000,000 x 8%) 800,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO 4
130. Assume that on January 1st, 20x5, the shares were converted when the market price of the share was $102. Prepare the required journal entry.Ans: Bonds Payable 10,000,000
Bond Premium 1,360,343Share equity – subordinated debentures 527,978
Common Shares $11,888,321
Note: The book value method is used for conversion, so the market value of the shares is irrelevant. The common shares amount is simply a plug.Difficulty: HardLevel of Learning: ApplicationTopic: LO 4
131. Assume that the shares were never converted, and the principal was simply repaid at maturity.Provide the required journal entry.
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Ans: Bonds Payable 10,000,000Cash 10,000,000
Share equity – subordinated debentures 527,978Contributed Capital – Lapsed Conversion rights 527,978
Difficulty: HardLevel of Learning: ApplicationTopic: LO 4
132. Assume that on January 1st, 20x5, the bonds were retired for $12.5 million. Valuation models indicate that $500,000 of the proceeds is attributable to the equity portion, while the balance is attributable to the bonds. Prepare the required journal entry.Ans: Bonds Payable 10,000,000
Bond Premium 1,360,343Share equity – subordinated debentures 527,978Loss on Bond Retirement 639,657
Contributed Capital – Retirement of share conversion rights 27,978Cash 12,500,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO 4
The following information pertains to questions 133-136 inclusively:
On January 1st, 20x9, GHI Inc. granted options to its twenty employees allowing for the purchase of 12,000 shares at $5 per share. The options vest evenly over the 3 years following the date of issue. The options are only exercisable as of December 31st, 20x11. The fair value of these options (using an Option Pricing model) is $30,000.
133. Assume that all options have vested but that none were exercised on December 31st, 20x11. Provide the required journal entry.Ans:
Contributed Capital: Common share options outstanding $30,000Contributed Capital: share options expired $30,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO6
134. Assume that all options have vested and all were exercised on December 31st, 20x11. Provide the required journal entry.Ans:
Cash $60,000Contributed Capital: Common share options outstanding $30,000
Common shares $90,000
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Difficulty: HardLevel of Learning: ApplicationTopic: LO6
135. Suppose that some of the options were forfeited by the employees. Actual and estimated forfeiture data are provided in the table below:
Year 1 2 3
Total employees 20 20 20
Employees expected to forfeit2
(10%)4
(20%)
Employees expected to remain until vesting18
(90%)16
(80%)
Employees actually forfeiting in the year 1 2 0
Employees receiving options 17
Provide the required journal entries to record the accrual of compensation expense and the exercise of the options as per IFRS.
Ans:Although not required, students may find the following table helpful:
Time Period 1 2 3
Fair value 30,000 30,000 30,000
x Cumulative vested fraction =1/3 =2/3 =3/3
x Estimated Retention 90% 80% 85%
Required year-end equity account balance: 9,000 16,000 25,500
Opening balance 0 9,000 16,000
Expense (credit) for the period: 9,000 7,000 9,500
Year 20x9:
Compensation expense $9,000Contributed Capital: Common Share options outstanding $9,000
Year 20x10:
Compensation expense $7,000Contributed Capital: Common Share options outstanding $7,000
Year 20x11:
Compensation expense $9,500Contributed Capital: Common Share options outstanding $9,500
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To record the exercise of the options on December 31, 20x11:
Cash $60,000Contributed Capital: Common Share options outstanding $25,500
Common Shares $85,500Difficulty: HardLevel of Learning: ApplicationTopic: LO6
136. Repeat question 135 above (using the same data) and provide the journal entries required under ASPE.
Ans:
Year 20x9:
Compensation expense $10,000Contributed Capital: Common Share options outstanding $10,000
Year 20x10:
Compensation expense $10,000Contributed Capital: Common Share options outstanding $10,000
Year 20x11:
Compensation expense $5,500Contributed Capital: Common Share options outstanding $5,500*
*=85%*$30,000-$10,000-$10,000
To record the exercise of the options on December 31, 20x11:
Cash $60,000Contributed Capital: Common Share options outstanding $25,500
Common Shares $85,500
Note: Although the accounting for employee stock options is similar under ASPE and IFRS, under ASPE, no provision is made for forfeitures under ASPE. “Catch-up” is performed during the year in which the options become exercisable. In this example, both IFRS and ASPE come to the same Contributed Capital account balance of $51,000 just prior to the exercise of the options. However, the timing of the related compensation expense differs under IFRS and ASPE, as show in exercises 135 and 136 above. The entry
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to record the actual exercise of the options is identical under both IFRS and ASPE.Difficulty: HardLevel of Learning: ApplicationTopic: LO6, 9
137. On January 1st, 20x1, 20,000 units of stock appreciation rights were granted to JKL Inc’s 200 employees, each of which received 100 units which accrue evenly over the following three years. The rights allow the employees to receive cash compensation for any stock price increase on December 31st, 20x3, if they are still with the company at that time.
The cash to be distributed is the difference between the fair value of the share and the reference price of $5 per share. Cumulative retention rates are expected to be 80% and 70% for 20x1 and 20x2 respectively. Twenty employees forfeited their rights in 20x1 and thirty forfeited their rights in 20x2. On December 31st, 20x3 there were 150 employees working for JKL Inc.
The following data applies to JKL’s SARS plan:
Year 20x1 20x2 20x3
Market value per share 8 7 10
Reference price per share 5 5 5
Intrinsic value per share 3 2 5
Estimated fair value per share 4.5 3 n/a
Total fair value (20,000 units) 90,000 60,000
Cash payout value (excluding forfeitures) 100,000
Required:
Prepare the required journal entries for 20x1, 20x2 and 20x3 to record the compensation expense and ultimate cash payout related to the company’s SARS plan.
Ans:Although not required, students may find the following table helpful:
Time Period 1 2 3
Fair value 90,000 60,000 100,000
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x Cumulative vested fraction =1/3 =2/3 =3/3
x Estimated Retention 80% 70% 75%
Required year-end equity account balance: 24,000 28,000 75,000
Opening balance 0 24,000 28,000
Expense (credit) for the period: 24,000 4,000 47,000
Year 20x1:
Compensation expense $24000Long-term compensation liability $24,000
Year 20x2:
Compensation expense $4000Long-term compensation liability $4,000
Year 20x3:
Compensation expense $47,000Long-term compensation liability $47,000
To record the cash payout on December 31, 20x3:
Long-term compensation liability $75,000Cash $75,000*
*=200*75%*100*5Difficulty: HardLevel of Learning: ApplicationTopic: LO6
138. Assume that on January 1st, 20x1, Jane Smith is awarded units in an existing Phantom Stock Plan whereby she can receive either 20,000 common shares or a cash payout equivalent to the value of 15,000 shares at the time.
The shares are worth $5 each upon the inception of the plan. The value of the shares rose to $8 and $10 each at the end of 20x1 and 20x2 respectively.
Option valuation models valued the company’s stock at $6 per share on January 1st, 20x1.
Jane is her company’s only full-time employee currently eligible under this plan and she has signed a non-competition agreement which essentially forbids her from seeking employment elsewhere.
Required:
Provide the company’s journal entries to record compensation expense for 20x1 and 20x2 and
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provide the necessary journal entries assuming that Jane:
a. Elects to receive shares andb. Opts for the cash payment, allowing her options to expire.
Ans:
Equity alternative fair value at plan initiation: $100,000Cash alternative, fair value, at plan initiation $75,000Equity portion $25,000
20x1:
Compensation Expense $72,500(15,000*8+$25,000)/2
Contributed Capital – Common Shares Outstanding $12,500Long-Term Compensation Liability $60,000
20x2:
Compensation Expense $87,500((15,000*9+$25,000)-72,500)
Contributed Capital – Common Shares Outstanding $12,500Long-Term Compensation Liability $75,000
a. Jane receives shares:
Contributed Capital – Common Shares Outstanding $ 25,000Long-Term Compensation Liability $135,000
Common Shares $160,000
b. Jane opts for the cash payout:
Contributed Capital – Common Shares Outstanding $ 25,000Long-Term Compensation Liability $135,000
Cash $135,000Contributed Capital –Share options expired $ 25,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO6
139. On January 1st, 20x12, ABC Inc. agrees to a futures contract to buy 1,000 shares of DEF Inc. for $20 per share in 60 days. The current value of the shares on January 1, 20x12 is $22 per share.The broker requires a 20% margin payment. The fair value of the shares is $24 per share on January 31st, 20x12 and $18 per share on February 29th, 20x12.
Required: Prepare all relevant journal entries.
Ans:January 1st, 20x12
Derivative Instrument $2,000
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Gain on Derivative Instrument $2,000
Derivative Instrument $4,400Cash $4,400*
*(20 %*( $20,000+$2,000)
January 31st, 20x12
Derivative Instrument $2,000Gain on Derivative Instrument $2,000
Derivative Instrument $400Cash $400*
*(20 %*$2,000)
February 29th, 20x12
Loss on derivative instrument $6,000Derivative Instrument $6,000
Investment in DEF Inc. Shares $18,000($18*1,000 shares)
Cash $15,200 ($20,000-$4,400-$400)Derivative Instrument $ 2,800 (balance)
Difficulty: HardLevel of Learning: ApplicationTopic: LO7
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test BankChapter 15 – Accounting for Corporate Income Tax
1. Future income tax liabilities are amounts owed to the government.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
2. The term “provision for income taxes” encompasses both income tax expenses and liabilities.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
3. Deferred taxes appear on a company’s balance sheet as a result of inter-period tax allocation.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
4. Temporary differences occur only because accounting standards and income tax laws differ as to when they recognize assets, liabilities, owners' equity, revenues, gains, expenses, and losses.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
5. The use of inter-period income tax allocation is mandatory under ASPE.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO8
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6. Temporary differences relate only to items that will be recognized on both the income statement and the tax return, but in different reporting periods.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
7. Temporary differences very seldom reverse (i.e., turnaround) in one or more future reporting periods.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
8. Permanent differences are those that factor into the computation of both net income and taxable income.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
9. Income tax expense generally equals the product of the current period income tax rate and pretax accounting income.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
10. Under IFRS, the amount of taxes paid must be disclosed on the face of the cash flow statement.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
11. The partial allocation approach has been adopted by IFRS to account for income tax allocation.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
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12. Deferred taxes must be discounted under IFRS.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
13. Deferred taxes may be classified as either current or non-current under IFRS.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
14. Prepayments of future income tax expense may be viewed as a future tax asset.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
15. "Taxable amounts" include revenues and gains that are included in the tax return BEFORE they are recognized for accounting purposes.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
16. "Taxable amounts" include expenses and losses that are included in the tax return BEFORE they are recognized for accounting purposes.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
17. Under the indirect method or preparing sash flows from operating activities, future income tax expense must be added back to net income.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
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18. Netting of deferred income tax assets and liabilities is forbidden under IFRS and ASPE.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3, 4, 8
19. During the originating period of a temporary difference, pretax accounting income is defined as taxable income plus taxable amounts minus deductible amounts.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
20. All temporary differences are related to differences in the timing of accounting recognition compared with income tax recognition.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
21. All temporary differences originate, then reverse, and eventually end with a zero net effect.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
22. Under the liability approach, deferred taxes on the balance sheet are valued at the tax rate in that will be in effect when the temporary differences reverse.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
23. Under the deferral approach, deferred taxes on the balance sheet are valued at the tax rate in that will be in effect when the temporary differences reverse.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
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24. In Canada, tax rates are usually enacted in the year to which they pertain.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
25. Differences between accounting recognition and recognition for tax purposes are called "temporary differences".
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
26. There are many types of organizations that are subject to income tax including corporations, partnerships and proprietorships.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
27. Only corporations are subject to income tax.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
28. For inter-period tax allocation, the total income tax expense must be allocated to ongoing operations, discontinued operations and extraordinary items on the income statement.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
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29. Income tax expense for continuing operations, discontinued operations and extraordinary items must be disclosed separately on the income statement.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
30. Temporary differences and timing differences are terms that mean the same thing.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
31. Ryan Company paid the golf dues of one of its employees. This represents a temporary difference.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
32. If a company incurs $1,500 of expenditures for meals and entertainment, this amount represents a permanent difference.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
33. Amanda Company sold an asset and as a result had a capital gain of $15,000. This amount represents a permanent difference.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
34. Golf Corporation sold an asset and recorded a capital gain of $15,000. $3,750 of this amount represents a permanent difference.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
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35. Comprehensive allocation recognizes the amount of taxes assessed in each year as the income tax expense for that year.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
36. If the enacted tax rate is changed for the current and future years, the earnings effect of the change in the beginning balances of the future tax assets is recognized in the current year.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
37. ABC Co. in its first year of business has taxable income of $2,000, book depreciation of $3,000 and tax depreciation of $4,600, and recognized $800 of warranty expense but performed no warranty service. ABC's pretax accounting income would be:A) $1,200B) $2,000C) $2,800D) $2,200
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
38. Which of the following transactions does not cause a temporary income tax difference?A) Revenues or gains that is included in taxable income one or more periods after they are
included in pretax accounting incomeB) Expenses or losses that are deducted in determining taxable income one or more periods
after they are deducted in determining pretax accounting incomeC) Revenues or gains that are included in pretax accounting income but are never included in
taxable incomeD) Expenses or losses that are deducted in determining taxable income before they are
deducted in determining pretax accounting income
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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39. Inter-period tax allocation accounts forA) All differences between tax regulations and GAAPB) Temporary differencesC) Permanent differencesD) Tax effects of specific income statement items in the same period
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
40. Company A had depreciation of $14,000 and CCA of $12,500. At the end of the year, they have:A) Deferred income tax asset of $1,500B) Deferred income tax liability of $1,500C) Deferred income tax asset of $14,000D) Deferred income tax liability of $14,000
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2, 3
41. Company B had depreciation of $13,000 and CCA of $18,000. At the end of the year, they have:A) Deferred income tax asset of $13,000B) Deferred income tax liability of $18,000C) Deferred income tax liability of $5,000D) Deferred income tax asset of $5,000
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2, 3
42. The general terminology used to describe income tax expense when disclosed in the financial statements is:A) Income tax expenseB) Income tax benefitC) Provision for income tax expensesD) Tax expense
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
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43. A taxable amount is exemplified by:A) Revenue that is included in the tax return before it is included in pretax accounting income.B) Gain that is included in the tax return before it is included in pretax accounting income.C) Expense that is included in the tax return after it is included in pretax accounting income.D) Expense that is included in the tax return before it is included in pretax accounting income.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
44. A deductible amount is exemplified by all of the following except:A) Revenue that is included in the tax return before it is included in pretax accounting income.B) Gain that is included in the tax return before it is included in pretax accounting income.C) Expense that is included in the tax return after it is included in pretax accounting income.D) Loss that is included in the tax return after it is included in pretax accounting income.E) Expense that is included in the tax return before it is included in pretax accounting income.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
45. Golf dues paid for by a company is an example of:A) A temporary differenceB) A timing differenceC) A permanent differenceD) A reversing difference
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
46. Choose the permanent differenceA) dues (country club, etc.) paid on behalf of executives are not deductible for tax purposes,
are deductible under GAAPB) carryback, carryforward option for taxes, no such option under GAAPC) straight-line depreciation for the books, accelerated depreciation for taxesD) point of sale revenue recognition for the books, instalment method for taxes
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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47. At the end of 2099, the only expected future temporary difference is implied by the following account found in the balance sheet:Prepaid rent...........$22,000.The footnotes reveal that the prepaid rent applies only to 2010. You would also expect to find which of the following in the balance sheet:A) Current future tax liabilityB) Current future tax assetC) Noncurrent future tax liabilityD) Noncurrent future tax asset
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
48. In computing future tax assets and liabilities, which tax rates are used:A) Current tax rateB) Estimated future tax ratesC) Enacted future tax ratesD) Past years' tax rates
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
49. At most, how many future tax accounts will a firm report in its balance sheet?A) 1B) 2C) 3D) 4
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
50. Which of the following is the most likely item to result in a future tax asset?A) Using straight-line depreciation for the books and accelerated depreciation for taxB) Rent received in advanceC) Prepayment of insuranceD) Point of sale revenue recognition for the books, and cost recovery method of revenue
recognition for tax
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
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51. XYZ had taxable income of $4,000 during 2011. XYZ used accelerated depreciation for tax purposes ($4,200) and straight-line depreciation for accounting purposes ($1,000). XYZ had no other temporary differences. XYZ's pretax accounting income for 2001 would be:A) $800B) $5,000C) $7,200D) $8,200
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
52. During 2011, MJB has pretax accounting income of $8,400. MJB's only temporary difference for 2001 was rent revenue collected in advance of $2,400. None of this amount is recognized for book purposes. MJB's taxable income for 2011 would be:A) $6,000B) $8,400C) $9,600D) $10,800
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
53. MNO's taxable income was $900 during 2011. MNO had product warranty costs of $360 recognizable for tax purposes and $400 recognizable for financial accounting purposes. MNO had no other temporary differences. MNO's pretax accounting income for 2011 would be:A) $860B) $900C) $940D) $1,260
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
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54. STR provided the following data related to income tax allocation:
2009 2010Pretax accounting income $4,000 $4,400Taxable income 4,400 4,000Income tax rate 34% 34%
The future tax account showed a zero balance at the start of 2009. There was only one temporary difference, a revenue amount, which was taxable in 2009, but was recorded for accounting purposes in 2001. There are no carry backs or carry forwards. The journal entry to record the income tax consequences for 2009 would include a:A) Debit of $136 to STR's future tax liability account.B) Credit of $136 to STR's future tax liability account.C) Debit of $136 to STR's future tax asset account.D) Credit of $136 to STR's future tax asset account.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
55. The following data of ABC Ltd. relates to the current year:
Pre-tax accounting income $20,000Depletion Tax 4,000 Books 2,000Depreciation Tax 10,000 Books 8,000Dividends from a tax Canadian corporation 6,000False advertising fine (not deductible) 1,000Rent revenue Tax 16,000 Books 12,000
Compute taxable income for the year.A) $13,000B) $15,000C) $17,000D) $19,000E) $11,000
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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56. A firm reported the following in its income statement for the current year: depletion expense, $4,000; pollution violation fine, $12,000; pre-tax accounting income, $10,000. The tax rate is 40%. For tax purposes, the depletion deduction was $9,000. What amount of income tax expense will be recognized for this year?A) $7,800B) $4,000C) $6,800D) $400E) $8,800
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
57. At the end of 2010, a firm reported $200,000 of credit sales for income statement purposes. Of that amount, only $60,000 had been collected. In addition, $20,000 of credit sales from 2009 had not been collected as of Dec. 31, 2010. Assume for tax purposes that only collected sales are taxable. As of Dec. 31, 2010, this firm has a futureA) $140,000 taxable differenceB) $160,000 deductible differenceC) $160,000 Taxable differenceD) $ 60,000 taxable differenceE) $140,000 deductible difference
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
58. Ryan Company paid golf dues on behalf of their two top employees. This is an example of a:A) Temporary differenceB) Reversing differenceC) Permanent differenceD) Fully deductible for income tax purposes
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
59. Amanda Corporation incurred $10,000 of meals and entertainment expenses for the year ended December 31. The amount that is deductible for tax purposes is:A) $5,000B) $7,500C) $10,000D) $0
Ans: A
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Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
60. EGR just completed its first year end. During the year, EGR recorded $12,000 in depreciation ($18,500 CCA). In addition there was a deduction in the accounting records for meals and entertainment amounting to $6,000. As a result taxable income will:A) Be lower than accounting income by $3,500B) Be lower than accounting income by $500C) Be higher than accounting income by $6,500D) Be lower than accounting income by $6,500E) Will be equal to accounting income
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
61. KEG just completed its year end. During the year, KEG recorded $12,000 in depreciation ($9,000 CCA). In addition there was a deduction in the accounting records for meals and entertainment amounting to $5,000. As a result taxable income will:A) Be lower than accounting income by $3,000B) Be higher than accounting income by $3,000C) Be higher than accounting income by $5,500D) Be lower than accounting income by $5,500E) Will be equal to accounting income
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
62. Temporary differences can be dealt with in a number of different ways. The method recommended in the CICA Handbook is:A) Flow-through methodB) Comprehensive allocationC) Partial allocationD) Any of the above
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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63. A characteristic of comprehensive allocation is that:A) Income tax expense = current income taxB) inter-period income tax allocation is applied to some types of temporary differences but
not allC) The matching principle is better servedD) It is called the taxes payable method
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
64. All of the following are characteristics of comprehensive allocation except:A) Proponents say that a future cash flow impact arises from all temporary differences.B) The matching principle is best served by using the comprehensive allocation method.C) Income tax is an aggregate measure, applied to the overall operations of the company.D) recommended by the CICA Handbook.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
65. Which of the following could never be subject to inter-period tax allocation?A) Proceeds from life insuranceB) Depreciation expense on operational assetsC) Estimated warranty expenseD) Rent revenue
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
66. Which of the following is an example of a temporary difference, which would result in a future tax liability?A) Use of straight-line depreciation for accounting purposes and an accelerated rate for
income tax purposesB) Rent revenue collected in advance when included in taxable income before it is included in
pre-tax accounting incomeC) Use of a shorter depreciation period for accounting purposes than is used for income tax
purposesD) Investment losses recognized earlier for accounting purposes than for tax purposes
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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67. Which of the following is an example of a temporary difference, which could result in a deferred tax asset?A) Gain on disposal of an asset when included in taxable income before it is included in pre-
tax accounting incomeB) Use of straight-line depreciation for accounting purposes and an accelerated rate for
income tax purposesC) Gross margin on instalment sales is recognized for accounting purposes before it is
included in taxable income in the income tax returnD) Prepayments of expenses in year of payment; recognition of expense for accounting
purposes occurs in a later year
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
68. Which of the following is an example of a temporary difference which would not result in a deferred tax asset?A) Allowance method for doubtful accounts is used for accounting purposes while direct
write-off is required for tax purposes.B) Use of sales method of revenue recognition for accounting purposes, and instalment
method of revenue recognition for tax purposes.C) Unrealized loss on short term investment is recognized for accounting purposes during the
holding period while the actual loss on date of disposal is used for tax purposes.D) Estimated loss on disposal of a segment of a business recognized for accounting purposes
but reported on the income tax return later on the basis of the actual loss.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
69. The term "taxable amount" includes:A) Gains that are included in the tax return AFTER they are recognized for accounting
purposes.B) Revenues that are included in the tax return BEFORE they are recognized for accounting
purposes.C) Losses that are included in the tax return AFTER they are recognized for accounting
purposes.D) Warranty deductions for accounting purposes.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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70. JMR Corp. incurred an expenditure that qualified for an investment tax credit. The expenditure amounted to $150,000, the Corporation's tax rate is 44% and the expenditure qualifies for a 6% tax credit. The Corporation had taxable income in the year. What is the amount of the tax reduction?A) $66,000B) $9,000C) $0D) $6,000
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1, 3
71. A temporary difference that is deductible in future years is called:A) A temporary tax liabilityB) A temporary tax assetC) A permanent tax assetD) A permanent tax liability
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
72. JMR Corporation has one asset worth $350,000. Depreciation accumulated to date is $200,000 and accumulated CCA is $230,000. Assuming the tax rate is 40% what is the income tax implication?A) A Deferred income tax asset of $30,000B) A Deferred income tax liability of $30,000C) A Deferred income tax asset of $12,000D) A Deferred income tax liability of $12,000
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3, 4, 5
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73. JMR Corporation has one asset worth $350,000. Depreciation accumulated to date is $230,000 and accumulated CCA is $200,000. Assuming the tax rate is 40% what is the income tax implication?A) A Deferred income tax asset of $30,000B) A Deferred income tax liability of $30,000C) A Deferred income tax asset of $12,000D) A Deferred income tax liability of $12,000
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3, 4, 5
74. EGR Corporation has one asset worth $450,000. Depreciation accumulated to date is $190,000 and accumulated CCA is $220,000. The Corporation also recorded warranty expense of $30,000. To date no customers have required warranty service. Assuming the tax rate is 40% what is the income tax implication?A) A Deferred income tax asset of $30,000B) No temporary differencesC) A Deferred income tax asset of $12,000D) A Deferred income tax liability of $12,000
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3, 4, 5
75. EGR Corporation has one asset worth $650,000. Depreciation accumulated to date is $230,000 and accumulated CCA is $200,000. The Corporation also recorded warranty expense of $35,000. To date no customers have required warranty service. Assuming the tax rate is 40% what is the income tax implication?A) A Deferred income tax asset of $65,000B) A Deferred income tax liability of $65,000C) A Deferred income tax asset of $26,000D) A Deferred income tax liability of $26,000
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 3, 4, 5
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76. The following information is available for Ryan Corporation: Assets at cost - $260,000; Accumulated depreciation - $80,000; Accumulated CCA - $90,000; meals and entertainment recorded in the books - $12,000; golf dues paid - $5,000. Based on this information and a tax rate of 45%, what is the amount of the temporary difference?A) $0B) $1,000C) $4,000D) $10,000
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
77. The following information is available for Ryan Corporation: Assets at cost - $260,000 (8 year life, straight-line depreciation and purchased 2 years ago); Accumulated depreciation - $65,000; Accumulated CCA - $105,300; CCA rate – 30%; meals and entertainment recorded in the books -$12,000; golf dues paid - $5,000; accounting income - $40,000. Based on this information and a tax rate of 45%, what is taxable income?A) $10,000B) $18,000C) $17,200D) $102,500
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
78. The following information is available for Ryan Corporation: Assets at cost - $160,000 (5 year life, straight-line depreciation and purchased 4 years ago); Accumulated depreciation - $128,000; Accumulated CCA - $113,352; CCA rate – 30%; meals and entertainment recorded in the books -$10,000; golf dues paid - $2,500; accounting income - $90,000. Based on this information and a tax rate of 45%, what is taxable income?A) $102,008B) $114,508C) $104,508D) $109,508
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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79. The following information is available for Ryan Corporation: Assets at cost - $160,000 (5 year life, straight-line depreciation and purchased 4 years ago); Accumulated depreciation - $128,000; Accumulated CCA - $113,352; CCA rate – 30%; meals and entertainment recorded in the books -$10,000; golf dues paid - $2,500; accounting income - $90,000. Based on this information and a tax rate of 45%, What should the future tax asset amount to?A) $6,591.60B) $14,548.00C) $3,216.60D) $5,466.60
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
80. The following information is available for Ryan Corporation: Assets at cost - $160,000 (5 year life, straight-line depreciation and purchased 4 years ago); Accumulated depreciation - $128,000; Accumulated CCA - $113,352; CCA rate – 30%; meals and entertainment recorded in the books -$10,000; golf dues paid - $2,500; accounting income - $90,000. Based on this information and a tax rate of 45%, what is the amount of the temporary difference?A) 6,592B) $17,148C) $4,648D) $14,648
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
81. The following information is available for Ryan Corporation: Assets at cost - $160,000 (5 year life, straight-line depreciation and purchased 4 years ago); Accumulated depreciation - $128,000; Accumulated CCA - $113,352; CCA rate – 30%; meals and entertainment recorded in the books -$10,000; golf dues paid - $2,500; accounting income - $90,000. Based on this information and a tax rate of 45%, what is the amount of the permanent differences?A) 6,592B) $7,500C) $4,648D) $14,648
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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82. An example of a "deductible amount" occurs when:A) A gain on instalment sales is recognized for tax purposes as the receivable is collected, but
was earlier recognized for accounting purposes when the sale was made.B) Accelerated depreciation is used for tax purposes but straight-line depreciation is used for
accounting purposes.C) Product warranty costs recognized for tax purposes as the warranty conditions are met but
recognized for accounting purposes earlier on the accrual basis.D) Expenses are recognized more quickly for taxes than for accounting purposes.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
83. KER had recorded an accrual for warranty in its books during the year ended December 31, 2009amounting to $100,000. During the year 2000, customers required service from goods sold in 2009 amounting to $60,000. KER recorded an amount for possible warranty costs for goods sold during the year in the amount of $95,000. KER has a temporary difference for the year 2000 amounting to:A) 0B) Future tax asset $135,000C) future tax liability $135,000D) Cannot be determined from the information given
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1, 3
84. KER had recorded an accrual for warranty in its books during the year ended December 31, 2010amounting to $100,000. During the year 2011, customers required service from goods sold in 2010 amounting to $60,000. KER recorded an amount for possible warranty costs for goods sold during the year in the amount of $95,000. Accounting income amounted to $80,000 and the tax rate is 40%. Assuming that KER has no other differences between accounting and tax what is the current and future income tax amounts?A) Current: $70,000; future tax liability: $135,000B) Current: $46,000; future tax liability: $135,000C) Current: $46,000; future tax asset: $135,000D) Cannot be determined from the information given
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 3
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85. Recommended disclosures for the provision for income tax expense include all of the following except:A) Public companies should disclose the nature of temporary differencesB) Income tax expense or benefit should be reported separately on the financial statementsC) Income tax expense should not be grouped with other expensesD) Income taxes relating to discontinued items must be disclosed separately on the financial
statements
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
86. Which of the following does not help explain why (1) and (2) are different:(1) Income tax expense(2) The product of pre-tax income and the current tax rate.A) Permanent differencesB) Temporary differencesC) The fact that future and current tax rates are differentD) A change in the effective tax rate
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
87. During 2001, XZY had pre-tax accounting income of $420. XZY's only temporary difference for 2003 was the collection of a receivable, which resulted in $120 of income under the instalmentsales method of revenue recognition, which XZY uses, for tax purposes. The sale was originally made in 2000 and recognized for accounting purposes at that time. XZY's taxable income for 2003 would be:A) $300B) $420C) $460D) $540
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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88. CDE had taxable income of $1,500 during 2001. CDE used accelerated depreciation for tax purposes ($2,000) and straight-line depreciation for financial accounting purposes ($800). On December 30, 2001, CDE collected January 2002's $600 rent on a lot it rents on a month-by-month basis to JCB. CDE's pre-tax accounting income for 2001 would be:A) $900B) $2,100C) $3,300D) $3,700
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
89. GFH had pre-tax accounting income of $1,400 during 2001. GFH used accelerated depreciation for tax purposes ($1,000) and straight-line depreciation for financial accounting purposes ($200). During 2001 GFH accrued warranty expenses of $900 and paid cash to honour warranties of $500. GFH's taxable income for 2001 would be:A) $200B) $1,000C) $1,800D) $2,600
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
90. Kate Corporation sold a truck resulting in a capital gain of $7,600. The amount to be reported for tax purposes is:A) $7,600B) $0C) $5,700D) $3,800
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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91. JMR Corporation sold a truck resulting in a capital gain of $11,000. $5,500 represents a:A) Permanent differenceB) Temporary differenceC) Timing differenceD) None of the above
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
92. KAR Company sold a building resulting in a capital gain of $15,000. Choose the statement below that best describes what the impact of this is:A) Accounting income will be reduced by $7,500B) There will be a permanent difference of $7,500C) There will be a permanent difference of $11,250D) There will be a temporary difference of $7,500E) There will be a temporary difference of $3,750
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
93. ABC has taxable income of $5,000, future taxable amounts of $4,000, and future deductible amounts of $2,000 at the end of its first year of operations. Calculate ABC's pretax accounting income for this first year.Ans: $5,000 + $4,000 - $2,000 = $7,000 pre-tax accounting incomeDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
94. During 2001, JBC had pre-tax accounting income of $8,400, originating taxable amounts of $4,800 and originating deductible amounts of $2,400. Calculate JBC's taxable income for 2001.Ans: $8,400 - $4,800 + $2,400 = $6,000 taxable incomeDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
95. Explain the difference between a temporary and permanent difference.Ans: A temporary difference will, at some point in time reverse. It is an amount that is
deductible for accounting purposes at a different time than for tax purposes. A permanent difference never reverses. It is an item that is recorded for accounting purposes but will never be accounted for in the calculation of taxable income. The reverse is also true.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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96. List five amounts that are permanent differences.Ans: 1. dividends received by Canadian corporations from other taxable Canadian corporations
2. 50% of capital gains3. Equity in earnings of significantly influenced investors4. Golf club dues5. 50% of meals and entertainment expenses6. Interest and penalties on taxes7. Political contributions
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
97. List five amounts that are temporary differences.Ans: 1. depreciation for accounting purposes, CCA for tax
2. Amortization for capitalized development costs; immediate deduction for tax.3. Gains and losses on inventories valued at market for accounting; taxed when realized.4. Warranty costs accrued for accounting purposes in period of sale; tax deductible when incurred.5. Bond discount or premium amortized for accounting but realized for tax purposes only when the principle is settled at maturity.6. Percentage-of-completion accounting for contracts; completed contract reporting for tax (for contracts lasting no more than two years).
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
98. What tax rate should be used to measure a deferred income tax asset or liability?Ans: Enacted tax ratesDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
99. What term is used to describe an amount that will eventually be tax deductible?Ans: A Deferred income tax assetDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
100. What term is used to describe an amount that will eventually be taxable?Ans: A Deferred income tax liabilityDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
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101. Briefly explain the three basic issues with respect to inter-period income tax allocation.
Ans: 1. Extent of Allocation: There are discussions on whether the allocations of temporary differences should be full, partial or none at all. The CICA handbook recommends Comprehensive (full) allocation as it more closely meets the matching principle.2. The measurement method: Discusses whether the tax rate used should be the current tax rate or the enacted tax rate. The CICA Handbook recommends the use of using enacted tax rates.3. Discounting: There are discussions on whether discounting should be used to measure the future tax amounts. The Handbook does not recommend discounting.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2
102. What is the main conceptual issue regarding the recognition of deferred income taxes assets or deferred income tax liabilities?
Ans: Deferred income tax “assets’ do not meet the definition of an asset UNLESS they result in a future benefit such as a tax loss carry-forward. Most deferred income tax assets and liabilities, however, appear on the balance sheet as a result of cumulative temporary differences over time and as such, do not embody future economic benefits (as in the case of an asset) or a sacrifice of resources (as in the case of a liability).
Difficulty: HardLevel of Learning: KnowledgeTopic: LO7
103. The following information is available to you: Income before tax; $80,000; depreciation, $15,000; CCA, $13,500; tax rate, 44%. Calculate the Deferred income tax asset (liability).Ans: temporary difference = $1,500x44%=$660Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
104. The following information is available to you: Income before tax $1,230,000, depreciation, $350,000; CCA, $300,000; tax rate, 40%. Prepare the journal entry to record taxes for the year. (Assume there are no previous tax differences.)Ans: Taxable income = 1,230,000+350,000-$300,000=1,280,000x40%=$512,000
Deferred income tax asset = 350,000-300,000=50,000x40%=$20,000
Dr. current income tax expense $512,000 Cr. Income tax payable $512,000Dr. Deferred income tax assets $20,000 Cr. Income tax expense $20,000
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
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105. The following information is available to you: Income before tax $1,540,000, depreciation, $309,000; CCA, $350,000; tax rate, 40%. Prepare the journal entry to record taxes for the year. (Assume there are no previous tax differences.)Ans: Taxable income = 1,540,000+309,000-$350,000=1, x40%=$599,600
Deferred income tax liability = 309,000-350,000= (41,000) x40%=$16,400
Dr. current income tax expense $599,600 Cr. Income tax payable $599,600Dr. Income tax expense $16,400 Cr. Deferred income tax liability $16,400
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1,2, 3
106. JMR Corporation has income before tax of $500,000. Included in this amount are meals and entertainment amounting to $10,000, warranty costs of $80,000 ($20,000 in warranty claims), depreciation $78,000 and dividends from a taxable Canadian Corporation of $20,000. CCA for the year amounted to $90,000. Calculate taxable income.Ans: Taxable income: $500,000+$5,000+$80,000-$20,000+$78,000-$90,000-
$20,000=$533,000 Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
107. JMR Corporation has income before tax of $800,000. Included in this amount are meals and entertainment amounting to $9,000, warranty costs of $100,000 ($65,000 in warranty claims), depreciation $94,000 and dividends from a taxable Canadian Corporation of $15,000. CCA for the year amounted to $90,000. Calculate taxable income.Ans: Taxable income: $800,000+$4,500+$100,000-$65,000+$94,000-$90,000-
$15,000=$828,500Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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108. JMR Corporation has income before tax of $800,000. Included in this amount are meals and entertainment amounting to $9,000, warranty costs of $100,000 ($65,000 in warranty claims), depreciation $94,000 and dividends from a taxable Canadian Corporation of $15,000. CCA for the year amounted to $90,000 and the tax rate is 40%. Calculate income tax expense.Ans: Taxable income: $800,000+$4,500+$100,000-$65,000+$94,000-$90,000-
$15,000=$828,500x40%=$331,400Deferred income tax asset= 100,000-65,000+94,000-90,000=39,000x40%=15,600Income tax expense=331,400-15,600=315,800
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
109. JMR Corp. had one temporary difference during the year. The carrying value of its capital assets for accounting purposes amounted to $350,000; the carrying value for CCA purposes was $380,000. What is the temporary difference amount, what would it be called and where should it be presented on the balance sheet?Ans: The temporary difference is $30,000, which would appear as a future tax asset and should
be recorded as a non-current future tax asset on the balance sheet (tax rate is needed to determine the amount of the future tax asset).
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
110. EGR Company provided you with the following information:2009 Net Income: $1,500,0002010 Net Income: $900,0002009 Tax rate: 35%2010 Tax rate: 40%In addition, the only difference between accounting and tax are warranty costs accrued of $100,000 in 2009. No actual warranty expenses were incurred in 2009 or 2010. Prepare journal entries for 2009 and 2010 to record income tax expense.
Ans: 2009:Dr. Income tax expense $560,000 Cr. Income tax payable $560,000Dr. Deferred income tax asset $35,000 Cr. Income tax expense $35,000
2010:Dr. Income tax expense $360,000 Cr. Income tax payable $360,000Dr. Deferred income tax asset $5,000 Cr. Income tax expense $5,000
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2, 3
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111. EGR Company provided you with the following information:2009 Net Income: $1,500,0002010 Net Income: $900,0002009 Tax rate: 40%2010 Tax rate: 35%In addition, the only difference between accounting and tax are warranty costs accrued of $100,000 in 2009. No actual warranty expenses were incurred in 2009 or 2010. Prepare journal entries for 2009 and 2010 to record income tax expense.Ans: 2009:
Dr. Income tax expense $600,000 Cr. Income tax payable $600,000Dr. Deferred income tax asset $40,000 Cr. Income tax expense $40,000
2010:Dr. Income tax expense $315,000 Cr. Income tax payable $315,000Dr. Income tax expense $5,000 Cr. Deferred income tax asset $5,000
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2, 3
112. Define the effective tax rate.Ans: The effective tax rate is the ratio of the income tax expense including those relating to
temporary differences divided by the pre-tax net income.Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
113. RG Corporation has a temporary difference of $40,000 in 2009. Its tax rate in 2009 is 40% and the government enacted tax rate known at the end of 2009 for 2000 and subsequent years is 45%. What tax rate should be used to calculate the deferred income tax asset or liability?Ans: The enacted tax rate should be used (45%).Difficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 2, 3
114. What is inter-period tax allocation?Ans: Inter-period tax allocation is the process of allocating temporary differences between years.
There are three approached, the comprehensive allocation method is the one recommended by the CICA as it promotes better matching.
Difficulty: HardLevel of Learning: KnowledgeTopic: LO2
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115. KG Company had capital assets with a carrying value of $1,670,000 and a tax value of $1,560,000. In addition they had an accrued warranty liability of $80,000 of which $20,000 had actually been incurred and golf club dues in the amount of $3,000. Calculate the temporary difference deductible (taxable).Ans: Temporary taxable = 1,560,000-1,670,000-20,000+80,000= (50,000) Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2, 3
116. KG Company had capital assets with a carrying value of $1,560,000 and a tax value of $1,670,000. In addition they had an accrued warranty liability of $80,000 of which $20,000 had actually been incurred and golf club dues in the amount of $3,000. Calculate the temporary difference deductible (taxable).Ans: Temporary deductible = 1,670,000-1,560,000-20,000+80,000=170,000Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2, 3
117. Explain the income tax disclosures recommended by the CICA.Ans: The amount of income tax expense or benefit that is included in net income before
extraordinary items and discontinued operations should be reported separately. The amount that is attributable to future income taxes should be shown separately either in the statements or in the notes. The amounts of income tax expense that relates to each of discontinued operations, extraordinary items, and capital transactions should be disclosed.
Difficulty: HardLevel of Learning: KnowledgeTopic: LO4
118. CDE had taxable income of $7,500 during 2009. CDE used accelerated depreciation for tax purposes ($10,000) and straight-line depreciation for financial accounting purposes ($4,000). On December 30, 2009, CDE collected January 2000's $3,000 rent on a lot it rents on a month-by-month basis to JCB. CDE's pre-taxaccounting income for 2009 would be (show calculations):Ans: $7,500 + $10,000 - $4,000 - $3,000 = $10,500 pre-tax accounting incomeDifficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2, 3
119. GFH had pre-tax accounting income of $5,600 during 2009. GFH used accelerated depreciation for tax purposes ($4,000) and straight-line depreciation for financial accounting purposes ($800). During 2009 GFH accrued warranty expenses of $3,600 and paid $2,000 cash to honourwarranties. GFH's taxable income for 2009 would be (show calculations):Ans: $5,600 - $4,000 + $800 + $3,600 - $2,000 = $4,000 taxable incomeDifficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2, 3
120. ABC Inc. purchased new machinery for $2 million on January 1st, 2011. For accounting purposes, the company depreciates all machinery on a straight-line basis (no salvage value) over a five year period. For tax purposes, CCA on all machinery is taken at a rate of 20%, with half a
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year’s CCA taken in the year of acquisition. The tax rate for 2011 is 40%. The tax rate for years 2012 and later is 35%. Assume that all rates are enacted in the year to which they pertain. Using the shortcut approach, determine the deferred income tax asset or liability at the end of 2011.Ans:Tax Basis: $2,000,000-0.5*20%*$2,000,000=$1,800,000Accounting Basis: $2,000,000-$400,000=$1,600,000.
Difference: $1, 8 million-$1.6 million= $200,000*40%=$80,000 deferred income tax asset
Note that this is a deferred income tax asset since less CCA is taken than depreciation in the first year, resulting in a larger future deductible amount. The 2012 rate is not known in 2011 so the temporary difference will be valued at the 2011 rate of 40%.Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2, 3, 5
121. Refer to question 120 above. How (if at all) would your answer change if the tax rate for all years 2011 and beyond were enacted in 2011?Ans: In this case, the tax rates for years 2012 would be known in 2011. Since this temporary difference will reverse out after 2011, the deferred income tax asset would be valued at the rate that is expected to be in effect when the reversal is complete. In this case, the rate in effect will be 35%, thus, the difference between the tax and accounting bases calculated in question 120 above, which was $200,000, will be multiplied by 35%. Thus the deferred income tax asset in this case will be valued at $70,000 ($200,000*35%).
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2, 3, 5
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test BankChapter 16 – Accounting for Tax Losses
1. Under income tax laws and regulations a corporation that sustains a net operating loss for the current year may elect to carry back and/or carry forward the loss for income tax purposes.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
2. Net operating tax carry backs and carry forwards never result in a cash refund of prior taxes paid but may result in a reduction in taxes for subsequent years.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
3. The use of a valuation allowance account is mandatory under IFRS.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3, 7
4. If a corporation incurs a taxable loss, they are entitled to carry the loss back for three years or forward for twenty years.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
5. Under ASPE, deferred income tax assets due to carry forwards may or may not be realized, depending whether the company uses the taxes payable method.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
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6. IFRS requires that deferred income taxes due to carry-forwards be recognized at the tax rate enacted for the current year.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
7. Companies normally apply tax loss carry backs sequentially.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
8. A tax loss represents the present and deferred benefit that the company will be able to realize from the tax loss through a reduction of income taxes paid to governments.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
9. A company will show the same income tax expense/benefit regardless of whether or not a valuation account is used.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2, 3
10. A tax benefit represents the present and deferred benefit that the company will be able to realize from the tax loss through a reduction of income taxes paid to governments.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
11. Under current law, at the end of the year of loss or anytime during the next 15 years, a company may select to either carry back-carry forward the loss or carry forward-only the loss.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
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12. In general, deferred income tax assets due to tax loss carry forwards only to the extent that they are likely to be realized.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
13. The terms “probable” and “more likely than not” refer to probabilities that are greater than or equal to 50%.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2, 6
14. Under IFRS, the income tax expense pertaining to continuing operations must be presented on the face of the income statement.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO5
15. Taxes are recovered at the rate at which it was originally paid. The tax rate in the year the loss is not relevant.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
16. Taxes are recovered at the tax rate in effect during the year of the loss.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
17. If any part of the loss recovered is attributable to discontinued operations or extraordinary, the recovery must be allocated to the different components.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO5
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18. The amount of any unused tax losses must be disclosed on the face of the income statement.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO5
19. The recovery of income tax expense is credited to income tax expense (recovery) account.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
20. A company carrying back a loss must use the earliest year first.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
21. In the year in which a tax loss is incurred, the tax loss must equal the net loss reported on the company’s financial statements.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
22. CCA is an optional deduction and may be adjusted downwards in order to create taxable income.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
23. Better matching is achieved when deferred income tax assets due to carry forwards are recognized in the year of the loss.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
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24. The rules for a loss carry forward remain the same between the old Handbook section (3470) and the new Handbook section (3465).
