ACTG ch 7-9

The cost of an oil change for a company's delivery truck is expensed in the current period.

true Repairs and maintenance expenditures that benefit the current period only are expensed.

current liabilities examples

notes payable accounts payable payroll liabilities deferred revenue sales tax payable current portion of long-term debt

Which of the following is included in calculating the current ratio, but excluded in calculating the acid-test ratio?

prepaid expenses By eliminating current assets that are less readily convertible into cash, such as inventory and prepaid expenses, the acid-test ratio might provide a better indication of a company's liquidity than the current ratio.

depreciation

allocating the cost of most tangible assets is called _______

XYZ Company has a 10 year installment note requiring $5,000 to be paid within the current year and $45,000 to be paid over the remaining 9 years. How is this installment note reported in the balance sheet of XYZ Company?

$5,000 current note payable; $45,000 long-term note payable

3 essential characteristics of liabilities

-result of past transactions or events -arise from present obligations -probable future sacrifices of economics benefits (cash)

The journal entry to recognize the signing of an installment notes payable includes:

Debit CashCredit Notes Payable

Dexter Tours is a defendant in litigation involving an accident that occurred during a cruise. The company is sued for $5 million in damages. The likelihood of a payment occurring is probable, and the amount is estimated to be $3 million. Which of the following is the company required to do in this scenario?

Record a $3 million liability. A contingent liability is recorded only if a loss is probable and the amount can be reasonably estimated.

Accumulated Depreciation:

a contra asset account and has a normal balance

mixture of liabilities + stockholders equity a business uses is called ____________

capital structure

current ratio equation

current assets / current liabilities

All of the following are primary sources of long-term debt financing for companies, except _____.

stock issues Companies have three primary sources of long-term debt financing: bonds, notes, and leases.

The method that allocates an equal amount of depreciation to each year of an asset's service life is:

straight-line The straight-line method allocates an equal amount of depreciation to each year.

capitalize legal fees only for the ________ defense

successful

2 major categories of long-term assets

tangible asset and intangible asset

The accounting treatment for a lawsuit depends on:

the ability to estimate the amount of payment the likelihood of payment

In an installment note, a portion of each installment payment goes towards interest, and the remaining portion represents a reduction of the outstanding loan balance.

true

In general, the higher the current ratio, the greater the company's liquidity.

true

In the case of installment notes, interest expense is calculated as a constant percentage of the carrying value.

true

asset turnover

measures the sales per dollar of assets invested

We do not amortize intangible assets _____.

with indefinite useful lives

Windsor Hospital purchases $90,000 in surgical equipment on October 1, Year 1. The useful life is estimated to be 5 years, and the residual value is estimated to be $10,000. What will be the depreciation expense reported for this equipment in Year 1 if the hospital uses the straight-line method?

$4,000 Depreciation expense for Year 1 is calculated as [($90,000 − $10,000)/5] × 3/12

Book value equation

Book value = Original cost − Accumulated depreciation

Identify a liability that does not require a cash payment.

Deferred revenue Deferred revenue requires giving up inventory or services rather than cash to satisfy the debt.

We record purchased intangible assets at their original cost plus all other costs, such as legal fees, necessary to get the asset ready for use.

true

When a company collects sales taxes, it debits Cash, and credits both Sales Revenue and Sales Tax Payable.

true

Windsor Corporation borrows $100,000 from a bank on November 1, Year 1, by signing a 9 percent, six-month note for the amount borrowed plus accrued interest due six months later on May 1, Year 2. What is the interest expense per month on this note?

$750 Interest expense per month = $100,000 × 0.09 × 1/12 = $750

On January 1, Year 1, Toy Factory purchases a patent for a printing process for $40,000. The original legal life of the patent was 10 years, and there are 8 years remaining. However, due to expected technological obsolescence, the company estimates that the useful life of the patent is only 5 more years. What will be the amortization expense for the patent in Year 1?

$8,000 Annual depreciation= 40,000/5= $8,000

The legal life of a patent is _____ years.

20 years

Prime, Inc., purchases $100,000 in construction machinery on January 1, Year 1. The useful life is estimated to be 8 years, and the residual value is estimated to be $20,000. What will be the depreciation rate if the company uses the double-declining-balance method?

