Reading 18: Understanding Balance Sheets

Under IFRS and U.S. GAAP, all of the following should be expensed as incurred: Start-up and training costs. Administrative overhead. Advertising and promotion costs. Relocation and reorganization costs. Termination costs.

Under IFRS and U.S. GAAP, all of the following should be expensed as incurred: Start-up and training costs. Administrative overhead. Advertising and promotion costs. Relocation and reorganization costs. Termination costs.

Liquidity Ratios include:

Liquidity Ratios include: - Current Ratio - Quick Ratio - Cash Ratio

Other current assets include items such as [...] [...] and [...] [...] assets.

Other current assets include items such as prepaid expenses and deferred tax assets.

Under IFRS, items that must be included as current liabilities even when they cannot be settled within 1 year after the balance sheet date are:

- Trade payables - Some accruals for employees

Current liabilities include (5)

Accounts Payable Notes Payable Short term debt Accrued Expenses Deferred Revenues

For a company without a clearly identifiable operating cycle, current liabilities are expected to be settled within: A. six months. B. one year. C. two years.

B. Liabilities expected to be settled within one year or within one operating cycle of the business, whichever is greater, are classified as current liabilities. When an entity's normal operating cycle is not clearly identifiable, its duration is assumed to be one year. A is incorrect because when an entity's normal operating cycle is not clearly identifiable, the cycle's duration is assumed to be one year (not six months). C is incorrect because when an entity's normal operating cycle is not clearly identifiable, the cycle's duration is assumed to be one year (not two years). [LOS 18.b]

In a set of common-size financial statements, unearned revenue should most likely be calculated as a percentage of: A. sales. B. assets. C. liabilities.

B. [LOS 18.g]

When a company buys shares of its own stock to be held in treasury, it records a reduction in: A. both assets and liabilities. B. both assets and shareholders' equity. C. assets and an increase in shareholders' equity.

B. B is correct. Share repurchases reduce the company's cash (an asset). Shareholders' equity is reduced because there are fewer shares outstanding and treasury stock is an offset to owners' equity. [LOS 18.f]

Accrued expenses (accrued liabilities) are: A. expenses that have been paid. B. created when another liability is reduced. C. expenses that have been reported on the income statement but not yet paid.

C. Accrued liabilities are expenses that have been reported on a company's income statement but have not yet been paid. [LOS 18.e]

When a company pays its rent in advance, its balance sheet will reflect a reduction in: A. assets and liabilities. B. assets and shareholders' equity. C. one category of assets and an increase in another.

C. Paying rent in advance will reduce cash and increase prepaid expenses, both of which are assets. [LOS 18.e]

"Other current assets" typically include: A. trade receivables. B. customer prepayments. C. items deemed too small to be individually listed on the balance sheet

C. The amounts shown in "other current assets" reflect items that are individually not material enough to require separate line items on the balance sheet and so are aggregated into a single category. A is incorrect because trade receivables or accounts receivable typically are shown as a separate line item on the balance sheet and so are not aggregated into the "other current assets" category. B is incorrect because prepayments made by customers are deferred income and thus a current liability, not an asset [LOS 18.e]

An analyst gathers the following data for a company: Cash/Marketable securities: $50 Receivables: $75 Other current assets: $25 Payables: $75 Other current liabilities: $25 All else equal, if the company reduces its payables balance by $25 using a combination of cash and marketable securities, which of the following pairs of liquidity ratios will most likely both increase? A. Cash ratio and quick ratio B. Current ratio and cash ratio C. Quick ratio and current ratio

C. [LOS 18.h]

Working capital is current [...] less current [...]. Higher levels of working capital indicate that a company has a [...] ability to meet its [...]-term obligations.

Working capital is current assets less current liabilities. Higher levels of working capital indicate that a company has a greater ability to meet its short-term obligations.

Components of Equity (6)

1. Common shares 2. Preferred shares 3. Treasury stock 4. Retained earnings 5. Accumulated other comprehensive income 6. Non-controlling interest

Authorized shares: [...] number of shares issued Issued shares: number of shares [...] Outstanding shares: difference between [...] shares and [...] shares (or [...] shares)

Authorized shares: maximum number of shares issued Issued shares: number of shares sold Outstanding shares: difference between issued shares and repurchased shares (or treasury shares)

A liquid asset can be easily converted into cash in a short amount of time at: A. any price. B. a price close to fair market value. C. a price above the original purchase value.

B. A liquid asset is one that can be easily converted into cash in a short period of time at a price close to fair market value. A is incorrect because fair market value is the applicable convertibility standard for liquidity, not merely convertibility into cash at any price. C is incorrect because fair market value, not the original purchase value, is the applicable convertibility standard for liquidity. [LOS 18.c]

Which of the following is most likely to be classified as a contra account on a company's balance sheet? A. Bad debt expense B. Unearned revenue C. Accumulated depreciation

C. A contra account is an account that is used to offset or deducted from another account. Examples of this include allowance for bad debts (offset to accounts receivable), accumulated depreciation (offset to property, plant, and equipment), and sales returns and allowances (offset to sales). Unearned revenue is a liability, while bad debt expense is an income statement item. [LOS 18.f]

The most likely costs included in both the cost of inventory and property, plant, and equipment are: A. selling costs. B. storage costs. C. delivery costs.