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
25. Existing sufficient taxable temporary differences, which will result in taxable income, is one piece of evidence to support a more likely than not criteria.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
26. Existing sufficient taxable permanent differences, which will result in taxable income, is one piece of evidence to support a more likely than not criteria.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
27. It is possible to amend prior years' tax returns in order to reduce or eliminate CCA.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
28. Once it is deemed that a potential benefit of a loss carry forward does not meet the more likely than not criteria, the benefit may not be set up until realized.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
29. If a potential benefit of a loss carry forward is determined not to meet the more likely than not criteria in one year, it may still be set up in a deferred period if the criteria are subsequently met.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
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30. If a potential benefit of a loss carry forward that was previously determined to meet the more likely than not criteria has now been determined not to meet the criteria, it should be reversed.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
31. A deferred income tax asset that has been recorded for a tax loss carry forward must be maintained at the tax rate that is expected to be in effect when the carry forward is utilized.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
32. The criteria of more likely or not must be met in order for a Company incurring a loss during the year and upon carry back had a tax recovery of $135,000.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
33. An excess of fair value over the tax basis of the enterprise's net asset in an amount sufficient to realize the deferred income tax asset is evidence to support recognition of a deferred income taxbenefit except:
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
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34. When deferred benefits of a tax loss carry forward are recognized in the year of the loss, the credit to income tax recovery will be given inter-period allocation.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
35. The current tax benefit from tax loss carry backs and carry forwards, segregated between continuing operations and discontinued operations and extraordinary items should be disclosed.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO5
36. The amount and expiry date of unrecognized tax losses follow the same carry forward rules as recognized tax losses.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
37. Carry back and carry forward procedures for temporary differences are always applied, even when there are no temporary differences for deductible items and there are no current income taxes payable.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
38. Under one method of accounting, but not both, for the investment tax credit, ITCs obtained in prior years may affect reported earnings in deferred years even though ITC is not available in those deferred years.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
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39. A Corporation that incurs a taxable loss is entitled to offset the loss as follows:A) Carried back 7 years and forward 3 yearsB) Carried back 3 years and forward 7 yearsC) Carried back 3 years and forward 10 yearsD) Carried back 10 years and forward 3 years
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
40. VB Corporation has a net loss of $50,000. Included in the loss are golf dues totalling $3,000. VB has:A) A tax loss of $53,000B) A tax benefit of $50,000C) A tax loss of $47,000D) Cannot be determined from the information given
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
41. VB Corporation has a loss of $50,000 with a tax rate of 40%. Included in the loss are golf dues totalling $3,000. VB has:A) a tax loss of $20,000B) a tax benefit of $18,800C) a tax loss of $18,800D) a tax benefit of $21,200
Ans: B
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2
42. A tax benefit represents:A) the final number of the taxable loss on the tax returnB) the amount of refund to be received in the yearC) assistance from the governmentD) the present and deferred benefit that the company will be able to realize from the tax loss
through a reduction of income taxes
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
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43. A tax loss represents:A) the final number of the taxable loss on the tax returnB) the amount of refund to be received in the yearC) assistance from the governmentD) the present and deferred benefit that the company will be able to realize from the tax loss
through a reduction of income taxes
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
44. VB Corporation incurred a tax loss of $86,000. Based on a tax rate of 45% what is the potential tax benefit?A) $86,000B) $38,700C) $0D) cannot be determined
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
45. KG Corporation incurred a tax loss of $345,000. Based on a tax rate of 38% what is the potential tax benefit?A) $131,100B) $345,000C) $0D) cannot be determined
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
46. JG Corporation incurred a tax loss of $945,000. Based on a tax rate of 38% what is the potential tax benefit?A) $0B) $945,000C) $359,100D) cannot be determined
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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47. The following information for JMR Corporation is available:
Year Taxable Tax Income taxesIncome Rate Paid
20x11 $30,000 40% $12,00020x12 $90,000 38% $34,20020x13 $85,000 38% $32,30020x14 $(125,000) 35% -
The taxes recovered for the year ended 20x14 amounted to:A) $150,000B) $0C) $48,100D) $43,750
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
48. The following information for LAS Corporation is available:
Year Taxable Tax Income taxesIncome Rate Paid
20x11 $30,000 35% $10,50020x12 $90,000 38% $34,20020x13 $85,000 38% $32,30020x14 $(125,000) 40% -
The taxes recovered for the year ended 20x14 amounted to:A) $46,600B) $0C) $52,660D) $43,750
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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49. The following information for KEG Corporation is available:
Year Taxable Tax Income taxesIncome Rate Paid
20x11 $60,000 45% $27,00020x12 $90,000 38% $34,20020x13 $85,000 38% $32,30020x14 $(125,000) 40% -
The taxes recovered for the year ended 20x14 amounted to:A) $46,600B) $51,700C) $52,660D) $43,750
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
50. The following information for JG Corporation is available:
Year Taxable Tax Income taxesIncome Rate Paid
20x11 $30,000 45% $13,50020x12 $90,000 38% $34,20020x13 $85,000 38% $32,30020x14 $(150,000) 40% -
The taxes recovered for the year ended 20x14 amounted to:A) $48,600B) $46,600C) $52,660D) $59,100
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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51. The following information for KAR Corporation is available:
Year Taxable Tax Income taxesIncome Rate Paid
20x11 $30,000 35% $10,50020x12 $90,000 38% $34,20020x13 $85,000 38% $32,30020x14 $(205,000) 40% -
The taxes recovered for the year ended 20x14 amounted to:A) $82,000B) $77,000C) $75,850D) $43,750
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1, 2
52. A Company incurred a loss during the year and upon carry back had a tax recovery of $114,000. All of the following are true except:A) debit to income tax receivable for $114,000B) credit to income tax expenses for $114,000C) the taxes were recovered at the rate paidD) the criteria of more likely than not must have been met
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
53. A Company incurred a loss during the year and upon carry back had a tax recovery of $135,000. All of the following are true except:A) debit to income tax receivable for $114,000B) credit to income tax expenses for $114,000C) the taxes were recovered at the rate paidD) the criteria of more likely than not must have been met
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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54. Geisler Corp. provided you with the following information for the year ending December 31, 20x17:Net Income before taxes of - $150,000Depreciation (included in above) - $90,000CCA - $250,000Net book value of capital assets of $1,100,000 and UCC of $900,000 on January 1, 20x17, a temporary difference of $200,000 that is reflected in an accumulated deferred income tax liability balance of $90,000 at January 1, 20x17No permanent differencesTaxable income in the three-year carry back period of $400,000Tax rate of 45% in the current and previous yearsBased on the above information, what is the tax recovery for 20x17?A) $4,500B) $0C) $180,000D) $40,500E) cannot be determined
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
55. Brimley Corp. provided you with the following information for the year ending December 31, 20x17:Net Income before taxes of - $100,000
Depreciation (included in above) - $90,000CCA - $260,000Net book value of capital assets of $1,100,000 and UCC of $900,000 on January 1, 20x17, a temporary difference of $200,000 that is reflected in an accumulated deferred income tax liability balance of $80,000 at January 1, 20x17No permanent differencesTaxable income in the three-year carry back period of $400,000Tax rate of 40% in the current and previous yearsBased on the above information, what is the tax recovery for 20x17?A) $4,500B) $0C) $180,000D) $40,500E) none of the above
Ans: EDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1, 2
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56. Ryan Corp. provided you with the following information for the year ending December 31, 20x17:Net Income before taxes of - $100,000
Depreciation (included in above) - $67,000CCA - $250,000Net book value of capital assets of $1,100,000 and UCC of $900,000 on January 1, 20x17, a temporary difference of $200,000 that is reflected in an accumulated deferred income tax liability balance of $80,000 at January 1, 20x17No permanent differencesTaxable income in the three-year carry back period of $400,000Tax rate of 40% in the current and previous yearsBased on the above information, what is the tax recovery for 20x17?A) $4,500B) $0C) $33,200D) $40,500E) cannot be determined
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1, 2
57. Elizabeth Corp. provided you with the following information for the year ending December 31, 20x17:Net Income before taxes of - $150,000
Depreciation (included in above) - $90,000CCA - $250,000Net book value of capital assets of $1,100,000 and UCC of $900,000 on January 1, 20x17, a temporary difference of $200,000 that is reflected in an accumulated deferred income tax liability balance of $76,000 at January 1, 20x17No permanent differencesTaxable income in the three-year carry back period of $400,000Tax rate of 38% in the current and previous yearsBased on the above information, what is the tax recovery for 20x17?A) $4,500B) $0C) $3,800D) $40,500E) cannot be determined
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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58. JMR Corp. provided you with the following information for the year ending December 31, 20x17:Net Income before taxes of - $160,000
Depreciation (included in above) - $80,000CCA - $290,000Net book value of capital assets of $1,200,000 and UCC of $800,000 on January 1, 20x17, a temporary difference of $400,000 that is reflected in an accumulated deferred income tax liability balance of $176,000 at January 1, 20x17No permanent differencesTaxable income in the three-year carry back period of $400,000Tax rate of 44% in the current and previous yearsBased on the above information, what is the tax recovery for 20x17?A) $4,500B) $0C) $18,000D) $22,000E) cannot be determined
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1, 2
59. Ryan Corp. provided you with the following information for the year ending December 31, 20x17:Net Income before taxes of - $100,000
Depreciation (included in above) - $67,000CCA - $250,000Net book value of capital assets of $1,100,000 and UCC of $900,000 on January 1, 20x17, a temporary difference of $200,000 that is reflected in an accumulated deferred income tax liability balance of $80,000 at January 1, 20x17No permanent differencesTaxable income in the three-year carry back period of $400,000Tax rate of 40% in the current and previous yearsBased on the above information, what is the income tax expense for 20x17?A) $4,500B) $46,800C) $33,200D) $40,500E) cannot be determined
Ans: B
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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60. Elizabeth Corp. provided you with the following information for the year ending December 31, 20x17:Net Income before taxes of - $150,000
Depreciation (included in above) - $90,000CCA - $250,000Net book value of capital assets of $1,100,000 and UCC of $900,000 on January 1, 20x17, a temporary difference of $200,000 that is reflected in an accumulated deferred income tax liability balance of $76,000 at January 1, 20x17No permanent differencesTaxable income in the three-year carry back period of $400,000Tax rate of 38% in the current and previous yearsBased on the above information what is the tax recovery for 20x17?A) $4,500B) $72,200C) $3,800D) $40,500E) cannot be determined
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
61. JMR Corp. provided you with the following information for the year ending December 31, 20x17:Net Income before taxes of - $160,000
Depreciation (included in above) - $80,000CCA - $290,000Net book value of capital assets of $1,200,000 and UCC of $800,000 on January 1, 20x17, a temporary difference of $400,000 that is reflected in an accumulated deferred income tax liability balance of $176,000 at January 1, 20x17No permanent differencesTaxable income in the three-year carry back period of $400,000Tax rate of 44% in the current and previous yearsBased on the above information what is the tax recovery for 20x17?A) $4,500B) $105,600C) $154,000D) $22,000E) cannot be determined
Ans: D
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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62. A company that has sustained a tax loss during the year and is not able to carry it back may potentially do all of the following except:A) File amended tax returns for previous years changing CCAB) Choose not to claim CCA in the current yearC) Carry forward the amount for 10 yearsD) Do nothing
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
63. JMR Corporation incurred a tax loss in 20x15 of $900,000. After carrying back the tax loss to previous years, there remains $100,000. This amountA) can be recovered through a cash payment from the governmentB) represents a deferred income tax lossC) represents a deferred income tax benefitD) cannot be recovered
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
64. JMR Corporation incurred a tax loss in 20x15 of $900,000. After carrying back the tax loss to previous years, there remains $150,000. This amount:A) can be recovered through a cash payment from the governmentB) represents a deferred income tax benefitC) represents a deferred income tax lossD) cannot be recovered
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
65. All of the following are evidence to support recognition of a deferred income tax benefit except:A) It is acceptable industry practice to recognize the deferred income tax benefitB) There are existing taxable temporary differences to absorb the lossC) An excess of fair value over the tax basis of the enterprise's net assets in an amount
sufficient to realize the deferred income tax assetD) A strong earnings history suggesting that the loss is not expected to continue
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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66. The following data represents the complete taxable income history for a firm:
Taxable income Tax rate20x11 $20,000 .3020x12 $16,000 .3020x13 $12,000 .3520x14 $ 4,000 .4020x15 $(40,000) .40
What amount of refund will it receive for tax year 20x15?A) $10,600B) $12,200C) $13,000D) $15,000
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
67. A firm's complete taxable income history follows. The tax rate has always been .30.
Taxable income20x11 $15,00020x12 $5,00020x13 $30,00020x14 $10,00020x15 $(50,000)20x16 $(10,000)20x17 $25,00020x18 $25,000
The firm always chooses the carry back, carry forward option. What is the tax liability for 20x18?A) $3,000B) $7,500C) $4,500D) $0
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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68. The following data represents the complete taxable income history for a firm:
Taxable income Tax rate20x11 $20,000 .3020x12 $25,000 .3020x13 $12,000 .3520x14 $ 4,000 .4020x15 $(50,000) .40
What amount of refund will it receive for tax year 20x15?A) $10,600B) $12,200C) $13,300D) $15,000
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
69. The following data represents the complete taxable income history for a firm:
Taxable income Tax rate20x11 $20,000 .3520x12 $16,000 .3020x13 $12,000 .3020x14 $ 4,000 .3820x15 $(18,000) .30
What amount of refund will it receive for tax year 20x15?A) $6,300B) $6,840C) $13,000D) $5,400
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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70. The following data represents the complete taxable income history for a firm:
Taxable income Tax rate20x11 $20,000 .3020x12 $16,000 .3020x13 $12,000 .3520x14 $ 4,000 .4020x15 $(40,000) .40
What is the amount of carry forward left at the end of 20x15?A) $0B) $12,000C) $4,000D) $8,000
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
71. The following data represents the complete taxable income history for a firm:
Taxable income Tax rate20x11 $20,000 .3020x12 $56,000 .3020x13 $12,000 .3520x14 $ 4,000 .4020x15 $(90,000) .40
What amount of the tax carry forward left at the end of 20x15?A) $18,000B) $90,000C) $0D) $4,000
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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72. All of the following are evidence that recognition is not likely except:A) History of tax losses expiring before they have been usedB) An expectation of losses in carry forward periodC) Unsettled circumstances that may adversely affect the companyD) They all constitute unfavourable evidence
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
73. All of the following are evidence that recognition is not likely except:A) Changes in managementB) An expectation of losses in carry forward periodC) Unsettled circumstances that may adversely affect the companyD) History of tax losses expiring before they have been used
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
74. JMR Corp. sustained taxable income in 20x11 of $50,000 when the tax rate was 40%. In 20x12they suffered a tax loss of $80,000 when the tax rate was 38%. All of the following are true except:A) JMR Corp. has a potential carry forward of $30,000B) A more likely than not criteria is needed to set up the benefitC) The tax refund will amount to $19,000D) Prior years' tax returns may be amended to create more taxable income.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
75. KER Corp. sustained taxable income in 20x11 of $50,000 when the tax rate was 40%. In 20x12they suffered a tax loss of $80,000 when the tax rate was 45%. All of the following are true except:A) KER Corp. has a potential carry forward of $30,000B) A more likely than not criteria is needed to set up the benefitC) The tax refund will amount to $20,000D) KER may carry forward for 10 years
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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76. EGR Corp. sustained taxable income in 20x11 of $70,000 when the tax rate was 40%. In 20x12they suffered a tax loss of $85,000 when the tax rate was 38%. All of the following are true except:A) EGR Corp. has a potential carry forward of $30,000.B) A more likely than not criteria is needed to set up the benefit.C) The tax refund will amount to $28,000.D) Prior years' tax returns may be amended to create more taxable income.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
77. JMR Corp. sustained taxable income in 20x11 of $50,000 when the tax rate was 40%. In 20x12they suffered a tax loss of $80,000 when the tax rate was 38%. All of the following are true except:A) JMR Corp. has a potential carry forward of $30,000B) A more likely than not criteria is needed to set up the benefitC) The tax refund will amount to $20,000D) Depreciation may be reduced to create a higher income to absorb the loss
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
78. RG Corp. sustained taxable income in 20x11 of $65,000 when the tax rate was 40%. In 20x12they suffered a tax loss of $80,000 when the tax rate was 38%. All of the following are true except:A) RG Corp. has a potential carry forward of $25,000.B) Virtual certainty is needed to set up the benefit.C) The tax refund will amount to $24,700.D) Prior years' tax returns may be amended to create more taxable income.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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79. Choose the best statement with respect to tax rates.A) The tax rate used to record a deferred income tax asset or liability should be the enacted
tax rate at the balance sheet date.B) The current tax rate should be used to record a deferred income tax asset or liability.C) The projected tax rate should be used to record a deferred income tax asset or liability.D) None of the above.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
80. Choose the best statement with respect to tax rates.A) The tax rate used to record a deferred income tax asset or liability should be the enacted
tax rate at the beginning of the year.B) The current tax rate should be used to record a deferred income tax asset or liability.C) The projected tax rate should be used to record a deferred income tax asset or liability.D) Once recorded, the deferred income tax asset must be maintained at a rate expected to be in
effect when the carry forward is utilized.
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
81. JMR Corporation suffered a loss in 20x13. As a result, the Corporation has a $87,000 accumulated tax loss carry forward at the tax rate of 40%. The benefit was recorded in the accounts as JMR believed it was more likely than not to be realized. In 20x14 the tax rate goes down to 38% and JMR has not yet used the benefit. Which of the following statements is true?A) No change to the accounts is necessaryB) Income tax expense should be increased by $1,740C) Deferred income tax asset – benefit should be increased by $1,740D) Deferred income tax asset – benefit will not change
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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82. JMR Corporation suffered a loss in 20x13. As a result, the Corporation has a $87,000 accumulated tax loss carry forward at the tax rate of 40%. The benefit was recorded in the accounts as JMR believed it was more likely than not to be realized. In 20x14 the tax rate goes down to 45% and JMR has not yet used the benefit. Which of the following statements is true?A) No change to the accounts is necessaryB) Income tax expense should be increased by $1,740C) Deferred income tax asset – benefit should be increased by $1,740D) Income tax expense should be decreased by $4,350
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
83. Disclosure related to tax loss carry forwards and carry backs include all of the following except:A) current tax benefit from tax loss carry backs and carry forwards should be segregated
between continuing operations, discontinued operations and extraordinary itemsB) there should be disclosure of the amount of unrecognized tax lossesC) disclosure of the expiry date of unrecognized tax lossesD) all of the above
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
84. Disclosure related to tax loss carry forwards and carry backs include all of the following except:A) current tax benefit from tax loss carry backs and carry forwards need not be segregated
between continuing operations, discontinued operations and extraordinary itemsB) there should be disclosure of the amount of unrecognized tax lossesC) disclosure of the expiry date of unrecognized tax lossesD) all of the above
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO5
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85. The following data represents the complete taxable income history for a firm:
Taxable income Tax rate20x11 $20,000 .3020x12 $16,000 .3020x13 $12,000 .3520x14 $ 4,000 .4020x15 $(40,000) .4020x16 $20,000 .45
What is the tax liability for 20x16?A) $9,000B) $5,400C) $8,000D) $6,000
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
86. Reducing CCA is one tax strategy that a company may employ. All of the following are true except:A) CCA not claimed in one year is only partially lost for deferred years.B) Minimizing CCA can create taxable income so that losses may be used.C) CCA may be eliminated in the carry forward years.D) Returns may be amended for the previous three years.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
87. Reducing CCA is one tax strategy that a company may employ. All of the following are true except:A) CCA is an optional deduction and is not lost if not used.B) Minimizing CCA can create taxable income so that losses may be used.C) CCA may be eliminated in the carry forward years.D) Returns may be amended for the previous seven years.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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88. All of the following are true regarding loss carry forwards except:A) the probability of realization needs to be greater than 50%B) the carry forward benefit is set up on the balance sheetC) management may choose not to set up the benefitD) any deferred income tax benefit set up should not be subsequently written down
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
89. In 20x11, JMR Corp. set up a deferred income tax benefit of a tax loss carry forward as the probability of realization was greater than 50%. It is now the end of 20x12 and management has determined that 50% of the benefit will not be realized. Management should:A) continue to carry the total deferred income tax benefit of the tax loss carry forwardB) write down the entire benefitC) write down 50% of the benefitD) none of the above
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
90. All of the following are true regarding loss carry forwards except:A) the more likely than not criteria must be metB) the carry forward benefit cannot be set up in deferred yearsC) any deferred income tax benefit should be reviewed yearly for potential write downsD) deferred income tax benefits may still be used even if not set-up
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
91. A company, which operated pro-deferred income tax assets during its first five years, sustained a loss in the sixth year which equalled its pre-tax income of any four of the first five years of its operations. The company can choose to obtain a refund of income taxes paid by filing an amended return for:A) any of the first three years of operations.B) any years before the loss, provided the loss equals or exceeds profits of those years.C) the four most pro-deferred income tax asset years preceding the loss.D) the three years immediately preceding the loss.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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92. The maximum number of years a tax loss can be carried forward is:A) 3 years.B) 20 years.C) 10 years.D) 17 years.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
93. What factor would most likely cause a firm to choose the carry forward only option for a net operating loss?A) expectations of lower earnings in the deferred relative to the pastB) expectations of higher earnings in the deferred relative to the pastC) expectations of lower tax rates in the deferred relative to the pastD) expectations of higher tax rates in the deferred relative to the past
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
94. CJM provided the following data related to income tax allocation:
20x13 20x14Pre-tax accounting income $5,300 $5,000Taxable income 5,000 5,300Income tax rate 34% 34%
The deferred income tax account showed a zero balance at the start of 20x13. There was only one temporary difference, an expense, which was deductible for tax purposes in 20x13, but was recorded for accounting purposes in 20x14. There are no carry backs or carry forwards and no originating temporary differences in 20x14. The journal entry to record the income tax consequences for 20x14 would include a:A) debit of $102 to CJM's deferred income tax liability account.B) credit of $102 to CJM's deferred income tax liability account.C) debit of $102 to CJM's deferred income tax asset account.D) credit of $102 to CJM's deferred income tax asset account.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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95. FGH had a $1,200 temporary difference for deferred gross margin on instalment sales at the end of 20x12. This temporary difference will reverse equally during 20x13, 20x14 and 20x15. The enacted corporate income tax rate is 48% and government is discussing a reduction in the corporate income tax rates for 20x14 and 20x15 to 38%. The deferred income tax liability related to this temporary difference at the end of 20x12 would be:A) $192B) $248C) $516D) $576
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
96. MDB had a $1,200 temporary tax difference for deferred gross margin on instalment sales at the end of 20x12. This temporary difference will reverse equally during 20x13, 20x14, and 20x15. The enacted corporate income tax rate is 25% and Congress is discussing an increase in the corporate income tax rates for 20x14 and 20x15 to 35%. The deferred income tax liability related to this temporary difference at the end of 20x12 would be:A) $100B) $300C) $380D) $420
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
97. XYZ Ltd., a taxable Canadian corporation, reported the following revenues and expenses in these amounts for both taxes and financial reporting (the tax rate is 40%).
Operating revenues $10,000Operating expenses 4,000Dividend revenue from a taxable Canadian corporation 2,000Insurance proceeds from life insurance on CEO 3,000
What is income tax expense for the year?A) $4,400B) $3,600C) $4,000D) $2,400
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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98. JR Company incurred a loss in 20x11, due in part to a fire at one of its plants. The deferredbenefit of a loss carry forward was not recognized in the year as the probability of realization was less than 50%. In 20x12, JR Company incurred a small loss, but due to large contracts upcoming, it was determined that the probability of realization was greater than 50%. The tax rate for 20x11was 40% and 20x12 45%. JR Company should:A) record the deferred income tax benefit for 20x12 onlyB) record the deferred income tax benefit for both years using the 40% rateC) record the deferred income tax benefit for both years using the 45% rateD) record the deferred income tax benefit for 20x11 only
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
99. JG Ltd. provided you with the following information:
Year Taxable TaxIncome (loss) rate
20x11 $300,000 38%20x12 ($150,000) 40%20x13 $330,000 45%20x14 $80,000 40%20x15 ($400,000) 40%
There are no temporary differences. What is the tax recovery in 20x15?A) $160,000B) $169,500C) $176,000D) None
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
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100. JR Ltd. provided you with the following information:
Year Taxable TaxIncome (loss) rate
20x11 $300,000 38%20x12 ($150,000) 40%20x13 $330,000 45%20x14 $80,000 40%20x15 ($400,000) 40%
There are no temporary differences. What will be the credit to the income tax expense account assuming a greater than 50% probability of realization?A) $32,000B) $0C) $196,000D) $80,000
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
101. JR Ltd. provided you with the following information:
Year Taxable TaxIncome (loss) rate
20x11 $300,000 38%20x12 ($150,000) 40%20x13 $330,000 45%20x14 $80,000 40%20x15 ($400,000) 40%
There are no temporary differences. What will be the credit to the income tax expense account assuming a less than 50% probability of realization?A) $32,000B) $0C) $196,000D) $80,000
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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102. ER Ltd. provided you with the following information:
Year Taxable TaxIncome (loss) rate
20x11 $190,000 38%20x12 ($150,000) 40%20x13 $330,000 45%20x14 $80,000 38%20x15 ($580,000) 38%
There are no temporary differences. What will be the credit to the income tax expense account assuming a greater than 50% probability of realization?A) $194,100B) $0C) $220,000D) $64,600
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
103. ER Ltd. provided you with the following information:
Year Taxable TaxIncome (loss) rate
20x12 $190,000 38%20x13 ($150,000) 40%20x14 $330,000 45%20x15 $80,000 38%20x16 ($580,000) 38%
There are no temporary differences. What will be the credit to the income tax expense account assuming a less than 50% probability of realization?A) $194,100B) $0C) $220,000D) $64,600
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
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104. VB Ltd. provided you with the following information:
Year Taxable TaxIncome (loss) rate
20x11 $190,000 38%20x12 ($150,000) 40%20x13 $330,000 45%20x14 $80,000 38%20x15 ($580,000) 38%
There are no temporary differences. The deferred income tax benefit of the loss carry forwardwas set up in 20x15 as the probability of realization was greater than 50%. In 20x16 it was determined that the probability of realization was less than 50%. What would be the carrying amount of the deferred income tax benefit – loss carry forward on the balance sheet at the end of 20x16?A) $194,100B) $0C) $220,000D) $64,600
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
105. VB Ltd. provided you with the following information:
Year Taxable TaxIncome (loss) rate
20x11 $190,000 38%20x12 ($150,000) 40%20x13 $330,000 45%20x14 $80,000 38%20x15 ($580,000) 38%
There are no temporary differences. The deferred income tax benefit of the loss carry forwardwas set up in 20x15 as the probability of realization was greater than 50%. In 20x16 a further loss of $140,000 was incurred. Management determined that they were still more likely than not to realize the loss. The tax rate for 20x16 was 45%. What would be the carrying amount of the deferred income tax benefit – loss carry forward on the balance sheet at the end of 20x16?A) $273,600B) $127,600C) $139,500D) some other amount
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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106. How far can a tax loss be carried back?Ans: 3 yearsDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
.107. How far can a tax loss be carried forward?
Ans: 20 yearsDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
108. Describe the difference between a tax loss and a tax benefit.Ans: A tax loss is the final number of the taxable loss on the return. The tax benefit is the
present and deferred benefit that the company may realize from the tax loss through reductions in income taxes.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
109. How does the existence of a loss in the year impact the accounting of temporary differences?Ans: Tax losses do not impact the accounting of temporary differences. The recording of them
remains the same whether there is a loss or taxable income.Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
110. JMR has a tax loss of $970,000 and a tax rate of 38%. What is the potential benefit of the tax loss?Ans: Potential tax benefit = $970,000x38%=$386,600Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
111. KAR has a tax loss of $563,000 and a tax rate of 44%. What is the potential benefit of the tax loss?Ans: Potential tax benefit = $563,000x44%=$247,720Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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112. JMR's taxable income for the first five years was as follows:
Year Taxable Tax Income taxesIncome rate paid
20x11 $125,000 40% $ 50,00020x12 $190,000 40% $ 76,00020x13 $225,000 38% $ 85,50020x14 $298,000 35% $104,30020x15 (400,000) 38% -
Calculate the tax recovery in 20x15.Ans:
Year Carry back Tax rate Tax recover20x12 190,000 40% 76,00020x13 210,000 38% 79,800
400,000 155,800====== ======
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
113. KAR's taxable income for the first five years was as follows:
Year Taxable Tax Income taxesIncome rate paid
20x11 $125,000 40% $ 50,00020x12 $190,000 40% $ 76,00020x13 $225,000 38% $ 85,50020x14 $298,000 35% $104,30020x15 (500,000) 38% -
Calculate the tax recovery in 20x15.Ans:
Year Carry back Tax rate Tax recover20x12 190,000 40% 76,00020x13 225,000 38% 85,50020x14 85,000 35% 29,750
500,000 191,250 ====== ======
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
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114. AG's taxable income for the first five years was as follows:
Year Taxable Tax Income taxesIncome rate paid
20x11 $125,000 40% $50,00020x12 $190,000 40% $76,00020x13 $225,000 38% $85,50020x14 $298,000 35% $104,30020x15 (80,000) 38% -
Calculate the tax recovery in 20x15.Ans:Year Carry back Tax rate Tax recover20x12 80,000 40% 32,000
80,000 32,000====== ======
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
115. JMR's taxable income for the first five years was as follows:
Year Taxable Tax Income taxesIncome rate paid
20x11 $125,000 40% $50,00020x12 $190,000 40% $76,00020x13 $25,000 38% $9,50020x14 $298,000 35% $104,30020x15 (460,000) 38% -
Calculate the tax recovery in 20x15.Ans:Year Carry back Tax rate Tax recover20x12 190,000 40% 76,00020x13 25,000 38% 9,50020x14 245,000 35% 85,750
460,000 171,250 ====== ======
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
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116. JMR's taxable income for the first five years was as follows:
Year Taxable Tax Income taxesIncome rate paid
20x11 $125,000 40% $50,00020x12 $90,000 40% $36,00020x13 $125,000 38% $47,50020x14 $298,000 35% $104,30020x15 (400,000) 38% -
Calculate the tax recovery in 20x15.Ans:Year Carry back Tax rate Tax recover20x12 90,000 40% 36,00020x13 125,000 38% 47,50020x14 185,000 35% 64,750
400,000 148,250 ====== ======
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
117. How can a company use CCA to fully utilize losses that have been incurred?Ans: CCA is an optional deduction. Tax returns for the previous three years may be amended in
order to create enough taxable income to absorb tax losses. CCA may also be eliminated or reduced in the current or deferred years in order to use up losses that may be about to expire. CCA is not lost if it is not used.
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
118. Based on Handbook Section 3465, when may a deferred benefit of tax loss carry forwards be recognized?Ans: Deferred benefits of tax loss carry forwards may be recognized if it is more likely than not
that they will be realized. More likely than not occurs when the probability is greater than 50%.
Difficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 2
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119. In order to help companies and their auditors determine whether the criteria "more likely than not" has been realized, the Handbook has set out some guidelines for favourable evidence. List two of these.Ans: 1. existing sufficient taxable temporary differences which would result in taxable amounts
against which the unused tax losses can be utilized;2. existing contracts or firm sales backlog that will produce more than enough taxable income to realize the deferred income tax asset based on existing sales prices and cost structures;3. an excess of fair value over the tax basis of the enterprise's net assets in an amount sufficient to realize the deferred income tax asset; or4. a strong earnings history exclusive of the loss that created the deferred deductible amount together with evidence indicating that the loss is an aberration rather than a continuing condition.[CICA 3465.28
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
120. In order to help companies and their auditors determine whether the criteria "more likely than not" has been realized, the Handbook has set out some guidelines for unfavourable evidence. List two of these.Ans: 1. a history of tax losses expiring before they have been used;
2. an expectation of losses in the carry forward period; and3. unsettled circumstances that, if unfavourable resolved, would adversely affect deferredoperations and profit levels on a continuing basis in deferred years.[CICA 3465.27]
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
121. How should a deferred income tax benefit of a tax loss carry forward be treated on a yearly basis?Ans: According to the handbook, the benefit should be reviewed each year that it remains on the
books. If the probability of realization has been reduced below 50%, then it should be written down to the most probable amount. It is possible to continue to adjust the amount up and down to the maximum possible benefit.
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
122. What options are open to a company that did not previously set up a deferred income tax benefit of a tax loss carry forward but has now determined that the probability of realization is greater than 50%?Ans: Companies may continue to adjust the deferred benefit throughout the carry forward
benefit. This includes setting up a deferred benefit that was previously thought not to be realizable.
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
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123. What options are open to a company that had previously set up a deferred income tax benefit of a tax loss carry forward but has now determined that the probability of realization is less than 50%?Ans: Companies must determine whether all or only part of the deferred benefit has fallen below
the 50% probability. The amount, which is now, less than 50% should be written down through a credit to the deferred income tax asset account and a debit to income tax expense.
Difficulty: HardLevel of Learning: KnowledgeTopic: LO4
124. JMR Corp. incurred a loss in 20x15 after several years of taxable income. After the carry back, JMR still had losses to use up in the amount of $500,000. The applicable tax rate was 40%. In 20x16, the tax rate goes down to 38%. Assuming that losses have not been used but it is still probable that they will be used, prepare the journal entry to set up the deferred benefit in 20x15and any other entries applicable to the deferred benefit.Ans: 20x15Deferred income tax asset – carry forward benefit 200,000 Income tax expense 200,000(500,000x.40)
20x16Income tax expense 10,000 Deferred income tax asset – carry forward benefit 10,000(500,000x.40)- (500,000x.38)Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
125. KER Corp. incurred a loss in 20x15 after several years of taxable income. After the carry back, KER still had losses to use up in the amount of $357,000. The applicable tax rate was 40%. In 20x16, the tax rate goes up to 45%. Assuming that losses have not been used but it is still probable that they will be used, prepare the journal entry to set up the deferred benefit in 20x15and any other entries applicable to the deferred benefit.Ans: 20x15Deferred income tax asset – carry forward benefit 142,800 Income tax expense 142,000(357,000x.45)
20x16Deferred income tax asset – carry forward benefit 17,850 Income tax expense 17,850(357,000x.45)- (500,000x.40)Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
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126. EGR Ltd. has been in business for five years and incurs a loss of $320,000 in 20x15. The company has no temporary differences. The history of the company's earnings since they began operations is as follows:
Year Taxable TaxesIncome (loss) paid (recovered)
20x11 $30,000 $12,00020x12 ($15,000) 6,00020x13 $130,000 52,00020x14 $30,000 12,000
The tax rate has been constant at 40%.
Required:Prepare journal entries to record the recovery of taxes and any journal entries necessary for any loss carry forwards. Assume probability of recovery is greater than 50%Ans: 20x15Income tax receivable – carry back 64,000 Income tax expense (recovery) 64,000(130,000+30,000) x.40deferred income tax asset – carry forward benefit 64,000 Income tax expense (recovery) 64,000(320,000-160,000) x.40Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
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127. KAR Ltd. has been in business for five years and incurs a loss of $320,000 in 20x15. The company has no temporary differences. The history of the company's earnings since they began operations is as follows:
Year Taxable TaxesIncome (loss) paid (recovered)
20x11 $30,000 $12,00020x12 ($15,000) 6,00020x13 $130,000 52,00020x14 $30,000 12,000
The tax rate has been constant at 40%.
Required:Prepare journal entries to record the recovery of taxes and any journal entries necessary for any loss carry forwards. Assume probability of recovery is less than 50%Ans: 20x15Income tax receivable – carry back 64,000 Income tax expense (recovery) 64,000(130,000+30,000)x.40
No entry to record carry forward benefit as the probably of realization is less than 50%Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
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128. JG Ltd. has been in business for five years and incurs a loss of $520,000 in 20x15. The company has no temporary differences. The history of the company's earnings since they began operations is as follows:
Year Taxable TaxesIncome (loss) paid (recovered)
20x11 $300,000 $114,00020x12 ($150,000) 57,00020x13 $330,000 125,40020x14 $80,000 30,400
The tax rate has been constant at 38%.
Required:Prepare journal entries to record the recovery of taxes and any journal entries necessary for any loss carry forwards. Assume probability of recovery is greater than 50%Ans: 20x15Income tax receivable – carry back 155,800 Income tax expense (recovery) 155,800(410,000x.38)Deferred income tax asset – carry forward benefit 34,200 Income tax expense (recovery) 34,200(520,000-410,000) x.38Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
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129. JG Ltd. has been in business for five years and incurs a loss of $520,000 in 20x15. The company has no temporary differences. The history of the company's earnings since they began operations is as follows:
Year Taxable TaxesIncome (loss) paid (recovered)
20x11 $300,000 $114,00020x12 ($150,000) (57,000)20x13 $330,000 125,40020x14 $80,000 30,400
The tax rate has been constant at 38%.
Required:Prepare journal entries to record the recovery of taxes and any journal entries necessary for any loss carry forwards. In 20x16, JG incurs a further loss of $40,000. The tax rate changed to 40%. Assume probability of recovery is greater than 50%.Ans: 20x15Income tax receivable – carry back 155,800 Income tax expense (recovery) 155,800(410,000x.38)Deferred income tax asset – carry forward benefit 41,800 Income tax expense (recovery) 41,800(520,000-410,000) x.38
20x16Deferred income tax asset – carry forward benefit 16,000 Income tax expense (recovery) 16,000(40,000x.40)Deferred income tax asset – carry forward benefit 2,200 Income tax expense (recovery) 2,200(410,000x.38)- (410,000x.40)Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
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130. JG Ltd. has been in business for five years and incurs a loss of $520,000 in 20x15. The company has no temporary differences. The history of the company's earnings since they began operations is as follows:
Year Taxable TaxesIncome (loss) paid (recovered)
20x11 $300,000 $114,00020x12 ($150,000) 57,00020x13 $330,000 125,40020x14 $80,000 30,400
The tax rate has been constant at 38%.
Required:Prepare journal entries to record the recovery of taxes and any journal entries necessary for any loss carry forwards. In 20x16, JG incurs a further loss of $40,000. The tax rate changed to 40%. Assume probability of recovery is greater than 50% in 20x15 but less than 50% in 20x16.Ans: 20x15Income tax receivable – carry back 155,800 Income tax expense (recovery) 155,800(410,000x.38)Deferred Income Tax Asset – carry forward benefit 41,800 Income tax expense (recovery) 41,800(520,000-410,000) x.38
20x16No deferred benefit record as probability of realization less than 50%
Income tax expense (recovery) 41,800 Deferred Income Tax Asset – carry forward benefit 41,800
Difficulty: HardLevel of Learning: KnowledgeTopic: LO1, 2
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131. Once a deferred benefit of a tax loss carry forward has been recorded, does it have to remain on the balance sheet until realized? Explain.Ans: The deferred benefit should be analyzed every year to determine whether the probability of
realization is still greater than 50%. If it is not, a portion, or all (depending on whether the probability for all of the amount or just a portion has gone below 50%) should be written down.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
132. There is some question as to whether there should be early recognition of the deferred benefit of a loss carry forward. Discuss.Ans: The new Handbook is now consistent with the US as they permit early recognition,
although this was permitted after some lobbying by industry. Supporters argue that the deferred benefits should be matched to the loss that created it. Others argue that there has been no transaction that establishes the right to the benefit. In addition, the recognition is based strongly on management's judgment that may be biased
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test BankChapter 17 – Leases
1. Typically, the lessee owns the leased assets in a finance lease situation.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
2. All long-term leases should be capitalized in the accounts by the lessee.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
3. Operating leases are usually of shorter duration than finance leases and under this type of lease, the risks and rewards of asset ownership remain with the lessor.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
4. The use of contingent lease payments is one method companies use to avoid lease capitalization.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO6
5. A lessee is usually motivated to report a lease liability as a finance lease because the lessee can capitalize the "cost" of the leased asset.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
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6. Companies that opt for finance leases usually do so because of the tax advantages finance leases provide.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO6
7. The lessee's incremental borrowing rate is the rate that, at the inception of the lease, the lessee would have incurred to borrow over a similar term the funds necessary to purchase the leased asset.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
8. The lessee should use the lessor’s borrowing rate (if known) to account for a finance lease, even if this provides a present value of lease payments that is higher than the fair value of the asset at the inception of the lease.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
9. Both guaranteed and unguaranteed residual values should be included in the calculation of the lessee’s minimum lease payments.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
10. The same quantitative thresholds for determining the existence of finance leases apply under both IFRS and ASPE.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2, 9
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11. Geisler Company leased a building from Ryan Company for 5 years. The first year of the lease was forgiven with payments beginning in the second year. No journal entry is required until the second year.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1, 3
12. The term of a finance lease includes the initial lease term and any bargain renewal terms.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
13. To qualify as a lessor for tax purposes, a company must derive at least 90% of its revenues from leasing.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
14. If a lease transfers the residual value of the leased asset to the lessee at the end of the lease term, the lessee has permanent ownership of the leased asset.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
15. If the straight-line method is used by the lessee to amortize the non-refundable down payment in an operating lease, a constant dollar amount of the prepayment is allocated as expense to each period covered by the lease.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
16. The lessor’s internal rate of return is normally the rate implicit in the lease.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO7
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20. A lessee’s insurance expense throughout the term of a finance lease is usually an estimate as opposed to an actual expense amount.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
21. The effective interest method must always be used to compute the lessee’s interest expense related to a finance lease.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
22. For an operating lease, the amount initially capitalized by the lessee is the present value of the lease rents to be paid over the lease term.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
23. Any operating or executory costs should be excluded from the calculation of the minimum lease payments.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
24. A finance lease is accounted for "as if" it transfers a material interest in the leased asset from the lessor to the lessee.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
25. To be classified as a finance lease by the lessee, no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor may exist.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
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26. Company enters into a renewable 5 year lease (renewable for another 5 years) at $20,000 per year. There is an initial upfront cost of $5,000. This amount should be amortized over 10 years.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
27. A finance lease is based upon the view that there was a sale/purchase (between the parties) of the leased asset at the inception date of the lease.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
28. A lease which contains a bargain purchase option, but which has a term equal to only 70% of the estimated economic life of the leased property cannot properly be classified as a finance lease by a lessee.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
29. Under both operating and finance leases, periodic rent expense for a lessee is likely to be the same over successive periods.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
30. Contingent rent is a bargaining tool used by the lessee in order to negotiate a more favourable lease agreement.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
31. Contingent rent is one of three common methods used to avoid capitalization.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO6
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32. One of the most common methods of avoiding the capitalization of a lease is to enter into lease agreements that provide year-by-year renewal.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
33. A sale and leaseback occurs when one party sells an asset to a second party who then leases it back to the first party.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
34. A lessee's debt to equity ratio is not increased if the lease is a finance lease, whereas, it would be if the asset were purchased outright.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
35. Under ASPE, if a lessor’s estimated future cash flow collections under finance leases are in doubt, an impairment loss may have occurred.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO9
36. Under ASPE, if a leased asset’s fair value is less than its carrying value at the date of sale under a sale-and-lease-back transaction, the lessor has experienced an impairment loss.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO9
37. For a finance lease, the amount initially capitalized by the lessee is the sum of the future value of the periodic lease payments, plus the future value of any bargain purchase option.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
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38. Both the lessee’s interest and depreciation expense should be added back to net income to calculate cash flows from operating activities under the indirect method.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO8
39. Off-balance sheet financing occurs when a company makes use of assets but does not record the asset or corresponding liability on the financial statements.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
40 Leased assets treated as a finance lease for accounting purposes and an operating lease for tax purposes will create a temporary difference.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO7
41. The distinction between a sales-type lease and a direct financing lease is based on whether there is a dealer's or manufacturer's profit.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
42. The basic distinction between direct financing leases and sales-type leases is that in a direct financing lease, a gross margin (i.e., manufacturer's or dealer's profit or loss) is recognized by the lessor at inception of the lease.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
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43. The lessor recognizes two different kinds of earnings for a sales-type lease, that is, dealer's profit and interest revenue.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
44. Under a sales-type lease, the lessor recognizes a dealer's or manufacturer's profit on the date of inception of the lease.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
45. The same lease may be classified differently by the lessor as compared to the classification used by the lessee.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1, 2
46. Non-refundable payments made in advance on operating leases may be amortized either over the term of the lease, or any other period consistent with the GAAP guidelines for amortizing intangible assets.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
47. In an operating lease, if a non-refundable down payment is made in advance, the lessor should initially debit Cash and credit Unearned Rent (liability).
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
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48. A journal entry is not required for either the lessor or lessee when an operating lease is initiated unless there is an advance payment, such as a lease bonus or prepayment of rent in addition to the periodic rents.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
49. Each periodic rent collected on a finance lease by the lessor is usually part principal and part interest revenue.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
50. Interest revenue is recognized on a finance lease because the leased asset is considered sold at the inception of the lease, and the lease is a way of financing the lease.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
51. On January 1, 20x11, WXY signed an operating lease agreement, which required $5,800 annual rentals to be paid at the end of each year. The accounting period ends December 31. At the end of 20x11, WXY (lessee) should make the following entry:
1 Leased asset 5,800 Cash 5,800
2 Rent paid in advance 5,800 Cash 5,800
3 Rent expense 5,800 Lease liability 5,800
4 Rent expense 5,800 Cash 5,800
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
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52. While only certain leases are currently accounted for as a sale or purchase, there is theoretical justification for considering all leases to be sales or purchases. The principle reason that supports this idea is that:A) a lease reflects the purchase or sale of a quantifiable right to the use of the property.B) during the life of the lease, the lessee can effectively treat the property as if it were owned
by the lessee.C) all leases are generally for the economic life of the property and the residual value of the
property at the end of the lease is minimal.D) at the end of the lease, the property usually can be purchased by the lessee.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
53. The term usually used to describe the situation where a lessee has an option to purchase the leased property at a price that is sufficiently lower than its fair market value so that the exercise of the option appears reasonably assured is:A) assured purchase option.B) bargain buy-out option.C) bargain purchase option.D) bargain renewal option.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
54. The classifications of leases, from the standpoint of the lessee, are:A) capital, direct financing, or sales-type.B) capital or operating.C) direct financing, sales-type or operating.D) direct financing, or sales-type.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
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55. The appropriate valuation of an operating lease on the balance sheet of a lessee is:A) the present value of the sum of the lease payments discounted at an appropriate rate.B) the market value of the asset at the date of the inception of the lease.C) the absolute sum of the lease payments.D) zero unless the lessee made a prepayment of rent.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
56. The straight-line method is frequently used to amortize non-refundable rental payments made in advance on leased assets because:A) it is less complex, therefore, less costly.B) the interest method may result in unreliable amounts being recognized as expense.C) it is more theoretically sound.D) GAAP requires that it be used in all situations.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
57. ABC signed a 5-year operating lease agreement whereby WXY Rentals will provide a truck which cost WXY $20,000. The lease payments are $2,500, payable at the end of each year. The truck has a 10-year useful life. At the inception of the lease, ABC should:A) make no journal entry.B) record rental expense of $2,500 for the first year's rental.C) record the leased asset at its current market value.D) record the asset at the present value of the five equal annual lease payments.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO1
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58. Assume the following facts relating to a lease:Leased asset, new at inception of lease term.Estimated useful life, 14 years.Lease term, 8 years; asset returns to lessor.Interest rate implicit in the lease, 10 percent (known by lessee).Lessee's marginal borrowing rate, 12 percent.Amount of each lease payment, $2,000.Lessor's cost of the leased asset, $15,164.Market value of leased asset at inception of the lease term, $15,164Lease payments are due at the end of each period.From the perspective of the lessee, this lease should be classifiedas a(n):A) sales-type lease.B) direct financing lease.C) operating lease.D) finance lease.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
59. What is the cost basis of an asset acquired by a lease, which is in substance an instalmentpurchase?A) The present value of the market price of the asset discounted at an appropriate rate as an
amount to be received at the end of the leaseB) The present value of the future minimum lease payments under the lease (exclusive of
executory costs and any profit thereon) discounted at an appropriate rateC) The net realizable value of the asset determined at the date of the lease agreement plus the
sum of the future minimum lease payments under the leaseD) The sum of the future minimum lease payments under the lease
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2, 3
60. What are the three types of period costs that a lessee experiences with finance leases?A) Depreciation expense, executory costs, lease expenseB) Executory costs, interest expense, lease expenseC) Lease expense, interest expense, depreciation expenseD) Interest expense, depreciation expense, executory costs
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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61. At the inception of a finance lease which calls for payments on an annuity due basis, the lessee typically debits:A) leased asset.B) lease expense.C) rent expense.D) lease receivable.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO2, 3
64. The lessee measures the cost of a leased asset, and the corresponding lease liability of a finance lease, as the:A) fair market value of the leased asset.B) future value of the periodic rental payments.C) sum of the annual cash payments to be made during term of the lease.D) present value of the periodic rental payments.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
65. The depreciation period used by the lessee for a depreciable leased asset must be:A) the same period that was used by the lessor.B) the remaining life of the asset from the lease inception.C) the term of the lease.D) at least the term of the lease but possibly longer.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
66. For a finance lease, an amount equal to the present value at the beginning of the lease term of minimum lease payments during the lease term, excluding that portion of the payments representing executory costs such as insurance, maintenance, and property taxes to be paid by the lessor, together with any profit thereon, should be recorded by the lessee as a(n):A) expense.B) asset but not a liability.C) liability but not an asset.D) asset and a liability.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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67. The estimated residual value of a depreciable leased asset at the end of the lease term is:A) added to the bargain purchase option at the expiration of the lease.B) always guaranteed by either the lessor or the lessee.C) an important factor in how the lessor and lessee must account for the lease.D) used by the lessor to compute the annual amount of depreciation expense.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
68. When the lessee guarantees the residual value at the end of the lease term, the:A) lessor will use this amount in computing periodic depreciation expense.B) lessor will receive an additional cash flow at the end of the lease term.C) lessee may have to pay the lessor additional cash if the actual residual value is not equal to
the estimated residual value.D) lessee will have to pay the lessor additional cash because the guaranteed residual value was
included in computing the annual rental amounts.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
69. If the residual value of a leased asset turns out to be more than the amount guaranteed by the lessee, the:A) lessee may reduce depreciation expense for the prior year, through a prior period
adjustment, to take into account the excess.B) lessor is under no obligation to compensate the lessee for the excess.C) lessor must pay the lessee the amount of the excess.D) lessee may reduce the annual rentals for the excess.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
70. Which of the following would be excluded from both the minimum lease payments and net lease liability at inception for the lessee?A) lessee guarantee of residualB) bargain purchase optionC) third party guarantee of residualD) annual lease payments
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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71. A lessee wants to lease an asset on a long-term non-cancellable basis, but wants to avoid capitalizing the lease. Which of the following strategies has the best chance of achieving the lessee's goal?A) use a lessee guarantee of residual valueB) make it impossible for the lessee, who has a very low borrowing rate, to determine the
lessor's implicit rate, which is much higher than the lessee's borrowing rateC) include a bargain purchase option in the lease agreementD) use a third-party guarantee of residual value
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO6
72. A lessee is attempting to circumvent the accounting rules, which require lease capitalization. Which of the following is most likely to lead to classification of a lease as an operating lease for the lessee?A) contract provides that lessee pays executory costsB) contract provides for a third-party guarantee of residual valueC) attempt to reduce the lessee's borrowing rateD) increase the term of the lease. decrease annual executory costs
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
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73. A company became a lessee by leasing equipment on January 1, 20x11 from a lessor. The lease has the following characteristics:
Original useful life of asset 14 yearsBoth lessor and lessee use 10% for lease capitalizationMarket value of equipment at lease inception $200,000Book value of equipment at lease inception $150,000Remaining useful life of equipment at inception 10 yearsA third party guarantees the entire residual value of $31,887Six end-of-year lease payments are due beginningDecember 31, 20x11 in the amount of $41,788
The lease term ends December 31, 20x16Assume this is a finance lease for both parties. Over what number of years will the lessee amortize the leased asset?A) 14B) 10C) 7D) 6E) 40
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
74. On January 1, 20x11, MU Corporation leased an asset, under an operating lease, to obtain the use of a special machine for three years. The lease payments were $9,000 per year payable at each year-end; the lessee must pay all operating expenses. At the inception date, MU Corporation should:A) record the asset at $27,000.B) record the rent expense of $27,000.C) record the asset at its fair market value.D) record the asset at the present value of the annual lease payments.E) make no entry.
