Accounting Mods 19.1+

Continental Corporation reported sales revenue of $150,000 for the current year. If accounts receivable decreased $10,000 during the year and accounts payable increased $4,000 during the year, cash collections were:

$150,000 sales + $10,000 decrease in accounts receivable = $160,000 cash collections. The change in accounts payable does not affect cash collections. Accounts payable result from a firm's purchases from its suppliers.

Assume that the exercise price of an option is $5, and the average market price of the stock is $8. Assuming 816 options are outstanding during the entire year, what is the number of shares to be added to the denominator of the diluted EPS?

(816)(5) = $4,080. $4,080 / $8 = 510 shares. 816 − 510 = 306 new shares or [(8 − 5) / 8]816 = 306.

Assume that the exercise price of an option is $10, and the average market price of the stock is $13. Assuming 999 options are outstanding during the entire year, what is the number of shares to be added to the denominator of the diluted earnings per share (EPS)?

(999)(10) = 9,990 9,990 / 13 = 768 999 − 768 = 231

Which of the following equations least accurately represents return on equity?

(ROA)(interest burden)(tax retention rate).

Which of the following securities would least likely be found in a simple capital structure?

A simple capital structure contains no potentially dilutive securities such as stock options, warrants, or convertible preferred stock.

Which of the following would most likely result in higher gross profit margin, assuming no fixed costs?

A 5% decrease in production cost per unit. .A 5% decrease in per unit production cost will increase gross profit by reducing cost of goods sold. Assuming no fixed costs, gross profit margin will remain the same if sale quantities increase. Administrative expenses are not included in gross profit margin

Which of the following transactions affects owners' equity but does not affect net income?

A foreign currency translation gain is not included in net income but the gain increases owners' equity. Dividends received are reported in the income statement. The repayment of principal does not affect owners' equity

Which of the following characteristics are required for recognition of a balance sheet asset? Characteristic #1: Future economic benefits to the firm are probable. Characteristic #2: The asset is tangible and is obtained at a cost.

An asset is recognized on the balance sheet only if it is probable that it will provide future economic benefits. Assets can be tangible or intangible. In some cases, assets are acquired without cost, but will be reported to the extent that they will provide future economic benefit, and thus have value.

Other things equal, which of the following actions related to property, plant, and equipment will most likely decrease a firm's return on assets in future periods?

An upward revaluation will increase the book value of assets and increase depreciation expense in future periods (decreasing net income), both of which reduce ROA. Impairment would have the opposite effects, decreasing future depreciation and book values. Derecognizing an asset may increase, decrease, or not affect ROA in future periods

Antidilutive securities should be assumed to have been converted to common shares when calculating:

Antidilutive securities would increase EPS if exercised or converted to common stock. Therefore we do not assume they are converted when we calculate diluted EPS. Basic EPS is calculated before assuming any potentially dilutive securities are converted.

Roome Corp. has 5,000,000 common shares outstanding. There are 500,000 warrants outstanding to purchase the stock at $20, and there are 200,000 options outstanding to buy the stock at $50. The average market price for the stock over the year was $40, and the current stock price is $60. The number of shares used to calculate diluted EPS is:

Applying the treasury stock method to the warrants, 5,000,000 + [500,000 − (500,000 × $20) / $40] = 5,250,000 shares. The options are antidilutive because their exercise price is higher than the average stock price for the year.

On January 1, Orange Computers issued employee stock options for 400,000 shares. Options on 200,000 shares have an exercise price of $18, and options on the other 200,000 shares have an exercise price of $22. The year-end stock price was $24, and the average stock price over the year was $20. The change in the number of shares used to calculate diluted earnings per share for the year due to these options is closest to:

Based on the average stock price, only the options at 18 are in the money (and therefore dilutive). Using the treasury stock method, the average shares outstanding for calculating diluted EPS would increase by [(20 − 18) / 20]200,000 = 20,000 shares.

Stannum Records obtains two intangible assets in a business acquisition: legal rights to reproduce songs, valued at $5 million, and a trademark valued at $1 million. The trademark expires in 10 years and can be renewed at a minimal cost. Stannum estimates a 5-year useful life for the song rights. Because much of the songs' economic value is realized in their early years, Stannum uses double-declining balance amortization. Amortization expense in the first year after the acquisition is closest to:

Because the trademark can be renewed at minimal cost, it should be treated as an intangible asset with an indefinite life: the asset is not amortized but is tested for impairment at least annually. For the song rights, DDB depreciation in the first year = 2/5 × $5 million = $2 million.

At the beginning of the year, a company that reports under U.S. GAAP purchased some bonds for $80,000. During the year, the bonds paid interest of $4,000. At the end of the year, the bonds had a market value of $75,000. What amounts should the company report on its balance sheet at year-end for the bonds if they are treated as trading securities and if they are treated as available-for-sale securities? What amounts of investment income should the company report on its income statement if the bonds are treated as trading securities and if they are treated as available-for-sale securities?