C. C is correct. Both the cost of inventory and property, plant, and equipment include delivery costs, or costs incurred in bringing them to the location for use or resale. [LOS 18.e]

Defining total asset turnover as revenue divided by average total assets, all else equal, impairment write-downs of long-lived assets owned by a company will most likely result in an increase for that company in: A. the debt-to-equity ratio but not the total asset turnover. B. the total asset turnover but not the debt-to-equity ratio. C. both the debt-to-equity ratio and the total asset turnover.

C. C is correct. Impairment write-downs reduce equity in the denominator of the debt-to-equity ratio but do not affect debt, so the debt-to-equity ratio is expected to increase. Impairment write-downs reduce total assets but do not affect revenue. Thus, total asset turnover is expected to increase. [LOS 18.h]

Which of the following best describes common equity? A. The initial investment by common shareholders in the company B. The resources owned or controlled by a company C. The residual interest in a company's assets after deducting its liabilities

C. Common equity is a component of the balance sheet and represents the owners' residual interest in the company's assets after deducting its liabilities. A is incorrect. Common equity includes the initial investment by the shareholders and the retained earnings; this definition is incomplete. B is incorrect. Assets are a component of the balance sheet and represent resources controlled by an enterprise as a result of past events and from which future economic benefits to the enterprise are expected to flow. [LOS 18.a], [LOS 18.b]

The difference between what a company owns and what it owes is best described as: A. market value. B. working capital. C. shareholders' equity.

C. Shareholders' equity is determined by subtracting the liabilities of a company from its assets. A company owes liabilities, while it owns assets. A is incorrect because the balance sheet amounts of equity (assets, net of liabilities) should not be viewed as a measure of either the market value or the intrinsic value of a company's equity. B is incorrect because working capital is the excess of current assets over current liabilities. The calculation of working capital does not account for non-current assets and non-current liabilities, which are other elements of what a company owns and owes. [LOS 18.a]

Trade receivables are: A. typically reported at gross value. B. owed by customers for products and services to be delivered. C. based on the company's estimate of amounts that ultimately will be collectible.

C. Trade receivables are typically reported at net realizable value, based on estimates of collectability A is incorrect because trade receivables are reported net of an allowance for doubtful accounts or at their net realizable value. B is incorrect because trade receivables are amounts owed to a company by its customers for products and services already delivered, not for items with delivery pending. [LOS 18.e]

Current assets include (5)

Cash and cash equivalents Marketable securities Accounts receivable Inventories Other current assets

Cash and equivalents are considered [...] assets. Cash equivalents examples include [...] bills, [...] paper, and [...] [...] funds. Measured at [...] [...] or [...] [...] will produce [...] results

Cash and equivalents are considered financial assets. Cash equivalents examples include Treasury bills, commercial paper, and money market funds. Measured at amortized cost or fair value will produce same results

Deferred Tax Asset: income tax incurred before tax expense is recognized on the income statement arising from: - expenses or losses are recognized in the income statement before they are tax deductible, or - revenues or gains are taxable before they are recognized in the income statement.

Deferred Tax Asset: income tax incurred before tax expense is recognized on the income statement arising from: - expenses or losses are recognized in the income statement before they are tax deductible, or - revenues or gains are taxable before they are recognized in the income statement.

IFRS Statement of changes in equity: Total comprehensive income Effects of retrospectively applied accounting changes Capital transactions with owners Reconciliation of carrying amounts of each component

IFRS Statement of changes in equity: Total comprehensive income Effects of retrospectively applied accounting changes Capital transactions with owners Reconciliation of carrying amounts of each component

Inventories are carried at lower of [...] cost or [...] value under IFRS. Under GAAP, inventories are carried at the lower of [...] cost or [...] value.

Inventories are carried at lower of historical cost or net realizable value under IFRS. Under GAAP, inventories are carried at the lower of historical cost or market value.

PPE: [...] permits companies to use either the cost model or the revaluation model, while [...] only permits the cost model.

PPE: [...] permits companies to use either the cost model or the revaluation model, while [...] only permits the cost model.

Preferred Shares: shares that give owners privileges over [...] shares Classified as equity: [...], non-[...] preferred shares Classified as debt: mandatory [...] at [...] amount preferred shares

Preferred Shares: shares that give owners privileges over common shares Classified as equity: perpetual, non-redeemable preferred shares Classified as debt: mandatory redemption at fixed amount preferred shares

Under [...], investment property includes assets that generate [...] income or [...] appreciation. [...] does not have a specific definition of investment property. Under IFRS, investment property can either be reported at [...] cost or [...] value. Under the [...] value model, any change in [...] value is recognized in the [...] [...].

Under IFRS, investment property includes assets that generate rental income or capital appreciation. GAAP does not have a specific definition of investment property. Under IFRS, investment property can either be reported at amortized cost or fair value. Under the fair value model, any change in fair value is recognized in the income statement.

An example of a contra asset account is: A. depreciation expense. B. sales returns and allowances. C. allowance for doubtful accounts.

C. A contra asset account is netted against (i.e., reduces) the balance of an asset account. The allowance for doubtful accounts reduces the balance of accounts receivable. Accumulated depreciation, not depreciation expense, is a contra asset account. Sales returns and allowances create a contra account that reduce sales, not an asset. [LOS 18.e]

(£ millions) 2014 2013 Accounts receivable, gross 6,620 4,840 Allowance for doubtful accounts 92 56 Write-offs during the year 84 42 Based on the presented information about a company's trade receivables, the bad debt expense (in £ millions) for 2014 is closest to: A. 84. B. 36. C. 120.

