FRA questions

Amounts recorded as deferred revenue are most likely included in income when they are: earned. invoiced. paid.

A is correct. Deferred revenue is a liability account that arises when money has been collected for goods or services that have not been delivered. Revenue is recognized (included in income) as it is earned, and the deferred revenue liability will decrease accordingly.

When a company issues common stock as part of the conversion of a convertible bond, the cash flow statement will most likely: omit the transaction but disclose it in a separate note or supplementary statement. omit the transaction without disclosure. include the transaction because it materially affects the company's financial position.

A is correct. Significant non-cash transactions, such as the exchange of non-monetary assets or issuance of stock as part of a stock dividend or conversion are not incorporated in the cash flow statement. They are required to be disclosed, however, in either a separate note or a supplementary schedule to the cash flow statement.

The year-end balances in a company's last-in, first-out (LIFO) reserve are $56.8 million as reported in the company's financial statements for both 2013 and 2014. For 2014, the measure that will most likely be the same regardless of whether the company uses the LIFO or the first-in, first-out (FIFO) inventory method is the: gross profit margin. amount of working capital. inventory turnover.

A is correct. The LIFO reserve did not change from 2013 to 2014. With no change in the LIFO reserve, cost of goods sold will be the same under both methods. Sales are always the same for both methods, so gross profit margin will be the same for 2014. The FIFO inventory will be higher because the LIFO inventory and LIFO reserve are added to compute FIFO inventory. Because the inventory balances would differ under FIFO, both inventory turnover and the amount of working capital would also differ under FIFO.

Q. 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.

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

A is correct. The cash ratio determines how much of a company's near-term obligations can be settled with existing amounts of cash and marketable securities.

For which of the following inventory valuation methods is the gross profit margin least likely to be the same under both a perpetual inventory system and a periodic inventory system? LIFO Specific identification FIFO

A is correct. The periodic and perpetual systems result in the same inventory and cost of goods sold values (and thus gross profit margin) using both FIFO and specific identification valuation methods, but not always under LIFO.

Zimt AG wrote down the value of its inventory in 2017 and reversed the write-down in 2018. Compared to the results the company would have reported if the write-down had never occurred, Zimt's reported 2018: profit was overstated. cash flow from operations was overstated. year-end inventory balance was overstated.

A is correct. The reversal of the write-down shifted cost of sales from 2018 to 2017. The 2017 cost of sales was higher because of the write-down, and the 2018 cost of sales was lower because of the reversal of the write-down. As a result, the reported 2018 profits were overstated. Inventory balance in 2018 is the same because the write-down and reversal cancel each other out. Cash flow from operations is not affected by the non-cash write-down, but the higher profits in 2018 likely resulted in higher taxes and thus lower cash flow from operations.

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

A is correct. 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.

Under US GAAP, property, plant, and equipment is reported on the balance sheet based on: a cost model only. a revaluation model only. either a cost model or a revaluation model.

A is correct. Under US GAAP, only the cost model is permitted for reporting property, plant, and equipment (PPE). Under the cost model, PPE is carried at amortized cost (historical cost less any accumulated depreciation or accumulated depletion and less any impairment losses).

If inventory unit costs are increasing from period-to-period, a LIFO liquidation is most likely to result in an increase in: gross profit. LIFO reserve. inventory carrying amounts.

A is correct. When the number of units sold exceeds the number of units purchased, a company using LIFO will experience a LIFO liquidation. If inventory unit costs have been rising from period-to-period and a LIFO liquidation occurs, it will produce an increase in gross profit as a result of the lower inventory carrying amounts of the liquidated units (lower cost per unit of the liquidated units).

Zimt AG uses the FIFO method, and Nutmeg Inc. uses the LIFO method. Compared to the cost of replacing the inventory, during periods of rising prices, the cost of sales reported by: Zimt is too low. Nutmeg is too low. Nutmeg is too high.

A is correct. Zimt uses the FIFO method, so its cost of sales represents units purchased at a (no longer available) lower price. Nutmeg uses the LIFO method, so its cost of sales is approximately equal to the current replacement cost of inventory.