Ans: EDifficulty: MediumLevel of Learning: ApplicationTopic: LO1
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75. A 5-year lease contract is signed 1/1/x1 calling for $4,000 to be paid by the lessee on 12/31/x1, and $6,000 on 12/31/x2, x3, and x4. Total lease payments over the lease term are therefore $22,000. The lessee expects to use the leased asset evenly throughout the lease term, which ends 12/31/x5. No payment is due in 20x15. The entry recorded by the lessee for this operating lease, on 12/31/x1 includes which of the following:A) cr. rent payable $200B) dr. rent expense $4,400C) dr. prepaid rent $400D) dr. rent expense $4,000
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO1
76. Lessee ABC leased from Lessor QRS a machine that cost $35,000, which was properly classified as a finance lease by both parties. Assume the lessor used a 12 percent implicit interest rate and that the lessee was informed of that rate. The lease did not include a bargain purchase option and the estimated residual value at termination of the lease was zero. Equal semi-annual lease payments are to be made at the start of each such period, including one on the date the lease was signed. The amount of each semi-annual payment, assuming a five-year lease term, would be:A) $2,074B) $2,916C) $4,486D) $4,755E) $9,709
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
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77. The following information relates to a lease contract:Inception: 1/1/x1
Annual lease payments of $3,000 due each 12/31 beginning 12/31/x1End of lease term: 1/1/x5There are 4 lease payments in allUseful life of asset at inception: 10 yrsExpected residual value at 1/1/x5: $6,000Lessee is given option to purchase asset at 1/1/x5 for $1,000Using an interest rate of 10%, what is the present value of minimum lease payments for the lessee at inception?A) $10,193B) $ 9,510C) $10,419D) $13,608E) $13,000
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO2
78. A lessor and lessee enter into a lease agreement with the following characteristics:Inception: 1/1/x06 annual lease payments of $10,000 are due each Jan. 1 beginning1/1/x0End of lease term: 12/31/x5Book value of equipment under lease, at inception: $35,000Market value of equipment under lease at inception: $50000Remaining useful life of equipment at inception: 9 yrsExpected residual value at end of lease term: $4,000Interest rate used by lessor and lessee: 10%
Assuming the lessee will capitalize this lease, what is the amount of the net lease liability at inception, before the first payment is made?A) $47,908B) $60,000C) $50,166D) $64,000
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO2
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79. An asset with a market value of $100,000 is leased on 1/1/x0. Five annual lease payments are due each January 1 beginning 1/1/x0. The unguaranteed residual value on 12/31/x4, the last day of the lease term, is estimated at $40,000. The lessor's implicit interest rate is 8%. What is the annual lease payment?A) $18,227B) $16,877C) $23,191D) $25,046
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO2
80. An asset with a market value of $100,000 is leased on 1/1/x0. Five annual lease payments are due each January 1 beginning 1/1/x0. The lessee guarantees the $40,000 residual value as of 12/31/x4, the last day of the lease term. The lessor's implicit interest rate is 8%. What is the annual lease payment?A) $18,227B) $16,877C) $23,191D) $25,046
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO2
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81. A company became a lessee by leasing equipment on January 1, 20x11 from a lessor. The lease has the following characteristics:Original useful life of asset 14 yearsBoth lessor and lessee use 10% for lease capitalizationMarket value of equipment at lease inception $200,000Book value of equipment at lease inception $150,000Remaining useful life of equipment at inception 10 yearsA third party guarantees the entire residual value of $31,887
Six end-of-year lease payments are due beginningDecember 31, 20x11 in the amount of $41,788The lease term ends December 31, 20x16Assume this is a finance lease for both parties. What is the present value of minimum lease payments for the lessee?A) $200,000B) $181,998C) $180,000D) $194,566E) $178,233
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
82. XYZ leased a tract of land for a 20-year term. The lease agreement did not contain a bargain purchase option, and consequently, the land will revert back to the lessor at the end of the lease term. At the inception of the lease, XYZ initiated construction on a small building on the land. The building was completed at the end of the third year of the lease, at a cost of $60,000. The building was a permanent structure on the land. Its estimated life was 20 years and was expected to have no residual value. XYZ should record annual depreciation (straight-line) on the building of:A) $2,400B) $3,000C) $3,529D) $6,000
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO2
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83. CDE leases land and secures the landowner's permission to erect a warehouse on the leased site. The lease has 25 years to run from the time CDE completes the warehouse at a cost of $300,000. The warehouse is expected to last 50 years. In connection with the warehouse, CDE's annual depreciation should be:A) $6,000B) $7,500C) $12,000D) The entire $300,000 should be expensed the first year.
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO2
84. Equal monthly rental payments for a particular lease should be charged to rental expense by the lessee for which of the following?
Finance lease Operating lease1 No No2 No Yes3 Yes No4 Yes Yes
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
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85. Lease Y contains a bargain purchase option and the lease term is equal to 75 percent of the estimated economic life of the leased property. Lease Z contains a bargain purchase option and the lease term is less than 75 percent of the estimated economic life of the leased property. How would the lessee classify these leases?
Lease Y Lease Z 1 Finance lease Finance lease2 Finance lease Operating lease 3 Operating lease Operating lease 4 Operating lease Finance lease
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2
86. On December 31, 20x12, JKL leased a new machine from MNO. The following information relates to the lease transaction:*the machine has an estimated useful life of seven years, which coincides with the lease term.
*lease rentals consist of seven equal annual payments of $100,000, the first of which was paid on December 31, 20x12.*MNO's implicit interest rate is 12 percent, which is known by JKL.*JKL's incremental borrowing rate is 14 percent at December 31, 20x12.*present value of an annuity of $1 in advance for seven periods at 12 percent is 5.11.*present value of an annuity of $1 in advance for seven periods at 14 percent is 4.89.At the inception of the lease, JKL should record a capitalized lease liability of:A) $411,000B) $489,000C) $500,000D) $511,000
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
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87. ABC leased a new machine from QRS on July 1, 20x19, under a lease with the following pertinent information:lease term 10 yearsannual rental payable at the beginning of each lease year $30,000useful life of the machine 12 yearsimplicit interest rate 14 percentpresent value of an annuity of $1 in advance for 10 periods at 14 percent 5.95Present value of $1 for 10 periods at 14 percent. 0.27ABC has the option to purchase the machine at the end of the lease term, by paying $40,000, which approximates the expected fair value of the machine on the option exercise date. The cost of the machine on QRS's accounting records is $150,000. On July 1, 20x19, ABC should record a net capitalized leased asset of:A) $150,000B) $178,500C) $189,300D) $190,000
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
88. CDE leased equipment from HIJ on December 31, 20x11, for a 10-year period (also the useful life of the asset). Equal annual payments under the lease are $50,000 and are due on December 31 of each year. The first payment was made on December 31, 20x11, and the second payment was made on the next due date. The present value at December 31, 20x11, of the minimum lease payments over the lease term discounted at 10 percent (the implicit rate computed by HIJ and known by CDE) was $338,000. CDE's incremental borrowing rate was 12 percent at December 31, 20x11. The lease is appropriately accounted for as a finance lease by CDE. What should be the balance in CDE's liability under finance lease account at December 31, 20x12?A) $266,800B) $272,560C) $303,980D) $400,000
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO2
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89. On December 1, 20x11, XYZ leased office space for its own use for 10 years at a monthly rental of $15,000. On December 31, 20x11, XYZ paid the lessor the following amounts:Refundable rent deposit (for possible property damage) $20,000First month's rent 15,000Rent for last month of year 10 (paid in advance) 15,000Installation of new walls and offices 96,000Total $146,000
========The entire amount of $146,000 was reported as rent expense in 20x11 because it is an operating lease. What amount should XYZ have reported as expense for the year ended December 31, 20x11?A) $15,000B) $15,800C) $30,800D) $96,000
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO1
90. Amanda Company leased an office building for six years for an annual rent of $170,000. The lessor agreed to forgive the first year of the lease (i.e. payments would not begin until the second year). The entry in the second year would include a debit to:A) deferred liability - $28,333B) deferred liability - $141,667C) rent expense - $170,000D) rent expense – some other amount
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO1
91. Amanda Company leased an office building for six years for an annual rent of $170,000. The lessor agreed to forgive the first year of the lease (i.e. payments would not begin until the second year). The entry in the second year would include a debit to:A) rent expense - $28,333B) rent expense - $141,667C) rent expense - $170,000D) rent expense – some other amount
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO1
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92. JMR Company leases an asset from KAR Company. The rate implicit in the lease is 11% and JMR's incremental borrowing rate is 12%. JMR is aware of the implicit rate. The rate that JMR should use for discounting the net lease payment is:A) 11.5%B) 12%C) 9%D) 11%
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
93. JMR Company leases an asset from KAR Company. The rate implicit in the lease is 11% and JMR's incremental borrowing rate is 12%. JMR is not aware of the implicit rate. The rate that JMR should use for discounting the net lease payment is:A) 11.5%B) 12%C) 9%D) 11%
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
94. All of the following are true of off-balance sheet financing except:A) lessees obtain full use of the assetsB) assets and debt obligations are not reported on the statements of the lesseeC) a new IASB guideline has eliminated the use of off-balance sheet financingD) new leasing sub-industries have developed to ensure that the three guidelines for finance
leases are not met
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
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95. Which of the following is not a possible advantage of long-term leases?A) 100% financingB) flexibilityC) protection from interest rate changesD) ability to always claim CCA and depreciation
Ans: D
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO6
96. KER leased an asset from EGR for 5 years. The lease met the conditions of a finance lease. The present value of the minimum lease payments using a rate of 11% was calculated at $65,017. The asset should be set up on the books of KER Company with a debit of:A) $66,017B) $65,017C) $325,085D) cannot be determined from the information given
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
97. KER leased an asset from EGR for 5 years on January 2, 20x11. The lease met the conditions of a finance lease. The present value of the minimum lease payments using a rate of 11% was calculated at $65,017. Assuming a calendar year end, the interest expense to be recorded is:A) $8,000B) $7,152C) $0D) cannot be determined from the information given
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO3
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98. Ryan Company leased an asset that qualified as a finance lease for accounting purposes and an operating lease for Canada Revenue Agency (CRA) purposes. Ryan Company assumed all maintenance costs. Selected financial data for the company include insurance $2,500; interest $7,657; amortization $11,234 and general office supplies $1,500. The annual lease payment amounts to $25,000. The temporary difference for tax purposes during the year amounts to:A) 0B) $2,109C) $3,609D) cannot be determined
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
99. Ryan Company leased an asset that qualified as a finance lease for accounting purposes and an operating lease for Canada Revenue Agency (CRA) purposes. Ryan Company assumed all maintenance costs. Selected financial data for the company include insurance $4,700; interest $5,347; amortization $8,540 and cost of goods sold $5,000. The annual lease payment amounts to $23,000. The temporary difference for tax purposes during the year amounts to:A) 0B) $4,413C) $587D) cannot be determined
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
100. Brimley Corp. leased an asset from Geisler Corp. At the end of the first year Brimley Corp. reported a leased asset of $87,098, accumulated amortization of $8,710 and a lease liability of $74,567. The temporary difference for tax purposes is:A) $8,710B) $11,241C) $3,821D) $21,241
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
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101. Brimley Corp. leased an asset from Geisler Corp. At the end of the first year Brimley Corp. reported a leased asset of $54,051, accumulated amortization of $10,810 and a lease liability of $40,537. The temporary difference for tax purposes is:A) $4,821B) $2,911C) $3,821D) $2,704
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO6
102. Brimley Corp. leased an asset from Geisler Corp. At the end of the first year Brimley Corp. reported a leased asset of $87,098, accumulated amortization of $8,710 and a lease liability of $74,567. Assuming an income tax rate of 40%, the impact on Brimley Corp. financial statements is:A) $8,710B) $11,241C) $3,821D) $1,528
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO3
103. All of the following are methods of avoiding capitalization except:A) legal agreementB) use of contingent rentC) use of a third partyD) shorten the lease term
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO6
104. In a sale and leaseback arrangement, the lessee is also:A) the new owner of the propertyB) the sellerC) the buyerD) a third party guarantor
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
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105. In a sale and leaseback situationA) all gains and losses are deferred and amortized by the sellerB) if the present value of the lease payments is equal to or less than 90% of the fair value of
the property, the lessee recognizes the entire gain or loss on sale immediatelyC) the lessee immediately recognizes any loss on sale up to the amount of the difference
between carrying value and fair valueD) the lessor recognizes all losses on the sale immediately but must defer and amortize all
gains
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
106. Generally accepted accounting principles require that certain lease agreements be accounted for as purchases. The theoretical basis for this treatment is that a lease of this type:A) provides the use of the leased asset to the lessee for a limited period of time.B) must be recorded in accordance with the concept of cause and effect.C) is an example of form over substance.D) effectively conveys all of the benefits and risks incident to the ownership of property.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
107. When a lessee measures the present value of future rentals to be capitalized under a finance lease, identifiable payments expected to be paid by the lessee to cover taxes, insurance, and maintenance should be:A) capitalized, but at a different discount rate and reported in a different account than the
present value of the future rental payments.B) capitalized, but at a different discount rate and for a relevant period that usually is different
than for the future rental payments.C) included in the present value of the future rentals to be capitalized.D) excluded from the present value of the future rentals to be capitalized.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
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108. A bargain purchase option in a finance lease affects the:A) incremental target rate of return.B) dealer's profit in a sales-type lease.C) guaranteed residual value.D) lessee's capitalized cost of the leased asset.
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
109. When the lessee guarantees the residual value at the end of the lease term, for accounting purposes, the:A) annual rentals will always be more than they would have been if the residual value was not
guaranteed.B) guaranteed residual value does not affect the annual rentals because it is a cash flow at the
end of the lease term.C) annual rentals will be the same as they would have been if the residual value was not
guaranteed.D) annual rentals will always be less than they would have been if the residual value was not
guaranteed.
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO2, 3
110. When the lessee guarantees only a portion of the estimated residual value, the:A) lessee only takes into account the guaranteed portion when computing depreciation
expense.B) guaranteed portion is disregarded when computing the annual rentals.C) lessor's and lessee's accounting entries will be symmetrical.D) lessee will never have to compensate the lessor for the excess of the guaranteed amount
over the actual residual value.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
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111. Choose the correct statement regarding including the terms listed in the lessee's (1) minimum lease payments and (2) lease liability for a capitalized lease:
(1) (2) 1 unguaranteed residual no yes 2 lessee guarantee of residual yes yes 3 third party guarantee of residual no yes 4 bargain purchase option yes no
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
112. Which of the following is included in only one or the other, but not both, of the lessee's minimum lease payments and net lease receivable?A) bargain purchase optionB) unguaranteed residual valueC) third party guarantee of residualD) lessee guarantee of residual valueE) none of the above
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
113. A lessee wants to lease an asset on a long-term non-cancellable basis, but wants to avoid capitalizing the lease. The lessee is considering several strategies: 1) use a lessee guarantee of residual value; 2) make it impossible for the lessee, who has a very low borrowing rate, to determine the lessor's implicit rate, which is much higher than the lessee's borrowing rate; 3) include a bargain purchase option in the lease agreement; 4) include title transfer in the lease agreement. Which of the above strategies will provide the desired result?A) noneB) 1 and 3C) 1 and 4D) 2 and 3E) only 2
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO63
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114. If a lessee does not exercise a bargain purchase option prior to its lapse date, the:A) lessee continues to record depreciation on the lease asset because it was assumed from the
beginning that the lessee would retain ownership of the asset.B) bargain purchase option cannot lapse because this option was included in computing the
annual rental amounts.C) lessee recognizes a loss due to the lapse.D) lessee recognizes a gain due to the lapse.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
115. LMN signed a finance lease for a special railroad tank car. The lease specified 10 annual rentals at each year-end. The lessor's implicit interest rate was 18 percent and is known to the lessee, and the lessee's incremental borrowing rate was 20 percent. The annual rental was $12,000. The lease provided for a bargain purchase option; that is, at the termination of the lease, the lessee could purchase the car for $20,000, even though its estimated value at that date was $36,000. At inception date, LMN will make the following entry:
Leased asset (tank car) XXX Lease liability XXX
The amount in the above entry should be:A) $50,108B) $51,928C) $57,750D) $120,000
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
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116. A lessee capitalized a lease with a 1/1/x1 inception and which required annual lease payments of $5,000 to be paid each December 31 beginning 12/31/x1. The lessee is to pay an additional $200 each December 31 for maintenance and insurance for the year ending on that date. The last lease payment is due 12/31/x6, on which date the title to the asset transfers to the lessee. The asset is expected to be used by the lessee until 12/31/x9 at which time the asset will have no residual value. What is the total expense related to the lease recognized by the lessee in 20x11? Both lessor and lessee use 10%.A) $4,797B) $2,378C) $7,620D) $6,008E) $4,598
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
117. A lease with a three-year term calls for a $5,000 payment at the end of each of those years. The three payments are the only ones required in the lease. The residual value at the end of the lease term is not guaranteed. The asset reverts to the lessor at the end of the term. The lessee has no way of knowing the unguaranteed residual value at the end of the lease term, or the one at the end of the asset's useful life, or the total useful life of the asset at inception. However, the lessee does know the lessor's implicit rate (10%), and the asset's fair market value at inception ($14,000). The lessee's borrowing rate on similar debt is 8%. Therefore:A) lessee has an operating lease as none of the four criteria are fulfilledB) lessee has a finance lease as the present value of lessee minimum lease payments exceeds
90% of the asset's fair market value at inceptionC) lessee has a finance lease as the lease term is at least 75% of the asset's remaining life at
inceptionD) lessee has an operating lease as the present value of lessee minimum lease payments is less
than 90% of the asset's fair market value at inceptionE) the 90% criterion does not apply in this case
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
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118. LOR leased a computer to LES which cost the lessor $8,000. The terms of the lease specify four years, an annual interest rate of 15 percent, and four year-end rental payments. The lease qualifies as a finance lease (direct financing). The lessor will get the computer after the fourth year and its residual value at that time is estimated to be $1,000. The amount of each rental payment is (round to the nearest dollar):A) $2,000B) $2,335C) $2,501D) $2,602
Ans: D
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
119. Which of the following are the required operating lease note disclosure requirements for the lessee?
1. Minimum lease payments2. Contingent Rents3. Scheduled lease payments for the next year4. Scheduled lease payments in total for the next four years5. Scheduled lease payments in total for all years.
A) 1, 2, 3, 4, & 5.B) 1, 2, & 5.C) 1, 2, 3 & 4.D) 1& 2.E) 1, 2 & 3.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
120. One incentive for entering into sale-and-leaseback arrangements is:A) tax implications are favourable for the lessor.B) improvement in cash flow for the lessor.C) lessee may be able to reduce interest expense through the refinancing aspects of the sale-
leaseback.D) lessor has an abundance of cash.E) lessee wants to increase return on investment.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
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121. If the lessor and lessee use different interest rates to account for a finance lease, then:A) the lessor will use different account titles to record the leasing transaction.B) total expenses (or revenues) will be equal for each.C) total expenses (or revenues) will be different for each.D) the lessee and lessor cannot use different interest rates.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
122. LAS owns a building in North Bay. LAS enters into an agreement with BH as follows: LAS sells the building to BH for $2,900,000 and immediately leases it back for $500,000 per year for 10 years. The historical cost of the building was $9,000,000 and accumulated amortization amounted to $7,000,000. Part of the journal entry to record these transactions includes:A) credit to building for $2,000,000B) credit to deferred gain for $2,000,000C) credit to gain on sales for $2,000,000D) credit to lease liability for $5,000,000
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
123. STU made the following journal entry at the end of the first lease year:Rent expense..............1,500
Cash..................................1,500STU must have a(n):A) direct financing lease.B) lease with a bargain purchase option.C) operating lease.D) sales-type lease.
Ans: CDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
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124. The lessor recognizes a profit at the inception of the lease when the lease is classified as a(n):A) operating lease.B) non-finance lease.C) direct financing lease.D) sales-type lease.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3, 4
125. The basic accounting issue for lessors is:A) computing depreciation on the leased asset.B) determination of the cost of the leased asset.C) revenue recognition during the lease term.D) expense recognition during the lease term.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO7
126. Which of the following is the complete list of classifications of leases from the standpoint of the lessor:A) direct financing and operating.B) direct financing and sales-type.C) direct financing, sales-type and operating.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
127. When a non-refundable down payment on a leased asset is made in advance under an operating lease, at the payment date, the lessor credits:A) lease liability.B) rent revenue.C) cash.D) unearned rent.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
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128. If the lessor records unearned rent at the inception of a lease, then the lease must:A) be an operating lease.B) be a direct financing lease.C) contain a bargain purchase option.D) be an annuity due.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
129. JKL received an $8,000 advance, non-refundable, bonus payment on a 5-year operating lease. An acceptable accounting treatment for this lease bonus is:A) recognize $8,000 revenue at the end of the lease term.B) recognize $8,000 revenue when the cash is received.C) recognized $1,600 revenue at the end of the first year of the lease term.D) to record an $8,000 deferred charge until the other rental payments are assured.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO1
130. Under a finance lease that includes a bargain purchase option (BPO), how is depreciation on the asset under lease recognized by:
Lessor Lessee 1 not recognized depreciate over lease term 2 depreciate over remaining life depreciate over remaining life 3 not recognized depreciate over remaining life 4 depreciate over remaining life not recognized
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3, 7
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131. LMN made the following journal entry relating to a finance lease:
Cash........................... XXXX Lease receivable.............. XXXX Interest revenue.............. XXXXTherefore, LMN must be the:A) third party guarantor.B) lessee.C) lessor.D) either the lessee or lessor.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
132. The amount of each rental payment on a direct financing lease is based on the:A) cost of the leased asset.B) cost of the asset plus interest.C) cost of the asset plus profit.D) cost of the asset, profit, and interest.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
133. In a direct financing lease, the present value of the periodic rental payments must equal the amount of the:A) lessor's cost of the leased asset.B) lessee's total rent expense.C) guaranteed residual value.D) bargain purchase option.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
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134. WXY leased an asset from CDE that cost $104,974 (i.e., the present value of the lease rentals). The contract required ten $20,125 annual payments to be made each year-end. This rental amount was necessary in order for CDE to earn a 14 percent rate of return. (Assume a present value factor of 5.216116). To CDE, the lease was most likely a(n):A) operating lease.B) sale-type lease.C) direct financing lease.D) leveraged lease.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
135. TUV Leasing Company entered into an agreement to lease a computer which cost $113,534. There was no bargain purchase option, nor a guaranteed residual value. The lease term was for 6 years and payments of $30,000 are payable at the end of the year. The target rate of return was 15 percent. (Assume the present value of an ordinary annuity, for six years, at 15 percent equals 3.78448.) The lease must have been classified by the lessor as a(n):A) sales-type lease.B) operating lease.C) direct financing lease.D) Cannot be determined.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1, 2, 3
136. The amount of each rental payment on a sales type lease is based on the:A) cost of the leased asset.B) cost of the asset plus interest.C) cost of the asset plus profit.D) cost of the asset, profit, and interest.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
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137. The amount of each rental payment on a sales type lease includes:A) a return of cost.B) a return of cost, and interest.C) a return of cost, interest, and profit.D) interest and profit.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
138. For the lessor, under a sales-type lease, the excess of the normal sales price (i.e., current market) of the leased asset over its cost (or carrying amount) should be recognized as revenue by the lessor:A) in decreasing amounts during the lease term.B) in increasing amounts during the lease term.C) in equal amounts during the lease term.D) in full at the inception date of the lease.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
139. The market value of an asset to be leased exceeds the original cost of the asset. The lease will contain a bargain purchase option. The collectability of lease payments is assured, and there are no material cost uncertainties for the lessor. Therefore the lease will be accounted for by the lessor as aA) direct financing leaseB) operating leaseC) rental leaseD) sales type leaseE) unguaranteed lease
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1,2,3, 4
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140. Among the following types of finance leases, for the lessor, which likely recognizes the greatest amount of revenue at inception?A) OperatingB) Direct financingC) Sales-typeD) Among those in this list, there would be no material difference
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
141. Under a sales-type lease, the difference between the cost of the leased asset and the lease receivable is accounted for by the lessor and lessee as follows:
Lessor Lessee 1 gross margin not recognized 2 interest revenue not recognized 3 gross margin interest expense 4 interest revenue included in capitalization of the leased asset 5 gross margin included in capitalization of the leased asset
A) Choice 1B) Choice 2C) Choice 3D) Choice 4E) Choice 5
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3, 4, 7
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142. LMN correctly recorded a 5-year lease on a special machine by making the following entry on the date the lease was signed:
Lease receivable....................... XXXX Asset-machine under lease............. XXX Gross margin (dealer's profit)........ XX Unearned interest revenue............. X
The lease was the following:A) direct financing lease.B) operating lease.C) sales-type lease.D) could be either a direct financing or sales-type lease.E) cannot determine with confidence based on the limited data given.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
143. Which of the following is included in only one or the other, but not both, of the lessor's minimum lease payments and net lease receivable?A) bargain purchase optionB) unguaranteed residual valueC) third party guarantee of residualD) lessee guarantee of residual value
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3, 7
144. In a sales-type lease with an unguaranteed residual value, the gross margin recognized by the lessor in the year of inception is:A) market value of asset less book value of assetB) market value of asset less book value of asset less the present value of the unguaranteed
residual valueC) market value of asset less book value of asset less the nominal value of the unguaranteed
residual valued. D) 0 (zero)
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
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145. Material gains resulting from sale-and-leaseback transactions usually should be accounted for:A) by crediting the gain to the cost of the related property.B) by amortizing the gain over the life of the lease.C) as an ordinary gain of the period of the transaction.D) as an unusual gain of the period of the transaction.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
146. A company sold property at a price in excess of book value and then leased back the property for a ten-year term. The gain resulting from the sale of the property should be recognized:A) over the lease term.B) as a prior period adjustment in the period of sale.C) in the year of the sale.D) at the end of the ten-year period or termination of the lease, whichever is earlier.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
147. For which party is finance lease accounting affected most when the property is first sold and then leased back:A) lessorB) lesseeC) both lessor and lessee accounting are affected to the same extentD) neither lessor nor lessee accounting are affected to a significant extent
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
148. The lessor must classify a sale-and-leaseback arrangement as a(n):A) direct financing lease or an operating lease.B) direct financing lease or a sales-type lease.C) operating lease or a guaranteed lease.D) operating lease or a sales-type lease.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
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149. One incentive for entering into sale-and-leaseback arrangements is:A) tax implications are favourable for the lessor.B) improvement in cash flow for the lessor.C) lessee may be able to reduce interest expense through the refinancing aspects of the sale-
leaseback.D) lessor has an abundance of cash.E) lessee wants to increase return on investment.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
150. One incentive for entering into sale-and-leaseback arrangements is:A) tax implications are favourable for the lessor.B) improvement in cash flow for the lessor.C) lessee may be able to reduce interest expense through the refinancing aspects of the sale-
leaseback.D) lessor has an abundance of cash.E) lessee wants to increase return on investment.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
151. In a sale-and-leaseback agreement, the lessor is also:A) the buyer.B) a third party guarantor.C) the lessee.D) the seller.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
152. In a sale and leaseback arrangement, the lessee is also:A) the new owner of the propertyB) the sellerC) the buyerD) a third party guarantor
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
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153. In a sale and leaseback situationA) all gains and losses are deferred and amortized by the sellerB) if the present value of the lease payments is equal to or less than 90% of the fair value of
the property, the lessee recognizes the entire gain or loss on sale immediatelyC) the lessee immediately recognizes any loss on sale up to the amount of the difference
between carrying value and fair valueD) the lessor recognizes all losses on the sale immediately but must defer and amortize all
gains
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
154. RST leased equipment from MNO to be used in its warehouse. The lease term is five years. RST spent $5,000 for ordinary repairs during the second year of the lease. RST should:A) expense the $5,000 immediately.B) write the $5,000 off at the end of the lease term.C) capitalize the $5,000 permanently in the lease account.D) amortize the $5,000 over the life of the lease on a reasonable basis.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
155. Executory costs include:A) interest expense incurred.B) annual lease rentals paid.C) insurance premiums.D) leasehold improvements.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1, 2, 3
156. Initial direct costs are:A) insurance, property taxes, and maintenance costs.B) interest and annual lease rental paid.C) non-refundable down payments made by the lessee.D) incremental costs incurred by the lessor in negotiating and consummating the lease
agreement.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
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157. If the title to a leased asset does not transfer to the lessee at the end of the lease term, but the lessee guarantees the residual, what is the period and residual value used by the lessor to depreciate the leased asset?
Period Residual value 1 lease term 0 2 lease term lessee guarantee 3 remaining life at inception lessee guarantee 4 remaining life at inception 0
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2, 3
158. What amount of sales is recognized by the lessor in a sales type lease when the residual value is guaranteed?A) market value of the asset leasedB) cost of asset leasedC) market value of asset leased less present value of unguaranteed residual valueD) cost of asset leased less present value of unguaranteed residual value
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
159. What amount of sales is recognized by the lessor in a sales type lease when the residual value is unguaranteed?A) market value of the asset leasedB) cost of asset leasedC) market value of asset leased less present value of unguaranteed residual valueD) cost of asset leased less present value of unguaranteed residual value
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
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160. Initial direct costs include lessor costs incurred:A) before obtaining the commitment of a potential lessee to enter into a lease contractB) after obtaining the commitment of a potential lessee to enter into a lease contractC) before and after obtaining the commitment of a potential lessee to enter into a lease
contractD) for the purpose of upgrading an existing lease contract
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3
161. On the first day of its fiscal year, Lessor, Inc., leased certain property at an annual rental of $100,000 receivable at the beginning of each year for ten years. The first payment was received immediately. The leased property, which is new, had cost $650,000 and has an estimated useful life of thirteen years and no salvage value.Lessor's borrowing rate is 8 percent. The present value of an annuity of $1 payable at the
beginning of the period at 8 percent for ten years is 7.247. Lessor had no other costs associated with this lease. Lessor should have accounted for this lease as a sales-type lease, but it mistakenly treated the lease as an operating lease. What was the effect on net earnings during the first year of the lease by having treated this lease as an operating lease rather than as a sales-type lease?A) OverstatedB) No effectC) UnderstatedD) The effect depends on the method selected for income tax purposes
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
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162. On January 1, 20x11, CDE Company leased an asset from LMN which originally cost the lessor $75,000. The lease agreement was an operating lease and specified that three $10,500 annual rentals were to be paid at the beginning of each year. LMN should make the following entry on January 1, 20x11:
1 Cash 10,500 Unearned rent revenue 10,500 2 Cash 10,500 Lease receivable 10,500 3 Cash 10,500 Rent revenue 10,500 4 Rent receivable 10,500 Rent revenue 10,500
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
163. A lease agreement includes the following provisions:Inception: 1/1/x0Annual lease payments of $6,000 are due 12/31/x0, x1, x2Annual lease payments of $4,000 are due 12/31/x3, x4, x5There are 6 lease payments in allLessor's implicit rate of return: 12%This is a finance lease to the lessorHow much interest revenue is recognized in 20x10 by the lessor (assume a calendar year fiscal year)?A) $3,600B) $3,419C) $2,550D) $2,118
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO7
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164. A lessor and lessee enter into a lease agreement with the following characteristics:Inception: 1/1/x0 6 annual lease payments of $10,000 are due each Jan. 1 beginning1/1/x0End of lease term: 12/31/x5Book value of equipment under lease, at inception: $35,000Market value of equipment under lease, at inception: $50,000Remaining useful life of equipment at inception: 9 yrsExpected residual value at end of lease term: $4,000Interest rate used by lessor and lessee: 10%This lease is:A) an operating lease for both lessor and lesseeB) a finance lease for lessee because the lease term is sufficiently longC) a finance lease for lessee because the present value of minimum lease payments is
sufficiently largeD) a direct financing lease for the lessor
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
165. A lessor and lessee enter into a lease agreement with the following characteristics:Inception: 1/1/x06 annual lease payments of $10,000 are due each Jan. 1 beginning1/1/x0End of lease term: 12/31/x5Book value of equipment under lease, at inception: $35,000Market value of equipment under lease, at inception: $50,000Remaining useful life of equipment at inception: 9 yrsExpected residual value at end of lease term: $4,000Interest rate used by lessor and lessee: 10%Assuming the lessor will capitalize this lease, what is the amount of the net lease receivable for the lessor, before the first payment is made?A) $47,908B) $60,000C) $64,000D) $50,166
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO7
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166. ABC entered into a direct financing lease with QRS to rent a machine that cost $18,000. The lease term was for six years. The annual rentals are payable at the beginning of each year, and ABC expects to earn a 14 percent rate of return. The required amount of the annual rentals is (rounded to the nearest dollar):A) $30,000B) $36,600C) $40,604D) $46,288
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO7
167. RST entered into a direct financing lease agreement, which required rentals of $9,600, each year-end. The lease term was for ten years and a 14 percent rate of return is expected by RST. The cost of the machine for RST was (rounded to the nearest dollar):A) $50,075B) $82,560C) $96,000D) $109,440
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO2
168. XYZ agreed to lease an industrial machine that cost $108,000 to RST for six years. The lease was a direct financing lease and a 12 percent interest rate was used to calculate the annual lease payments, which were payable at the end of each year. The amount of each annual rental was:A) $18,000B) $20,160C) $26,268D) $44,402
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
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169. On January 1, 20x11, ABC leased a machine to MNO. The lease was for a 10-year period, which approximated the useful life of the machine. ABC purchased the machine for $120,000 and expects to earn a 10 percent return on its investment, based upon an annual rental of $17,754 payable in advance each January 1st. Assuming that the lease was a direct financing lease, what should be the interest entry on ABC's books on December 31, 20x11?
1 Cash.................................. 5,754 Interest revenue..................... 5,7542 Unearned interest revenue.............. 10,225 Interest revenue...................... 10,2253 Unearned interest revenue.............. 12,000 Interest revenue...................... 12,0004 Cash................................... 17,754 Interest revenue...................... 12,000 Equipment............................. 5,754
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO7
170. XYZ Rental leased a special crane to ABC that originally cost $40,000. The lease was for six years and the rentals were $10,000 per year, payable at each year-end. The implicit interest rate was 10 percent. XYZ Rental recognized a gross margin (dealer's profit) of (rounded to nearest dollar):A) $3,553B) $4,000C) $20,000D) $24,000
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO7
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171. RST entered into a sales-type lease with EFG to rent special equipment for six years. The equipment cost $40,000 and RST will earn a $4,000 dealer's profit and 12 percent interest revenue. Therefore, RST will receive year-end lease payments of:A) $7,333B) $8,213C) $10,702D) $12,090
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 7
172. ABC entered into a sales-type lease to lease JKL an asset that cost ABC $120,000. The lease agreement requires five annual year-end rentals of $40,000 each. ABC used a 15 percent interest rate to compute the rentals. The dealer's profit (or loss) that ABC recognized was:A) $14,086 loss.B) $14,086 gain.C) $18,000 gain.D) $80,000 gain.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
173. LMN leases construction equipment on sales-type leases. LMN wants to record a $7,000 dealer's profit on assets leased, each of which cost $60,000. What annual year-end rentals should LMN quote to earn a 12 percent return on 8-year leases?A) $6,625B) $8,375C) $9,380D) $13,487
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 7
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174. JKL leased an asset to RST that cost $100,000 when purchased by JKL. The lease term was for six years and specified year-end rentals. JKL earns a $12,000 dealer's profit and uses an interest rate of 14 percent to compute the annual rentals. The amount of each annual rental must be:A) $16,666B) $18,666C) $21,280D) $28,802
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
175. BCD leased special equipment to QRS on January 1, 20x11. The lease is for an eight-year period ending December 31, 20x18. The first of eight equal annual payments of $300,000 was made on January 1, 20x11. BCD had purchased the equipment on December 29, 20x10, for $1,600,000. The lease is appropriately accounted for as a sales-type lease by BCD. Assume that the present value at January 1, 20x11, of all rent payments over the lease term discounted at a 10 percent interest rate was $1,760,000. What amount of interest revenue should BCD record at the end of 20x12 (the second year of the lease period) as a result of the lease?A) $130,600B) $146,000C) $160,000D) $163,600
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO7
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176. A lessee that enters into a finance least must disclose which of the following?
1. Any significant finance lease arrangements.2. Any contingent rent recognized as expense during the period.3. The net carrying value of each class of leased asset at the reporting date.4. Total future minimum lease payments.5. A reconciliation between total minimum future lease payments and their present value.
A) 1, 2 & 3.B) 1, 2 & 4.C) 1, 2, 3 & 4.D) 1, 2, 3, 4 & 5.
Ans: D
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO5
177. Based solely upon the following sets of circumstances indicated below, which set gives rise to a sales-type or direct financing lease of a lessor?
Transfers Contains Collectabilityownership bargains of lease Anyby end of purchase payments Important
lease? provision? assured? Uncertainties?1 Yes No No Yes2 Yes No No No3 No Yes Yes Yes4 No Yes Yes No
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
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178. Which of the following statements best describes the finance lease guidelines under ASPE from the lessee’s point of view?A) The lease term must be at least 75% of the asset’s life.B) The present value of the minimum lease payments must be equal to 90% or more of the
asset’s fair value.C) The criteria for finance leases is met if either A or B are met.D) The criteria for finance leases are met if A AND B are met.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO9
179. Which interest rate must be used by the lessee to account for a finance lease under ASPE?A) The lessor’s implicit rate if known, otherwise the lessee’s incremental borrowing rate.B) The lessor’s implicit rate.C) The lessee’s incremental borrowing rate.D) The lower of B & C above.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO9
180. Under ASPE, a lessor may classify a lease as a finance lease if:A) The credit risk relating to the lease and lessee are normal.B) The lessor’s unreimbursable costs can be reasonably estimated.C) Either A or B must be met to meet the finance lease criteria under ASPE.D) Both A and B must be met to meet the finance lease criteria under ASPE.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO9
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181. ABC leased equipment to XYZ on January 1, 20x10. The lease is for a 9-year period expiring January 1, 20x18. The first equal annual payment of $400,000 was made on January 1, 20x10. The cash selling price of the equipment is $2,347,500, which is equal to the present value of the lease payments at 10 percent. ABC had purchased the equipment for $2,100,000. The lease is appropriately recorded as a sales-type lease by ABC. What amount of interest income should ABC record in 20x10 as a result of the lease?A) $194,750B) $210,000C) $234,750D) $280,000
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO7
182. MNO Company leased equipment from RST Corporation on July 1, 20x19, for an 8-year period. Equal payments under the lease are $600,000 and are due on July 1 of each year. The first payment was made on July 1, 20x19. The rate of interest contemplated by MNO and RST is 10 percent. The cash selling price of the equipment is $3,520,000 and the cost of the equipment on RST's accounting records is $2,800,000. Assuming that the lease is appropriately recorded as a sales-type lease, what is the amount of profit on the sale and interest income that RST should record for the year ended December 31, 20x19?A) $0 and $0B) $0 and $146,000C) $720,000 and $146,000D) $720,000 and $160,000
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO7
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183. Choose the correct statement regarding the terms listed in the lessor's (1) minimum lease payments and (2) net lease receivable for a capitalized lease:
Include in:(1) (2)
1 unguaranteed residual yes yes 2 lessee guarantee of residual no yes 3 third party guarantee of residual no yes 4 bargain purchase option no no
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
184. If the title to a leased asset does not transfer to the lessee at the end of the lease term, but a third party guarantees the residual, what is the period and residual value used by the lessor to depreciate the leased asset?
Period Residual value 1 lease term 0 2 lease term residual value at end of term 3 remaining life at inception residual value at end of term 4 remaining life at inception 0
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
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185. If the title to a leased asset does not transfer to the lessee at the end of the lease term, and no party guarantees the residual, what is the period and residual value used by the lessor to depreciate the leased asset?
Period Residual value 1 lease term 0 2 lease term residual value at end of term 3 remaining life at inception residual value at end of term 4 remaining life at inception 0
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
186. If the title to a leased asset transfers to the lessee at the end of the lease term, what is the period and residual value used by the lessor to depreciate the leased asset?
Period Residual value 1 remaining life at inception residual value at end of term 2 original useful life residual value at end of life 3 remaining life at inception residual value at end of life 4 lease term residual value at end of term
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
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187. With respect to a lessor’s indirect costs, under ASPE:A) These should be expensed for both direct financing and sales-type leases.B) These should be capitalized for both direct financing and sales-type leases.C) These should be expensed under direct financing leases and capitalized under sales-type
leases.D) These should be capitalized under direct financing leases and expensed under sales-type
leases.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO9
188. An asset was purchased by a lessor several years ago. At date of purchase, the asset was expected to have a 40-year useful life. Today, the asset has only 8 years of remaining service life. The asset is leased today. The lease has a term of 5 years starting today and the present value of minimum lease payments is $18,000 for the lessor. What is the minimum book value of the asset to the lessor for this lease to qualify as a direct financing lease?A) $20,000B) $16,200C) $18,000D) this lease is not a direct financing lease
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO7
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189. On January 1, 20x11, BE Company collected a $15,000 cash, non-refundable, bonus payment on an operating lease. Assuming a 12 percent interest rate and a five-year lease term, the lease bonus amortization journal entry for 20x11, if the interest method is used, is:
1 Cash.................................. 15,000 Rent revenue......................... 15,0002 Lease receivable...................... 3,000 Rent revenue......................... 3,0003 Unearned rent revenue................. 3,000 Rent revenue......................... 3,0004 Unearned rent revenue................. 2,361 Rent revenue......................... 2,361
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO7
190. The inception of a lease is 1/1/x1. A third party guarantees the residual value of the asset under lease, estimated to be $12,000 at 1/1/x6, the end of the lease term. Annual lease payments are $10,000 due each December 31 beginning 12/31/x1. The last payment is due 12/31/x5. Both the lessor and lessee use 10% as the interest rate. The remaining useful life of the asset was 6 years at inception. What is the net asset balance for the lessor and net liability balance for the lessee, at inception?
Net asset (lessor) Net liability (lessee) 1 $45,359 $45,359 2 $37,908 $37,908 3 $45,359 $37,908 4 $37,908 $45,359 5 $47,119 $38,339
A) Choice 1B) Choice 2C) Choice 3D) Choice 4E) Choice 5
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3, 7
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191. WXZ entered into a direct financing lease with TUV for the use of an asset which cost WXZ $240,000. The lease agreement contained a bargain purchase option effective immediately after the fifth rental, which provided that TUV could purchase the asset at that time. The estimated life of the asset was 10 years with an estimated residual value of $400. TUV's annual depreciation expense is (use straight- line):A) $22,200B) $23,960C) $44,400D) $48,000
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3, 7
192. XYZ agreed to lease a computer, at cost, to ABC for $36,000 each year-end for seven years without a bargain purchase option, or, as an equivalent alternative, for $33,000 per year with a bargain purchase option, after the seventh rental. If the lease is a direct financing lease, and XYZ expects to earn a 12 percent rate of return, the amount of cash ABC would have to remit for the bargain purchase option is:A) $30,266B) $26,340C) $21,000D) $9,498
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
193. WXY entered into a direct financing lease (interest rate 12 percent) to lease ABC an asset that cost WXY $90,000. The lease specified annual year-end payments for seven years. The lease also specified that, along with the last payment, ABC could purchase the asset for $8,000 cash. ABC will have to pay equal annual payments of:A) $11,714B) $12,858C) $17,966D) $18,928
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
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194. RST entered into a direct financing lease with ZAB, which called for seven annual rentals of $3,500 (interest rate 12 percent) to be paid at the end of each year. The lease also contained a bargain purchase option allowing ZAB to purchase the asset for $2,500 after making the seventh annual rental payment. The cost of the asset must have been:A) $17,104B) $18,473C) $25,631D) $27,000
Ans: ADifficulty: Medium
Level of Learning: ApplicationTopic: LO2, 3
195. LMO leased an asset for use in its factory. The lease specified that LMO was to make annual payments of $2,818 payable at the end of each year. The lessor classified the lease as a direct financing lease because LMO was allowed to lease the asset at cost of $14,000 (i.e., the present value of the lease payments). The lessor received a 12 percent rate of return on the lease. The estimated residual value at the end of the lease term is zero. If the lease was classified as a finance lease by LMO, how much annual depreciation (using SL) should LMO record?A) $1,400B) $1,750C) $1,310D) $2,818
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO7
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196. On January 1, 20x11, LOR leased a machine (original cost $60,000) to LES for a 5-year period at an implicit interest rate of 15 percent. The lease qualified as a direct financing lease and the annual lease payments ($17,306) are made each December 31. LOR retained the $4,000 estimated unguaranteed residual value (i.e., the machine reverts to LOR at the end of the lease term). Therefore, at inception date (January 1, 20x11), LOR's net receivable and LES's liability would be (round to the nearest dollar):
LOR Receivable LES Liability 1 $60,000 $60,000 2 $58,011 $58,011 3 $60,000 $58,011 4 $58,011 $60,000
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO2, 3, 7
197. On December 10, 20x11, LMN purchased a special machine for leasing purposes; it cost $10,000. On January 1, 20x12, the machine was leased to ABC under the following terms (it is a direct financing lease): a. lease term 4 years; interest rate 10 percent; rentals payable at year-end. b. LMN retains the residual value of $1,000 (i.e., the RV when the machine is returned to LMN at the end of year 4). There is no guarantee on the residual value.On January 1, 20x12, when the lease term starts, the following accounting amounts should be used:
LMN's net Lease ABC's LeaseLease payment Receivable Liability
1 $2,939 $ 9,317 $ 9,3172 2,939 10,000 9,3173 3,155 9,317 10,0004 3,155 10,000 10,000
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3, 7
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198. Company A enters into a lease agreement with Company B. The fair value of the asset is $100,000. The present value of the minimum lease payments is $90,000. The yearly payment is $10,000, depreciation amounts to $5,000 and the lease meets the requirement of an operating lease. What is the journal entry at the end of the first year assuming a full 12 months have passed?Ans: A lease is operating therefore only record the payment.
Dr. Lease/Rent expense $10,000 Cr. Cash $10,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
199. What guidelines are used under IFRS to determine whether a lease is an operating lease?Ans: A lease is an operating lease if it does not meet the criteria established for a finance leaseDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
200. Ryan Corp. enters into an sale and leaseback agreement with Geisler Corp. Ryan Corp. sold its building to Geisler Corp. for $400,000. The building had a historical cost of $600,000 and accumulated depreciation of $300,000. Ryan Corp. then leased it back from Geisler corp. for $80,000 per year for 10 years. Prepare the journal entry to record the sale.Ans:Dr. Cash $400,000Dr. Accumulated depreciation $300,000 Cr. Building $600,000 Cr. Deferred gain on sale and leaseback of building $100,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO4
201. Ryan Corp. enters into an sale and leaseback agreement with Geisler Corp. Ryan Corp. sold its building to Geisler Corp. for $400,000. The building had a historical cost of $600,000 and accumulated depreciation of $300,000. Ryan Corp. then leased it back from Geisler corp. for $80,000 per year for 8 years. The lease qualifies as a finance lease. It is Ryan Corp's policy to depreciate buildings over 10 years. Prepare the journal entry to record the amortization for the first year. (assume a January 1 transaction and a December 31 year end).Ans: Deferred gain = $100,000 ($400,000 received less the BV $300,000). The deferred gain
should be amortized in proportion to the amortization of the leased asset and the lease payments. Therefore amortization should be $10,000/yr
Dr. Deferred gain on sale and leaseback of building $10,000 Cr. Amortization expense, leased building $10,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO4
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202. Leasing assets can result in much time and effort on the part of the lessee. Contracts, details, complex calculations and journal entries are all required to accurately track each lease. Why then, with all the extra work involved would a company be inclined to lease instead of buy?Ans: Many companies lease due to the nature of their business. They acquire the right to use the
asset but the risks associated with ownership remains with the lessor. Other companies enter into a lease with the hope of improving or maintaining their cash flow. Often leases can be structured so that the payments are less than if the asset were purchased via financing.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO6
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203. Lessor Company rented a machine to Lessee Company on January 1, 20x11, for a period of 3 years. Rent of $6,000 is due January 1, of each year (starting in 20x11). The lease qualified as an operating lease for both the lessor and lessee. In addition to the monthly rentals, the lease contract required Lessee Company to pay $1,000 on January 1, 20x11 (this is non-refundable). The accounting period ends December 31. Complete the entries required for Lessee Company on the following dates, using the straight-line method.(a) January 1, 20x11:(b) December 31, 20x11:Ans: (a) January 1, 20x11:Prepaid rent expense 1,000Rent expense 6,000 Cash 7,000
(b) December 31, 20x11:Rent expense ($1,000/3) 333 Prepaid rent expense 333
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
204. On January 1, 20x11, LE Corporation leased a machine from LOC for a period of three years and paid $4,800 at the inception of the lease.In addition, five equal rentals of $4,800 are to be paid at the beginning of each six-month period thereafter. The effective annual interest rate was 8%. The lease qualifies as a finance lease.(a) Compute the amount of the lease liability at 1/1/x1.(b) Complete LEC's partial amortization schedule given below.Round amounts to the nearest dollar.
