Contingencies and Commitments/Derivatives and Hedge Accounting /Foreign Currency Transactions and Translation

Which of the following information about threatened litigation should not be considered to determine whether an accrual is appropriate prior to issuance of a company's financial statements? A The period in which the underlying cause of the threatened litigation occurred B The degree of probability of an unfavorable outcome C The ability to make a reasonable estimate of the amount of loss D The period in which the threatened litigation became known to management

D The period in which the threatened litigation became known to management The following information about threatened litigation should be considered to determine whether an accrual is appropriate prior to issuance of a company's financial statements: The period in which the underlying cause of the threatened litigation occurred. The degree of probability of an unfavorable outcome. The ability to make a reasonable estimate of the amount of loss. This would be quantitative but a range is permissible.

Green Co. was preparing its year-end financial statements. Green had a pending lawsuit against a competitor for $5,000,000 in damages. Green's attorneys indicate that obtaining a favorable judgment was probable and the amount of damages is reasonably estimated. Green incurred $100,000 in legal fees. The income tax rate was 30%. What amount, if any, should Green recognize as a contingency gain in its financial statements? A $0 B $3,430,000 C $3,500,000 D $4,900,000

A $0 Contingencies arise from events or circumstances occurring before the balance sheet date, the resolution of which is contingent on a future event or circumstance. Where the likelihood of a loss is considered probable and the loss can be reasonably estimated, the estimated loss should be charged to income and the nature of the contingency should be disclosed. Gain contingencies should be disclosed but not recognized as income.

Martin Pharmaceutical Co. is currently involved in two lawsuits. One is a class-action suit in which consumers claim that one of Martin's best selling drugs caused severe health problems. It is reasonably possible that Martin will lose the suit and have to pay $20 million in damages. Martin is suing another company for false advertising and false claims against Martin. It is probable that Martin will win the suit and be awarded $5 million in damages. What amount should Martin report on its financial statements as a result of these two lawsuits? A $0 B $5 million income. C $15 million expense. D $20 million expense.

A $0 Reasonably possible means more than remote, but less than probable. Where the loss is considered reasonably possible, no charge should be made to income but the nature of the contingency should be disclosed. This treatment also applies to probable losses that cannot be reasonably estimated. Gain contingencies should be disclosed but not recognized as income. Care should be taken to avoid misleading implications as to the likelihood of realization. Therefore, Martin should report $0 on its financial statements, but disclose both events in the notes.

During January of the current year, Haze Corp. won a litigation award for $15,000 which was tripled to $45,000 to include punitive damages. The defendant, who is financially stable, has appealed only the $30,000 punitive damages. Haze was awarded $50,000 in an unrelated suit it filed, which is being appealed by the defendant. Counsel is unable to estimate the outcome of these appeals. In its current year financial statements, Haze should report what amount of pretax gain? A $15,000 B $45,000 C $50,000 D $95,000

A $15,000 Haze should report a pretax gain of $15,000 (i.e., $45,000 - $30,000) for the amount of litigation award from the financially stable defendant that is not being appealed. The portion of the litigation awards that are being appealed (i.e., $30,000 and $50,000) represent gain contingencies and, thus, should not be accrued before realization; however, they should be disclosed in the financial statement notes.

On June 19, Don Co., a U.S. company, sold and delivered merchandise on a 30-day account to Cologne GmbH, a German corporation, for 200,000 euros. On July 19, Cologne paid Don in full. Relevant currency exchange rates were: June 19 July 19 Spot rate $ .988 $ .995 30-day forward rate .990 1.000 What amount should Don record on June 19 as an account receivable for its sale to Cologne? A $197,600 B $198,000 C $199,000 D $200,000

A $197,600 At the date a transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from a foreign currency transaction should be measured and recorded in the functional currency of the recording entity by use of the exchange rate (i.e. spot rate) in effect at that date. Don Co should record an account receivable of $197,600 on June 19 (200,000 x .988)

On November 2, year 1, Platt Co. entered into a 90-day futures contract to purchase 50,000 Swiss francs when the contract quote was $0.70. The purchase was for speculation in price movement. The following exchange rates existed during the contract period: 30-day futures Spot rate November 2, year 1 $0.62 $0.63 December 31, year 1 0.65 0.64 January 30, year 2 0.65 0.68 What amount should Platt report as foreign currency exchange loss in its income statement for the year ended December 31, year 1? A $2,500 B $3,000 C $3,500 D $4,000

A $2,500 Foreign currency units to be purchased 50,000 Times: Excess of futures rate available for the remaining maturity of the contract and the contracted futures rate ($0.70 - $0.65) × $0.05 Loss on futures contract $ 2,500

During the prior year, Manfred Corp. guaranteed a supplier's $500,000 loan from a bank. On October 1 of the current year, Manfred was notified that the supplier had defaulted on the loan and filed for bankruptcy protection. Counsel believes Manfred will probably have to pay between $250,000 and $450,000 under its guarantee. As a result of the supplier's bankruptcy, Manfred entered into a contract in December to retool its machines so that Manfred could accept parts from other suppliers. Retooling costs are estimated to be $300,000. What amount should Manfred report as a liability in its current year December 31 balance sheet? A $250,000 B $450,000 C $550,000 D $750,000

A $250,000 To accrue a contingent liability, the likelihood of the loss must be probable and the amount reasonably estimable. It is probable that Manfred will have to pay between $250,000 to $450,000 under its guarantee of the supplier's loan. Since no indication is given that any amount in the range is a better estimate than the others, the lower limit of the range, $250,000, is accrued as a contingent liability. On the other hand, the contract Manfred entered into to retool its machines involves a commitment but not a liability because no performance has been made by the other party to the contract. Thus, there is no asset or liability to be reported for the contract.

The following information pertains to Flint Co.'s sale of 10,000 foreign currency units under a forward contract dated November 1, of the current year for delivery on January 31 of the following year: 11/1 12/31 Spot-rate $0.80 $0.83 30-day future rates 0.79 0.82 90-day future rates 0.78 0.81 Flint entered into the forward contract in order to speculate in the foreign currency. In Flint's income statement for the current year ended December 31, what amount of loss should be reported from this forward contract? A $400 B $300 C $200 D $0

A $400 Foreign currency units 10,000 Times: excess of forward rate available for the remaining maturity of the contract and the contracted forward rate ($0.82 - $0.78) × $0.04 Loss on forward contract $ 400

Fogg Co., a U.S. company, contracted to purchase foreign goods. Payment in foreign currency was due one month after the goods were received at Fogg's warehouse. Between the receipt of goods and the time of payment, the exchange rates changed in Fogg's favor. The resulting gain should be included in Fogg's financial statements as a(an) A Component of income from continuing operations. B Extraordinary item. C Deferred credit. D Item of other comprehensive income.