Both trading securities and available-for-sale securities are reported on the balance sheet at their fair values. At year-end, the fair value is $75,000. A loss of $1,000 is recognized if the securities are considered trading securities ($4,000 interest − $5,000 unrealized loss). Income is $4,000 if the investment in Company S bonds is considered available-for-sale.

Which of the following statements about indefinite-lived intangible assets is most accurate?

Indefinite-lived intangible assets are not amortized; rather, they are reported on the balance sheet indefinitely unless they are impaired

An analyst has gathered the following information about a company: Cost of goods sold = 65% of sales. Inventory of $450,000. Sales of $1 million. What is the value of this firm's average inventory processing period using a 365-day year?

COGS = (0.65)($1,000,000) = $650,000 Inventory turnover = CGS / Inventory = $650,000 / $450,000 = 1.4444 Average Inventory Processing Period = 365 / 1.4444 = 252.7 days

In periods of rising prices and stable inventory quantities, which of the following best describes the effect on gross profit of using LIFO as compared to using FIFO?

Compared to FIFO, COGS calculated under LIFO will be higher because the most recent, higher cost units are assumed to be the first units sold. Higher COGS under LIFO will result in lower gross profit

A segment of a common-size balance sheet for Olsen Company in its most recent year shows the following data: Common stock 1% Additional paid-in capital 19% Preferred stock 15% How should an analyst most appropriately interpret these data?

Common-size balance sheets express each balance sheet item as a percentage of total assets. Contributed capital from issuing common shares may be included in common stock (at par value) or additional paid-in capital (for proceeds in excess of par value). Shareholders' equity is unlikely to consist only of common and preferred stock, as it also includes components such as retained earnings and accumulated other comprehensive income.

During a period of increasing prices, compared to reporting under LIFO, a firm that reports using average cost for inventory will have a:

Compared to using LIFO, using average cost would produce lower COGS, higher gross operating income, and higher ending inventory, so current assets and the current ratio would be higher. Consequently, gross margin would be higher and asset turnover would be lower under the average cost inventory method.

Connecticut, Inc.'s stock transactions during the year 20X5 were as follows: January 1: 360,000 common shares outstanding. April 1: 1 for 3 reverse stock split. July 1: 60,000 common shares issued. When computing for earnings per share (EPS) computation purposes, what is Connecticut's weighted average number of shares outstanding during 20X5?

Connecticut's January 1 balance of common shares outstanding is adjusted retroactively for the 1 for 3 reverse stock split, meaning there are (360,000 / 3) = 120,000 "new" shares treated as if they had been outstanding since January 1. The weighted average of the shares issued in July, (60,000 × 6 / 12) = 30,000 is added to that figure, for a total of 150,000.

Which of the following is an analyst least likely to rely on as objective information to include in a company analysis?

Corporate press releases. Corporate reports and press releases are written by management and are often viewed as public relations or sales materials.

Which of the following expense items is best described as being classified by function rather than classified by nature?

Cost of goods sold includes a number of expenses related to the same function, the production of inventory. Depreciation and wages are examples of expenses classified by nature.

The amortized cost of a trademark is least likely to appear on a firm's balance sheet if the trademark was:

Costs of developing a trademark are expensed in the period incurred. The value of a trademark can appear on the balance sheet if the trademark was purchased or obtained in a business acquisition.

Which of the following is least likely a limitation of financial ratios?

Data on comparable firms are difficult to acquire.

A debt covenant is most likely to restrict a firm from:

Debt covenants exist to protect creditors. Repurchasing common shares is a use of cash that rewards equity investors but might harm creditors by reducing the firm's solvency. Decreasing dividends or issuing new shares would increase the cash available to repay creditors.

Which of the following transactions is most likely to be recognized on a firm's statement of changes in equity?

Declaring a dividend on common shares.

Czernezyk Company buys a delivery vehicle for €60,000. Czernezyk expects to drive the vehicle 400,000 kilometers over 4 years, at the end of which the firm expects to be able to sell the vehicle for €10,000. At the end of Year 2, the vehicle has been driven 250,000 kilometers. If Czernezyk depreciates the vehicle by the units of production method, its carrying value at the end of Year 2 is:

Depreciation per unit of production = (€60,000 - €10,000) / 400,000 km = €0.125 per kilometer. Through year 2, depreciation expense = €0.125 × 250,000 = €31,250. Carrying value at the end of Year 2 = €60,000 - €31,250 = €28,750.

In calculating the numerator for diluted earnings per share, the dividends on convertible preferred stock are:

Diluted EPS = [(Net income − Preferred dividends) + Convertible preferred dividends + (Convertible debt interest)(1 − t)] / [(Weighted average shares) + (Shares from conversion of conv. pfd shares) + (Shares from conversion of conv. debt) + (Shares issuable from stock options)]

Which of the following is least likely to result in low-quality financial statements?

Even if earnings or cash flows are unsustainable (i.e., low quality), the firm's financial statements can still be high quality. Conservative accounting choices are considered to be biased compared to the ideal of neutral accounting choices. Earnings management is viewed as reducing the quality of a firm's financial statements.

