2011 AICPA Newly Released Financial Questions

2011 AICPA Newly Released Questions Financial
Following are multiple choice questions and simulations recently released by the
AICPA. These questions were released by the AICPA with letter answers only. Our
editorial board has provided the accompanying explanation.
Please note that the AICPA generally releases questions that it does NOT intend to use
again. These questions and content may or may not be representative of questions you
may see on any upcoming exams.
1
1.
Fenn Museum, a nongovernmental not-for-profit organization, had the following balances in its statement
of functional expenses:
Education $300,000
Fundraising 250,000
Management and general 200,000
Research 50,000
What amount should Fenn report as expenses for support services?

a. $350,000
b. $450,000
c. $500,000
d. $800,000
Solution:
Choice "b" is correct. The expenses of not for profit organizations are typically classified within generic
functions as either program or support services. Program services relate to the mission or service
delivery objectives of the organization, while support services relate to costs that indirectly support the
organization's mission such as general and administrative costs, fund raising, membership development,
etc.
Of the four expenses listed in the fact pattern, two are clearly support services as follows:
Fundraising $250,000
Management and general 200,000
Total $450,000
Education and Research expenses are likely program services of the Fen Museum
Choice "a" is incorrect. The proposed answer combines the likely program service amounts associated
with Education and Research to arrive at $350,000. Program services would not be displayed as support
services.
Choice "c" is incorrect. The proposed answer either combines the likely program service amount
associated with Education and the Support service of Management and General to arrive at $500,000 or
combines the program service amount associated with Research and all Support services to arrive at
$500,000. Program services would not be displayed as support services.
Choice "d" is incorrect. The proposed answer combines all the amounts in the fact pattern, both program
and support services, to arrive at $800,000. Program services would not be displayed as support
services.
2
2.
In January, Stitch, Inc. adopted the dollar-value LIFO method of inventory valuation. At adoption,
inventory was valued at $50,000. During the year, inventory increased $30,000 using base-year prices,
and prices increased 10%. The designated market value of Stitch's inventory exceeded its cost at year
end. What amount of inventory should Stitch report in its year-end balance sheet?
a. $80,000
b. $83,000
c. $85,000
d. $88,000
Solution:
Choice "b" is correct. Since inventory increased $30,000 using base-year prices, under dollar value LIFO
we must restate this increase by the appropriate price-level index, in this case 10%. $30,000 times 10%
equals $3,000, so this increase actually becomes $33,000 using current-year prices. Therefore, the
amount of inventory Stitch should report in its year-end balance sheet is the $50,000 at adoption plus the
$33,000 increase, so $83,000 in total since they are utilizing dollar-value LIFO for inventory valuation.
Choice "a" is incorrect. $80,000 would only be correct if we were not utilizing dollar-value LIFO.
Choice "c" is incorrect. $85,000 Is incorrect since we do not have to adjust the original $50,000.
Choice "d" is incorrect. $88,000 is incorrect since we only have to adjust the $30,000 increase.
3
3.
Jonn City entered into a capital lease for equipment during the year. How should the asset obtained
through the lease be reported in Jonn City's government-wide statement of net assets?
a. General capital asset.
b. Other financing use.
c. Expenditure.
d. Not reported.
Solution:
Choice "a" is correct. Capital lease obligations associated with general governmental activities are
recorded as an asset and as a liability on the full accrual government-wide financial statements.
Governmental fund financial statements would record the asset financed by a capital lease as an
expenditure and the lease financing as other financing sources under modified accrual accounting.
Choice "b" is incorrect. Although governmental fund financial statements (GRaSPP funds) would initially
record an asset financed by a capital lease as an expenditure and the lease financing as other financing
sources under modified accrual accounting, capital lease obligations associated with governmental
activities are recorded as an asset and as a liability on the full accrual government-wide financial
statements.
Choice "c" is incorrect. Although governmental fund financial statements (GRaSPP funds) would initially
record an asset financed by a capital lease as an expenditure and the lease financing as other financing
sources under modified accrual accounting, capital lease obligations associated with governmental
activities are recorded as an asset and as a liability on the full accrual government-wide financial
statements.
Choice "d" is incorrect. Capital lease obligations associated with general governmental activities are
recorded as an asset and as a liability on the full accrual government-wide financial statements. Capital
outlay would be recorded as an expenditure in the modified accrual governmental fund financial
statements. Lease financing would be recorded as other financing sources in the fund financial
statements. Governments would report capital lease activity in both fund and government-wide financial
statements.
4
4.
Jane Co. owns 90% of the common stock of Dun Corp. and 100% of the common stock of Beech Corp.
On December 30, Dun and Beech each declared a cash dividend of $100,000 for the current year. What
is the total amount of dividends that should be reported in the December 31 consolidated financial
statements of Jane and its subsidiaries, Dun and Beech?
a. $10,000
b. $100,000
c. $190,000
d. $200,000
Solution:
Choice "a" is correct. Since Jane owns 90% of Dun and 100% of Beech, when they declare and pay
dividends, the only amounts that should appear in their year-end consolidated financial statements are
the dividends paid to outsiders or external parties. Intercompany dividends should be eliminated upon
consolidation. In this case, the only non-controlling interest that exists is the 10% of Dun that Jane does
not own. So all 100% of Beech's $100,000 dividend would be eliminated, but only 90% of Dun's
$100,000 would be eliminated. Therefore, just 10% of Dun's $100,000 dividend, or $10,000, will appear
in Jane and subs' year-end consolidated financial statements.
Choice "b" is incorrect. $100,000 is incorrect since we do not present half the dividends just because we
don't own 100% of one sub.
Choice "c" is incorrect. $190,000 out of $200,000 in dividends are "eliminated", leaving us with $10,000
reported in the consolidated financial statements.
Choice "d" is incorrect. $200,000 are the total dividends declared, but the $190,000 paid to Jane gets
eliminated when the financial statements are consolidated.
5
5.
Lem Co., which accounts for treasury stock under the par value method, acquired 100 shares of its $6 par
value common stock for $10 per share. The shares had originally been issued by Lem for $7 per share.
By what amount would Lem's additional paid-in capital from common stock decrease as a result of the
acquisition?
a. $0
b. $100
c. $300
d. $400
Solution:
Choice "b" is correct. Under the par value method, when the shares are (re)acquired by Lem, the
treasury stock is recorded at par value ($6/share) and additional paid-in-capital is reduced by the $100
recorded when the shares were originally issued. The difference, in this case between the $10 buy-back
price and the $7 initial issuance price, or $3/share, is assigned to retained earnings as a reduction.
Here are the journal entries for additional clarification:
At issuance:
Cash 700
Common Stock 600
Add'l Paid-In-Capital 100
At (re)acquisition:
Treasury Stock 600
Add'l Paid-In-Capital 100
Retained Earnings-plug 300
Cash 1,000
Choice "a" is incorrect. Under the par value method, the acquisition of treasury stock is recorded by
reducing additional paid in capital by the amount recorded when the shares were originally issued to
investors.
Choice "c" is incorrect. The $300 difference between the $1,000 paid by the company to reacquire the
shares and the $700 originally received when the shares were issued to investors is recorded as a
reduction to retained earnings.
Choice "d" is incorrect. The $400 is the amount of both the debit to APIC and the debit to retained
earnings. This question asks only for the reduction in APIC.
6
6.
Abbott Co. is preparing its statement of cash flows for the year. Abbott's cash disbursements during the
year included the following:
Payment of interest on bonds payable $500,000