C. C is correct. The allowance for doubtful accounts increases by the bad debt expense recognized for the year and decreases by the amounts written off during the year. Ending balance £92 = Beginning balance £56 - write-offs £84 + bad debt expense --> bad debt expense = 92 - 56 + 84 = £120 [LOS 18.e]

The following data are available for a company's first year of operations: Metric £ thousands Earnings before tax reported on the income statement 2,640 Depreciation expense included in earnings before tax 4,500 Accounting expenses that are not deductible for tax purposes 2,130 Depreciation expense deductible for tax purposes in first year of operations 6,340 Corporate tax rate 25% The company's end-of-year balance sheet will most likely include (in thousands) a deferred tax A. asset of £73. B. liability of £460. C. liability of £733.

Deferred tax balances result from temporary differences between a company's income as reported for tax purposes and income reported for financial statement purposes. The temporary difference in this case arises from the difference between the depreciation for accounting purposes and the depreciation for tax purposes. Because of this difference, the company would report more income tax expense than would actually be paid in taxes. The difference is a deferred tax liability. Temporary difference balance = Depreciation expense for accounting purposes - Depreciation for tax purposes = £6,340 - £4,500 = £1,840 Deferred tax balance = Temporary difference balance × Corporate tax rate = £1,840 × 25% = £460 A is incorrect. This balance would be obtained by mistakenly assuming that the accounting expenses that are not deductible for tax purposes are also a temporary difference, resulting in the calculation of a deferred tax asset. Deferred tax balance = Temporary difference balance × Corporate tax rate = (£1,840 - £2,130) × 25% = £73 C is incorrect. This is the tax payable balance, not the deferred tax balance. Taxable income = Accounting income ± Permanent differences ± Temporary differences = £2,640 + £2,130 - £1,840 = £2,930 Tax payable = Taxable income × Corporate tax rate = £2,930 × 25% = £733 [LOS 18.e]

Intangible assets that are created [...], such as research and development costs, are [...] under GAAP. Under IFRS, the firm must [...] costs during the research stage but can [...] costs incurred during the development stage.

Intangible assets that are created internally, such as research and development costs, are expensed as incurred under GAAP. Under IFRS, the firm must expense costs incurred during the research stage but can capitalize costs incurred during the development stage.

Intangible assets: Under IFRS, identifiable intangibles that are purchased can be reported using the cost model or the revaluation model, although the revaluation model can only be used if an active market for the intangible asset exists. Under U.S. GAAP, only the cost model is allowed.

Intangible assets: Under IFRS, identifiable intangibles that are purchased can be reported using the cost model or the revaluation model, although the revaluation model can only be used if an active market for the intangible asset exists. Under U.S. GAAP, only the cost model is allowedterm-48.

Non-controlling interest: equity interest of [...] shareholders in [...]

Non-controlling interest: equity interest of minority shareholders in subsidiaries

The balance sheet does not represent the market value of the firm because: Some assets and liabilities are carried at their [...] cost rather than their [...] value. Even when [...] values are used, they are only [...] on the balance sheet date. Many items that affect a company's market value (e.g., reputation and management skills) are not included on the balance sheet.

The balance sheet does not represent the market value of the firm because: Some assets and liabilities are carried at their historical cost rather than their market value. Even when market values are used, they are only current on the balance sheet date. Many items that affect a company's market value (e.g., reputation and management skills) are not included on the balance sheet.

Treasury shares: [...] shares that can be [...] Arise to prevent: [...], [...] from stock [...] Reduces [...]' [...] and [...] shares

Treasury shares: repurchased shares that can be reissued Arise to prevent: undervalued, dilution from stock options Reduces shareholders' equity and outstanding shares

Under the revaluation model, PP&E is reported at [...] value less any [...] [...]. Changes in [...] value are reflected in shareholders' equity and may be recognized in the [...] [...] in certain circumstances.

Under the revaluation model, PP&E is reported at fair value less any accumulated depreciation. Changes in fair value are reflected in shareholders' equity and may be recognized in the income statement in certain circumstances.

Accounts payable are: A. amounts a company owes its vendors for purchase of goods and services. B. financial liabilities owed by a company through a formal loan agreement. C. reported in a different section of the balance sheet from notes payable due in one year.

A. A is correct. Accounts payable are amounts that a company owes its vendors for purchases of goods and services. They represent the unpaid amount as of the balance sheet date of the company's purchases on credit. B is incorrect because notes payable (not accounts payable) are financial liabilities owed by a company through a formal loan agreement. C is incorrect because accounts payable and notes payable due in one year both are current liabilities, which are reported in the current liability section of the balance sheet. [LOS 18.e]

A company has recorded an expense for interest costs that have not yet been paid as of the balance sheet date. On the balance sheet, they are best reported as: A. deferred expenses. B. accounts payable. C. accrued expenses.