25% The depreciation rate is calculated as 2 × (1/8) = 2/8

Prime, Inc., purchases $100,000 in construction machinery on January 1, Year 1. The useful life is estimated to be 8 years, and the residual value is estimated to be $20,000. If the company uses the double-declining-balance method, the asset will reach its residual value in the ____ year.

6th The asset will reach its residual value in the sixth year, in which $3,730 ($23,730 − $20,000) will be the depreciation expense.

Papa's Pizza has the following items for the past year: Net sales are $24,128, net income is $2,223, total assets at the beginning of year are $14,898, and total assets at the end of year are $15,465. What is the profit margin?

9.2% The profit margin is computed by taking net income and dividing by net sales. $2,223/$24,128 results in a profit margin of 9.2%

Return on Assets equation

= Net Income/Average Total Assets

Annual depreciation equation

=(original cost - salvage value)/estimated life (years)

Gain/Loss Equation

=Sale amount − Book value

interest for a current notes playable equation

=face value x annual interest rate x fraction of the year

profit margin equation

=net income/net sales

capitalized cost equation

=purchase price + closing cost - sale of salvage materials

When considering total depreciation recorded over the entire life span of an asset, the method resulting in the highest total depreciation is:

All three methods result in the same amount of total depreciation. Total depreciation over the life of an asset is the same under all methods of depreciation.

Relevant financial information for Gordon, Inc. and Jordan, Inc. for the current year is provided below. Based on these data, which of the following is a correct conclusion?

Asset Turnover is 2.2 times for Gordon and 3.1 times for Jordan. Thus, Jordan generates more sales per dollar of assets than does Gordon.

if an asset is sold at the end of its first year of use, which depreciation method would result in the highest amount of gain (or lowest amount of loss) assuming the asset is used fairly evenly over its life?

double-declining-balance

To maximize profitability, companies seek to achieve:

high profit margin and high asset turnover **To maximize profitability, a company ideally strives to increase both profit margin and asset turnover.**

Anderson Company acquires Thompson Company by paying $30 million in cash. The fair value of the identifiable assets acquired is $38 million. The fair value of the identifiable liabilities acquired is $6 million. What will be the amount of goodwill that Anderson Company would record as part of this acquisition?

$0 The purchase price ($30 million) is less than the fair value of identifiable net assets acquired ($32 million = $38 million − $6 million). Thus, there is no goodwill to record.

Which of the following is not a measure of liquidity?

gross profit ratio Measures of liquidity include the acid-test ratio, current ratio, and working capital. The gross profit ratio is a measure of profitability.

Liquidity refers to:

having sufficient cash (or other assets convertible to cash in a relatively short time) to pay currently maturing debts.

loss

if we dispose of an asset for less than its book value, we record a _______.

gain

if we dispose of an asset for more than its book value, we record a _______.

Boyd Corporation borrows $300,000 from a bank on March 1, Year 1, by signing a 6 percent, nine-month note for the amount borrowed plus accrued interest due nine months later. On issuance date, this transaction:

increases assets and increases liabilities.

An attorney adds an air purification system to his office building. The addition:

increases future benefits and should be capitalized The cost of the addition should be capitalized since it increases future benefits.

profit margin

indicates the earnings per dollar of sales

On December 31, Leann Corp. paid $5,120 on an installment note that requires annual payments. The outstanding loan balance on January 1 was $50,000; the effective interest rate is 8%. The journal entry to recognize the payment should include debits to

interest expense for $4,000 notes payable for $1,120

We record goodwill as an intangible asset in the balance sheet only when _____.

it is part of an acquisition of another business

tangible assets examples

land land improvements buildings equipment natural resources (known as property, plant, and equipment)

most companies would prefer to report a liability as __________ rather than current because it will seem that the firm is less risky

long-term

intangible assets

most intangible assets have a finite useful life that can be estimated

land improvements examples

parking lot sidewalks driveways landscaping lighting systems fences sprinklers similar additions

Which of the following intangible assets are usually subject to amortization?

patent franchise

Which of the following accounts are affected when recording the expense related to the portion of a patent that expired during the year?

patents Amortization Expense

intangible assets subject to amortization (those with finite useful life)

patents trademarks (those with define life) copyrights franchises (have no physical substance)

expenditure examples

repairs and maintenance improvements additions litigation costs

The amount a company expects to receive from selling a long-term asset at the end of its service life is known as:

residual value

components of return on assets

return on assets = profit margin x asset turnover

3 methods of asset disposal

sale= most common methods to dispose of a long-term asset retirement= occurs when a long-term asset is no longer useful but cannot be sold exchange= occurs when 2 companies trade long-term assets

A return on assets of 5% indicates that for every $1 invested in assets:

the company generates $0.05 in net income.