Which of the following statements best describes the effect of finance leases on financial statements? A lessee reports the interest portion of the lease payment as operating cash flow under IFRS and financing cash flow under US GAAP. The lessor reports a profit on the sale of the leased asset on the income statement in the case of a sales-type lease. Balance sheet effects differ based on whether the lease is a direct financing lease or a sales-type lease.

B is correct. A lessor reports a profit on the sale of the asset on the income statement when the present value of the lease payments exceeds the carrying amount of the leased asset (sales-type lease).

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 categorized 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.

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

B is correct. 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.

Under which section of a manufacturing company's cash flow statement are the following activities reported? Item 1: Purchases of securities held for trading Item 2: Sales of securities considered cash equivalents Both items are investing activities. Both items are operating activities. Only Item 1 is an investing activity.

B is correct. The purchase and sale of securities considered cash equivalents and securities held for trading are considered operating activities even for companies in which this activity is not a primary business activity.

One of the notable differences between IFRS and US GAAP when dealing with income tax is best illustrated by the fundamental treatment of: non-deductible goodwill. the revaluation of property, plant, and equipment. temporary differences between the carrying amount and tax base of assets and liabilities.

B is correct. US GAAP prohibits the revaluation of PP&E. Therefore, this is a source of an important difference between US GAAP and IFRS with respect to reporting of income taxes. A is incorrect. For non-deductible goodwill, despite some differences, US GAAP and IFRS are fundamentally the same. C is incorrect. Both US GAAP and IFRS treat temporary differences in the same way fundamentally.

Derecognition of a long-lived asset other than by a sale most likely involves: spinning off a portion of assets from a cash-generating unit of a company. removing the carrying amount of the asset given up, adding a fair value for the asset acquired if an asset is exchanged, and reporting any difference in values. recording cash proceeds if an asset is retired or abandoned.

B is correct. When an asset is exchanged, accounting for the exchange typically involves removing the carrying amount of the asset given up, adding a fair value for the asset acquired, and reporting any difference between the carrying amount and the fair value as a gain or loss.

If a company has a deferred tax asset reported on its statement of financial position and the tax authorities reduce the tax rate, which of the following statements is most accurate concerning the effect of the change? The existing deferred tax asset will: not be affected. increase in value. decrease in value.

C is correct. A decrease in the tax rate will result in a decrease in the previously reported amounts of deferred tax assets. That is, the value of the future tax assets, based on the new lower rate, is reduced for offsetting future tax payments.

A firm with convertible securities initially calculates that its diluted EPS is greater than its basic EPS. The firm will: not be required to report diluted EPS. report basic EPS that is not equal to reported diluted EPS. report basic EPS that is equal to reported diluted EPS.

C is correct. A higher diluted EPS indicates that the company's convertible securities are antidilutive (i.e., their inclusion in the computation would result in an EPS higher than the company's basic EPS), and the company is required to report a basic EPS that equals diluted EPS. This occurs because, by definition, diluted EPS has to be equal to or lower than basic EPS.

Which of the following statements most accurately describes a valuation allowance for deferred taxes? A valuation allowance is required under: both IFRS and US GAAP on deferred tax assets arising from the translation of foreign operations. IFRS on revaluation of a deferred tax asset. US GAAP if there is doubt about recovering a deferred tax asset.

C is correct. A valuation allowance is required under US GAAP if there is doubt about whether a deferred tax asset will be recovered. Under IFRS, the deferred tax asset is written down directly.

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.

Under US GAAP, which of the following would require the lessee to classify a lease as a capital lease? The term is 60% of the useful life of the asset. The lease contains an option to purchase the asset at fair value. The present value of the lease payments is 95% of the fair value.

C is correct. If the present value of the lease payments is greater than 90% of the fair value of the asset, the lease is considered a capital lease. A lease with a term that is 75% or more of the useful life of the asset is deemed to be a capital lease. The option to purchase the asset must be deemed to be cheap (bargain purchase option), not just include the option to purchase the asset.

Which combination of depreciation methods and useful lives is most conservative in the year a depreciable asset is acquired? Straight-line depreciation with a short useful life. Declining balance depreciation with a long useful life. Declining balance depreciation with a short useful life.

C is correct. This would result in the highest amount of depreciation in the first year and hence the lowest amount of net income relative to the other choices.