C. Accrued expenses, also known as accrued liabilities, have been recognized on a company's income statement but have not been paid as of the balance sheet date. Unpaid interest costs are an example of an accrued expense. A is incorrect. Deferred expenses refer to payments that have been made but will not be reported as an expense until a future accounting period. B is incorrect. Accounts payable are amounts that a company owes its vendors for purchases of goods and services that have already been delivered. They represent the unpaid amount of the company's purchase on credit as of the balance sheet date. [LOS 18.e]

Goodwill is the excess of [...] price over the [...] value of the identifiable net assets (assets minus liabilities) acquired in a business acquisition. Goodwill is only created in a(n) [...]. Internally generated goodwill is [...]. If impaired, goodwill is reduced and a loss is recognized in the [...] [...]. The impairment loss does not affect [...][...].

Goodwill is the excess of purchase price over the fair value of the identifiable net assets (assets minus liabilities) acquired in a business acquisition. Goodwill is only created in an acquisition. Internally generated goodwill is expensed. If impaired, goodwill is reduced and a loss is recognized in the income statement. The impairment loss does not affect cash flow.

Solvency Ratios include:

Solvency Ratios include: - Long-term debt-to-equity - Total Debt-to-equity - Total Debt Ratio - Financial leverage ratio

Under the cost model, PPE is carried at [...] cost, which is the historical cost less [...] depreciation and [...] losses. Depreciation is used to allocate the cost over an asset's useful life. Historical cost includes the [...] price plus any cost necessary to get the asset ready for use, such as [...] and [...] costs. PP&E must be tested for impairment- if its [...] value exceeds the [...] amount. Under IFRS, the recoverable amount of an asset is the greater of [...] value less any [...] costs, or the asset's value in use-[...] value of the asset's future [...] [...] stream. If impaired, the asset is written [...] to its [...] amount and a [...] is recognized in the income statement. Loss recoveries are allowed under [...] but not under [...].

Under the cost model, PPE is carried at amortized cost, which is the historical cost less accumulated depreciation and impairment losses. Depreciation is used to allocate the cost over an asset's useful life. Historical cost includes the purchase price plus any cost necessary to get the asset ready for use, such as delivery and installation costs. PP&E must be tested for impairment- if its carrying value exceeds the recoverable amount. Under IFRS, the recoverable amount of an asset is the greater of fair value less any selling costs, or the asset's value in use-present value of the asset's future cash flow stream. If impaired, the asset is written down to its recoverable amount and a loss is recognized in the income statement. Loss recoveries are allowed under IFRS but not under U.S. GAAP.

The analytical tool that would be most appropriate for an analyst to use to identify the percentage of a company's assets that are liquid is the: A. common-size balance sheet. B. cash ratio. C. current ratio.

A. A is correct. A common-size balance sheet expresses all balance sheet accounts as a percentage of total assets and would provide insight into what portion of a company's assets is liquid. On the other hand, cash and current ratios measure liquidity relative to current liabilities, not relative to total assets. B is incorrect. The cash ratio is a measure of liquidity relative to current liabilities (but not assets) and does not describe the portion of the company's assets that are liquid. C in incorrect. The current ratio is a measure of liquidity relative to current liabilities (but not assets) but doesn't indicate the portion. A common-size balance sheet expresses all balance sheet accounts as a percentage of total assets and would provide insight into what portion of a company's assets is liquid. [LOS 18.g]

A company issued bonds in 2012 that mature in 2022. The measurement basis that will most likely be used on the 2012 balance sheet for the bonds is: A. amortized cost. B. market value. C. historical cost.

A. A is correct. Bonds payable issued by a company are financial liabilities that are usually measured at amortized cost. B is incorrect. Only financial liabilities held for trading are measure at market value, and that does not include bonds issued by the company. C is incorrect. Historical cost would record the bonds at the value at date of issue and not amortize the bond premium or discount over the life of the bond. [LOS 18.e]

The initial measurement of goodwill is most likely affected by: A. an acquisition's purchase price. B. the acquired company's book value. C. the fair value of the acquirer's assets and liabilities.

A. A is correct. Initially, goodwill is measured as the difference between the purchase price paid for an acquisition and the fair value of the acquired, not acquiring, company's net assets (identifiable assets less liabilities). [LOS 18.e]

If all of the assets and liabilities are listed on the balance sheet broadly in order of how easily they can be converted into cash, the presentation format is best described as: A. liquidity based. B. current/non-current. C. classified.

A. A liquidity-based presentation format presents all of the assets and liabilities on the balance sheet broadly in order of liquidity. With respect to a particular asset or liability, liquidity refers to its "nearness to cash." B is incorrect. Current/non-current presentation is a type of classified balance sheet presentation that groups assets and liabilities into subcategories. C is incorrect. A classified balance sheet is organized to group together various assets and liabilities into subcategories such as current and non-current. [LOS 18.a], [LOS 18.b]

The most likely company to use a liquidity-based balance sheet presentation is a: A. bank. B. computer manufacturer holding inventories. C. software company with trade receivables and payables.

A. A liquidity-based presentation, rather than a current/non-current presentation, may be used by such entities as banks if broadly presenting assets and liabilities in order of liquidity is reliable and more relevant. [LOS 18.c]

Which of the following is most likely to be classified as a non-current asset? A. Fully-depreciated machinery B. Marketable securities purchased two years ago C. Inventory that has been held for more than one year

A. Regardless of whether it has been fully-depreciated, machinery that is expected to be used for more than one accounting period would be classified as a non-current asset - specifically, property, plant, and equipment. Regardless of how long inventory has been held, it would be classified as a current asset because is expected to be consumed during the operating cycle. Marketable securities are also included among current assets. [LOS 18.e]

The most stringent test of a company's liquidity is its: A. cash ratio. B. quick ratio. C. current ratio.