Sonic Corporation purchases a delivery truck for $24,000. The company expects the truck to be in service for 100,000 miles, and the residual value is estimated to be $4,000. What is the depreciation rate using activity-based depreciation?

$0.20 The depreciation rate is calculated as depreciable cost ($24,000 − $4,000) divided by total units (100,000 miles) expected to be produced.

Clarendon Corporation has a $5 million liability at December 31, Year 1, of which $1 million is payable in Year 2. In its December 31, Year 1 balance sheet, the company will report the $5 million debt as a:

$1 million current liability and $4 million long-term liability. The portion of long-term debt maturing within one year of the balance sheet date is classified as a current liability. Debt maturing in more than one year is classified as a long-term liability.

Havier Corporation borrows $1 million from a bank on September 1, Year 1, by signing a 6 percent, nine-month note for the amount borrowed plus accrued interest due nine months later on June 1, Year 2. Which of the following is recorded on June 1, Year 2?

$1,045,000 credit to Cash Note Payable will be debited for $1 million, Interest Expense will be debited for $25,000 (for 5 months' interest incurred), and Interest Payable will be debited for $20,000. Cash will be credited for $1,045,000

On January 1, Year 1, a company purchases a machine for $18,000. The estimated residual value is $6,000, and the estimated service life is 8 years or 30,000 units. After three years of use, the company estimates the remaining service life of the machine to be nine years rather than the original eight. Using the straight-line method, calculate the amount of depreciation for Year 4.

$1,250 For Years 1-3, annual depreciation expense = ($18,000 − $6,000)/8 = $1,500. At the end of Year 3, Accumulated depreciation = $1,500 × 3 = $4,500 and Book value = $18,000 − $4,500 = $13,500. Under the revised estimate of a 9 year useful life, 6 years remain, implying that the annual depreciation expense for Years 4-9 will be ($13,500 − $6,000)/6 = $1,250.

On January 1, Year 1, a company purchases a machine for $18,000. The estimated residual value is $6,000, and the estimated service life is 8 years or 30,000 units. Using the straight-line method, calculate the amount of depreciation for Year 2.

$1,500 Depreciation expense for each year is calculated as ($18,000 − $6,000)/8 = $1,500

Star Appliance sells previously owned appliances. Each appliance carries a one-year warranty against defects. Suppose that appliance sales for the entire month of December are $50,000. The company expects future warranty costs to be 3% of sales. What amount should Star Appliance report as a liability on December 31?

$1,500 The company records the warranty liability on December 31 for $1,500 ($50,000 × 3%).

Caddell Corporation borrows $100,000 from a bank on August 1, Year 1, by signing an 8 percent, six-month note for the amount borrowed plus accrued interest due six months later on February 1, Year 2. Which of the following is recorded on August 1, Year 1?

$100,000 credit to Notes Payable The journal entry on issuance date includes a debit to Cash and a credit to Notes Payable for the face amount of the note, $100,000

On December 31, Katie Corp. records a journal entry related to an installment note that includes a debit to interest expense for $4,000, and a debit to notes payable for $9,000. Katie's journal entry should also include a credit to cash for:

$13,000

A company purchases a machine for $12,000. The estimated residual value is $4,000. The machine has a useful life of 5 years, and is expected to produce 20,000 units during its lifetime. Use the activity-based depreciation method to calculate the amount of depreciation in Year 1, assuming that the machine was used to produce 6,000 units.

$2,400 Depreciation rate = ($12,000 − $4,000)/20,000 = $0.40 per unit. Depreciation expense for usage of 6,000 units = $0.40 × 6,000 = $2,400.

Havier Corporation borrows $1 million from a bank on September 1, Year 1, by signing a 6 percent, nine-month note for the amount borrowed plus accrued interest due nine months later on June 1, Year 2. Which of the following is recorded on December 31, Year 1?

