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A

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(4) When you are done, raise your hand and ask permission to approach to podium. Please do not
talk or stand up without permission.
(5) Put your answers both on this paper and scantron. You need to turn in both scantron and exam
sheets back to me at the end of the exam. Please write your name on the exam sheet and
scantron now. Please note that only the scantron will be graded.
(6) Please note the exam type (A or B) on scantron.
(7) You have 120 minutes to complete the exam.
(8) There are 60 questions in the exam. 20 of them are True/False and 40 of them are M/C
questons. In True/False questions, (A) in your scantron refers to True, (B) refers to False.
GoodLuck!

FORMULASHEET
Assets=Liabilities+Equity
AccountspayableTurnover=COGS/averageAccountspayable
InventoryTurnover=COGS/averageInventory
AccountsreceivableTurnover=Sales/averageAccountsreceivable

True/False
1. Next year, Dow Chemical Corporation plans to build a laboratory dedicated to a special
project. The company will not use the laboratory after the project is finished. Under GAAP,
this laboratory should be expensed.
Answer: True
Rationale: R&D costs must be expensed under GAAP unless they have alternative
future uses. If these assets do, indeed, have alternative future uses, they will be
capitalized and depreciated.
2. Revenues from discontinued operations of a company are reported separately from
revenues from continuing operations in the income statement.
Answer: True
Rationale: Discontinued operations refer to any identifiable business unit that the
company intends to sell. The income (loss) of the discounted operation (net of tax), and
the after-tax gain (loss) on sale of the unit, are reported in a separate section of the
income statement below income from continuing operations.
3. Accounts payable are a short-term source of non-interest-bearing financing.
Answer: True
Rationale: Accounts payable that arise from the purchase of goods and services usually
do not carry any interest charges and can represent a good source of short-term
inexpensive financing.
4. Accrued liabilities are obligations for which there is no external transaction.
Answer: True
Rationale: Companies must estimate accrued liabilities such as rent payable because there
has been no bill received or no transaction.
5. If accrued liabilities are overestimated in the current period, the reported income in a
following period will be lower than it should be.
Answer: False
Rationale: If the accrued liabilities in this period are overestimated, then the current income
is lower than it should be. This error will be corrected in a following period, and will artificially
inflate income.
6. Contingent liabilities that are probable and can be reasonably estimated are recorded on
the balance sheet as a liability and as an expense in the income statement.
Answer: True

Rationale: Only probable contingent liabilities are estimated and recorded on the
balance sheet or the income statement. Anything less than probable liabilities (such as
reasonably possible) are referenced in footnotes.
7. The principal and interest that will be paid on long-term debt within the next operating cycle
are reported on the balance sheet as current portion of long-term debt.
Answer: False
Rationale: Only the principal portion is classified as current portion of long-term debt.
8. All gains and losses on bond repurchases are reported as extraordinary items.
Answer: False
Rationale: GAAP specifies that gains and losses should be included as extraordinary
items (below income from continuing operations) only if they meet the criteria of unusual
and infrequent. As relatively few bond repurchases meet these criteria, they are typically
included as part of income from ongoing operations.
9. For an item to be classified as extraordinary, it needs to be both unusual and infrequent.
However, there is an exception for material items for one-time items that are extremely
large, firms have the option of classify these items as extraordinary to provide better
information to investors.
Answer: False
Rationale: Both of the above conditions need to be fulfilled for an item to be categorized
extraordinary. There is no materiality exception.
10. Income tax expense is not recorded at the amount owing to the tax authorities even if this is
the most objectively measured amount.
Answer: True
Rationale: Income tax expense is based on GAAP numbers. The amount paid is based
on tax rules. The difference between the two is recorded as deferred tax expense
(benefit).
11. In order to report accounts receivable, net, companies estimate the amount they do not
expect to collect from their credit customers.
Answer: True
Rationale: Companies must report the amount of accounts receivable that they expect to
collect. To do this, they estimate the amount they expect to not collect.
12. Overestimating the allowance for uncollectible accounts receivable can shift income from
the current period into one or more future periods.
Answer: True