A Component of income from continuing operations. A change in exchange rates between the functional currency and the currency in which the transaction is denominated increases or decreases the expected amount of functional currency cash flows upon a settlement of the transaction. That increase or decrease in expected functional currency cash flows is a foreign currency transaction gain or loss that generally should be included as a component of income from continuing operations for the period in which the transaction is settled.

Management can estimate the amount of loss that will occur if a foreign government expropriates some company assets. If expropriation is reasonably possible, a loss contingency should be A Disclosed but not accrued as a liability B Disclosed and accrued as a liability C Accrued as a liability but not disclosed D Neither accrued as a liability nor disclosed

A Disclosed but not accrued as a liability Since the contingent loss from the expropriation of assets is judged to be reasonably possible, it should be disclosed in the footnotes, but not accrued. A contingent loss is accrued only in situations where the loss is probable and estimable.

Eagle Co. has cosigned the mortgage note on the home of its president, guaranteeing the indebtedness in the event that the president should default. Eagle considers the likelihood of default to be remote. How should the guarantee be treated in Eagle's financial statements? A Disclosed only B Accrued only C Accrued and disclose D Neither accrued nor disclosed

A Disclosed only Contingent liabilities that are considered to have a remote possibility of loss normally do not require disclosure. Exceptions include the guarantees of indebtedness of others, in which case disclosure, but not accrual, is required.

A(n) _________________ is a risk management strategy to protect against the possibility of loss, such as from price fluctuations. A Hedge B Underlying C Forecasted transaction D Firm commitment

A Hedge Hedging is a risk management strategy to protect against the possibility of loss, such as from price fluctuations.

A company's foreign subsidiary operation maintains its financial statements in the local currency. The foreign operation's capital accounts would be translated to the functional currency of the reporting entity using which of the following rates? A Historical exchange rate B Functional exchange rate C Weighted-average exchange rate D Current exchange rate at the balance sheet date

A Historical exchange rate Prior to translation, the foreign currency statements must be conformed to US GAAP and be measured in the functional currency of the foreign entity (otherwise, remeasurement into the functional currency is required). The remeasuring process should achieve the same result as if the books had been initially recorded in the functional currency. This requires the remeasuring of certain accounts (nonmonetary items) at historical exchange rates, including the foreign operations' capital accounts. All other accounts are remeasured at current rates.

At December 31 of the current year, Date Co. awaits judgment on a lawsuit for a competitor's infringement of Date's patent. Legal counsel believes it is probable that Date will win the suit and indicated the most likely award together with a range of possible awards. How should the lawsuit be reported in Date's current year financial statements? A In note disclosure only B By accrual for the most likely award C By accrual for the lowest amount of the range of possible awards D Neither in note disclosure nor by accrual

A In note disclosure only Gain contingencies are not to be accrued before realization, thus no gain contingency can be accrued until the lawsuit is settled; however, the gain should be disclosed in the financial statement notes.

When remeasuring foreign currency financial statements into the functional currency, which of the following items would be remeasured using historical exchange rates? A Inventories carried at cost. B Marketable equity securities reported at market values. C Bonds payable. D Accrued liabilities.

A Inventories carried at cost. If an entity does not maintain its books in its functional currency, remeasuring into the functional currency is required prior to translation into the reporting currency (i.e., the parent company's currency). In this process, nonmonetary balance sheet items are remeasured using historical exchange rates. Hence, inventories carried at cost should be remeasured using historical exchange rates because it is an example of a nonmonetary balance sheet item.

Which of the following is the characteristic of a perfect hedge? A No possibility of future gain or loss B No possibility of future gain only C No possibility of future loss only D The possibility of future gain and no future loss

A No possibility of future gain or loss Hedging is a risk management strategy to protect against the possibility of loss, such as from price fluctuations. Generally, the strategy involves counterbalancing transactions in which a loss on one financial instrument or cash flow stream would be offset by a gain on the related derivative. A perfect hedge would result in no possibility of future gain or loss.

The functional currency of Nash, Inc.'s subsidiary is the euro. Nash borrowed euros as a partial hedge of its investment in the subsidiary. In preparing consolidated financial statements, Nash's translation loss on its investment in the subsidiary exceeded its exchange gain on the borrowing. How should the effects of the loss and gain be reported in Nash's consolidated financial statements? A The translation loss less the exchange gain is reported in other comprehensive income. B The translation loss less the exchange gain is reported in net income. C The translation loss is reported in other comprehensive income and the exchange gain is reported in net income. D The translation loss is reported in net income and the exchange gain is reported in other comprehensive income.

A The translation loss less the exchange gain is reported in other comprehensive income. Translation adjustments are not be included in determining net income, but in OCI. Gains and losses on foreign currency transactions that are designated as, and are effective as, economic hedges of a net investment in a foreign entity are not included in determining net income, but are reported in the same manner as translation adjustments. Therefore, the net translation loss is be reported in OCI in Nash's consolidated financial statements.

A foreign subsidiary's functional currency is its local currency, which has not experienced significant inflation. The weighted average exchange rate for the current year would be the appropriate exchange rate for translating # Salaries expense Sales to external customers A Yes Yes B Yes No C No Yes D No No

A Yes Yes Foreign currency financial statements should be translated by means of the following rates: all assets and liabilities at the current exchange rate at the balance sheet date; revenues and expenses at the exchange rate at the time the revenue or expense was recognized, however, due to the impracticability of this where rates change frequently, a weighted-average exchange rate for the period may be used; contributed capital at the historical exchange rate; and retained earnings at the translated amount of retained earnings for the prior period, plus (less) net income(loss) at the weighted-average rate, less dividends declared during the period at the exchange rate when declared. The weighted average exchange rate would be an appropriate exchange rate for salaries expense and sales to external customers.

During the prior year, Haft Co. became involved in a tax dispute with the IRS. At December 31 of the prior year, Haft's tax advisor believed that an unfavorable outcome was probable. A reasonable estimate of additional taxes was $200,000, but could be as much as $300,000. After the prior year financial statements were issued, Haft received and accepted an IRS settlement offer of $275,000. What amount of accrued liability should Haft have reported in its prior year December 31 balance sheet? A $200,000 B $250,000 C $275,000 D $300,000

A loss from a contingent liability, arising from events or circumstances occurring before the balance sheet date and the resolution of which is contingent upon a future event or circumstance, of which an unfavorable outcome is probable, should be accrued. The amount should be estimated and the minimum amount in the range of estimates should be accrued.

PQR Ltd. enters into a contract with a customer for the sale of a tangible asset on January 1, 20X7, for $1 million. The contract also gives the entity the right to repurchase the asset for $1.1 million on or before December 31, 20X7. The expected market value for the asset is $1.05 million. This option is: A A forward option accounted for as a lease. B A call option accounted for as a financing arrangement. C A put option accounted for as a sale with a right to return. D A forward option accounted for as a financing arrangement.

As PQR has the right to repurchase the asset this is a call option and as the repurchase price of 1.1 million is greater than the original price of $ 1 million, this is to be accounted for as a financing arrangement.