$20,000 credit to Interest Payable Interest payable is credited for $20,000 ($1 million × 6% × 4/12)

Light Company acquires Photon Company by paying $25 million in cash. The fair value of the identifiable assets acquired is $30 million. The fair value of the identifiable liabilities acquired is $8 million. What will be the amount of goodwill that Light Company would record as part of this acquisition?

$3 million Goodwill = $3 million ($25 million purchase price − $22 million fair value of net assets).

A company pays $5,000 for equipment. Annual depreciation on the equipment is $500. What is the book value of the equipment at the end of Year 2?

$4,000 Book value = Original cost − Accumulated depreciation. At the end of Year 2, Accumulated depreciation = $500 × 2 = $1,000. Thus, at the end of Year 2, Book value = $5,000 − $1,000 = $4,000.

Industrial Metals purchases land, building, and equipment together for $1.2 million. The estimated fair values of the land, buildings, and equipment are $500,000, $800,000, and $200,000, respectively. What amount should be recorded in the separate account for the land?

$400,000 This is calculated as [$500,000 / ($500,000 + $800,000 + $200,000)] × $1.2 million

Barnes Corporation introduces a new e-book reader that carries a two-year warranty against manufacturer's defects. Based on industry experience with similar product introductions, warranty costs are expected to be approximately 10 percent of sales. By the end of the first year of selling the product, total sales are $5 million, and actual warranty expenditures are $100,000. What amount should Barnes report as a liability at the end of the year?

$400,000 Warranty Liability is increased by $500,000 (10 percent of $5 million) and then reduced by the $100,000 expenditure.

A company purchases a machine for $10,000. The estimated residual value is $4,000, and the estimated service life is 4 years or 10,000 units. The company uses the straight-line method of depreciation. The depreciable cost of the asset is:

$6,000 Depreciable cost = Original cost − Residual value = $10,000 − $4,000 = $6,000.

At the beginning of the year, Petra owes $10,000 on an installment notes payable, which has an interest rate of 6%. At the end of the year, Petra makes a payment of $2,000. After the payment, the carrying value of the installment notes payable will be:

$8,600 $10,000 - $(2,000 - (10,000 x .06) = $8,600

acid-test ration (quick ratio) equation

(cash + current investments + accounts receivable) / current liabilities

Terra Corporation purchased equipment with a 10-year useful life and zero residual value for $100,000. At the end of the fourth year, the equipment is exchanged for new equipment worth $110,000. Terra gets a trade-in allowance of $70,000 on the exchange, with the remaining $40,000 paid in cash. Which of the following is true of the net effect of this transaction? Assume the straight-line depreciation method is used. (Select all that apply.)

Assets increase by $10,000 stockholders' equity increase by $10,000

Depreciable cost equation

Depreciable cost = Original cost − Residual value

Dexter Tours is a defendant in litigation involving an accident that occurred during a cruise. The company is sued for $5 million in damages. The likelihood of a payment occurring is probable, and the amount is estimated to be in the range of $2 to $3 million. No amount within the range appears more likely than others. Which of the following is the company required to do in this scenario?

Record a $2 million liability and disclose the potential additional loss. When no amount within the range appears more likely than others, we record the minimum amount and disclose the potential additional loss.

Relevant financial information for Gordon, Inc. andJordan, Inc. for the current year is provided below. Based on these data, which of the following is a correct conclusion?

Return on Assets is 7.8% for Gordon and 6.2% for Jordan. Thus, Gordon is more profitable than Jordan. Return on Assets = Net Income/Average Assets Average Assets = (Beginning Assets + Ending Assets)/2 Gordon = 118/1,510= 7.81% Jordan = 132/2125= 6.21%

During the current year, Katie Corp. pays $5,120 on an installment note. The outstanding loan balance at the beginning of the year was $50,000; the effective interest rate is 8%. Which of the statements regarding the installment note balance at the end of the current year is correct?

The balance is $48,880 $50,000 - (5,120 - 4,000 interest)

A company receives cash in November, Year 1 for services to be performed in January, Year 2. The company increases both assets and service revenue in November, Year 1.

The company debits Cash (asset) and credits Deferred Revenue (liability).

Banner Corporation receives $30,000 in May, Year 1 to manufacture and deliver its product in September, Year 1. At the time the product is delivered, Banner will _____.

The company will decrease (debit) Deferred Revenue and increase (credit) Sales Revenue.

