Framework and Financial Reporting
The following information pertains to Eagle Co.'s 20X5 sales: Cash Sales Gross $ 80,000 Returns and allowances 4,000 Credit sales Gross 120,000 Discounts 6,000 On January 1, 20X5, customers owed Eagle $40,000. On December 31, 20X5, customers owed Eagle $30,000. Eagle uses the direct write-off method for bad debts. No bad debts were recorded in 20X5. Under the cash basis of accounting, what amount of net revenue should Eagle report for 20X5?
Net cash sales collected $80,000 − $4,000 $76,000 Plus cash collections from credit sales: Beginning accounts receivable $40,000 Plus net credit sales $120,000 − $6,000 114,000 Less ending accounts receivable (30,000) equals cash collections from credit sales 124,000 Equals revenue recognized under the cash basis of accounting $200,000
On February 12, 20X5, VIP Publishing, Inc. purchased the copyright to a book for $15,000 and agreed to pay royalties equal to 10% of book sales, with a guaranteed minimum royalty of $60,000. VIP had book sales of $800,000 in 20X5. In its 20X5 Income Statement, what amount should VIP report as royalty expense?
A royalty is an amount to be paid based on the sales of a commodity or product, in this case a book. The royalty expense is 10% of $800,000 sales ($80,000) because this amount exceeds the minimum of $60,000 that would be paid if sales were less than $600,000.
On July 1, 20X3, Roxy Co. obtained fire insurance for a three-year period at an annual premium of $72,000 payable on July 1 of each year. The first premium payment was made July 1, 20X3. On October 1, 20X3, Roxy paid $24,000 for real estate taxes to cover the period ending September 30, 20X4. This prepayment was made to obtain a discount. In its December 31, 20X3, Balance Sheet, Roxy should report prepaid expenses of:
$36,000 Unexpired fire insurance premium: $72,000(1/2) = The premium covers only one year, and half the year is elapsed as of December 31. Unexpired property tax prepayment: $24,000(9/12) 18,000 Total prepaid expenses (asset) at December 31, 2003 $54,000
Multico is a securities dealer whose principal market is with other securities dealers. To take advantage of a perceived opportunity, on December 31, the end of its fiscal year, Multico acquired a financial asset in a market other than its principal market for $50,000. At that date, the identical instrument could be sold in Multico's principal market for $50,100 with a $200 transaction cost. Which of the following amounts would constitute fair value to Multico for the financial asset at December 31?
$50,100 Since fair value is based on an exit price, the amount at which Multico could have sold the asset in its principal market is its fair value to Multico. Since the asset could have been sold by Multico in its principal market for $50,100, that is its fair value to Multico. The transaction cost to execute the sale should not be deducted from the market price to get fair value.
Bird Corp.'s trademark was licensed to Brian Co. for royalties of 15% of the sales of the trademarked items. Royalties are payable semiannually on March 15 for sales in July through December of the prior year, and on September 15 for sales in January through June of the same year. Bird received the following royalties from Brian: March 15 September 15 20X4 $5,000 $7,500 20X5 6,000 8,500 Brian estimated that the sales of the trademarked items would total $30,000 for July through December 20X5. In Bird's 20X5 Income Statement, the royalty revenue should be:
20X5 royalty revenue is the amount earned in 20X5, regardless of when it is received. The September receipt of $8,500 accounts for the royalties earned the first half of 20X5. Royalties for the second half are estimated to be .15($30,000) = $4,500. Although this is an estimate, if reliable, it provides relevant information. Waiting for the exact amount is not justified in this case. The small increase in reliability does not justify postponing recognition in 20X5. Thus, total royalty revenue for 20X5 is $13,000, which equals $8,500 + $4,500.
Alphaco has two subsidiaries, Betaco and Charlieco, both of which are consolidated by Alphaco. Alphaco and Betaco have elected to measure their respective debt investments held-to-maturity at fair value. Charlieco measures its debt investments held-to-maturity using amortized cost. In its consolidated financial statements, for which companies, if any, may Alphaco elect to report debt investment held-to-maturity at fair value?
Alphaco, Betaco, and Charlieco As the parent, Alphaco may elect to report all of the debt investments held-to-maturity at fair value in its consolidated statements (only), whether or not the fair value option was elected by its subsidiaries for their separate books and any separate reporting purposes.
Ina Co. had the following beginning and ending balances in its prepaid expense and accrued liabilities accounts for the current year: Prepaid expenses Accrued liabilities Beginning balance $ 5,000 $ 8,000 Ending balance 10,000 20,000 Debits to operating expenses totaled $100,000. What amount did Ina pay for operating expenses during the current year?