Potter Co. has the following contingencies, all resulting from lawsuits in progress during the current year: Probable loss contingency $1,500,000 Reasonably possible loss contingency 500,000 Probable gain contingency 700,000 Reasonably possible gain contingency 300,000 Potter's accountant believes the financial statements will be misleading if the probable loss contingency is not disclosed. How much should be disclosed, and how much should be accrued in Potter's financial statements for the current year? # Disclosed Accrued A $ 500,000 loss $ 1,000,000 gain $ 1,500,000 loss $ 700,000 gain B $ 2,000,000 loss $ 1,000,000 gain $ 1,500,000 loss C $ 1,000,000 gain $ 1,500,000 loss $ 500,000 loss D $ 500,000 loss $ 300,000 gain $ 1,500,000 loss

B $ 2,000,000 loss $ 1,000,000 gain $ 1,500,000 loss Gain contingencies, whether probable or reasonable possible, should be disclosed but not recognized as income. Potter would disclose the $2,000,000 in loss contingencies and the $100,000 in gain contingencies. Potter would accrue just the $1,500,000 probable loss contingency.

Park Co.'s wholly-owned subsidiary, Schnell Corp., maintains its accounting records in euros. Because all of Schnell's branch offices are in Switzerland, its functional currency is the Swiss franc. Remeasurement of Schnell's current year financial statements resulted in a $7,600 gain, and translation of its financial statements resulted in an $8,100 gain. What amount should Park report as a foreign exchange gain in its income statement for the current year ended December 31? A $0 B $ 7,600 C $ 8,100 D $15,700

B $ 7,600 Park's foreign subsidiary does not maintain its accounting records in its functional currency (the Swiss Franc). Therefore, the financial statements of the foreign subsidiary must be remeasured. The $7,600 remeasurement gain is reported in income from continuing operations. The $8,100 translation gain is reported in other comprehensive income. Translation gains and losses are not reported in income.

On November 1, year 2, Kir Co. signed a contract to purchase 10,000 British pounds on February 2, year 3. The relevant exchange rates are as follows: Spot Rate Forward Rate November 1, year 2 $1.98 $2.05 December 31, year 2 $2.00 $2.06 Kir accounts for the forward contract as a speculative transaction. What amount of gain, if any, should Kir report from this forward contract in its income statement for the year ended December 31, year 2? A $0 B $100 C $600 D $700

B $100 Kir Co. signed a contract to purchase 10,000£ at a forward price of $20,500 (10,000 × 2.05). This is the amount initially recorded on November 1, year 2. As the value of the forward contract has increased to $20,600 (10,000 × 2.06) by December 31, Year 2, an increase of $100 must be recorded to mark up the derivative to fair value. There will be an unrealized holding gain of $100 reported on the income statement on Dec 31, year 2.

On October 1 of the current year, a U.S. company sold merchandise on account to a British company for 2,000 pounds (exchange rate, 1 pound = $1.43). At the company's December 31 fiscal year end, the exchange rate was 1 pound = $1.45. The exchange rate was 1 pound = $1.50 on collection in January of the subsequent year. What amount would the company recognize as a gain(loss) from foreign currency translation when the receivable is collected? A $0 B $100 C $140 D ($140)

B $100 The U.S. company would recognize a gain of $100 when the receivable is collected (settlement date) based on 2,000 pounds × $0.05, the increase in the exchange rate of $1.45 on the balance sheet date to $1.50 on the settlement date.

On December 12, year 1, Imp Co. entered into three forward exchange contracts, each to purchase 100,000 euros in 90 days. The relevant exchange rates are as follows: Spot rate Forward rate (for 3/12, year 2) December 12, year 1 $1.86 $1.80 December 31, year 1 $1.96 $1.83 Imp entered into the first forward contract to hedge a purchase of inventory in November of year 1, payable in March of year 2. At December 31, year 1, what amount of foreign currency transaction gain should Imp include in income from this forward contract? A $0 B $3,000 C $ 10,000 D $ 5,000

B $3,000 Since the forward contract was entered into to hedge a liability that is payable in March, it would be accounted for as a cash flow hedge. At December 31, Imp has a contract to purchase 100,000 Euros on March 12 for $1.80 per Euro when the expected exchange rate is $1.83 per Euro. As a result, Imp will gain $.03 per Euro and the derivative would be worth (100,000 x $.03) $3,000.

On December 31, year 1, Andover Co. acquired Barrelman, Inc. Before the acquisition, a product lawsuit seeking $10 million in damages was filed against Barrelman. As of the acquisition date, Andover believed that it was probable that a liability existed and that the fair value of the liability was $5 million. What amount should Andover record as a liability as of December 31, year 1? A $0 B $5,000,000 C $7,500,000 D $10,000,000

B $5,000,000 A $10,000,000 product liability lawsuit was filed against Barrelman. As of the acquisition date by Andover Co., it was probable that a liability existed and that its fair value was $5,000,000. Andover believed that the loss from the product lawsuit was probable and estimated the loss to be $5 million, Andover Co. will accrue a liability of $5 million in its financial statements in year 1 as well as disclose the liability in the notes to the financial statements

Bell Co. is a defendant in a lawsuit that could result in a large payment to the plaintiff. Bell's attorney believes that there is a 90% chance that Bell will lose the suit, and estimates that the loss will be anywhere from $5,000,000 to $20,000,000 and possibly as much as $30,000,000. None of the estimates are better than the others. What amount of liability should Bell report on its balance sheet related to the lawsuit? A $0 B $5,000,000 C $20,000,000 D $30,000,000

B $5,000,000 Where the likelihood of confirmation of a loss is considered probable and the loss can be reasonably estimated, the estimated loss should be accrued by a charge to income and the nature of the contingency should be disclosed. If, however, only a range of possible loss can be estimated—and no amount in the range is a better estimate than the others—the minimum amount in the range should be accrued. In addition, the nature of the contingency and the additional exposure to loss should be disclosed.

Hunt Co. purchased merchandise for £300,000 from a vendor in London on November 30 of the current year. Payment in British pounds was due on January 30 of the next year. The exchange rates to purchase one pound were as follows: Nov. 30 Dec. 31 Spot-rate $1.65 $1.62 30-day rate 1.64 1.59 60-day rate 1.63 1.56In its December 31, current year income statement, what amount should Hunt report as foreign exchange gain? A $12,000 B $9,000 C $6,000 D $0

B $9,000 Initial obligation, 11/30, in U.S. dollars (£300,000 × $1.65) $ 495,000 Amount payable, 12/31, in U.S. dollars (£300,000 × $1.62) (486,000) Foreign exchange gain recognized $ 9,000

Gordon Ltd., a 100% owned British subsidiary of a U.S. parent company, reports its financial statements in local currency, the British pound. A local newspaper published the following U.S. exchange rates to the British pound at year end: Current rate $1.50 Historical rate (acquisition) 1.70 Average rate 1.55 Inventory (FIFO) 1.60 Which currency rate should Gordon use to convert its income statement to U.S. dollars at year end? A 1.50 B 1.55 C 1.60 D 1.70

B 1.55 The foreign currency income statement should conceptually use the exchange rate at the time the revenue or expense was recognized. However, due to the impracticability of this where rates change frequently, a weighted-average exchange rate for the period may be used. The current exchange rate would be used for all assets and liabilities at the balance sheet date. The historical exchange rate is used for contributed capital. There is no inventory (FIFO) exchange rate used in the financial statements.