A firm that uses LIFO for inventory accounting reported COGS of $300,000 and ending inventory of $200,000 for the current period, and a LIFO reserve that decreased from $40,000 to $35,000 over the period. If the firm had reported using FIFO, its gross profit would have been:

FIFO COGS = LIFO COGS - (ending LIFO reserve - beginning LIFO reserve) Ending LIFO reserve - beginning LIFO reserve = $35,000 - $40,000 = -$5,000 With FIFO COGS $5,000 greater than LIFO COGS, gross profit under FIFO would be $5,000 lower than under LIFO. (LOS 25.f)

For balance sheet purposes, inventories based on:

FIFO are preferable to those based on LIFO, as they more closely reflect current costs.

The following information is summarized from Famous, Inc.'s financial statements for the year, which ended December 31, 20X0: Sales were $800,000. Net profit margin was 20%. Sales to assets was 50%. Equity multiplier was 1.6. Interest expense was $30,000. Dividends declared were $32,000. Famous, Inc.'s sustainable growth rate based on results from this period is closest to:

Famous, Inc.'s sustainable growth rate = (retention rate)(ROE). ROE = 0.20(800,000) / [(800,000 / 0.5)(1 / 1.6)] = 160,000 / 1,000,000 = 16%. Alternatively: ROE = (0.20)(0.50)(1.6) = 0.16 = 16% Retention rate = (1 − dividend payout ratio) = 1 − {32,000 / [(0.20)(800,000)]} = 0.80. Sustainable growth = 0.80(16%) = 12.8%.

An analyst gathered the following information about a company: 100,000 common shares outstanding from the beginning of the year. Earnings of $125,000. 1,000, 7%, $1,000 par bonds convertible into 25 shares each, outstanding as of the beginning of the year. The tax rate is 40%. The company's diluted EPS is closest to:

First, calculate basic EPS = $125,000100,000=$1.25.$125,000100,000=$1.25. Next, check if the convertible bonds are dilutive: numerator impact = (1,000 × 1,000 × 0.07) × (1 - 0.4) = $42,000 denominator impact = (1,000 × 25) = 25,000 shares per share impact=$42,00025,000 shares=$1.68per share impact=$42,00025,000 shares=$1.68 Since $1.68 is greater than the basic EPS of $1.25, the bonds are antidilutive. Thus, diluted EPS = basic EPS = $1.25.

In addition to the audited financial statements included in a firm's annual report, which of the following sources of information is most likely to contain audited data?

Footnotes to the annual financial statements.

Under IFRS, a lessor retains the leased asset on its balance sheet for:

For an operating lease, the lessor retains the leased asset on its balance sheet and recognizes depreciation expense over its life. For a finance lease, the lessor removes the leased asset from its balance sheet and recognizes a lease receivable.

For a firm financed with common stock and long-term fixed-rate debt, an analyst should most appropriately adjust which of the following items for a change in market interest rates?

For the purpose of analysis, the value of debt should be adjusted for a change in interest rates. This will change the debt-to-equity ratio.

Which of the following items would least likely be included in cash flow from financing?

Gain on sale of stock of a subsidiary. Gains or losses will be found in cash flow from investments.

SF Corporation has created employee goodwill by reorganizing its retirement benefit package. An independent management consultant estimated the value of the goodwill at $2 million. In addition, SF recently purchased a patent that was developed by a competitor. The patent has an estimated useful life of five years. Should SF report the goodwill and patent on its balance sheet?

Goodwill developed internally is expensed as incurred. The purchased patent is reported on the balance sheet.

Which of the following is most likely for a firm with high inventory turnover and lower sales growth than the industry average? The firm:

High inventory turnover coupled with low sales growth relative to the industry may be an indication of inadequate inventory levels. In this case, the firm may be losing sales by not carrying enough inventory.

According to IFRS guidance for management's commentary, addressing the company's key relationships is:

IFRS recommends that management commentary address the company's key relationships, resources, and risks, as well as the nature of the business, management's objectives, the company's past performance, and the performance measures used. Securities regulators may impose requirements for publicly traded firms to address certain topics in management's commentary, but accounting standards do not.

An IFRS-reporting airline leases a new airplane from its manufacturer for ten years. For financial reporting, the airline:

IFRS requires an asset and a liability to be recorded on the lessee's balance sheet, unless the lease is short-term or for a low-value asset. The lessor classifies a lease as finance or operating under IFRS.

Bluff, Inc.'s stock transactions during the year were as follows: January 190,000 common shares outstanding.April 120% stock dividend is declared and issued.October 110,000 shares are reacquired as treasury stock. What is Bluff's weighted average number of shares outstanding during the year?

Initial shares: 90,000 × 1.20 =108,000- Reacquired treasury shares: 10,000 × 3/12 =-2,500105,500

Interest expense is reported on the income statement as a function of:

Interest expense is always equal to the book value of the bond at the beginning of the period multiplied by the market rate at issuance.

Which of the following inventory valuation methods is required by the accounting standard-setting bodies?

Inventories are required to be valued at the lower of cost or net realizable value (or "market" under U.S. GAAP). FIFO and average cost are two of the inventory cost flow assumptions among which a firm has a choice.

