final 461 multiple choice

Financial reports of the lowest level of quality reflect: fictitious events. biased accounting choices. accounting that is non-compliant with GAAP.

A is correct. Financial reports span a quality continuum from high to low based on decision-usefulness and earnings quality (see Exhibit 2 of the reading). The lowest-quality reports portray fictitious events, which may misrepresent the company's performance and/or obscure fraudulent misappropriation of the company's assets.

A lessor will record interest income if a lease is classified as: a capital lease. an operating lease. either a capital or an operating lease.

A is correct. A portion of the payments for capital leases, either direct financing or sales-type, is reported as interest income. With an operating lease, all revenue is recorded as rental revenue.

Under US GAAP, a lessor's reported revenues at lease inception will be highest if the lease is classified as: a sales-type lease. an operating lease. a direct financing lease.

A is correct. A sales-type lease treats the lease as a sale of the asset, and revenue is recorded at the time of sale equal to the present value of future lease payments. Under a direct financing lease, only interest income is reported as earned. Under an operating lease, revenue from rent is reported when collected.

A company is most likely to: use a fair value model for some investment property and a cost model for other investment property. change from the fair value model when transactions on comparable properties become less frequent. change from the fair value model when the company transfers investment property to property, plant, and equipment.

C is correct. A company will change from the fair value model to either the cost model or revaluation model when the company transfers investment property to property, plant, and equipment.

Which of the following is most likely to reflect conservative accounting choices? Decreased reported earnings in later periods Increased reported earnings in the current period Increased debt reported on the balance sheet at the end of the current period

C is correct. Accounting choices are considered conservative if they decrease the company's reported performance and financial position in the current period. Conservative choices may increase the amount of debt reported on the balance sheet. Conservative accounting choices may decrease the amount of revenues, earnings, and/or operating cash flow reported in the current period and increase those amounts in later periods.

When accounting standards require recognition of an expense that is not permitted under tax laws, the result is a: deferred tax liability. temporary difference. permanent difference.

C is correct. Accounting items that are not deductible for tax purposes will not be reversed and thus result in permanent differences.

An audit opinion of a company's financial reports is most likely intended to: detect fraud. reveal misstatements. assure that financial information is presented fairly.

C is correct. An audit is intended to provide assurance that the company's financial reports are presented fairly, thus providing discipline regarding financial reporting quality. Regulatory agencies usually require that the financial statements of publicly traded companies be audited by an independent auditor to provide assurance that the financial statements conform to accounting standards. Privately held companies may also choose to obtain audit opinions either voluntarily or because an outside party requires it. An audit is not typically intended to detect fraud. An audit is based on sampling and it is possible that the sample might not reveal misstatements.

Intangible assets with finite useful lives mostly differ from intangible assets with infinite useful lives with respect to accounting treatment of: revaluation. impairment. amortization.

C is correct. An intangible asset with a finite useful life is amortized, whereas an intangible asset with an indefinite useful life is not.

Using the straight-line method of depreciation for reporting purposes and accelerated depreciation for tax purposes would most likely result in a: valuation allowance. deferred tax asset. temporary difference.

C is correct. Because the differences between tax and financial accounting will correct over time, the resulting deferred tax liability, for which the expense was charged to the income statement but the tax authority has not yet been paid, will be a temporary difference. A valuation allowance would only arise if there was doubt over the company's ability to earn sufficient income in the future to require paying the tax.

Debt covenants are least likely to place restrictions on the issuer's ability to: pay dividends. issue additional debt. issue additional equity.

C is correct. Covenants protect debtholders from excessive risk taking, typically by limiting the issuer's ability to use cash or by limiting the overall levels of debt relative to income and equity. Issuing additional equity would increase the company's ability to meet its obligations, so debtholders would not restrict that ability.

The information provided by a low-quality financial report will most likely: decrease company value. indicate earnings are not sustainable. impede the assessment of earnings quality.