Rent Interest Reduction LiabilityDate Payment Expense of Liab. Balance
1/1/20x11 Start1/1/x1 $ 4,8006/30/20x117/1/20x11 4,800Ans: (a) $4,800 x PVAD, 4% 6 (5.45182) = $26,169
(b) Annuity date basis:
Rent Reduction LiabilityDate Payment Interest Expense of Liab. Balance1/1/20x11 Start $26,1691/1/x1 $4,800 $4,800 $21,3696/30/20x11 $21,369 x 4% = $855 (855) 22,2247/1/20x11 4,800 4,800 17,424
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
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205. A lessee rented a machine that had a market value (cost new to the lessor) of $26,132, for a 6-year term, with annual year-end rentals (ordinary annuity situation) of $6,000 each. The annual implicit interest rate would be _______________%Ans: 10%, computed as follows:
$26,132 ÷ $6,000 = 4.35533; (PVA, 6) for n=6; implicit interest rate, 10%Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3, 7
206. The following information relates to a lease contract:Lease inception 1-1-x1Market value and book value (to lessor) of new equipment under lease $10,000Interest rate used by both lessee and lessor for lease accounting 10%Lease payments due 12-31-x1 , x2, x3End of lease term 1-1-x4Expected residual value at 1-1-x4 $1,000Expected residual value at 1-1-x7 (end of useful life) $100The lease allows the lessee to purchase the asset for $200 on 1-1-x4.There are no uncertainties with respect to collectability of lease payments, or performance by lessor.(a) Determine the annual lease payment(b) Classify the lease for the lessee(c) Record the 20x11 entries
Ans: (a) $10,000 = LP (PVA, .10, 3) + $200(PV1, .10, 3); LP = $3,961 2.48685 .75131(b) Minimum lease payments for = 3($3,961) + $200 = $12,083PV of min lease payments = $10,000Lessee: capitalize (fulfills criteria 2, 4)
(c) LesseeJan. 1Leased asset 10,000 Lease liability 10,000Dec. 31Lease liability 2,961Interest expense 1,000 Cash 3,961Dep. Expense 1,650 Accum. dep. 1,650$1,650 = ($10,000-$100)/6
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
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207. A finance lease signed on January 1, 20x11, calls for 5 annual lease payments of $40,000 starting January 1, 20x11. The asset reverts to the lessor on December 31, 20x15 at which time it is expected to be worth $25,000. The lessor's implicit interest rate is 10%. What is the market value of the asset at inception?Ans: Market value = $40,000 + $40,000(PVA, 10%, 4) (3.16987) +
$25,000(PV1, 10%, 5) (.62092) = $182,318Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
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208. On January 1, 20x11, LOR Company rented a machine (3-year life, no residual value, straight-line) to LEE Company for a cash rental payable each December 31, 20x11, x2, and x3. The rental is based on the regular sales price: cost, $35,665; sale price, $45,665. The agreed interest rate was 15% and the lessee retains the machine at the end of the lease term at no additional cost.(a) The annual rental is $_____________________.(b) Complete the following lease amortization schedule:
LeaseDate Payments Amortization Balance
(c) Give the lessor's and lessee's entries on the following dates:LOR LEE
January 1, 20x11:
December 31, 20x11:Ans:
(a) Annual rental: $20,000=======
$45,665 ÷ PVA, 15%, 3 = 2.28323, = $20,000(b)
LeaseDate Payments Amortization Balance1/01/x1 $45,66512/31/x1 $20,000 $45,665 x 15% = $6,850 $13,150 32,51512/31/x2 20,000 32,515 x 15% = 4,877 15,123 17,39212/31/x3 20,000 17,392 x 15% = 2,608* 17,392 -0-*Rounded(c)
LOR LEEJanuary 1 20x11:Lease receivable 60,000 Leased machine 45,665 Asset 35,665 Lease liability 45,665 Gross margin 10,000 Unearned int. 14,335
ORLease receivable 60,000CGS 35,665 Asset (inventory) 35,665 Sales 45,665 Unearned int. 14,335
LOR LEEDecember 31, 20x11:Cash 20,000Unearned int. 6,850 Lease liability 13,150Lease receivable 20,000 Interest expense 6,850Interest revenue 6,850 Cash 20,000
Depr. expense 15,222
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Accum. epr.,machine
15,222*
* $45,665/3
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3, 7
209. On January 1, 20x11, TA acquired a machine (for leasing purposes) for $52,000 cash. The machine had an estimated eight-year useful life and no residual value. On January 1, 20x11, the machine was leased to LTB on an eight-year direct financing lease that required year-end annual rentals of $9,395 starting on December 31, 20x11. The lessor's implicit interest rate was (rounded to the nearest percent): __________%.Ans: 9%; $52,000 ÷ $9,395 = 5.53486 (PVA, 8); 9% is the nearest %.Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3hzzled
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210. LAC has negotiated a lease agreement with LEC effective January 1, 20x11. LAC will provide LEC with a special-purpose building for ten (10) years. The lease is non-cancellable; requires LEC to provide maintenance, insurance, taxes, etc.; and stipulates that the building reverts back to LAC's control at the end of the lease. The building cost LAC $200,000 and is expected to have no residual value at the end of the lease. LAC expects a 15% return on investments and the lease qualifies as a direct financing lease. Rents are paid each December 31 starting in 20x11.(a) How much annual rent will the lessee pay (rounded to the nearest dollar)? $______________________________.(b) Complete the following schedule of lease amortization for the lessee for the first two years:
Annual Liability LiabilityDate Rental Interest Expense Reduction Balance
1/01/20x1112/31/20x1112/31/20x12
(c) Complete the following entries for the lessee: January 1, 20x11, inception of lease.December 31, 20x11, first rental payment and lessee's year-end entries (end of the accounting period).December 31, 20x11, accrual by lessee of $4,000 taxes on the building and payment of $800 for repairs on the building.Ans: (a) $200,000 ÷ PVA, 15%, 10 (5.01877) = $39,850
(b)
Annual Liability LiabilityDate Rental Interest at 15% Reduction Balance1/01/20x11 $200,00012/31/20x11 $39,850 $30,000 $ 9,850 190,15012/31/20x12 39,850 28,523 11,327 178,823
(c)January 1, 20x11:Leased Asset 200,000 Lease liability 200,000
December 31, 20x11:Depreciation expense ($200,000 ÷ 10) 20,000 Accumulated depreciation 20,000Interest expense 30,000Lease liability 9,850 Cash 39,850
December 31, 20x11:Property tax expense 4,000Repair expense 800 Property taxes payable 4,000 Cash 800
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
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211. You are analyzing the balance sheet of a large manufacturing company and come across the following account in the property, plant and equipment section:Equipment acquired under finance lease................$400,000
The footnotes indicate that the lease was signed three years ago, that there are several years left in the finance lease, and that the equipment reverts to the lessor at the end of the lease term. The reporting company does not use the accumulated depreciation account for assets under finance leases.Explain (a) what this account and (b) amount means, and (c) how it came to be included as a long-term asset.Ans: (a) The account came about through capitalizing the present value of the future cash flows
expected under the lease.(b) The amount is the original present value less amortization to date.(c) The lease term must have been at least 3/4 of the remaining useful life of the asset at inception, or the present value of minimum lease payments must have been 90% or more of the market value of the asset at inception.
Difficulty: HardLevel of Learning: KnowledgeTopic: LO2, 3
212. What interest rate does a lessee use for lease capitalization purposes? Be as specific as possible. Also, once this rate is decided, specifically what does the lessee use the interest rate for?Ans: The lessee's interest rate for lease capitalization purposes is the lower of the lessor's
implicit rate (if known or determinable by lessee) and the lessee's incremental borrowing rate. It is used for criterion 4 to determine the present value of the minimum lease payments; and for computing interest expense.
Difficulty: EasyLevel of Learning: KnowledgeTopic: LO2, 3
213. In order for a lessee to capitalize a lease, at least one of four criteria must be met. Answer the following questions about the third criterion, the one having to do with the useful life of the leased asset.(a) State the criterion itself, specifically.(b) Why does fulfilling this criterion imply a capitalized lease (i.e. why is this one of the criteria)?(c) When is this criterion not applicable (i.e. when can it not be used to test whether a lease should be capitalized)?Ans: (a) If the lease term is at least equal to 75% of the remaining useful life at inception, the
lease is a finance lease.(b) If the term is 3/4 or more of the life, the lessee has most of the use of the asset and the lease is therefore similar in substance to an instalment purchase.(c) When the asset is in its last 1/4 of total life at inception.
Difficulty: EasyLevel of Learning: KnowledgeTopic: LO2, 3
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214. State completely criterion 2 (bargain purchase option) and criterion 4 (90%) as they pertain to capitalizing leases under ASPE. Then, explain why fulfilling either constitutes a capitalized lease for the lessee.Ans: Criterion 2: if the lease contains the option for the lessee to purchase the asset at a bargain,
the lease is a finance lease. Such an option is likely to be taken by the lessee, making the lease a purchase in-substance.
Criterion 4: if the present value of minimum lease payments equal or exceed 90% of the market value of the asset, the lease is a finance lease. If the present value of payments made by the lessee are essentially equal to the cost of the asset, the lessee is essentially committing to purchasing the asset. This implies that, for the lessee to do so, the lessee must be getting substantially all the benefits (and has taken most of the risk because of the cost) of a purchase otherwise lessee would not have committed to such an agreement.
Difficulty: HardLevel of Learning: KnowledgeTopic: LO2, 9
215. Ryan Corp. enters into an agreement with Montgomery Corp. to lease some office space in a very popular part of town. The agreement called for payments of $100,000 per year for five years and an upfront payment of $85,000. Explain the proper accounting treatment for the above situation.Ans: The upfront payment should be amortized over the term of the lease instead of recognizing
it in the first year. Therefore the $85,000 should be deferred on the books and amortized at a rate of $17,000 per year.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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216. Ryan Corp. enters into an agreement with Montgomery Corp. to lease some office space in town. There are currently a large number of vacant units which allowed Ryan Corp. to obtain favourable lease terms. The agreement called for payments of $150,000 per year for five years; however, given the large number of vacancies, Montgomery Corp. forgave the first year's lease payment. Prepare the journal entries for the five years of the lease.Ans: Year 1
Dr. rent expense $120,000 Cr. Deferred rent liability $120,000
Year 2Dr. Rent expense $120,000Dr. Deferred rent liability 30,000 Cr. Cash $150,000
Year 3Dr. Rent expense $120,000Dr. Deferred rent liability 30,000 Cr. Cash $150,000
Year 4Dr. Rent expense $120,000Dr. Deferred rent liability 30,000 Cr. Cash $150,000
Year 5Dr. Rent expense $120,000Dr. Deferred rent liability 30,000 Cr. Cash $150,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
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217. Match the typical characteristics with the type of lease by entering the appropriate letters in the spaces provided.Type of LeaseA. Operating leaseB. Finance leaseTypical Characteristics___ 1. Long-term financing.___ 2. Special property rights are transferred.___ 3. The lease term often approximates the useful life of the property.___ 4. Non-cancellable during the term.___ 5. Lessor pays taxes, insurance, and similar costs without specific reimbursement therefore.___ 6. Lease may include a bargain purchase option.___ 7. Collectability of the lease payments is reasonably assured.
Ans: 1: B, 2: B, 3: B, 4: B, 5: A, 6: B, 7: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
218. Define the following terms:(1) bargain renewal option(2) incremental borrowing rate(3) lease termAns: (1) The lessee has the option of extending the lease at a substantially reduced rate.
(2) The interest rate that the lessee would receive from a financial institution if the asset were to be purchased.(3) The lease term includes all terms prior to the exercise date of a bargain purchase option; all bargain renewal terms; and all renewal terms at the lessor's option
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
219. Explain what is meant by off-balance sheet financing?Ans: Off-balance sheet financing occurs essentially when leases are treated as operating leases.
Neither the asset nor the liability is recorded on the books of the lessee. In some cases this enables companies to improve their return on assets and debt-to-equity ratio. The CICA Handbook attempted to eliminate this advantage by instituting the guidelines for finance leases; however, companies are finding ways around the current guidelines
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO6
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220. Ryan Corp. leased an asset from Amanda Corp. under a finance lease. The original entry for finance lease included a debit to leased asset for $75,000. Amortization on the asset amounted to $7,500. At the end of the year, the lease liability on the books was $64,567. What is the temporary difference?Ans:Asset under finance lease – net (75,000-7,500) 67,500Lease liability (64,567)Net temporary difference $2,933
=====
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO6
221. Explain what a temporary difference is and how it arises?Ans: Leases are normally taxed according to their legal form, which means that Canada
Revenue Agency (CRA) normally allows a deduction for tax purposes equal to the payment made during the year. Therefore, Canada Revenue Agency (CRA) treatment may differ from accounting treatment. This gives rise to a temporary difference. This difference arises because there is no tax carrying value when the lease is treated as an operating lease by Canada Revenue Agency (CRA).
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO6
222. Ryan Corp. leased an asset from Amanda Corp. under a finance lease. The original entry for finance lease included a debit to leased asset for $75,000. Amortization on the asset amounted to $7,500. At the end of the year, the lease liability on the books was $64,567. What is the after tax impact assuming a tax rate of 40%?Ans:Asset under finance lease – net (75,000-7,500) 67,500Lease liability (64,567)Net temporary difference $2,933Tax rate 40%After tax impact $1,173
======Difficulty: MediumLevel of Learning: KnowledgeTopic: LO6
223. Ryan Corp. enters into a finance lease agreement with a 5-year term and a bargain renewal option of 3 years. Over what period should the asset be amortized?Ans: 8 yearsDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2, 3
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224. Explain the most common methods of avoiding lease capitalization?Ans: Contingent Rent: this is a rent that depends on future events. The most common example is
a retail store that pays, in addition to a regular lease payment, a payment based on a percentage of sales. This agreement results in a lower lease payment.
Third Party: A third party (generally formed by the lessee) enters into an agreement with the lessor and then leases to the operating company on a year-by-year basis
Shorten the lease term: By making the lease term one year at a time or considerably shorter than the economic life, lease capitalization can be avoided.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO6
225. Company A enters into a lease agreement with Company B. The going lease payment for a similar agreement is $90,000 per year. Company A negotiates a lease whereby they pay $40,000 per year and 6% of annual sales revenues. This is an example of what method?Ans: Contingent RentDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
226. How is the cash flow statement impacted if the lease is deemed to be an operating lease versus a finance lease?Ans: If the lease is an operating lease, the payment represents a cash flow from operations.
If the lease is a finance lease the amortization of the asset is included in the income statement but added back on the cash flow statement as a non-cash item. The portion that represents interest is shown on the cash flow statement as part of interest expense. The principal repayment portion is shown on the cash flow statement as a financing activity.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO8
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Use the following to answer questions 227-229:
ABC Inc. leased a computer to the Lennox Silver Company on 1 April 20x15. The terms of the lease are as follows:
Lease term (fixed and non cancellable) 3 yearsEstimated economic life of the computer 5 yearsFair market value at lease inception $ 5,000Bargain purchase offer NoneTransfer of title NoneGuaranteed residual value by lessee, 1 April 20x18 $ 2,000Lessee's normal depreciation method straight lineLessee's incremental borrowing rate 11%Executory costs included in lease payments noneInitial direct costs noneAnnual lease payment, beginning of each lease year $1,620Lessor's implicit interest rate unknown to lesseeLessee's fiscal year – end 31 December
*** ABC Inc. company charges a half-year depreciation in the year of acquisition and a half-year in the year of disposition, regardless of the actual dates of acquisition and disposal.
227. From the above information classify the lease from the perspective of the lessee.Ans: This lease qualifies as a finance lease because the present value of the minimum lease
payments, $5,856 exceeds 90% if the fair market value of the leased property.
P = $1,620 (P/A due, 11%, 3) + $2,000 (P/F, 11%, 3) = $4,394 + $1,462 = $5,856
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
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228. From the above information, show how the leased asset and the lease obligation will be shown on the lessee's balance sheet at 31 December 20x16.Ans: The Lessee’s balance sheet at 31 December 20x16 will include the following
amounts:
Capital assets Asset under finance lease $ 5,000 Less accumulated amortization 1,500
$ 3,500
Current Liabilities Current portion of finance lease liability $1,461[$477 accrued interest at 31 December 20x16, plus $984 principal portion of the next payment (from amortization table)
Long Term LiabilitiesObligation under finance lease (from amortization table) $1,606
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
229. Suppose that at the end of the lease, the lessor tells the lessee to dispose of the asset, and to keep any proceeds in excess of the guaranteed residual value. Provide entries for the lessee on 1 April 20x18, assuming that the lessee sells the asset for $2,100 and remits the required $2,000 payment to the lessor.Ans: 1 April 20x18 – Sale of asset
Cash (received from sale) 2,100Lease Liability 2,000Accumulated Amortization 3,000 Asset under finance lease 5,000 Cash (paid to lessor) 2,000 Gain on disposal of leased asset 100
This entry assumes that adjustments have already been made to (1) accrued the last of the interest and (2) record amortization for 20x18.
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
Use the following to answer questions 230-233:
Over the life of a lease, ABC Inc. received a total cash inflow of $73,000; $65,000 from lease payments plus the $8,000 estimated residual value. The present value of the future cash flow is $55,000. The $18,000 difference between the gross cash flows and the discounted present value is the interest income (or finance revenue) that will be reported by ABC Inc.
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230. Using the gross method, record the cash inflow from lease payment of $73,000.Ans: 2 January 20x12
Lease payments receivable 73,000 Cash 55,000 Unearned finance revenue 18,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
231. Record the unearned finance revenue as it would appear on the balance sheet.Ans: 31 December 20x12
Unearned finance revenue 6,967 Finance revenue 6,967
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
232. Record the full amount of the lease payment that will be credited to the lease receivable.Ans: 2 January 20x13
Cash 20,000 Lease payments receivable 20,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
233. Provide calculation to show the net balance of the lease receivable after the payment is received and recorded.Ans:Lease payments receivable, 31 December 20x12 * $45,665/3Payment received, 2 January 20x13 * $45,665/3Remaining lease payments receivable * $45,665/3Unearned finance revenue ($18,000 - $6,967) * $45,665/3Net lease receivable * $45,665/3
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
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234. Match the following (there may be more than one response for each type of lease):Standpoint of:A. LessorB. LesseeC. Lessor and LesseeType of Lease Standpoint of:___ 1. Capital___ 2. Operating___ 3. Sales-type___ 4. Direct financing
Ans: 1: C, 2: C, 3: A, 4: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO1, 2, 3, 7
235. What is the interest rate used for discounting the net lease payments by the lessor?Ans: The rate implicit in the leaseDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2,3, 7
236. What is a direct financing lease?Ans: The lessor is acting solely as a financial intermediary. There is only one profit component
– the interest earned on the leaseDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3, 7
237. What is a sales-type lease?Ans: In a sales-type lease, there are two profit components: the profit (or loss) on the sale and
the interest revenue from the lease. Manufacturers often use this type of lease.Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3, 7
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238. Lessor Company rented a machine to Lessee Company on January 1, 20x11, for a period of 3 years. Rent of $8,000 is due January 1, of each year (starting in 20x11). The lease qualified as an operating lease for both the lessor and lessee. In addition to the monthly rentals, the lease contract required Lessee Company to pay $2,000 on January 1, 20x11 (this is non-refundable). The accounting period ends December 31. Complete the entries required for Lessor Company on the following dates, using the straight line method.(a) January 1, 20x11:(b) December 31, 20x11:Ans: (a) January 1, 20x11:Cash. . . . . . . . . . . . . . . . . . 10,000
Unearned rent revenue. . . . . . . . . 2,000 Rent revenue . . . . . . . . . . . . . 8,000
(b) December 31, 20x11:Unearned rent revenue ($2,000/3). . . . 667
Rent revenue . . . . . . . . . . . . . 667
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
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239. LOR leased to LEE a computer that cost LOR $20,000. The explicit interest rate is 20%; rentals are paid at each year-end; and the lease term is three years. Residual value at the end of the lease term is $2,000. Assume a direct financing lease.
Requirement 1:
LEE retains the computer at the end of the lease term at a BPO cost of $1,500.(a) The rental amount computed by LOR is $_______________________.(b) The amount LEE should capitalize is $________________________.
Requirement 2:How much interest should be recognized at the end of year 1, in the above situation, by: (a) LOR? $____________ (b) LEE? $____________
Requirement 3:At the end of year 1, in the above situation, how much would theprincipal be reduced for (a) LOR's lease receivable?$_________________ and (b) LEE's lease liability?$_________________.
Ans: Requirement 1:(a)
The rental amount computed by the lessor is $9,082======
Cost of leased asset...................... $20,000Less: BPO, $1,500 x PV1, 20%, 3 (.57870).. 868
=======Net investment to recover $19,132
=======Rental: $19,132 ÷ PVA, 20%, 3 (2.10648) = $9,082
======(b) The amount the Lessee should capitalize is $20,000
=======Check:PV of rentals: $9,082 x PVA, 20%, 3 (2.10648). $19,132Add: BPO, $1,500 x PV1, 20%, 3 (.57870)....... 868Capitalize.................................... $20,000
=======Requirement 2:Interest recognized at end of Year 1:(a)LOR $4,000 (b)LEE $4,000
======$20,000 x 20% = $4,000
======Requirement 3:Reduction of principle at end of Year 1:(a)LOR's lease receivable $5,082
======(b)LEE's lease liability $5,082
======$9,082 - $4,000 = $5,082
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Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3, 7
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240. If a lessor has property that has a market value (cost if new) of $89,718 and leases it on a finance lease for 5 years and desires a 20% annual return (assuming an ordinary annuity situation annually), the annual rentals would be $_____________________.Ans: $30,000, computed as follows:
=======$89,718 ÷ PVA, 20%, 5 (2.99061) = $30,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
241. The following information relates to a lease contract:Lease inception 1-1-x1Market value and book value (to lessor) of new equipment under lease $10,000Interest rate used by both lessee and lessor for lease accounting 10%Lease payments due 12-31-x1, x2, x3End of lease term 1-1-x4Expected residual value at 1-1-x4 $1,000Expected residual value at 1-1-x7 (end of useful life) $100
The lease allows the lessee to purchase the asset for $200 on 1-1-x4.There are no uncertainties with respect to collectability of lease payments or performance by lessor.
(a) Determine the annual lease payment(b) Classify the lease for the lessor(c) Record the 20x11 entriesAns: (a) $10,000 = LP(PVA,.10,3) + $200(PV1,.10,3); LP = $3,961
2.48685 .75131
(b)Minimum lease payments = 3($3,961) + $200 = $12,083PV of min lease payments = $10,000Lessor: direct financing lease (fulfills criteria 2,4,5,6)
(c) Lessor
Lease Rec 12,083 Unearn. Int 2,083 Equipment 10,000
Dec. 31Cash 3,961Unearn int 1,000 Interest rev 1,000 Lease Rec 3,961
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3, 7
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242. The following information relates to a lease contract:The lessor contracted with an insurance company, which guaranteed the residual value at 1-1-x4.Lease inception 1-1-x1Market value and book value (to lessor) of new equipment under lease $10,000Interest rate used by both lessee and lessor for lease accounting 10%Lease payments due 12-31-x1, x2, x3End of lease term 1-1-x4Expected residual value at 1-1-x4 $1,000Expected residual value at 1-1-x7 (end of useful life) $100
There are no uncertainties with respect to collectability of lease payments or performance by lessor.(a) Determine the annual lease payment(b) Classify the lease for both lessee and lessor(c) Record the 20x11 entries for both partiesAns: (a) $10,000 = LP(PVA,.10,3) + $1,000(PV1,.10,3); LP = $3,719
2.48685 .75131
(b)Minimum lease payments for lessee = 3($3,719) = $11,157Minimum lease payments for lessor = $11,157 + $1,000 = $12,157PV of minimum lease payments for lessee = $3,719(PVA,3,.10) =$9,248 [ > (.90)$10,000]PV of minimum lease payments for lessor = $10,000Lessee: capitalize (fulfills criterion 4)Lessor: direct financing lease (fulfills criteria 4,5,6)
(c) Lessee Lessor
Jan. 1 Leased asset 9,428 Lease Rec 12,157 Lease liability 9,428 Unearn int 12,157
Equipment 10,000
Dec. 31 Lease liability 2,794 Cash 3,719Interest expense 925 Unearn int 1,000 Cash 3,719 Interest rev 1,000
Lease Rec 3,719Dep expense 3,083 Accum dep. 3,083
$3,083 = $9,248/3Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3, 7
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243. The following information relates to a lease contract:The lessee guarantees the residual value at 1-1-x4.Lease inception 1-1-x1Market value and book value (to lessor) of new equipment under lease $10,000Interest rate used by both lessee and lessor for lease accounting 10%Lease payments due 12-31-x1, x2, x3End of lease term 1-1-x4Expected residual value at 1-1-x4 $1,000Expected residual value at 1-1-x7 (end of useful life) $100There are no uncertainties with respect to collectability of lease payments or performance by lessor.(a) Determine the annual lease payment(b) Classify the lease for both lessee and lessor(c) Record the 20x11 entries for both partiesAns: (a) $10,000 = LP(PVA,.10,3) + $1,000(PV1,.10,3); LP = $3,719
2.48685 .75131
(b)Minimum lease payments for both parties = $11,157 + $1,000 = $12,157PV of minimum lease payments for both parties = $10,000Lessee: capitalize (fulfills criterion 4)Lessor: direct financing lease (fulfills criteria 4,5,6)
(c) Lessee Lessor
Jan. 1 Leased asset 10,000 Lease Rec 12,157 Lease liability 10,000 Unearn int 2,157
Equipment 10,000
Dec. 31 Lease liability 2,719 Cash 3,719Interest expense 1,000 Unearn int 1,000 Cash 3,719 Interest rev 1,000
Lease Rec 3,719Dep expense 3,000 Accum dep. 3,000
3,000 = ($10,000 - $1,000)/3Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3, 7
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244. On January 1, 20x11, a lessor and lessee signed a lease calling for 5 annual payments of $10,000 to be made starting on December 31, 20x11. The market value and book value of the asset at inception is $41,013. The lessee also guarantees the full $5,000 residual value at December 31, 20x15, the end of the lease term. Both parties use 10%. The lessee uses straight-line depreciation. Provide the first year (20x11) entries for both lessor and lessee. Assume there are no uncertainties concerning collection of lease payments by lessor, nor unreimbursable costs of lessor.
Ans: $41,013 = $10,000(PVA,10%,5) (3.79079) + $5,000(PV1,10%,5) (.62092)Present value of minimum lease payments for both parties = market value of the asset leased; therefore this is a finance lease for both parties.
Lessor:1/1/x1
Lease receivable 55,000 Unearned interest revenue 13,987 Asset 41,013
12/31/x1Cash 10,000Unearned interest revenue 4,103 Interest revenue 4,103 Lease receivable 10,000
Depreciation expense 7,203 Accumulated dep. 7,203
.10($41,013) = $4,103($41,013 - $5,000)/5 = $7,203
Lessee:1/1/x1
Leased asset 41,013 Lease liability 41,013
12/31/x1Lease liability 5,891
Interest expense 4,103 Cash 10,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3, 7
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245. A lessor leased equipment to a lessee on January 1, 20x11. The lease has the following characteristics:Book value of the asset to the lessor: $100,000Market value: $167,417 on that date.Lessor's implicit rate: 10%Lessee's borrowing rate: 12%Lessee knows the lessor's implicit rate.Five equal payments of $40,000 are due each January 1, beginning20x11Lease term ends: December 31, 20x15Remaining useful life of equipment at January 1, 20x11: 8 years (atthe end of which time the equipment will have no residual value)Estimated residual value on December 31, 20x15: $30,000Lessee has the option to buy the asset on December 31, 20x15 for$1,000.
Assume there is no uncertainty as to payment of lease payments bylessee or unreimbursable costs for lessor.Assume straight-line depreciation or amortization.(a) Is this an operating or finance lease for the lessee, and why?(b) Prepare all the required journal entries for the lessor and lessee for 20x11.
Ans: (a) This is a finance lease because of the bargain purchase option.Also, the present value of the minimum lease payments = 100% of the market value: $40,000 + $40,000(PVA,10%,4) (3.16987) +$1,000(PV1,10%,5) (.62092) = $167,417
Lessor:1/1
Lease receivable 5($40,000) + $1,000 201,000Cost of goods sold 100,000 Unearned interest 33,583 Sales 167,417 Inventory or equipment 100,000
1/1Cash 40,000 Lease receivable 40,000
12/31Unearned interest ($167,417 - $40,000).10 12,742 Interest revenue 12,742
Lessee:1/1
Equipment 167,417 Lease liability 167,417
1/1Lease liability 40,000 Cash 40,000
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12/31Interest expense 12,742 Lease liability 12,742
12/31Depreciation expense ($167,417/8) 20,927 Accumulated depreciation 20,927
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3, 7
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246. LXR leased to LXE a computer that cost the lessor $15,000. The explicit interest rate is 15%; rentals are paid at each year-end; and the lease term is 3 years. Residual value at the end of the lease term is $3,000. Assume this is a direct financing lease.
Requirement 1:LXE retains the computer at the end of the lease term at a BPO cost of $2,000.(a) The rental amount computed by lessor is, $___________________.(b)The amount the lessee should capitalize is, $________________.
Requirement 2:How much interest should be recognized at the end of year 1, in the above situation, by the:(a) lessor? $_________________ (b) lessee? $________________.
Requirement 3:At the end of year 1, in the above situation, how much would the principal be reduced for the(a) lessor's lease receivable? $____________________ and (b) lessee's lease liability? $_________________________.
Ans: Requirement 1:(a) Rental amount computed by lessor $5,944
======Cost of leased asset............................ $15,000Less: BPO, $2,000 x PV1, 15%, 3 (.65752)........ 1,315Net investment to recover....................... 13,685
=======Rental: $13,685 ÷ PVA, 15%, 3 (2.28323) = $5,994
======(b) Amount the lessee should capitalize, $15,000
=======Check:PV of rentals: $5,994 x PVA, 15%, 3 (2.28323).... $13,685Add: BPO, $2,000 x PV1, 15%, 3 (.65752).......... 1,315Capitalize....................................... $15,000
=======
Requirement 2: Interest recognized at end of Year 1:(a) Lessor $2,250
======(b) Lessee $2,250
====== $15,000 x 15% = $2,250
Requirement 3: principle reduced at end of Year 1:(a) Lessor's lease receivable $3,744
======(b) Lessee's lease liability $3,744
======$5,994 - $2,250 = $3,744
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3, 7
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247. Lessor Company leases small computers on three-year leases at the end of which the residual value is not material in amount. Rents are collected at year-end. On January 1, 20x11, Lessor signed a 3-year lease with Lessee Company that called for annual rents of $12,063, which was a return to Lessor of 10% on the $30,000 cost (market value at date of lease). Assume the lease qualifies as a direct financing lease to the lessor and a finance lease to the lessee. There was no bargain purchase option or residual value. The lessee's incremental borrowing rate is 12%.(a) Complete the following amortization schedule for the lease. Round to the nearest dollar.
Periodic Reduction UnrecoveredPeriod Cash Rent Annual Interest of Balance Balance
Start
20x11
20x12
20x13*
Total
*May have slight rounding error.(b) Can both the lessor and lessee use the amortization schedule values in this instance?Yes__________________ No___________________
Explain why__________________________________________________.
(c) Give the entries for the lessor and lessee on the following dates (assume the accounting period ends December 31). Use the abbreviated account titles.January 1, 20x11-Inception of the lease: LESSOR LESSEE
a. December 31, 20x11-Interest date and end of accounting period (giveall entries except closing entries):Ans: (a) Amortization schedule:
Periodic Reduction UnrecoveredPeriod Cash Rent Annual Interest of Balance BalanceStart $30,00020x11 $12,063 $30,000 x 10% = $3,000 $ 9,063 20,93720x12 12,063 20,937 x 10% = 2,094 9,969 10,96820x13* 12,063 10,968 x 10% = 1,095* 10,968 -0-
===== ======Total $36,189 $6,189 $30,000 -0-
======= ====== =======*Small rounding to come out even.
(b) Yes. If both use the same interest rate.
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(c) Entries: LESSOR LESSEEJanuary 1, 20x11-Inception of the lease:
Lease receivable 36,189 Asset Leased 30,000Leased Asset 30,000Unearned int. 6,189 Lease liability 30,000
December 31, 20x11-Interest date and end of accounting period
Cash 12,063Unearned int 3,000 Lease liability 9,063Lease rec. 12,063 Int. expense 3,000Int. rev. 3,000 Cash 12,063
Depr. expense 10,000Acc. Depr.-L.A. 10,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3, 7
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248. Lamont Company leases computers for a three-year term, at the end of which they are regarded as obsolete with no residual value because Lamont donates them to schools. Rents are collected at the end of each six-month period; the leases qualify as direct financing leases to Lamont (lessor). The computers cost Lamont $20,000 each. Lamont bases the rents on a 16% annual rate.(a) The semi-annual rental on one computer, rounded to the nearest dollar, is $________________________.(b) Complete the following amortization schedule for the lease of one computer.
Receivable ReceivablePeriod Rental Interest Revenue Reduction Balance
Start
1
2
3
4
5
6
(c) Give the entries that should be made by the lessor on the following dates:(1) At the date the lease is signed:(2) At the date of collection of the first rental payment:(d) Show the lessor's income statement and balance sheet amounts with respect to the lease
immediately after the first rental collection:Ans: (a) $20,000 ÷ PVA, 8%, 6 (4.62288) = $4,326
(b)
Receivable ReceivablePeriod Rental Interest Revenue Reduction Balance
Start $20,000 1 $4,326 $20,000 x 8% = $1,600 $2,726 17,274
2 4,326 17,274 x 8% = 1,382 2,944 14,330
3 4,326 14,330 x 8% = 1,146 3,180 11,150
4 4,326 11,150 x 8% = 892 3,434 7,716
5 4,326 7,716 x 8% = 617 3,709 4,007
6 4,326 4,007 x 8% = 319* 4,007 -0-
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*Rounded
(c) Entries:(1) Date lease is signed:
Lease receivable.............................. 25,956 Equipment (on direct financing lease)........ 20,000
Unearned interest revenue.................... 5,956(2) Date of collection of first rental:Cash.......................................... 4,326
Unearned interest revenue..................... 1,600 Lease receivable............................. 4,326
Interest revenue............................. 1,600
(d) Financial statements; immediately after first rental:Income Statement:
Interest revenue............................. $ 1,600Balance Sheet:
Lease receivable............................. $21,630Unearned interest............................ 4,356
Net lease receivable 17,274
Difficulty: HardLevel of Learning: ApplicationTopic: LO7
249. List the guidelines required under ASPE that are used to determine whether a lease is a finance lease from the lessors point of view?Ans: (1) reasonable assurance that lessee will obtain ownership through bargain purchase option
or automatic transfer.(2) Lessee will obtain substantially all the benefits of the asset generally defined as 75% of its economic life.(3) Lessor assured of recovering the investment in the leased property, plus a return on the investment, over the lease term. This is defined as the present value of the minimum net lease payments = to at least 90% of the fair value of the asset at the inception of the lease(4) Credit risk is normal(5) Amounts of unreimbursable costs that are likely can be reasonably estimated
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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250. Match the following for the LESSOR:Type of LeaseA. Sales-typeB. Direct financingA Manufacturer's or Dealer's Profit is:___ 1. Recognized___ 2. Not recognized
Ans: 1: A, 2: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3, 7
251. Associate the term or phrase below with the general description by entering the appropriate letters in the spaces provided.Term or PhraseA. LesseeB. Sale and leasebackC. Calls for use of incremental borrowing rate.D. LessorE. Synonymous with operating lease.F. Initial direct costsG. Executory costsH. Calls for use of annuity due present valuesI. Direct financing leaseJ. Associated with third party guarantors.
General Description___ 1. Three-party lease.___ 2. Tenant in a lease contract transaction.___ 3. Asset owner in a lease contract transaction.___ 4. Insurance, property taxes, and maintenance.___ 5. Incremental direct costs incurred by a lessor in negotiating and consummating a lease
contract.___ 6. Lease payments precede each period of usage of leased asset.___ 7. A form of finance lease.
Ans: 1: J, 2: A, 3: D, 4: G, 5: F, 6: H, 7: IDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3, 7
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252. This question relates to the different types of finance leases. To the left are listed eight different items related to such leases. To the right are three columns that identify the types of leases. Place one or two check marks on each line to identify the item with the type of lease to which it primarily relates.
Item Separately Recognized by:
Lessor Lessee
Direct CapitalItem Financing Sales-Type Lease
1. Dealer's profit (i.e., grossmargin)
2. Interest revenue
3. Interest expense
4. Depreciation expense
5. Lease receivable
6. Lease liability
7. Asset lease (cost per lease contract)
8. Expense for operating and ownership expendituresAns:
Item Separately Recognized by:
Lessor Lessee
Direct CapitalItem Financing Sales-Type Lease
1. Dealer's profit (i.e., grossmargin)
X
2. Interest revenue X X
3. Interest expense X
4. Depreciation expense X
5. Lease receivable X X
6. Lease liability X
7. Asset lease (cost per
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lease contract) X
8. Expense for operating and ownership expenditures X
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3, 7
253. What are the income tax implications for the lessor with respect to a finance lease?Ans: Net income will include an imputed amount for interest as finance revenue. On the tax
return the lessor will include the full payment as revenue and will deduct the CCA charge. Therefore, there will be a difference between the revenue reported on the income statement and that reported on the tax return. This is a temporary difference (future income tax liability).
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO6
254. What disclosures are recommended by the CICA for lessors?Ans: (1) the lessor's net investment – (lease receivable less unearned revenue)
(2) the amount of finance income(3) lease revenue recognition policy
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO7
255. Ryan Corp. is a manufacturer of high tech golf carts. On December 31, 1999, Ryan Corp. leases 100 golf carts to a local golf course for five years at $95,000 per year payable at the beginning of the lease term. The normal cash sales price of the carts is $4,000 each. The carts cost Ryan Corp. $2,000 each to manufacture. The lease meets all the conditions necessary to be a sales-type lease from the lessor's point of view. Provide the journal entry(ies) on December 31 to account for the lease.Ans:Lease payment receivable 475,000 Unearned finance revenue 75,000 Sales revenue 400,000
Cost of goods sold 200,000 Golf cart inventory 200,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
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256. Ryan Corp. is a manufacturer of high tech golf carts. On December 31, 1999, Ryan Corp. leases 100 golf carts to a local golf course for five years at $95,000 per year payable at the beginning of the lease term. The normal cash sales price of the carts is $3,500 each. The carts cost Ryan Corp. $3,000 each to manufacture. The lease meets all the conditions necessary to be a sales-type lease from the lessor's point of view. Provide the journal entry(ies) on December 31x1 to account for the lease and the first payment on December 31x2Ans:Lease payment receivable 475,000 Unearned finance revenue 125,000 Sales revenue 350,000
Cost of goods sold 300,000 Golf cart inventory 300,000
December 31x2Cash 95,000 Lease payments receivable 95,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
257. ML leased a computer to LH on January 1, 20x11. The lease was a five year fixed, non-cancellable agreement. The payments were finalized at $2,380 per year with the first payment on January 1, 20x11 and ML paid $9,500 for the computer. Carrying value is equal to fair value. The lease is deemed a finance lease. Based on the above information, what type of lease is this for the lessor. Prepare the journal entries for at the inception of the lease using the gross method.
Ans: (a) this is a financing lease as the carrying value is equal to the fair value.(b) January 1 20x11
Lease receivable (2,380x5) 11,900 Unearned finance revenue 2,400 Cash, Inventory, etc. 9,500
Cash 2,380 Lease receivable 2,380
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
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258. ML leased a computer to LH on January 1, 20x11. The lease was a five year fixed, non-cancellable agreement. The payments were finalized at $2,380 per year with the first payment on January 1, 20x11 and ML paid $9,500 for the computer. Carrying value is equal to fair value and there was a guaranteed residual value by lessee of $2,000. The lease is deemed a finance lease. Based on the above information, what type of lease is this for the lessor? Prepare the journal entries for at the inception of the lease using the gross method.Ans: (a) this is a financing lease as the carrying value is equal to the fair value.
(b) January 1 20x11Lease receivable (2,380x5)+2,000 13,900 Unearned finance revenue 4,400 Cash, Inventory, etc. 9,500
Cash 2,380 Lease receivable 2,380
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
259. What is the difference between the net method and gross method of accounting for leases by the lessor?Ans: The net method is the same method used by the lessee and it shows the net present value of
the remaining lease payments. The gross method is undiscounted. The offset amount goes to an account called unearned finance revenue. For reporting purposes only the net method is shown on the balance sheet. The CICA Handbook assumes that the lessor is using the gross method. Both however ultimately produce the same results.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3, 7
260. Why is the gross method used by the lessor in most cases instead of the net method if both produce the same results?
Ans: In accounting the reconciliation of accounts receivable is very important. The gross method allows for easier reconciliation because the amounts can be traced quickly back to the subsidiary records. Under the net method it would be necessary to present value each lease at a particular point of time in order to perform the reconciliation. Companies with very few leases will not find this a problem. Companies with a substantial number of leases will find this time consuming.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO7
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261. Company X leased an asset to Y on December 31 20x11 with the first payment occurring on that date. The lease was a sales-type lease (it met all the conditions). The cash payment on December 31, 20x11 was $1,582 representing 1/5th of the lease arrangement. Assuming that the profit on the sales amounted to 11% of the total lease receivable and the unearned finance revenue was 1.57 times the profit on the sale, prepare the journal entry at the inception of the lease (use the gross profit method).Ans: Total lease receivable: 1,582x5 = 7,910
Profit on sales = 7,910x11%=870Unearned finance revenue = 870x1.58=1,375
Dr. Lease payment receivable 7,910 Cr. Unearned finance revenue 1,375 Cr. Sales Revenue 6,535
Dr. Cost of goods sold 5,665 Cr. Computer inventory 5,665
Dr. Cash 1,582
Cr. Lease payment receivable 1,582
Difficulty: MediumLevel of Learning: ApplicationTopic: LO7
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test BankChapter 18 – Post-employment Benefits
1. In a defined contribution pension plan the retirement benefits to the employee are not defined.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
2. In a defined contribution plan, employers run the risk of high pension contributions.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 2
3. Employees are not allowed to make contributions to a defined contribution pension plan.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1, 2
4. The formula used to calculate pension expense must necessarily be the same as the formula used to calculate funding to the plan.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
5. The accumulated benefit and projected unit credit methods both result in increasing employer contributions to the pension plan over time.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
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6. The accumulated benefit and projected unit credit methods both take into account employee salary changes over time.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
7. A non-funded pension plan is one where the employee must bear a part of the cost of the plan.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
8. All three funding approaches result in full funding of a pension plan over time.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
9. Current service cost is usually the largest single component of pension expense under a defined benefit pension plan..
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
10. Under ASPE, Past service costs are amortized over the vesting period or the expected remaining service life of the employee group, whichever is longer.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4, 5, 10
11. The accumulated and vested benefit obligations typically are different amounts.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4, 5
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12. Any transitional asset or obligation may be applied retroactively or prospectively under IFRS.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO7
13. Post retirement benefits other than pensions must now be accounted for in a manner similar the way pensions are accounted for
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO8, 9
14. In order to be registered, a pension plan must be trusteed.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
15. Actuarial gains and losses to be amortized must always be computed using the 10% corridor approach.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
16. Gains and losses from plan settlements and curtailments should be recognized in income immediately.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO7
17. An employee of XYZ will receive retirement benefits of $1,000 per month if the employment period is 15 years. However, if the employment period is 20 years, the retirement benefits will be $1,300 per month. This is an example of a defined contribution pension plan.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1, 2, 4
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18. Contributions made by an employer to a qualified pension plan usually are taxable to the employee at that time.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 2, 4
19. A pension plan that gives an employee the right to retirement benefits which are not contingent upon the employee remaining with the company provides vesting benefits to the employee.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
20. Pension plans that are registered meet Revenue Canada requirements and hence qualify for tax advantages.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
21. Usually, the amount of funding by an employer will exceed the benefits to be paid out to employees.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
22. A pension plan is fully funded when the assets in the pension fund are adequate to pay the current retirees.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
23. Defined benefit pension plans do not specify benefits per period after retirement, but base the pension benefits directly on the specified contributions.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
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24. Past service costs that have vested must be amortized immediately through pension expense under both ASPE and IFRS.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3, 4, 9
25. Under the simplified approach to accounting for defined benefit pension plans under ASPE, the actuarial cost method used for pension accounting will be different than that used for funding.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO9
26. Under the simplified approach to accounting for defined benefit pension plans under ASPE, all Past service costs and unrecognized actuarial gains and losses must all flow through pension expense immediately.
Ans: True
Difficulty: EasyLevel of Learning: KnowledgeTopic: LO9
27. Under the simplified approach to accounting for defined benefit pension plans under ASPE there may be a limit on any pension plan asset.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO9
28. Under proposed changes to IASB standards for pension accounting, service costs and net interest (finance) revenue or expense will both be recognized in income, but separately.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO10
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29. Under proposed changes to IASB standards for pension accounting, re-measurement of actuarial gains and losses will flow through equity reserves or Other Comprehensive Income.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO10
30. Under the standard approach to defined benefit plan accounting, Past service costs are amortized over the expected period to full eligibility of pension benefits.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO9
31. When a pension plan is not trusteed, a company must report its pension plan assets and accrued pension liability on the balance sheet.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
32. Under a defined contribution pension plan, forfeitures are estimated in advance.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
33. A change in actuarial assumptions is the only possible cause for an actuarial gain or loss.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
34. If the actuarial gains and losses exceed 10% of the greater of the accrued obligation at the beginning of the year or the value of the plan assets at the beginning of the year, the maximum amortization is calculated using the average remaining service period.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
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35. For income tax purposes, an employee would prefer to make contributions to a qualified pension plan than to a nonqualified pension plan.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
36. Total net pension expense recognized over the life of a pension plan will be in excess of the total amount paid into the pension fund.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
37. Pension plans are drafted to meet Revenue Canada requirements so that the benefits received after retirement are not subject to income tax and the contributions by the employer are not a taxable benefit to the employee.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
38. In a non-contributory, defined benefit pension plan, the plan assets are composed of the employer's cumulative contributions less cumulative pension benefits paid from the fund.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
39. A trustee is independent and receives the pension contribution from the employer and invests it in accordance with provincial regulations.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
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40. Pension plans are normally registered with the pension commissioner in the province of jurisdiction.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
41. In accounting for pension costs, any difference between current service pension expense and the payment into the pension trust should be reported as an:A) offset to pension plan assets.B) accrued actuarial liability.C) deferred pension liability/cost.D) operating expense of the current period.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO5
42. The vested benefit of an employee in a pension plan represents benefits:A) accumulated in the pension plan (at fair value).B) that are not contingent on the employee continuing in the service of the employer.C) to be paid to the retired employee in the current year.D) to be paid to the retired employee in the next year.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
43. Benefits pursuant to a pension plan that are not contingent upon an employee's continuing service are referred to as:A) funded.B) underfunded.C) insured.D) vested.
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
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44. ABC's pension plan has a provision that employees will receive benefits upon retirement even though the employees are not working for ABC at the time of retirement. Such a benefit is characterized as:A) defined benefit.B) defined contribution.C) nonvesting.D) vested.E) non-contributory.