During periods of rising prices:

LIFO COGS > Weighted Average COGS > FIFO COGS.

From an analyst's point of view, which accounting methods are preferable for income statements and balance sheets?

Last in, first out (LIFO) for income statements and first in, first out (FIFO) for the balance sheet.

Lawson, Inc.'s net income for the year was $1,060,000 with 420,000 shares of common stock outstanding. Lawson has 2,000 shares of 8%, $1,000 par value convertible preferred stock that were outstanding the entire year. Each share of preferred is convertible into 50 shares of common stock. Lawson's diluted earnings per share are closest to:

Lawson's basic EPS ((net income − preferred dividends) / weighted average common shares outstanding) is ($1,060,000 − (2,000 × $1,000 × 0.08)) / 420,000 = $2.14. To calculate diluted EPS the convertible preferred shares are presumed to have been converted, the preferred dividends paid are added back to the numerator of the EPS equation, and the additional common shares are added to the denominator of the equation. Lawson's diluted EPS is $1,060,000 / (420,000 + 100,000) = $2.04.

Calculate Duster's liabilities and stockholders' equity as of December 31, 2007.

Liabilities are equal to $3,790 million ($240 million unearned revenue + $1,570 long-term debt + $1,150 accounts payable + $830 accrued expenses). Stockholders' equity is equal to $3,420 million ($30 common stock at par + $440 capital in excess of par - $2,000 treasury stock + $5,160 retained earnings - $210 accumulated other comprehensive loss).

in millions Unearned revenue=$240 Common stock at par =30. Capital in excess of par = 440. Accounts payable=1,150 Treasury stock=2,000 Retained earnings =5,160 Accrued expenses = 830 Accumulated other comprehensive loss = 210 Long-term debt = 1,570 Calculate Duster's liabilities and stockholders' equity as of December 31, 2007.

Liabilities are equal to $3,790 million ($240 million unearned revenue + $1,570 long-term debt + $1,150 accounts payable + $830 accrued expenses). Stockholders' equity is equal to $3,420 million ($30 common stock at par + $440 capital in excess of par - $2,000 treasury stock + $5,160 retained earnings - $210 accumulated other comprehensive loss).

Two firms are identical except that the first pays higher interest charges and lower dividends, while the second pays higher dividends and lower interest charges. Both prepare their financial statements under U.S. GAAP. Compared to the first, the second will have cash flow from financing (CFF) and earnings per share (EPS) that are:

Lower Higher Interest paid is an operating cash flow, and dividends paid are a financing cash flow, so the firm that pays higher dividends will have lower CFF. The firm with lower interest expense will have higher EPS. ((Study Session 7, Module 23.1, LOS 23.e))

Costs that are included in the balance sheet value of inventory most likely include:

Manufacturing overhead.

An analyst contemplates using the indirect method to create the projected statement of cash flows. She decides to research the differences between the direct and indirect methods. Which of the following is least likely a component of the statement of cash flows under the direct method?

Net income.

All of the following are considered a potentially dilutive securities EXCEPT:

Not all preferred stock is dilutive. Only convertible preferred stock is potentially dilutive.

The following data pertains to the Sapphire Company: Net income equals $15,000. 5,000 shares of common stock issued on January 1st. 10% stock dividend issued on June 1st. 1,000 shares of common stock were repurchased on July 1st. 1,000 shares of 10%, $100 par preferred stock each convertible into 8 shares of common were outstanding the whole year.

Number of average common shares: 1/1 5,500 shares issued (includes 10% stock dividend on 6/1) × 12 = 66,000 7/1 1,000 shares repurchased × 6 months = -6,000 = 60,000 60,000 shares / 12 months = 5,000 average shares Preferred dividends = ($10)(1,000) = $10,000 Number of shares from the conversion of the preferred shares = (1,000 preferred shares)(8 × 1.1 shares of common/share of preferred) = 8,800 common Diluted EPS = [$15,000(NI) - $10,000(pfd) + $10,000(pfd)] / (5,000 common shares + 8,800 shares from the conv. pfd.) = $15,000 / 13,800 shares = $1.09/share This number needs to be compared to basic EPS to see if the preferred shares are antidilutive. Basic EPS = [$15,000(NI) - $10,000(preferred dividends)] / 5,000 shares = $5,000 / 5,000 shares = $1/share Since the EPS after the conversion of the preferred shares is greater than before the conversion the preferred shares are antidilutive and they should not be treated as common in computing diluted EPS. Therefore diluted EPS is the same as basic EPS or $1/share.

A firm has had the following numbers of shares outstanding during the year: Beginning of year10,000,000 sharesIssued on April 1500,000 sharesSplit 2 for 1 on July 1Issued on October 1100,000 sharesSplit 2 for 1 on December 31 Based on this information, what is the weighted number of shares outstanding for the year?