Rationale: By overestimating current accounts receivable provisions, current income


decreases because expenses are increased. However, due to the overestimation, future
year provisions will need to decrease to compensate, thus increasing future profitability.
Income has been shifted to future periods from the present.
13. The financial statement effects for uncollectible accounts occur when the company writes off
the account because that is when all the uncertainty is resolved.
Answer: False
Rationale: Under GAAP, costs relating to anticipated bad debts expense are matched
with sales in the period that the sales are recognized. Upon write-off, both the receivable
and the allowance account are reduced, leaving net receivables unchanged.
14. The three components of manufacturing costs are direct materials, direct labor, and
manufacturing overhead.
Answer: True
Rationale: These three components make up the manufacturing cost for manufacturing
companies.
15. LIFO inventory costing yields more accurate reporting of the inventory balance on the
balance sheet.
Answer: False
Rationale: LIFO assumes that the most recently purchased goods are sold, thus the cost
of the oldest items remain in the inventory balance. Hence, the balance sheet reports
inventories at less current costs.
16. Companies using LIFO are required to disclose the amount at which inventory would have
been reported had it used FIFO. Similarly, companies using FIFO are required to disclose
what their inventory would have been if the company had used LIFO.
Answer: False
Rationale: Only the first sentence is true. The disclosure of the LIFO reserve is required
for those companies using LIFO inventory costing. This disclosure allows analysts to
adjust the balance sheet and income statement for LIFO effects when comparing LIFO
and FIFO companies.
17. In general, in a period of falling prices, LIFO produces higher gross profits than FIFO.
Answer: True
Rationale: Gross profit is affected by the choice of inventory costing method.
Specifically, in periods of rising costs and prices, FIFO produces higher gross profits
then LIFO because lower- cost inventories (i.e., first inventories bought are first out) are
matched against sales revenues at current market prices. The converse holds true in
periods of falling prices.

18. Impairment of long-term assets is determined by comparing the sum of the present value of
the assets expected future cash flows to the assets net book value.
Answer: False
Rationale: Impairment of long-term assets is determined by comparing the sum of
expected future (undiscounted) cash flows from the asset with its net book value. If the
asset is deemed to be impaired, it is written down to its market value and the write-down
is recorded as an expense in the income statement.
19. The gain or loss on the sale of the asset is computed by: Gain/(Loss) on sale = Market value
of asset Net book value of asset
Answer: False
Rationale: The correct equation involves the proceeds received, which may differ from
the assets market value.
20. For self-constructed assets, a firm may capitalize any expenses required to place the asset
in service. This includes any interest expense on loans during the construction period.
Answer: True
Rationale: A firm may capitalize any costs to construct the asset providing the costs
bring future expected benefits.

Multiple Choice
21. Boston Consulting Group (BCG) is a management consulting, technology services and
outsourcing organization. Which of the following actions should managers take when there
is evidence that a fixed-rate contract is over budget and will generate a loss for the firm?
A) Use the percentage of completion method to recognize the loss over the remaining term
of the engagement.
B) Recognize the loss in the current period rather than over the remaining term of the
engagement.
C) Restate the financial statements and recognize the loss in the earliest period of the
engagement.
D) Use the percentage of completion method and pro rate the loss over the entire term of
the engagement.
E) None of the above is an appropriate action.
Answer: B
Rationale: When contracts are over-budget, managers should estimate the new, revised,
total engagement cost. If this results in a loss on the engagement, that loss should be
recognized immediately rather than over the remaining term of the engagement.
22. On December 31, 2012, Tri-State Construction Inc. signs a contract with the state of Texas
Department of Transportation to manufacture a bridge over the Rio Grande. Tri-State
anticipates the construction will take three years. The companys accountants provide the
following contract details relating to the project:

Contract price
Estimated construction costs
Estimated total profit

$420 million
$300 million
$120 million

During the three-year construction period, Tri-State incurred costs as follows:


2013
2014
2015

$ 30 million
$180 million
$ 90 million

Tri-State uses the percentage of completion method to recognize revenue. Which of the
following represent the revenue recognized in 2013, 2014, and 2015?
A)
B)
C)
D)
E)