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
45. RST's pension plan provides retirement benefits of $8,000 per year to all employees who have worked for the company for at least 10 years. Contributions to the plan are made 75 percent by RST and 25 percent by the employees. The pension plan is characterized as both:A) contributory and defined benefit.B) funded and defined contribution.C) defined contribution and defined benefit.D) defined contribution and contributory.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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46. Current costs of a pension plan that occur each year due to service credits earned after the inception of the plan are called:A) Interest costs.B) actuarial losses.C) Past service costs.D) service cost.
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO5
47. Conceptually, the employer's current pension obligation if the pension plan is discontinued is the:A) accrued pension obligation.B) accumulated benefit obligation.C) vested benefit obligation.D) underfunded pension cost.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
48. Choose the most complete description of the possible relationship(s) between the discount rate (D) and the expected long-term rate of return on plan assets (R) used for defined benefit pension plans.A) D > RB) D < RC) D = RD) D can be equal to, greater than, or less than R for any given firm
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
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49. A pension fund may be:
Fully funded Over funded Under funded1 *2 * *3 * * *4 * *
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
50. Costs related to a new pension plan that are necessary to "catch up" for services rendered prior to the inception of the pension plan are classified as:A) actuarial losses.B) Past service costs.C) retroactive deferred charge.D) service costs.E) transition costs.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
51. Under IFRS, the straight-line amount of periodic amortization of Past service costs is applied by dividing total Past service costs by the:A) ratio of service years rendered in an accounting year to total future service years of
qualified employees.B) vesting period.C) total future service years of qualified employees.D) total number of qualified employees.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
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52. Changes in defined benefit pension plans that eliminate or reduce, for a significant number of employees, the accrual of defined benefits for some or all of their future services are:A) settlements.B) eliminations.C) curtailments.D) terminations.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO7
53. When a settlement gain or loss arises due to closing a business segment it is recognized as a debit or credit to (in):A) accrued pension obligation.B) other costs within discontinued operations.C) pension expense.D) accrued/prepaid pension cost.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
54. ABC has decided to pay retirement benefits to its president for 10 years after retirement in the amount of $40,000 per year. The payments will be made at the end of each year, starting at the end of the first year of retirement. Assuming a 9 percent interest rate, what is the minimum necessary balance that must be in the pension fund at the beginning of the retirement period?A) $256,706B) $364,000C) $366,972D) $400,000
Ans: ADifficulty: Medium
Level of Learning: ApplicationTopic: LO3
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55. On January 1, 20x12, HIJ offered special termination benefits of $7,500 cash to 100 employees inconnection with a reduction in operations. Employees had three months to accept or reject the termination benefit offer. How much loss due to termination benefits should HIJ recognize on January 1, 20x12?A) $0B) $250,000C) $750,000D) Cannot be determined from the information given.
Ans: ADifficulty: Medium
Level of Learning: ApplicationTopic: LO7
56. XYZ has a pension plan with the following characteristics: XYZ makes all contributions and employees receive benefits upon retirement that are based upon the balance in the accumulated fund account. This pension plan may be characterized as:A) contributory and defined benefit.B) contributory and defined contribution.C) non-contributory and defined benefit.D) non-contributory and defined contributions.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
57. Choose the correct statement concerning accounting for pensions:A) APO is reduced by amortization of Past service costsB) Interest cost does not include interest on Past service costsC) The difference between accumulated benefit obligation and vested benefit obligation is
attributed to differences in assumed compensation levelsD) One of the purposes of the corridor is to allow gains and losses to cancel each other before
affecting pension expenseE) The sum of accrued pension cost and additional minimum pension liability completely
describes the total unfunded obligation for pension benefits to which a sponsor has committed, assuming the benefit formula incorporates future compensation levels
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
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58. Interest cost represents:A) the increase in projected pension obligation as a result of recomputing the firm's pension
obligation when estimated turnover and other relevant pension factors are reassessed.B) the increase in accrued pension obligation from the beginning of the year to the end of the
year solely due to the passage of time.C) the increase in accrued pension obligation during the year resulting from all factors
affecting accrued pension obligation.D) expected return on plan assets for the year.
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
59. A firm has a $40,000 balance in its pension liability account. This meA) the plan is underfundedB) accrued pension obligation is less than plan assets at fair valueC) pension expense recognized to date exceeds total contributions to the pension plan to dateD) pension expense recognized to date exceeds plan assets at fair value
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
60. A firm has a $40,000 balance in its deferred pension cost account. This meA) the plan is underfundedB) accrued pension obligation is less than plan assets at fair valueC) pension expense recognized to date exceeds total contributions to the pension plan to dateD) pension expense recognized to date exceeds plan assets at fair value
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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61. How many of the following pension expense components could be negative (i.e. reduce pension expense)? Service cost Interest cost Amortization of net unrecognized gain or loss Amortization of transition amountA) 1B) 2C) 3D) 4
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 4, 5
62. Recognition of pension expense is primarily based on the:A) cost principle.B) revenue principle.C) matching principle.D) full disclosure principle.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
63. The components of pension expense that involve delayed recognition are:A) interest cost, Past service costs, transition cost, and expected return on plan assets.B) service cost, transition cost, and gains and losses.C) gains and losses, transition cost, and Past service costs.D) transition cost, Past service costs, and expected return on plan assets.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
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64. Pension data for ABC for three separate cases were:Case 1 Case 2 Case 3
APO $300,000 $300,000 $300,000Plan assets at fair value $315,000 $300,000 $280,000
The funded status of the APO for each case is:
Case 1 Case 2 Case 3 1 fully funded overfunded underfunded 2 underfunded fully funded overfunded 3 overfunded underfunded fully funded 4 overfunded fully funded underfunded
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
65. The balance of pension plan assets at fair value, as of any measurement date, reflects the cumulative:
Plan earnings Employer contributions Benefits paid1 *2 * *3 * * *4 * *
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
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66. The amount of the expected return on plan assets is computed by multiplying the:A) ending market-related value of the plan assets by the expected long-term rate of return on
plan assets.B) beginning carrying value of the plan assets by the actuary's interest rate.C) average carrying value of the plan assets by the expected long-term rate of return on plan
assets.D) beginning market-related value of the plan assets by the expected long-term rate of return
on plan assets.
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
67. When a pension plan is adopted subsequent to organizing the company and credit for past service is granted, there will be a Past service costs which must be:A) debited directly to expense of the first year of the pension plan.B) debited directly to retained earnings.C) debited to expense as funded (with cash).D) unrecognized, then amortized in the future as part of pension expense.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
68. Which of the following statements is not correct?A) As of a measurement date, accrued pension obligation minus plan assets at fair value
equals underfunded or overfunded accrued pension obligation.B) During an accounting period, beginning pension liability/asset plus pension expense equals
ending deferred pension liability/asset.C) As of a measurement date, APO minus plan assets plus or minus unrecognized pension
amounts equals deferred pension liability/cost.D) During an accounting period, beginning plan assets at fair value plus or minus actual return
on plan assets plus pension plan contributions minus pension benefits paid equals ending plan assets at fair value.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
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69. Factors affecting estimates of benefits under a postretirement health care plan include all of the following except:A) per capita claims cost by age.B) health care cost trend rates.C) plan demographics.D) discount rate.
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
70. Choose the correct statement concerning pensions (defined benefit) and other post employmentbenefits.A) pension expense has six components; other post employment benefits expense has only
fiveB) Only pensions require a reconciliation of funded status to be disclosedC) Other post employment benefits payments are more difficult to predict than are pension
paymentsD) the entire other post employment benefits obligation must be recognized in the balance
sheet whereas, in most cases, the pension obligation is not
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
71. The full eligibility date for an employee covered in a non-pay related other post employmentbenefits plan isA) the retirement dateB) the date the employee is eligible for the maximum benefit the plan has to offerC) the date the employee is eligible for the benefits he or she is expected to receiveD) the date the employee attains his or her final salary
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
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72. Changes in defined benefit pension plans that reduce the expected years of future service of present employees are:A) settlements.B) adjustments.C) terminations.D) curtailments.
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO7
73. The total gain or loss due to a curtailment should be recognized:A) when it is probable that a curtailment will occur and the effects are reasonably estimable,
for either a gain or a loss.B) immediately.C) if a loss, when the employees terminate or the curtailment occurs.D) if a gain, when it is probable that a curtailment will and the effects are reasonably
estimable.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
74. Employers who provide contractual termination benefits must recognize a loss and a related liability when:A) the employees accept the termination benefit offer.B) the termination benefit can be reasonably estimated.C) it is probable that employees will be entitled to the benefit and the amount of the benefit
can be reasonably estimated.D) the termination occurs.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO7
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75. ABC has a non-contributory, defined benefit pension plan. Data for 20x12 were as follows: Pension plan assets (at fair value) January 1, 20x12, $240,000, and December 31, 20x12, $285,000; APO, January 1, 20x12, $243,000 and December 31, 20x12, $345,000. The accrued pension obligation was underfunded at the end of 20x12 in the amount of:A) $15,000B) $30,000C) $45,000D) $60,000
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO5
76. The corridor method is an approach that refers to:A) expected return on plan assetsB) actuarial gains and lossesC) experience gains and lossesD) pension obligations
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
77. You are given the following information about JMR Ltd.'s defined benefit plan:
Accrued pension obligation, beginning of 20x12 $675,765Value of plan assets, beginning of 20x12 $774,300Unamortized actuarial loss, beginning of 20x12 $89,000Vesting/Average remaining service period 8 years
The amount of amortization for the year ended 20x12 is:A) $0B) $11,125C) $11,570D) $1,446
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO5
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78. You are given the following information about KER Ltd.'s defined benefit plan:
Accrued pension obligation, beginning of 20x12 $101,765Value of plan assets, beginning of 20x12 $119,300Unamortized actuarial loss, beginning of 20x12 $13,000Vesting/Average remaining service period 10 yearsAmortization expense in 20x11 $300
The amount of amortization for the year ended 20x12 is:A) $0B) $407C) $107D) $1,446
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO5
79. You are given the following information about KAR Ltd.'s defined benefit plan:
Accrued pension obligation, beginning of 20x12 $675,765Value of plan assets, beginning of 20x12 $623,300Unamortized actuarial loss, beginning of 20x12 $89,000Vesting/Average remaining service period 8 years
The amount of amortization for the year ended 20x12 is:A) $0B) $11,125C) $11,570D) $1,446
Ans: ADifficulty: Medium
Level of Learning: ApplicationTopic: LO5
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80. Under the corridor method when the accumulated amount of actuarial gains and losses exceed 10% of the greater of the accrued obligation at the beginning of the year or the value of the plan assets at the beginning of the year, the excess must be amortized over:A) at a maximum, the average remaining service periodB) at a minimum, the average remaining service periodC) 10 yearsD) a rational and systematic amount chosen by management
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
81. The accrued pension obligation at the beginning of the year is $340,000; the value of the plan assets at the beginning of the year is $420,000. Assuming an interest factor of 7% what is the interest cost for the year?A) $29,400B) $21,000C) $23,800D) $26,500
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO5
82. The accrued pension obligation at the beginning of the year is $340,000; the value of the plan assets at the beginning of the year is $420,000. Assuming an interest factor of 7% what is the expected return for the year?A) $29,400B) $21,000C) $23,800D) $26,500
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
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83. The expected return on plan assets was $8,700; the actual return was $9,400. The difference represents:A) unrealized gainB) realized gainC) interest revenueD) experience gain
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO4, 5
84. The expected return on plan assets was $7,700; the actual return was $6,400. The difference represents:A) unrealized lossB) realized lossC) interest expenseD) experience loss
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
85. The corridor test for actuarial gains and losses looks at two items. One of them is:A) the accrued obligation at the beginning of the yearB) the accrued obligation at the end of the yearC) the expected return at the beginning of the yearD) the expected return at the end of the year
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
86. The corridor test for actuarial gains and losses looks at two items. One of them is:A) the value of the plan assets at the end of the yearB) the value of the plan assets at the beginning of the yearC) the expected return at the beginning of the yearD) the expected return at the end of the year
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
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87. The accrued obligation at the beginning of the year was $456,000 and the current service cost for the year is $67,000. Assuming an interest factor of 6% what is the accrued obligation at the end of the year?A) $523,000B) $389,000C) $550,360D) $554,380
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
88. The accrued obligation at the beginning of the year was $289,000 and the current service cost for the year is $92,000. Assuming an interest factor of 8% what is the accrued obligation at the end of the year?A) $404,120B) $381,000C) $403,860D) $363,660
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
89. The accrued obligation at the beginning of the year was $289,000, current service cost for the year is $92,000, plan assets at the beginning of the year was $300,000. Assuming an interest rate of 8% for all factors, what is the pension expense for the year?A) $681,000B) $380,120C) $404,120D) $363,660
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
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90. The accrued obligation at the beginning of the year was $589,000, current service cost for the year is $122,000, plan assets at the beginning of the year was $560,000. Assuming an interest rate of 6% for all factors, what is the pension expense for the year?A) $681,000B) $151,000C) $404,120D) $712,740
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
91. When a pension plan is ended, the obligation is settled by transferring the assets to:A) each individualB) a financial bankC) a trusteeD) none of the above
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
92. Gains and losses from plan settlements and curtailments should be:A) amortized over the average remaining service periodB) amortized over a systematic and rational mannerC) recognized in income immediatelyD) deferred to the balance sheet
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO7
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93. When a company offers termination benefits as the result of a restructuring plan, the special termination benefits should be:A) recognized with normal pension expenseB) amortized over the average remaining service periodC) amortized over a systematic and rational mannerD) included with the restructuring costs on the income statement
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO7
94. Pension related estimates (not funding data) are provided by the:A) employer company.B) independent actuary.C) pension fund trustee.D) employee union.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
95. Choose the best description of the components of pension expense.A) Service cost + interest cost + pension benefits paid to retirees + amortization of Past
service costs + gain or loss recognized + amortization of transition asset or liability.B) Service cost + interest cost + pension benefits paid to retirees + expected return on plan
assets + amortization of Past service costs + gain or loss recognized.C) Service cost + interest cost +/- expected return on plan assets + amortization of past/Past
service costs + amortization of excess\ actuarial loss/gain.D) Service cost + interest cost +/- expected return on plan assets + expected return on plan
assets + amortization of Past service costs + gain or loss recognized.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4, 5
96. Under IFRS, unrecognized transition costs are accounted for:A) straight-line method using any systematic and rational approach.B) retroactively.C) interest method using the actuary's discount rate.D) the service method similar to Past service costs amortization.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO7
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97. Funding a pension plan may be handled as follows:
independent retirement internallypension fund annuity managed
1 *2 * *3 * * *4 * *
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO3
98. Timu joined the firm 12 years ago and is 42 today. The firm has a postretirement health care plan with the following coverages for retirees:Age 65 at retirement and 30 years of service 100% coverageAge 60 at retirement and 30 years of service 75% coverage
Timu is expected to retire at age 63. The present value today of 100% postretirement health care coverage for Timu is $20,000, considering life expectancy and other factors. The present value of 75% coverage is $14,000. What is the accumulated postretirement benefit obligation for Timu today?A) $20,000B) $14,000C) $ 8,000D) $ 5,600
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
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99. Today is John's 57th birthday and he has served 14 years for his firm. John is expected to retire on his 65th birthday. His firm expects to incur $5,000 of annual net health care claims costs for John beginning one year after his retirement date and continuing each year for a total of seven years (assume seven end of year payments in all). To be fully eligible for these benefits, John must work 20 years. Compute expected postretirement benefit obligation for John today if the discount rate is 8%.A) $15,244B) $12,322C) $18,916D) $14,064
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
100. Bonnie joined a firm at age 25 and is expected to retire at 57. The postretirement benefit plan provides the following coverage given the indicated years of service after age 30.
% of full coverage Years of service after age 3025% 1550% 25100% 35
What is Bonnie's full eligibility date (her age when fully eligible)?A) 57B) 55C) 50D) 60
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
101. All of the following are relevant policy disclosures suggested by the AcSB except:A) a reconciliation of relevant pension amountsB) amount of pension expense for the period, broken down by componentC) the number of employeesD) a reconciliation of the defined benefit obligation from the beginning to the end of the yearE) changes to reserves and other comprehensive income if any
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO9
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102. All of the following are relevant policy disclosures suggested by the AcSB except:A) a reconciliation of pension plan assets from the beginning to the end of the yearB) description of how expected return on pension plan assets is calculatedC) actual return on plan assets during the yearD) principle actuarial assumptionsE) the risk profile of the employee group
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO9
103. The following pension data relates to a non-contributory, defined-benefit pension plan (000s):
December 3120x12 20x13
Pension obligation $190 $210Accumulated benefit obligation 140 150Vested benefit obligation 100 118Service cost 110 115Unrecognized Past service costs 6 5Pension plan assets (at fair value) 160 225
Compute the under (or over) funded pension obligation at the end of each year.Ans: 20x12: Pension obligation, $190 - Plan assets, $160 = $30 underfunded.
20x13: Pension obligation, $210 - Plan assets, $225 = $15 overfunded.
Difficulty: MediumLevel of Learning: ApplicationTopic: LO1
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104. What is the most critical value or amount in a defined benefit pension plan from the point of view of the financial statement user, and is this amount generally reported in the balance sheet for most firms? Explain.Ans: Funded status of the plan is the most critical amount because it represents the degree to
which funds have been accumulated to pay promised benefits. Generally this amount is not reported in the balance sheet because of delayed recognition of Past service costs, net unrecognized gain or loss, and transition item. These amounts cause the balance sheet account, accrued pension cost, to differ from funded status.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
105. What is a defined contribution plan?Ans: A defined contribution plan places the risk of the future amount to be received by the
employee on the employee. The employer agrees to make specific contributions with the amount to be received by the employee dependent on the interest rate earned.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2
106. How does a trustee impact upon accounting for defined pension plans?Ans: A trustee is independent and receives the contributions from the employer. The trustee
invests the money (unless an independent money manager is hired to perform the investment function) and pays the benefits to the employees. Trustees are not individuals but may be financial institutions. If the pension plan is administered by the company instead of a trustee, the company must report the plan assets and the accrued pension liability on the balance sheet because the plan is under the control of the company. If the trustee administers the plan, the company no longer has control and neither the plan assets nor the pension plan liabilities are reported on the company's statements.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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107. Match the brief description with the terms by entering the appropriate letters in the blank spaces provided.Brief DescriptionA. Pension expense is the sum of certain pension costs, losses, and gains.B. The relationship between the accrued pension obligation and the pension plan assets at fair value.C. Certain changes in the employer's pension obligations and the value of plan assets are not recognized when they occur.D. Actuary's report of pension plan estimates.E. Reporting on the balance sheet of certain recognized pension assets and liabilities as a single amount.F. Employer's pension obligation that is not contingent on future employment of employees.G. The date that pension plan assets and obligations are determined.H. Cumulative employer's contributions in excess of recognized net pension expense.Term___1. Netting___2. Underfunded, overfunded, or fully funded___3. Measurement date___4. Delayed recognition___5. Accrued pension obligation report___6. Vested benefit obligation___7. Offsetting___8. Prepaid pension cost
Ans: 1:A, 2:B, 3:G, 4:C, 5:D, 6:F, 7:E, 8:HDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3, 4
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108. Match the brief definitions with the terms by entering the appropriate letters in the blank spaces provided.Brief DefinitionA. Actuarial present value of all future pension benefits including the effects of current and future compensation levels.B. Beginning accrued pension obligation multiplied by the actuary's discount rate.C. Specifies the retirement benefits in conformity with the pension plan.D. Resources related to the pension that is administered by the independent trustee.E. The employer provides all of the required funding.F. Actuarial present value of all future pension benefits excluding the effects of future compensation levels.G. The interest rate used by the actuary to adjust for the time value of money.H. Beginning balance of plan assets at fair value multiplied by the long-term expected rate of return on plan assets.I. Allocation (assignment) of pension costs to periodic pension expense.J. Amount computed by the employer as total pension expense; may be comprised of six components.Term___1. Discount rate___2. Pension plan assets___3. Accrued pension obligation___4. Expected return on plan assets___5. Accumulated benefit obligation___6. Non-contributory pension plan___7. Pension benefit formula___8. Attribution of pension plan costs___9. Interest cost (component)___10. Net periodic pension expense
Ans: 1:G, 2:D, 3:A, 4:H, 5:F, 6:E, 7:C, 8:I, 9:B, 10:JDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3, 4
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109. Match the brief description with the terms by entering the appropriate letters in the blank spaces provided.Brief DescriptionA. Transaction that is irrevocable, relieves employer of some pension plan obligations, and eliminates significant risk related to the plan obligation and assets.B. Net of any unrecognized gain or loss and any unrecognized net transition asset (i.e., gain).C. Plan to which two or more employers contribute and for which pension assets are not separately identified for each employer.D. Compensation offered for a short period of time when an employee is terminated prior to expected retirement date.E. Increase or decrease in the accrued pension obligation.F. Compensation to employees required by a pension plan only if a specified event occurs which causes an employee to be terminated prior to expected retirement date.G. Any unrecognized Past service costs and unrecognized transition cost related to curtailed years of service.H. Event that either reduces the expected years of future service of present employees, or eliminates accrual of defined benefits for some or all future services.Term___1. Contractual termination benefit___2. Maximum gain or loss for a settlement___3. Accrued pension obligation gain or loss due to a curtailment___4. Past service and transition loss due to a curtailment___5. Multiemployer pension plan___6. Curtailment___7. Settlement___8.. Special termination benefit
Ans: 1:F, 2:B, 3:E, 4:G, 5:C, 6:H, 7:A, 8:DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 2, 3, 4
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110. JTD began working for XYZ at age 45 and immediately qualified for the company pension plan. The retirement age in the company is 65 (i.e., 20 full years of employment for JTD). The pension specifies a $30,000 annual (year-end) pension benefit for JTD and the life expectancy is age 80 (i.e., the pension benefit will be paid for 15 years). Assume a constant 8% interest rate during the 20 working years, and a 7% constant rate during the retirement years per the actuarial estimates (assume all cash flows at year-end). XYZ plans to fund a constant amount per period at each year-end during the employment period.Required:(a) What amount of funds should be in the pension fund at the beginning of the first retirement year?(b) What amount should XYZ pay to the funding agency each year-end during the employment period?(c) Is it possible to determine pension expense for the first year of the plan?Ans: (a) $30,000 x (PVA, 7%, 15) (9.10791) = $273,237.
(b) $273,237 ÷ (FVA, 8%, 20) (45.76196) = $5,971.(c) There is not sufficient data to determine pension expense; the amount in (b) is only the required annual funding amount needed to reach the company's goal.
Difficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
111. What are past service costs and how should they be amortized (if at all)?Ans: Past service costs are incurred when a company implements a new defined pension plan
and employees already working receive past credit for their employment. In other words, the employees would be eligible for an immediate pension entitlement. The amount is a liability but should not be set up on the balance sheet. It should remain off the balance sheet and amortized on a straight-line basis over a reasonable time period (recommended to be the expected period to full eligibility of the employee group).
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
112. What is the corridor method?Ans: The corridor method refers to the treatment given to actuarial gains and losses. Actuarial
gains and losses must be amortized if the accumulated amount exceeds 10% of the greater of the accrued obligation at the beginning of the year, or the value of the plan assets at the beginning of the year. If amortized, the amount by which the accumulated actuarial gains and losses exceeds the above is amortized over the average remaining service period. If the threshold is not met no amortization is required although companies may amortize if they wish to be conservative. Note that the corridor method represents a minimum amortization amount of actuarial gains and losses.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
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113. You are given the following information about AG Ltd.:
TotalAccrued pension obligation, beginning of 20x12 $567,432Value of plan assets, beginning of 20x12 $612,349Unamortized actuarial loss, beginning of 20x12 $72,340Average remaining service period 8 years
Required:Calculate the amount of amortization, if any for 20x12.Ans: 10% x $567,432 (accrued pension obligation) = $56,743
10% x $612,349 (plan assets) = $61,235Excess (72,340-61,235) =11,105. 11,105/8=$1,388
Difficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
114. You are given the following information about JG Ltd.:
TotalAccrued pension obligation, beginning of 20x13 $567,432Value of plan assets, beginning of 20x13 $612,349Unamortized actuarial loss, beginning of 20x13 $42,340Vesting/Average remaining service period 8 years
Required:Calculate the amount of amortization, if any for 20x12.Ans: 10% x $567,432 (accrued pension obligation) = $56,743
10% x $612,349 (plan assets) = $61,235Actuarial loss is less than above therefore no amortization is necessary.
Difficulty: MediumLevel of Learning: ApplicationTopic: LO4, 5
115. What are plan settlements and curtailments and how should the gains and losses be accounted for?Ans: Plan settlements and curtailments occur when an employer ends a pension plan. This may
also happen when a company closes down a portion of their operations. In the event that a pension is settled there may be significant gains and losses due to the funding of the plan versus the accounting for that plan. Gains and losses on settlement or curtailment are not amortized, as the employees related to the plan are no longer employed. These gains and losses are recognized immediately. Unlike a settlement, where obligations are paid, the benefits earned to date remain unpaid in a curtailment
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO7
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116. When should the cost of termination benefits be recognized?Ans: The cost of termination benefits should be recognized immediately after the employees
have accepted the offer. Amortization is not appropriate, as employment has ceased.Difficulty: MediumLevel of Learning: KnowledgeTopic: LO7
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The following information applies to questions 117 to 120 inclusively:
ABC Inc. had the following balances pertaining to its defined benefit pension plan:
Balances, end of 20x10:
Defined benefit obligation, end of 20x10: $12,000,000Pension plan assets at fair value, end of 20x10: $ 9,000,000
Unrecognized past service costs, recognized at theend of 20x10 (to be amortized as of 20x11) $1,000,000
Unrecognized actuarial gains: $1,500,000Accrued pension asset in the financial statements $3,500,000
The following additional information is provided:
Current service cost, 20x11 $300,000Benefit payments to retired employees in 20x11 $60,000Funding contributions by employer in 20x11 $400,000Actual return on plan assets $600,000Expected return on plan assets 9%Interest rate on long-term debt 6%Employee average remaining service life 10 yearsVesting period for past service costs (Note 1) 5 years
Note 1:25% of the unrecognized past service costs above have vested by the end of 20x11
117. Use the data above to prepare a pension worksheet assuming that ABC Inc. adheres to IFRS. Also assume that ABC uses the 10% corridor method for amortization of unrecognized actuarial gains and losses.
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Ans:
Memo Accounts Statement accounts
Values Unrecognized pension costs
20x11
Defined Benefit Obligation
Plan Assets
Unrecognized Loss (Gain)
Past Service cost
Pension expense
Accrued Pension Asset (Liability)
20x11
Beginning Balances -12,000,000 9,000,000 -1,500,000 1,000,000 3,500,000
Current service cost -300,000 300,000
Interest on Obligation -720,000 720,000
Expected return on plan assets 810,000 -810,000
Actual return on plan assets 600,000 -600,000
PSC Amortization* -400,000 400,000
Excess actuarial gain amortization** 30,000 -30,000
580,000 -580,000
Funding 600,000 600,000
Ending balances -13,020,000 10,200,000 -1,260,000 600,000 3,520,000
* $250,000 VESTED +$750,000/5 YEAR VESTING PERIOD
**1,5 million-10%*12 million=$300,000/10 years=$30,000
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Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5, 6, 10
118. Refer to question 117 above. Explain how the data in the spreadsheet above would appear on ABC’s financial statements under the proposed IASB changes to pension accounting.
Ans:
Pension expense would include only current service costs as well as amortization of any past service cost (i.e. $300,000+$400,000) on the statement of comprehensive income.
There would also be a net finance charge of (-$12 million+$9 million)*6% of $180,000 on thestatement of comprehensive income.
Finally, any unrecognized actuarial and experience gains and losses 9excluding unamortized past service costs) would be recorded on ABC’s statement of financial position as an asset or liabilitywith the offset increasing or decreasing reserves and other comprehensive income respectively. The rationale for this is partly due to the fact that any experience or actuarial gains or losses may ultimately be realized or compensated by the company (thus meeting the definition of an asset or liability).
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5, 6, 10
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119. Use the data above to prepare a pension worksheet assuming that ABC Inc. adheres to ASPE and uses the standard approach to account for its defined benefit pension plan. Also assume that ABC uses the 10% corridor method for amortization of unrecognized actuarial gains and losses.
Ans:
Memo Accounts Statement accounts
Values Unrecognized pension costs
20x11
Defined Benefit Obligation
Plan Assets
Unrecognized Loss (Gain)
Past Service cost
Pension expense
Accrued Pension Asset (Liability)
20x11
Beginning Balances -
12,000,000 9,000,000 -1,500,000 1,000,000 3,500,000
Current service cost -300,000 300,000
Interest on Obligation -720,000 720,000
Expected return on plan assets 810,000 -810,000
Actual return on plan assets 600,000 -600,000
PSC Amortization* -100,000 100,000
Excess actuarial gain amortization** 30,000 -30,000
280,000 -280,000
Funding 600,000 600,000
Ending balances-
13,020,000 10,200,000 -1,260,000 900,000 3,820,000
* $1 million/10 YEAR AVERAGE REMAINING SERVICE LIFE
**1,5 million-10%*12 million=$300,000/10 years=$30,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5, 6, 10
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120. Use the data above to prepare a pension worksheet assuming that ABC Inc. adheres to ASPE and uses the simplified approach to account for its defined benefit pension plan.
Ans:
Memo Accounts Statement accounts
Values Unrecognized pension costs
20x11
Defined Benefit Obligation
Plan Assets
Unrecognized Loss (Gain) Past Service cost
Pension expense
Accrued Pension Asset (Liability)
20x11
Beginning Balances -
12,000,000 9,000,000 -500,000 3,500,000
Current service cost -300,000 300,000
Interest on Obligation -720,000 720,000
Actual return on plan assets 600,000 -600,000
420,000 -420,000
Funding 600,000 600,000
Ending balances-
13,020,000 10,200,000 0 0 3,680,000
* Note that the Unrecognized loss and past service cost columns are not necessary.
Difficulty: HardLevel of Learning: ApplicationTopic: LO4, 5, 6, 10
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test BankChapter 19 – Earnings per Share
1. An anti-dilutive effect means that EPS is decreased as a result.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
2. Only firms with a complex capital structure must compute diluted EPS.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO 1
3. Stock dividend and stock splits are treated as though they had been in effect for the entire period.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
4. Convertible securities and options are always included in the calculation of diluted EPS.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
5. Reporting earnings per share for public companies is optional; however, its presentation is strongly recommended.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
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6. When a midyear stock dividend increases the number of common shares outstanding for the period, the new shares resulting from the dividend are weighted by one-half a year for purposes of computing EPS.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
7. Earnings per share refer to the amount of earnings attributable to each share of common and preferred stock.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
8. When a midyear stock dividend increases the number of common shares outstanding for the period, the average number of common shares outstanding is computed as if the stock dividend was distributed at the beginning of the year.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
9. The treasury stock method is only used for options, and only the denominator is affected..
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
10. Provided that the conditions for share issuance are met at the end of a period and the date of the contingency period has not expired, contingently issuable shares will be included in EPS calculations.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
11. For purposes of computing the average number of common shares outstanding, stock dividends are treated in the same manner as stock splits.
Ans: TrueDifficulty: Easy
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Level of Learning: KnowledgeTopic: LO3
12. Nonconvertible, cumulative preferred shares affect the computation of EPS (for simple capital structure), basic EPS and diluted EPS.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
13. A simple capital structure refers to a shareholders' equity section which only has common shares and no potentially dilutive securities that, upon their conversion or exercise in the aggregate, would dilute earnings per share.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
14. A simple capital structure is one in which the shareholders' equity consists only of common shares or includes no potentially dilutive securities.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
15. Corporations with simple capital structures are required to present two sets of EPS data.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
16. In some cases, diluted earnings per share amounts may be the same as the basic earnings per share amounts.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
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17. Anti-dilution must be considered only with complex capital structures.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
18. The basic EPS can be compared with basic EPS numbers from the past years to see whether the company is earning more or less for its common shareholders.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
19. The diluted EPS does not have to be disclosed in the financial statements.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
20. The diluted EPS should be disclosed in the financial statements only if it is materially different from basic EPS.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
21. Basic EPS is an historical amount.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
22. Diluted EPS is meant to be a worst-case scenario.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
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23. A reverse split may be used to increase the value per share of a company.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
24. Where there are significant changes in a corporation's capital structure after year end but before the financial statement date, the transaction must be disclosed and described.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
25. EPS figures must be disclosed under both ASPE and IFRS.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
26. Diluted EPS indicate long-run impact that the likely conversion will have on the earnings attributable to common shares.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
27. Company A has an EPS of $6 and Company B has an EPS of $23. Based on this information, Company B is the better investment.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
28. When there has been a retrospective change in Accounting policy or a restatement, EPS figures must be recalculated accordingly.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
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29. Options are in-the-money if the exercise price is higher that the market value of common shares.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
30. Option adjustments are based on the treasury stock method.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
31. Bonds and preferred share adjustments are based on the if-converted method.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
32. When computing diluted earnings per share, convertible securities are a sale of additional common stock.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
33. For purposes of computing the weighted average number of shares outstanding during the year, a midyear event that must be treated as occurring at the beginning of the year is the purchase of treasury stock.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
34. EPS figures must be disclosed on the face of the financial statements for discontinued operations.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO6
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35. Wholly-owned subsidiaries are required to disclose earnings per share.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO6
36. ABC Inc. has 20,000 common shares outstanding throughout the year. It also had 20,000, 6 percent preferred shares, par $20, (cumulative and nonconvertible) outstanding throughout the year. Net income was $300,000. The earnings per share amount would be $13.80
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
37. Diluted EPS recalculates EPS as though the conversions of different instruments had taken place at the beginning of the year.
Ans: True
Difficulty: EasyLevel of Learning: KnowledgeTopic: LO3
38. Diluted earnings per share recalculate EPS as though the conversions of different instruments had taken place at the end of the year.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
39. At December 31, 20x2, the shareholders' equity of ABC Inc. reported as outstanding: 100 common shares and 30 nonconvertible preferred shares. On July 1, 20x3, ABC Inc. issued a 10 percent stock dividend on its common shares and paid a cash dividend of $2.00 per share on its preferred (the full year's requirement). Income for the year ended December 31, 20x3 was $1,170. The 20x3 EPS, rounded to the nearest cent, for ABC Inc. should be $8.58.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
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40. When computing the weighted average number of shares outstanding, an actual conversion of convertible preferred shares is assumed to have occurred on the first day of the year, regardless of when it was converted.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
41. If the corporation purchases common treasury stock, those shares would be included in the EPS computation only for the fraction of the year that they were outstanding.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
42. If nonconvertible preferred shares are noncumulative, subtraction of the current year's dividend must be made whether preferred dividends are declared or not for the current year.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
43. Nonconvertible, cumulative, preferred shares affect the computation of EPS (for a simple capital structure), basic EPS, but not diluted EPS.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 2
44. Stock rights, options, and warrants determined to be dilutive when computing fully diluted earnings per share may be anti-dilutive when computing basic earnings per share.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
45. In computing EPS for a simple capital structure, net income is reduced by cumulative preferred dividends on nonconvertible preferred shares, whether dividends are declared or not.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 2
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46. Dilutive securities potentially increase EPS.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
47. Earnings per share is computed on the basis of:A) A weighted average of the number of common shares outstanding during the year.B) A weighted average of the number of preferred and common shares outstanding during the
year.C) The number of common shares outstanding at the end of the year.C) The number of common and preferred shares outstanding at the end of the year.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
48. Earnings per share figures are required to be reported:A) On the face of the income statement.B) They need not be presented, however, it is recommended.C) At an undesignated place in the financial statements.D) In the notes to the financial statements or at the bottom of the income statement.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
49. If net income is $10,000 and there were 8,000 common shares issued and outstanding the entire year, and $100,000 of noncumulative, nonconvertible 6% $100 par preferred shares outstanding the entire year, what is EPS if no dividends were declared during the year?A) $1.18B) $1.23C) $1.25D) $1.16
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
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50. The annual dividend on nonconvertible cumulative preferred shares is $10,000. At the beginning of the current year, there were 3 years of dividends in arrears. During the current year, $38,000 of dividends on the preferred shares were declared, and $35,000 were paid. What amount of dividends on preferred shares will be subtracted from earnings when computing basic EPS for the current year?A) $40,000B) $10,000C) $38,000D) $35,000E) $30,000
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
51. The annual dividend on nonconvertible cumulative preferred shares is $10,000. At the beginning of the current year, there were 3 years of dividends in arrears. During the current year, $38,000 of dividends on the preferred shares were declared, and $35,000 were paid. What amount of dividends on preferred shares will be subtracted from earnings when computing diluted EPS for the current year?A) $40,000B) $10,000C) $38,000D) $35,000E) $30,000
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
52. At December 31, 20x2, XYZ had 40,000 common shares issued and outstanding and 10,000 nonconvertible preferred shares issued and outstanding. XYZ's net income for the year ended December 31, 20x3, was $120,000. During 20x3, XYZ declared and paid $50,000 cash dividends on common and $8,000 cash dividends on the nonconvertible preferred (the annual requirement). There were no common share or preferred share transactions during the year. The earnings per common share for the year ended December 31, 20x3, should be:A) $1.75B) $2.40C) $2.80D) $3.00
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
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53. When computing diluted earnings per share, convertible securities are:A) Ignored.B) Recognized only if they are dilutive.C) Recognized only if they are anti-dilutive.D) Recognized whether they are dilutive or anti-dilutive.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
54. Dilutive convertible securities must be used in the computation of:A) Diluted and basic earnings per share.B) diluted earnings per share.C) Basic earnings per share.D) Dilutive convertible securities are not used in any computations of earnings per share.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
55. ABC paid $5,000 in dividends to its preferred shareholders. The 5 percent preferred shares (10,000 shares outstanding) are nonconvertible and noncumulative. The $5,000 dividend:A) Will be added to the numerator of the EPS calculation.B) Will be subtracted from the numerator of the EPS calculation.C) Will be added to the denominator of the EPS calculation.D) May not affect the EPS calculation, depending on the declaration date of the dividends.
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
56. In computing the weighted average number of shares outstanding, the following is considered outstanding only as of the date issued or sold:A) Stock splits.B) Reverse stock splits.C) Stock dividends.D) Common shares issued.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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57. A preferred dividend claim should be subtracted from income to compute basic EPS if the preferred shares are:A) Noncumulative, nonconvertible, and a dividend has not been declared; however, a dividend
was paid this year in fulfillment of the obligation from last year's declaration.B) Noncumulative, nonconvertible, and the company would like to declare a dividend;
however, by law they can't because of a debit balance in the retained earnings account.C) Noncumulative, nonconvertible, non-participating, and the dividend has been declared.D) Participating, nonconvertible, noncumulative, and the dividend has not been declared.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
58. A simple capital structure could have, in addition to common shares, a security that is a:A) Stock right.B) Stock warrant.C) Convertible preferred shares.D) Convertible bond.E) Nonconvertible preferred shares.
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
59. Which of the following statements is correct?A) Basic EPS is hypothetical figure while diluted EPS is a historical figure.B) Basic EPS is a historical figure while diluted EPS is a hypothetical figure.C) Basic and diluted EPS are both historical figures.D) Basic and diluted EPS are both hypothetical figures.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
60. With respect to the computation of earnings per share, which of the following would be most indicative of a simple capital structure?A) Ownership interests consisting only of common sharesB) Equity represented only by common and convertible preferred sharesC) Common shares, preferred shares, and convertible securities outstanding in lots of even
thousandsD) Earnings derived from one primary product segment of business
Ans: ADifficulty: Medium
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Level of Learning: KnowledgeTopic: LO2
61. When a company has negative net income and potentially dilutive securities, the calculation of EPS results in:A) Diluted EPS i.e. all potentially dilutive securities are included in the calculation (whether
dilutive or anti-dilutive)B) No EPS being reportedC) Diluted EPS being reported and it will be more than basic EPSD) None of the above
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
62. The classification of a security as a convertible security should be based on information available at the time:A) The security would be the most dilutive.B) The security would be the most anti-dilutive.C) The EPS calculation is made each year.D) The security is issued.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
63. A basic earnings per share figure is presented for:A) A complex capital structure.B) A simple capital structure.C) Both simple and complex structures.D) Neither simple nor complex structures.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
64. Convertible noncumulative preferred stock for which the current year's dividend has not been declared does not affect the EPS figures if it:A) Has been converted.B) is anti-dilutive.C) Is a common convertible security.D) None of the above.
Ans: BDifficulty: Medium
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Level of Learning: KnowledgeTopic: LO2
65. The reported diluted earnings per share figure may be:A) less than the basic earnings per share figure.B) More than the basic earnings per share figure.C) Equal to the basic earnings per share figure.D) More than or less than the basic earnings per share figure.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
66. Concerning earnings per share for a complex capital structure, which of the following statements is incorrect?A) Basic earnings per share must be based on the weighted average number of common shares
outstanding.B) Both basic and diluted earnings per share must be presented on the face of the financial
statements.C) A "convertible security" is a security which is not, in form, a common share but which
contains provisions to enable its holder to become a common shareholder.D) "Basic earnings per share" is never reported at less than "diluted earnings per share."E) If the only potentially dilutive security outstanding is an employee stock option plan, then
primary and diluted EPS must be equal.
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
67. When computing diluted earnings per share, convertible securities are:A) Incorporated into diluted EPS only if they are dilutive.B) Incorporated into diluted EPS only if they are anti-dilutive.C) Ignored for EPS purposes.D) Incorporated into diluted EPS whether they are dilutive or anti-dilutive.
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68. For purposes of computing the weighted average number of shares outstanding during the year, a midyear event that must be treated as occurring at the beginning of the year is the:A) sale of additional common shares.B) Issuance of stock warrants.C) Purchase of treasury stock.D) Declaration and issuance of stock dividend.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
69. ABC experienced the following changes in its capital structure during 20x3:Outstanding on January 1, 20x3, 90 common stock shares
Sold 120 common shares on February 1, 20x3Sold 60 common shares on April 1, 20x3Issued a 2 for 1 split on August 1, 20x3ABC's weighted average number of common shares outstanding for 20x3 would be:A) 245B) 315C) 490D) 540
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
70. WXY had the following common share transactions:January 1 60 shares outstandingApril 1 2 for 1 splitAugust 1 10 percent stock dividendSeptember 1 Purchased 10 shares of treasury stockThe weighted average number of shares outstanding for the year was:A) 95 shares.B) 110.13 shares.C) 115.33 shares.D) 128.67 shares.
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
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71. ABC has 20,000 common shares outstanding throughout the year. It also had 20,000, 6 percent preferred shares, par $20, (cumulative and nonconvertible) outstanding throughout the year. Net income was $300,000. The earnings per share amount would be:A) $9.20B) $10.00C) $13.80D) $15.00
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
72. XYZ reported the following equity accounts on December 31 of this year:Liabilities: Bonds payable, 12 percent, nonconvertible $200Shareholders' equity: Preferred shares, $15 par, 7 percent, non convertible, non cumulative 300 Common shares, no par, 40 shares outstanding 400 Retained earnings 120
Additional Information:(1) The Board of Directors declared a 10 percent stock dividend on all classes of shares on April 1, and issued these shares on August 1.(2) Income for the period was $88.(3) There were no share transactions during the year, other than the stock dividend.The basic earnings per share amount is:A) $1.52B) $1.68C) $2.00D) $2.20E) There would not be a basic earnings per share figure for XYZ this year.
Ans: CDifficulty: Medium
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73. RST's net income for the year ended December 31, 20x3, was $30,000. During 20x3, RST declared and paid $3,000 cash dividends on preferred shares (the full year's requirement) and $5,250 cash dividends on common shares. At December 31, 20x3, 36,000 common shares were issued and outstanding, 30,000 of which had been outstanding throughout the year and 6,000 of which were issued on July 1, 20x3. No other common share transactions were completed during the year, and there is no potential dilution of earnings per share. The 20x3 earnings per common share of RST, rounded to the nearest penny, should be:A) $.75B) $.82C) $.91D) $1.00
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
74 At December 31, 20x2, MNO had 50,000 common shares issued and outstanding. On April 1, 20x3, an additional 10,000 common shares were issued. MNO's net income for the year ended December 31, 20x3, was $1,035,000. During 20x3, MNO declared and paid $600,000 cash dividends on its nonconvertible preferred shares (the full year's requirement). The earnings per common share, rounded to the nearest cent, for the year ended December 31, 20x3, should be:A) $7.57B) $7.92C) $18.00D) $18.84
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO3
75 At December 31, 20x2, the shareholders' equity of LMN reported as outstanding: 100 common shares and 30 nonconvertible preferred shares. On July 1, 20x3, LMN issued a 10 percent stock dividend on its common shares and paid a cash dividend of $2.00 per share on its preferred (the full year's requirement). Income for the year ended December 31, 20x3 was $1,170. The 20x3 EPS, rounded to the nearest cent, for LMN should be:A) $10.09B) $10.58C) $10.64D) $11.70
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO3
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76 At December 31, 20x3, QRS had 500 common shares issued and outstanding, 400 of which had been issued and outstanding throughout the year and 100 of which were issued on October 1, 20x3. Net income for the year ended December 31, 20x3, was $4,288. What should be QRS's 20x3 earnings per common share, rounded to the nearest cent?A) $8.58B) $9.53C) $10.09D) $10.72
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO3
77. firm that earned $20,000 (after tax) had the following securities outstanding all year during which the tax rate was 40%:20,000 common shares
1,000, 6%, $100 par cumulative nonconvertible preferred shares2,000, 4%, $50 par cumulative preferred shares, each share convertible into 5 common shares100, 8%, $1,000 convertible bonds, each convertible into 10 common shares (bonds were issued at face)What is basic EPS?A) $ .50B) $ .70C) $1.00D) $ .75
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO3
78. PPO Inc. discloses the following results and information at the end of the current year:
Earnings $400,000Dividends on preferred shares declared and paid $100,000Common shares outstanding Jan. 1 50,000The shares were split 4-for-1 August 1Common dividends declared and paid $200,000
What are BEPPO's earnings per share for the current year?A) $1.50B) $6.00C) $2.00D) $8.00
Ans: ADifficulty: Medium
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Level of Learning: ApplicationTopic: LO3
79. JUNK BONDS Inc. began operations Jan. 1, 20x3. The following events related to common shares took place on the indicated dates during 20x3.Jan. 1 Issued 25,000 common shares
Apr. 1 Purchased 4,000 treasury sharesMay 1 Split the common shares 4-for-1Aug. 1 Issued 20,000 common sharesDec. 1 Issued a 25% stock dividendAssuming no potentially dilutive securities, what is the weighted average shares for EPS in 20x3?A) 96,333B) 37,917C) 120,417D) 118,345
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO3
80. Jimbo Co. began operations Jan. 1, 20x3. The following events related to common stock took place on the indicated dates during 20x3.Jan. 1 Issued 5,000 common shares
Apr. 1 Purchased 400 treasury sharesMay 1 Split 2-for-1Aug. 1 Issued 2,000 common sharesDec. 1 issued a 20% stock dividendAssuming no potentially dilutive securities, what are the weighted average shares for EPS in 20x3?A) 12,280B) 10,233C) 6,640D) 12,080
Ans: A
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81. If net income is $25,000 and there were 18,000 common shares issued and outstanding the entire year, and 100 cumulative, nonconvertible, 6% $100 par preferred shares outstanding the entire year, what is EPS if no dividends were declared during the year. There are two years' dividends in arrears on the preferred shares.A) $1.39B) $1.18C) $1.25D) $1.16E) $1.36
Ans: EDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
82. WEIGHTY Inc. started the current year with 2,000 common shares issued, but only 1,500 were outstanding at that time. The following events took place during the current year:March 30 issued 200 previously unissued sharesJune 1 sold 400 treasury sharesDecember 1 purchased 100 treasury sharesDecember 31 issued 500 previously unissued sharesWhat is WEIGHTY's denominator of earnings per share for the current year?A) 1,917B) 2,375C) 1,875D) 2,125
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
83. A firm has 10,000 common shares outstanding on January 1 of the current year. The following events take place during the current year:May 1 issued 3,000 new common shares
June 30 purchased 4,000 shares for the treasuryOctober 31 distributed a 20% stock dividendDecember 1 reissued the June 30 treasury stockWhat is the weighted-average number of shares to be used for computing EPS?A) 8,333B) 14,133C) 10,000D) 12,333
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
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84. Given the following sequence of events, determine the weighted average number of shares for earnings per share purposes:January 1 100 common shares issued and outstanding
April 1 Issued 50 previously unissued sharesMay 1 Split the stock 2-for-1June 30 Purchased 100 shares for the treasuryJuly 30 distributed a 20% stock dividendDecember 31 Split the stock 3-for-1A) 1,125B) 475C) 270D) 810
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
85. Last year, TUV had 40,000 $15 par, 7 percent, cumulative, convertible preferred shares outstanding. The Board of Directors did not declare a dividend for the current period because all of these shares were converted to common shares on the first day of the period. What is the effect on the numerator of the EPS calculation for this year due to the preferred shares? (Tax rate is 40 %.)A) $0B) Add $42,000C) Subtract $42,000D) Subtract $25,200E) Not determinable from the information given.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO2
86. On January 1, 20x3, WXY had stock warrants outstanding to purchase 6,000 shares at an option price of $10. The common shares' market price was $15 the entire year. The firm has 200,000 common shares outstanding at the end of the year. The effect of the warrants on EPS is to:A) Increase the denominator of all EPS calculations by 6,000 shares.B) Increase the denominator of all EPS calculations by 2,000 shares.C) Affect the diluted EPS calculation, but not the basic EPS calculation.D) Have no potentially dilutive effect on the EPS calculation.E) Increase the denominator of all EPS calculations by 4,000 shares.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
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87. The balance sheet at the beginning of the current year for GHI Inc. reflected the following:Liabilities:
Bonds payable, 7 percent, nonconvertible $400Discount on bonds payable 20
Shareholders' equity:Preferred shares, $20 par, 5 percent cumulative, convertible one for one 300Common shares, no par, 100 shares issued 1,040Retained earnings 28Treasury stock, common (8 shares) 80
No transactions affecting the denominator of EPS occurred during the year. Assume the preferred shares are dilutive. The number of potential common shares to be included in the denominator of fully diluted EPS is:
A) 15.B) 14.C) 13.D) 10.E) 0.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO3
88. At December 31, 20x2, HIJ had 2,000 common shares outstanding. On January 1, 20x3, HIJ issued 1,000 convertible preferred (one share of common for one share of preferred) shares. During 20x3, HIJ declared and paid $4,000 cash dividends on the common and $4,000 cash dividends on the preferred (the annual requirement). Net income for the year ended December 31, 20x3, was $36,000. Assuming an income tax rate of 50 percent, what should be diluted earnings per share for the year ended December 31, 20x3?A) $12B) $16C) $17D) $18
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO3
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89. FGH had 5,000 common shares outstanding on December 31, 20x2. An additional 1,000 common shares were issued on April 1, 20x3, and 500 more on July 1, 20x3. On October 1, 20x3, FGH issued 10, $1,000 maturity value, 7 percent convertible bonds. Each bond is convertible into 40 common shares. No bonds were converted into common shares in 20x3. What was the number of shares that should be used to compute basic earnings per share and diluted earnings per share, respectively, for the year ended December 31, 20x3 (ignore anti-dilution)?A) 5,750 and 5,950 sharesB) 5,750 and 6,150 sharesC) 6,000 and 6,100 sharesD) 6,000 and 6,400 shares
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
90. On January 2, 20x3, CBA issued at par $10,000 of 8 percent bonds convertible into 2,000 of CBA's common shares. No bonds were converted during 20x3. Throughout 20x3, CBA had 2,000 common shares outstanding. CBA's net income after tax was $1,000. CBA's income tax rate is 50 percent. No potentially dilutive securities other than the convertible bonds were outstanding during 20x3. CBA's basic EPS and diluted EPS for 20x3 would be:A) Basic EPS $0.30; diluted EPS $0.45B) Basic EPS $0.50; diluted EPS $0.35C) Basic EPS $0.70; diluted EPS $0.25D) Basic EPS $0.90; diluted EPS $0.15
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO2, 3
91. At December 31, 20x2, BCD had 700 common shares outstanding. On September 1, 20x3, an additional 300 common shares were issued. In addition, BCD had $20,000 of 8 percent,convertible bonds outstanding December 31, 20x2, which are convertible into 400 common shares. No bonds were converted into common shares in 20x3. Net income for the year ended December 31, 20x3, was $6,000. Assuming the income tax rate was 50 percent, what should be the basic earnings per share for the year ended December 31, 20x3?A) $7.50B) $5.67C) $5.00D) $4.33
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO2
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92. The accountant for a firm has computed the numerator and denominator effects for the following potentially dilutive securities outstanding all year, allowing you to determine the D/A ratio of each and to finish the calculation of EPS:Security Numerator DenominatorA $2,000 1,800B 5,000 4,600C 7,000 2,100D 1,000 1,200Basic EPS has been computed as: ($15,000 - $3,000)/3,000 = $4.00.What is the diluted EPS (rounded)?A) $3.10B) $2.05C) $1.89D) $2.13
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO3
93. A firm has correctly computed the following values: (Its shares are trading on the Vancouver Stock Exchange)Basic EPS $4.32
Diluted EPS 4.17Which of the following correctly states the EPS amounts to be reported?A) Basic EPSB) Diluted EPSC) Basic and diluted EPSD) No EPS need be reported
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
94. For purposes of computing the weighted-average number of shares outstanding during the year, a mid-year event that must be treated as occurring at the beginning of the year is the:A) stock split.B) Sale of additional common shares.C) Issuance of stock warrants.D) Purchase of treasury stock.