A. The cash ratio determines how much of a company's near-term obligations can be settled with existing amounts of cash and marketable securities. [LOS 18.h]

Which of the following statements is most likely correct? Trade payables are: A. a source of financing. B. considered to be an accrued expense. C. reported net of allowance for doubtful accounts.

A. Trade payables, or accounts payable, are recorded when a company has received goods or services for which it has yet to pay. The practice of suppliers allowing companies to delay cash payments is known as trade credit and it is used by companies as a source of financing. Accrued expenses are costs that have already been recorded on a company's income statement, but have yet to be paid. Trade payables have yet to be recognized on the income statement. Trade receivables, not trade payables, are reported net of allowance for doubtful accounts. [LOS 18.e]

Trade receivables are most commonly reported at: A. net realizable value. B. net present value. C. face value.

A. Trade receivables are amounts owed to a company by its customers for products and services already delivered. They are typically reported at net realizable value, an approximation of fair value based on estimates of collectability. B is incorrect. Present value is the present discounted value of future net cash inflows that the asset is expected to generate in the normal course of business. Trade receivables are typically reported at net realisable value. C is incorrect. Face value would not account for the potential for uncollectability. Trade receivables are typically reported at net realisable value. [LOS 18.e]

Under US GAAP, internally created identifiable intangible assets most likely: A. are expensed and not reported on the balance sheet. B. have their amortization method and useful life reviewed at least annually. C. can be revalued only when there is an active market for the specific intangible asset.

A. Under US GAAP, internally created identifiable intangibles are expensed rather than reported on the balance sheet. B is incorrect because under both IFRS and US GAAP, internally created identifiable intangible assets are immediately expensed and not amortized. C is incorrect because a revaluation process applies only to those intangible assets that either have been acquired or are the result of specific contractual or legal rights or privileges and is not used for internally created intangible assets. [LOS 18.e]

The difference between the fair value and the amortized cost for cash equivalents is most likely: A. immaterial under both IFRS and US GAAP. B. positive for companies that report in accordance with IFRS. C. negative for companies that report in accordance with US GAAP.

A. With cash and cash equivalents, no matter how they are measured (fair value, amortized cost, or otherwise), the value is always about the same. For instance, $100,000 of currency is worth $100,000, no matter the measurement basis. The treatment is similar for items deemed equivalent to cash. [LOS 18.e]

At the beginning of the year, a company had total shareholders' equity consisting of ¥200 million in common share capital and ¥50 million in retained earnings. During the year, the following events occurred: (¥ millions) Net income reported: 42 Dividends paid: 7 Unrealized loss on investments carried at fair value through other comprehensive income: 3 Repurchase of company stock, to be held as Treasury stock: 6 The total shareholders' equity (in ¥ millions) at the end of the year is closest to: A. 276. B. 279. C. 282.

A. [LOS 18.f]

For financial assets classified as held to maturity, how are unrealized gains and losses reflected in shareholders' equity? A. They are not recognized. B. They flow through retained earnings. C. They are a component of accumulated other comprehensive income.

A. Financial assets classified as held to maturity are measured at amortised cost. Gains and losses are recognized only when realized. [LOS 18.e]

Inventory values under IFRS are recorded at the lower of cost or: A. market. B. net realizable value. C. estimated selling price.

B. B is correct. Inventories are measured at the lower of cost or net realizable value under IFRS. A is incorrect because inventories are measured at the lower of cost or market under US GAAP. C is incorrect because inventories are measured at the lower of cost or net realizable value under IFRS. Net realizable value is the estimated selling price less the estimated costs of completion and costs necessary to make the sale, not just the estimated selling price. [LOS 18.e]

The non-controlling or minority interests found in the equity section of the balance sheet are best described as the equity interests: A. held by the corporation in other entities that it does not control, but has significant influence. B. of minority shareholders in subsidiaries that have been consolidated. C. of minority shareholders of the corporation who have significant influence, but not control.

B. B is correct. Non-controlling interests found in the equity section represent the equity interests of minority shareholders in non-wholly-owned subsidiaries that have been consolidated. A is incorrect. Equity interests held by the corporation in other entities over which it holds significant influence would be shown as "Equity investment" assets on the balance sheet. C is incorrect. The equity interests of minority shareholders in the corporation itself are encompassed in all the components of shareholders' equity other than preferred shares and non-controlling interest. [LOS 18.f]

On 1 January, Feng Automotive purchased machinery for $100,000, which the company will depreciate to zero on a straight-line basis over 10 years. As a result of this transaction, which of the following is most likely correct as of 31 December? A. Assets are now $100,000 higher and liabilities are now $10,000 higher B. Expenses were $10,000 higher during the year and assets are now $90,000 higher C. Expenses were $10,000 higher during the year and assets are now $100,000 higher

B. By depreciating the $100,000 asset to zero on a straight-line basis over 10 years, Feng Automotive will incur a depreciation expense of $10,000 in each of those years. Additionally, at the end of each year, $10,000 will be added to accumulated depreciation, which is a contra-asset account on the company's balance sheet. The company's assets will be $90,000 higher at the end of the first year as a result of this transaction because fixed assets will have increased by $100,000 and accumulated depreciation will have increased by $10,000. [LOS 18.e]

Which of the following would an analyst most likely be able to determine from a common-size analysis of a company's balance sheet over several periods? A. An increase or decrease in sales. B. An increase or decrease in financial leverage. C. A more efficient or less efficient use of assets.