A derivative financial instrument is best described as A Evidence of an ownership interest in an entity such as shares of common stock. B A contract that has its settlement value tied to an underlying notional amount. C A contract that conveys to a second entity a right to receive cash from a first entity. D A contract that conveys to a second entity a right to future collections on accounts receivable from a first entity.

B A contract that has its settlement value tied to an underlying notional amount. A derivative instrument is an instrument or other contract that has the following three characteristics: 1) at least one underlying and at least one notational amount or payment provision or both, 2) requires no initial net investment, or one that is smaller than would be required for other types of contracts expected to have a similar response to market factor changes, and 3) requires or permits net settlement, can be readily settled net by a means outside the contract, or provides for delivery of an asset that puts the recipient in a position not substantially different from net settlement.

The primary criteria for determining a fair value hedge includes the fact that the hedged item does which of the following? A The hedged item is specifically identified as either all or a specific portion of a recognized asset or liability or of an unrecognized firm commitment. B All answer choices are correct. C The hedged item is a single asset or liability (or a specific portion thereof) or is a portfolio of similar assets or a portfolio of similar liabilities. D The hedged item presents an exposure to changes in fair value attributable to the hedged risk that could affect reported earnings.

B All answer choices are correct. An asset or a liability is eligible for designation as a hedged item in a fair value hedge if all of the following additional criteria are met: The hedged item is specifically identified as either all or a specific portion of a recognized asset or liability or of an unrecognized firm commitment. The hedged item is a single asset or liability (or a specific portion thereof) or is a portfolio of similar assets or a portfolio of similar liabilities. The hedged item presents an exposure to changes in fair value attributable to the hedged risk that could affect reported earnings.

Which of the following statements regarding foreign exchange gains and losses is correct? A An exchange gain occurs when the exchange rate increases between the date a payable is recorded and the date of cash payment. B An exchange gain occurs when the exchange rate increases between the date a receivable is recorded and the date of cash receipt. C An exchange loss occurs when the exchange rate decreases between the date a payable is recorded and the date of the cash payment. D An exchange loss occurs when the exchange rate increases between the date a receivable is recorded and the date of the cash receipt.

B An exchange gain occurs when the exchange rate increases between the date a receivable is recorded and the date of cash receipt. Receivable: Rate increase results in a gain (receive more at settlement), rate decrease results in a loss (receive less at settlement). Payable: Rate increase results in a loss (pay more at settlement), rate decrease results in a gain (pay less at settlement).

Invern Inc. has a self-insurance plan. Each year, retained earnings is appropriated for contingencies in an amount equal to insurance premiums saved less recognized losses from lawsuits and other claims. As a result of an accident this year, Invern is a defendant in a lawsuit in which it will probably have to pay damages of $190,000. What are the effects of this lawsuit's probable outcome on Invern's current year financial statements? A An increase in expenses and no effect on liabilities B An increase in both expenses and liabilities C No effect on expenses and an increase in liabilities D No effect on either expenses or liabilities

B An increase in both expenses and liabilities The potential loss for damages that may be paid should be reported by accruing a loss in the income statement and a liability in the balance sheet. Accrual is required because both of the following conditions are met: (1) it is considered probable that a liability has been incurred, and (2) the amount of the loss can be reasonably estimated. In addition, the nature of the lawsuit should be separately disclosed in the notes to the financial statements. The loss should not be charged to the appropriation of retained earnings for contingencies.

On January 17 of the current year, an explosion occurred at a Sims Co. plant causing extensive property damage to area buildings. Although no claims had yet been asserted against Sims by March 10, Sims' management and counsel concluded that it is likely that claims will be asserted and that it is reasonably possible Sims will be responsible for damages. Sims' management believed that $1,250,000 would be a reasonable estimate of its liability. Sims' $5,000,000 comprehensive public liability policy has a $250,000 deductible clause. In Sims' prior year December 31 financial statements, which were issued on March 25 of the current year, how should this item be reported? A As an accrued liability of $250,000 B As a footnote disclosure indicating the possible loss of $250,000 C As a footnote disclosure indicating the possible loss of $1,250,000 D No footnote disclosure or accrual is necessary

B As a footnote disclosure indicating the possible loss of $250,000 Accruing a contingent liability requires that the likelihood of the loss be probable and the amount be reasonably subject to estimation. Since the likelihood of the loss contingency in question is only reasonably possible, the loss contingency should not be accrued; it should only be disclosed. The disclosure should indicate the nature of the contingency and the minimum amount of the possible loss, the $250,000 deductible clause of the policy.

On October 1 of the current year, Mild Co., a U.S. company, purchased machinery from Grund, a German company, with payment due on April 1 of next year. If Mild's current-year operating income included no foreign exchange transaction gain or loss, then the transaction could have A Resulted in a Foreign Currency translation gain to be reported in company's income statement. B Been denominated in U.S. dollars. C Caused a foreign currency gain to be reported as a contra account against machinery. D Caused a foreign currency translation gain to be reported in other comprehensive income.

B Been denominated in U.S. dollars. Foreign currency transactions are transactions denominated in a currency other than the entity's functional currency. Hence, no foreign currency transaction gain or loss would occur if the purchase of the machinery by the U.S. company is denominated in U.S. dollars.

A U.S. company purchased inventory on account at a cost of 1,000 foreign currency units (FCU) from a non-U.S. company on November 15, to be paid on December 15. The FCU is valued at $0.85 on November 15 and at $0.90 on December 15. The journal entry to record payment on December 15 should include which of the following? A Debit inventory and credit cash for $850 B Debit exchange gains and losses and credit accounts payable for $50 C Debit accounts payable and credit exchange gains and losses for $50 D Debit accounts payable and credit cash for $850

B Debit exchange gains and losses and credit accounts payable for $50 Purchased inventory would have been recorded for $850 on November 15th because of $0.85 FCU value x 1,000. On December 15th, with an exchange rate of $0.90, it will require $900 to make the payment. Accounts payable will be increased with a credit of $50 and an exchange loss will be recognized with a debit of $50. Exchange loss $50 A/P $50

Shore Co. records its transactions in U.S. dollars. A sale of goods resulted in a receivable denominated in Japanese yen, and a purchase of goods resulted in a payable denominated in euros. Shore recorded a foreign exchange gain on collection of the receivable and an exchange loss on settlement of the payable. The exchange rates are expressed as so many units of foreign currency to one dollar. Did the number of foreign currency units exchangeable for a dollar increase or decrease between the contract and settlement dates? # Yen exchangable for $1 Euros exchangable for $1 A Increase Increase B Decrease Decrease C Decrease Increase D Increase Decrease

B Decrease Decrease To record a foreign exchange gain on collection of the receivable, the exchange rate of Japanese yen to one U.S. dollar must have decreased. For instance, assume a receivable for l,000 yen and an exchange rate of 10 yen to 1 dollar at the contract date. If the exchange rate changed to 5 yen to 1 dollar, the 1,000 yen when collected could be converted into 200 U.S. dollars at the settlement date.