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95. A company with a simple capital structure would include which of the following in the computation of earnings per share?A) Convertible securitiesB) Number of shares of nonconvertible cumulative preferred sharesC) Dividends on nonconvertible cumulative preferred sharesD) Dividends on common shares
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
96. DCE had 900 common shares outstanding on January 1, 20x3, issued 600 shares on May 1 and had income applicable to common shares of $5,200 for the year ending December 31, 20x3. Earnings per common share for 20x3 would be:A) $5.78B) $4.00C) $3.60D) $3.46
Ans: BDifficulty: Medium
Level of Learning: ApplicationTopic: LO2
97. In determining basic earnings per share, the annual dividend on nonconvertible cumulative preferred shares should be:A) Added back to net income whether declared or not.B) Disregarded.C) Deducted from net income only if declared.D) Deducted from net income whether declared or not.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
98. In determining basic earnings per share, the annual dividend on convertible cumulative preferred shares, which are not a dilutive convertible security, should be:A) Added back to net income whether declared or not.B) Disregarded.C) Deducted from net income only if declared.D) Deducted from net income whether declared or not.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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99. Anti-dilutive convertible securities would generally be used in the calculation of:A) Basic earnings per share.B) diluted earnings per share.C) Basic earnings per share and diluted earnings per share.D) Neither basic earnings per share nor diluted earnings per share.
Ans: D
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO3
100. When computing diluted earnings per share, convertible securities are:A) Incorporated whether they are dilutive or anti-dilutive.B) Incorporated only if they are anti-dilutive.C) Incorporated only if they are dilutive.D) Ignored.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
101. Which one of the following organizations are required to disclose EPS?A) Corporations that do not have share capitalB) Public corporationsC) government-owned corporationsD) Companies with few shareholders
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
102. Steps in calculating diluted EPS include the following except:A) Identify options outstanding at the end of the periodB) Identify any convertible senior debt or shares that actually converted during the period.C) Rank the items from the least dilutive to the most dilutive.D) Determine if the options exercised were in-the-money and thus dilutive.
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103. Transactions that take place in the period between the end of the fiscal year and the financials statement released must be disclosed and described when which of the following happens:A) When a subsequent event would significantly change the number of commons shares or the
potential common shares used in basic or diluted EPS.B) When common shares are issued after the fiscal year end and the proceeds were used to
retire preferred shares.C) When common shares are issued after the fiscal year end for cash, on the exercise of
options.D) All of the above.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
104. ABC Inc. began business on January 1, 20x3. Due to difficulties in getting the business started, 30 common shares were issued on January 1, 20x3 to the organizers and 15 additional shares were sold on that date. The company wanted the market to hear about the shares. Therefore, the following share transactions were implemented during the year 20x3:February 1: 2 for 1 stock split
April 1: 10 percent stock dividendAugust 1: 5 for 1 stock splitDecember 1: 2 for 1 reverse stock splitThe weighted average number of shares outstanding for 20x3 was:A) 64.08 shares.B) 146.25 shares.C) 180.00 shares.D) 247.50 shares.
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
105. FED had 100 common shares issued and outstanding at December 31, 20x2. On July 1, 20x3, FED issued a 10 percent stock dividend. Unexercised stock options to purchase 20 common shares (adjusted for 20x3 stock dividends) at $20 per share were outstanding at the beginning and end of 20x3. The average market price of FED'S common shares (which was not affected by the stock dividend) was $25 per share during 20x3. The ending market price was $30. Net income for the year ended December 31, 20x3, was $2,200. What was FED'S 20x3 basic earnings per share, rounded to the nearest cent?A) $16.92B) $18.33C) $20.00D) $22.00
Ans: CDifficulty: Medium
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106. FED had 100 common shares issued and outstanding at December 31, 20x2. On July 1, 20x3, FED issued a 10 percent stock dividend. Unexercised stock options to purchase 20 common shares (adjusted for 20x3 stock dividend) at $20 per share were outstanding at the beginning and end of 20x3. The average market price of FED'S common shares (which was not affected by the stock dividend) was $25 per share during 20x3. The ending market price was $40. FED earned interest at 8% and had a 50% tax rate. Net income for the year ended December 31, 20x3, was $2,200. What was FED'S 20x3 diluted earnings per share, rounded to the nearest cent?A) $17.05B) $17.17C) $18.47D) $18.60
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO3
107. At December 31, 20x2, BCD had 700 common shares outstanding. On September 1, 20x3, an additional 300 common shares were issued. In addition, BCD had $20,000 of 8 percent convertible bonds outstanding December 31, 20x2, which are convertible into 400 commonshares. No bonds were converted into common shares in 20x3. Net income for the year ended December 31, 20x3, was $6,000. Assuming the income tax rate was 50 percent, what should be the diluted earnings per share for the year ended December 31, 20x3?A) $7.50B) $5.67C) $5.00D) $4.33
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
108. The 20x3 net income of MNO was $300,000, and 100,000 of its common shares were outstanding during the entire year. In addition, outstanding options existed to purchase 10,000 common shares at $10 per share. These options were granted in 20x1 and none had been exercised by December 31, 20x3. MNO earned interest at 8% and had a 50% tax rate. The amount, which should be shown as MNO's basic earnings per share for 20x3, is (rounded to the nearest cent).A) $2.96B) $3.00C) $3.04D) $3.08
Ans: BDifficulty: Medium
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Level of Learning: ApplicationTopic: LO2
109. The 20x3 net income of MNO was $300,000, and 100,000 of its common shares were outstanding during the entire year. In addition, outstanding options existed to purchase 10,000 common shares at $10 per share. These options were granted in 20x1 and none had been exercised by December 31, 20x3. MNO earned interest at 8% and had a 50% tax rate. The amount, which should be shown as MNO's diluted earnings per share for 20x3, is (rounded to the nearest cent).A) $2.69B) $2.73C) $2.76D) $2.80
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
110. At December 31, 20x2, GHI had 400 common shares outstanding. On October 1, 20x3, an additional 100 common shares were issued. In addition, GHI had $40,000 of 8 percent,convertible bonds outstanding at December 31, 20x2, which are convertible into 225 common shares. No bonds were converted into common shares in 20x3. Net income for the year ended December 31, 20x3, was $14,000. Assuming the income tax rate was 50 percent, the basic earnings per share for the year ended December 31, 20x3, should be: (rounded to the nearest cent)A) $24.00B) $25.54C) $32.94D) $36.71
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
111. At December 31, 20x2, GHI had 400 common shares outstanding. On October 1, 20x3, an additional 100 common shares were issued. In addition, GHI had $40,000 of 8 percent, convertible bonds outstanding at December 31, 20x2, which are convertible into 225 common shares. No bonds were converted into common shares in 20x3. Net income for the year ended December 31, 20x3, was $14,000. Assuming the income tax rate was 50 percent, the diluted earnings per share for the year ended December 31, 20x3 should be (rounded to the nearest cent):A) $24.00B) $25.54C) $32.94D) $36.71
Ans: ADifficulty: Medium
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Level of Learning: ApplicationTopic: LO3
112. A firm had 8,000 common shares outstanding at the end of the current period and earned $8,000 that period (net of tax). Also, options to purchase 5,000 shares at $5 each were outstanding all year. For the entire year the firm had $20,000 of 6% debt and $10,000 of 8% debt outstanding. The 8% debt is convertible into 500 common shares. The firm earns interest at 7 percent and has a 50 percent tax rate. The diluted earnings per share for the current year should be (rounded to the nearest cent):A) $1.00B) $.68C) $.69D) $.72
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
113. A firm that earned $20,000 (after tax) had the following securities outstanding all year during, which the tax rate was 40%:20,000 common shares
1,000, 6%, $100 par cumulative nonconvertible preferred shares2,000, 4%, $50 par noncumulative preferred shares, each share convertible into 5 common shares100, 8%, $1,000 convertible bonds, each convertible into 10 common shares (bonds were issued at face)No dividends were paid for the year.The diluted earnings per share for the year should be (rounded to the nearest cent):A) $.70B) $.47C) $.73D) $.86
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
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114. A company had 50,000 common shares and the following 3 convertible securities outstanding the entire year:1. 6%, $100 par cumulative preferred shares, 200 shares outstanding, each convertible into
5 common shares2. 200 6% convertible bonds, face $1,000, each bond convertible into 40 common shares3. 2,000 stock options to purchase one common share each at $40.The company earns interest at 6%. Its net income after tax income was $75,000. The tax rate is 40%. What is the diluted EPS (rounded to the nearest cent):A) $1.39B) $1.40C) $1.45D) $1.48
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO3
115. Assume a company had net income of $20,000 and 8,000 common shares were outstanding the entire year. Also assume there were 2 convertible securities outstanding the entire year:
Effect of Assumed ConversionNumerator Denominator
#1 $8,000 6,000#2 12,000 5,000What is the diluted EPS?A) $2.50B) $2.40C) $2.11D) $2.00
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO3
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116. A company earned $20,000 in 20x3 and had 20,000 common shares outstanding the entire year. The following four potentially dilutive securities were also outstanding the entire year. The numerator and denominator of the D/A ratios are as indicated.
Effect of Assumed ConversionNumerator Denominator
#1 $8,000 12,000#2 4,000 25,000#3 6,000 10,000#4 1,000 12,000What is the diluted EPS?A) $ .44B) $ .32C) $1.00D) $ .81
Ans: ADifficulty: Medium
Level of Learning: ApplicationTopic: LO3
117. LASTEPS Co. had granted 20,000 options to buy one common share at $10 per share several years ago. The company earned $200,000 this year and had 300,000 common shares outstanding the entire year. The company earns interest at 8% and has a 40% tax rate. Given only the above information, what are basic EPS and diluted EPS respectively that should be reported?A) $.67, $.66B) $.65, $.63C) $.63, $.62D) $.65, $.64E) Only basic EPS need be reported
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO3
118. The following information relates to the SPE company in 20x3.Net income: $50,000
Common shares outstanding on January 1: 30,000On June 30 issued 2,000 8% cumulative convertible preferred shares$100 par, each convertible into 10 common sharesIssued a 40% stock dividend on Sept. 30What is the diluted EPS?A) $1.00B) $ .89C) $ .81D) $ .76
Ans: BDifficulty: Medium
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Level of Learning: ApplicationTopic: LO3
119. Earnings for a firm for the current year are $20,000 and the weighted average number of common shares before considering potentially dilutive securities is 18,000. The firm has no preferred shares but has 100, 8%, $1,000 convertible bonds which were issued at face value many years ago. Each bond is convertible into 50 common shares. The tax rate is 40%. Compute EPS to be reported for this firm.A) Basic EPS $1.11 diluted EPS $1.08B) Basic EPS $1.08 diluted EPS $1.08C) Basic EPS $1.11 diluted EPS $1.11D) Basic EPS $1.14 diluted EPS $1.11
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
120. Assume basic EPS has been determined. In determining the diluted earnings per share, the annual dividend on convertible cumulative preferred shares, which are a dilutive convertible security, should be:A) Added back to the numerator of basic EPS whether declared or not.B) Disregarded.C) Added back to the numerator of basic EPS only if declared.D) Deducted from the numerator of basic EPS whether declared or not.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
121. Assume basic EPS has been determined. In determining the diluted earnings per share, the annual dividend on convertible noncumulative preferred shares, which are a dilutive convertible security, should be:A) Added back to the numerator of basic EPS whether declared or not.B) Disregarded.C) Added back to the numerator of basic EPS only if declared.D) Deducted from the numerator of basic EPS whether declared or not.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
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122. At December 31, 20x3 and 20x2, GHI had 90 common shares and 20 convertible preferred shares outstanding, in addition to 9% convertible bonds payable in the face amount of $4,000. During 20x3, GHI paid dividends of $2.50 per share on the preferred shares (the annual requirement). The preferred shares are convertible into 20 common shares. The 9% convertible bonds are convertible into 30 common shares. Net income for 20x3 was $1,940. Assume an income tax rate of 40%. The earnings per share amounts would be:A) Basic $21.00; diluted $15.40B) Basic $21.00; diluted $15.76C) Basic $21.56; diluted $15.40D) Basic $21.56; diluted $15.76
Ans: ADifficulty: Medium
Level of Learning: ApplicationTopic: LO3
123. Choose the correct statement concerning EPS.A) Usually, reported EPS is the actual historical income per weighted average share
outstanding during the periodB) EPS can never be negativeC) If net income is less than zero, all potentially dilutive securities are anti-dilutive.D) All convertible securities must be incorporated into diluted EPS
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
124. What would be the effect on book value per share and earnings per share if the corporation purchased its own shares in the open market at a price greater than book value per share?A) Increase both book value per share and earnings per shareB) Decrease both book value per share and earnings per shareC) Decrease book value per share and increase earnings per shareD) No effect on book value per share but increase earnings per share
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
125. Basic earnings per share represent the amount of earnings attributable to:A) All common shares and dilutive securities.B) Common shares, preferred shares, and all dilutive securities.C) Each common share outstanding, including dilutive securities.D) Each common share outstanding.
Ans: DDifficulty: Medium
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Level of Learning: KnowledgeTopic: LO2
126. In computing EPS, convertible preferred shares may increase the number of shares outstanding:A) In a complex capital structure only if they have been converted.B) Only in a complex capital structure, whether or not they have been converted.C) In a simple capital structure, whether or not they have been converted.D) In a complex capital structure and a simple capital structure, whether or not they have been
converted.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
127. On January 1, 20x1, JMR had 30,000 common shares issued and outstanding. On July 1, JMR sold 500 shares. The net income for the year was $300,000. Calculate the basic earnings per share.Ans:
30,000 x 12/12 = 30,000500 x 6/12 = 250
30,250
EPS = 300,000/30,250= $9.91
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
128. On January 1, 20x1 JMR had 30,000 common shares issued and outstanding. On July 1, JMR sold 500 shares. The net income for the year was $100,000. Calculate the basic earnings per share.Ans:
25,000 x 12/12 = 25,0005,000 x 6/12 = 2,500
27,500=====
EPS = 800,000/27,500= $29.09
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
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129. On January 1, 20x1, KER had 25,000 common shares issued and outstanding. On July 1, KER sold 5,000 shares. The net income for the year was $800,000. Calculate the basic earnings per share.Ans:25,000 x 12/12 = 25,0005,000 x 6/12 = 2,500
27,500
EPS = 800,000/27,500= $29.09
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
130. On January 1, 20x1, KAR had 60,000 common shares issued and outstanding. On July 1, KAR sold 1,000 shares. KAR The net income for the year was $80,000. Calculate the basic earnings per share.Ans:60,000 x 12/12 = 60,0001,000 x 6/12 = 500
60,500
EPS = 80,000/60,500= $1.32
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
131. You calculate basic EPS to be $15.87 and diluted EPS to be $11.65. From a disclosure point, what needs to be disclosed?Ans: Both basic EPS and diluted EPS must be disclosed on the face of the Statement of
Comprehensive Income.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO6
132. You calculate basic EPS to be $15.87 and diluted EPS to be $16.65. From a disclosure point, what needs to be disclosed?Ans: Both basic EPS and diluted EPS must be disclosed on the face of the Statement of
Comprehensive Income.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO6
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133. For earnings per share purposes, the capital structure of the company is classified as either simple or complex. Indicate the types of securities that are included in each category (a complete answer may require more than one letter).Capital StructureA. SimpleB. ComplexC. Simple and ComplexTypes of Securities___ 1 Common shares___ 2. Bonds, convertible to common shares___ 3. Preferred shares, nonconvertible___ 4. Common stock warrants outstanding___ 5. Preferred shares, convertible to common shares
Ans: 1: C, 2: B, 3: C, 4: B, 5: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
134. Given the following information, EPS is, $__________________ .
Net income. $63,750Common shares outstanding, January 1-April 30 10,000May 1, sold and issued common shares 5,000October 1, purchased common treasury shares 3,000November 1, sold and issued common shares 1,000
Ans:EPS: $63,750 ÷ 12,750* = $5.00
=====
*Average shares outstanding: 10,000 x 4 = 40,00015,000 x 5 = 75,00012,000 x 1 = 12,00013,000 x 2 = 26,000
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
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135. On January 1, 20x3, XZC had outstanding 6,000 common shares and 1,000, $3 nonconvertible cumulative preferred shares. On March 1, 20x3, the corporation sold and issued an additional 6,000 common shares. At year-end, there were common stock warrants outstanding for 200 common shares; the option price was $15. The company earns interest at 10% and has a 40% tax rate. Net income was $41,675. Compute the diluted EPS that would be reported and show your computations.
Diluted EPS: $___________________________ .
Ans: Diluted EPS $3.47Computations:Weighted SharesJan. 1 6,000 x 12/12 6,000Mar. 1 6,000 x 10/12 5,000
11,000 shares======
Pref. Dividend1,000 shares x $3 = $3,000
======Warrants income (net of tax)200 x $15 x 10% x (1-.4) = $180
====D/A Warrants $180 ÷ 200 = $.90
====Basic EPS($41,675 - $3,000) ÷ 11,000 = $3.52
Diluted NI ÷ SHARE = EPSBasic $38,675 11,000 $3.52Warrants 180 200
38,855 11,200 $3.47
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
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136. SKZ reported the following capital structure on December 31, 20x3, and the related results of operations for 20x3:Preferred shares, $.50, cumulative, 25,000 shares outstanding all year $250,000Common shares, 10,000 shares outstanding all year 250,000Common stock warrants outstanding (from January 1) for 1,000 common shares 25,000Retained earnings 365,000Net income for 20x3 93,300
Additional data:
(a) Company earns interest at 10%(b) Option price of common shares for holders of common stock warrants, $54.(c) No preferred dividends were declared or paid during 20x3.(d) The tax rate is 40%.
ComputeBasic EPS $___________Diluted EPS $___________Ans:
Basic EPS $8.08Diluted EPS $7.64
Computations:Pref. Dividend 25,000 x $.50 = $12,500
=======Warrant Interest (Net of tax)1,000 x $54 x 10% (1-.4) = $3,240
======Basic EPS (93,300 - 12,500) ÷ 10,000 = $8.08
D/A Warrant $3,240 ÷ 1,000 = $3.24=====
Diluted EPS ($80,800 + $3,240) ÷ (10,000 + 1,000) = $7.64=====
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
137. Calculate the weighted average shares for EPS purposes if a firm started the year with 100 common shares outstanding, reissued 80 treasury shares March 1, split 2 for 1 on April 1, purchased 50 shares for the treasury on July 1, issued a 40% stock dividend on November 1, and issued 120 shares under a stock option plan on December 1.
Ans: WA = {[100 + 80(10/12)] 2 - 50(1/2)} 1.4 + 120(1/12) = 442
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Difficulty: HardLevel of Learning: ApplicationTopic: LO2
138. You are given the following information about JG Ltd.Class A preferred shares, 1,000 shares issued and outstanding; annual dividend rate of $500 per share, cumulative, paid at the end of each quarter; each share is convertible into 40 shares of Class B commonClass B common shares, 80,000 shares issued and outstandingThere are no other senior securitiesNet Income for 20x1, the year of the conversion, is $1,650,000; there are no discontinued operations.All 1,000 shares of Class A are converted into 40,000 Class B shares on October 1 20x1; dividends for the first three quarters of the year were fully paid. Calculate the basic EPS.
Ans: Basic:Net Income $1,650,000Less Preferred dividends 1,000 @ 125 for 3 quarters (375,000)Earnings available to common $1,275,000
========
WACS80,000 common shares x 12/12 $80,0001,000x40x3/12 10,000weighted average $90,000
=====
Basic EPS: 1275 000/90000 = $14.17======
Difficulty: HardLevel of Learning: ApplicationTopic: LO2
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139. You are given the following information about VB Ltd.:Class A preferred shares, 800 shares issued and outstanding; annual dividend rate of $100 per share, cumulative, paid at the end of each quarter; each share is convertible into 50 shares of Class B commonClass B common shares, 90,000 shares issued and outstandingThere are no other senior securitiesNet Income for 20x1, the year of the conversion, is $850,000; there are no discontinued operations.All 1,000 shares of Class A are converted into 40,000 Class B shares on October 1 20x1; dividends for the first three quarters of the year were fully paid. Calculate the basic EPS.
Ans: Basic:Net Income $850,000Less Preferred dividends 800 @ 25 for 3 quarters (60,000)Earnings available to common $790,000
=======
WACS90,000 common shares x 12/12 90,000800x50x3/12 10,000weighted average $100,000
======
Basic EPS: 790,000/100,000 = $7.90====
Difficulty: HardLevel of Learning: ApplicationTopic: LO2
140. You are given the following information about KER Ltd.:30,000 common shares outstanding on January 1, 20x12,000 shares sold on March 1, 20x11,000 shares sold on September 1, 20x12 for 1 Stock split recorded on October 1, 20x1Net Income for the year $340,000
Required:Calculated the basic EPS.
Ans: WACS:January 1 30,000 x 12/12 x 2 60,000March 1 2,000 x 10/12 x 2 3,333September 1 1,000 x 4/12 x 2 667
$64,000=====
EPS:340,000/64,000= $5.31
====
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Difficulty: HardLevel of Learning: ApplicationTopic: LO2
141. You are given the following information about JMR Ltd.:80,000 common shares outstanding on January 1, 20x1
6,000 shares sold on March 1, 20x13,000 shares sold on September 1, 20x13 for 1 Stock split recorded on October 1, 20x1Net Income for the year $1,040,000Required:Calculated the basic EPS.
Ans: WACS:January 1 80,000 x 12/12 x 3 240,000March 1 6,000 x 10/12 x 3 15,000September 1 3,000 x 4/12 x 3 3,000
$258,000======
EPS:1,040,000/258,000= $4.03
====
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
142. You are given the following information about DWWR Ltd.:130,000 common shares outstanding on January 1, 20x1
12,000 shares sold on March 1, 20x111,000 shares sold on September 1, 20x14 for 1 Stock split recorded on October 1, 20x1Net Income for the year $2,340,000
Required:Calculated the basic EPS.Ans: WACS:January 1 130,000 x 12/12 x 4 130,000March 1 12,000 x 10/12 x 4 40,000September 1 11,000 x 4/12 x 4 14,667
$184,667======
EPS:2,340,000/184,667= $12.67
======
Difficulty: HardLevel of Learning: ApplicationTopic: LO2
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143. You are given the following information about DWWR Ltd.:130,000 common shares outstanding on January 1, 20x1
$100,000 8% preferred shares, cumulative, nonconvertible dividends paid at the end of the year12,000 shares sold on March 1, 20x111,000 shares sold on September 1, 20x14 for 1 Stock split recorded on October 1, 20x1Net Income for the year $2,340,000Required:Calculate the basic EPS.Ans: WACS:January 1 130,000 x 12/12 x 4 130,000March 1 12,000 x 10/12 x 4 40,000September 1 11,000 x 4/12 x 4 14,667
$184,667======
EPS:2,340,000-8,000/184,667= $12.63
======
Difficulty: HardLevel of Learning: ApplicationTopic: LO2
144. You are given the following information about KER Ltd.:30,000 common shares outstanding on January 1, 20x1
5,000 preferred shares, no-par, $1.30 (cumulative, nonconvertible) outstanding on January 12,000 shares sold on March 1, 20x11,000 shares sold on September 1, 20x12 for 1 Stock split recorded on October 1, 20x1Net Income for the year $340,000Required:Calculated the basic EPS.Ans: WACS:January 1 30,000 x 12/12 x 2 60,000March 1 2,000 x 10/12 x 2 3,333September 1 1,000 x 4/12 x 2 667
$64,000=====
EPS:340,000-6500/64,000= $5.21
=====
Difficulty: HardLevel of Learning: ApplicationTopic: LO2
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145. What does diluted EPS take into account?Ans: Diluted EPS takes into account the impact on EPS that occurs if the convertible securities
outstanding at the end of the fiscal year are exercised, and all options to purchase shares that are outstanding at the end of the year are exercised.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO 3
146. What does the term anti-dilution mean?Ans: When diluted EPS is calculated, any security that would result in increasing EPS is term
anti-dilutive and should not be used in the calculation.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO 3
147. What is diluted EPS?Ans: Diluted EPS is similar to basic earnings per share but the weighted average number of
shares is adjusted to reflect all of the shares that would be outstanding if the common share entitlements of dilutive convertible senior securities and stock options were issued. The numerator also is adjusted to reflect the potential impact of conversions.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO 3
148. At the beginning of the year, a firm issued (1) $100,000 of 5% bonds (at face value) convertible into a total of 2,000 of the firm's common shares, and (2) $1,000, $9 cumulative preferred shares convertible into a total of 1,000 of the firm's common shares. The tax rate is 40%. There were no conversions during the year; the firm earned $100,000, and had 20,000 common shares outstanding the entire year. Compute basic EPS and diluted EPS.
Basic EPS $__________Diluted EPS $__________
Chapter 19 – Earnings per Share
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Copyright © 2011 McGraw-Hill Ryerson Limited. Page 45
Ans:Basic EPS $4.55
====Diluted EPS $4.27
====
Pref. Dividend 1,000 x $9 = $9,000======
Bond Interest (net of tax) ( 100,000 x 5% x [1-.4]) = $3,000======
D/A Pref. $9,000 ÷ 1,000 = $9.00*Anti-dilutive
D/A Bond $3,000 ÷ 2,000 = $1.50Basic EPS($100,000 - $9,000) ÷ 20,000 = $4.55
Diluted NI ÷ SHARE = EPSBasic $91,000 20,000 $4.55*Bond 3,000 2,000
94,000 22,000 $4.27 ===== ==== =====
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
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149. A company reported the following capital structure on December 31, 2002, and the related results of operations for the year then ended.
Bonds payable, 7%, convertible into common shares at the rate of 40 shares per 1,000 face value of bonds
$200,000
Common shares, no par 500,000 Shares outstanding on January 1-15,000
Shares issued for cash on June 30-1,000Income from continuing operations 193,000Income from discontinued operations (3,000)Net income $190,000
=======
A 2 for 1 stock split was issued on December 31, 2002.The tax rate for the year is 40%.
Show the earnings per share of the company as it would appear on the income statement of the company for 2002. Show all computations.Ans:
Basic EPS Diluted EPSIncome from continuing operations $6.23 $5.16Income from discontinued operations (.10) (.08)Net income $ 6.13 $5.08
===== ====
Computations:Bond interest (net of tax)
$200,000 x 7% x (1-.4) = $8,400======
Shares on conversion($200,000 ÷ $1,000) x 40 = 8,000 shares
======Weighted common sharesJan. 1 15,000 x 12/12 x 2 = 30,000June 30 1,000 x 6/12 x 2 = 1,000
31,000 shares==========
Basic EPS $193,000 ÷ 31,000 = $6.23($3,000) ÷ 31,000 = $(.10)$190,000 ÷ 31,000 = $6.13
Diluted EPS($193,000 + $8,400) ÷ (31,000 + 8,000) = $5.16($3,000) ÷ (31,000 + 8,000) = $(.08)($190,000 + $8,400) ÷ (31,000 + 8,000) = $5.08
* Note: Disclosure on the face of the Statement of Comprehensive Income is NOT required for Discontinued Operations. Under IFRS, these figures may also be presented in the notes to the financial statements.
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Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
150. ABC reported the following capital structure on December 3, 2002, and the related results of operations for the year then ended:Preferred shares, $6, cumulative, convertible into common shares at the rate of two common shares for each share of preferred; 2,000 shares outstanding all year
$ 200,000
Common shares, 10,000 shares outstanding on January 1; 20,000 additional shares issued on January 31 in 200% stock dividend; 10,000 additional shares issued for cash on September 30
2,000,000
Income from continuing operations 195,000Income from discontinued operations 5,000Net income $200,000
=======Show earnings per share of ABC as it should appear on the income statement of the company for 2002. Show all computations.Ans:
Basic EPS Diluted EPSIncome from continuing operations $5.63 $5.34Income from discontinued operations .15 .14Net income $ 5.78 $ 5.48
===== =====
Computations:Pref. Dividends 2,000 x $6= $12,000
=======Shares on Conversion 2,000 x 2= 4,000 shares
=====Weighted Common SharesJan. 1 10,000 x 12/12 x 3 30,000Sept.30 10,000 x 3/12 2,500
32,500 shares=======
Basic EPS ($195,000 - 12,000) ÷ 32,500 = $5.635,000 ÷ 32,500 = $ .15(200,000 - 12,000) ÷ 32,500 = $5.78 =====
Diluted EPS(183,000 + 12,000) ÷ (32,500 + 4,000) = $5.345,000 ÷ (32,500 + 4,000) = .14(188,000 + 12,000) ÷ (32,500 + 4,000) = 5.48====
* Note: Disclosure on the face of the Statement of Comprehensive Income is NOT required for Discontinued Operations. Under IFRS, these figures may also be presented in the notes to the financial statements.
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Copyright © 2011 McGraw-Hill Ryerson Limited. Page 48
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
151. Selected accounting data for JCB for 20x3 were:(a) Common shares, outstanding shares on January 1, 20x3, 80,000.(b) Preferred shares, $.24, nonconvertible; cumulative; outstanding 5,000 shares.(c) Preferred shares, $.15, cumulative; convertible-one share of preferred for two shares of common; outstanding 1,500 shares.(d) Stock options outstanding for 4,000 common shares; option price $20;(e) Bonds payable, 6%; each $1,000 bond is convertible to 50 common shares, par value outstanding $40,000.(f) Net income was $202,400 average income tax rate, 40%.(g) Company earns interest at 5%.
Required: Determine basic and diluted EPS. Ans: $2.51 Basic EPS
====$2.30 Diluted EPS====
Computations:Pref. Dividends
Nonconvertible 5,000 x $.24 = $1,200======
Convertible 1,500 x $.15 = 225===
Interest (net of tax)Stock Rights 4,000 x $20 x 5% x (1.4) = $2,400Bond $40,000 x 6% x (1.4) = $1,440
Shares on conversionPref.1,500 x 2 = 3,000Bond (40,000 ÷ 1,000) x 50 = 2,000
Basic EPS (202,400 - 1,200 - 225) ÷ 80,000 =D/A Pref $225 ÷ 3,000 = $.08D/A Rights $2,400 ÷ 4,000 = $.60D/A Bond $1,440 ÷ 2,000 = $.72
Diluted EPS(200,975 + 225 + 2,400 + 1,440) ÷ (80,000 + 3,000 + 4,000 + 2,000) = $2.30
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test BankChapter 20 – Accounting Changes
1. A change from inventory costed using FIFO to inventory costed using LIFO is an example of a change in accounting principle.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
2. Revised estimates of the useful life or residual value of a depreciable asset are examples of a change in accounting principle.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
3. A change, for depreciation purposes, of either estimated useful life or estimated residual value usually is referred to as a change in accounting estimate.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
4. Accounting policy changes are only justifiable when there is a change to a primary source of GAAP.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
5. Accounting policy changes must always be handled retrospectively.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
6. The failure to expense a prepaid asset is an example of a counterbalancing error.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
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7. Accounting changes reported by using the current approach, require that the "catch-up adjustment" include the effect on earnings in the year of the change.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1, 2
8. If a change in estimate and a change in principal occur on the same item and at the same time, the one that is dominant is reported.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
9. Changes in accounting policy are always voluntary in nature.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
10. A change in the useful life of an asset requires an accounting estimate change, which affects only periods after the change, is made.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
11. When an asset's residual value estimate is changed, the entire depreciation schedule for the asset is recomputed all the way back to the date of acquisition.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
12. A company switching from straight-line depreciation to sum-of-the-years'-digits depreciation should report the change prospectively.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
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13. If a corporation changes from reporting investments on the cost basis to reporting on the equity basis, the prospective approach of reporting must be used.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
14. Some changes in accounting principle must be reported by using the retrospective approach.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
15. A change from a non-GAAP procedure to a GAAP accounting principle usually is referred to as a change in accounting principle.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
16. A change, for depreciation purposes, of either estimated useful life or from one GAAP to another GAAP accounting method, usually is referred to as a change in accounting principle.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
17. A change in accounting principle occurs when a company adopts a principle that is different from a previously used principle that is also generally accepted.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
18. Most changes in accounting principle are recognized by using the current approach.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
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19. A voluntary change in accounting policy is only justifiable when it results information that is both more reliable and more relevant.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
20. A change in accounting principle occurs when a company adopts a principle different from an approved principle previously used.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
21. An overstatement of opening inventory will result in an understatement of operating cash flows in the current period.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4, 5
22. A misstatement of opening inventory is an example of a counterbalancing error.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
23. A change in an accounting estimate should be reported on the financial statements on a retrospective basis.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
24. The fact that most accounting changes are not disclosed may lead to ethical concerns among stakeholders.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO5
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25. If a change in an accounting estimate affects the current period and future periods, the retrospective reporting approach must be used.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2, 3
26. An overstatement of opening inventory will result in an understatement of Cost of Goods Sold and therefore an overstatement of the current period’s earnings.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
27. Change in accounting estimate requires that a "catch-up adjustment" be recorded and reported in the year of the change.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1, 3
28. All changes in accounting estimates should be accounted for only in the period of the change; there is no effect on future periods.
Ans: False
Difficulty: EasyLevel of Learning: KnowledgeTopic: LO3
29. Many changes in accounting estimates are accounted for both in the period of change and in some future period.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3
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30. Changing from an insupportable (bad faith) estimate to a supportable estimate is classified as a change in estimate.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3, 5
31. The correction of an accounting error affecting prior years' income is reported and recorded by using the retrospective approach.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
32. Accounting policy changes may be mandatory or voluntary.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
33. The overstatement of ending inventories in a given year is an example of a counterbalancing error, which will correct itself in the following year.
Ans: True
Difficulty: EasyLevel of Learning: KnowledgeTopic: LO4
34. If a $1,000 purchase on credit last year was not recorded until this year and these goods purchased were not included in any year's ending inventory, the purchase error is counterbalancing.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
35. An understatement of ending inventory will result in a credit to Future Income Taxes.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
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36. If it is impracticable to determine the cumulative effect at the beginning or the current period or, if it is allowed by the creation of a new accounting standard, an accounting change may be applied prospectively
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2, 3
37. If it is not feasible to restate prior period, this means that the financial statements of the current period will not be affected.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2, 3
38. A change in an estimate, which was not determined reasonable (i.e., not in good faith) to a good faith estimate, is accounted for as an accounting error.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3, 5
39. A change in accounting principle occurs when a company adopts a principle different from an inappropriate procedure that was used previously.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO3, 5
40. Accounting errors require the restatement or previous years’ financial statements.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
41. An understatement of accrued wages will, if not corrected, cause income for the current and following reporting period, separately, to be overstated.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
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42. Failure to record depreciation expense in one-year results in what is usually called a counterbalancing error.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
43. With respect to a retrospectively applied change in accounting policy, the effects on prior years’ income is treated as an adjustment to opening retained earnings.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1, 2
44. When an error is discovered, it should be corrected as of the end of the year in which the error was made.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
45. Te failure to accrue revenues for services rendered but not billable until future periods would be considered a self-correcting error.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
46. Failure to record accrued wages at year-end (an adjusting entry) results in what usually is called a counterbalancing error.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
47. An error in the inventory amount recorded involves a self-correcting error.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
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48. An overstatement of opening inventory entails an overstatement of Cost of Goods Sold in the current period.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
49. A retrospectively applied change in accounting policy relating to fixed assets where a company changes from the straight-line amortization method to the double-declining balance method would result in a decrease to opening retained earnings.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
50. When an accounting change is recorded and reported using the retrospective approach, the cumulative effect on Retained Earnings is recorded in that account.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
51. An increase in assets relating to a retrospective change in accounting policy will result in a credit to the related future tax accounts.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
52. On comparative financial statements, all errors must be corrected for each year presented, rather than only for the current year.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
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53. Which of the following is not a change in accounting policy?A) Change in depreciation method from straight-line to declining balance.B) Change from completed contract to percentage of completion.C) Change from LIFO to FIFO.D) Change in depreciation from eight years to five years.E) They are all changes in accounting policy.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
54. A change from an accelerated depreciation method to the straight-line depreciation method should be accounted for as a:A) Change in accounting entity.B) Change in accounting principle.C) Change in accounting estimate.D) Correction of accounting error.E) B or C, depending on the degree of practicality.
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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55. A change from the sum-of-the-years'-digits depreciation method to the straight-line depreciation method should be accounted for as a(n):A) Change in accounting policy.B) Prospective change.C) Change in accounting estimate.D) Accounting error.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
56. When a firm changes only the estimated residual value of equipment,A) Depreciation must be recomputed for each previous year based on the new residualB) The remaining book value, reduced by the new residual value, is the basis for subsequent
depreciationC) The original cost, reduced by the new residual value, is the basis for subsequent
depreciationD) No adjustment is needed
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
57. On January 1, 20x9, JTC changed to the weighted-average cost method from the first-in, first-out (FIFO) cost method for inventory cost flow purposes. JTC can justify the change, which was made for both financial statement and income tax reporting purposes. The change will result in a $120,000 decrease in the beginning inventory at January 1, 20x9. Ignoring income taxes, the cumulative effect of changing to the weighted-average method from the FIFO method must be reported by JTC in the 20x9:A) Income statement as a $120,000 debit.B) Statement of retained earnings as a $120,000 debit adjustment to the beginning balance.C) Income statement as a $120,000 credit.D) Statement of retained earnings as a $120,000 credit adjustment to the beginning balance.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
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58. Which of the following events would require disclosure in the current financial statements?A) Change in the method used to calculate bad debt expenseB) Change from LIFO to FIFO for merchandise inventoryC) Change in the estimated amortization period for an intangible assetD) Change in recording the income for long-term construction contractsE) All of the above
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
59. A change in the unit depletion rate would be accounted for as a:A) Correction of an accounting error.B) Change in accounting estimate.C) Change in accounting principle.D) Change in accounting entity.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
60. Which one of the following statements is not correct?A) A change from an inappropriate accounting principle to a proper one should be accounted
for as an accounting error.B) Assets purchased on the 14th of the month may be depreciated from the first of the month
for practical reasons.C) Depreciation accounting is a process of allocation of periodic expense, rather than one of
asset valuation.D) Use of straight-line depreciation gives a higher total expense than accelerated methods
over the total useful life of the asset.
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
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61. Choose the correct statement regarding accounting changes.A) All changes in accounting principle require a cumulative effect to be recognized in the
income statement.B) Changing from FIFO to LIFO is a retrospective accounting principle change.C) Income statements numbers are required to be disclosed for most accounting principle
changes.D) The amount of the correction for an error affecting previous earnings will be disclosed in
current earnings.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
62. Choose the correct statement.A) A change in estimated useful life for a building should cause a correction to prior years’
retained earnings.B) A change in method of accounting for depreciation should cause an adjustment to current
year's depreciation expense and a Cumulative Effect for the effect of the change on prior year's earnings.
C) An error affecting prior year’s depreciation is treated as a change in estimate.D) A Cumulative Effect will never be accompanied by a related tax effect.
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
63. The concept of consistency is sacrificed in the accounting for which of the following items?A) Change is the estimated salvage value of an assetB) Cumulative effect of change in accounting principleC) Discontinued operationsD) Loss on disposal of a segment of a business
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
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64. Which of the following changes would be accounted for prospectively?A) Changing from declining-balance depreciation to straight-line depreciationB) Change in the expected life of a depreciable assetC) First time presentation of assumption financial statements with the FIFO cost flowD) Error corrections
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
65. Which of the following changes would be accounted for using the approach of a retrospectiveapproach without restatement?A) Change in the estimated life of a depreciable assetB) Change from a non-GAAP accounting method to a GAAP method of accounting for bad
debtsC) Overstatement of unearned revenue of the prior periodD) Change in the method of accounting for long-term construction contractsE) Change to LIFO with previous year's information unavailable
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
66. The effects for a change in accounting principle would usually be reported on the face of the income statement for a change:A) From the straight-line method of depreciation to the declining-balance method.B) From presenting statements for errors which effect only one of the financial statements.C) In the service lives of depreciable assets.D) In the residual value of a depreciable asset.E) None of the above.
Ans: EDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
67. When an accounting change is to be recorded and reported under the retrospective approach, the:A) Retained earnings is adjusted for the cumulative effect of the change.B) Cumulative effect of the change is reported as a special item in the income statement in the
year of the change.C) Effect of the change is spread over the past, current, and future accounting periods.D) Pro forma financial statements for future years must be disclosed.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
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68. The primary principle addressed by recent changes to ASPE and IFRS on accounting changes and error corrections is the:A) Going-concern principle.B) Matching principle.C) Comparability principle.D) Full-disclosure principle.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
69. A change in the salvage value of a depreciable asset should be accounted for as a:A) Change in accounting entity.B) Correction of an accounting error.C) Change in accounting estimate.D) Change in accounting principle.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO3
70. In 20x2, a firm changed from the completed contract (CC) method of accounting for revenue on long-term contracts to the percentage of completion (PC) method. The firm's 20x1 and 20x2 comparative financial statements will reflect which method or methods.
20x1 20x2 1 PC PC 2 CC PC 3 CC CC4 CC either CC or PC
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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71. In 20x2, a firm changed from the straight-line (SL) method of depreciation to double declining balance (DDB) to conform to long-standing industry practice. The firm's 20x1 and 20x2 comparative financial statements will reflect which method or methods.
20x1 20x2 1 SL SL 2 SL DDB 3 DDB DDB 4 SL either SL or DDB
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
72. In 20x2, a firm changed from the FIFO method of accounting for inventory to LIFO based on new experience. The firm's 20x1 and 20x2 comparative financial statements will reflect which method or methods.
20x1 20x2 1 LIFO LIFO 2 FIFO FIFO 3 FIFO LIFO 4 LIFO either LIFO or FIFO
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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73. In 20x2, a firm changed from the LIFO method of accounting for inventory to FIFO to conform to long-standing industry practice. The firm's 20x1 and 20x2 comparative financial statements will reflect which method or methods.
20x1 20x2 1 LIFO LIFO 2 FIFO FIFO 3 LIFO FIFO 4 LIFO either LIFO or FIFO
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
74. Which of the following is treated as a retrospective accounting principle change? (Assume that prior information is available)A) A change in an inventory method for a natural resources companyB) A change in revenue recognition method for a construction companyC) A change from LIFO to FIFOD) Correction of an error affecting prior year incomeE) All of the above
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
75. Which type of accounting change should always be accounted for in current and future periods?A) Change in accounting estimateB) Correction of an errorC) Change in accounting principleD) Change in inventory costing methods
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
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76. Which of the following is characteristic of a change in accounting estimate?A) Requires the reporting of income statements amounts for prior periodsB) Does not affect the financial statements of prior periodsC) Never needs to be disclosedD) Should be reported through restatement of the financial statements
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
77. Which of the following is not an example of a change in accounting estimate?A) Change in the estimated loss rate on receivablesB) Change in the residual value of natural resources subject to depletionC) Change in the expected warranty costs on goods sold under a warrantyD) Change in the expected recovery of a deferred chargeE) Change in the composition of inventory cost
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
78. A change in an amortization rate, such as on a copyright, should be accounted for:A) Retrospectively.B) By recording an amount in retained earnings only.C) Prospectively.D) Currently.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
79. Which of the following is an example of a change in accounting estimate?A) Change from the percentage-of-completion method to the completed-contract method of
income recognition for long-term construction contractsB) Change from capitalizing research and development costs to expensing such costsC) Change from the gross margin method to the retail method of estimating the ending
inventoryD) Change from the LIFO method to the FIFO inventory methodE) Change in the estimate of future warranty costs
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
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80. If the estimated useful life of an asset was originally 10 years and then later changed to 12 years, the effects of this change should be:A) Reported as a special item on the income statement in the year it occurs.B) Spread over the current and future periods.C) Reported and recorded retrospectively, including pro forma financial statements in the year
of change.D) Recorded in an adjustment to the Accumulated Depreciation account and the Retained
Earnings account in the year of change.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
81. Reported income during the early years of the estimated life of a depreciable asset usually would be understated the most as a result of:A) High estimates of residual value and useful life.B) Using actual residual value and actual useful life.C) Low estimate of residual value and useful life.D) Low estimate of residual value and high estimate of useful life.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
82. WZ acquired some machinery on January 2, 20x1. WZ used straight-line depreciation with an estimated life of 15 years with no residual value. On January 1, 20x6, WZ estimated that the remaining life of this machinery was 6 years with no residual value. How should this change be accounted for by WZ?A) Revising future depreciation per year, computed by dividing the book value on January 1,
20x6 by six.B) Revising future depreciation per year, computed by dividing the original cost by six.C) Estimating the effect of the change on each year's net earnings, but maintaining the method
of depreciation as originally determined.D) None of the above.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
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83. A change in the estimated useful life of a buildingA) Is not allowed under ASPE or IFRSB) Affects depreciation on the building beginning with the year of the changeC) Must be handled as a retrospective adjustment to all accounts affected, back to the year of
building acquisitionD) Creates a new account to be recognized on the income statement, and reflects the
depreciation difference up to the beginning of the year of change
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
84. Under which of the following changes would no "catch-up" entry be required, because the remaining accounting value is allocated over the present and future periods?A) Correction of an errorB) Change to new tax lawsC) Change in accounting principleD) Change in accounting estimate
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
85. An accounting clerk working for DBB neglected to record the purchase of merchandise in 20x1, which was, shipped f.o.b. shipping point on December 20, 20x1, and which arrived on December 31. The goods were included in the ending 20x1 inventory. What was the effect on DBB's 20x1 cost of goods sold?A) Cost of goods sold was correct.B) Cost of goods sold was understated.C) Cost of goods sold was overstated.D) Data are not available to determine effect on cost of goods sold.