An increase in prepaid expenses indicates that more cash was paid than expensed (5,000). An increase in accrued liabilities indicates that more expense was accrued than paid (12,000). The reconciliation of operating expense to cash paid is: 100,000 + 5,000 − 12,000 = 93,000.
The premium on a three-year insurance policy expiring on December 31, 20X4 was paid in total on January 2, 20X2. If the company has a six-month operating cycle, then on December 31, 20X2, the prepaid insurance reported as a current asset would be for:
At the end of 20X2, two years of coverage remains. The cost of coverage for 20X3 is a current asset because it will be consumed within a year of the 20X2 Balance Sheet. The definition of a current asset uses the period "operating cycle or one year, whichever is longer." An operating cycle of any length, not exceeding one year, would yield the same answer to this question. The fact that the operating cycle is only six months versus, for example eight months, has no effect on the classification of the prepaid insurance into a current component (to expire within a year of the 20X2 Balance Sheet) and a long-term component (the portion to expire after 20X3).
Under East Co.'s accounting system, all paid insurance premiums are debited to prepaid insurance. For interim financial reports, East makes monthly estimated charges to insurance expense with credits to prepaid insurance. Additional information for the year ended December 31, 20X5, is as follows: Prepaid insurance at December 31, 20X4 $105,000 Charges to insurance expense during 20X5 (including a year-end adjustment of 17,500) 437,500 Prepaid insurance at December 31, 20X5 122,500 What was the total amount of insurance premiums paid by East during 20X5?
Beginning prepaid balance + Premiums paid − Expense charges = Ending prepaid balance $105,000 + Premiums paid − $437,500 = $122,500 Premiums paid = $455,000
Which of the following valuation methods may be used to measure debt investments classified as held-to-maturity?
Both amortized cost and fair value may be used to measure and report investments classified as held-to-maturity. Amortized cost is the traditional measurement method for investments held-to-maturity and would be used unless an entity elects to use fair value, which is permitted by the fair value option.
Which of the following would be reported as an investing activity in a company's statement of cash flows?
Collection on a note receivable from a related party is an investing activity. The company is lending money to the related party and lending is not a primary business activity - the fact that the loan is in the form of a note implies that it is interest bearing.
A partial listing of a company's accounts is presented below: Revenues $80,000 Operating expenses 50,000 Foreign currency translation adjustment gain, net of tax 4,000 Income tax expense 10,000 What amount should the company report as net income?
Net income is revenues less expenses, or $80,000 - 50,000 - 10,000 = $20,000. The foreign currency translation adjustment is part of comprehensive income.
An analysis of Thrift Corp.'s unadjusted prepaid expense account at December 31, 20X4, revealed the following: Thrift had an opening balance of $1,500 for its comprehensive insurance policy. Thrift had paid an annual premium of $3,000 on July 1, 20X3. A $3,200 annual insurance premium payment made July 1, 20X4 was unadjusted. A $2,000 advance rental payment for a warehouse Thrift leased for one year beginning January 1, 20X5 was included. In its December 31, 20X4, Balance Sheet, what amount should Thrift report as prepaid expenses?
Opening balance $1,500 less the amortization of remaining balance. The $3,000 payment on July 1, 20X3 covers the period July 1, 20X3 - June 30, 20X4. Thus by the end of 20X4, the prepayment has expired. (1,500) Plus the annual payment made July 1, 20X4 3,200 Less 1/2 year's amortization to December 31, 20X4 (1,600) Plus warehouse prepayment (no amortization is required for this payment because the lease term begins Jan. 1, 20X5) 2,000 Equals ending 20X4 prepaid expenses (prepaid asset) 3,600
At December 31, 20X0, Ashe Co. had a $990,000 balance in its advertising expense account before any year-end adjustments relating to the following: Radio advertising spots broadcast during December 20X0 were billed to Ashe on January 4, 20X1. The invoice cost of $50,000 was paid on January 15, 20X1. Included in the $990,000 is $60,000 for newspaper advertising for a January 20X1 sales promotional campaign. Ashe's advertising expense for the year ended December 31, 20X0, should be:
Preadjusted balance $990,000 Plus radio advertising (benefit was received in 2000; the expense should be recognized in 2000) 50,000 Less the newspaper advertising (benefit to be received in 20X1; there is no expense in 20X0) (60,000) Equals advertising expense, 2000 $980,000
In Dart Co.'s year two single-step Income Statement, as prepared by Dart's controller, the section titled "Revenues" consisted of the following: Sales $250,000 Purchase discounts 3,000 Recovery of accounts written off 10,000 Total revenues $263,000 In its year two single-step Income Statement, what amount should Dart report as total revenues?