Payment of dividends to stockholders 300,000
Payment to acquire 1,000 shares
of Marks Co. common stock 100,000
What should Abbott report as total cash outflows for financing activities in its statement of cash flows
under U.S. GAAP?
a. $0
b. $300,000
c. $800,000
d. $900,000
Solution:
Choice "b" is correct. The $300,000 dividend to stockholders should be classified as a financing cash
outflow. Other financing activities would include the issuance of stock, the purchase of treasury stock, the
issuance of bonds, borrowing funds, and paying back principal related to bonds and loans. The payment
of interest on the bonds payable is an operating cash outflow under U.S. GAAP and the payment to
acquire the common stock of Marks is an investing cash outflow.
Choice "a" is incorrect. The $300,000 dividend to stockholders should be classified as a financing cash
outflow.
Choice "c" is incorrect. The $500,000 payment of interest, although related to a financing activity, is not
reported in the financing section under U.S.GAAP. It is reported as an operating cash outflow.
Choice "d" is incorrect. The $100,000 payment to acquire someone else's common stock should be
classified as an investing activity.
7
7.
In preparing Chase City's reconciliation of the statement of revenues, expenditures, and changes in fund
balances to the government-wide statement of activities, which of the following items should be
subtracted from changes in fund balances?
a. Capital assets purchases.
b. Payment of long-term debt principal.
c. Internal service fund increase in net assets.
d. Book value of capital assets sold during the year.
Solution:
Choice "d" is correct. The elimination of the book value of a previously acquired asset has no impact on
fund financial statements but serves to reduce the changes in net assets of the government-wide financial
statements as the asset is written off (net of proceeds and accumulated depreciation). The book value of
capital assets is, therefore, essentially subtracted from change in fund balance to reconcile to the change
in government-wide net assets. Actual reconciling items might focus more on the computation of a gain
or loss and proceeds from the disposal rather than individual components such as the asset book value.
Choice "a" is incorrect. Capital asset purchases are added back to the changes in fund balance to
reconcile to the change in net assets displayed on the government-wide statement of activities. Capital
asset purchases are displayed as an expenditure in fund financial statements but are capitalized in the
government-wide financial statements. Capital outlay is the "E" in "GOES" and is added back, not
subtracted.
Choice "b" is incorrect. Payment of long term debt principal is added back to the changes in fund balance
to reconcile to the change in net assets displayed on the government-wide statement of activities.
Payment of long term debt principal is displayed as an expenditure in fund financial statements but is
shown as a reduction liabilities in the government-wide financial statements. Principal payment on debt is
part of the "E" in "GOES" and is added back, not subtracted.
Choice "c" is incorrect. Increases in internal service fund net assets would be added to the changes in
fund balance to reconcile to the change in net assets displayed on the government-wide statement of
activities. A net loss in the internal service funds would be subtracted. Internal Service fund activity is the
"S" in "GOES" and is added back.
8
8.
Neron Co. has two derivatives related to two different financial instruments, instrument A and instrument
B, both of which are debt instruments. The derivative related to instrument A is a fair value hedge, and
the derivative related to instrument B is a cash flow hedge. Neron experienced gains in the value of
instruments A and B due to a change in interest rates. Which of the gains should be reported by Neron in
its income statement?
Gain in value Gain in value
of debt instrument A of debt instrument B
a. Yes Yes
b. Yes No
c. No Yes
d. No No
Solution:
Choice "b" is correct. Fair value hedge gains and losses are recorded on the income statement, while
cash flow hedge gains and losses, to the extent they are effective (which is assumed in this fact pattern),
are recorded as a component of other comprehensive income (the E in our PUFER mnemonic.)
Choice "a" is incorrect. Only fair value hedge gains and losses should be reported within the income
statement.
Choice "c" is incorrect. This selection is backwards. Fair value gains and losses appear on the income
statement while cash flows gains and losses should be presented as a component of other
comprehensive income (PUFER).
Choice "d" is incorrect. Fair value hedge gains and losses are to be reported within the income
statement.
9
9.
Fern Co. has net income, before taxes, of $200,000, including $20,000 interest revenue from municipal
bonds and $10,000 paid for officers' life insurance premiums where the company is the beneficiary. The
tax rate for the current year is 30%. What is Fern's effective tax rate?
a. 27.0%
b. 28.5%
c. 30.0%
d. 31.5%
Solution:
Choice "b" is correct. The municipal bond income and keyperson life insurance premiums are both
permanent differences. Therefore, pretax income must be adjusted for both items to compute taxable
income:
Pretax income $200,000
- Municipal bond income (20,000)
+ Life insurance premiums 10,000
Taxable income $190,000
The $20,000 of municipal bond income is subtracted because it is not taxable income. The insurance
premiums are added back because they are not deductible. Because there are no temporary differences
and no deferred taxes, income tax expense is equal to taxable income times the current period tax rate:
Income tax expense = Taxable income x Tax rate = $190,000 x 30% = $57,000
The effective tax rate can then be calculated as income tax expense divided by pretax income:
Effective tax rate = Income tax expense / Pretax income = $57,000 / $200,000 = 28.5%
Choice "a" is incorrect. This answer choice would result if you computed $180,000 times 30% or $54,000
and divided this back by the $200,000. However, this is incorrect since you must remember to add back
the $10,000 in insurance premiums.
Choice "c" is incorrect. The effective tax rate is equal to income tax expense divided by pretax income.
The effective tax rate is not equal to the current year tax rate of 30% due to the existence of the two
permanent differences.
Choice "d" is incorrect. This answer choice would result if the municipal bond income was added and the
life insurance premiums were subtracted when calculating taxable income. The $20,000 of municipal
bond income should be subtracted because it is not taxable income. The insurance premiums should be
added back because they are not deductible.
10
10.
Assuming constant inventory quantities, which of the following inventory-costing methods will produce a
lower inventory turnover ratio in an inflationary economy?
a. FIFO (first in, first out).
b. LIFO (last in, first out).
c. Moving average.
d. Weighted average.
Solution:
Choice "a" is correct. Since the inventory turnover ratio is computed by taking the cost of goods sold for
the year and dividing this by the average inventory, then we're looking for an answer that would result in a
lower COGS figure and/or a higher average inventory valuation. Keep in mind that we're assuming an
inflationary environment or rising prices. Under FIFO, our COGS would be lower, and our ending
inventory would be higher, causing our average inventory to be higher as well. Therefore, FIFO will result
in a lowest inventory turnover in an inflationary environment assuming constant inventory quantities.
Choice "b" is incorrect. LIFO's effects would be the reverse. LIFO results in a higher COGS figure and a
lower ending inventory valuation amount which in turn causes a lower average inventory valuation
amount as well. Therefore, LIFO would yield a higher inventory turnover ratio in an inflationary
environment, not a lower one, assuming constant inventory quantities.
Choice "c" is incorrect. The moving average inventory costing method would result in an inventory
turnover ratio between those calculated using FIFO and LIFO.
Choice "d" is incorrect. The weighted average inventory costing method would result in an inventory
turnover ratio between those calculated using FIFO and LIFO.
11
11.
Hilltop Co.'s monthly bank statement shows a balance of $54,200. Reconciliation of the statement with
company books reveals the following information:
Bank service charge $10

Insufficient funds check 650
Checks outstanding 1,500
Deposits in transit 350
Check deposited by Hilltop and cleared by the bank for $125,
but improperly recorded by Hilltop as $152
What is the net cash balance after the reconciliation?

a. $52,363
b. $53,023
c. $53,050
d. $53,077
Solution:
Choice "c" is correct. This fact pattern provided us with the balance per the bank statement of $54,200.
There are only two reconciling items for the balance per the bank statement, ignoring bank errors, and
these are deposits in transit and outstanding checks.
Any other reconciling items, namely service charges, NSF checks, credit memos (customer collections via
wire transfer), interest income, and errors made by the company are only reconciling items to the balance
per the books or general ledger balance, and this balance was not provided here.
Therefore, starting with the $54,200, the only two things we can do are to add the deposits in transit of
$350 and subtract the outstanding checks of $1,500. This yields us a corrected or adjusted cash balance
of $53,050.
Choices "a", "b", and "d" are incorrect. The bank service charge, NSF check, and recording error are only
reconciling items to the book, or GL, balance, but the examiners did not provide us with this amount
12
12.
A nongovernmental not-for-profit organization received a $2 million gift from a donor who specified it be
used to create an endowment fund that would be invested in perpetuity. The income from the fund is to
be used to support a specific program in the second year and beyond. An investment purchased with the
gift earned $40,000 during the first year. At the end of the first year, the fair value of the investment was
$2,010,000. What is the net effect on temporarily restricted net assets at year end?
a. $0
b. $10,000 increase.
c. $40,000 increase.
d. $50,000 increase.
Solution:
Choice "d" is correct. Temporarily restricted net assets would increase by $50,000, the amount of the
investment earnings of $40,000 and the $10,000 increase in the market value of the underlying
permanently restricted investment.
Choice "a" is incorrect. Investment earnings and growth are accounted for as temporarily restricted.
Choice "b" is incorrect. Temporarily restricted earnings would include both the investment growth of
$10,000 as well as the $40,000 in earnings.
Choice "c" is incorrect. Temporarily restricted earnings would include both the $40,000 in earnings as
well as investment growth of $10,000.
13
13.
When purchasing a bond, the present value of the bond's expected net future cash inflows discounted at
the market rate of interest provides what information about the bond?
a. Price.
b. Par.
c. Yield.
d. Interest.
Solution:
Choice "a" is correct. The issue price of a bond is a function of two different cash flows, one a lump sum
and the other a regular stream of payments. First, we need to present value the eventual return of
principal using present value tables and factors at the market or effective rate of interest, also known as
the yield. Second, we need to present value the regular interest payments, whether annual or
semiannual, using present value of an annuity tables and factors at the same market or effective interest
rate (yield). Remember that the face rate of interest only has one job, and this is to compute the regular
interest payments. It's the market rate of interest that will determine the bond's selling price.
Choice "b" is incorrect. The par value of the bond is also known as the maturity value since this is the
amount that must be paid back at maturity.
Choice "c" is incorrect. The yield is another term for market or effective interest rate. It is this rate that
will be used when using the PV table and the PV annuity table to determine the issue price of the bond.
Choice "d" is incorrect. Interest will be paid semiannually (usually) or annually, and this interest must be
present valued at the market rate along with the bond principal in order to come up with the bond price.
14
14.
A company calculated the following data for the period:
Cash received from customers $25,000