C is correct. Financial reporting quality pertains to the quality of the information contained in financial reports. High-quality financial reports provide decision-useful information that faithfully represents the economic reality of the company. Low-quality financial reports impede assessment of earnings quality. Financial reporting quality is distinguishable from earnings quality, which pertains to the earnings and cash generated by the company's actual economic activities and the resulting financial condition. Low quality earnings are not sustainable and decrease company value.

Income tax expense reported on a company's income statement equals taxes payable, plus the net increase in: deferred tax assets and deferred tax liabilities. deferred tax assets, less the net increase in deferred tax liabilities. deferred tax liabilities, less the net increase in deferred tax assets.

C is correct. Higher reported tax expense relative to taxes paid will increase the deferred tax liability, whereas lower reported tax expense relative to taxes paid increases the deferred tax asset.

Which of the following will cause a company to show a lower amount of amortization of intangible assets in the first year after acquisition? A higher residual value. A higher amortization rate. A shorter useful life.

A is correct. A higher residual value results in a lower total depreciable cost and, therefore, a lower amount of amortization in the first year after acquisition (and every year after that).

According to IFRS, all of the following pieces of information about intangible assets must be disclosed in a company's financial statements and footnotes except for: fair value. impairment loss. amortization rate.

A is correct. IFRS do not require fair value of intangible assets to be disclosed.

Deferred tax liabilities should be treated as equity when: they are not expected to reverse. the timing of tax payments is uncertain. the amount of tax payments is uncertain.

A is correct. If the liability will not reverse, there will be no required tax payment in the future and the "liability" should be treated as equity.

Investment property is most likely to: earn rent. be held for resale. be used in the production of goods and services.

A is correct. Investment property earns rent. Inventory is held for resale, and property, plant, and equipment are used in the production of goods and services.

Which of the following statements most likely describes a situation that would motivate a manager to issue low-quality financial reports? The manager's compensation is tied to stock price performance. The manager has increased the market share of products significantly. The manager has brought the company's profitability to a level higher than competitors.

A is correct. Managers often have incentives to meet or beat market expectations, particularly if management compensation is linked to increases in stock prices or to reported earnings.

Which of the following best describes an opportunity for management to issue low-quality financial reports? Ineffective board of directors Pressure to achieve some performance level Corporate concerns about financing in the future

A is correct. Opportunities to issue low quality financial reports include internal conditions such as an ineffective board of directors and external conditions such as accounting standards that provide scope for divergent choices. Pressure to achieve some performance level and corporate concerns about financing in the future are examples of motivations to issue low-quality financial reports. Typically, three conditions exist when low-quality financial reports are issued: opportunity, motivation, and rationalization.

A company receives advance payments from customers that are immediately taxable but will not be recognized for accounting purposes until the company fulfills its obligation. The company will most likely record: a deferred tax asset. a deferred tax liability. no deferred tax asset or liability.

A is correct. The advances represent a liability for the company. The carrying value of the liability exceeds the tax base (which is now zero). A deferred tax asset arises when the carrying value of a liability exceeds its tax base.

When accounting standards require an asset to be expensed immediately but tax rules require the item to be capitalized and amortized, the company will most likely record: a deferred tax asset. a deferred tax liability. no deferred tax asset or liability.

A is correct. The capitalization will result in an asset with a positive tax base and zero carrying value. The amortization means the difference is temporary. Because there is a temporary difference on an asset resulting in a higher tax base than carrying value, a deferred tax asset is created.

Which of the following situations will most likely motivate managers to inflate earnings in the current period? Possibility of bond covenant violation Earnings in excess of analysts' forecasts Earnings that are greater than the previous year

A is correct. The possibility of bond covenant violations may motivate managers to inflate earnings in the current period. By inflating earnings in the current period, the company may be able to avoid the consequences associated with violating bond covenants.

Which of the following amortization methods is most likely to evenly distribute the cost of an intangible asset over its useful life? Straight-line method. Units-of-production method. Double-declining balance method.

A is correct. The straight-line method is the method that evenly distributes the cost of an asset over its useful life because amortization is the same amount every year.

In early 2009 Sanborn Company must pay the tax authority €37,000 on the income it earned in 2008. This amount was recorded on the company's 31 December 2008 financial statements as: taxes payable. income tax expense. a deferred tax liability.