An example of an expense classification by function is: tax expense. interest expense. cost of goods sold.

Cost of goods sold is a classification by function. The other two expenses represent classifications by nature.

A company extends its trade credit terms by four days to all its credit customers. These credit customers are most likely to experience a four-day:

decrease in their net operating cycle. increase in their operating cycle. decrease in their operating cycle. A is correct. The company's customers are receiving a four-day increase in their number of days of payables, which will reduce the company's cash conversion cycle (net operating cycle) by four days.

Distinguishing between current and non-current items on the balance sheet and presenting a subtotal for current assets and liabilities is referred to as: a classified balance sheet. an unclassified balance sheet. a liquidity-based balance sheet.

A is correct. A classified balance sheet is one that classifies assets and liabilities as current or non-current and provides a subtotal for current assets and current liabilities. A liquidity-based balance sheet broadly presents assets and liabilities in order of liquidity.

Under IFRS, a loss from the destruction of property in a fire would most likely be classified as: continuing operations. discontinued operations. other comprehensive income.

A is correct. A fire may be infrequent, but it would still be part of continuing operations and reported in the profit and loss statement. Discontinued operations relate to a decision to dispose of an operating division.

A company acquires some new depreciable assets. It uses straight-line deprecation for all of its assets. Which of the following combinations of estimated residual values and useful lives is most likely to produce the highest net profit margin? Estimated residual values should be: high with long average lives. low with long average lives. high with short average lives.

A is correct. A high residual value estimate reduces the depreciable base and thus depreciation expense. Long average lives reduce the annual depreciation expense for any given depreciable base. The combination of the two would result in the lowest depreciation expense, which would lead to the highest net income and profit margins. B is incorrect. Low residual values increase depreciation, though long lives reduce it. C is incorrect. Short lives increase depreciation expense, though high residual values reduce it.

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.

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

A is correct. Financial assets classified as held to maturity are measured at amortised cost. Gains and losses are recognized only when realized.

According to US GAAP, the payment of cash dividends during the year will most likely affect the cash flow from which type of activity? Financing Investing Operating

A is correct. For a company that prepares its financial statements under US GAAP, cash dividends paid are reported as a cash outflow in the cash flow from financing activities section on the statement of cash flows.

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.

Fernando's Pasta purchased inventory and later wrote it down. The current net realisable value is higher than the value when written down. Fernando's inventory balance will most likely be: higher if it complies with IFRS. higher if it complies with US GAAP. the same under US GAAP and IFRS.

A is correct. IFRS require the reversal of inventory write-downs if net realisable values increase; US GAAP do not permit the reversal of write-downs.

Under US GAAP, interest paid is most likely included in which of the following cash flow activities? Operating only Financing only Either operating or financing

A is correct. Interest paid must be categorized as an operating cash flow activity under US GAAP, although it can be categorized as either an operating or financing cash flow activity under IFRS.

LIFO reserve is most likely to increase when inventory unit: costs are increasing. costs are decreasing. levels are decreasing.

A is correct. LIFO reserve is the FIFO inventory value less the LIFO inventory value. In periods of rising inventory unit costs, the carrying amount of inventory under FIFO will always exceed the carrying amount of inventory under LIFO. The LIFO reserve may increase over time as a result of the increasing difference between the older costs used to value inventory under LIFO and the more recent costs used to value inventory under FIFO. When inventory unit levels are decreasing, the company will experience a LIFO liquidation, reducing the LIFO reserve.

Other factors held constant, the reduction of a company's average accounts payable because of suppliers offering less trade credit will most likely: not affect the operating cycle. reduce the operating cycle. increase the operating cycle.

A is correct. Payables are not part of the operating cycle calculation, which includes receivables and inventory.

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.

The gain or loss on a sale of a long-lived asset to which the revaluation model has been applied is most likely calculated using sales proceeds less: carrying amount. carrying amount adjusted for impairment. historical cost net of accumulated depreciation.

A is correct. The gain or loss on the sale of long-lived assets is computed as the sales proceeds minus the carrying amount of the asset at the time of sale. This is true under the cost and revaluation models of reporting long-lived assets. In the absence of impairment losses, under the cost model, the carrying amount will equal historical cost net of accumulated depreciation.