Cash received from sale of equipment 1,000
Interest paid to bank on note 3,000
Cash paid to employees 8,000
What amount should the company report as net cash provided by operating activities in its statement of
cash flows?
a. $14,000
b. $15,000
c. $18,000
d. $26,000
Solution:
Choice "a" is correct. Cash received from customers, interest paid to bank on note, and cash paid to
employees are all operating activities within the direct method statement of cash flows. Cash received
from customers is a cash inflow and interest paid to bank on note and cash paid to employees are cash
outflows:
Cash received from customers $25,000
Cash paid to employees (8,000)
Interest paid (3,000)
Net cash provided by operating activities $14,000
Choice "b" is incorrect. The $1,000 of cash received from sale of equipment would fall under the
investing activities section along with any other capital expenditures or other investments.
Choice "c" is incorrect. The $3,000 of interest paid to bank on note, while related to a financing activity, is
actually classified as an operating activity within the statement of cash flows.
Choice "d" is incorrect. The $8,000 of cash paid to employees is considered an operating activity and
therefore must be deducted from this section. This section looks very much like a cash-basis income
statement.
15
15.
A company records items on the cash basis throughout the year and converts to an accrual basis for
year-end reporting. Its cash-basis net income for the year is $70,000. The company has gathered the
following comparative balance sheet information:
Beginning of year End of year

Accounts payable $ 3,000 $1,000
Unearned revenue 300 500
Wages payable 300 400
Prepaid rent 1,200 1,500
Accounts receivable 1,400 600
What amount should the company report as its accrual-based net income for the current year?
a. $68,800
b. $70,200
c. $71,200
d. $73,200
Solution:
Choice "c" is correct. One approach for converting from cash-basis to accrual-basis is as follows:
1) Add increases in current assets. For example, when AR increases, the increase is not
considered to be income under the cash basis because the cash has not been collected, but the
increase is income under the accrual basis.
2) Subtract decreases in current assets. Conversely, when AR decreases, then cash-basis counted
it as revenue when the cash was collected, but under the accrual basis, the income was
recognized in a prior period and should not be recognized again in the current period.
3) Add decreases in current liabilities. For example, when AP decreases, this represents a cash
outflow that is recorded as an expense under the cash basis. However, under the accrual basis
the paid expenses were recorded in a prior period and should not be recorded again in the
current period.
4) Subtract increases in current liabilities. Conversely, when AP increases, this represents
expenses incurred under the accrual basis method that have not been recorded under the cash
basis method because they have not been paid.
Therefore, starting with the $70,000, we add the $2,000 decrease in AP, subtract the $200 and $100
increases in unearned revenue and wages payable, add the $300 increase in prepaid rent, and finally
subtract the $800 decrease in accounts receivable:
$70,000 + $2,000 - $300 + $300 - $800 = $71,200
16
16.
Under U.S. GAAP, restorations of carrying value for long-lived assets are permitted if an asset's fair value
increases subsequent to recording an impairment loss for which of the following?
Held for use Held for disposal
a. Yes Yes
b. Yes No
c. No Yes
d. No No
Solution:
Choice "c" is correct. Under U.S. GAAP, long-lived assets that are impaired can only have their carrying
value restored if they are held for disposal. Assets that are held for continued use that are impaired are
not permitted to have any restoration of carrying value. Keep in mind that any write-ups are limited to
previous write-downs.
Choices "a", "b", and "d" are incorrect as per the rules above.
17
17.
What are the components of the lease receivable for a lessor involved in a direct-financing lease?
a. The minimum lease payments plus any executory costs.
b. The minimum lease payments plus residual value.
c. The minimum lease payments less residual value.
d. The minimum lease payments less initial direct costs.
Solution:
Choice "b" is correct. Lessors recording a lease receivable for a direct-financing lease should include the
minimum lease payments PLUS any residual value. The reason for this is because the lessor can also
expect to collect this residual value from the lessee at the culmination of the lease.
Choice "a" is incorrect. Executory costs, like insurance, taxes, and maintenance, are always recorded
separately and do not affect the computation of the minimum lease payments nor the lease receivable.
Choice "c" is incorrect. The residual value needs to be added, not subtracted, since the lessee is
obligated to pay this to the lessor at the culmination of the lease.
Choice "d" is incorrect. Initial direct costs, like executory costs, do not affect the computation of the lease
receivable.
18
18.
When the effective interest method of amortization is used for bonds issued at a premium, the amount of
interest payable for an interest period is calculated by multiplying the:
a. Face value of the bonds at the beginning of the period by the contractual interest rate.
b. Face value of the bonds at the beginning of the period by the effective interest rates.
c. Carrying value of the bonds at the beginning of the period by the contractual interest rate.
d. Carrying value of the bonds at the beginning of the period by the effective interest rates.
Solution:
Choice "a" is correct. The interest payable on a bond is calculated by taking the face value of the bond at
the beginning of the period and multiply this amount by the contractual interest rate.
Choice "b" is incorrect. This calculation is not used in bond accounting.
Choice "c" is incorrect. This calculation is not used in bond accounting.
Choice "d" is incorrect. This is the formula used to calculate the interest expense on a bond.
19
19.
In year 1, a company reported in other comprehensive income an unrealized holding loss on an
investment in available-for-sale securities. During year 2, these securities were sold at a loss equal to the
unrealized loss previously recognized. The reclassification adjustment should include which of the
following?
a. The unrealized loss should be credited to the investment account.
b. The unrealized loss should be credited to the other comprehensive income account.
c. The unrealized loss should be debited to the other comprehensive income account.
d. The unrealized loss should be credited to beginning retained earnings.
Solution:
Choice "b" is correct. In year 1, the company would have debited an unrealized holding loss within other
comprehensive income (the U in PUFER) and they would have credited either the investment account
itself or more likely a valuation allowance associated with this asset account. In Year 2 when these
securities were sold for the exact same loss, the company would need to eliminate this unrealized loss
from OCI by crediting it and record a realized loss on the income statement by debiting it.
Choice "a" is incorrect. The investment account would need to be credited at the time of the sale for the
carrying value of the investment.
Choice "c" is incorrect. The unrealized loss was debited in Year 1 when the unrealized loss was initially
recorded, so a credit is needed to eliminate it.
Choice "d" is incorrect. The unrealized loss would not affect retained earnings, although the realized loss
certainly would.
20
20.
Toigo Co. purchased merchandise from a vendor in England on November 20 for 500,000 British pounds.
Payment was due in British pounds on January 20. The spot rates to purchase one pound were as
follows:
November 20 $1.25
December 31 1.20
January 20 1.17
How should the foreign currency transaction gain be reported on Toigo's financial statements at
December 31?
a. A gain of $40,000 as a separate component of stockholders' equity.
b. A gain of $40,000 in the income statement.
c. A gain of $25,000 as a separate component of stockholders' equity.
d. A gain of $25,000 in the income statement.
Solution:
th
Choice "d" is correct. On November 20 , the company enter into an agreement to purchase merchandise
for an amount that it expected to settle for $625,000 (500,000 pounds x $1.25/pound). On December
st
31 , the spot rate had fallen to $1.20 per pound, at which rate the purchase could be settled for $600,000
(500,000 pounds x $1.20/pound). This represents a $25,000 foreign currency transaction gain that is
recognized on the year-end income statement.
st
Choices "a", "b", and "c" are incorrect. Since it's only December 31 , we will not recognize all $40,000 in
the first year, and foreign currency transaction gains like these are reported on the income statement.
Foreign currency translation gains and losses are reported in other comprehensive income and
recognized as a separate component of stockholders' equity.
21
21.
A company enters into a three-year operating lease agreement effective January 1, year 1. The amounts
due on the first day of each year are $25,000 in year 1, $30,000 in year 2, and $35,000 in year 3. What
amount, if any, is the related liability on the first day of year 2?
a. $0
b. $5,000
c. $60,000
d. $65,000
Solution:
Choice "b" is correct. Operating lease expense must be recorded equally over the life of the lease. The
average annual lease amount is $30,000 per year, or $2,500 per month. In year 1, the lease would be
accounted for as follows:
Beginning of Year 1:
Prepaid rent 25,000
Cash 25,000
Monthly AJE's for first 10 months:

Rent Expense 2,500
Prepaid rent 2,500
Monthly AJE's for final 2 months:

Rent Expense 2,500
Rent payable 2,500
After recording monthly AJE's for both November and December, our rent payable is $5,000 by 1/1/Y2.
22
22.
Damon Co. purchased 100% of the outstanding common stock of Smith Co. in an acquisition by issuing
20,000 shares of its $1 par common stock that had a fair value of $10 per share and providing contingent
consideration that had a fair value of $10,000 on the acquisition date. Damon also incurred $15,000 in
direct acquisition costs. On the acquisition date, Smith had assets with a book value of $200,000, a fair
value of $350,000, and related liabilities with a book and fair value of $70,000. What amount of gain
should Damon report related to this transaction?
a. $55,000
b. $70,000
c. $80,000
d. $250,000
Solution:
Choice "b" is correct. Please see following journal entry with additional details and explanation:
Investment in Smith 280,000 ($350,000 asset fair value less $70,000 liabilities fair value)
Common Stock 20,000 (20,000 shares times $1 par value)
Add'l-paid-in-capital 165,000 (20,000 shares times $9 excess, less $15,000 in dir. acq. costs)
Contingent consideration 10,000 (given)
Cash 15,000 (direct acquisition costs)
Gain 70,000 (plug)
23
23.
If a city government is the primary reporting entity, which of the following is an acceptable method to
present component units in its combined financial statements?
a. Consolidation.
b. Cost method.
c. Discrete presentation.
d. Government-wide presentation.
Solution:
Choice "c" is correct. Component units may be presented using either the discrete or blended method
within the financial statements of the primary reporting entity. Discrete presentation is an acceptable
method to present component units.
Choice "a" is incorrect. Component units may be presented using either the discrete or blended method
within the financial statements of the primary reporting entity. Consolidation is not an acceptable method
to present component units.
Choice "b" is incorrect. Component units may be presented using either the discrete or blended method
within the financial statements of the primary reporting entity. The "cost method" is not an acceptable or
recognized method to present component units.
Choice "d" is incorrect. Component units may be presented using either the discrete or blended method
within the financial statements of the primary reporting entity. Government-wide presentation is a
component of basic financial statement presentation and is not an acceptable or recognized method to
present component units.
24
24.
Which of the following statements correctly describes the proper accounting for nonmonetary exchanges
that are deemed to have commercial substance?
a. It defers any gains and losses.
b. It defers losses to the extent of any gains.
c. It recognizes gains and losses immediately.
d. It defers gains and recognizes losses immediately.
Solution:
Choice "c" is correct. For nonmonetary exchanges that contain commercial substance, meaning that the
amount and timing of future cash flows changes as a result of this exchange, gains and losses are
recognized immediately.
Choice "a" is incorrect. Losses are never deferred, no matter whether the exchange contains commercial
substance or not. A portion of a gain can only be deferred for nonmonetary exchanges that do NOT
contain commercial substance, meaning the amount and timing of future cash flows did not change as a
result of this exchange, and only if boot (cash) is RECEIVED as a minor component (less than 25%) of
this transaction.
Choice "b" is incorrect. Losses are never deferred, no matter whether the exchange contains commercial
substance or not.
Choice "d" is incorrect. Losses are recognized immediately, but a portion of a gain can only be deferred
for nonmonetary exchanges that do NOT contain commercial substance, meaning the amount and timing
of future cash flows did not change as a result of this exchange, and only if boot (cash) is RECEIVED as
a minor component (less than 25%) of this transaction.
25
25.
Campbell Corp. exchanged delivery trucks with Highway, Inc. Campbell's truck originally cost $23,000,
its accumulated depreciation was $20,000, and its fair value was $5,000. Highway's truck originally cost
$23,500, its accumulated depreciation was $19,900, and its fair value was $5,700. Campbell also paid
Highway $700 in cash as part of the transaction. The transaction lacks commercial substance. What
amount is the new book value for the truck Campbell received?
a. $5,700
b. $5,000
c. $3,700
d. $3,000
Solution:
Choice "c" is correct. The gain or loss can be derived by subtracting the net book value or carrying
amount of the asset being surrendered with its fair value. The fair value of the asset being surrendered
must always equals the fair value of the asset being received, even if only one of these amounts are
given. In this fact pattern, Campbell's truck's carrying value was $3,000 ($23,000 less $20,000), and its
fair value is $5,000. So there is a gain of $2,000.
However, since this exchange lacks commercial substance, Campbell can only recognize a gain if it
received boot/cash. If boot/cash is given, or there is no boot or cash in the transaction, then no gain is
recognized. Because Campbell pays cash of $700, not gain is recognized. Therefore, the journal entry
to record the transaction and "plug" for the book value of the Truck received by Campbell is:
New truck 3,700 (plug)
Accumulated depreciation 20,000
Old truck 23,000
Cash 700
26
26.
The replacement cost of an inventory item is below the net realizable value and above the net realizable
value less a normal profit margin. The inventory item's original cost is above the net realizable value.
Under the lower of cost or market method, the inventory item should be valued at:
a. Original cost.
b. Replacement cost.
c. Net realizable value.
d. Net realizable value less normal profit margin.
Solution:
Choice "b" is correct. The market value of the inventory is the middle value of the replacement cost, the
market ceiling (net realizable value) and the market floor (net realizable value normal profit margin).
Because replacement cost falls between the market ceiling and the market floor, it is considered to be the
market value of the inventory.
Under U.S. GAAP, the inventory is reported at the lower of cost or market. Because the cost is above the
replacement cost (market value), the inventory is reported at replacement cost.
Choice "a" is incorrect. The inventory is not reported at original cost because the original cost exceeds
the market value (replacement cost). Under U.S. GAAP, inventory is reported at the lower of cost or
market.
Choice "c" is incorrect. The inventory is not reported at net realizable value because the net realizable
value exceeds the replacement cost and the replacement cost exceeds net realizable value less normal
profit margin. Therefore, the replacement cost is the market value of the inventory and is the amount
used to determine lower of cost or market.
Choice "d" is incorrect. The inventory is not reported at net realizable value less normal profit margin
because this amount is less than the replacement cost and the replacement cost is less than net
realizable value. Therefore, the replacement cost is the market value of the inventory and is the amount
used to determine lower of cost or market.
27
27.
Encumbrances would not appear in which fund?
a. Capital projects.
b. Special revenue.
c. General.
d. Enterprise.
Solution:
Choice "d" is correct. An enterprise fund would not use encumbrance accounting. Encumbrance
accounting is used in the governmental (GRaSPP) funds but is not used in the proprietary (SE) or
fiduciary (PAPI) funds. Enterprise is the "E" in "SE".
Choice "a" is incorrect. A capital projects fund would use encumbrance accounting. Encumbrance
fiduciary (PAPI) funds. Capital projects is the first "P" in "GRaSPP".
Choice "b" is incorrect. A special revenue fund would use encumbrance accounting. Encumbrance
fiduciary (PAPI) funds. Special Revenue is the "R" in "GRaSPP".
Choice "c" is incorrect. The general fund would use encumbrance accounting. Encumbrance accounting
is used in the governmental (GRaSPP) funds but is not used in the proprietary (SE) or fiduciary (PAPI)
funds. The General fund is the "G" in "GRaSPP".
28
28.
Roy City received a gift, the principal of which is to be invested in perpetuity with the income to be used to
support the local library. In which fund should this gift be recorded?
a. Permanent fund.
b. Investment trusts fund.
c. Private-purpose trusts fund.
d. Special revenue fund.
Solution:
Choice "a" is correct. The gift will be accounted for in a permanent fund. Permanent funds are used to
report resources that are legally restricted to the extent income, and not principal, may be used for
purposes supporting the reporting government's programs for the benefit of the public. The library is to
be supported by a gift endowment and the library is intended to support the needs of the general
community, not a specifically identified individual.
Choice "b" is incorrect. Investment trust funds are used to account for external investment pools. An
endowment contributed in support of a library to benefit the public is not an external investment pool.
Choice "c" is incorrect. Private purpose trust funds are fiduciary relationships that do not meet the
definition of a pension, agency or investment trust fund and are intended for the benefit of specific
individuals, private organizations or other governments. The library to be benefitted by the endowment is
for the general public, not specific private individuals.
Choice "d" is incorrect. Special revenue funds account for revenues from specific taxes or other
earmarked sources that (by law) are restricted or committed to finance particular activities of a
government. Roy City is accounting for income from a gift that is not appropriate for accounting within a
special revenue fund.
29
29.
Which of the following costs is unique to postretirement health-care benefits?
a. Per capita claims.
b. Service.
c. Prior service.
d. Interest.
Solution:
Choice "a" is correct. Per capita claims are unique to postretirement health-care benefits.
Choice "b" is incorrect. Service costs are one part of net pension expense and SIR-AGE.
Choice "c" is incorrect. Prior service costs also affect net pension expense and SIR-AGE.
Choice "d" is incorrect. Interest costs are also part of net pension expense and SIR-AGE.
30
30.
During the current year, the Finn Foundation, a nongovernmental not-for-profit organization, received a
$1,000,000 permanent endowment from Chris. Chris stipulated that the income must be used to provide
recreational activities for the elderly. The endowment reported income of $80,000 in the current year.
What amount of permanently restricted contribution revenue should Finn report at the end of the current
year?
a. $1,080,000
b. $1,000,000
c. $80,000
d. $0
Solution:
Choice "b" is correct. Finn Foundation would report permanently restricted income in the amount of the
$1,000,000 contribution. The permanently restricted amount cannot be spent but, instead, must be
invested. The restrictions on the donation will never disappear or be satisfied by the Foundation by
expenditure of the money. The $80,000 in earnings from the investment, however, would be accounted
for as temporarily restricted revenue since it can be used to satisfy donor stipulations, a recreational
program for the elderly.
Choice "a" is incorrect. Although total revenue for the Finn Foundation would be $1,080,000, the
company would only report permanently restricted income in the amount of the $1,000,000 contribution to
establish the endowment in the year received. The $80,000 in earnings from the investment would be
accounted for as temporarily restricted revenue since it can be used to satisfy donor stipulations, a
recreational program for the elderly.
Choice "c" is incorrect. Although the Finn Foundation would report $80,000 as temporarily restricted, the
company would report the contributed endowment as permanently restricted income in the amount of the
$1,000,000 contribution in the year received.
Choice "d" is incorrect. Finn Foundation would report permanently restricted income in the amount of the
$1,000,000 contribution. The $80,000 in earnings from the investment would be accounted for as
temporarily restricted revenue.
31
31.
Larkin Co. has owned 25% of the common stock of Devon Co. for a number of years, and has the ability
to exercise significant influence over Devon. The following information relates to Larkin's investment in
Devon during the most recent year:
Carrying amount of Larkin's investment in Devon