Revenues are inflows of economic resources. The purchase discounts would be netted against purchases, not sales. The recovery of accounts written off is not revenue, it is an adjustment to the allowance for uncollectible accounts. Therefore the total revenue reported should be $250,000.
On January 1, 20X5, Layton Co. acquired the copyright to a book owned by Garner for royalties of 15% of future book sales. Royalties are payable on September 30 for sales in January through June of the same year, and on March 31 for sales in July through December of the preceding year. During 20X5 and 20X6, Layton remitted royalty checks to Garner as follows: March 31 September 30 2005 $ - $25,000 2006 22,000 40,000 Layton's sales of the Garner book totaled $300,000 for the last half of 20X6. In its 20X6 Income Statement, Layton should report royalty expense of:
Royalty expense for 20X6 equals 15% of sales for the year 2006, regardless of when the royalties are paid. The $40,000 paid on September 30, 20X6 applies to the sales in the first half of 2006 (January—June). Sales for the second half of 20X6 were $300,000. The royalty expense associated with these sales is .15($300,000) = $45,000. Therefore, total royalty expense for the year 2006 is $40,000 + $45,000 = $85,000.
Marco has an investment that is traded in two different markets, Front market and Side market. Marco has equal access to each market. In order to determine the fair value of its investment, Marco has obtained the following per share information for the securities as of the close of business December 31, the end of its fiscal year: Front Market Side Market Selling Price $52/sh $50/sh Transaction Cost $ 6/sh $ 1/sh If Front market is the principal market for the security for Marco, using the market approach, which one of the following would be the per share amount used for measuring the investment at fair value?
Since Front market is the principal market, fair value would be based on the price at which Marco could sell the investment in that market, or $52/sh. The market selling price would not be adjusted for the related direct transaction cost.
Marco has an investment that is traded in two different markets, Front market and Side market. Marco has equal access to each market. In order to determine the fair value of its investment, Marco has obtained the following per share information for the securities as of the close of business December 31, the end of its fiscal year: Front Market Side Market Selling Price $52/sh $50/sh Transaction Cost $ 6/sh $ 1/sh If neither Front market nor Side market is a principal market for the security for Marco, using the market approach which one of the following would be the per share amount used for measuring the investment at fair value?
Since neither market is the principal market for the security, Marco must determine the most advantageous market, which is the market in which the asset could be sold at a price that maximizes the amount that would be received. Marco would receive $52/sh − $6/sh = $46/sh in Front market and would receive $50/sh − $1/sh = $49/sh in Side market. Therefore, Side market is its most advantageous market, and fair value would be determined in that market as the price at which the security could be sold, or $50/sh. The market selling price would not be adjusted for the related direct transaction cost, even though it enters into determining the most advantageous market.
Sanni Co. had $150,000 in cash-basis pretax income for the year. At the current year end, accounts receivable decreased by $20,000 and accounts payable increased by $16,000 from their previous year-end balances. Compared to the accrual-basis method of accounting, Sanni's cash-basis pretax income is:
The $20,000 AR decrease implies that cash received on account was $20,000 greater than accrual sales. Cash-basis income is, therefore, $20,000 greater than accrual income for this difference. The $16,000 accounts payable increase implies that more inventory was purchased and included in accrual cost of goods sold than was paid. Cash-basis income is, therefore, $16,000 more than accrual income for this difference. In total, cash-basis income is $36,000 greater than accrual income.
Roro, Inc. paid $7,200 to renew its only insurance policy for three years on March 1, 20X5, the effective date of the policy. At March 31, 20X5, Roro's unadjusted trial balance showed a balance of $300 for prepaid insurance and $7,200 for insurance expense. What amounts should be reported for prepaid insurance and insurance expense in Roro's financial statements for the three months ended March 31, 20X5?
The $300 of prepaid insurance on March 31 before adjustment represents the remaining unexpired portion of the insurance policy before renewal. This amount must have expired by March 31 because there is only one insurance policy, and that policy was renewed March 1. The $300 is included in insurance expense for the three months ended March 31. In addition, one month of coverage has been used on the renewed policy as of March 31. Therefore $7,200/36 months or $200 is included in insurance expense for the three months ended March 31. In total, $500 of insurance expense is recognized. Prepaid insurance remaining at March 31 is $7,200 - $200 = $7,000.