A balance arising from the translation or remeasurement of a subsidiary's foreign currency financial statements is reported in the consolidated income statement when the subsidiary's functional currency is the: # Foreign currency U.S. dollar A No No B No Yes C Yes No D Yes Yes

B No Yes The functional currency of a foreign entity may be its local currency (i.e., the foreign currency) or the reporting currency (e.g., the U.S. dollar). If the functional currency is the foreign currency, the foreign currency financial statements must be translated into U.S. dollars. The translation adjustments which result from this process are not reported in the consolidated income statement but are reported in other comprehensive income. If the functional currency is the U.S. dollar, the foreign currency financial statements must be remeasured into U.S. dollars. The foreign exchange gains/losses which result from this process are reported in the consolidated income statement.

A(n) ________________ is a number of currency units, shares, bushels, pounds, or other units specified in a derivative instrument. A Underlying B Notional amount C Firm commitment D Counter amount

B Notional amount A notional amount is a number of currency units, shares, bushels, pounds, or other units specified in a derivative instrument.

If Tron Inc. a US-based entity has accounts payable valued in foreign currency, it should be adjusted forchanges in the: A Spot rate and the foreign exchange gains or losses are reported as operating gains or losses on the income statement. B Spot rate and the foreign exchange gains or losses are reported as non-operating gains or losses on the income statement. C Average rate and the foreign exchange gains or losses are reported as operating gains or losses on the income statement. D Average rate and the foreign exchange gains or losses are reported as non-operating gains or losses on the income statement.

B Spot rate and the foreign exchange gains or losses are reported as non-operating gains or losses on the income statement. When an entity with the US Dollar as a functional currency engages in a transaction in a foreign currency, it remeasures the transaction using the spot rate as of the transaction date. If the entity has any monetary assets or liabilities (e.g., cash, accounts receivable, accounts payable) valued in the foreign currency, these need to be adjusted for changes in the spot rate and the foreign exchange gains or losses are reported as non-operating gains or losses on the Income Statement

A company from the United Kingdom uses British pounds in its normal operations, reports in the European Union in euros, and reports in the United States in U.S. dollars. The company is owned by a private equity firm in Japan. What is the company's functional currency? A The Euro B The British pound C The U.S. dollar D The Japanese yen

B The British pound Functional currency represents the primary economic environment in which an entity generates cash and expends cash. The functional currency is the currency primarily used by a business or business unit. As a monetary unit of account, a functional currency represents the primary economic environment in which that entity operates. It would be the British Pound for a company from the United Kingdom that uses British pounds in its normal operations.

How should gains or losses from fair value hedges be recognized? A As an extraordinary item in the period of fair value change because of the unusual and infrequent nature of derivative contracts. B The gain or loss, along with the offsetting loss or gain attributable to the hedged risk, should be recognized currently in earnings in the same accounting period. C As a component of other comprehensive income in the period of fair value change and subsequently in earnings in the period net settlement occurs. D No gain or loss recognition in the period of fair value change, but subsequent recognition of gain or loss in earnings in the period net settlement occurs.

B The gain or loss, along with the offsetting loss or gain attributable to the hedged risk, should be recognized currently in earnings in the same accounting period. With fair value hedges, the gain or loss, along with the offsetting loss or gain attributable to the hedged risk, should be recognized currently in earnings in the same accounting period. Net loss or gain in the hedging activity indicates the effectiveness of the hedge.

A foreign subsidiary of a U.S. parent company should measure its assets, liabilities and operations using A The subsidiary's local currency B The subsidiary's functional currency C The U.S. dollar D The best available spot rate

B The subsidiary's functional currency The assets, liabilities, and operations of a foreign subsidiary of a U.S. parent company should be measured in its functional currency. An entity's functional currency is the currency of the primary economic environment in which the entity operates; normally, that is the currency of the environment in which an entity primarily generates and expends cash. The functional currency of a foreign subsidiary may be its local currency, the U.S. dollar, or another foreign currency.

A foreign subsidiary of a U.S. parent company should measure its assets, liabilities, and operations using A The subsidiary's local currency. B The subsidiary's functional currency. C The U.S. Dollar. D The best available spot rate.

B The subsidiary's functional currency. Foreign currency transactions are transactions with a foreign entity denominated in a foreign currency. A foreign subsidiary of a US parent company should measure its assets, liabilities, and operations using the subsidiary's functional currency. For example, a US company with the bulk of its operations in Canada would consider the Canadian dollar its functional currency, even if financial figures on its balance sheet and income statement are expressed in US dollars. For the subsidiary, the US company may use Canada's currency or the US dollar, whichever it deems to be the functional currency. Generally, a company chooses the currency with the highest number of transactions, as its functional currency.

Neron Co. has two derivatives related to two different financial instruments, instrument A and instrument B, both of which are debt instruments. The derivative related to instrument A is a fair value hedge, and the derivative related to instrument B is a cash flow hedge. Neron experienced gains in the value of instruments A and B due to a change in interest rates. Which of the gains should be reported by Neron in its income statement? # Gain in value of debt instrument A Gain in value of debt instrument B A Yes Yes B Yes No C No Yes D No No

B Yes No The gain or loss of a fair value hedge (instrument A) is recognized in earnings in the period of change, together with the offsetting loss or gain in the hedged item. The effective portion of the gain or loss of a cash flow hedge (instrument B) is initially reported as a component of other comprehensive income (OCI) on the balance sheet, and subsequently reclassified into earnings when the forecasted transaction affects earnings.

A foreign subsidiary's functional currency is its local currency, which has not experienced significant inflation. The weighted average exchange rate for the current year would be the appropriate exchange rate for translating # Sales to customers Wages expense A No No B Yes Yes C No Yes D Yes No

B Yes Yes Since the foreign subsidiary's functional currency is its local currency, which has not experienced significant inflation, it is appropriate to translate the amounts of its revenues, expenses, gains and losses at a weighted average exchange rate for the period.