B. Common-size analysis (as presented in the reading) provides information about composition of the balance sheet and changes over time. As a result, it can provide information about an increase or decrease in a company's financial leverage. [LOS 18.g]

A payment received for a subscription service at the beginning of the period will most likely be recorded as: A. trade payable. B. deferred income. C. notes payable.

B. Deferred income (also called deferred revenue and unearned revenue) arises when a company receives payment in advance of delivery of the goods and services associated with the payment. A is incorrect because trade payables are amounts that a company owes its vendors for purchases of goods and services. In other words, these represent the unpaid amount as of the balance sheet date of the company's purchases on credit. C is incorrect because notes payable are financial liabilities owed by a company to creditors, including trade creditors and banks, through a formal loan agreement. [LOS 18.e]

For financial assets classified as trading securities, how are unrealized gains and losses reflected in shareholders' equity? A. They are not recognized. B. They flow through income into retained earnings. C. They are a component of accumulated other comprehensive income.

B. For financial assets classified as trading securities, unrealized gains and losses are reported on the income statement and flow to shareholders' equity as part of retained earnings. [LOS 18.e]

Which of the following statements regarding balance sheets is correct? A. Equity stated on the balance sheet fairly represents a company's intrinsic value as of the reporting date. B. Important aspects of a company's ability to generate future cash flows are absent from its balance sheet. C. On the reporting date, shareholders' equity is adjusted to account for changes in expectations about future market conditions.

B. Important aspects of a company's ability to generate future cash flows—for example, its reputation and management skills—are not included in its balance sheet. A is incorrect because the balance sheet amount of equity should not be viewed as a measure of either the market value or the intrinsic value of a company's equity for a variety of reasons. The balance sheet amount of equity will differ from the market value of equity because some assets and liabilities are measured at historical cost and others are measured at current value. Furthermore, the value of a company is a function of many factors, including future cash flows expected to be generated by the company and current market conditions. C is incorrect because owners' equity is determined simply by subtracting the liabilities from the assets of a company. [LOS 18.b]

A company pays $4,500 upfront to rent a piece of machinery for 90 days based on a monthly rental rate of $1,500. The adjusting entries at the end of each month of use will most likely: A. reduce the company's cash account balance. B. record an expense on the company's income statement. C. create an accrued asset account on the company's balance sheet.

B. In this example, the company has made a cash payment in advance of receiving the associated benefit of using the rented machinery. This mismatch between making a cash payment and incurring an expense requires the use of an accrual account. Specifically, the originating entry will reduce the company's cash balance by the amount of the $4,500 up-front payment and use an asset account to record this prepaid expense. The original balance of the prepaid expense account (considering this transaction in isolation) will be $4,500 because no benefit has been derived and therefore no expense must be recognized. At the end of each month, the company will record adjusting entries that recognize expenses of $1,500 on the income statement and reduce the prepaid expense asset by an equivalent amount. [LOS 18.e]

Which of the following is most likely classified as a current liability? A. Payment received for a product due to be delivered at least one year after the balance sheet date B. Payments for merchandise due at least one year after the balance sheet date but still within a normal operating cycle C. Payment on debt due in six months for which the company has the unconditional right to defer settlement for at least one year after the balance sheet date

B. Payments due within one operating cycle of the business, even if they will be settled more than one year after the balance sheet date, are classified as current liabilities. Payment received in advance of the delivery of a good or service creates an obligation or liability. If the obligation is to be fulfilled at least one year after the balance sheet date, it is recorded as a non-current liability, such as deferred revenue or deferred income. Payments that the company has the unconditional right to defer for at least one year after the balance sheet may be classified as non-current liabilities. [LOS 18.e]

Which of the following best describes a limitation of the balance sheet in determining a company's intrinsic value? A company's balance sheet: A. reflects the company's intrinsic value only at the end of the reporting period. B. adjusts the value of debt obligations only when interest rates change. C. records some values using different measurement methods.

B. The balance sheet provides important information about a company's financial condition, but it is limited in its ability to provide all the detail necessary to determine a company's market or intrinsic value. One limitation is that under current accounting standards, some assets and liabilities are measured at historical cost but others are measured on a current value basis. A is incorrect. Although the balance sheet reflects values as of the end of the reporting period, the balance sheet should not be viewed as a measure of a company's intrinsic value, even at the end of the reporting period. B is incorrect. The statement is not correct and hence not a limitation. [LOS 18.a], [LOS 18.b]

If a company purchases, at a premium, bonds that it expects to hold until maturity, they are most likely measured on the balance sheet at: A. historical cost. B. amortized cost. C. fair value.

B. The bonds would be a type of financial asset that is measured at amortized cost. This classification applies to financial assets whose cash flows occur on specific dates and consist solely of principal and interest, and if the entity's business model for this investment is to hold the asset to maturity. C is incorrect. Financial assets can be measured at fair value but because the entity intends to hold these bonds to maturity, amortized cost is more likely. A is incorrect. Some financial assets, notably loans to other companies, are measured at historical cost, but not a purchased bond. [LOS 18.e]

Money received from customers for products to be delivered in the future is recorded as: A. revenue and an asset. B. an asset and a liability. C. revenue and a liability.