Outstanding all year10,000,000 × 2 × 2 × 140,000,000Outstanding for 0.75 years500,000 × 2 × 2 × 0.751,500,000Outstanding for 0.25 years100,000 × 2 × 0.2550,000Weighted average number of shares for year:41,550,000

At the beginning of the year, Parent Company purchased all 500,000 shares of Sub Incorporated for $15 per share. Just before the acquisition date, Sub's balance sheet reported net assets of $6 million. Parent determined the fair value of Sub's property and equipment was $1 million higher than reported by Sub. What amount of goodwill should Parent report as a result of its acquisition of Sub?

Purchase price of $7,500,000 [$15 per share × 500,000 shares] - fair value of net assets of $7,000,000 [$6,000,000 book value + $1,000,000 increase in property and equipment] = goodwill of $500,000.

Vasco Ltd. purchased a unit of heavy equipment one year ago for £500,000 and capitalized it as a long-lived asset. Because demand for equipment of this type has grown significantly, Vasco believes the fair value of its equipment has increased to £600,000. If Vasco revalues its equipment to £600,000, what will be the most likely effect on Vasco's financial results, compared to not revaluing the equipment?

Revaluing the asset to £600,000 will increase future depreciation expense, and therefore reduce net income in subsequent periods. Because Vasco has not previously recognized a loss on this asset, the revaluation is not recognized as income but is recorded as an adjustment to equity. An increase in equity (with unchanged debt) will decrease the debt-to-equity ratio.

Sales of inventory would be classified as:

Sales of inventory would be classified as operating cash flow

Eagle Manufacturing Company reported the following selected financial information for 2007: Accounts payable turnover5.0Cost of goods sold$30 millionAverage inventory$3 millionAverage receivables$8 millionTotal liabilities$35 millionInterest expense$2 millionCash conversion cycle13.5 days Assuming 365 days in the calendar year, calculate Eagle's sales for the year.

Set up the cash conversion cycle formula and solve for the missing variable, sales. Days in payables is equal to 73 [365 / 5 accounts payable turnover]. Days in inventory is equal to 36.5 [365 / ($30 million COGS / $3 million average inventory)]. Given the cash conversion cycle, days in inventory, and days in payables, calculate days in receivables of 50 [13.5 days cash conversion cycle + 73 days in payables - 36.5 days in inventory]. Given days in receivables of 50 and average receivables of $8 million, sales are $58.4 million [($8 million average receivables / 50 days) × 365]

An analyst is comparing a firm to its competitors. The firm has a deferred tax liability that results from accelerated depreciation for tax purposes. The firm is expected to continue to grow in the foreseeable future. How should the liability be treated for analysis purposes?

The DTL is not expected to reverse in the foreseeable future because a growing firm is expected to continue to increase its investment in depreciable assets, and accelerated depreciation for tax on the newly acquired assets delays the reversal of the DTL. The liability should be treated as equity at its full value.

GTO Corporation purchased all of the common stock of Charger Company for $4 million. At the time, Charger reported total assets of $3 million and total liabilities of $1 million. At the acquisition date, the fair value of Charger's assets was $3.5 million and the fair value of Charger's liabilities was $1.3 million. What amount of goodwill should GTO report as a result of the acquisition and is it necessary for GTO to amortize the goodwill?

The acquisition goodwill is equal to $1.8 million [$4 million purchase price - $2.2 million fair value of net assets acquired ($3.5 million assets at fair value - $1.3 million liabilities at fair value)]. Under IFRS or U.S. GAAP, goodwill is not amortized but is subject to an annual impairment test.

Under U.S. GAAP, the actual coupon payment on a bond is reported on the statement of cash flow as:

The coupon payment is recorded on the statement of cash flows as an operating cash outflow under U.S. GAAP

Moore Ltd. uses the LIFO inventory cost flow assumption. Its cost of goods sold in 20X8 was $800. A footnote in its financial statements reads: "Using FIFO, inventories would have been $70 higher in 20X8 and $80 higher in 20X7." Moore's COGS if FIFO inventory costing were used in 20X8 is closest to:

The ending LIFO reserve is $70 and the beginning LIFO reserve is $80. FIFO COGS = LIFO COGS − (ending LIFO reserve − beginning LIFO reserve) $800 − ($70 − $80) = $810

The Hall Corporation had 100,000 shares of common stock outstanding at the beginning of the year. Hall issued 30,000 shares of common stock on May 1. On July 1, the company issued a 10% stock dividend. On September 1, Hall issued 1,000, 10% bonds, each convertible into 21 shares of common stock. What is the weighted average number of shares to be used in computing basic and diluted EPS, assuming the convertible bonds are dilutive?

The new stock is weighted by 8 / 12. The bonds are weighted by 4 / 12 and are not affected by the stock dividend. Basic shares = {[100,000 × (12 / 12)] + [30,000 × (8 / 12)]} × 1.10 = 132,000 Diluted shares = 132,000 + [21,000 × (4 / 12)] = 139,000

Which of the following transactions would least likely be reported in the cash flow statement as investing cash flows?

The purchase of plant and equipment with financing provided by the seller is a non-cash transaction. Non-cash transactions are disclosed separately in a note or supplementary schedule to the cash flow statement.