$140 million, $140 million, $140 million


$30 million, $180 million, $90 million
$12 million, $72 million, $36 million
$42 million, $252 million, $126 million
None of the above

Answer: D
Rationale:
($ in millions)
Construction costs incurred
Percentage to total costs
Revenue recognized

Year 1
$30
$30 / $300 =
10%
10% $420 =
$42

Year 2
$180
$180 / $300 = 60%

Year 3
$90
$90 / $300 = 30%

60% $420 =
$252

30% $420=
$126

23. In spring 2012, Mainline Engineering Company signed an $80 million contract with the city
of Duluth, to construct a new city hall. Mainline expects to construct the building within two
years and incur expenses of $60 million. The city of Duluth paid $20 million when the
contract was signed, $40 million within the next six months, and the final $20 million exactly
one year from the signing of the contract. Mainline incurred $24 million in costs during 2012
and rest in 2013 to complete the contract on time.
Using the percentage-of-completion method how much revenue should Mainline recognize
in 2012?
A)
B)
C)
D)
E)

$32 million
$60 million
$20 million
$40 million
None of the above

Answer: A
Rationale: According to the percentage-of-completion method Mainline Engineering
Company should recognize the revenues as shown in the table below:
Year

Total contract

Percentage completed

Revenue Recognized

2012

$24 million/$60 million


= 40%

$80 million

40% $80 million


= $32 million

24. Tickets Now contracts with the producer of Riverdance to sell tickets online. Tickets Now
charges each customer a fee of $4 per ticket and receives $10 per ticket from the producer.
Tickets Now does not take control of the ticket inventory. Average ticket price for the event is
$150. How much revenue should Tickets Now recognize for each Riverdance ticket sold?
A)
B)
C)
D)
E)

$4 because the $10 from the producer is similar to a negative cost of goods sold
$14 because both the fee from the customer and the producer are earned
$150 because the $140 is cost of goods sold paid to the Riverdance producer
$186 because the $140 is cost of goods sold paid to the Riverdance producer
None of the above

Answer: B
Rationale: Tickets Now should record $14 revenue each time it sells a ticket. Of that $4 will
be received in cash and $10 will be recorded as receivable from the Riverdance producers.
25. On its 2011 income statement, Yahoo! reported Product development expense of
$1,005,090. Which of the following statements must be true?
A)
B)
C)
D)

Yahoo spent $1,005,090 in cash to develop new products and improve old products.
Product development expense reduced Yahoos 2011 net income by $1,005,090.
Yahoo capitalized at least $1,005,090 of product development costs in 2011.
The $1,005,090 included amortized product development costs from prior years that
were not previously expensed, because Yahoo incurs such expenses each year.
E) None of the above
Answer: E
Rationale: Yahoo included in product development expense certain non-cash expenses
such as depreciation on related assets, thus a is not correct. Yahoo recorded deferred tax
expense on the product development expense, thus net income was affected on an after-tax
basis and b is therefore not correct. Under US GAAP, firms may not capitalize R&D costs,
thus c is not correct. All R&D expenses must be included in the income statement in the
period, thus d is wrong.
26. Life Technologies Corporation and Affymetrix Inc. are competitors in the life sciences and
clinical healthcare industry. Following is a table of Total revenue and R&D expenses for both
companies.
Life Technologies Corporation
2011
2010
2009
Total
revenue
R&D
expenses

$3,775,672 $3,588,094 $3,280,344


$377,924

$375,465

$337,099

Which of the following is true?

Affymetrix Inc
2011
2010
2009
$241,27
$277,743 $279,186
3
$63,591

$67,934

$77,358

A)
B)
C)
D)
E)

Life Technologies Corporation is the more R&D intensive company of the two.
Life Technologies Corporation has become more R&D intensive over the three years.
Affymetrix is more R&D intensive in 2011 than in 2010.
Affymetrix is less R&D intensive in 2011 than in 2010.
None of the above

Answer: C
Rationale: To make comparisons, we need to common size the R&D expenditures of both
firms by scaling by total revenues.
Life Technologies
Corporation
2011
2010
2009
Common sized
R&D