Under IFRS, what must be disclosed under the cost model of valuation for investment properties? Useful lives The method for determining fair value Reconciliation between beginning and ending carrying amounts of investment property

A is correct. Under IFRS, when using the cost model for its investment properties, a company must disclose useful lives. The method for determining fair value, as well as reconciliation between beginning and ending carrying amounts of investment property, is a required disclosure when the fair value model is used.

Under the revaluation model for property, plant, and equipment and the fair model for investment property: fair value of the asset must be able to be measured reliably. net income is affected by all changes in the fair value of the asset. net income is never affected if the asset increases in value from its carrying amount.

A is correct. Under both the revaluation model for property, plant, and equipment and the fair model for investment property, the asset's fair value must be able to be measured reliably. Under the fair value model, net income is affected by all changes in the asset's fair value. Under the revaluation model, any increase in an asset's value to the extent that it reverses a previous revaluation decrease will be recognized on the income statement and increase net income.

Which of the following ratios is most likely to be used as a measure of operating performance? Cash ratio Working capital turnover ratio Defensive interval ratio

B is correct. Activity ratios are typically used to measure operating performance. Working capital turnover is an example of an activity ratio; the defensive interval ratio and cash ratio are liquidity ratios used to measure a company's ability to meet its short-term obligations.

When computing net cash flow from operating activities using the indirect method, an addition to net income is most likely to occur when there is a: gain on the sale of an asset. loss on the retirement of debt. decrease in a deferred tax liability.

B is correct. An addition to net income is made when there is a loss on the retirement of debt, which is a non-operating loss. A gain on the sale of an asset and a decrease in deferred tax liability are both subtracted from net-income.

During periods of rising inventory unit costs, a company using the FIFO method rather than the LIFO method will report a lower: current ratio. inventory turnover. gross profit margin.

B is correct. During a period of rising inventory costs, a company using the FIFO method will allocate a lower amount to cost of goods sold and a higher amount to ending inventory as compared with the LIFO method. The inventory turnover ratio is the ratio of cost of sales to ending inventory. A company using the FIFO method will produce a lower inventory turnover ratio as compared with the LIFO method. The current ratio (current assets/current liabilities) and the gross profit margin [gross profit/sales = (sales less cost of goods sold)/sales] will be higher under the FIFO method than under the LIFO method in periods of rising inventory unit costs.

Which of the following is an appropriate method of computing free cash flow to the firm? Add operating cash flows to capital expenditures and deduct after-tax interest payments. Add operating cash flows to after-tax interest payments and deduct capital expenditures. Deduct both after-tax interest payments and capital expenditures from operating cash flows.

B is correct. Free cash flow to the firm can be computed as operating cash flows plus after-tax interest expense less capital expenditures.

Which of the following statements regarding the extinguishment of debt is correct? After an offsetting adjustment of net income, cash paid to extinguish debt is classified as cash used for operating activities. Net income is adjusted to remove any gain or loss on the extinguishment of debt from operating cash flows. A gain or loss on the extinguishment of debt is disclosed on the income statement in a separate line item, even if the amount is immaterial.

B is correct. In a statement of cash flows prepared using the indirect method, net income is adjusted to remove any gain or loss on the extinguishment of debt from operating cash flows.

In a period of declining inventory unit costs and constant or increasing inventory quantities, which inventory method is most likely to result in a higher debt-to-equity ratio? LIFO FIFO Weighted average cost

B is correct. In an environment of declining inventory unit costs and constant or increasing inventory quantities, FIFO (in comparison with weighted average cost or LIFO) will have higher cost of goods sold (and net income) and lower inventory. Because both inventory and net income are lower, total equity is lower, resulting in a higher debt-to-equity ratio.

A regional jet manufacturer delivers 20 regional jets to an airline under long-term leases. The lease terms are for 15 years with annual payments of $5 million per plane; the first payment is due on delivery. The airline leasing the jets is responsible for all maintenance and operating costs. If the company that manufactures and leases the jets prepares its financial statements according to US GAAP the leases will most likely be classified as: operating leases. sales-type leases. direct financing leases.