A is correct. The taxes a company must pay in the immediate future are taxes payable.

Innovative Inventions, Inc. needs to raise €10 million. If the company chooses to issue zero-coupon bonds, its debt-to-equity ratio will most likely: rise as the maturity date approaches. decline as the maturity date approaches. remain constant throughout the life of the bond.

A is correct. The value of the liability for zero-coupon bonds increases as the discount is amortised over time. Furthermore, the amortised interest will reduce earnings at an increasing rate over time as the value of the liability increases. Higher relative debt and lower relative equity (through retained earnings) will cause the debt-to-equity ratio to increase as the zero-coupon bonds approach maturity.

Oil Exploration LLC paid $45,000 in printing, legal fees, commissions, and other costs associated with its recent bond issue. It is most likely to record these costs on its financial statements as: an asset under US GAAP and reduction of the carrying value of the debt under IFRS. a liability under US GAAP and reduction of the carrying value of the debt under IFRS. a cash outflow from investing activities under both US GAAP and IFRS.

A is correct. Under US GAAP, expenses incurred when issuing bonds are generally recorded as an asset and amortised to the related expense (legal, etc.) over the life of the bonds. Under IFRS, they are included in the measurement of the liability. The related cash flows are financing activities.

Fairmont Golf issued fixed rate debt when interest rates were 6 percent. Rates have since risen to 7 percent. Using only the carrying amount (based on historical cost) reported on the balance sheet to analyze the company's financial position would most likely cause an analyst to: overestimate Fairmont's economic liabilities. underestimate Fairmont's economic liabilities. underestimate Fairmont's interest coverage ratio.

A is correct. When interest rates rise, bonds decline in value. Thus, the carrying amount of the bonds being carried on the balance sheet is higher than the market value. The company could repurchase the bonds for less than the carrying amount, so the economic liabilities are overestimated. Because the bonds are issued at a fixed rate, there is no effect on interest coverage.

If a particular accounting choice is considered aggressive in nature, then the financial performance for the current period would most likely: be neutral. exhibit an upward bias. exhibit a downward bias.

B is correct. Aggressive accounting choices aim to enhance the company's reported performance by inflating the amount of revenues, earnings, and/or operating cash flow reported in the period. Consequently, the financial performance for the current period would most likely exhibit an upward bias.

Compared to using a finance lease, a lessee that makes use of an operating lease will most likely report higher: debt. rent expense. cash flow from operating activity.

B is correct. An operating lease is not recorded on the balance sheet (debt is lower), and lease payments are entirely categorised as rent (interest expense is lower.) Because the rent expense is an operating outflow but principal repayments are financing cash flows, the operating lease will result in lower cash flow from operating activity.

Bias in revenue recognition would least likely be suspected if: the firm engages in barter transactions. reported revenue is higher than the previous quarter. revenue is recognized before goods are shipped to customers.

B is correct. Bias in revenue recognition can lead to manipulation of information presented in financial reports. Addressing the question as to whether revenue is higher or lower than the previous period is not sufficient to determine if there is bias in revenue recognition. Additional analytical procedures must be performed to provide warning signals of accounting malfeasance. Barter transactions are difficult to value properly and may result in bias in revenue recognition. Policies that make it easier to prematurely recognize revenue, such as revenue being recognized before goods are shipped to customers, may be a warning sign of accounting malfeasance.

For a lessor, the leased asset appears on the balance sheet and continues to be depreciated when the lease is classified as: a sales-type lease. an operating lease. a financing lease.

B is correct. When a lease is classified as an operating lease, the underlying asset remains on the lessor's balance sheet. The lessor will record a depreciation expense that reduces the asset's value over time.

Low quality earnings most likely reflect: low-quality financial reporting. company activities which are unsustainable. information that does not faithfully represent company activities

B is correct. Earnings quality pertains to the earnings and cash generated by the company's actual economic activities and the resulting financial condition. Low-quality earnings are likely not sustainable over time because the company does not expect to generate the same level of earnings in the future or because earnings will not generate sufficient return on investment to sustain the company in the future. Earnings that are not sustainable decrease company value. Earnings quality is distinguishable from financial reporting quality, which pertains to the quality of the information contained in financial reports.