10.0%

10.5%

10.3%

Affymetrix Inc
2011
2010
2009
26.4%

24.5%

27.7%

Affymetrix spends proportionately more on R&D than Life Technologies, thus a is not true.
Life Technologies has spent less on R&D in 2011 than in 2010 and 2009, thus b is not true.
Affymetrix increased R&D from 24.5% in 2010 to 26.4% in 2011, thus C is true, but not D.
27. Dow Chemical recorded pretax restructuring charges of $689 million in 2009. The charges
consisted of asset write-downs of $454 million, costs associated with exit or disposal
activities of $66 million, and employee severance costs of $169 million. The company paid
$72 million cash to settle these restructuring charges during the year (2009). At year end,
the restructuring accrual associated with these charges was:
A)
B)
C)
D)
E)

$689 million
$617 million
$163 million
$ 97 million
There is not enough information to determine the amount.

Answer: C
Rationale: Of the $689 million total restructuring charge, only the exit costs and severance
costs must eventually be settled in cash. The asset write downs are not accrued they
reduce the assets on the balance sheet. The company accrued $66 million + $169 million =
$235 million as a liability. Thus, if the company paid $72 million cash, the remaining accrual
is $163 million at year end.
28. Intelligentsia Corp. recorded restructuring charges of $157,028 thousand during fiscal 2012
related entirely to anticipated employee separation payments. Intelligentsia had never
before incurred restructuring charges. At the end of the year, the companys balance sheet
included a restructuring accrual of $19,762. The cash flow effect of Intelligentsias
restructuring during fiscal 2012 was:
A)
B)
C)
D)
E)

$19,762 thousand
$157,028 thousand
$176,790 thousand
$137,266 thousand
None of the above

Answer: D
Rationale: The total restructuring charge accrued was $157,028 of which $19,762 was still
unpaid (a liability) at the end of the year. The difference of $137,266 must have been paid in
cash during the year. The cash flow effect is $137,266.
29. The 2010 annual report of Dow Chemical Company disclosed a valuation allowance of $682
million related to various deferred tax assets. The 2009 valuation allowance had a balance
of $721 million. What effect did this decrease in the allowance have on Dow Chemicals net
income in 2010?
A)
B)
C)
D)
E)

Increase net income by $39 million


Decrease net income by $39 million
Increase net income by $682 million
Decrease net income by $682 million
None of the above

Answer: A
Rationale: Changes in valuation allowance affect net income in the opposite direction, dollar
for dollar. Dow Chemical decreased the allowance by $39 million ($721 million - $682
million). The effect was to increase Dows net income by $39 million in 2010.
30. As a result of using accelerated depreciation for tax purposes, The MED Corporation
reported $186 million income tax expense in its income statement, while the actual amount
of taxes paid by the company was $206 million. How did these tax transactions affect the
companys balance sheet?
A)
B)
C)
D)
E)

Increase deferred tax liability by $20 million


Decrease deferred tax assets by $186 million
Decrease retained earnings by $186 million
Decrease cash by $186 million
Both C and D

Answer: C
Rationale: The tax expense of $186 million will reduce net income by that amount and thus,
retained earnings on the balance sheet will be $186 million lower. The company pays $206
million tax in cash, which reduces assets (cash). The difference of $20 million is recorded as
an increase in deferred tax asset.
31. The income tax footnote to the financial statements of Life Technologies Company for the
year ended December 31, 2011, includes the following information (in thousands). How
much of the income tax expense is payable in 2011?
Current tax provision
Federal
State
Foreign

$113,783
1,771
45,237
160,791

Deferred tax provision


Federal

(50,907)

State
Foreign
Changes in tax rate
Changes in valuation allowance
Provision for income taxes

(6,119)
(4,514)
(61,540)
(95)
1,712
$100,868

A) $100,868 thousand
B) $61,540 thousand
C) $160,791 thousand
D) $99,251 thousand
E) None of the above
Answer: C
Rationale: The current tax provision of $160,791 is payable in 2011.