B is correct. It appears the risks and benefits of ownership of the jets has been transferred to the lessee as it is responsible for all maintenance and operating costs. Therefore, under US GAAP the leases should be classified as sales-type leases.

Compared to a company that uses the FIFO method, during periods of rising prices a company that uses the LIFO method will most likely appear more: liquid. efficient. profitable.

B is correct. LIFO will result in lower inventory and higher cost of sales. Gross margin (a profitability ratio) will be lower, the current ratio (a liquidity ratio) will be lower, and inventory turnover (an efficiency ratio) will be higher.

Which of the following ratios will most likely result in an increase in a company's sustainable growth rate? Higher dividend payout Higher tax burden Lower interest burden

B is correct. Sustainable growth rate = Retention ratio × ROE

If a company capitalizes an expenditure related to capital assets instead of expensing it, ignoring taxes, the company will most likely report: a lower cash flow per share in that period. the same free cash flow to the firm (FCFF) in that period. a higher earnings per share in future periods.

B is correct. The FCFF [Cash flow from operations (CFO) + Interest × (1 − t) − Capital expenditures] would be the same. CFO and capital expenditures would both increase by the same amount (ignoring taxes). Therefore, the net effect on FCFF would be zero.

For a bond issued at a premium, using the effective interest rate method, the: carrying amount increases each year. amortization of the premium increases each year. premium is evenly amortized over the life of the bond.

B is correct. The amortization of the premium equals the interest payment minus the interest expense. The interest payment is constant and the interest expense decreases as the carrying amount decreases. As a result, the amortization of the premium increases each year.

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.

Which of the following is the most likely reason for an analyst to choose the direct method rather than the indirect method for analyzing a firm's operating cash flows? To understand the relationship between net income and operating cash flows To identify operating cash flows by source and by use To avoid making adjustments for non-cash items

B is correct. The direct method cash flow statement presents specific operating cash flows by source and use. A is incorrect because the indirect method starts with net income and presents clearly the relationship between net income and operating cash flows. C is incorrect because the indirect method cash flow statement adjusts for non-cash items, not the direct method

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.

Which of the following statements best describes the usual balance sheet presentation of long-term debt? Long-term debt due after one year is presented as multiple line items. Non-current, long-term debt is presented as a single line item. All long-term debt is excluded from classification as a current liability.

B is correct. The non-current (long-term) liabilities section of the balance sheet usually includes a single line item of the total amount of a company's long-term debt due after one year.

Which of the following is most likely a benefit of the direct method for reporting cash flow from operating activities? Compared with the indirect method, the direct method: mirrors the forecasting approach normally used by analysts. provides details on the specific sources of operating receipts and payments. provides insight on differences between net income and operating cash flows.

B is correct. The primary benefit of the direct method is that it provides information on the specific sources of operating cash receipts and payments. A is incorrect because this is a benefit of the indirect method when analysts start their forecasting with forecasted net income. C is incorrect because this is also a benefit of the indirect method.

Under IFRS, an impairment loss on a property, plant, and equipment asset is measured as the excess of the carrying amount over the asset's: fair value. recoverable amount. undiscounted expected future cash flows.

B is correct. Under IFRS, an impairment loss is measured as the excess of the carrying amount over the asset's recoverable amount. The recoverable amount is the higher of the asset's fair value less costs to sell and its value in use. Value in use is a discounted measure of expected future cash flows. Under US GAAP, assessing recoverability is separate from measuring the impairment loss. If the asset's carrying amount exceeds its undiscounted expected future cash flows, the asset's carrying amount is considered unrecoverable and the impairment loss is measured as the excess of the carrying amount over the asset's fair value.

Under IFRS, the costs incurred in the issuance of bonds are most likely: expensed when incurred. included in the measurement of the bond liability. deferred as an asset and amortized on a straight-line basis.

B is correct. Under IFRS, debt issuance costs are included in the measurement of the bond liability. A is incorrect. Under both US GAAP and IFRS, they are not expensed. C is incorrect. This is US GAAP.

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

B is correct. Under US GAAP, intangibles must be valued at historical cost; under IFRS they can be valued at cost or revaluation. A is incorrect because under IFRS, a classified balance sheet does separate current assets from non-current assets, but non-current assets could be presented first.