B. The cash received from customers represents an asset. The obligation to provide a product in the future is a liability called "unearned income" or "unearned revenue." As the product is delivered, revenue will be recognized and the liability will be reduced. [LOS 18.e]

During 2013, the following events occurred at a company: It purchased a customer list for $100,000, which is expected to provide equal annual benefits for the next four years. It recorded $200,000 of goodwill in the acquisition of a competitor. It is estimated that the acquisition would provide substantial benefits for the company for at least the next 10 years. It spent $300,000 on media placements announcing that the company had donated products and services to the community. The CEO believes the firm's reputation was enhanced substantially and that the company will likely benefit from it for the next five years. Based on those events, the amortization expense that the company should report in 2014 is closest to: A. $85,000. B. $25,000. C. $45,000.

B. The customer list is the only identifiable intangible asset, and it should be amortized on a straight-line basis over its expected future life: $100,000/4 = $25,000/year. Goodwill is an unidentifiable intangible and should be tested for impairment but not amortized. All advertising and promotion costs, such as the media placements, are typically expensed. If the reputation of the company has been enhanced as the CEO suggests, it is an internally generated intangible that is not recorded on the balance sheet and is thus not amortized. A is incorrect. It includes the $300,000 of donation amortized over 5 years (300,000/5 = 60,000) added to the customer list amortization: 25,000 + 60,000 = 85,000. C is incorrect. It amortizes the goodwill over 10 years and adds it to the $25,000 amortization of the customer list: $200,000/10 + $100,000/4 = $45,000. [LOS 18.e]

Non-current assets are most likely distinguished from current assets on the basis of: A. age. B. liquidity. C. book value.

B. The difference between current and non-current assets is that current assets are more easily sold. If the company suffers financial hardship and all its assets are difficult to sell, either at all or without taking a significant loss, the company could be at risk. This short-term flexibility is referred to as liquidity. Age and book value are not used as factors in determining whether an asset should be included among current or non-current assets. [LOS 18.e]

The non-controlling (minority) interest in consolidated subsidiaries is presented on the balance sheet: A. as a long-term liability. B. separately, but as a part of shareholders' equity. C. as a mezzanine item between liabilities and shareholders' equity.

B. The non-controlling interest in consolidated subsidiaries is shown separately as part of shareholders' equity. [LOS 18.f]

Macron, an agricultural supply wholesaler, is scheduled to deliver fertilizer to Harlson Farms on 1 September. On 15 August, Harlson Farms pays $95,000 in advance for the upcoming delivery and receives a 5% discount. As a result of the 15 August transaction Macron's assets would most likely: A. be unaffected. B. increase by $95,000. C. decrease by $95,000.

B. The overall effect of the 15 August transaction on Macron's balance sheet would be $95,000 increases in both assets and liabilities. Unearned revenue, a liability account, would increase by $95,000. Cash, an asset, would also increase by $95,000. Because no delivery will be made until 1 September, inventory would be unaffected. [LOS 18.e]

Which of the following statements about balance sheets is most accurate? For balance sheets prepared under: A. IFRS, a classified balance sheet must present current assets before non-current assets. B. US GAAP, intangibles must be valued at historical cost. C. IFRS, a commercial real estate company should use a liquidity based presentation.

B. Under US GAAP, intangibles must be valued at historical cost; under IFRS they can be valued at cost or revaluation. A is incorrect. Under IFRS, a classified balance sheet does separate current assets from non-current assets, but non-current assets could be presented first. C is incorrect. A commercial real estate company would have many non-liquid assets and would not likely use the liquidity-based presentation under IFRS. A commercial bank would use this format. [LOS 18.e]

Shareholders' equity reported on the balance sheet is most likely to differ from the market value of shareholders' equity because: A. historical cost basis is used for all assets and liabilities. B. some factors that affect the generation of future cash flows are excluded. C. shareholders' equity reported on the balance sheet is updated continuously.

B. [LOS 18.a], [LOS 18.b]

For which of the following assets is it most appropriate to test for impairment at least annually? A. Land B. A patent with a legal life of 20 years C. A trademark with an indefinite expected life

C. C is correct. Intangible assets with indefinite lives need to be tested for impairment at least annually. Property, plant, and equipment (including land) and intangibles with finite lives are only tested if there has been a significant change or other indication of impairment. A is incorrect. Property, plant, and equipment (including land) are not tested annually but only when significant events suggest a need to test for impairment. B is incorrect. Intangible assets with finite lives are not tested annually but only when significant events suggest a need to test for impairment. [LOS 18.e]

Which of the following statements is most accurate? A. Non-controlling interest on the balance sheet represents a position the company owns in other companies. B. A classified balance sheet arises when in an auditor's opinion the financial statements materially depart from accounting standards and are not presented fairly. C. Treasury stock is non-voting and receives no dividends.