On September 1, Brady Corp. entered into a foreign exchange contract for speculative purposes by purchasing 50,000 deutsche marks for delivery in 60 days. The rates to exchange $1 for 1 deutsche mark follow: 9/1 9/30 Spot rate $0.75 $0.70 30-day forward rate $0.73 $0.72 60-day forward rate $0.74 $0.73 In its September 30 income statement, what amount should Brady report as foreign exchange loss? A $2,500 B $1,500 C $1,000 D $ 500

C $1,000 Foreign currency units purchased under speculative forward contract $50,000 Times excess of contracted forward rate over forward rate available for remaining portion of contract ($0.74 - $0.72) × 0.02 Foreign exchange loss recognized September $ 1,000

During 2004, a former employee of Dane Co. began a suit against Dane for wrongful termination in November 2003. After considering all of the facts, Dane's legal counsel believes that the former employee will prevail and will probably receive damages of between $1,000,000 and $1,500,000, with $1,300,000 being the most likely amount. Dane's financial statements for the year ended December 31, 2003, will not be issued until February 2004. In its December 31, 2003, balance sheet, what amount should Dane report as a liability with respect to the suit? A $0 B $1,000,000 C $1,300,000 D $1,500,000

C $1,300,000 Contingent liabilities arise from events or circumstances occurring before the balance sheet date, the resolution of which is contingent on a future event or circumstance. Pending or threatened litigation is one example of a contingent liability. The accounting treatment depends on the likelihood that future events will confirm the contingent loss and whether the amount can be reasonably estimated.

Certain balance sheet accounts of a foreign subsidiary of Rowan Inc., at December 31, have been translated into U.S. dollars as follows: Translated at Current Rates Historical Rates Note receivable, long-term $240,000 $200,000 Prepaid rent 85,000 80,000 Patent 150,000 170,000 $475,000 $450,000 The subsidiary's functional currency is the currency of the country in which it is located. What total amount should be included in Rowan's December 31 consolidated balance sheet for the above accounts? A $450,000 B $455,000 C $475,000 D $495,000

C $475,000 Since the subsidiary's functional currency is the currency of the country in which it is located, all of its assets are translated at the current rate (i.e., the exchange rate in effect at the balance sheet date).

An entity may designate, as a type of hedge of foreign currency exposure, a derivative instrument or a non derivative financial instrument that may give rise to a foreign currency transaction gain or loss as which of the following? A A fair value hedge B A cash flow hedge C A hedge of a net investment in a foreign operation D None of the above

C A hedge of a net investment in a foreign operation An entity may designate a derivative instrument or a non derivative financial instrument that may give rise to a foreign currency transaction gain or loss as a hedge of the foreign currency exposure of a net investment in a foreign operation.

Which of the following is (are) examples of contingent liabilities? A Obligations related to product warranties B Pending or threatened litigation C Both A. and B. D Neither A. nor B.

C Both A. and B. Examples of contingent liabilities include obligations related to product warranties and pending or threatened litigation. Since answers A. and B. are correct, answer C., both A. and B., is the best choice.

Which of the following risks are inherent in an interest rate swap agreement? The risk of exchanging a lower interest rate for a higher interest rate The risk of nonperformance by the counterparty to the agreement A I only. B II only. C Both I and II. D Neither I nor II.

C Both I and II. An interest rate swap agreement is an arrangement used to limit interest rate risk. Two companies swap interest payments, but not the principal, in an agreement such as an exchange of a variable interest rate for a fixed rate. The risk of accounting loss from an interest rate swap includes both (1) the risk of exchanging a lower interest rate for a higher rate and (2) the risk of nonperformance by the other party.

Which of the following should be reported in accumulated other comprehensive income? A Discount on convertible bonds that are common stock equivalents B Premium on convertible bonds that are common stock equivalents C Cumulative foreign exchange translation loss D Organization costs

C Cumulative foreign exchange translation loss If an entity's functional currency is a foreign currency, which has not experienced significant inflation, translation adjustments result from the process of translating that entity's financial statements into the reporting currency. Translation adjustment should not be included in determining net income but should be reported in OCI. A cumulative foreign exchange translation loss would be reported in accumulated OCI as a stockholders' equity contra account.

DeeCee Co. adjusted its historical cost income statement by applying specific price indexes to its depreciation expense and cost of goods sold. DeeCee's adjusted income statement is prepared according to A Fair value accounting. B General purchasing power accounting. C Current cost accounting. D Current cost/general purchasing power accounting.

C Current cost accounting. DeeCee adjusts the depreciation and cost of goods sold reported in the historical cost income statement by applying specific price indexes to these amounts. Therefore, DeeCee's adjusted income statement is prepared using current cost accounting. The income statement is not prepared using fair value accounting because only depreciation expense and cost of goods sold are restated by applying specific price indexes. The income statement is not prepared using general purchasing power accounting because DeeCee's historical costs are not remeasured into units of a currency with the same general purchasing power. The income statement is not prepared using current cost/general purchasing power accounting because amounts are not remeasured into units of a currency with the same general purchasing power.

Blythe Corp. is a defendant in a lawsuit. Blythe's attorneys believe it is reasonably possible that the suit will require Blythe to pay a substantial amount. What is the proper financial statement treatment for this contingency? A Accrued and disclosed. B Accrued but not disclosed. C Disclosed but not accrued. D No disclosure or accrual.

C Disclosed but not accrued. Where the loss is considered reasonably possible, no charge should be made to income but the nature of the contingency should be disclosed. This treatment also applies to probable losses that cannot be reasonably estimated.

Conlon Co. is the plaintiff in a patent-infringement case. Conlon has a high probability of a favorable outcome, and can reasonably estimate the amount of the settlement. What is the proper accounting treatment of the patent infringement case? A A gain contingency for the minimum estimated amount of the settlement. B A gain contingency for the estimated probable settlement. C Disclosure in the notes only. D No reporting is required at this time.

C Disclosure in the notes only. Gain contingencies should be disclosed but not recognized as income. Care should be taken to avoid misleading implications as to the likelihood of realization.

On December 15, a U.S. company bought inventory from a European supplier. Payment is required in euros in 30 days. What exchange rate should be used to value the payable for this transaction at year-end? A Exchange rate at settlement date. B Exchange rate at purchase date. C Exchange rate at year-end. D Weighted-average exchange rate for the year.

C Exchange rate at year-end. An organization which purchases or sells goods in currencies other than in its functional currency is required to recognize foreign currency gain/loss on them at the settlement date using the spot rate. Where the settlement date is after the year-end, the foreign currency gain/loss is recognized at such year-end using the exchange rate at year-end.

On December 1 of the current year, Bann Co. entered into an option contract to purchase 2,000 shares of Norta Co. stock for $40 per share (the same as the current market price) by the end of the next two months. The time value of the option contract is $600. At the end of December, Norta's stock was selling for $43, and the time value of the option is now $400. If Bann does not exercise its option until January of the subsequent year, which of the following changes would reflect the proper accounting treatment for this transaction on Bann's December 31, year-end financial statements? A The option value will be disclosed in the footnotes only. B Other comprehensive income will increase by $6,000. C Net income will increase by $5,800. D Current assets will decrease by $200

C Net income will increase by $5,800. On December 1, Bann would initially record the option contract at $80,600 (2,000 shares × $40 market price on December 1 + $600 time value). At the end of December, the fair value of the option contract was $86,400 (2,000 shares × $43 market price on December 31 + $400 time value). Bann would report this change in fair value which would result in net income increasing by $5,800.