32. All of the following are potentially dilutive in computing diluted EPS except:
A)
B)
C)
D)
E)

Employee stock options


Convertible preferred stock
Convertible bonds
Warrants
All of the above are dilutive securities

Answer: E
33. The 2011 financial statements of Leggett & Platt, Inc. include the following information in a
footnote. What are the companys gross accounts and other receivables at the end of 2011?
(in millions)
Allowance for doubtful accounts
Total accounts and other receivables, net
A)
B)
C)
D)
E)

2011
$24.3
$503.6

2010
$22.1
$478.9

$503.6 million
$479.3 million
$503.2 million
$527.9 million
None of the above

Answer: D
Rationale: $503.6 million + $24.3 million = $527.9 million
34. The 2012 annual report of Oracle Corporation included the following information relating to
their allowance for doubtful accounts: Balance in allowance at the beginning of the year
$372 million, accounts written off during the year of $141 million, balance in allowance at the
end of the year $323 million. What did Oracle Corporation report as bad debt expense for
the year?

10

A) $49 million
B) $190 million
C) $92 million
D) $182 million
E) None of the above
Answer: C
Rationale: Balance in allowance at the beginning of the year + bad debt expense - accounts
written off during the year = balance in allowance at the end of the year. Bad debt expense
= $323 million - $372 million + $141 million = $92 million.
35. Magic Animation Corporation has aged its accounts receivable and estimated uncollectible
accounts as follows (in thousands). What bad debt expense should the company report for
the current period?
Age of Receivables
Current
30-60 days past due
61-90 days past due
Over 90 days past due
A)
B)
C)
D)
E)

AR Balance

Estimated %
uncollectible
1%
3%
6%
10%

$4,000
1,600
900
510

Allowance
$40
48
54
51

$52 thousand
$193 thousand
$7,010 thousand
$6,816 thousand
There is not enough information to determine the amount.

Answer: E
Rationale: The bad debt expense should bring the allowance balance up to $193 thousand
(the sum of the allowance amounts in the last column of the table). Because we dont know
the existing balance in the allowance account, we cannot determine bad debt expense.

36. The 2011 financial statement of Willamette Valley Vineyards reported Net revenues of
$15,661,905 and Cost of goods sold of $7,944,635. Note 3 reported that Inventories
consisted of:

Winemaking and packaging materials


Work-in-process
Finished goods
Obsolescence reserve
Total inventories
The inventory turnover for 2011 was:
A) 1.63
B) 0.83

11

2011
$ 248,350
3,535,028
5,889,816
(54,049)
$9,619,145

2010
$ 296,012
3,209,692
7,226,730
(20,416)
$10,712,018

C) 0.78
D) 1.54
E) None of the above
Answer: C
Rationale: Inventory turnover = COGS / Average inventory = $7,944,635 / [($9,619,145 +
$10,712,018) /2] = 0.78
37. The 2010 financial statements of Walgreen Co. reported the following information (in
millions):
Cost of sales
Inventories, net

2010
$48,444
7,378
1,379

LIFO reserve

2009
$45,722
6,789
1,23
9

The 2010 average inventory days outstanding is:


A)
B)
C)
D)
E)

55.6 days
66.0 days
57.2 days
61.6 days
None of the above

Answer: A
Rationale: Average inventory days outstanding = Inventory / (COGS / 365) = $7,378 /
($48,444 / 365) = 55.6.
38. The 2010 financial statements of Walgreen Co. reported the following information (in
millions).
2010
$48,444
7,378
1,379

Cost of sales
Inventories, net
LIFO reserve

2009
$45,722
6,789
1,239

If Walgreens had used the FIFO method of inventory costing, 2010 inventory would have
been:
A)
B)
C)
D)
E)

$7,378 million
$8,757 million
$5,999 million
$8,316 million
None of the above

Answer: B
Rationale: FIFO Inventory = LIFO inventory + LIFO reserve = $7,378 million + $1,379 million
= $8,757 million

12

39. The 2010 financial statements of Walgreen Co. reported the following information (in
millions).
2010
$48,444
7,378

Cost of sales
Inventories, net
LIFO reserve

1,379

2009
$45,722
6,789
1,23
9

If Walgreens had used the FIFO method of inventory costing, 2010 COGS would have
been:
A)
B)
C)
D)
E)

$48,444 million
$49,823 million
$47,065 million
$48,304 million
None of the above