C. C is correct. Treasury stock is non-voting and does not receive dividends. A is incorrect. Non-controlling interest is the portion in consolidated subsidiaries that is owned by others, i.e., shares in subsidiaries not owned by the parent. B is incorrect. An adverse audit opinion arises when in an auditor's opinion, the financial statements materially depart from accounting standards and are not presented fairly. A classified balance sheet groups together the various classes of assets and liabilities. [LOS 18.f]

Which of the following is most accurately classified as a contra account that is used to offset a company's revenues? A. Unearned revenue B. Allowance for bad debts C. Sales returns and allowances

C. Contra accounts are used to offset the balance of an associated account. Sales returns and allowances is a contra account that offsets revenues in cases when, for example, cash refunds are provided or unsatisfactory items are sold at a discount from their regular price. Unearned revenue is an accrual account that is used to record a liability in cases when cash has been received before revenues can be recognized as earned. Allowance for bad debts is a contra account that is used to reduce the net book value of a company's receivables by the amount that is estimated to be uncollectible. [LOS 18.e]

For financial assets classified as available for sale, how are unrealized gains and losses reflected in shareholders' equity? A. They are not recognized. B. They flow through retained earnings. C. They are a component of accumulated other comprehensive income.

C. For financial assets classified as available for sale, unrealized gains and losses are not recorded on the income statement and instead are part of other comprehensive income. Accumulated other comprehensive income is a component of Shareholders' equity [LOS 18.e]

Which of the following is most likely to be included among current liabilities on a company's balance sheet? A. Bank loans B. Deferred tax liability C. Income taxes payable

C. Income taxes payable represents unpaid taxes on earned income. Since companies typically pay taxes annually, these liabilities are usually at most one year and are considered current liabilities. Deferred tax liability and bank loans are typically included among non-current liabilities. Bank loans could potentially be a current liability if those loans are due within one year. However, it is more likely that bank loans will be due in more than one year and therefore should be listed among non-current liabilities. By contrast, income taxes payable will always be listed among current liabilities because they will be paid within a year. [LOS 18.e]

Balance sheet items presented on a current value basis are measured at the: A. start of the reporting period. B. midpoint of the reporting period. C. end of the reporting period.

C. Items measured at current value reflect the value that was current at the end of the reporting period. The values of those items can change after the balance sheet is prepared. A is incorrect because items measured at current value reflect the value that was current at the end of the reporting period (not at the start of the reporting period). B is incorrect because items measured at current value reflect the value that was current at the end of the reporting period (not at the midpoint). [LOS 18.b]

Debt with a maturity date beyond a company's next operating cycle is most likely classified as a component of: A. trade payables. B. accrued liabilities. C. non-current liabilities.

C. Non-current liabilities include all liabilities not expected to be settled within one year or within one operating cycle of a business. These include financial liabilities such as debt with a maturity date beyond a company's next operating cycle. A is incorrect because trade payables are amounts that a company owes its vendors for purchases of goods and services. Trade payables are generally classified as current liabilities, to be settled within one operating cycle. B is incorrect because accrued liabilities (also called accrued expenses) are expenses that have been recognized on a company's income statement but that have not been paid as of the balance sheet date, while debt is classified as a liability. [LOS 18.e]

The following data are available on a company for the current fiscal year: Metric£ thousands Allowance for doubtful accounts balance, 1 January: 137 Write-offs of accounts receivable during the year because of customer bankruptcy: 86 Credit sales: 21,000 Accounts receivable balance, 31 December: 4,200 During the year, bad debts expense was charged at a rate of 0.5% of credit sales. At year end, an aging analysis of the accounts receivable indicates that the appropriate allowance for doubtful accounts balance is 3% of the outstanding accounts receivable balance. The most appropriate year-end adjustment (in thousands) to the allowance for doubtful accounts is a(n): A. increase of £126. B. reduction of £116. C. reduction of £30.

C. The target allowance for doubtful accounts balance is 3% of £4,200, or £126. Ending balance is calculated as follow: [LOS 18.e]

A company owns a ski lodge that is carried on its balance sheet as a non-current asset in the investment property account. Increases in the property's value are recorded on the company's income statement. The company most likely adheres to: A. IFRS and has chosen to use the cost model. B. US GAAP and has chosen to use the cost model. C. IFRS and has chosen to use the fair value model.

C. Under IFRS, investment property is in its own category. Companies must use either the fair value model or the cost model. If the fair value model is chosen, companies must report changes in the property's market value on the income statement. Companies that choose the cost model carry investment properties at historical cost less accumulated depreciation and impairment costs. US GAAP do not have a specific definition of investment property and offer no guidance on this topic. [LOS 18.e]

At the beginning of the year, a company paid $1.2 million to purchase debt securities and classified these as available-for-sale. At the end of the year, the securities had a market value of $1.5 million. All else equal, if these financial assets had been classified as trading securities, the company's net income for the year would most likely have been: A. lower. B. the same. C. higher.

C. Unrealized gains and losses on trading securities are included in the income statement. By contrast, unrealized gains and losses on available-for-sale securities bypass the income statement and are instead included directly in shareholders' equity. In this example, the securities increased in value by $300,000 over their initial purchase price. If they had been classified as trading securities at that time, this appreciation would have been recorded on the income statement and the company's net income would have been higher. [LOS 18.e]

The carrying value of inventories reflects: A. their historical cost. B. their current value. C. the lower of historical cost or net realizable value.

C. C is correct. Under IFRS, inventories are carried at historical cost, unless net realizable value of the inventory is less. Under US GAAP, inventories are carried at the lower of cost or market. [LOS 18.e]