Contributed capital in foreign currency financial statements should be translated by means of which of the following? A The current exchange rate at the balance sheet date B A weighted-average exchange rate for the period C The historical exchange rate D The weighted-average rate, less dividends declared during the period, at the exchange rate when declared

C The historical exchange rate Contributed capital is translated using the historical exchange rate.

Which of the following is true where a foreign operation is relatively self-contained, integrated within one country and performs independently of the parent company? A The entity's functional currency will be in U.S. dollars. B The entity's functional currency will be in the parent company's currency. C Translation of financial statements from the functional currency into the parent's reporting currency will be required. D None of the above is true.

C Translation of financial statements from the functional currency into the parent's reporting currency will be required. Where the foreign operation is relatively self-contained and integrated within one country, the functional currency will be the local currency; and translation of financial statements from the functional currency into the parent's reporting currency will be required.

On September 22 of the previous year, Yumi Corp. purchased merchandise from an unaffiliated foreign company for 10,000 units of the foreign company's local currency. On that date, the spot rate was $.55. Yumi paid the bill in full on March 20 of the current year, when the spot rate was $.65. The spot rate was $.70 on December 31 of the previous year. What amount should Yumi report as a foreign currency transaction loss in its income statement for the previous year ended December 31? A $0 B $ 500 C $1,000 D $1,500

D $1,500 Accounts payable, 12/31 of previous year, in $US (10,000 local currency units × $0.70) $7,000 Initial obligation, 9/22 or previous year, in $US (10,000 local currency units × $0.55) (5,500) Foreign exchange loss recognized in the previous year $1,500

On November 1 of the current year, Davis Co. discounted with recourse at 10% a one-year, noninterest bearing, $20,500 note receivable maturing on January 31 of next year. What amount of contingent liability for this note must Davis disclose in its financial statements for the current year ended December 31? A $0 B $20,000 C $20,333 D $20,500

D $20,500 Davis discounted the note receivable with recourse. If the maker fails to pay at maturity, the note is presented to Davis, who is then liable for $20,500, the amount due at maturity. Davis should disclose this contingent liability in its current year 12/31 financial statements.

Ball Corp. had the following foreign currency transactions during the current year: Merchandise was purchased from a foreign supplier on January 20 for the U.S. dollar equivalent of $90,000. The invoice was paid on March 20 at the U.S. dollar equivalent of $96,000. On July 1, Ball borrowed the U.S. dollar equivalent of $500,000 evidenced by a note that was payable in the lender's local currency on July 1 in two years. On December 31, the U.S. dollar equivalents of the principal amount and accrued interest were $520,000 and $26,000, respectively. Interest on the note is 10% per annum. In Ball's year-end income statement, what amount should be included as foreign exchange loss? A $0 B $ 6,000 C $21,000 D $27,000

D $27,000 The payable from the merchandise purchased was recorded at $90,000 on 1/20. It was paid on 3/20 at the U.S. dollar equivalent of $96,000, resulting in a $6,000 foreign exchange loss. The payable from the borrowing was recorded at $500,000 at 7/1. Accrued interest on the borrowing was $25,000 ($500,000 × 10% × 6/12) at 12/31. At 12/31, the U.S. dollar equivalents of principal and accrued interest were $520,000 and $26,000, respectively, resulting in an additional $21,000 [($520,000 + $26,000) - ($500,000 + $25,000)] foreign exchange loss. Thus, the total amount of foreign exchange loss to be recognized in the yearend income statement is $27,000 ($6,000 + $21,000).

On July 1, year 1, Clark Company borrowed 1,680,000 local currency units (LCUs) from a foreign lender, evidenced by an interest bearing note due on July 1, year 2, which is denominated in the currency of the lender. The U.S. dollar equivalent of the note principal was as follows: Date Amount 7/1, year 1 (date borrowed) $210,000 12/31, year 1 (Clark's year end) 240,000 7/1, year 2 (date repaid) 280,000 In its income statement for year 2, what amount should Clark include as a foreign exchange gain or loss? A $70,000 gain B $70,000 loss C $40,000 gain D $40,000 loss

D $40,000 loss A transaction gain or loss (measured from the transaction date or most recent balance sheet date, whichever is later) is realized upon settlement of a foreign currency transaction. In year 2, a loss of $40,000 (i.e., $240,000 - $280,000) is recorded due to the additional amount that must be repaid since the last balance sheet date.

On January 2 of the current year, LTTI Co. entered into a three-year, non-cancelable contract to buy up to 1 million units of a product each year at $.10 per unit with a minimum annual guarantee purchase of 200,000 units. At year end, LTTI had only purchased 80,000 units and decided to cancel sales of the product. What amount should LTTI report as a loss related to the purchase commitment as of December 31 of the current year? A $0 B $8,000 C $12,000 D $52,000

D $52,000 The contract guaranteed LTTI purchase 200,000 units per year, so LTTI would recognize a loss for the 520,000 units that it had guaranteed to purchase throughout the life of the contract but had not yet purchased (120,000 current year units + 200,000 year 2 units + 200,000 year 3 units = 520,000 units). 520,000 × $0.10 = $52,000.

Smythe Co. invested $200 in a call option for 100 shares of Gin Co. $.50 par common stock, when the market price was $10 per share. The option expired in three months and had an exercise price of $9 per share. What was the intrinsic value of the call option at the time of initial investment? A $50 B $100 C $200 D $900

D $900 In this case, limited information is provided, so the value of the options would be the difference between the current/ market price and the strike/exercise price: 100 * ($10 - $9) = $100.

Toigo Co. purchased merchandise from a vendor in England on November 20 for 500,000 British pounds. Payment was due in British pounds on January 20. The spot rates to purchase one pound were as follows: November 20 $1.25 December 31 1.20 January 20 1.17 How should the foreign currency transaction gain be reported on Toigo's financial statements at December 31? A A gain of $40,000 as a separate component of stockholders' equity. B A gain of $40,000 in the income statement. C A gain of $25,000 as a separate component of stockholders' equity. D A gain of $25,000 in the income statement.

D A gain of $25,000 in the income statement. At the date the transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from the transaction should be measured and recorded in the functional currency of the recording entity by use of the exchange rate in effect at that date. Toiga would record a liability of $625,000 (500,000 x $1.25). At each balance sheet date, recorded balances that are denominated in a currency other than the functional currency of the recording entity should be adjusted to reflect the current exchange rate. These adjustments should be currently recognized as transaction gains or losses and reported as a component of income from continuing operations. Toigo would recognize a gain of $25,000 on the December 31 financial statements based on 500,000 pounds × $1.20 = $600,000 as of December 31.