At the end of Year 1, Swanson Corporation has $650,000 in current assets and $500,000 in current liabilities. During Year 2, the company realizes a $100,000 increase in each amount, such that at the end of Year 2, the company has $750,000 in current assets and $600,000 in current liabilities. Calculate the current ratio for Year 1 and for Year 2.

Year 1 = 1.30; Year 2 = 1.25 -Year 1 is 1.30 ($650,000/$500,000) -Year 2 is 1.25 ($750,000/$600,000).

Infinity Corporation purchased equipment with a 10-year useful life and zero residual value for $10,000. At the end of the fifth year, the equipment was destroyed in a fire. If the equipment is not insured, the entry to record the retirement of this asset will include _______. Assume the straight-line depreciation method is used. (Select all that apply.)

a debit to Accumulated Depreciation for $5,000 a debit to Loss for $5,000 a credit to Equipment for $10,000.

Terra Corporation purchased equipment with a 10-year useful life and zero residual value for $100,000. At the end of the seventh year, the equipment is sold for $20,000. The entry to record this sale will include _______. Assume the straight-line depreciation method is used. (Select all that apply.)

a debit to Cash for $20,000 a debit to Accumulated Depreciation for $70,000 a debit to Loss for $10,000 a credit to Equipment for $100,000.

Infinity Corporation purchased equipment with a 10-year useful life and zero residual value for $10,000. At the end of the fifth year, the equipment is sold for $6,000. The entry to record this sale will include _______. Assume the straight-line depreciation method is used. (Select all that apply.)

a debit to Cash for $6,000 a debit to Accumulated Depreciation for $5,000 a credit to Gain for $1,000 a credit to Equipment for $10,000.

equity financing

additional investment from stockholders

amortization

allocating the cost of intangible assets to expense is called ________. most companies use straight-line amortization for intangibles intangible assets with an indefinite useful life (goodwill and most trademarks) are not amortized

Working capital is the best measure of liquidity when comparing one company with another.

false Working capital is not the best measure of liquidity when comparing one company with another because it does not take into account the relative size of each company.

Debit Financing

borrowing money from creditors

A profit margin of 10% indicates that:

for every $1 in net sales, the company generates $0.10 in net income.

Walker Inc. signs a $24,000 installment note, which requires equal monthly payments of $1,100 over the next two years. The journal entry to recognize the note includes a:

credit to Notes Payable for $24,000

Sales taxes collected from customers by the seller are recorded as _____.

current liabilities Sales taxes collected from customers by the seller are not an expense. Instead, they represent current liabilities payable to the government.

A current ratio of 2.2 indicates that:

for every $1 of current liabilities, the company has $2.20 of current assets. The current ratio indicates the amount of current assets per $1 of current liabilities.

The journal entry to record annual depreciation for equipment includes a:

debit to Depreciation Expense The journal entry to record annual depreciation includes a debit to Depreciation Expense and a credit to Accumulated Depreciation.

Diamond Electronics sells previously owned electronics. Each product carries a one-year warranty against defects. Suppose that product sales for the entire month of December are $80,000. The company expects future warranty costs to be 6% of sales. On December 31, Year 1, the company will record a:

debit to Warranty Expense for $4,800 On December 31, Year 1, the company records the warranty in an adjusting entry with a debit to Warranty Expense and a credit to Warranty Liability for $4,800 ($60,000 × 6%).

As natural resources are used, their cost is allocated to an expense through a process known as _____________.

depletion We distinguish natural resources from other property, plant, and equipment by the fact that we can physically use up, or deplete, natural resources.

intangible assets not subject to amortization (those with indefinite useful life)

goodwill trademarks (with indefinite life) *indefinite= means you cant tell how long they are going to be good for the company*

Depreciation is the process of allocating the cost of an asset to a(n) _________ over its service life.

expense

On January 1, Year 1, a company purchases a long-term asset having a service life of ten years. In comparing the straight-line and double-declining-balance methods, the method that produces higher depreciation expense in Year 1 of the asset's life is the straight-line method.

false In the earlier years of an asset's life, double-declining-balance produces higher depreciation expense and lower net income when compared to straight-line.

Land has an unlimited useful life.

false Land is an asset we do not depreciate because its life is indefinite.