Answer: D
Rationale: FIFO COGS = LIFO COGS - Increase in LIFO reserve = $48,444 ($1,379
million - $1,239 million) = $48,304 million
40. Assume that Campo Jewelry Co. uses the LIFO inventory costing method for both tax and
financial reporting purposes. The balance sheet reports inventories at $204 million. Then, in
its footnotes, the company reports that inventories would have been $266 million had the
company used the FIFO method. The difference between these two numbers ($62 million)
is referred to as:
A)
B)
C)
D)
E)

LIFO reserve
LIFO conformity rule
LIFO holding gain
Inventory temporary difference
None of the above

Answer: A
Rationale: Companies using LIFO are also required to state the amount at which inventory
would have been reported had it used FIFO. The difference between the two is called the
LIFO reserve.
41. Montana Great Outdoors had the following inventory in fiscal 2012. The company uses the
FIFO method of accounting for inventory.
Beginning Inventory, August 1, 2011: 140 units @ $19.50
Purchase 300 units @ $19.00
Purchase 50 units @ $20.00
Purchase 120 units @ $20.30
Ending Inventory, July 31, 2012: 130 units
The companys cost of goods sold for fiscal 2012 is:

13

A) $9,230
B) $2,636
C) $9,331
D) $11,866
E) None of the above
Answer: A
Rationale:
Costs of goods available for sale*
Less Ending Inventory (120 units @ $20.30)
Less Ending Inventory (10 units @ $20.00)
Cost of goods sold

$11,866.00
2,436.00
200.00
$ 9,230.00

*Cost of goods available for sale:


(140 units $19.50) + (300 units $19) + (50 units $20) + (120 units $20.30) = $11,866
42. Montana Great Outdoors had the following inventory in fiscal 2012. The company uses the
LIFO method of accounting for inventory.
Beginning Inventory, August 1, 2011: 140 units @ $19.50
Purchase 300 units @ $19.00
Purchase 50 units @ $20.00
Purchase 120 units @ $20.30
Ending Inventory, July 31, 2012: 130 units
The companys cost of goods sold for fiscal 2012 is:
A) $9,230
B) $2,636
C) $11,866
D) $9,331
E) None of the above
Answer: D
Rationale:
Costs of goods available for sale*
Less Ending Inventory (130 units @
$19.50)
Cost of goods sold

$11,866
2,535
$ 9,331

*Cost of goods available for sale:


(140 units $19.50) + (300 units $19) + (50 units $20) + (120 units $20.30) = $11,866
43. Which of the following estimates are not always required when calculating depreciation
expense? Select all that apply.
A)
B)
C)
D)

Depreciation rate
Useful life
Depreciation method
Salvage value

14

E) None of the above


Answer: D
Rationale: If the double-declining-balance method is used to determine depreciation,
salvage value is not required. Therefore the correct answer is D.
44. The 2011 financial statements for BNSF Railway report the following information:
Year ended December 31,
(In millions)
Revenues
Property and equipment, net
Total assets

2011
$19,548
48,047
70,380

2010
$16,850
45,486
68,647

The 2011 property, plant and equipment turnover is:


A)
B)
C)
D)
E)

0.41
1.46
0.42
0.39
None of the above

Answer: C
Rationale: Turnover = Revenues / Average PPE, net= $19,548 / [($48,047 + $45,486) / 2] =
0.42
45. Central Supply purchased a new printer for $30,000. The printer is expected to operate for
eight (8) years, after which it will be sold for salvage value (estimated to be $3,000). How
much is the first years depreciation expense if the company uses the double-decliningbalance method?
A)
B)
C)
D)
E)

$7,500
$5,625
$3,750
$3,375
None of the above

Answer: A
Rationale: Depreciation rate: 2 straight-line rate (1/useful life) = 2 (1/8) = 0.25
Depreciation expense, year 1: $30,000 0.25 = $7,500

46. Which of the following does not affect the current liabilities section of the balance sheet?
A)
B)
C)
D)
E)

Purchase of inventory on credit


Wages owning to employees but not yet paid
Insurance bill to be paid next month
Sale of goods on credit
A probable legal obligation, due within 12 months