at the beginning of the year $200,000
Net income of Devon for the year 600,000
Total dividends paid to Devon's stockholders
during the year 400,000
What is the carrying amount of Larkin's investment in Devon at year end?

a. $100,000
b. $200,000
c. $250,000
d. $350,000
Solution:
Choice "c" is correct. Since Larkin is utilizing the equity method due to its ability to exercise significant
influence over Devon, it will record a proportionate share of Devon's earnings (25% x $600,000 =
$150,000) as an increases to the investment account and a proportionate share of Devon's dividends
(25% x $400,000 = $100,000) as a reduction in the investment account:
Initial carrying amount $200,000
+ Share of earnings 150,000
- Share of dividends (100,000)
Ending carrying amount $250,000
Choice "a" is incorrect. Under the equity method, the ending carrying amount is equal to the initial
carrying amount plus the investor's share of earnings minus the investor's share of dividends. This
answer fails to add the investor's share of earnings.
Choice "b" is incorrect. Under the equity method, the ending carrying amount is equal to the initial
carrying amount plus the investor's share of earnings minus the investor's share of dividends. The ending
carrying amount is not equal to the beginning carrying amount, unless the investee had no earnings and
paid no dividends.
Choice "d" is incorrect. Under the equity method, the ending carrying amount is equal to the initial
carrying amount plus the investor's share of earnings minus the investor's share of dividends. This
answer fails to subtract the investor's share of dividends.
32
32.
Which of the following transactions qualify as a discontinued operation?
a. Disposal of part of a line of business.
b. Planned and approved sale of a segment.
c. Phasing out of a production line.
d. Changes related to technological improvements.
Solution:
Choice "b" is correct. The planned and approved sale of a segment qualifies as a discontinued operation.
Because a segment is a component of the entity. Segments may be functional in nature, like a major
product category or service division, or they can be geographical as well.
Choice "a" is incorrect. The disposal of part of a line of business would not qualify as a discontinued
operation, although it's possible that the elimination of the "entire" line could qualify as one if the business
line meets the definition of a component of the entity.
Choice "c" is incorrect. Phasing out a production line is not the discontinuation of a component of the
entity and does not qualify as a discontinued operation.
Choice "d" is incorrect. Changes related to "technological" improvements are not the discontinuation of a
component of the entity and does not qualify as discontinued operations.
33
33.
Rowe Inc. owns 80% of Cowan Co.'s outstanding capital stock. On November 1, Rowe advanced
$100,000 in cash to Cowan. What amount should be reported related to the advance in Rowe's
consolidated balance sheet as of December 31?
a. $0
b. $20,000
c. $80,000
d. $100,000
Solution:
Choice "a" is correct. All intercompany transactions, including loans and advance, should be eliminated
upon consolidation. Therefore, none of the $100,000 advance should appear in the consolidated balance
sheet. The percentage ownership here is irrelevant. Therefore, the correct answer is zero.
Choices "b", "c", and "d" are incorrect as per the rule above.
34
34.
Chape Co. had the following information related to common and preferred shares during the year:
Common shares outstanding, 1/1 700,000

Common shares repurchased, 3/31 20,000
Conversion of preferred shares, 6/30 40,000
Common shares repurchased, 12/1 36,000
Chape reported net income of $2,000,000 at December 31. What amount of shares should Chape use as
the denominator in the computation of basic earnings per share?
a. 684,000
b. 700,000
c. 702,000
d. 740,000
Solution:
Choice "c" is correct. When computing the weighted average number of common shares outstanding
(WACSO), shares issues, repurchased or converted must be time-weighted for the number of months
outstanding:
The 20,000 common shares repurchased (treasury stock) on 3/31 were only outstanding for 9
months.
The conversion of 40,000 preferred shares on 6/30 were only outstanding for 6 months.
The 36,000 common shares repurchased (treasury stock) on 12/1 were only outstanding for 1
month.
1/1 700,000 x 12/12 = 700,000
3/31 20,000 x 9/12 = (15,000)
6/30 40,000 x 6/12 = 20,000
12/1 36,000 x 1/12 = (3,000)
WACSO = 700,000 15,000 + 20,000 3,000 = 702,000 shares
35
35.
Marr Co. had the following sales and accounts receivable balances, prior to any adjustments at year end:
Credit sales $10,000,000