To properly assess a company's past performance, an analyst requires: high earnings quality. high financial reporting quality. both high earnings quality and high financial reporting quality.

B is correct. Financial reporting quality pertains to the quality of the information contained in financial reports. If financial reporting quality is low, the information provided is not useful to assess the company's performance. Financial reporting quality is distinguishable from earnings quality, which pertains to the earnings and cash generated by the company's actual economic activities and the resulting financial condition.

According to IFRS, all of the following pieces of information about property, plant, and equipment must be disclosed in a company's financial statements and footnotes except for: useful lives. acquisition dates. amount of disposals.

B is correct. IFRS do not require acquisition dates to be disclosed.

If a company uses a non-GAAP financial measure in an SEC filing, then the company must: give more prominence to the non-GAAP measure if it is used in earnings releases. provide a reconciliation of the non-GAAP measure and equivalent GAAP measure. exclude charges requiring cash settlement from any non-GAAP liquidity measures.

B is correct. If a company uses a non-GAAP financial measure in an SEC filing, it is required to provide the most directly comparable GAAP measure with equivalent prominence in the filing. In addition, the company is required to provide a reconciliation between the non-GAAP measure and the equivalent GAAP measure. Similarly, IFRS require that any non-IFRS measures included in financial reports must be defined and their potential relevance explained. The non-IFRS measures must be reconciled with IFRS measures.

A company wishing to increase earnings in the current period may choose to: decrease the useful life of depreciable assets. lower estimates of uncollectible accounts receivables. classify a purchase as an expense rather than a capital expenditure.

B is correct. If a company wants to increase reported earnings, the company's managers may reduce the allowance for uncollected accounts and uncollected accounts expense reported in the period. Decreasing the useful life of depreciable assets would increase depreciation expense and decrease earnings in the current period. Classifying a purchase as an expense rather than a capital expenditure would decrease earnings in the current period. The use of accrual accounting may result in estimates included in financial reports, because all facts associated with events may not be known at the time of recognition. These estimates can be grounded in reality or can be managed by the company to present a desired financial picture.

Analysts should treat deferred tax liabilities that are expected to reverse as: equity. liabilities. neither liabilities nor equity.

B is correct. If the liability is expected to reverse (and thus require a cash tax payment) the deferred tax represents a future liability.

Which of the following would most likely signal that a company may be using aggressive accrual accounting policies to shift current expenses to later periods? Over the last five-year period, the ratio of cash flow to net income has: increased each year. decreased each year. fluctuated from year to year.

B is correct. If the ratio of cash flow to net income for a company is consistently below 1 or has declined repeatedly over time, this may be a signal of manipulation of information in financial reports through aggressive accrual accounting policies. When net income is consistently higher than cash provided by operations, one possible explanation is that the company may be using aggressive accrual accounting policies to shift current expenses to later periods.

MARU S.A. de C.V., a Mexican corporation that follows IFRS, has elected to use the revaluation model for its property, plant, and equipment. One of MARU's machines was purchased for 2,500,000 Mexican pesos (MXN) at the beginning of the fiscal year ended 31 March 2010. As of 31 March 2010, the machine has a fair value of MXN 3,000,000. Should MARU show a profit for the revaluation of the machine? Yes. No, because this revaluation is recorded directly in equity. No, because value increases resulting from revaluation can never be recognized as a profit.

B is correct. In this case, the value increase brought about by the revaluation should be recorded directly in equity. The reason is that under IFRS, an increase in value brought about by a revaluation can only be recognized as a profit to the extent that it reverses a revaluation decrease of the same asset previously recognized in the income statement.

Which of the following characteristics is most likely to differentiate investment property from property, plant, and equipment? It is tangible. It earns rent. It is long-lived.

B is correct. Investment property earns rent. Investment property and property, plant, and equipment are tangible and long-lived.