15

Answer: D
Rationale: The sale of goods on credit impacts non-cash assets, specifically accounts
receivable; all the other items are liabilities that the company must pay within the next year,
hence current liabilities.
47. Which of the following would not require the company to record an accrual on the balance
sheet?
A) The company owes $40,000 in wages to its employees for the previous two weeks.
B) Interest will be paid when a note payable matures in the following accounting period
C) Management believes a lawsuit against the company is meritless because they have
never had a single complaint about dangerous side effects of their drug in two years.
D) The company knows that they will be fined for pollution as a result of their manufacturing
process and can estimate the amount of the obligation.
E) None of the above
Answer: C
Rationale: Based on managements belief, the lawsuit at hand can be deemed less than
reasonably possible and therefore does not need to be disclosed in the financial statements.
48. Which of the following does not represent a current liability?
A)
B)
C)
D)
E)

Accrual of taxes payable


Short-term loan
Purchase of equipment on credit
Bond issue
None of the above

Answer: D
Rationale: Bonds are issued to raise capital with repayment of the principal amount on a
specified date in the future (more than one year from the point of issue); therefore, bonds
are considered long-term liabilities.
49. On January 1, Powells Club borrows $20,000 from Second State Bank. The loan is due in
one year along with 6% interest. The company is preparing its quarterly report for March 31.
Which of the following best describes the necessary accrual for interest expense?
A)
B)
C)
D)
E)

$ 300 increase liabilities, increase expenses


$1,200 decrease liabilities, decrease cash
$1,200 increase expenses, decrease cash
$1,200 increase liabilities, decrease expenses
$ 300 decrease liabilities, decrease cash

Answer: A
Rationale: The quarterly interest charge is calculated by multiplying the loan amount
($20,000) by the interest rate (6%) and then by the portion of the year outstanding (3/12), or
$300 accrued interest. The company needs to reflect the outstanding interest owed
(accrued interest) by increasing liabilities and increasing interest expense.

16

50. Selected recent balance sheet and income statement information for American Eagle
Outfitters follows:
(in thousands)

2011

Year-end accounts payable


Average accounts payable
Sales
Cost of goods sold

$
183,783
175,753
3,159,818
2,031,477

Accounts payable turnover for 2011 is:


A) 11.05
B) 17.19
C) 17.98
D) 11.56
E) None of the above
Answer: D
Rationale: APT = COGS / average Accounts payable = $2,031,477 / $175,753 = 11.56
51. Selected recent balance sheet and income statement information for The Gap, Inc. follows:
(in millions)
Year-end accounts payable
Average accounts payable
Sales
Cost of goods sold

2011
$ 1,066
1,058
14,549
9,275

Accounts payable days outstanding for 2011 is:


A)
B)
C)
D)
E)

41.6 days
42.0 days
26.7 days
26.5 days
None of the above

Answer: B
Rationale: APDO = Accounts payable / average daily COGS = $1,066 / [$9,275 / 365 days]
= 42.0 days
52. Selected recent balance sheet and income statement information for American Eagle
Outfitters and The Gap, Inc. follows:
American Eagle Outfitters
(in thousands)
2011
$
Year-end accounts payable
183,783
Average accounts payable
175,753

17

The Gap, Inc.