Accounts receivable 3,000,000
Allowance for uncollectible accounts (debit balance) 50,000
Marr uses 3% of accounts receivable to determine its allowance for uncollectible accounts at year end.
By what amount should Marr adjust its allowance for uncollectible accounts at year end?
a. $0
b. $40,000
c. $90,000
d. $140,000
Solution:
Choice "d" is correct. Since Marr uses the percentage of accounts receivable method for estimating bad
debts, the ending allowance is calculated by multiply 3% by $3,000,000, for a required allowance of
$90,000.
Note that the unadjusted balance in the allowance account right now is a debit balance of $50,000. The
allowance should be a credit balance, or contra-asset. A debit balance in the allowance account means
that last year was a particularly bad year for Marr and they wrote off so many bad accounts receivable
that they didn't have enough in their allowance to account for it all.
To adjust from a debit balance in the allowance account of $50,000 to a credit balance of $90,000, the
following journal entry must be recorded:
Uncollectible Accounts Expense 140,000
Allowance for Doubtful Accounts 140,000
($50,000) + $140,000 = $90,000
Choice "a" is incorrect. An adjusting journal entry is required to report an allowance of $90,000
($3,000,000 x 3%), so zero is incorrect.
Choice "b" is incorrect. The $40,000 would be correct had the $50,000 balance in the allowance account
been a credit balance instead.
Choice "c" is incorrect. The $90,000 is the required ending balance, but the fact pattern is asking for the
amount of the adjustment required.
36
36.
On April 1, year 1, Hall Fitness Center leased its gym to Dunn Fitness Center under a four-year operating
lease. Hall normally charges $6,000 per month to lease its gym, but as an incentive, Hall gave Dunn half
off the first year's rent, and one quarter off the second year's rent. Dunn's rental payments were as
follows:
Year 1 12 x $3,000 = $36,000
Year 2 12 x $4,500 = $54,000
Year 3 12 x $6,000 = $72,000
Year 4 12 x $6,000 = $72,000
Dunn's rent payments were due on the first day of the month, beginning on April 1, year 1. What amount
should Dunn report as rent expense in its monthly income statement for April, year 3?
a. $3,000
b. $4,500
c. $4,875
d. $6,000
Solution:
Choice "c" is correct. Rent expense must be reported on a straight-line basis. When lease rates fluctuate
and when reduced rent is given, the average lease rate must be computed. In this case, total rent
expense over the life of the lease is $234,000 ($36,000 + $54,000 + $72,000 + $72,000) and the average
rent expense is $58,500 per year ($234,000 / 4 years). $58,500 divided by 12 months equals $4,875 per
month.
Choice "a" is incorrect. Under accrual accounting, we do not divide the first $36,000 by 12 months to
report as monthly rental expense. Rent expense must be reported on a straight-line basis over the life of
the lease.
Choice "b" is incorrect. Under accrual accounting, we do not divide the second $54,000 by 12 months to
report as monthly rental expense. Rent expense must be reported on a straight-line basis over the life of
the lease.
Choice "d" is incorrect. Under accrual accounting, we do not divide the third and fourth year $72,000 by
12 months to report as monthly rental expense. Rent expense must be reported on a straight-line basis
over the life of the lease.
37
37.
Which of the following activities should be excluded when governmental fund financial statements are
converted to government-wide financial statements?
a. Proprietary activities.
b. Fiduciary activities.
c. Government activities.
d. Enterprise activities.
Solution:
Choice "b" is correct. Fiduciary activities are excluded from the government-wide financial statements.
Transactions with fiduciary funds are treated as if those transactions were conducted with an independent
trustee for purposes of display in the government-wide financial statements.
Choice "a" is incorrect. Proprietary activities may show up in both governmental and business type
activities displayed in the government-wide financial statements. Enterprise funds will be displayed as
business type activities while internal services funds will generally be included in governmental type
activities, presuming that the internal service funds provide support to general governmental activities.
Choice "c" is incorrect. Governmental activities would be displayed in the government-wide financial
statements. Generally speaking governmental activities include governmental funds (GRaSPP) and the
internal service funds.
Choice "d" is incorrect. Enterprise funds are displayed as business type activities in the government-wide
financial statements.
38
38.
Frame construction company's contract requires the construction of a bridge in three years. The
expected total cost of the bridge is $2,000,000, and Frame will receive $2,500,000 for the project. The
actual costs incurred to complete the project were $500,000, $900,000, and $600,000, respectively,
during each of the three years. Progress payments received by Frame were $600,000, $1,200,000, and
$700,000, respectively. Assuming that the percentage-of-completion method is used, what amount of
gross profit would Frame report during the last year of the project?
a. $120,000
b. $125,000
c. $140,000
d. $150,000
Solution:
Choice "d" is correct. The expected gross profit from this contract is $500,000 ($2,500,000 sales price -
$2,000,000 anticipated costs). The actual project costs are $2,000,000 ($500,000 + $900,000 +
$600,000).
In the first year, the percentage of completion was 25% ($500,000 / $2,000,000), so gross profit of
$125,000 (25% x $500,000) was recognized.
In the second year, the percentage of completion was 70% [($500,000 + $900,000) / $2,000,000], so
cumulative gross profit was $350,000.
Finally, in the third year, the project was completed, so the remaining 30% of the profit is recognized:
$500,000 x 30% = $150,000.
Choices "a", "b", and "c" are incorrect as per the explanation above.
39
39.
Pann, a nongovernmental not-for-profit organization, provides food and shelter to the homeless. Pann
received a $15,000 gift with the stipulation that the funds be used to buy beds. In which net asset class
should Pann report the contribution?
a. Endowment.
b. Temporarily restricted.
c. Permanently restricted
d. Unrestricted.
Solution:
Choice "b" is correct. Pann would report a $15,000 gift restricted as to purpose for the purchase of beds
as temporarily restricted. Temporarily restricted net assets are subject to donor imposed stipulations that
either expire by passage of time or can be fulfilled and removed by actions of the organization. Pann can
satisfy the donor's restrictions by purchasing beds.
Choice "a" is incorrect. Pann would report a $15,000 gift restricted as to purpose for the purchase of
beds as temporarily restricted. There is no "endowment" classification for net assets.
Choice "c" is incorrect. Pann would report a $15,000 gift restricted as to purpose for the purchase of beds
as temporarily restricted. Temporarily restricted net assets are subject to donor imposed stipulations that
either expire by passage of time or can be fulfilled and removed by actions of the organization. Pann can
satisfy the donor's restrictions by purchasing beds. Permanent restrictions neither expire by passage of
time nor can be fulfilled by the actions of the organization.
Choice "d" is incorrect. Pann would report a $15,000 gift restricted as to purpose for the purchase of
beds as temporarily restricted. Temporarily restricted net assets are subject to donor imposed
stipulations that either expire by passage of time or can be fulfilled and removed by actions of the
organization. Pann can satisfy the donor's restrictions by purchasing beds. Unrestricted net assets are
available to finance general operations and may be expended as the discretion of the governing board.
Pann does not have that latitude, they must purchase beds.
40
40.
Grayson Co. incurred significant costs in defending its patent rights. Which of the following is the
appropriate treatment of the related litigation costs?
a. Litigation costs would be capitalized regardless of the outcome of the litigation.
b. Litigation costs would be expensed regardless of the outcome of the litigation.
c. Litigation costs would be capitalized if the patent right is successfully defended.
d. Litigation costs would be capitalized only if the patent was purchased rather than internally
developed.
Solution:
Choice "c" is correct. Litigation costs can only be capitalized as a part of the patent asset account if they
result in a successful patent defense so that the patent can be retained and continue to provide benefit.
Choice "a" is incorrect. Litigation costs would be expensed immediately if the outcome was unfavorable
since the patent would be lost and would no longer be able to provide benefit to the company.
Choice "b" is incorrect. Litigation costs are capitalized if the litigation results in a successful patent
defense.
Choice "d" is incorrect. The issue of whether the patent was developed internally or whether it was
purchased is irrelevant when it comes to determining what to do with litigation costs. The real key and
determining factor is whether the litigation is successful or not.
41
41.
A company decided to sell an unprofitable division of its business. The company can sell the entire
operation for $800,000, and the buyer will assume all assets and liabilities of the operations. The tax rate
is 30%. The assets and liabilities of the discontinued operation are as follows:
Buildings $5,000,000
Accumulated depreciation 3,000,000
Mortgage on buildings 1,100,000
Inventory 500,000
Accounts payable 600,000
Accounts receivable 200,000
What is the after-tax net loss on the disposal of the division?