Galaxy Corporation manufactures custom motorcycles. Galaxy finances the motorcycles over 36 months for customers who make a minimum down payment of 10%. Historically, Galaxy has experienced bad debt losses equal to 1% of sales. Galaxy also provides a 24 month unlimited warranty on all new motorcycles. In the past, warranty expense has averaged 3% of sales. Ignoring taxes, how does the recognition of bad debt expense and warranty expense at the time of sale affect Galaxy's liabilities?

The recognition of bad debt expense has no effect on liabilities, current revenues are reduced by the expected amount of uncollectable accounts. Bad debt expense reduces net income and reduces assets. The recognition of expected warranty expense decreases net income

A firm recognizes a goodwill impairment in its most recent financial statement, reducing goodwill from $50 million to $40 million. How should an analyst most appropriately adjust this financial statement for goodwill when calculating financial ratios?

The recommended adjustment for goodwill before calculating financial ratios is to remove goodwill from the balance sheet (decreasing assets) and reverse any losses recognized due to goodwill impairment (increasing earnings).

The statement of changes in equity is least likely to provide information on the firm's:

The statement of changes in equity shows a firm's comprehensive income (net income and other comprehensive income) and transactions with shareholders, such as dividends paid and issuance or repurchases of stock. Repayment of bond principal is not a change in equity: assets (cash) decrease and liabilities (long-term debt) decrease.

An analyst has gathered the following information about a company: 50,000 common shares outstanding from the beginning of the year. Warrants outstanding all year on 50,000 shares, exercisable at $20 per share. Stock is selling at year-end for $25. The average price of the company's stock for the year was $15. How many shares should be used in calculating the company's diluted EPS?

The warrants in this case are antidilutive. The average price per share of $15 is less than the exercise price of $20. The year-end price per share is not relevant. The denominator consists of only the common stock for basic EPS. (LOS 21.g, 21.h)

Poulter Products reports under IFRS and wrote its inventory value down from cost of $400,000 to net realizable value of $380,000. The most likely financial statement effect of this change is:

The write-down in inventory value from cost to net realizable value is reported on the income statement either as an addition to cost of sales or as a separate line item, not as other comprehensive income. Depreciation will not be affected as inventory is not depreciated.

.Which of the following reasons is least likely a valid limitation of ratio analysis?

There is not a great deal of subjectivity involved in calculating ratios. The mechanical formulas for the calculations are fairly standard and objective for the activity, liquidity, solvency, and profitability ratios, for instance. On the other hand, determining the target or comparison value for a ratio is difficult as it requires some range of acceptable values and that introduces an element of subjectivity. Conclusions cannot be made from viewing one set of ratios as all ratios must be viewed relative to one another in order to make meaningful conclusions. It can be difficult to find comparable industry ratios, especially when analyzing companies that operate in multiple industries.

Selected data from Alpha Company's balance sheet at the end of the year follows: Investment in Beta Company, at fair value$150,000Deferred taxes$86,000Common stock, $1 par value$550,000Preferred stock, $100 par value$175,000Retained earnings$893,000Accumulated other comprehensive income$46,000 The investment in Beta Company had an original cost of $120,000. Assuming the investment in Beta is classified as available-for-sale, Alpha's total owners' equity at year-end is closest to:

Total stockholders' equity consists of common stock of $550,000, preferred stock of $175,000, retained earnings of $893,000, and accumulated other comprehensive income of $46,000, for a total of $1,664,000. The $30,000 unrealized gain from the investment in Beta is already included in accumulated other comprehensive income

The correct set of cash flow treatments as they relate to interest paid according to U.S. generally accepted accounting principles (GAAP) and International Accounting Standards (IAS) GAAP is:

U.S. GAAP treats interest paid as CFO whereas IAS GAAP treats interest paid as either CFO or CFF.

A tax rate that has been substantively enacted is used to determine the balance sheet values of deferred tax assets and deferred tax liabilities under:

Under IFRS, a tax rate that has been enacted or substantively enacted is used to measure deferred tax items. Under U.S. GAAP, only a tax rate that has actually been enacted can be used.

During the life of a long-term lease under IFRS, the lessee recognizes:

Under IFRS, at lease inception the lessee records an asset and a liability, both equal to the present value of the lease payments. In each period over the life of the lease, the lessee recognizes interest expense for the interest portion of the lease payments and depreciation expense on the lease asset.

Under IFRS, deferred tax assets and deferred tax liabilities are classified on the balance sheet as:

Under IFRS, deferred tax assets and liabilities are classified as noncurrent. Under U.S. GAAP, deferred tax items may be current or noncurrent, depending on how the underlying asset or liability is classified.

A firm determines that inventory of manufactured goods with a cost of €10 million has a net realizable value of €9 million and writes down its carrying value to this amount. One period later, the firm determines that the net realizable value of this inventory has increased to €11 million. Under IFRS, the carrying value of this inventory:

Under IFRS, inventory is measured at the lower of cost or net realizable value. Inventory that has been written down can later be revalued upward if its net realizable value recovers, but only to the extent that reverses the writedown (i.e., no higher than cost). Under U.S. GAAP, inventory that has been written down may not be revalued upward.