Balance Sheet
The Balance Sheet discloses the assets and liabilities, usually classified by proximity to realization (assets) or payment (liabilities). The balance shows the relative magnitude of assets and liabilities and, therefore, the ability to pay obligations in the near and longer term. It also shows the degree of leverage and ability to adapt to changing financial conditions as well as the ability to manage future cash flows when conditions change. Much of the potential of the firm is disclosed in the Balance Sheet. It is a statement of the wealth position of the firm and allows an assessment of the relative risk of the enterprise.
Young & Jamison's modified cash-basis financial statements indicate cash paid for operating expenses of $150,000, end-of-year prepaid expenses of $15,000, and accrued liabilities of $25,000. At the beginning of the year, Young & Jamison had prepaid expenses of $10,000, while accrued liabilities were $5,000. If cash paid for operating expenses is converted to accrual-basis operating expenses, what would be the amount of operating expenses?
The approach on this question is to first calculate the cash-based operating expenses. Cash-based operating expenses are $150,000. The next step is to adjust the cash-based expense for the prepaid and accrued expenses. Beginning of the year prepaid expenses were paid in the prior year, but the expense was incurred (or consumed) in the current year, and end of the year prepaid expenses were paid this year but will be consumed next year. Therefore, you add the beginning of the year prepaid and subtract the end of the year prepaid expenses from the cash-based number. Cash-based expenses will also be adjusted for the accrued expense. Beginnings of the year accrued expenses were not paid last year, but were last year's expense item paid this year. End of the year accrued expenses were not paid this year, but are this year's expense paid next year. Therefore, you subtract beginning of the year accrued and add end of the year accrued expenses to the cash-based number. Cash-based operating expenses $150,000 Add the beginning of the year prepaid expenses 10,000 Subtract the end of the year prepaid expenses (15,000) Subtract the beginning of the year accrued expenses ( 5,000) Add the end of the year accrued expenses 25,000 Accrual-based operating expenses $165,000
A company records items on the cash basis throughout the year and converts to an accrual basis for year-end reporting. Its cash-basis net income for the year is $70,000. The company has gathered the following comparative Balance Sheet information: Beginning of year End of year Accounts payable $ 3,000 $ 1,000 Unearned revenue 300 500 Wages payable 300 400 Prepaid rent 1,200 1,500 Accounts receivable 1,400 600 What amount should the company report as its accrual-based net income for the current year?
The general rule to convert from cash to accrual is to add decreases in liabilities and increases in assets, and subtract increases in liabilities and decreases in assets. Cash basis net income $70,000 Add: Increase in accounts payable $2,000 Subtract: Increase in unearned revenue $200 Subtract: Increase in wages payable $100 Add: Increase in prepaid rent $300 Subtract: Decrease in accounts receivable $800 Accrual basis net income $71,200
Zeta Co. reported sales revenue of $4,600,000 in its Income Statement for the year ended December 31, 20X1. Additional information is as follows: 12/31/X0 12/31/X1 Accounts receivable $1,000,000 $1,300,000 Allowance for uncollectible accounts (60,000) (110,000) Zeta wrote off uncollectible accounts totaling $20,000 during 20X1. Under the cash basis of accounting, Zeta would have reported 20X1 sales of:
The question requires a solution for cash collected on accounts receivable. Using the information for accounts receivable, the collections amount can be found: Beginning balance + sales − collections − write-offs = ending balance $1,000,000 + $4,600,000 − collections − $20,000 = $1,300,000 collections = $4,280,000 Under the cash basis of accounting, sales equals cash collections.
Doren Co.'s officers' compensation expense account had a balance of $490,000 at December 31, 20X4, before any appropriate year-end adjustment relating to the following: No Salary accrual was made for the week of December 25-31, 20X4. Officers' salaries for this period totaled $18,000 and were paid on January 5, 20X5. Bonuses to officers for 20X4 were paid on January 31, 20X5 in the total amount of $175,000. The adjusted balance for officers' compensation expense for the year ended December 31, 20X4, should be:
Total compensation expense should include the two adjusting items. Therefore, the total expense is $490,000 + $18,000 + $175,000 = $683,000. The two adjusting items are not included in the expense account balance because the adjustments have not yet been made. The accrued, but unpaid, salaries, as well as the bonuses, relate to 20X4. Officer bonuses are another form of employee compensation.
U Co. had cash purchases and payments on account during the current year totaling $455,000. U's beginning and ending accounts payable balances for the year were $64,000 and $50,000, respectively. What amount represents U's accrual-basis purchases for the year?
Using an equation, or a T-account, to analyze accounts payable (AP) yields accrual purchases: Beginning AP ($64,000) + Accrual purchases—Cash payments ($455,000) = Ending AP ($50,000). Solving for accrual purchases yields $441,000.