A company that reports under US GAAP leases assets for its own use and classifies its leases as finance leases. In the first year of a least, how would it most likely report a lease payment on its Statement of Cash Flows? The full payment in cash from operations The interest portion of the payment in cash from operations The full payment in cash from financing activities

B is correct. Under US GAAP, when a lease is classified as a finance lease, the lease payment is split between an interest portion, which is reported in cash from operations, and a principal repayment portion reported in financing activities.

A company sells a product with a three-year warranty included in the price. According to IFRS, which of the following is the most appropriate accounting treatment for the warranty? Fully recognizing the revenue at the time of the sale but waiting until the actual warranty costs are incurred to recognize the expense. Fully recognizing the revenue and estimated warranty expense at the time of the sale and updating the expense as indicated by experience over the life of the warranty. Deferring all of the revenue and recognizing it over the life of the warranty period.

B is correct. Under the matching principle, a company is required to estimate the amount of future expenses resulting from its warranties and to update the expense as indicated by experience over the life of the warranty. Waiting until actual costs are incurred will not match the expense with the associated revenue.

When constructing an asset for sale, directly related borrowing costs are most likely: expensed as incurred. capitalized as part of inventory. capitalized as part of property, plant, and equipment.

B is correct. When a company constructs an asset, borrowing costs incurred directly related to the construction are generally capitalized. If the asset is constructed for sale, the borrowing costs are classified as inventory.

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.

During a period of rising inventory costs, a company decides to change its inventory method from FIFO to the weighted average cost method. Under the weighted average method, which of the following financial metrics will most likely be higher than under FIFO? Current ratio Number of days in inventory Debt-to-equity ratio

C is correct. If all else is held constant, in a period of rising costs the ending inventory will be lower under the weighted average cost method and the cost of goods sold will be higher (compared to FIFO), resulting in lower net income and retained earnings. There will be no impact on the debt level, current or long-term. Therefore, the debt-to-equity ratio (Total debt/Total shareholders' equity) will increase because of the decrease in retained earnings (and lower shareholders' equity).

When the market rate of interest falls after issuance, a company selecting the fair value option for reporting a liability with a fixed coupon rate will report: no change. a gain. a loss.

C is correct. A company selecting the fair value option for a liability with a fixed coupon rate will report a loss when market interest rates decrease.

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.

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

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.

Compared with its net income, a mature company's operating cash flow is most likely: the same. lower. higher.

C is correct. For a mature company, because net income includes non-cash expenses (depreciation and amortization), operating cash flow typically exceeds net income.

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

C is correct. 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

Three companies in the same industry are identical except in how they account for inventory: One uses first-in, first-out (FIFO), another uses last-in, first-out (LIFO), and the third uses weighted average cost. Although the industry experienced increasing prices in prior years, a recent technological breakthrough has substantially reduced the value of the companies' inventories, and each company will face inventory write-downs. Which of the reporting methods will most likely lead to the smallest write-down?

C is correct. Given increasing inventory costs in prior years, the inventory carrying amounts under the LIFO method are already presented at the oldest and lowest costs. The magnitude of the write-down under LIFO is likely to be the lowest. Prior to the write-down, inventory under FIFO will be at the highest level and will result in the largest write-down. The write-down for the company using weighted average cost will be in between that of the two other companies.

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

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 company has announced that it is going to distribute a group of long-lived assets to its owners in a spin-off. The most appropriate way to account for the assets until the distribution occurs is to classify them as: held for sale with no depreciation taken. held for use until disposal with no deprecation taken. held for use until disposal with depreciation continuing to be taken.

C is correct. Long-lived assets that will be disposed of other than by sale, such as in a spin-off, an exchange for other assets, or abandonment, are classified as held for use until disposal and continue to be depreciated until that time.

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

C is correct. Paying rent in advance will reduce cash and increase prepaid expenses, both of which are assets.

In an issuer's financial statements, reported interest expense for a bond is computed using the: bond's coupon rate. market rate of interest. effective interest rate.

C is correct. Reported interest expense for a company's bonds is computed using the effective interest rate, which is the market interest rate at issuance.