U.S. GAAP least likely requires property, plant, and equipment to be tested for impairment:

Under U.S. GAAP, a PP&E asset is tested for impairment when events and circumstances indicate the firm may not recover its carrying value through future use, or if the asset is reclassified from held-for-use to held-for-sale. Under IFRS, firms are also required to assess at least annually whether events and circumstances indicate impairment may have occurred.

At the beginning of this year, Fairweather Corp. incurred $200,000 of research costs and $100,000 of development costs to create a new patent. The patent is expected to have a useful life of 40 years with no salvage value. Calculate the carrying value of the patent at the end of this year, assuming Fairweather follows U.S. GAAP.

Under U.S. GAAP, research and development costs are expensed as incurred. Thus, the entire $300,000 of R&D is expensed this year. The result is a zero carrying value.

A snowmobile manufacturer that uses LIFO begins the year with an inventory of 3,000 snowmobiles, at a carrying cost of $4,000 each. In January, the company sells 2,000 snowmobiles at a price of $10,000 each. In July, the company adds 4,000 snowmobiles to inventory at a cost of $5,000 each. Compared to using a perpetual inventory system, using a periodic system for the firm's annual financial statements would:

Under a perpetual inventory system, the snowmobiles sold in January are associated with the $4,000 cost of the beginning inventory. Cost of sales is $8,000,000, gross profit is $12,000,000, and end-of-year inventory is $24,000,000. Under a periodic inventory system, the snowmobiles sold in January would be associated with the $5,000 cost of the snowmobiles manufactured in July. Cost of sales would be higher by $2,000,000, gross profit would be lower by $2,000,000, and ending inventory would be lower by $2,000,000

A firm acquires investment property for €3 million and chooses the fair value model for financial reporting. In Year 1 the market value of the investment property decreases by €150,000. In Year 2 the market value of the investment property increases by €200,000. On its financial statements for Year 2, the firm will recognize a:

Under the fair value model, all gains and losses from changes in the value of investment property are recognized on the income statement. The firm will recognize a loss of €150,000 in Year 1 and a gain of €200,000 in Year 2.

At the beginning of the year, Alpha Corporation, which reports under U.S. GAAP, purchased 10,000 shares of Beta Corporation for $20 per share. During the year, Beta paid a $2,000 cash dividend to Alpha. At the end of the year, Beta's stock was selling for $22 per share. What amount should Alpha recognize in its year-end income statement if the investment is treated as an available-for-sale security and what amount should be recognized in the income statement if the investment is treated as a trading security?

Unrealized gains and losses from trading securities are recognized in the income statement while unrealized gains and losses from available-for-sale securities bypass the income statement and are reported as other comprehensive income, a component of stockholders' equity. Cash dividends are recognized in the income statement for both trading and available-for-sale securities. Thus, Alpha will recognize only the $2,000 dividend if the shares are considered available-for-sale and will recognize $22,000 ($2,000 dividend + $20,000 unrealized gain) if the shares are considered trading securities.

A bond is issued at the end of the year 20X0 with an 8% semiannual coupon rate, 5 years to maturity, and a par value of $1,000. The bond's yield at issuance is 10%. Using the effective interest method, if the yield has decreased to 9% at the end of the year 20X1, the balance sheet liability for the bond is closest to:

Using the effective interest method, the value of the liability is calculated using the bond's yield at issuance. At the end of 20x1 the bond will have 8 semiannual periods remaining until maturity. N = 8; I/Y = 10 / 2 = 5; PMT = 8 / 2 × 1,000 = 40; FV = 1,000; CPT PV = -935.37.

Convenience Travel Corp.'s financial information for the year ended December 31, 20X4 included the following: Property Plant & Equipment$15,000,000Accumulated Depreciation9,000,000 The only asset owned by Convenience Travel in 20X5 was a corporate jet airplane. The airplane was being depreciated over a 15-year period on a straight-line basis at a rate of $1,000,000 per year. On December 31, 20X5 Convenience Travel sold the airplane for $10,000,000 cash. Net income for the year ended December 31, 20X5 was $12,000,000. Based on the above information, and ignoring taxes, what is cash flow from operations (CFO) for Convenience Travel for the year ended December 31, 20X5?

Using the indirect method, CFO is net income increased by 20X5 depreciation ($1,000,000) and decreased by the gain recognized on the sale of the plane [$10,000,000 sale price − ($15,000,000 original cost − $10,000,000 accumulated depreciation including 20X5) = $5,000,000]. $12,000,000 + $1,000,000 − $5,000,000 = $8,000,000.

For a firm that uses the cost basis for valuing its long-lived assets, fair value is a consideration when calculating a gain or loss on:

When exchanging one long-lived asset for another, a gain or loss is recorded as the difference between the old asset's carrying value and its fair value (or the fair value of the asset received in exchange, if that value is more evident). When selling an asset, the gain or loss is the difference between the carrying value and the cash received. When abandoning an asset, a firm records a loss equal to the carrying value of the asset.