a. $140,000
b. $200,000
c. $1,540,000
d. $2,200,000
Solution:
Choice "a" is correct. The value of the assets is $2,000,000 building + 500,000 inventory + 200,000 AR,
or $2,700,000. The value of the liabilities, which are to be assumed by the buyer, is $1,100,000 mortgage
+ 600,000 AP, or $1,700,000. So the value of the net assets, or assets less liabilities, is $1,000,000. The
before tax loss from the sale is $200,000 ($800,000 sales price - $1,000,000 book value of division), and
the after-tax loss is $140,000 [$200,000 x (1 30%)].
Choices "b", "c", and "d" are incorrect as per explanation above.
42
42.
On January 1, year 1, Newport Corp. purchased a machine for $100,000. The machine was depreciated
using the straight-line method over a 10-year period with no residual value. Because of a bookkeeping
error, no depreciation was recognized in Newport's year 1 financial statements, resulting in a $10,000
overstatement of the book value of the machine on December 31, year 1. The oversight was discovered
during the preparation of Newport's year 2 financial statements. What amount should Newport report for
depreciation expense on the machine in the year 2 financial statements?
a. $9,000
b. $10,000
c. $11,000
d. $20,000
Solution:
Choice "b" is correct. This error should be corrected by restating the opening balance of retained
earnings by $10,000 for Year 2, if only Year 2 financial statements are being presented. If Year 1
financial statements are being presented, then they should be corrected to reflect the proper Year 1
depreciation expense. In either case, this would have NO effect on the Year 2 depreciation expense,
which is $10,000.
Choices "a", "c", and "d" are incorrect. An error is not correct by spreading the difference into future years
or by double-counting the error in the following year. The error is corrected by adjusting beginning
retained earnings if the year of the error is not presented, or by correcting the error in the year of the error
if that year is presented. Year 2 depreciation expense should be shown as if the error did not occur.
43
43.
Four years ago on January 2, Randall Co. purchased a long-lived asset. The purchase price of the asset
was $250,000, with no salvage value. The estimated useful life of the asset was 10 years. Randall used
the straight-line method to calculate depreciation expense. An impairment loss on the asset of $30,000
was recognized on December 31 of the current year. The estimated useful life of the asset at December
31 of the current year did not change. What amount should Randall report as depreciation expense in its
income statement for the next year?
a. $20,000
b. $22,000
c. $25,000
d. $30,000
Solution:
Choice "a" is correct. The acquisition cost of this asset is $250,000, and it is depreciated at the rate of
$25,000 per year using the straight-line method based on a 10-year life. After four years, the
accumulated depreciation would be $100,000 and the net book value would be $150,000 ($250,000 -
$100,000). In Year 5, an impairment loss of $30,000 is recorded and the net book value of the asset is
$120,000 ($150,000 - $30,000). With 6 years remaining, the straight-line depreciation is $120,000 / 6
years = $20,000 per year.
Choices "b", "c", and "d" are incorrect as per explanation above.
44
44.
Which of the following items would best enable Driver Co. to determine whether the fair value of its
investment in Favre Corp. is properly stated in the balance sheet?
a. Discounted cash flow of Favre's operations.
b. Quoted market prices available from a business broker for a similar asset.
c. Quoted market prices on a stock exchange for an identical asset.
d. Historical performance and return on Driver's investment in Favre.
Solution:
Choice "c" is correct. Quoted market prices on a stock exchange for an identical asset are considered to
be a Level One input, the most reliable of all.
Choice "a" is incorrect. The discounted cash flow of Favre's operations are considered to be a Level Two
input, not as reliable as those coming from a stock exchange for an identical asset.
Choice "b" is incorrect. Quoted market prices available from a business broker for a similar asset are
considered to be a Level Two input, not as reliable as those coming from a stock exchange for an
identical asset.
Choice "d" is incorrect. The historical performance and return on Driver's investment in Favre are
considered to be Level Three unobservable inputs, the least reliable of all.
45
45.
A company has a defined benefit pension plan for its employees. On December 31, year 1, the
accumulated benefit obligation is $45,900, the projected benefit obligation is $68,100, and the fair value
of the plan assets is $62,000. What amount, if any, related to the defined benefit plan should be
recognized in the balance sheet at December 31, year 1?
a. An asset of $16,100.
b. A liability of $6,100.
c. Nothing, as the fair value of the plan assets exceeds the accumulated benefit obligation.
d. An unrealized loss of $6,100.
Solution:
Choice "b" is correct. Since the projected benefit obligation (PBO) of $68,100 exceeds the fair value of
the plan assets of $62,000, the pension is underfunded and a $6,100 liability should be recognized in the
year-end balance sheet.
Choices "a" is incorrect. The ABO is not used to compute the funded status of the pension plan.
Choice "c" is incorrect. The ABO is not used to compute the funded status of the pension plan.
Choice "d" is incorrect. This pension plan is underfunded by $6,100 ($68,100 PBO - $62,000 fair value of
plan assets). An underfunded pension plan is reported as a liability on the balance sheet, not as an
unrealized loss.
46
46.
A company's activities for year 2 included the following:
Gross sales $3,600,000
Cost of goods sold 1,200,000
Selling and administrative expense 500,000
Adjustment for a prior-year understatement of amortization expense 59,000
Sales returns 34,000
Gain on sale of available-for-sale securities 8,000
Gain on disposal of a discontinued business segment 4,000
Unrealized gain on available-for-sale securities 2,000
The company has a 30% effective income tax rate. What is the company's net income for year 2?
a. $1,267,700
b. $1,273,300
c. $1,314,600
d. $1,316,000
Solution:
Choice "c" is correct.
Net sales 3,566,000 = $3,600,000 gross sales - $34,000 sales returns
Cost of goods sold (1,200,000)
Gross profit 2,366,000
Selling and administrative (500,000)
Operating income 1,866,000
Other income (gain on sale) 8,000
Income from continuing operations 1,874,000
Income tax expense (562,200) = $1,874,000 x 30%
Income before discontinued operations 1,311,800
Gain from discontinued segment (after tax) 2,800 = $4,000 x (1 30%)
Net income 1,314,600
The adjustment for the prior year understatement of amortization expense is a prior period adjustment
that will be reflected in beginning retained earnings, not on the income statement. The unrealized gain
on the available for sale security will be reported in other comprehensive income.
47
47.
How should plan investments be reported in a defined benefit plan's financial statements?
a. At actuarial present value.
b. At cost.
c. At net realizable value.
d. At fair value.
Solution:
Choice "d" is correct. Pension plan investment assets must be reported at fair value in a defined benefit
plan's financial statements.
Choices "a", "b", and "c" are incorrect. Actuarial present value, cost, and net realizable value are not
appropriate bases for measuring pension plan asset investments.
48
48.
What is the purpose of reporting comprehensive income?
a. To summarize all changes in equity from nonowner sources.
b. To reconcile the difference between net income and cash flows provided from operating activities.
c. To provide a consolidation of the income of the firm's segments.
d. To provide information for each segment of the business.
Solution:
Choice "a" is correct. Comprehensive income represents all changes in stockholders' equity that come
from nonowner sources. Therefore, comprehensive income includes all net income plus any and all
components of other comprehensive income, the PUFER items. However, comprehensive income would
not include investments by stockholders (owners) nor would it include distributions or dividends to
stockholders (owners)
Choices "b", "c", and "d" are incorrect per the explanation above.
49
49.
Which of the following is a component of other comprehensive income?
a. Minimum accrual of vacation pay.
b. Cumulative currency-translation adjustments.
c. Changes in market value of inventory.
d. Unrealized gain or loss on trading securities.
Solution:
Choice "b" is correct. Cumulative currency translation adjustments are reported in other comprehensive
income.
Choice "a" is incorrect. Vacation pay is a standard operating item that properly affects net income, not
OCI.
Choice "c" is incorrect. Changes in market value of inventory, in accordance with lower of cost or market
(GAAP) or lower of cost or realizable value (IFRS) would also properly affect net income, not OCI.
Choice "d" is incorrect. Unrealized gains and loss on trading securities go directly to the income
statement. Its unrealized gains and losses on available-for-sale securities that would affect OCI.
50
50.
Nongovernmental not-for-profit organizations are required to provide which of the following external
financial statements?
a. Statement of financial position, statement of activities, statement of cash flows.
b. Statement of financial position, statement of comprehensive income, statement of cash flows.
c. Statement of comprehensive income, statement of cash flows, statement of gains and losses.
d. Statement of cash flows, statement of comprehensive income, statement of unrelated business
income.
Solution:
Choice "a" is correct. A not for profit organization is required to produce a statement of financial position,
statement of activities and statement of cash flows. Voluntary health and welfare organizations must
produce a statement of functional expenses as well, however, that statement is not mandatory for other
not for profit organizations.
Choice "b" is incorrect. A not for profit organization is required to produce a statement of financial
position, statement of activities and statement of cash flows. Not for profit organizations do not
contemplate the concept of comprehensive income.
Choice "c" is incorrect. A not for profit organization is required to produce a statement of financial
contemplate the concept of comprehensive income. There is no statement of gains and losses.
Choice "d" is incorrect. A not for profit organization is required to produce a statement of financial
contemplate the concept of comprehensive income. Unrelated business income, while highly significant
to tax reporting, is not a required component of external GAAP reporting.
51
AICPA Newly Released FAR Simulations
Task 543_01
52
53
54
Explanation:
SITUATION 1
The gain or loss on the intercompany sale of a depreciable asset is unrealized from a consolidated
financial statement perspective until the asset is sold to an outsider. An elimination entry in the period of
the sale eliminates the intercompany gain/loss and adjusts the asset and accumulated depreciation to
their original balance on the date of sale:
DR Gain on sale 40,000