Paying dividends to stockholders reduces taxable income because dividends are an expense.

false Paying dividends to stockholders does not reduce taxable income because dividends are not an expense.

The double-declining-balance method produces a higher net income than the straight-line method in the earlier years of an asset's life.

false Straight-line produces a higher net income than accelerated methods in the earlier years of an asset's life.

The current ratio is similar to the quick ratio but is based on a more conservative measure of current assets available to pay current liabilities.

false The acid-test ratio, or quick ratio, is similar to the current ratio but is based on a more conservative measure of current assets available to pay current liabilities.

An automobile manufacturer replaces a major component of a machine used in its assembly line. This cost should be expensed in the current period.

false The cost of replacing a major component of an asset is an improvement. The improvement to the machine should be capitalized to the Equipment account.

The entry to record monthly installment payments includes a credit to Notes Payable.

false The entry to record monthly installment payments includes a debit to Notes Payable.

The exclusive right of protection given to the creator of a published work is known as a patent.

false The exclusive right of protection given to the creator of a published work such as a song, film, painting, photograph, book, or computer software is known as a copyright.

Although the straight-line method of depreciation is the simplest to calculate, it is the least commonly used.

false The straight-line method of depreciation is not only the simplest, but also the most common depreciation method used in financial accounting.

Contingent gains are recorded only if a gain is probable and the amount can be reasonably estimated.

false Unlike contingent liabilities, contingent gains are not recorded until the gain is certain and no longer a contingency.

We classify the portion of long-term debt maturing within one year from the balance sheet date as a long-term liability.

false We classify the currently maturing portion of a long-term debt as a current liability on the balance sheet.

When a change in depreciation estimate is required, the company adjusts depreciation in prior periods.

false When a change in depreciation estimate is required, the company changes depreciation in current and future years, but not in prior periods

When a firm develops a trademark internally through advertising, it records the advertising costs as part of the cost of the intangible asset.

false When a firm develops a trademark internally through advertising, it doesn't record the advertising costs as part of the cost of the intangible asset.

double-declining-balance

the most depreciation in the first year and therefore the lowest book value. A low book value results in the highest amount of gain (or lowest amount of loss). Assuming that the asset is used uniformly, approximately the same amount of depreciation would be recorded each year of the asset's life under the straight-line method or activity-based method.

All of the following are essential characteristics of liabilities, except _____.

they represent probable future benefits Liabilities are (1) probable future sacrifices of economic benefits, (2) arising from present obligations to other entities, and (3) resulting from past transactions or events.

which of the following intangible assets would not be subject to amortization?

trademarks with an indefinite life

Goodwill has an indefinite useful life.

true

In most cases, current liabilities are payable within one year from the balance sheet date, and long-term liabilities are payable in more than one year.

true

Holding current assets constant, an increase in current liabilities will decrease the current ratio.

true (dividing by a bigger number makes the ratio smaller).

When an expenditure is not large enough to influence a decision, it is typically recorded as an expense regardless of its expected period of benefit.

true An item is said to be material if it is large enough to influence a decision. Expenditures that are not material are typically recorded as expenses regardless of their expected period of benefit.

Holding all else constant, a decrease in cash will decrease the acid-test ratio.

true Cash is a quick asset, so it is included in the numerator of the acid-test ratio. Holding all else constant, a decrease in cash will decrease the acid-test ratio (a decrease in the numerator makes the ratio smaller).

In the case of a contingent liability, if the likelihood of payment is reasonably possible, we record no entry but make full disclosure in a note to the financial statements to describe the contingency.

true If the likelihood of payment is reasonably possible rather than probable, we record no entry but make full disclosure in a note to the financial statements to describe the contingency.

The service life of an asset can be measured in units of time (such as years) or in units of activity (such as miles driven).

true Service life is one of three factors accountants must establish when recording depreciation. The service life can be defined in units of time or in units of activity.

Repairs and maintenance expenditures that benefit future periods are capitalized as an asset.

true We capitalize an expenditure as an asset if it benefits future periods.

A contingent liability is an existing:

uncertain situation that might result in a future loss. A contingent liability is an existing uncertain situation that might result in a loss depending on the outcome of a future event.

basket purchase

when companies purchase more than one asset at the same time for one purchase price

A trademark is a:

word, slogan, or symbol that distinctively identifies a company, product, or service.