United Corporation and Intrepid Company are similar firms operating in the same industry. United follows U.S. Generally Accepted Accounting Principles and Intrepid follows International Financial Reporting Standards. At the end of last year, Intrepid had a higher inventory turnover ratio than United. Are the following plausible explanations for the difference? Explanation #1 - United accounts for its inventory using the first-in, first-out method and Intrepid uses the last-in, first-out method. Explanation #2 - United recognized an upward valuation of inventory that had been previously written down. Intrepid does not revalue its inventory upward.

While the LIFO firm will typically report lower average inventory (higher inventory turnover), Intrepid cannot be a LIFO firm because LIFO is not permitted under IFRS. An upward revaluation of inventory would lower the inventory turnover ratio; however, United cannot revalue its inventory upward because it follows U.S. GAAP. U.S. GAAP prohibits upward inventory revaluations (except in very limited circumstances which are beyond the scope of the Level I exam).

If the tax base of an asset exceeds the asset's carrying value and a reversal is expected in the future:

a deferred tax asset is created.

Which of the following terms from the extended DuPont equation would an analyst least likely be able to obtain, given only a company's common-size income statement and common-size balance sheet? The company's:

asset turnover. asset turnover—revenue/assets —requires an item from the income statement and an item from the balance sheet, so this ratio cannot be obtained from the common-size statements. The EBIT margin—EBIT/revenue (or sales)—would be on a common-size income statement. Financial leverage—assets/equity—is the reciprocal of equity/assets, which would be shown on a common-size balance shee

Current assets that arise from the accrual process most likely include:

accounts receivable.

An asset's tax base is most accurately described as the:

amount of the asset to be expensed through the tax return in the future as the economic benefits of the asset are realized.

In accounting for PP&E using the cost model, companies are required to disclose both gross asset value and accumulated depreciation under:

both IFRS and U.S. GAAP.

A firm has deferred tax assets of $315,000 and deferred tax liabilities of $190,000. If the tax rate increases, adjusting the value of the firm's deferred tax items will:

decrease income tax expense. An increase in the tax rate increases the values of both DTAs and DTLs. Because the firm's DTAs are greater than its DTLs, the net effect of adjusting their values for an increase in the tax rate will be to decrease income tax expense.

For a firm with a simple capital structure, all of the following are necessary to measure basic earnings per share (EPS) EXCEPT:

dividends paid to common shareholders. Basic EPS = earnings available to common shareholders divided by the weighted average number of common shares outstanding. Earnings available to common shareholders equals net income minus preferred dividends.

According to the IASB Conceptual Framework for Financial Reporting, one of the qualitative characteristics of financial statements is:

faithful representation.

Information about accounting estimates, assumptions, and methods chosen for reporting is most likely found in:

financial statement notes.

A decrease in a firm's inventory turnover ratio is most likely to result from:

goods in inventory becoming obsolete.

Spenser Inc. owns a piece of specialized machinery with a current fair value of $400,000. The original cost of the machinery was $500,000 and to date has generated accumulated depreciation of $140,000. Which of the following must Spenser record on the income statement if it decides to abandon the asset?

ith an abandonment of an asset, the carrying value of the machinery is removed from the balance sheet and a loss of that amount is recognized in the income statement. The carrying value is $360,000, which equals the original cost ($500,000) less the accumulated depreciation ($140,000).

A company's quick ratio is 1.2. If inventory were purchased for cash, the:

numerator would decrease more than the denominator, resulting in a lower quick ratio.

The approach to revenue recognition in the converged accounting standards that were issued in May 2014 is best described as:

principles-based.

The objective of financial reporting, according to the IASB framework, is to:

provide information about the firm to current and potential investors.

Dubois Company bought land for company use five years ago for €2 million and presents its balance sheet value as €2.2 million. If the fair value of the land decreases to €1.8 million, Dubois will:

recognize a loss of €200,000 and decrease shareholders' equity by €400,000. Because the land is valued above its historical cost on the balance sheet, Dubois is using the revaluation model. The land's revaluation up to €2.2 million would have been reflected in shareholders' equity with a revaluation surplus of €200,000. The decrease in fair value to €1.8 million will reduce the revaluation surplus to zero, and the amount of the writedown below historical cost (€2 million - €1.8 million = €200,000) will be recognized as a loss on Dubois's income statement. This loss, combined with the removal of the revaluation surplus, will decrease shareholders' equity by €400,000. Note that the land was purchased for company use and therefore would not be classified as investment property.

Under IFRS, if a firm reports investment property using the fair value model, unrealized gains and losses on investment property are:

recognized on the income statement.

According to U.S. GAAP, an asset is impaired when:

the firm cannot fully recover the carrying amount of the asset through operations.

For publicly traded firms in the United States, the Management Discussion and Analysis (MD&A) portion of the financial disclosure is least likely required to discuss:

unusual or infrequent items.

An analyst who needs to model and forecast a company's earnings for the next three years would be least likely to: A)

use common-size financial statements to estimate expenses as a percentage of net income.