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
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86. Which of the following types of errors will not self-correct in the next year?A) Accrued expenses not recognized at year-endB) Accrued revenues (but not collected) not recognized at year-endC) Depreciation expense overstated for the yearD) Prepaid expenses not recognized at year-endE) Prepaid revenues (collected in advance) not recognized at year-end
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
87. On December 25, 20x2, JKL ordered merchandise for resale from QRS that cost $7,000 (terms cash within 10 days). QRS shipped the merchandise f.o.b. shipping point on December 28, 20x2, and the goods arrived on January 2, 20x3. The invoice was received on December 30, 20x2. JKL did not record the purchase in 20x2 and did not include the goods in the 20x2 ending inventory. The effects on JKL's 20x2 financial statements were:A) Income and owners' equity were correct; liabilities were incorrect, assets were correct.B) Income and owners' equity were correct; assets and liabilities were incorrect.C) Income, assets, liabilities, and owners' equity were correct.D) Income, assets, liabilities and owners' equity were incorrect.E) No errors because the goods were not on hand.
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
88. In reporting the effect of an accounting change on comparative financial statements, recommended accounting procedure requires that the following be used for correcting an accounting error:A) Prospective application.B) Future application.C) Retrospective application.D) Retrospective, no restatement application.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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89. Which of the following should not be reported retrospectively?A) Use of an unacceptable accounting principle, then changing to an acceptable accounting
principleB) Correction of an overstatement of ending inventory two years agoC) Use of an unrealistic accounting estimate, then changing to a realistic estimateD) Change from a good faith but erroneous estimate to a new estimate
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
90. Which of the following is a counterbalancing error?A) Understated depletion expenseB) Bond premium under-amortizedC) Prepaid expense adjusted incorrectlyD) Overstated depreciation expenses
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
91. If BJC's beginning inventory in the current year is overstated, and that is the only error in the current year, then BJC's income for the current year will be:A) Understated and assets correct.B) Understated and assets overstated.C) Overstated and assets overstated.D) Understated and assets understated.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
92. Which of the following is not an example of an accounting error, as distinguished from a change in accounting principle or change in estimate?A) Misstatement of an accounting value, such as inventory, deferred charge or credit,
liabilities, or owners' equity.B) Incorrect classification of an expenditure as between expense and an asset.C) Incorrect or unrealistic allocations of accounting values.D) Failure to recognize accruals and deferrals.E) Recognition of a gain on disposal of fully depreciated property.
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
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93. Which of the following would cause income of the current period to be understated?A) Capitalizing research and development costsB) Failure to recognize unearned rent revenueC) Changing from LIFO to FIFO for merchandise inventoryD) Understating estimates of asset residual values
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
94. Which of the following would cause income to be overstated in the period of occurrence?A) Overestimated bad debt expenseB) Understated beginning inventoryC) Overstated purchasesD) Understated ending inventory
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
95. XYZ decided to change its depreciation policy by (1) discontinuing to record depreciation on land, and (2) changing the estimated useful life on all autos used in the business from five yearsto four years. Choose the correct statement concerning these two changes:A) Both are changes in accounting principle.B) Both are changes in estimate.C) Both are error corrections.D) One is an error correction, and one is a change in principle.E) One is an error correction, and one is a change in estimate.
Ans: EDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2, 3, 4
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96. MMC changed depreciation methods from straight-line to sum-of-the-years'-digits on two of its machines. Data on the machines are as follows:
Machine Cost Residual Value Useful LifeA $100,000 $4,000 4B $160,000 $10,000 5
If MMC makes the change at the beginning of Year 2 of the life on each machine, what is the total amount of the catch-up adjustment for this change?A) $56,000 debit to Accumulated depreciation.B) $34,400 debit to Accumulated depreciation.C) $34,400 credit to Accumulated depreciation.D) The effects of this change are accounted for prospectively; therefore, a catch-up adjustment
is not recorded.E) $34,400 credit to retained earnings.
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO4
97. A corporation has a machine that cost $100,000, with an estimated useful life of 5 years and a residual value of $25,000. Immediately after the end of the second year, the company decided to change from SYD to straight-line depreciation. The entry to record the change would include an effect on accumulated depreciation which would be a:A) $15,000 debit.B) $15,000 credit.C) $30,000 debit.D) $30,000 credit.
Ans: ADifficulty: Medium
Level of Learning: ApplicationTopic: LO4
98. An asset that cost $66,000 was being depreciated on a SYD basis over 5 years with an estimated residual value of $6,000. After the end of the third year, it was decided to change to straight-line depreciation. What change would be made to the balance of accumulated depreciation?A) $12,000 debitB) $12,000 creditC) $13,200 DebitD) $13,200 credit
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
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99. We have been using straight-line depreciation over the last several years, which has amounted to a total of $20,000 depreciation before tax for those past years. This year we decide to change to units of production, which would have caused $30,000 of depreciation to be recognized in those past years, before tax. The tax rate has always been 40%. This year's depreciation under both methods is:
Straight-Line $5,000Units of Production 6,000
The Cumulative Effect account resulting from this change will decrease net income byA) $ 6,600B) $10,000C) $ 4,000D) $ 6,000
Ans: DDifficulty: Medium
Level of Learning: ApplicationTopic: LO2, 3
100. On July 1, 20x1, PRC purchased a delivery truck for $116,000 cash. Its estimated useful life was 7 years with a residual value of $4,000. Straight-line depreciation is used. On January 1, 20x4, PRC revised the estimated useful life of the truck to 6 years and projected a residual value of $7,400. The accounting period ends December 31. What amount of depreciation should PRC recognize on the truck at December 31, 20x4?A) $16,000B) $18,000C) $19,600D) $20,200
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO2, 3
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101. On January 1, 20x1, MBC purchased a pattern-making machine for $400,000 cash. The machine had an estimated useful life of 25 years and a residual value of $10,000. At the beginning of 20x6, the machine was given a major overhaul, which cost $28,000. The overhaul cost was properly debited to the asset account. The overhaul did not change the estimated residual value but did change the total estimated life to 30 years. The accounting period ends December 31. MBC should recognize 20x6 depreciation of:A) $13,600B) $14,000C) $16,000D) $17,000
Ans: ADifficulty: Medium
Level of Learning: ApplicationTopic: LO2, 3
102. An asset that originally cost $6,000 is being depreciated on the straight-line basis over an estimated useful life of 5 years. The estimated residual value was $1,500. Near the end of year 3, it was decided that better estimates would have been a total life of 6 years and a residual value of $800. Depreciation expense for year 3 would be:A) $900B) $750C) $850D) $825
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
103. The following errors were made in 20x3: An understatement of purchases of $500 and an understatement of ending inventory of $500. The net effect on the 20x3 ending amount of retained earnings is:A) $1,000 understatement.B) $1,000 overstatement.C) no effect, the errors offset.D) No effect, the errors affect income, not retained earnings.E) $500 understatement.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
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104. BVC began operations January 1, 20x1. Financial statements for the year ended December 31, 20x1, and 20x2, contained the following errors:
December 3120x1 20x2
Ending inventory $30,000 overstatedDepreciation expense $12,000 understatedInsurance expense $20,000 overstated $20,000 understated
In addition, on December 26, 20x2, fully depreciated machinery was sold for $21,600 cash, but the sale was not recorded until 20x3.There were no other errors during 20x1 or 20x2, and no corrections have been made for any of the errors.What is the total pretax effect of the errors on 20x2 net income?A) $28,400 overstatedB) $50,000 overstatedC) $53,600 OverstatedD) $71,600 overstated
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO4
105. At the end of the accounting year, December 31, 20x4, adjusting entries were not made for wages that had been earned but not yet paid, $1,800, and rent revenue of $1,400 that had been earned but not yet collected. As a consequence, the 20x4 amount of pretax earnings was:A) Overstated by $3,200.B) Understated by $3,200.C) Overstated by $400.D) Understated by $400.
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO4
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106. The following accounting errors occurred in 20x3, but were not discovered until 20x4:
Purchases for 20x3 overstated by $400Ending 20x3 inventory overstated by 400Depreciation expense for 20x3 overstated by 400
The combined effect of these three errors caused 20x3 pretax income to be:A) Overstated by $400.B) Overstated by $800.C) Understated by $400.D) Understated by $1,200.
Ans: C
. Difficulty: MediumLevel of Learning: ApplicationTopic: LO4
107. The following errors were discovered during January 20x3 (prior to any reversing entries). The accounting period ends December 31.
20x2 Ending inventory overstated $8,00020x3 Insurance premium paid in 20x2 for 20x3 was expensed in full in 20x2 6,00020x2 Accounts receivable overstated 2,000
What effect did these errors have on the 20x2 pretax income?A) Overstated $2,000B) Understated $2,000C) Overstated $1,000D) Understated $1,000
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO4
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108. The following errors were discovered during January 20x3 (prior to any reversing entries):
20x2 Ending 20x2 inventory overstated $4,00020x2 Annual insurance premium paid in advance at the end of 20x2; expensed in full in 20x2
3,000
20x2 Accounts receivable ending balance (from sales) overstated 1,000
The accounting period ends December 31. What effect would these errors have on 20x3 pretax income?A) Overstated $2,000B) Understated $2,000C) Overstated $1,000D) Understated $1,000
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
109. The only errors BGC made were in the valuation of ending inventory amounts. As a result, in 20x3, cost of goods sold was overstated by $1,000. In 20x4, cost of goods sold was understated by $500. What ending inventory error was made at the end of 20x4?A) Understated $500B) Overstated $500C) Overstated $1,500D) Overstated $1,000
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO4
110. An asset that costs $4,000 on January 1, 20x1, is being depreciated on the basis of a 10% straight-line rate. On January 1, 20x2, an ordinary repair of $600 was debited to the asset account and also was depreciated in the same way. As a result, 20x2 pretax income was:A) Overstated $600.B) Understated $600.C) Overstated $540.D) Understated $60.
Ans: C
Difficulty: MediumLevel of Learning: ApplicationTopic: LO4
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111. Reported income for CXC was incorrect due to two errors. One error was the overstatement of ending inventory by $2,000. Which of the following errors, in combination with the inventory error, could cause income to be overstated by $2,500?A) Purchases were understated $4,500B) Beginning inventory was understated $500C) A prepaid expense of $500 was capitalizedD) Accounts receivable was overstated $4,500E) Expenses were overstated by $500
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
112. The errors listed below occurred in 20x3 but were not discovered until much later in 20x4. The accounting period ends December 31.Purchases understated $400Ending inventory overstated 400Rent expense overstated 400What net effect did these errors have on 20x3 pretax income?A) Overstated by $400B) Overstated by $800C) Understated by $400D) Understated by $1,200
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO4
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113. The GXC made the following errors during 20x1, its first year of operations: Recorded $800 of interest expense as a debit to prepaid expense and a credit to cash. Recorded $2,000 of unearned revenue as a debit to revenue receivable and a credit to revenues.No adjusting entries were made related to these transaction entries.The effect of these errors is as follows: 20x1:
Pretax Income Current Assets 1 Understated $1,200 overstated $2,800 2 Overstated $2,800 overstated $2,800 3 Overstated $2,800 overstated $2,000 4 Overstated $1,200 overstated $2,800
A) Choice 1B) Choice 2C) Choice 3D) Choice
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
114. MGC reported $50,000 in income for 20x2. The following deferrals and accruals were not recorded in the 20x1 and 20x2 adjusting entries:
End of End of20x1 20x2
Prepaid interest $1,000 $0Unearned rent revenue (collected in advance) 300 800MGC's correct 20x2 income was:A) $51,300B) $50,500C) $49,300D) $48,500
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
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115. At the beginning of the current year, a capital expenditure of $24,000 for equipment with an estimated useful life of six years (and no residual value) was debited erroneously to maintenance expense. Straight-line depreciation is used. This error will cause the current year's ending retained earnings to be:A) Overstated by $4,000.B) Understated by $28,000.C) Understated by $24,000.D) Understated by $20,000.
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
116. The correction of an error in the financial statements of a prior period should be reflected, net of applicable income taxes, in the current:A) Income statement after income from continuing operations and before discontinued
operations.B) Income statement after income from continuing operations and after discontinued
operations.C) Statement of retained earnings as an adjustment of the opening balance.D) Statement of retained earnings after net income but before dividends.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
117. When a cumulative effect type change in accounting principle is made during the year, the cumulative effect on retained earnings is determined:A) During the year using the weighted-average method.B) As of the date of the change.C) As of the beginning of the year in which the change is made.D) As of the end of the year in which the change is made.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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118. An example of a special change in accounting principle that should be reported by restating the financial statements of prior periods is the change from the:A) Straight-line method of depreciating plant equipment to the sum-of-the-years'-digits
method.B) sum-of-the-years'-digits method of depreciating plant equipment to the straight-line
method.C) FIFO method of inventory valuation to the LIFO method.D) All of the above.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
119. A change in the salvage value of an asset depreciated on a straight-line basis and arising because additional information has been obtained is:A) An accounting change that should be reported in the period of change and future periods if
the change affects both.B) An accounting change that should be reported by restating the financial statements of all
prior periods presented.C) A correction of an error.D) Not an accounting change.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
120. The records of CTC reported rent expense for 20x5 (paid in cash during 20x5) of $53,500. An audit revealed that the following accrued and prepaid amounts were not recorded in the adjusting entries for 20x4 and 20x5:
End of 20x4 End of 20x5Accrued rent expense $6,000 $ 3,500Prepaid rent expense $7,000 $11,500
What amount should have been reported for 20x5 rent expense?A) $46,500B) $53,500C) $60,500D) $64,000
Ans: A
Difficulty: MediumLevel of Learning: ApplicationTopic: LO4
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121. The 20x4 income of MXC was understated by $3,000. This was due to three separate errors. One error was the overstatement of purchases by $2,000; the second error was the understatement of depreciation expense by $1,000. Which of the following errors, in combination with the other two, would cause the $3,000 understatement of income?A) These two errors alone caused the misstatementB) Prepaid expenses was overstated $2,000C) Revenue earned but not yet collected of $2,000 was not properly recognizedD) Interest expense was understated $2,000
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
122. Which of the following changes would be disclosed as a change in accounting principle but reported by applying the new method retrospectively as restatements of prior periods?A) Change from the first-in, first-out method to the last-in, first-out method of inventory
pricingB) Change in the composition of elements included in inventoryC) Change from completed-contract accounting to percentage of completionD) Change from the straight-line method to an accelerated method of depreciation
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
123. A firm, in business just a few years, decided to change from FIFO to LIFO for inventory measurement purposes. The firm carries only a few items of inventory, but sells in large volume. An excellent historical record is kept of inventory purchases, quantities and costs. In making the accounting change, the firmA) Must report the cumulative effect of the change on all previous years' incomeB) Need not report the cumulative effect of the change on all previous years' income even
though it is able to do soC) Cannot make the change unless it is able to determine the cumulative effect of the change
on all previous years' incomeD) Should report the cumulative effect of the change on all previous years' income if it is not
prohibitively expensive to do so
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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124. A retailing firm changed from FIFO to LIFO in 20x6. Beginning inventory in the year of the change is $300,000. After weeks of part-time work by the accounting department, it has become apparent that, had LIFO been used in previous years, many layers of inventory would exist reflecting costs from several years in the past. The information required to determine the cost of these layers is difficult if not impossible to obtain. Therefore, in terms of making the change, the firmA) May make the change, use $300,000 as the beginning inventory under LIFO, and disclose
the effect of the change on 20x5 and 20x6 earningsB) May make the change, use $300,000 as the beginning inventory under LIFO, and disclose
the effect of the change on 20x6 earningsC) May not make the change, because the cumulative effect on all previous years' income is
not feasibly determinableD) May make the change, and report a reasonable estimate of the cumulative effect on all
previous years' income in the income statementE) May make the change, and report a reasonable estimate of the cumulative effect on all
previous years' income as an adjustment to the beginning 20x6 balance of retained earnings
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
125. When a firm changed its method of accounting for inventory from LIFO to FIFO in 20x4, it decided that the 20x4 financial statements should be shown comparatively with 20x3 results. Choose the correct statement concerning reporting the change in the retained earnings (RE) statement.A) There is no direct adjustment to RE because earnings for both years has been adjusted to
reflect the changeB) Only the 1/1/x3 RE balance is adjusted for the effects of the change on earningsC) Only the 1/1/x4 RE balance is adjusted for the effects of the change on earningsD) Both the 1/1/x3 and 1/1/x4 RE balances are adjusted for the effects of the change on
earnings before those respective dates
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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126. The September 30, 20x1, physical inventory of JCB appropriately included $3,800 of merchandise purchased on account, which was not recorded in purchases until October 20x1. What effect will this error have on September 30, 20x1, assets, liabilities, retained earnings, and earnings for the year then ended, respectively?A) Understate; no effect; overstate; overstateB) No effect; overstate; understate; understateC) No effect; understate; overstate; overstateD) No effect; understate; understate; overstate
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
127. The ending inventory of XZW was overstated by $6,000 in 20x4. The overstatement will cause XZW's:A) Retained earnings to be understated on the 20x4 balance sheet.B) Cost of goods sold to be understated on the 20x5 income statement.C) Cost of goods sold to be overstated on the 20x4 income statement.D) Income to be overstated on the 20x5 income statement.E) No misstatements on the 20x5 balance sheet.
Ans: EDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
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128. A retailing firm changed from LIFO to FIFO in 20x5. Inventory valuations for the two methods appear below:
1/1/x4 1/1/x5 12/31/x5FIFO $10,000 $20,000 $25,000LIFO 7,000 16,000 18,000
Purchases in 20x4 and 20x5 were $60,000 in each year. In the comparative 20x4 and 20x5 income statements, what amounts would be shown for cost of goods sold?
20x4 20x5 1 $50,000 $58,000 2 $51,000 $55,000 3 $50,000 $55,000 4 $51,000 $58,000
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO2
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129. A firm changed from completed contract to percentage of completion for revenue recognition on long-term construction contracts in 20x7. This change had the following effects on earnings:Increase in earnings
20x7 $20,00020x6 30,000
All years before 20x6 100,000By what amounts are the beginning retained earnings balances for 20x6 and 20x7 adjusted, if the 20x6 and 20x7 statements are shown comparatively.
20x6 20x7 1 $130,000 $150,000 2 $100,000 $130,000 3 $100,000 no adjustment 4 no adjustment $130,000 5 no adjustment no adjustment
A) Choice 1B) Choice 2C) Choice 3D) Choice 4E) Choice 5
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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130. Jenell Inc. decides to change its method of accounting for inventory from LIFO to FIFO, for accounting purposes only in 20x1. Data for Jenell:
Retained earnings, January 1, 20x0 $160,000Income tax rate 30%
Effect of change on pretax net income in:
20x1: $20,000 increase20x0: 30,000 increase
Years before 20x0 in total: $120,000 increase
20x0 net income (after tax) under LIFO $80,00020x1 net income (after tax) under LIFO 105,000
The entry to record the accounting change will include which of the following.A) cr. expense $105,000B) cr. retained earnings $105,000C) cr. cumulative effect of change in accounting principle $105,000D) dr. retained earnings $150,000
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
131. A plant asset was purchased for $19,000 on 1/1/x0 with a residual value of $2,000 and useful life of five years. In 20x3, the total useful life is re-estimated to be seven years and the estimated salvage value is assumed to be zero. Sum of year's digits depreciation is used. What is depreciation expense in 20x3?A) $2,340B) $2,160C) $1,350D) $1,210
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO3
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132. Depreciation expense for the most recent fiscal year on equipment purchased a few years ago is $10,000. The balance sheet at the end of the same year disclosed the following:
Equipment $300,000Accumulated depreciation (40,000)Net book value $260,000
The asset is not expected to have a salvage value and the firm depreciates the asset on the straight-line basis. In March of the NEXT year (the year of change), the firm decided to reduce the original total useful life 20% and that a salvage value of $30,000 is a reasonable estimate. What is depreciation in the year of the change?A) $11,500B) $13,000C) $10,000D) $12,000E) $12,500
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO3
133. Super-Mineral began operations last year (year 1) on a mineral tract and expected a yield of 2,000,000 tons of a valuable ore used in the semiconductor industry. The total balance in the Depletion Base account (or "Natural Resources" account) was $2,000,000 before any depletion was recognized. During year 1, 400,000 tons of the ore were removed. Then, early in year 2, a new vein of ore was discovered holding an estimated additional 1,600,000 tons of ore. 800,000 tons were removed in year 2. What is depletion in year 2?A) $1,600,000B) $ 800,000C) $ 600,000D) $ 400,000
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
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134. In 20x4, a firm discovered that $10,000 of equipment purchased on 1/1/x1 was expensed in full. The equipment has a ten-year life, has no residual value, and should have been depreciated on the straight-line basis. The error is corrected. As a result, the comparative 20x3 and 20x4 financial statements will show what amounts as adjustments to the beginning balances of retained earnings dated:
1/1/x3 1/1/x41 $7,000 $7,000 2 $8,000 0 3 0 $7,000 4 $8,000 $7,000
A) Choice 1B) Choice 2C) Choice 3D) Choice 4
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
135. Which of the following combinations of errors would cause a $2,000 overstatement of pretax income?A) $4,000 overstated beginning inventory and $2,000 understated ending inventoryB) $4,000 understated beginning inventory and $2,000 understated ending inventoryC) $4,000 overstated ending inventory and $2,000 understated depreciation expenseD) $4,000 understated depreciation expense and $2,000 understated beginning inventory
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO4
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136. On January 1, 1999, Ryan Ltd. purchased equipment for $30,000 cash. Ryan Ltd's fiscal year end is December 31. At the time of acquisition, the equipment was expected to last 8 years and had an estimated salvage value of $1,200. Ryan Ltd. uses the straight-line method to depreciate its assets. On January 1, 2000, Ryan Ltd. changed its total estimated useful life of the vehicle from 8 years to 5 years and the estimated salvage value was changed to $2,000. Prepare the journal entry to record the depreciation on December 31, 2000.Ans: Original depreciation = ($30,000-$1,200)/8 = $3,600
January 1, 2000 NBV = 30,000- $3,600 = $26,400Revised depreciation = ($26,400-$2,000)/5 = $4,880
Depreciation expense $4,880 Accumulated depreciation $4,880
Difficulty: MediumLevel of Learning: ApplicationTopic: LO3
137. Match each example with the type of accounting change (or error) by entering a letter in each blank space to the left of the statement.Type of ChangeA. Accounting error correction.B. Change in accounting principle.C. Change in accounting estimate.D. None of the above.
Example___ 1. Change from percentage-of-completion to completed-contract method of
accounting for long-term construction contracts.___ 2. Change of the expense groupings included in combined financial statements.___ 3. Change in the expected warranty cost on goods sold under guarantee.___ 4. Change from a "bad faith" accounting estimate to a realistic estimate.___ 5. Change from expensing certain costs to capitalizing the costs and depreciating
them.
Ans: 1: B, 2: D, 3: C, 4: A, 5: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1-4
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138. Match the kind of change with each event by entering the appropriate letter in the blanks provided.Kind of ChangeA. Error correction.B. Change in principle.C. Change in estimate.Event___ 1. Change of inventory costing method from FIFO to average cost.___ 2. Debited the cost of a machine to expense when acquired.___ 3. Change of residual value from $2,000 to $3,000.___ 4. Forgot to record prepaid insurance, $600.___ 5. Change the estimated useful life of a depreciable asset from 5 years (not a good faith
estimate) to a 15-year reliable estimate.
Ans: 1: B, 2: A, 3: C, 4: A, 5: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO1-4
139. Enter a check mark on each line to indicate the proper classification of each example listed to the left.
Acct. Estimate Acct.Principle Change ErrorChange Correction
(a)Change in amortization period for a patent ______ ______ ______(b)Changed from completed contract to percentage-of-completion for long-term construction contract
______ ______ ______
(c)Change in residual value for depreciation ______ ______ ______(d)Change from FIFO to LIFO for inventory ______ ______ ______(e)Discovered mistake in computing depreciation expense which was made 3 years ago
______ ______ ______
Ans:(a) _____(b) __X__(c) _____ (d) __X__(e) _____
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140. There are three kinds of accounting changes (including error corrections) as follows:A. Correction of an accounting error.B. Change in accounting principle.C. Change in accounting estimate.D. None of the above.In the space to the left, enter one of the above letters to indicate the classification of the item in terms of the kind of change involved (enter A, B, C, or D).___ 1. Changed from straight-line to declining-balance depreciation method.___ 2. Used a non-GAAP procedure to record a transaction.___ 3. Debited an expense amount to an operational asset account.___ 4. For depreciation purposes, changed either useful life and/or residual value.___ 5. During the current year, Company P acquired 90% of the common voting
stock of Company S.___ 6. Changed from "bad faith" insupportable estimate of bad debt losses to a
"good faith" supportable estimate.___ 7. Changed from a non-GAAP procedure to a GAAP procedure.
Ans: 1: B, 2: A, 3: A, 4: C, 5: D, 6: A, 7: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO1-4
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141. For each item listed below, enter a check mark under the appropriate column to indicate the proper accounting treatment. Explain how any item should be handled that does not correspond with any one of the three treatments listed.
Accounting TreatmentItem Retrospective no restate Prospectively Retrospective
(a) Change from percentage-of-completion tocompleted contractmethod for long-termconstruction.
(b) Changed amortization ofgoodwill from 40 yeartotal life to 25 yeartotal life.
(c) Change in the amount ofthe residual value of anoperational asset.
(d) Change the estimateduseful life from a "badfaith" estimate to a"good faith" estimate.
(e) Change from a non-GAAPaccounting approach to aGAAP approach.
(f) Change from straight-line to declining-balance depreciation.
(g) A change from weightedaverage inventory costflow method to LIFO.
(h) A change in theestimated useful lifeof an operational asset.
(i) Correction of anaccounting error in aprior period; recordingdepletion.
(j) Change from LIFO to FIFOfor inventory costing.
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Ans:(a) Retrospective (f) Current(b) Prospectively (g) Current(c) Prospectively (h) Prospectively(d) Retrospective (error) (i) Retrospective (error)(e) Retrospective (error) (j) Retrospective
Difficulty: HardLevel of Learning: ApplicationTopic: LO1-4
142. Match each example with the type of accounting change or error correction.Type of Change or Error CorrectionA. Accounting error correction.B. Change in accounting principle.C. Change in accounting estimate.D. None of the above.Example___ 1. Change from FIFO to LIFO.___ 2. Change due to understatement of inventory.___ 3. Change due to differences in asset groupings on prior statements.___ 4. Change in rate used to compute doubtful accounts.___ 5. Change from percentage-of-completion to completed contract method on
construction contracts.___ 6. Change in definition of cash equivalents on statement of cash flows.___ 7. Change in residual value of an operational asset.___ 8. Change due to failure to recognize a prepaid expense.___ 9. Change because of deliberate understatement of useful life of operational
asset.
Ans: 1: B, 2: A, 3: D, 4: C, 5: B, 6: B, 7: C, 8: A, 9: ADifficulty: HardLevel of Learning: ApplicationTopic: LO1-4
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143. Listed below are a number of errors. Indicate the effect of each error on the reported net income for 20x1 and 20x2; use an "X" to respond.
20x1 Net Income was: 20x2 Net Income was:Over Under No Over Under No
Errors stated stated Eff. stated stated Eff.20x1:(a)Ending inventoryunderstated.
(b)Accrued wagespayable not recordedat year-end.
(c)20x1 purchase notrecorded until 20x2,included in 20x1 inv.
(d)Unearned rentrev. not recognizedat year-end.
(e)Prepaid insurancenot recorded; the fullamount of insurancepremium was reported(as expense in 20x1).
20x2:(f)Ending inventoryoverstated.
(g)Patent not amort.at year-end.
(h)Accrued interestrevenue (earned) notrecorded at year-end
(i)December salesreturn for credit notrecorded in 20x2.
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(j)Beginning inv.understated.Ans: Over Under No Over Under No
Errors stated stated Eff. stated stated Eff.(a) 200x1 Ending inventory understated. X X
(b) Accrued wages payable not recorded at year-end.
X X
(c) 20x1 purchase not recorded until 20x2 included in 20x1 inv.
X X
(d) Unearned rent rev. not recognized at year-end.
X X
(e) Prepaid insurance not recorded; the full amount of insurance premium was reported (as expense in 20x1).
X X
(f) 20x2: Ending inventory overstated. X X(g) Patent not amort. at year-end. X X(h) Accrued interest revenue (earned) not recorded at year-end.
X X
(i) December sales return for credit not recorded in 20x2.
X X
(j) Beginning inv. understated. X X
Difficulty: HardLevel of Learning: ApplicationTopic: LO1-4
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144. In 20x1, an asset was purchased for $45,000 and has been depreciated using sum-of-the-years'-digits based on an estimated useful life of five years and no residual value. In 20x3 (before the adjusting and closing entries), the company decided to change to straight-line depreciation. The estimated useful life was not to be changed.
(a) Give the entry required when the decision was made.(b) Give the entry for depreciation expense for 20x3.Ans: (a)
Accumulated depreciation 18,000 Cumulative effect of change in accounting principle 18,000
Depreciation taken, 90,000 x 9/15 $54,000Depreciation under new method: $90,000 x 2/5 36,000Change in accumulated depreciation $18,000
======(b)Depreciation expense 18,000 Accumulated depreciation($90,000 x 1/5 = $18,000) 18,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO3
145. An asset that cost $49,500 was being depreciated on a sum-of-the-years'-digits basis over five years with an estimated residual value of $4,500. After the end of the third year, it was decided to change to straight-line depreciation (ignore income taxes).(a) Give any required entry as of the beginning of year 4.(b) Give the adjusting entry to record depreciation at the end of the fourth year, taking into account the new decision.Ans: (a)
Entry to record the accounting change: Accumulated depreciation 9,000 Cumulative effect of accounting change 9,000
SYD: $45,000 x 12/15 =$36,000Straight-line: $45,000 x 3/5 = 27,000 Difference $ 9,000
=======(b)Adjusting entry: Depreciation expense 9,000 Accumulated depreciation 9,000($49,500 - $4,500) ÷ 5 years =$9,000
=====
Difficulty: HardLevel of Learning: ApplicationTopic: LO3
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146. A firm changes from accelerated depreciation to straight-line depreciation in 20x1:Depreciation: Total before 20x1 20x1Accelerated $4,200 $400SL 3,600 300Provide the 20x1 entries to record the accounting change and to record 20x1 depreciation expense, ignoring taxes.Ans:Accumulated depreciation 600 Cumulative effect of accounting change 600Depreciation expense 300 Accumulated depreciation 300
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
147. An asset cost $190,000; it is being depreciated, straight-line, $30,000 residual value, over 10 years. At the start of Year 7, it was decided that the residual value should be $14,000. Give the entries required on the following dates (if none explain why):January 1, Year 7:December 31, Year 7:Ans: January 1, Year 7:
None - a change in estimate; accounted for prospectively.December 31, Year 7:
Depreciation expense 20,500 Accumulated depreciation 20,500
Cost $190,000Depreciation to date ($190,000 - $30,000). x 6/10 96,000Revised residual value (14,000)To be depreciated $ 82,000
=======Annual depreciation $82,000 ÷ (10 - 6) $ 20,500
======= Difficulty: HardLevel of Learning: ApplicationTopic: LO3
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148. KEC has a machine that cost $75,000 (no residual value) that was being depreciated over a 15-year estimated life, using SL. On the basis of more experience, during the 9th year, management decided to use a revised total estimate of 20 years.(a) What kind of accounting change does this represent?___________.(b) Give entry in 9th year to reflect the change; if none is required, explain.(c) Give the depreciation entry (year-end adjusting entry) for the 9th year. Show computations.Ans: (a) Change in estimate.
(b) None required for a change in estimate. The effects are reflected prospectively.(c) Depreciation expense 2,917 Accumulated depreciation 2,917Computations:
Undepreciated balance: $75,000 x 7/15 = $35,000.Depreciation per period: $35,000 ÷ 12 years = $2,917.
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
149. An asset cost $12,000 when acquired and had an estimated useful life of 10 years with no estimated residual value. Use straight-line depreciation. During Year 7, the overall life was changed to 12 years.(a) What should be recorded as depreciation expense for Year 7? $_________________________.
(b) What would the balance of accumulated depreciation be at the start of Year 8? $_____________________________
(c) Would a correcting entry be made during Year 7 for the change?Yes____________ No______________ Explain why. _______________Ans: (a)
$12,000 ÷ 10 years = $1,200.$1,200 x 6 years = $7,200.$12,000 - $7,200 = $4,800; $4,800 ÷ (12 - 6 years) = $800.
====(b) $7,200 + $800 = $8,000.(c) No. There is a change in accounting estimate; depreciate remaining undepreciated balance over remaining life.
Difficulty: HardLevel of Learning: ApplicationTopic: LO2, 3
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150. On January 1, 20x1, DB purchased equipment that cost $48,000. It was depreciated on the straight-line basis for the years 20x1, 20x2 and 20x3 (estimated useful life 5 years and no residual value). During early 20x4, DB changed the estimated total useful life to 7 years and the residual value to $3,200 at the end of year 7.(a) Give any entry required during 20x4 by DB to reflect the change. If none is required, explain why.(b) Give the adjusting journal entry required on December 31, 20x4.Ans: a. None - This is a change in estimate.
b. Depreciation expense........................... 4,000 Accumulated depreciation...................... 4,000 $48,000 - $28,000* - $3,200 = $16,000 ÷ 4 = 4,000_________*$48,000 x 3/5 = $28,800
Difficulty: HardLevel of Learning: ApplicationTopic: LO3
151. An asset that cost $9,000 on January 1, 20x1, was being depreciated using the straight-line method over five years with an estimated residual value of $1,500. At the beginning of 20x3, the company decided to use a six-year life and a residual value of $600.(a) Give any correcting entry at January 1, 20x3.(b) Give the 20x3 adjusting entry to record depreciation.Ans: (a) This is a change in estimate; therefore, no correcting entry is needed.
(b)Adjusting entry:Depreciation expense 1,350 Accumulated depreciation 1,350
Undepreciated balance $9,000 - ($1,500 x 2) $6,000New residual value 600Balance to be depreciated $5,400 Depreciation expense: $5,400 ÷ 4 years = $1,350
===== Difficulty: HardLevel of Learning: ApplicationTopic: LO3
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152. The following accounting errors occurred in 20x1; they were discovered in 20x2: Purchases for 20x1 overstated by $600; ending 20x1 inventory overstated by $600; and depreciation expense for 20x1 overstated by $600. The combined effect of these errors caused 20x1 pre-tax income to be:
Overstated by $________ ; or Understated by $________ ; or NoEffect________.
Computations:Ans: Pretax income: Understated by $600. (Purchases, understatement,$600; ending inventory
overstatement, $600; depreciation expense, understatement, $600.)Difficulty: HardLevel of Learning: ApplicationTopic: LO4
153. The records of CDF reflected the following data for 20x1:Cash paid during 20x1 for expenses, $10,000.
January 1 December 31Prepaid expenses not recognized at year-end $600 $800Accrued expenses not recognized at end of prior year $60 $200The amount of expense that CDF should report on the 20x1 income statement is $_____________________.Ans: $10,000 + ($200 - $60) - ($800 - $600) = 9,940.Difficulty: HardLevel of Learning: ApplicationTopic: LO3
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154. Following are five separate and completely independent cases:CASE A: A $700 item was excluded incorrectly from the ending inventory; the related purchase was not recorded.CASE B: A $200 item was included incorrectly in the ending inventory; the related purchase was recorded.CASE C: A $900 item was included incorrectly in the ending inventory; the related purchase was not recorded.CASE D: A $500 item was excluded incorrectly from ending inventory; the related purchase was recorded.CASE E: The beginning inventory was overstated by $400.Enter dollar amounts where appropriate in the following tabulation to indicate the effect on the financial statements of each of the items given above (disregard income tax).
CASE A CASE B CASE C CASE D CASE EItem Over Under Over Under Over Under Over Under Over UnderBal. sheet Inventory
$ $ $ $ $ $ $ $ $ $
Otherassets
Accts.payable
Retainedearnings
Inc. state Sales
Beg. inv.
Purchases
End. inv.
Inc.(net)
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Ans:CASE A CASE B CASE C CASE D CASE E
Item Over Under Over Under Over Under Over Under Over UnderBal. Sheet: $ $700 $200 $ $900 $ $ $500 $ $InventoryOther assetsAccts. pay. 700 200Ret. earnings 900 500Inc. StatementSalesBeg. inv. 400Purchases 700 200Ending inv. 700 200 900 500Income (net) 900 500 400
Difficulty: HardLevel of Learning: ApplicationTopic: LO4
155. Give the correct response to each of the following events:(a) An overstatement of accrued wages payable by $2,000 at the end of 20x1 would cause retained earnings at the end of 20x2 to be _____ overstated; _____ understated; _____ correct (assuming no correcting entry).(b) A $6,000 purchase of merchandise on credit in 20x1 was not recorded in 20x1; but it was recorded in 20x2 when the cash was paid. It was discovered during 20x3. The merchandise was not included in the 20x1 ending inventory. Therefore, 20x1 income was: _____ overstated; _____ understated; _____ correct.(c) The 20x2 ending inventory was overstated by $4,000 and no correcting entry has been made. Therefore the 20x3 net income is: _____ overstated; _____ understated; _____ correct.
Ans: (a) Correct; the error self-corrected at the end of 20x2.(b) Correct; the two errors (purchases and ending inventory) offset in 20x1.(c) Understated; because the beginning 20x3 inventory was overstated.
Difficulty: HardLevel of Learning: ApplicationTopic: LO2-4
156. On January 1, 20x3; a company purchased an operational asset for $44,000. At the date of purchase, the full amount was debited to expense. At the end of 20x6, the audit discovered this error. The asset had no residual value and should be depreciated over 10 years, using the sum-of-years'-digits method. Give the entry at the end of 20x6 to correct the accounts. Assume the accounts for 20x6 have not been closed.
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Ans: Asset 44,000Depreciation expense 5,600 Accumulated depreciation 27,200 Retained earnings, error correction 22,400$44,000 x 7/55 = $5,600.$44,000 x 34/55 = $27,200.
Difficulty: HardLevel of Learning: ApplicationTopic: LO2
157. The records for OTC showed the following for 20x2:January 1 December 31
Prepaid expenses. $260 $300Accrued expenses 100 30
Cash paid during the year on expenses, $4,000.The amount of expense that should be reported on the income statement is: $__________________________.Ans:$4,000 - $300 - $100 + $30 + $260 = $3,890.
=====
Difficulty: MediumLevel of Learning: ApplicationTopic: LO1-4
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158. Indicate how the following errors would affect income and owners' equity. Use the symbol + (plus) for overstated, - (minus) for understated, and 0 (zero) for no effect or error offset.
(a)Overstated 20x1 depreciation expense. 20x2 depreciation expense was correct.
____ ____ ____ ____
(b)Purchase of goods made late in 20x1, recorded in 20x2 and included in 20x1 ending inventory.
____ ____ ____ ____
(c)An expenditure for factory equipment with a five-year usefullife was debited in full to maintenance expense in 20x1.
____ ____ ___ ____
(d)Failed to record the office supplies inventory at the end of 20x1. The office supplies were purchased for cash and were debited in full to office supplies expense during 20x1 when paid for.
____ ____ ____ ____
(e)Failed to accrue 20x1 wages payable at year-end. ____ ____ ____ ____(f)Ending inventory in 20x1 understated. ____ ____ ____ ____ (g)Ending inventory in 20x1 overstated. ____ ____ ____ ____(h)Failed to accrue 20x1 interest revenue earned (not yet collected at year-end).
____ ____ ____ ____
Ans:20x1 20x2
Net Owners' Net Owners'Errors Income Equity Income Equity
(a) - - 0 - (b) + + - 0(c) - - + -(d) - - + 0(e) + + - 0(f) - - + 0(g) + + - 0(h) - - + 0
Difficulty: HardLevel of Learning: ApplicationTopic: LO1-4
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159. Complete the following tabulation by inserting in each square the appropriate code as follows: "O" for overstated; "U" for understated; and "N" for no effect. Complete all squares. Each transaction (but not years) is a separate situation independent of the others.
20x1 20x2Net Owners' Net Owners’
Transaction Inc. Assets Liab. Equity Inc. Assets Liab. Equity
Ex: Accrued wages not recognized at end of 20x1.
(a) Prepaidexpenses overstatedat end of 20x2.
(b) Accruedexpensesunder-statedat end of 20x2.
(c) Accruedincomeunderstatedat end of20x2.
(d) Deferredincome under-stated atend of 20x2.
(e) Accruedwagesunderstated$100 at endof 20x1 and
alsounderstatedat end of20x2 by $300
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20x1 20x2Net Owners' Net Owners’
Transaction Inc. Assets Liab. Equity Inc. Assets Liab. Equity
(f) Prepaidexpenses under-statedat end of20x1. Allpayments on exp. weredebited infull toexpense when
paid.
(g) Endinginventory20x1 over-stated.
(h) Accruedexp. over-stated at end of 20x2.
(i) Beg.inventoryfor 20x2understated.
(j) Deprec.exp. under-stated in20x1.
Ans:20x1 20x2
Net Owners' Net OwnersTransaction Inc. Assets Liab. Equity Inc. Assets Liab. Equity (a) N N N N O O N O (b) N N N N O N U O (c) N N N N U U N U (d) N N N N O N U O (e) O N U O O N U O (f) U U N U O N N N (g) O O N O U N N N (h) N N N N U N O U (i) U U N U O N N N (j) O O N O N O N O
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Difficulty: HardLevel of Learning: ApplicationTopic: LO1-4
160. Depreciation expense for the most recent fiscal year on equipment purchased a few years ago is $10,000. The balance sheet at the end of the same year disclosed the following:Equipment $300,000Accumulated depreciation (40,000)Net book value $260,000
=======
The asset is not expected to have a salvage value and the firm depreciates the asset on the straight-line basis. In March of the NEXT year (the year of change), the firm decided to reduce the original total useful life 20% and that a salvage value of $30,000 is a reasonable estimate. The firm also decided that the double declining balance method is a more appropriate depreciation method for this asset.Required:(a) The entry to record the accounting change.(b) The entry to record depreciation expense in the year of change.Ans: (a) Original total life = $300,000/$10,000 = 30
Depreciation under DDB through beginning of year of change:
$300,000(2/30) = $20,000($300,000 - $20,000)(2/30) = 18,667($300,000 - $20,000 - $18,667)(2/30) = 17,422($300,000 - $20,000 - $18,667 - $17,422)(2/30) = 16,261
$72,350
Total difference in depreciation for first four years = $72,350 -$40,000 = $32,350.Cumulative effect of accounting principle change 32,350 Accumulated depreciation 32,350
(b) Book value after recording accounting principle change =$300,000 - $72,350 = $227,650New total life = .80(30) = 24Years depreciated = $40,000/$10,000 = 4 at beginning of year of change.Remaining useful life at beginning of year of change = 24 - 4 = 20(2/20)($227,650) = $22,765Depreciation expense 22,765 Accumulated depreciation 22,765
Difficulty: HardLevel of Learning: ApplicationTopic: LO2
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161. Liftoff Co. changed its method of accounting for inventory from LIFO to FIFO in 20x3. Ignore tax effects. Relevant information follows:
20x2 20x3FIFO LIFO FIFO LIFO
Beginning inventory $470 $450 $600 $500Ending inventory 600 500 800 680Beginning RE 860Reported earnings 1,600Required: (a) Record the entry in 20x3 to effect the accounting change.(b) Provide the comparative retained earnings statement for 20x3 and 20x2.Ans: (a)
NI effect of change to 1/1/x2: 470-450=20 increase in RENI effect of change to 1/1/x3: 600-500=100 increase in RE
NI effect of change for x2: BI effect decrease NI 20 EI effect increase NI 100 NI effect increase 80
Inventory 100 Retained earnings 100
(b)20x2 20x3
RE 1/1 as prev. reported $860 $2,460Adjust. for accy. change 20 100RE 1/1 as restated 880 2,560NI 1,680 1,760RE 12/31 $2,560 $4,320
===== =====
Difficulty: HardLevel of Learning: ApplicationTopic: LO2
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162. Information for a firm making an accounting change follows:20x0 20x1
Revenues $1,000 $2,500Expenses other than depreciation and tax 600 1,100Tax rate: 30%Common shares outstanding entire year for both years: 100;Retained earnings, 1/1/x0: $6,000
The firm changes from SYD to SL depreciation in 20x1 for financialreporting purposes only.Depreciation: Total before 20x0 20x0 20x1SYD $4,000 $200 $400SL 3,500 100 300
Required:(a) The 20x1 entries to record the accounting change and depreciation expense for 20x1.(b) The comparative 20x0 and 20x1 income statements including pro forma disclosures if needed, EPS, and any disclosure footnote required.Ans: (a)Accumulated depreciation 600 Deferred taxes 180 Cumulative effect of accounting change 420
Depreciation expense 300 Accumulated depreciation 300
Income statement: 20x0 20x1Revenues $1,000 $2,500Expenses other than.... (600) (1,100)Depreciation (200) (300)Income from cont. op before tax 200 1,100Income tax expense (60) (330)Income from cont. op 140 770Cumul. effect, net of $180 tax 420Net income $140 $1,190
==== =====EPS: Inc. fr. cont. op. $1.40 $7.70 Net income $1.40 $11.90Pro forma earnings:Net income $210 $770EPS: Net income $2.10 $7.70
Changed to SL from SYD, which increased 20x1 income before cont. op $70 [($400-$300).70] ($.70/share) and 20x1 net income $490 420 + $70 ($4.90/share)
Difficulty: HardLevel of Learning: ApplicationTopic: LO1-5
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163. AME did not account properly for the deferrals and accruals given below:20x1 20x2
Income $5,000 $4,000Items omitted at year-end: Prepaid expenses 250 225 Accrued expenses 200 280 Unearned revenue 275 230 Accrued revenue 325 360(a) The correct income for 20x1 was $ __________________.
(b) The correct income for 20x2 was $ _________________ .Ans: (a) $5,000 + $250 - $200 - $275 + $325 = $5,100.
(b) $4,000 - $250 + $200 + $275 - $325 + $225 - $280 - $230 + $360= $3,975.======
Difficulty: HardLevel of Learning: ApplicationTopic: LO4
164. The following errors were discovered during 20x3:End of End of
20x1 20x2Prepaid expense not recorded $500 $450Accrued wages payable not recorded $400 $560Revenue collected in advance not recorded $550 $460Revenue earned but not collected; not recorded $650 $720
Therefore, the pre-tax income for 20x2 was overstated or understated by $______________________________.Ans: Overstated by $50 computed as follows:
Prepaid expense not recorded ($500 - $450) $50 (O)Accrued wages not recorded ($560 - $400) 160 (O)Revenue collected in advance, not recorded ($550 - $460) 90 (U)Revenue earned, but not collected nor recorded ($720 - $650) 70 (U) Pretax income, overstated $50
====
Difficulty: HardLevel of Learning: ApplicationTopic: LO4
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165. Ending inventory for 20x0 is overstated in error by $4,000 due to a faulty count and costing. The tax rate is 30%. Assume the same accounting methods for both financial reporting and taxes. The error is discovered late in 20x1. Retained earnings at 1/1/x0 was $20,000, and reported earnings (both before correction of error) are: 20x0, $5,000; 20x1, $6,000. Prepare the comparative retained earnings statements for 20x0 and 20x1. The error overstates 20x0 earnings $4,000 before tax and $2,800 after tax.