(in millions)
Year-end accounts payable
Average accounts payable

2011
$ 1,066
1,058

Sales
Cost of goods sold

3,159,818
2,031,477

Sales
Cost of goods sold

14,549
9,275

Which of the two companies listed above is leaning on the trade more?
A) American Eagle because its accounts payable turnover is greater and its accounts
payable days outstanding is lower.
B) Gap because its accounts payable turnover is lower and its accounts payable days
outstanding is higher.
C) Gap because its accounts payable turnover is higher and its accounts payable days
outstanding is lower.
D) American Eagle because its accounts payable turnover is lower and its accounts
payable days outstanding is higher.
E) Gap because its accounts payable turnover is lower and its accounts payable days
outstanding is lower.
Answer: B
Rationale: Gaps APT ($9,275 / $1,058 = 8.77) is lower than American Eagles APT
($2,031,477 / $175,753 = 11.56).
Gaps APDO ($1,066 / [$9,275 / 365 days] = 42.0 days) is higher than American Eagles
APDO ($183,783 / [$2,031,477 / 365 days] = 33.0 days.
A company is said to be leaning on the trade more when it has a lower accounts payable
turnover and a higher accounts payable days outstanding.
53. Kirner Electric Corp. sells $100,000 of bonds to private investors. The bonds have an 8%
coupon rate and interest is paid semiannually. The bonds were sold to yield 9%.
What periodic interest payment does Kirner make?
A) $16,000
B) $ 4,000
C) $ 8,000
D) $ 2,250
E) None of the above
Answer: B
Rationale: Coupon rates are used to compute the dollar amount in interest payments paid to
the bondholder semiannually. Kirner pays $100,000 8% year = $4,000.
54. Which one of the following is not correct?
A) For debt issued at par: interest expense reported on the income statement equals the
cash paid for interest.
B) For bond repurchases: Gain (loss) on bond repurchase = Cash paid to repurchase Net
book value of bonds.
C) For debt issued at a discount: interest expense reported on the income statement equals
cash interest payment less amortization of the discount.
D) For debt issued at a premium, interest expense reported on the income statement
equals cash interest payment less amortization of the premium.
E) None of the above

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Answer: D
Rationale: For debt issued at a discount, interest expense reported on the income statement
is cash interest paid plus amortization of the discount.
55. Credit analysis concerns which of the following?
A)
B)
C)
D)
E)

The price of a companys stock


The ability of a company to consistently pay dividends
The probability a company will make timely payments
An assessment of a companys credit-granting policies
None of the above

Answer: C
Rationale: The probability a company will make timely payments, that is, the potential risk of
default. Bond investors are primarily concerned with a companys ability to make interest
and principal payments per the bond agreement.
56. Which of the following corporate debt ratings are ordered in terms of decreasing market
interest rate?
A)
B)
C)
D)
E)

AAA, A, BB, C
A, AAA, BB, C
BB, C, A, AAA
C, BB, A, AAA
None of the above

Answer: D
Rationale: As debt quality moves from AAA to CCC, the market interest rate required
increases. So, the required rate decreases from CCC to AAA.
57. Which of the following business factors does not play a role in determining a companys
credit rating?
A)
B)
C)
D)
E)

Industry characteristics
Capital structure
Management
Corporate marketing
Profitability

Answer: D
Rationale: Corporate marketing is not a risk factored into the rating agencies determination
of a companys credit rating.
58. Which of the following does Moodys not consider in deriving the credit rating of a company?
A) Profitability ratios
B) Loan covenants

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C) Solvency ratios
D) Collateral
E) None of the above
Answer: E
Rationale: Moodys considers many factors in deriving a credit rating, including profitability
ratios, covenants, solvency ratios, and collateral.

Inline Incorporated manufactures skates and equipment for in-line skating. The company
offers a one-year warranty on all products. During 2012, the company recorded net sales of
$3,887.4 million. Historically, about 4% of all sales are returned under warranty and the cost
of repairing and or replacing goods under warranty is about 25% of retail value. Assume that
at the start of the year Inlines balance sheet included an accrued warranty liability of $16.9
million and at the end of the year, the accrued warranty liability balance was $23.0 million.
59. Calculate Inlines warranty expense for 2012.
a) $28.9
b) $38.9
c) $48.9
d) $58.9
60. How much did Inline pay during the year to repair and or replace goods under warranty?
a) $28.8
b) $42.8
c) $24.8
d) $32.8
Answer:
a. Inline should record the estimated cost of product warranties at the time sales are
recognized. To do this, the company should estimate warranty obligation by reference to
historical product warranty return rates, material usage and service delivery costs
incurred in correcting the product. Should actual product warranty return rates, material
usage or service delivery costs differ from the historical rates, Inline should revise its
warranty liability.
b. Warranty expense for 2012 = $3,887.4 million 4% 25% = $38.9 million.
c. During the year, the accrued warranty liability decreased. This means that Inline paid out
more to replace or repair warrantied goods than the expense the company recorded.
Total cash paid out is $16.9 million + $38.9 million - $23.0 million = $32.8 million.

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