Q. A company purchases equipment for $200,000 with a five-year useful life and salvage value of zero. It uses the double-declining balance method of depreciation for two years, then shifts to straight-line depreciation at the beginning of Year 3. Compared with annual depreciation expense under the double-declining balance method, the resulting annual depreciation expense in Year 4 is: smaller. the same. greater.

C is correct. Shifting at the end of Year 2 from double-declining balance to straight-line depreciation methodology results in depreciation expense being the same in each of Years 3, 4, and 5. Shifting to the straight-line methodology at the beginning of Year 3 results in a greater depreciation expense in Year 4 than would have been calculated using the double-declining balance method.

Cash flows from taxes on income must be separately disclosed under: IFRS only. US GAAP only. both IFRS and US GAAP.

C is correct. Taxes on income are required to be separately disclosed under IFRS and US GAAP. The disclosure may be in the cash flow statement or elsewhere.

The impairment of intangible assets with finite lives affects: the balance sheet but not the income statement. the income statement but not the balance sheet. both the balance sheet and the income statement.

C is correct. The carrying amount of the asset on the balance sheet is reduced by the amount of the impairment loss, and the impairment loss is reported on the income statement.

Inventory cost is least likely to include: production-related storage costs. costs incurred as a result of normal waste of materials. transportation costs of shipping inventory to customers.

C is correct. Transportation costs incurred to ship inventory to customers are an expense and may not be capitalized in inventory. (Transportation costs incurred to bring inventory to the business location can be capitalized in inventory.) Storage costs required as part of production, as well as costs incurred as a result of normal waste of materials, can be capitalized in inventory. (Costs incurred as a result of abnormal waste must be expensed.)

When a firm can choose where in the cash flow statement to classify interest received, which of the following choices is the most appropriate? As an financing activity under IFRS As an investing activity under US GAAP As a operating activity under IFRS

C is correct. Under IFRS, interest received may be classified as either an operating activity or as an investing activity, but under US GAAP, it can be classified only as an operating activity.

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

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.

Which of the following statements related to the derecognition of debt is correct? Under US GAAP, debt issuance costs are accounted for as bonds payable. Under IFRS, debt issuance costs are excluded from the carrying amount. Under US GAAP, any unamortized debt issuance costs must be written off at the time of redemption.

C is correct. Under US GAAP, any unamortized debt issuance costs must be written off at the time of redemption and included in the gain or loss on debt extinguishment. B is incorrect because, under IFRS, debt issuance costs are included (not excluded) in the measurement of the liability and are thus part of its carrying amount.

Which of the following is a required financial statement disclosure for long-lived intangible assets under US GAAP? The useful lives of assets The reversal of impairment losses Estimated amortization expense for the next five fiscal years

C is correct. Under US GAAP, companies are required to disclose the estimated amortization expense for the next five fiscal years. Under US GAAP, there is no reversal of impairment losses. Disclosure of the useful lives—finite or indefinite and additional related details—is required under IFRS.

A company previously expensed the incremental costs of obtaining a contract. All else being equal, adopting the May 2014 IASB and FASB converged accounting standards on revenue recognition makes the company's profitability initially appear: lower. unchanged. higher.

C is correct. Under the converged accounting standards, the incremental costs of obtaining a contract and certain costs incurred to fulfill a contract must be capitalized. If a company expensed these incremental costs in the years prior to adopting the converged standards, all else being equal, its profitability will appear higher under the converged standards.

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.

An equity analyst is forecasting next year's net profit margin of a heavy equipment manufacturing firm by using the average net profit margin over the past three years. In making his profit projection, he identifies the following three items: The company reported losses from discontinued operations in each of the past three years. The most recent year's tax rate was only half of the prior two years' rate as a result of a fiscal stimulus. The company reported gains on the sale of investments in each of the past three years. Which of the following statements about the preparation of the forecast is most accurate?

exclude the gains on the sale from investments because the company is a manufacturing firm. The company is a heavy equipment manufacturer. Because gains on investments are not a core part of the company's business, they should not be viewed as an ongoing source of earnings. Discontinued operations are considered to be non-recurring items (even though they have occurred in the past three years); they are normally treated as random and unsustainable and should not be included in a short-term forecast. The change in the current tax rate is best viewed as temporary in the absence of additional information and should not be the basis of the calculation of the average tax rate.