CR Accumulated depreciation 15,000
CR Depreciation expense 5,000
CR Equipment 20,000
Gain on Sale, $40,000 Debit
Since Peterson sold the equipment to Silver, a 100% subsidiary, the gain of $40,000 is eliminated. It was
originally entered in the books of Peterson as a credit and is calculated as the sales price of the asset of
$120,000, less the net book value of $80,00 ($100,000 cost less accumulated depreciation on 1/1/Y3 of
$20,000).
Accumulated Depreciation, $15,000 Credit
The accumulated depreciation for the consolidated group at December 31, Yr 3 is based on the original
cost of $100,000. Three years of accumulated straight line depreciation is $30,000.
The accumulated depreciation shown by the separate companies is as follows:
$0 for Peterson since the accumulated depreciation was removed as part of the journal entry
recorded at the time of the sale.
$15,000 for Silver Corp., based on one year of straight-line depreciation ($120,000/8 years).
The eliminating journal entry raises the accumulated depreciation from $15,000 to the correct amount of
$30,000.
Depreciation Expense, $5,000 Credit
The correct amount of depreciation expense for Year 3 is $10,000 based on the original purchase of the
asset by Peterson ($100,000 cost to Peterson / 10 years = $10,000). Silver Corp. recorded depreciation
of $15,000 based on their purchase of the asset at the beginning of Year3 ($120,000 cost to Silva / 8
years = $15,000).
The eliminating journal entry reduces the depreciation from $15,000 to the correct amount of $10,000.
Equipment, $20,000 Credit
The original cost of the equipment to Peterson is $100,000. The $120,000 cost of the asset to Silva must
be reduced to the original amount paid by Peterson.
55
SITUATION 2
When affiliated companies sell inventory to one another, the total amount of the intercompany sale and
cost of goods sold is eliminated when preparing consolidated financial statements. In addition, the
intercompany profit must be eliminated from the ending inventory and cost of goods sold of the group.
DR Sales 50,000
CR Inventory 8,000
CR Cost of goods sold 42,000
Sales, $50,000 Debit
The gross sale amount of Petersons sale to Silver is eliminated.
Inventory, $8,000 Credit
40% of the goods sold by Peterson are still in the ending inventory of Silver. The original cost of this
inventory on Peterson's books was $12,000 ($30,000 x 40%). The inventory is on Silvers books at the
cost to Silva of $20,000 ($50,000 x 40%).
The reduction of inventory adjusts the $20,000 inventory on the books of Silver to the correct amount of
$12,000, the original cost to Peterson.
Cost of Goods Sold, $42,000 Credit
The entire amount of Petersons cost of goods sold is eliminated. This amount is $30,000.
In addition, Silvers cost of sales is based on the price paid to Peterson for the inventory. The additional
cost Silver paid is $20,000 ($50,000 intercompany sales price - $30,000 cost of goods sold). The amount
that was sold represents 60% of $20,000, so that another $12,000 needs to be eliminated to show the
cost of goods sold based on the original cost to Peterson.
56
Task 618_01
57
Explanation:
Construction period interest should be capitalized (based on the weighted average of accumulated
expenditures) as part of the cost of producing fixed assets.
Weighted average of accumulated expenditures for year 2: $360,000
The weighted average amount of accumulated expenditures (WAAE) for year 2 is calculated as follows:
$130,000 1/1-3/31/Y2 3 months $ 390,000

$370,000 4/1-9/30/Y2 6 2,220,000
$570,000 10/1-12/31/Y2 3 1,710,000
$4,320,000/12 months
Weighted average of accumulated expenditures $360,000
Interest incurred for all borrowings for year 2: $67,000
The interest expense is calculated as follows:
$300,000 Loan 12% $36,000

$100,000 10% 10,000
$300,000 7% 21,000
Total interest for the year $67,000
All loans were payable throughout Year 2.
Avoidable interest for year 2, $40,650
The amount of avoidable interest is the interest that would not have been incurred if the construction
project had not taken place:
Interest on construction note borrowings:

$300,000 construction note x 12% = $36,000
Interest on other borrowings used for construction:

Total WAAE $360,000
Less: Construction note funds (300,000)
Other borrowings used for construction 60,000
Weighted-average interest rate on other borrowings:

($10,000 + $21,000)/($100,000 + $300,000) = 8%
Interest on other borrowings used for construction = $60,000 x 8% = $4,650
Avoidable interest = $36,000 + $4,650 = $40,650
Interest capitalized for Year 2, $40,650
Capitalized interest cannot exceed the actual interest incurred for the period. The capitalized interest for
year 2 is $40,650 because the avoidable interest of $40,650 is less than the interest incurred of $67,000.
Interest expense for Year 2, $26,350
The interest expense is the amount to be shown on the income statement and is the difference between
the total interest of $67,000 and the capitalized interest of $40,650.
58
Task 4466_01
Keywords:
Cash flow per share
59

2011 AICPA Newly Released Financial Questions

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

2011 AICPA Newly Released Financial Questions

Uploaded by

Copyright:

Available Formats

2011 AICPA Newly Released Questions Financial

What amount should Fenn report as expenses for support services?

Payment of interest on bonds payable $500,000

Bank service charge $10

What is the net cash balance after the reconciliation?

Cash received from customers $25,000

Beginning of year End of year

Monthly AJE's for first 10 months:

Monthly AJE's for final 2 months:

Carrying amount of Larkin's investment in Devon

What is the carrying amount of Larkin's investment in Devon at year end?

Common shares outstanding, 1/1 700,000

WACSO = 700,000 15,000 + 20,000 3,000 = 702,000 shares

Credit sales $10,000,000

What is the after-tax net loss on the disposal of the division?

AICPA Newly Released FAR Simulations

DR Gain on sale 40,000

Gain on Sale, $40,000 Debit

Accumulated Depreciation, $15,000 Credit

The accumulated depreciation shown by the separate companies is as follows:

Depreciation Expense, $5,000 Credit

Equipment, $20,000 Credit

Sales, $50,000 Debit

The gross sale amount of Petersons sale to Silver is eliminated.

Inventory, $8,000 Credit

Cost of Goods Sold, $42,000 Credit

Weighted average of accumulated expenditures for year 2: $360,000

$130,000 1/1-3/31/Y2 3 months $ 390,000

Interest incurred for all borrowings for year 2: $67,000

The interest expense is calculated as follows:

$300,000 Loan 12% $36,000

Total interest for the year $67,000

All loans were payable throughout Year 2.

Avoidable interest for year 2, $40,650

Interest on construction note borrowings:

Interest on other borrowings used for construction:

Weighted-average interest rate on other borrowings:

Interest on other borrowings used for construction = $60,000 x 8% = $4,650

Avoidable interest = $36,000 + $4,650 = $40,650

Interest capitalized for Year 2, $40,650

Interest expense for Year 2, $26,350

You might also like