A company issues €1 million of bonds at face value. When the bonds are issued, the company will record a: cash inflow from investing activities. cash inflow from financing activities. cash inflow from operating activities.

B is correct. The company receives €1 million in cash from investors at the time the bonds are issued, which is recorded as a financing activity.

Penben Corporation has a defined benefit pension plan. At 31 December, its pension obligation is €10 million and pension assets are €9 million. Under either IFRS or US GAAP, the reporting on the balance sheet would be closest to which of the following? €10 million is shown as a liability, and €9 million appears as an asset. €1 million is shown as a net pension obligation. Pension assets and obligations are not required to be shown on the balance sheet but only disclosed in footnotes.

B is correct. The company will report a net pension obligation of €1 million equal to the pension obligation (€10 million) less the plan assets (€9 million).

A company incurs a capital expenditure that may be amortized over five years for accounting purposes, but over four years for tax purposes. The company will most likely record: a deferred tax asset. a deferred tax liability. no deferred tax asset or liability.

B is correct. The difference is temporary, and the tax base will be lower (because of more rapid amortization) than the carrying value of the asset. The result will be a deferred tax liability.

At the time of issue of 4.50% coupon bonds, the effective interest rate was 5.00%. The bonds were most likely issued at: par. a discount. a premium.

B is correct. The effective interest rate is greater than the coupon rate and the bonds will be issued at a discount.

Which of the following is most likely a lessee's disclosure about operating leases? Lease liabilities. Future obligations by maturity. Net carrying amounts of leased assets.

B is correct. The lessee will disclose the future obligation by maturity of its operating leases. The future obligations by maturity, leased assets, and lease liabilities will all be shown for finance leases.

Juan Martinez, CFO of VIRMIN, S.A., is selecting the depreciation method to use for a new machine. The machine has an expected useful life of six years. Production is expected to be relatively low initially but to increase over time. The method chosen for tax reporting must be the same as the method used for financial reporting. If Martinez wants to minimize tax payments in the first year of the machine's life, which of the following depreciation methods is Martinez most likely to use? Straight-line method. Units-of-production method. Double-declining balance method.

C is correct. If Martinez wants to minimize tax payments in the first year of the machine's life, he should use an accelerated method, such as the double-declining balance method.

Which of the following is an indication that a company may be recognizing revenue prematurely? Relative to its competitors, the company's: asset turnover is decreasing. receivables turnover is increasing. days sales outstanding is increasing.

C is correct. If a company's days sales outstanding (DSO) is increasing relative to competitors, this may be a signal that revenues are being recorded prematurely or are even fictitious. There are numerous analytical procedures that can be performed to provide evidence of manipulation of information in financial reporting. These warning signs are often linked to bias associated with revenue recognition and expense recognition policies.

A company is experiencing a period of strong financial performance. In order to increase the likelihood of exceeding analysts' earnings forecasts in the next reporting period, the company would most likely undertake accounting choices that: inflate reported revenue in the current period. delay expense recognition in the current period. accelerate expense recognition in the current period.

C is correct. In a period of strong financial performance, managers may pursue accounting choices that increase the probability of exceeding next period's earnings forecasts. By accelerating expense recognition or delaying revenue recognition, managers may increase earnings in the next period and increase the likelihood of exceeding next period's earnings targets.

When certain expenditures result in tax credits that directly reduce taxes, the company will most likely record: a deferred tax asset. a deferred tax liability. no deferred tax asset or liability.

C is correct. Tax credits that directly reduce taxes are a permanent difference, and permanent differences do not give rise to deferred tax.

When both the timing and amount of tax payments are uncertain, analysts should treat deferred tax liabilities as: equity. liabilities. neither liabilities nor equity.

C is correct. The deferred tax liability should be excluded from both debt and equity when both the amounts and timing of tax payments resulting from the reversals of temporary differences are uncertain.

If a company uses the fair value model to value investment property, changes in the fair value of the asset are least likely to affect: net income. net operating income. other comprehensive income.

C is correct. When a company uses the fair value model to value investment property, changes in the fair value of the property are reported in the income statement—not in other comprehensive income.