On June 1, year 1, ABC Co. issued a 200,000 euro purchase order for equipment to be supplied by a German company. ABC's functional currency is the U.S. dollar. The equipment was delivered to ABC on November 1, year 1, and ABC recorded a payable due to the German company. ABC paid for the equipment on January 31, year 2. The following are the exchange rates in effect: June 1, year 1 1 euro = 1.40 U.S. dollars November 1, year 1 1 euro = 1.50 U.S. dollars December 31, year 1 1 euro = 1.35 U.S. dollars January 31, year 2 1 euro = 1.30 U.S. dollars Under IFRS, what is the foreign currency gain or loss that ABC should record for the year ended December 31, year 1? A A loss of $30,000. B A loss of $20,000. C A gain of $10,000. D A gain of $30,000.

D A gain of $30,000. A foreign currency transaction gain or loss is recognized in the period when the exchange rate changes, e.g., at a balance sheet date and at the settlement date. ABC's functional currency is the US dollar. Therefore, the transaction must be measured in the US dollar. A gain of $30,000 is reported on 31st Dec, year 1. Date Unit Exchange Rate USD / GBP Amount (USD) 01- Nov 200,000 $1.50 300,000 31- Dec 200,000 $1.35 270,000 Gain $30,000

Which of the following financial instruments is not considered a derivative financial instrument? A Interest-rate swaps B Currency futures C Stock-index options D Bank certificates of deposit

D Bank certificates of deposit A derivative financial instrument is an instrument or contract that has three characteristics; (1) an underlying and notional amount or payment provision, (2) zero or small investment, and (3) net settlement. Bank certificates of deposit do not contain these features.

Which of the following is a true statement related to foreign currency accounting and reporting under US GAAP and IFRS? A Only IFRS requires the identification of hyperinflationary economies. B Both US GAAP and IFRS require foreign currency transactions to be re-measured into an entity's functional currency with amounts resulting from changes in exchange rates being reported in other comprehensive income. C Both US GAAP and IFRS require the "step-by-step" method of consolidation in reporting the consol-idation of foreign operations. D Both US GAAP and IFRS require re-measurement into the functional currency before translation into the reporting currency.

D Both US GAAP and IFRS require re-measurement into the functional currency before translation into the reporting currency. Both US GAAP and IFRS require re-measurement into the functional currency before translation into the reporting currency. Assets and liabilities are translated at the period-end rate and income statement amounts generally are translated at the average rate, with the exchange differences reported in equity.

Ace Co. settled litigation on February 1 of the current year for an event that occurred during the previous year. An estimated liability was determined as of December 31 of the previous year. This estimate was significantly less than the final settlement. The transaction is considered to be material. The financial statements for the previous year-end have not been issued. How should the settlement be reported in Ace's previous year-end financial statements? A Disclosure only of the settlement B Only an accrual of the settlement C Neither a disclosure nor an accrual D Both a dislosure and an accrual

D Both a dislosure and an accrual An estimated loss from a loss contingency shall be accrued by a charge to income if both of the following conditions are met: (1) it is probable that an asset has been impaired or a liability has been incurred, and (2) the amount of the loss can be reasonably estimated. When the amount of loss is known, as with a settlement after the balance sheet date but before issuance of the financial statements, that amount should be accrued and disclosed in the financial statements.

Grey Co. purchased stock in Cherry Co. Grey purchased a put option on the stock. The strike price is the current market price. What is the most likely reason Grey purchased the put option? A Cherry stock has remained flat, and Grey believes the stock is going to remain at its original purchase price. B Cherry stock has increased in price, and Grey believes the stock is going to continue to increase in price. C Cherry stock has decreased in price, but Grey believes the stock is going to increase in price. D Cherry stock has increased in price, but Grey is concerned that the price might decrease.

D Cherry stock has increased in price, but Grey is concerned that the price might decrease. Buying a put option confers the right on the holder of the option to sell the stock at a price, regardless of the trading price of the underlying asset/stock. In essence, the put option buyer buys the right to sell the underlying stock to the put option holder at a predetermined rate.

When remeasuring foreign currency financial statements into the functional currency, which two of the following items would be remeasured using historical exchange rates? Inventories carried at cost. Equity securities reported at market values. Bonds payable. Accrued liabilities. Prepaid expenses. A I and II B II and V C II and III D I and V

D I and V Nonmonetary balance sheet items, including intangibles, fixed assets, inventory, and prepaid expenses, are remeasured at historical rates.

In preparing consolidated financial statements of a U.S. parent company with a foreign subsidiary, the foreign subsidiary's functional currency is the currency A In which the subsidiary maintains its accounting records. B Of the country in which the subsidiary is located. C Of the country in which the parent is located. D Of the environment in which the subsidiary primarily generates and expends cash.

D Of the environment in which the subsidiary primarily generates and expends cash. Functional currency is the currency of the principal economy or country in which an entity carries on its business. The functional currency remains the same irrespective of the location of the parent or method of accounting.

Gains from remeasuring a foreign subsidiary's financial statements from the local currency, which is not the functional currency, into the parent company's currency should be reported as a(an) A Deferred foreign exchange gain. B Item of other comprehensive income. C Extraordinary item, net of income taxes. D Part of continuing operations.

D Part of continuing operations. If an entity does not maintain its books in its functional currency, remeasuring into the functional currency is required prior to translation into the reporting currency (i.e., the parent company's currency). Exchange gains and losses that result for the remeasuring process are recognized in income from continuing operations.

Which of the following methods should a company use to account for a contingent liability when the loss is probable but not reasonably estimated? A The liability should not be reported B The liability should be reported as a short-term liability C The liability should be reported as a long-term liability D The liability should only be disclosed in the notes to the financial statements

D The liability should only be disclosed in the notes to the financial statements Probability of loss Disclose in notes to Financial Statements Accrue Remote No No Reasonably possible Yes No Probable and estimable Yes Yes Probable but not estimable Yes No

If a company that is not a public business entity wants to apply the simplified hedge accounting approach to a cash flow hedge of a variable rate borrowing with a receive-variable, pay-fixed interest rate swap, which of the following is a condition that must be met? A The notional value of the swap is greater than the principal of the hedged borrowing B The fair value of the interest rate swap executed has a value equivalent to the hedged borrowing C The variable interest rate on the interest rate swap is capped at 250 basis points above the cap on the hedged borrowing D The variable interest rate on the interest rate swap and the variable interest rate on the hedged borrowing are linked to the same index

D The variable interest rate on the interest rate swap and the variable interest rate on the hedged borrowing are linked to the same index For a non-issuer (i.e., not a public business entity) to apply the simplified hedge accounting approach to such a cash flow hedge, the variable interest rate on the interest swap and the variable interest rate on the hedged borrowing must be linked to the same index.

What is the underlying concept governing the generally accepted accounting principles pertaining to recording gain contingencies? A Conservatism B Relevance C Consistency D Reliability

Gain contingencies should be disclosed in the financial statements in a footnote rather than being reflected in income because doing so could result in recognizing income prior to its realization. This treatment reflects the principle of conservatism which means that accountants who are selecting between two possible alternatives should choose the accounting alternative which is least likely to overstate assets and income.