Ans:Retained earnings, 1/1 as previously reported $20,000 $25,000*Error Correction (2,800)Retained earnings, 1/1 as adjusted 20,000 22,200Net income $5,000 - $2,800 for 20x0 2,200 8,800**Retained earnings, 12/31 $22,200 $31,000
====== ======* $20,000 + $5,000
** $6,000 + $2,800Difficulty: HardLevel of Learning: ApplicationTopic: LO4 hzzled
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166. MKC is being audited for the years 20x1 and 20x2, and the errors listed below were found (have not been corrected in the accounts).(a) You are to complete the following schedule to compute the correct income for each year (disregard income tax):
Item 20x1 20x2(1) Income reported by MKC $28,000 $30,000
Accruals and deferrals omitted at year-end:(2) Prepaid expenses(paid in advance) 200 300(3) Accrued revenue(earned but not collected) 240 140(4) Accrued expenses (incurred but not paid) 700 400(5) Unearned revenue (collected in advance) 600 900
Ending inventory:(6) Overstated 900(7) Understated 100
(8) Correct income
(b) Assuming the books are already closed for 20x2, give the single journal entry required to correct all of the accounts on January 25, 20x3:Ans: (a)
Item 20x1 20x2 Proof(1) Income reported by MKC $28,000 $30,000 -$760 = $57,240
(2) Prepaid expenses +200 +300-200
(3) Accrued revenue +240 +140-240
(4) Accrued expenses -700 -400+700
(5) Unearned revenue -600 -900+600
(6) 20x1 End. inv. overstated
-900 +900
(7) 20x2 End. inv. understated +100(8) Correct income $26,240 $31,000 = $57,240
(b) Prepaid expense 300Accrued revenue receivable 140Inventory 100Retained Earnings 760
Accrued expenses payable
400
Unearned revenue 900
Difficulty: Hard
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Level of Learning: ApplicationTopic: LO4
167. The following errors were discovered in the financial statements of CBK.(a) Ending inventories at December 31, were incorrect as follows: December 31, 20x1, understated by $4,000; December 31, 20x2 overstated by $3,600.(b) Depreciation expense (straight-line) for 20x1 was overstated by $800.(c) Insurance premium of $3,000 covering for 20x1, 20x2 and 20x3 was prepaid on January, 20x1 and expensed in full at the time.(d) On December 31, 20x2, fully depreciated machinery was sold for $6,400 on credit, but the sale was not recorded until January 1, 20x3.The accounting year ends December 31, and none of the above errors were corrected with journal entries prior to January 2, 20x3.Give the journal entry to correct the accounts on Januar2, 20x3 (after the 20x2 closing entries and before any reversing entries).
Debits Credits(AICPA Adapted)
Ans:Debits CreditsAccumulated depreciation 800 Inventory 3,600Prepaid insurance 1,000 Retained earnings 4,600Gain on sale 6,400
These can be made as four separate entries. (AICPA Adapted)Difficulty: HardLevel of Learning: ApplicationTopic: LO4
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168. On January 1, 20x1, CR purchased a special machine for use in the business that cost $110,000. The estimated useful life was 10 years with no residual value.Three separate and independent cases, involving accounting changes with respect to the machine, are given. For each case, two dates are specified upon which you are to give any required entry (if no entry is required, so state). Disregard income taxes.CASE A: At the end of the fifth year, it was discovered that no depreciation had ever been recorded. Assume the straight-line method is used and that the adjusting entries for 20x5 have not been made.(1) Entry at the date the omission was discovered:(2) Entry at December 31, 20x5, the end of the accounting period:CASE B: At the end of the fifth year, the estimated life was changed from 10 to 15 years. Assume the straight-line method is used and that the adjusting entries for 20x5 have not been made.(1) Entry at the date the decision to change was made:(2) Entry at December 31, 20x5, the end of the accounting period:CASE C: At the end of the fifth year, the company changed from the straight-line depreciation method to sum-of-the-years'-digits depreciation method. The adjusting entries for 20x5 have not been made.(1) Entry at the date of the change.(2) Entry at December 31, 20x5 the end of the accounting period.Ans: CASE A:(1) Retained earnings - error correction 44,000
Accumulated depreciation ($110,000 x 4/10) 44,000(2) Depreciation expense ($110,000 ÷ 10 years) 11,000
Accumulated depreciation 11,000
CASE B:(1) No entry is required because this is a change in estimate.
(2) Depreciation expense 6,000 Accumulated depreciation 6,000
$110,000 x 6/10 = $66,000, book value at beginning of year 5 $ 66,000 ÷ 11 years remaining = $6,000 per year.
CASE C:(1) Cumulative effect of accounting change 24,000
Accumulated depreciation 24,000 SYD: $110,000 x 34/55 = $68,000, under new method
St.-line $110,000 x 4/10 = $44,000 under old method Difference is $24,000, catch up adjustment.
(2) Depreciation expense ($110,000 x 6/55) 12,000 Accumulated depreciation 12,000
Difficulty: HardLevel of Learning: ApplicationTopic: LO1-4
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test BankChapter 21 – Financial Statement Analysis
1. Financial statement analysis is only used to determine whether a company is worth investing in.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
2. A prospective investor in common shares is primary interested in the long-run profitability of the company.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
3. A trade creditor will be primarily interested in the long-run profitability of the company.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
4. A clean opinion is another term to describe a company that has received an unqualified audit report.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
5. All companies are required to have audits.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
6. Information about the significant accounting policies of an entity is not necessary because GAAP prescribes uniform accounting treatment of all items, and it is widely understood.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
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7. The statement of significant accounting policies, which is included in the notes to the financial statements, must include reasons for the selection of one generally accepted accounting method over another generally accepted accounting method.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
8. A statement of accounting policies must be included in the annual financial statements.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
9. A statement of accounting policies is required to be clearly enunciated in the notes to the financial statements.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
10. Published financial statements are always the best source of timely information on practically all financial items relevant to investors and creditors.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
11. A primary reason for the analysis of financial statements is identification of major changes and to provide relative relationships among dollar amounts.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
12. One of the most important steps in an analysis of financial statements is the wording of the auditors' report.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
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13. A qualified auditors' opinion is given when the financial statements present information in conformity with GAAP.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
14. Examination of comparative financial statements does not enable financial statement users to better identify long-term trends.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
15. GAAP requires the presentation of financial statements for the current year and the two immediately preceding reporting periods.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
16. Vertical analysis of financial statements refers to the development of percentages indicating the proportionate changes in selected financial statements for two or more reporting periods.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
17. In horizontal analysis of financial statements, the base amounts used for purposes of comparison are the financial results of a previous time period.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
18. Ratios that measure current position are useful for assessing the ability of a company to pay its short-term obligations.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO5
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19. The current ratio is one measure of the adequacy of a company's working capital.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO5
20. A high working capital ratio is always a favourable situation from the shareholders' viewpoint.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO5
21. Generally, an acid-test ratio of 2 to 1 is preferable to a working capital ratio of 2 to 1.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO5
22. For both the accounts receivable turnover and the inventory turnover ratios, the numerator of the fraction is credit sales.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
23. Book value per common share is particularly useful for predicting the expected market value per share.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO4
24. A debt-equity ratio in excess of 1 indicates that a majority of the entity's resources was provided by the shareholders' or is reflected in shareholders' equity.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
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25. Profit margin on sales is very relevant for purposes of comparison, both between periods and between similar companies.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
26. Return on total assets and return on owners' equity are used to compute financial leverage.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
27. Book value per share is based upon all voting common and preferred shares.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO5
28. To calculate the book value per common share, total shareholders' equity (including retained earnings) must be allocated to the respective common and preferred equities.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO4
29. The quick (or acid-test) ratio always will be less than, or equal to, the current ratio.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO5
30. A price earnings ratio of 10 to 1 implies an earnings rate on market value per share of 10%.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
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31. Return on investment (of a corporation) is affected by the market price of its shares.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO2
32. A high current ratio is not always viewed as advantageous to the company.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO5
33. When data used in ratio analysis are based on historical book values, the resulting ratios reflect price-level effects and real economic values.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
34. A company which offers "n/30" credit terms would be expected to have a receivable turnover of about 12 times a year.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO3
35. The use of an accelerated depreciation method rather than the straight-line method may have an unfavourable effect on some ratios.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2, 3, 4, 5
36. Return on total assets is generally considered to be a better measure of the overall profit performance of a business than is profit margin on sales.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2
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37. If a company's ratio of net income to net sales (generally referred to as profit margin on sales) is low, then its return on investment will be low.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO2, 3
38. A review engagement provides more reliance for the users of the financial statements than an audit engagement.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
39. The section on significant accounting policies describes where deviations from GAAP have occurred.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
40. A company may decide not to follow GAAP if it does not present them in a favourable position.
Ans: FalseDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
41. An unqualified opinion is given if an audit has not been completed.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
42. An adverse opinion is given if the auditor disagrees with the company on decisions made. This is generally not a serious condition as it relates only to a difference of opinion.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
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43. The negotiating of a collective agreement is a contractual decision that may necessitate the use of financial analysis.
Ans: TrueDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
44. It is possible for companies with revenues totalling in excess of $10 million dollars to be exempt from an audit.
Ans: TrueDifficulty: Easy
Level of Learning: KnowledgeTopic: LO1
45. Data must be compared to be useful. Longitudinal comparisons look at the company in relation to other companies. Cross sectional analysis looks at the company over time.
Ans: FalseDifficulty: EasyLevel of Learning: KnowledgeTopic: LO1
46. Disclosure of significant accounting policies results from application of the:A) full disclosure principle.B) consistency principle.C) reliability principle.D) matching principle.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
47. To apply a vertical analysis to the balance sheet, the base amount usually selected is:A) total assets.B) total liabilities.C) total shareholders' equity.D) total revenues.E) either b or c.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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48. GAAP requires presentation of comparative financial statements by most companies for:A) five years.B) three years.C) two years.D) one year.E) none of the above.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
49. Which of the following ratios is an indicator of liquidity?A) Total current asset to total current assetsB) Inventory turnoverC) Age of receivablesD) Creditor's equity in total assets
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
50. RST has provided the following information in 000's on selected cash transactions for 20x12:Purchase of operating assets $6,400Purchase of inventories 16,000Proceeds from short-term borrowing 2,400Proceeds from long-term borrowing 8,000Proceeds from sale of RST's common shares 4,000What is the increase in working capital for the year ended December 31, 20x12, as a result of the above information?A) $400B) $4,000C) $5,600D) None of the above
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO5
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51. All of the following are decisions that may be made with financial statement analysis except:A) Share investment decisionsB) Regulatory decisionsC) Share offering decisionsD) Lending decisionsE) Contractual decisions
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
52. All of the following are examples of lending decisions except:A) finance the takeover of another corporationB) extend normal credit termsC) buy corporate bonds on the open marketD) accepting employment
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
53. All of the following are examples of regulatory decisions except:A) negotiating collective agreementsB) need for rate or price increasesC) impact of past regulatory decisionsD) ability to withstand competition
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
54. All of the following are examples of contractual decisions except:A) negotiating collective agreementsB) accepting employmentC) ability to withstand competitionD) entering into a joint venture
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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55. Disclosure of significant accounting policies should include all of the following items except:A) amortization methods.B) valuation method used for operational assets.C) depreciation methods.D) inventory costing methods.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
56. A company issuing financial statements would most prefer to receive an auditor's opinion that is:A) adverse.B) qualified.C) a disclaimer.D) unqualified.E) either b or d.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
57. The "best" opinion that an auditor can give is a(n):A) adverse opinion.B) unqualified opinion.C) qualified opinion.D) disclaimer of opinion.E) b and d are equally good.
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
58. A qualified auditor's opinion means that in the judgment of the auditor:A) the audit was not completed.B) all items on the financial statements are in conformity with GAAP.C) a number of substantive items on the financial statements are doubtful as to their ultimate
outcome.D) one, or only a few minor, items on the financial statements are doubtful as to their ultimate
outcome.E) none of the above.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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59. Which of the following is a list of the types of auditors' opinions going from worst to best?A) Unqualified, qualified, adverse, disclaimerB) Qualified, disclaimer, adverse, unqualifiedC) Disclaimer, unqualified, adverse, qualifiedD) Disclaimer, unqualified, qualified, adverseE) None of the above
Ans: EDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
60. Horizontal analysis:A) refers to the development of percentages indicating the proportionate change in the same
item over time.B) is exactly the same as "vertical analysis."C) is useful for balance sheet but not for income statement.D) involves the expression of each item on a particular period's financial statements as a
percent of one specific item which is referred to as a base.E) none of the above.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
61. Vertical analysis of financial statements refers to a comparison of amounts which are expressed in terms of a base amount that is from a:A) financial summary.B) previous time period.C) common size statement.D) specific amount that is on the same financial statement.E) either b or c.
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
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62. Quick assets, as usually defined, include:A) cash, accounts receivable, short-term investments in marketable securities, only.B) cash, accounts receivable, short-term investments in marketable securities, and inventories.C) cash only.D) cash and accounts receivable only.E) none of the above.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
63. The effect of recording a 100 percent stock dividend would be to:A) leave working capital unaffected, decrease earnings per share, and decrease book value per
share.B) leave working capital unaffected, decrease earnings per share, and decrease the debt to
equity ratio.C) decrease the current ratio, decrease working capital, and decrease book value per share.D) leave inventory turnover unaffected, decrease working capital, and decrease book value per
share.E) none of the above.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
64. If current assets exceed current liabilities, payments to creditors made on the last day of the month will:A) decrease net working capital.B) increase net working capital.C) decrease current ratio.D) increase current ratio.E) have no effect on either the current ratio or net working capital.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
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65. A company has a current ratio of 2 to 1. This ratio will decrease if the company:A) borrows cash on a six-month note.B) sells merchandise for more than cost and records the sale using the perpetual inventory
method.C) receives a 5 percent stock dividend on one of its marketable securities.D) pays a large account payable which had been a current liability.E) none of the above.
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
66. If a company converted a short-term note payable into a long-term note payable, this transaction would:A) decrease only working capital.B) decrease both working capital and the current ratio.C) increase only working capital.D) increase both working capital and the current ratio.E) have no effect on either the current ratio or net working capital.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
67. Which of the following transactions would increase a company's positive current ratio?A) Borrow money on a short-term noteB) Repay the principal on a short-term noteC) Sell a temporary investment at a lossD) Use the equity method to reflect earnings of an investeeE) None of the above would increase a company's positive current ratio
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO5
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68. The amount of working capital would not be affected by which of the following transactions?A) Sale of long-term investments for cash at a lossB) Transfer of a long-term investment for cashC) Issuance of a long-term note in exchange for cashD) Issuance of common shares of the corporation in exchange for noncurrent assetsE) All of the above would affect working capital
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4, 5
69. A company with sales terms of n/30 would prefer a receivable turnover of:A) 2B) 5C) 10D) 20E) All of the above are equally desirable if sales terms are n/30.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
70. Overall management performance is better measured by use of the:A) return on total assets.B) debt-equity ratio.C) current ratio.D) profit margin on sales.E) none of the above.
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO2, 3
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71. HIJ reported the following data for 20x12 in 000s:
Current assets $100Operational assets $260Other assets $ 40
Assuming vertical analysis, what is the relationship between current assets, operational assets, and other assets, respectively? (Rounded to the nearest percent)
Current Assets Operational Assets Other Assets 1 100 percent 36 percent 40 percent 2 40 percent 14 percent 100 percent 3 25 percent 65 percent 10 percent 4 36 percent 100 percent 14 percent 5 None of the above
A) Choice 1B) Choice 2C) Choice 3D) Choice 4E) Choice 5
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
72. STU reported the following ratios:
20x110 20x11 20x12Return on total assets 30 percent 35 percent 45 percentReturn on owners' equity 45 percent 35 percent 30 percent
The financial leverage factors in 20x110, 20x11, and 20x12 respectively, are (the parentheses indicate negative):
20x110 20x11 20x121 7.5 percent 0 ( 7.5 percent) 2 ( 7.5 percent) 0 7.5 percent 3 15 percent 0 (15 percent) 4 (15 percent) 0 15 percent 5 None of the above.
A) Choice 1B) Choice 2C) Choice 3D) Choice 4E) Choice 5
Ans: C
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Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3
73. CDE reported the following 20x12 data in 000s:
Sales revenue (1/3 cash) $300Average monthly inventory 40Cost of goods sold 120Average monthly receivables 50
CDE's inventory turnover for 20x12 was:A) 0.33B) 2.50C) 3.00D) 6.00E) None of the above.
Ans: CDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
74. Selected information from the accounting records of CDE is as follows in 000's:
Cost of goods sold for 20x12 $3,000Inventories at December 31, 20x11 550Inventories at December 31, 20x12 650
What was the inventory turnover for 20x12?A) 4.61B) 5.00C) 5.45D) None of the above.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO3
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75. DEF wrote off a $300 uncollectible account receivable against the $3,600 balance in its allowance account. Compare the current ratio before the write-off with the current ratio after the write-off.A) The current ratio before the write-off is greater than the current ratio after the write-off.B) The current ratio before the write-off is equal to the current ratio after the write-off.C) The current ratio before the write-off is less than the current ratio after the write-off.D) Cannot be determined from information given.E) None of the above.
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
76. LMN reported the following 20x12 data in 000's:
Sales revenue (1/3 cash) $150Average monthly inventory 10Cost of goods sold 60Average monthly receivables 25
LMN's average age of the receivables was (in days):A) 37 days.B) 61 days.C) 91 days.D) 115 days.E) None of the above.
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
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77. Information concerning XYZ's common shares is as follows:
Per ShareBook value at December 31, 20x12 $36Quoted market value on Toronto Stock Exchange on December 31, 20x12 27Earnings for 20x12 9Dividend for 20x12 3
What was the price-earnings ratio on common shares for 20x12?A) 2 to 1B) 2.67 to 1C) 3 to 1D) 4 to 1E) None of the above
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO2
78. All of the following represent situations where financial statements should be recast:A) Income statement and balance sheet are revised to reflect a different capitalization policy.B) Interest expense is removed from net income.C) Amortization or depreciation is removed yielding earnings before interest taxes and
depreciation.D) All of the above.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
79. Ryan Company analyzed its financial statements for the year ended December 31. During its analysis, Ryan Company compared the accounts receivable balance from 1999 to 1998. This type of analysis is called:A) Cross sectional comparisonB) Sectional comparisonC) Account comparisonD) Longitudinal comparison
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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80. Which of the following analytical techniques would best be used to compare a company’s performance to that of its competitors over time?A) Cross sectional comparisonB) Time- series analysisC) Residual analysisD) Statistical multivariate ratio analysis
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
81. Which of the following analytical techniques uses statistical models in an attempt to predict a certain outcome?A) Cross sectional comparisonB) Time- series analysisC) Residual analysisD) Statistical multivariate ratio analysis
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
82. Which of the following analytical techniques could be most likened to a form of trend analysis?A) Vertical analysisB) Time- series analysisC) Residual analysisD) Statistical multivariate ratio analysis
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
83. Which of the following is not known as a solvency ratio?A) Debt-to-equityB) Times interest earnedC) Debt-to-total assetsD) Defensive-interval ratio
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
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84. Which of the following is not known as a liquidity ratio?A) Current ratioB) Debt-to-equityC) Quick ratioD) Defensive-interval ratio
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
85. There still remain problems when accounting policies are disclosed for choices made among acceptable alternatives. All of the following are problems except:A) There is no disclosure of crucial policies, such as revenue recognitionB) Disclosure is generally too vague to be of use without additional informationC) Some industries do not have to disclose accounting policiesD) The disclosure is specific, but the numerical information is missing
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
86. The main place to look for clues as to management's reporting objectives is:A) in the financial statementsB) in the management discussion and analysis sectionC) in the financial statement highlightsD) in the notes to the financial statements
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
87. Upon reading the notes to the financial statements of JMR Ltd., you notice that the policies they have chosen tend to recognize revenue early in the earnings cycle while deferring costs to later periods. This approach leads you to believe that JMR Ltd. is employing a(n):A) Smoothing strategyB) Income tax minimization strategyC) Income tax maximization strategyD) Profit maximization strategy
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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88. Upon reading the notes to the financial statements of KAR Ltd., you notice that the policies they have chosen tend to be deferring and amortizing both revenue and expenses. This approach leads you to believe that KAR Ltd. is employing a(n):A) Smoothing strategyB) Income tax minimization strategyC) Income tax maximization strategyD) Profit maximization strategy
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
89. Upon reading the notes to the financial statements of KAR Ltd., you notice that the policies they have chosen tend to be deferring revenue but expensing operating costs as incurred. This approach leads you to believe that KAR Ltd. is employing a(n):A) Smoothing strategyB) Income tax minimization strategyC) Income tax maximization strategyD) Profit maximization strategy
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
90. Upon analyzing the financial statements of KER Ltd., you notice that there have been few capital asset acquisitions and that capital assets seem low relative to the type of business the company is in. This observation may mean that KER Ltd. is engaged in a(n):A) Smoothing strategyB) Income tax minimization strategyC) Off-balance sheet financingD) Profit maximization strategy
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
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91. A financial statement analyst will look at the cash flow statement for all of the following except:A) If earnings with amortization added back are significantly larger than cash flow from
operations, the company may be maximizing net incomeB) If cash flow is significantly larger than earnings, the company may be very conservative in
its accounting practicesC) To see if the cash flow statement excludes certain operating expendituresD) To determine the depreciation add back
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
92. There are certain situations where it is necessary to recast the financial statements in order to analyze them. All of the following are examples of the need to recast except:A) The income statement contains a number of gains not expected to occur in the futureB) There have been a number of temporary differences. They remain on the balance sheetC) Asset purchases were made during the yearD) Interest on long-term debt amounted to $1,000,000
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
93. In a popular business journal, JMR Ltd. was compared to KAR Corp. for the year ended December 31, 20x14. This is an example of:A) Cross sectional comparisonB) Historical comparisonC) Yearly comparisonD) Longitudinal comparisonE) Industrial comparison
Ans: ADifficulty: Medium
Level of Learning: KnowledgeTopic: LO6
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94. In a popular business journal, JMR Ltd. financial data for the last five years was compared. This is an example of:A) Cross sectional comparisonB) Yearly comparisonC) Longitudinal comparisonD) Industrial comparison
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO6
95. Vertical analysis is a(n):A) Longitudinal ratioB) Cross sectional ratioC) Historical ratioD) Industrial ratio
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
96. Common-size analysis is a(n):A) Longitudinal ratioB) Cross sectional ratioC) Historical ratioD) Industrial ratio
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
97. Historical analysis is part of a(n):A) Longitudinal ratioB) Cross sectional ratioC) Historical ratioD) Industrial ratio
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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98. Trend analysis is part of a(n):A) Longitudinal ratioB) Cross sectional ratioC) Historical ratioD) Industrial ratio
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
99. All of the following represent groups of ratios except:A) Profitability ratiosB) Effectiveness ratiosC) Solvency ratiosD) Liquidity ratios
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
100. Efficiency ratios are also known as:A) Profitability ratiosB) Effectiveness ratiosC) Solvency ratiosD) Turnover ratios
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
101. The accounts receivable turnover ratio is a measure of:A) The number of days that it takes to collect the receivablesB) The amount of time that it takes to create more receivablesC) The average length of time that it takes to collect the accounts receivableD) None of the above
Ans: CDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
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102. A short accounts receivable turnover ratio may mean all of the following except:A) That customers are dictating the payment termsB) That the company is realizing cash from sales in a short time periodC) Fewer old receivables that may prove to be uncollectibleD) All of the above
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
103. Solvency ratios can be further classified as:A) Liquidity ratiosB) Leverage ratiosC) Asset ratiosD) Fixed ratios
Ans: BDifficulty: Medium
Level of Learning: KnowledgeTopic: LO4
104. All of the following may be included in the numerator of the debt-to-equity ratio except:A) Short-term bank loansB) Retractable preferred sharesC) Current portion of long-term debtD) Shareholder loans
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
105. Current monetary assets divided by annual operating expenditures, which is itself divided by 365, is:A) Defensive-interval ratioB) Debt-to-total capitalization ratioC) Debt-to-capital employedD) None of the above
Ans: ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO4
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106. You are given the following information about JMR Corp.:
Cash $45,000Accounts Receivable $100,000Inventory $150,000Prepaids $96,000Fixed assets $670,000Current liabilities $634,000
What is JMR's current ratio?A) 1.67:1B) 1.23:1C) 0.46:1D) 0.37:1
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO5
107. You are given the following information about JMR Corp.:
Cash $45,000Accounts Receivable $100,000Inventory $150,000Prepaids $96,000Fixed assets $670,000Current liabilities $634,000
What is JMR's quick ratio?A) 1.67:1B) 1.23:1C) 0.46:1D) 0.23:1
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO5
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108. The rule of thumb for the current ratio is 2:1. When would a current ratio below this threshold not necessarily be a concern for a company?A) When accounts receivable balances are highB) When cash flows are steady and reliableC) When inventories are highD) None of the above
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
109. The rule of thumb for the quick ratio is 1:1. When would a current ratio below this threshold not necessarily be a concern for a company?A) When accounts receivable balances are highB) When cash flows are steady and reliableC) When inventories are highD) None of the above
Ans: BDifficulty: MediumLevel of Learning: KnowledgeTopic: LO5
110. It is important for the user to understand the financial statements in order to make an informed decision. A user must generally do all of the following except:A) If an equity investor, will generally use consolidated statementsB) If a lender, will generally use unconsolidated statementsC) All users must be able to evaluate risksD) All of the above are true
Ans: DDifficulty: Medium
Level of Learning: KnowledgeTopic: LO1
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111. If business conditions are stable, an increase in the number of accounts receivable turnover from one year to the next (based upon a company's accounts receivable at year-end) might indicate:A) that a longer discount period and a more distant due date were extended to customers in the
second year.B) a significant decrease in the volume of sales of the second year.C) that the second year's sales were made at lower prices than the first year's sales.D) a stiffening of the company's credit policies.E) none of the above.
Ans: DDifficulty: MediumLevel of Learning: KnowledgeTopic: LO3
112. Recording the payment (as distinguished from the declaration) of a cash dividend whose declaration was already recorded will:A) increase both the current ratio and working capital.B) have no effect on the current ratio or earnings per share.C) increase the current ratio but have no effect on working capital.D) decrease both the current ratio and working capital.E) none of the above.
Ans: CDifficulty: Medium
Level of Learning: KnowledgeTopic: LO5
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113. Information from LMN's balance sheet at December 31, 20x12, is as follows in millions:
Current assets:Cash $12Marketable securities, at cost which approximates market 28Accounts receivable, net of allowance for doubtful accounts 400Inventories, lower of cost or market 520Prepaid expenses 8Total current assets $968
====Current liabilities:Notes payable $16Accrued expenses 120Income taxes payable 4Payments due within one year on long-term debt 24Accounts payable 160Total current liabilities $324
====Long-term debt $720
====
What is the quick (acid-test) ratio?A) $440/$204B) $440/$324C) $448/$204D) $968/$1,044E) None of the above.
Ans: BDifficulty: MediumLevel of Learning: ApplicationTopic: LO5
114. ABC's net accounts receivable were $1,000 at December 31, 20x11 and $1,200 at December 31, 20x12. Net cash sales for 20x12 were $400. The accounts receivable turnover for 20x12 was 5.0. What were ABS's total net sales for 20x12?A) $5,900B) $6,000C) $6,400D) $11,000E) None of the above.
Ans: ADifficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3
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115. Selected information for HIJ in 000's is as follows:
December 3120x11 20x12
Preferred shares, $8, no-par, nonconvertible, noncumulative $375 $375 Common shares 900 1,200 Retained earnings 225 555 Dividends paid on preferred shares for year ended 30 30 Net income for year ended 180 360
HIJ's return on average common shareholders' equity, rounded to the nearest percentage point, for 20x12 is:A) 17 percent.B) 19 percent.C) 23 percent.D) 15 percent.E) None of the above.
Ans: CDifficulty: Medium
Level of Learning: ApplicationTopic: LO2
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116. Assume the following facts for XYZ in 000's:
Total assets $120 Total liabilities 50 Total revenue 220 Total expense (including income tax) 204 Income tax rate 30 percent Interest expense (included in expenses above) 6
XYZ's return on owners' equity, return on total assets, and leverage percentages (rounded to the nearest percent) are:
Return on Return on FinancialOwner's equity Total Assets Leverage
1 8 percent 17 percent 8 percent positive 2 13 percent 5 percent 8 percent negative 3 23 percent 5 percent 6 percent negative 4 23 percent 17 percent 6 percent positive 5 None of the above
A) Choice 1B) Choice 2C) Choice 3D) Choice 4E) Choice 5
Ans: DDifficulty: MediumLevel of Learning: ApplicationTopic: LO2, 4
117. What are the possible decisions that can be made with the use of financial analysis?Ans: A clean opinion is another term used to describe an unqualified audit report, which is
mandatory for public companiesDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1
118. Explain the differences between looking at a company as a new or prospective shareholder and as an existing shareholder?Ans: An existing shareholder already has a stake in the company. Analysis must be made to
determine the loss (either financial or operational) incurred if the investment is terminated. A new investor is concerned with the long-run profitability.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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119. When would a qualified audit opinion not necessarily be a concern to a company?Ans: When a company chooses policies that are primarily in the interests of the shareholders, for
example reporting assets at a restated value.Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
120. Determine whether each of the following statements is true or false.T. TrueF. False___ 1. The allocation to the respective common and preferred equities in calculation of the book
value per common share will depend upon the preferential rights of preferred shares. Liquidation, cumulative and participating preferences of the preferred shares must be satisfied; the balance of owners' equity then becomes the common share equity.
___ 2. Earnings per share is computed by dividing the number of shares issued into the net income for the period.
___ 3. A price-earnings ratio of 10 to 1 implies an earnings rate on market value per share of 10%.___ 4. A company's return on investment is affected by the market price of its shares.___ 5. Ratio analysis is aided by the presentation of comparative statements.___ 6. If a company's ratio of net income to net sales (generally referred to as profit margin) is low,
then return on investment will be low.___ 7. The quick ratio will always be less than or equal to the current ratio.___ 8. A company which offers "n/30" credit terms would be expected to have a receivable turnover
of about 12 times a year.___ 9. Where there is a deficit in total owners' equity, the ratio of total liabilities to total assets will
be greater than 1 to 1; e.g., 1.2 to 1.___ 10. If treasury stock is purchased and retired at a cost in excess of its book value, book value per
share (for the remaining shares) will decrease.___ 11. The current ratio is a measure of the adequacy of a company's working capital.___ 12. In calculating the book value per common share, total owners equity must be allocated to the
respective common and preferred.
Ans: 1:F, 2:F, 3:T, 4:F, 5:T, 6:F, 7:T, 8:T, 9:F, 10:T, 11:T, 12:TDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1-6
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121. Indicate which company characteristic is reflected best by the company indicators listed below. The characteristics are as follows:Characteristic:A. ProfitabilityB. Short-term solvencyC. Management efficiencyCompany Indicators:___ 1. Current ratio___ 2. Sales to total assets___ 3. Earnings per share___ 4. Return on investment (on total assets)___ 5. Inventory turnover___ 6. Price earnings ratio
Ans: 1:B, 2:C, 3:A, 4:A, 5:C, 6:ADifficulty: MediumLevel of Learning: KnowledgeTopic: LO2, 3, 5
122. The summarized and partial balance sheet of XYZ showed the following:Item 20x11 20x12Current assets $50,000 $58,000Operational assets 140,000 101,000Other assets 20,000 23,400(a) Prepare a horizontal analysis.(b) Prepare a vertical analysis for 20x11:Ans: (a) Horizontal analysis
Change from 20x11 to 20x1220x11 20x12 Increase (Decrease)
Current assets $50,000 $ 58,000 $8,000 16%Operational assets 140,000 101,000 (39,000) (28%)Other assets 20,000 23,400 3,400 17%Total assets $210,000 $182,400 ($27,600) (13%)
======== ======== ======== ====
(b) Vertical analysis
Assets Amount PercentageCurrent assets $50,000 24%Operational assets 140,000 67%Other assets 20,000 9%Total assets $210,000 100%
======== ====
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123. Explain the differences between the types of audit reports.Ans: Unqualified Audit Report: Amounts are fairly stated and are in accordance with GAAP.
Best report that a company can have.
Qualified Audit Report: There are one or more deviations from GAAP. These differences have been disclosed in the statements.
Adverse opinion: Results from a serious difference of opinion between management and auditors. This report is not acceptable for a public company.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
124. There is a section in every annual report that detail the accounting policies used by a company. Explain why this is important to users and what some of the limitations are.Ans: There are many different but acceptable methods of reporting amounts under GAAP.
These differences can cause significant differences in the financial statements. Disclosure of these items can help investors and potential investors analyze the company.
However, sometimes the information is too vague to be of any use. In addition, there may be a description but little in the way of numbers to enable the user to see the impact.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
125. What are some advantages to using ratio analysis? What are some of its limitations?Ans: Advantages
Ratios allow the user compare different companiesDownplay the importance of sizeAllow for comparison over timeServe as benchmarksDisadvantagesSome users do not understand the ratios and what they meanRatios are only as useful as the numbers that they are drawn fromRatios must be compared to something to be usefulRatios are clues, but rarely provide answers
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
126. What is vertical analysis?Ans: Vertical analysis or common size analysis are cross sectional ratios. The components of the
years' financial information are compared to a base. For example, the base for the balance sheet may be total assets.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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127. What is horizontal analysis?Ans: Horizontal or trend analysis use a base year. i.e. 20x11 may be the base year – set at 100
and every other year is compared to that base year.Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
128. Ratios, like the accounts receivable turnover ratio, can be difficult to interpret. Explain some of the problems associated with this ratio.Ans: Under normal circumstances, a short period is better than a long one as it shows that cash
is being collected. However, in some situations, there may be valuable customers that take more time to pay but collectability is assured. In addition, the amount of receivables on the balance sheet at year-end may not be typical of its normal balance.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
129. JMR Company has a current ratio of 1.3:1. What does this tell you about the Company? What other information would you like to know?Ans: Although a general rule of thumb for the current ratio is 2:1, it is impossible with the little
information given above to know whether JMR's ratio is too low or not. The ratio may be satisfactory especially if they have a steady cash flow. In order to properly analyze the company, it is necessary to have more than one year. In addition, knowing the industry that JMR Company is in, industry averages, etc. will help to gain a better understanding.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 5
130. You are given the following information about KER Corp.:
Cash $45,000Accounts Receivable $100,000Inventory $150,000Prepaids $96,000Fixed assets $670,000Current liabilities $634,000
Required:Calculate KER's quick ratio.Ans: (45,000+100,000)/634,000 = 0.23:1Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
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131. You are given the following information about KER Corp.:
Cash $45,000Accounts Receivable $100,000Inventory $150,000Prepaids $96,000Fixed assets $670,000Current liabilities $634,000
Required:Calculate KER's current ratio.Ans: (45,000+100,000+150,000+96,000)/634,000 = 0.62:1Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
132. You are given the following information about EGR Corp.:
Cash $135,000Accounts Receivable $210,000Inventory $150,000Prepaids $23,000Fixed assets $670,000Current liabilities $334,000
Required:Calculate EGR's current ratio.Ans: (135,000+210,000+150,000+23,000)/334,000 = 1.55:1Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
133. What do the liquidity ratios focus on? Name two liquidity ratios.Ans: Current ratio, quick ratio, defensive-interval ratio
Liquidity ratios focus on the company's ability to meet short-term obligations. Although there are rules of thumb attached to the ratios, it is important to note that in some industries and for some companies it is more important to have a liquidity ratio different from the rule of thumb.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO2
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134. What are multi-industry corporations and what problems, if any are associated with them (i.e. when analyzing their statements)?Ans: Multi-industry corporations operate in more than one area in the economy. They have a
broad spectrum of activities; for example, a company in the food industry that is also involved in rentals. It is sometimes difficult to place a company in a certain industry segment and gaining comparable information may be difficult. However, ratios, like the profitability ratios, can still be used as an investor is expecting a certain return on their investment at a given level of risk regardless of the industry. In order to evaluate risks, public, multi-industry corporations provide segmented information.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1, 6
135. What is the purpose of the times interest earned ratio?Ans: The times interest earned ratio indicates whether the company can still pay its interest
payments on its debts (thus avoiding default), should their earnings decrease.Difficulty: MediumLevel of Learning: KnowledgeTopic: LO4
136. Define the debt-to-equity ratio. What is its purpose?Ans: Total long-term debt/total owners' equity
This ratio indicates how much of the permanent investment is financed through debt vs. through shareholders. Items such as retractable preferred shares and loans from shareholders should be classified in accordance with their substance.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO4
137. What do solvency ratios measure?Ans: Solvency ratios are used to measure the ability of the company to make both interest and
principal payments on its long-term obligations.Difficulty: MediumLevel of Learning: KnowledgeTopic: LO4
138. What do efficiency ratios measure?Ans: Efficiency ratios attempt to measure operating efficiency. Included in this group – accounts
receivable turnover ratio and inventory turnover ratio.Difficulty: MediumLevel of Learning: KnowledgeTopic: LO3
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139. The following information for JG Ltd. is available to you:
Cash $85,000Average accounts receivable $546,000Average inventory $678,000Accounts payable $345,000Sales on account $1,300,000Cost of goods sold $1,000,000
Required:1. Calculate the accounts receivable turnover ratio2. You determined that the industry average was 4.5 and that JG Ltd. had turnovers in previous years of 3.5, 3.8, 4.4, and 4.7. Based on this information, can you make any conclusions?Ans: 1. 1,300,000/546,000=2.38
2. JG's ART ratio is decreasing and is much lower than the industry average. This may mean that they are having a hard time collecting. It would be nice to see an aging schedule to see if the receivables are old or if the balance is due to timing.
Difficulty: MediumLevel of Learning: ApplicationTopic: LO3
140. The following information for JG Ltd. is available to you:
Cash $85,000Average accounts receivable $546,000Average inventory $678,000Accounts payable $345,000Sales on account $1,300,000Cost of goods sold $1,000,000
Required:1. Calculate the inventory receivable turnover ratio2. You determined that the industry average was 3.5 and that JG Ltd. had turnovers in previous years of 2.4, 2.6, 3.4, and 3.7. Based on this information can you make any conclusions?
Ans: 1. 1,000,000/678,000= 1.47 times2. It appears as though JG Ltd. is having trouble turning over its stock and is significantly slower than the industry average and has been for several years. This may indicate that JG Ltd. is overstocked. However, we must use caution as the high balance may be due to the timing of deliveries to JG Ltd. In other words, deliveries of stock around the measurement date will cause the ratio to be lower.
Difficulty: MediumLevel of Learning: ApplicationTopic: LO3
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141. Enter a letter in each blank space to the left to indicate what each ratio is designed to measure.RatioA. Accounts receivable turnoverB. Book value per shareC. Inventory turnoverD. Payout ratioE. Current ratioF. Owners' equity to liabilitiesG. Acid test ratioH. Return on owners' equityI. Return on total assetsJ. Earnings per shareK. Price earnings ratioL. Financial leverage factorM. None of the aboveMeasurement of___ 1. Effect of borrowing on return earned for shareholders.___ 2. Rate that goods sold move into and out of stock.___ 3. Length of period for investor to recover the share cost.___ 4. Proportion of income paid out as dividends (per share basis).___ 5. Short-term solvency.___ 6. Equity position.___ 7. Profit earned on each common share.___ 8. Severe test of short-term solvency.___ 9. Amount each shareholder would receive if all assets, liabilities, and other "claims" were
liquidated at their carrying values.___10. Relationship of market price to earnings per share.___11. A measure of the movement of trade receivables.___12. Rate earned on total resources employed.
Ans: 1:L, 2:C, 3:M, 4:D, 5:E, 6:F, 7:J, 8:G, 9:B, 10:K, 11:A, 12:IDifficulty: MediumLevel of Learning: KnowledgeTopic: LO1-7
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142. Given the following year-end information, compute the required ratios:
Sales (2/3 on credit) $15,000Cost of goods sold (9,000)Operating expenses (includes interest expense of $150, net of tax (1,000) Pretax income $5,000 Income tax (40%) (2,000) Net Income $3,000
========
Assets:Cash $1,500Accounts receivable, (beginning balance, $2,600) 2,000Inventory (beginning balance, $3,000) 3,500Prepaid expenses 200Operational assets (net) 3,800Total assets $11,000
=======
Liabilities & Owners' Equity:Liabilities: Current liabilities $2,000 Long-term liabilities 3,000Shareholders' Equity: Common shares (500 shares issued) 5,000 Retained earnings 1,000Total Liabilities & Shareholders' Equity $11,000
=======
Required ratios (round to two decimal places):Ratio Computation Answer
(a) Current ratio(b) Receivable turnover(c) Profit margin(d) Return on total assets(e) Return on owners' equity(f) Financial leverage
Ans: (a) Current ratio:($1,500 + $2,000 + $3,500 + $200 = $7,200) ÷ $2,000 = 3.6
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(b)Receivable turnover($15,000 x 2/3 = $10,000) - [($2,600 + $2,000) ÷ 2 = $2,300] = 4.3 turnover
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(c) Profit margin on sales: $3,000 ÷ $15,000 = 20%===
(d) Return on total assets:($3,000 + $150 = $3,150) ÷ $11,000 = 28.6%
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(e) Return on owners' equity:$3,000 ÷ ($5,000 + $1,000 = $6,000) = 50%
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(f) Financial leverage: 50% - 28.6% = 21.4% positive.====
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3, 4, 5
143. The following data was taken from the 20x12 financial statements ofWXC:Income StatementSales $580,000Cost of goods sold (293,000)Depreciation expense ( 40,000)Interest expense ( 12,000)Remaining expenses ( 45,000)Income tax expense (30%) ( 57,000)
Income before E.O. items $ 133,000E.O. loss (net of tax) ( 3,000)
Net Income $ 130,000=========
Balance Sheet Total assets $500,000 Total liabilities 300,000 Shares outstanding, 20,000Based on the above data, compute the following (round to nearest percent):
Ratio Computation Answer(a) Profit margin on sales(b) ROI (on owners equity)(c) EPS(d) ROI (on total equities)(e) Debt to owners equity(f) Financial leverage
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Ans:(a) $133,000 ÷ $580,000 23%(b) $133,000 ÷ $200,000 67%(c) $130,000 ÷ 20,000 shares $6.50(d) 133,000 + ($12,000 x 70%) ÷ $500,000 28%(e) $300,000 ÷ $200,000 150%(f) 67% (per b) - 28% (per d) 39%
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3, 4, 5
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144. The following data was reported by JSB for a two-year period:
20x11 20x12Sales revenue (one-fourth on credit) $84,000 $120,000Cost of goods sold (51,000) (65,000)Operating expenses* (23,000) (27,000)Income tax (20%) (2,000) (5,600)Net income $8,000 $ 22,400
========= =========
Assets:Cash $15,000 $11,000Accounts receivable (net) 20,000 26,000Inventory 35,000 39,000Operational assets (net) 40,000 44,000Total assets $110,000 $120,000
======== ========
Liabilities:Current liabilities $30,000 $29,000Long-term liabilities 23,000 20,000Shareholders' equity:Common shares, 5,000 shares issued 50,000 50,000Retained earnings 7,000 21,000Total liabilities & shareholders' equity $110,000 $120,000
======== ========
*Includes interest expense, $2,500 (pretax)(a) Compute the following ratios for 20x12:(1) Receivable turnover(2) Inventory turnover(3) Creditors' equity to total assets(4) Acid test ratio(5) Return on owners' equity(6) Profit margin on sales(7) Current ratio(8) Return on total assets(9) Owners' equity to total assets(10) Financial leverage(b) Briefly explain and interpret financial leverage.
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Ans: (a)(1) ($120,000 x .25) ÷ [($20,000 + $26,000) ÷ 2] = 1.30
====(2) $65,000 ÷ [($35,000 + $39,000) ÷ 2] = 1.76
====(3) $49,000 ÷ $120,000 = 41%
===(4) $37,000 ÷ $29,000 = 1.28
====(5) $22,400 ÷ $64,000 = 35%
===(6) $22,400 ÷ $120,000 = 19%
===(7) $76,000 ÷ $29,000 = 2.63
====(8) 22,400 + ($42,500 x 80%) ÷ $115,000 = 21%
===(9) $71,000 ÷ $120,000 = 59%
===(10) Favourable. 35% - 21% = 14%
===
(b) The measure of financial leverage is the difference between return on owners' equity and return on total assets. If the former is larger, the leverage is positive. Leverage is the advantage accruing to owners when return earned on total assets is greater than the rate of interest (net of taxes) paid on debt.
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2, 3, 4, 5
145. What is the purpose of consolidated financial statements?Ans: Many companies operate through the use of subsidiaries. If the company is public, they are
required to prepare consolidated statements. This means that all of the assets, liabilities, revenues and expenses are combined. The purpose of consolidated financial is in part to show users and potential users the entire picture of the company, which is very important when the investor is purchasing shares in the company. The problem with consolidated statements is the fact that they give few insights into each individual company and how they are doing.
Difficulty: MediumLevel of Learning: KnowledgeTopic: LO1
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146. As an industry analyst comparing a firm to the industry, are you likely to praise or criticize the firm in terms of Net Income / Total AssetAns: Net Income / Total AssetsYear GHI Inc. Ratio Industry Ratio2000 12.0% 11.0%2001 11.2% 8.0%2002 10.0% 5.0%
Although the company has shown a declining return on assets since 2000, it has performed much better than the industry. Praise may be more appropriate than criticism.
Difficulty: MediumLevel of Learning: ApplicationTopic: LO1, 2
147. As an industry analyst comparing a firm to the industry, are you likely to praise or criticize the firm in terms of Debt / Total Asset.Ans: Debt / Total Asset
Year GHI Inc. Ratio Industry Ratio2000 53.3% 52.0%2001 51.5% 40.0%2002 50.0% 31.0%
While the company's debt ratio is improving, it is not improving nearly as rapidly as the industry ratio. Criticism may be more appropriate than praise.Difficulty: MediumLevel of Learning: ApplicationTopic: LO1, 5
Use the following to answer questions 148-151:
GHI Inc. Corporation has three subsidiaries
Computers Magazines Cable TVSales $16,000,000 $4,000,000 $8,000,000Net Income (after taxes) 1,000,000 160,000 600,000Assets 5,000,000 2,000,000 5,000,000
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148. Which division has the lowest return on sales?
Net Income / Sales Computers Magazines Cable TV6.25 % 4.00 7.50%
Ans:The magazine division has the lowest return on salesDifficulty: MediumLevel of Learning: ApplicationTopic: LO2
149. Which division has the highest return on assets?
Computers Magazines Cable TVNet Income / Total Assets 20.00% 8.00% 12.00%
Ans:The Computer division has the highest return on assets.Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
150. Compute the return on assets for the entire corporation.
Ans:Corporate net income = $1,000,000 + $160,000 + $600,000
= $1,760,000Corporate total assets = $5,000,000 + $2,000,000 + $5,000,000
= $12,000,000ROA = $1,760,000/ $12,000,000 = 0.1467 = 14.67%Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
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151. If the five million dollar investment in the Cable TV division is sold and redeployed in the computer subsidiary at the same rate of return on assets currently achieved in the computer division, What will be the new return on assets for the entire corporation?
Ans: Return on redeployed assets in computers:20% x $5,000,000 = $1,000,000
Return on assets for the entire corporation:New corporate net income = $1,000,000 + $160,000+$1,000,000
= $2,160,000ROA = $2,160,000 / $12,000,000 = 0.1800 = 18%
Difficulty: MediumLevel of Learning: ApplicationTopic: LO2
152. Calculate the balance sheet item Marketable securities
Ans: Capital Assets = $600,000 - $2,500,000Difficulty: MediumLevel of Learning: ApplicationTopic: LO1, 4
153. Calculate the balance sheet item Long-Term Debt
Ans: Total Debt = $2,400,000 - $1,400,000Difficulty: MediumLevel of Learning: ApplicationTopic: LO1, 4
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