FSA 3321 – Summer (2007)
Exam 2 – Version 1
Moore
Second Examination – Finance 3321
Summer 2007 (Moore) – Version 1
Section Time:
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Clearly Circle the BEST response for each of the following questions:
1. Aggressive use of which of the following accounting choices can lead to the problem of
“off-balance sheet financing”?
a. Operating leases
b. Failure to write down obsolete inventory
c. Reporting all related party transactions
d. Overstating depreciation for long-term assets
e. Using the intrinsic method to account for executive stock options
2. The suspect accounting practice for AOL involved:
a. Operating leases
b. Overstating accounts receivable
c. Executive stock options
d. Overstating inventory
e. Capitalizing advertising costs
3. Which of the following adjustments to the accounts must always be made when it is
found (suspected) a company overstates the balance of its long-term assets?
a. Increase the right-hand side of the balance sheet
b. Decrease liabilities
c. Increase income tax expense
d. Decrease post-retirement benefits liability
e. Decrease the asset account
4. Which of the following must result in understated liability balances?
a. Delays in the write-down (expensing) of current assets such as inventory.
b. Understating the growth rate in future post-retirement benefit costs
c. Overstated amortization of goodwill
d. Overstating the growth rate in future post-retirement benefit costs
e. Delaying the write-down (expensing) of obsolete factory equipment
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FSA 3321 – Summer (2007)
Exam 2 – Version 1
Moore
Questions 5-8 (Operating and Capital Lease Adjustments)
Use the following information for questions 5-8
ABC Company is a startup company in an industry that exclusively uses capital leases for it’s
expensive highway construction equipment. ABC, however, used operating lease accounting
in its first year of operations. Assume the average lifespan of ABC’s leased equipment is 20
years and that their annual cost of debt is .092%. The annual lease payments are
$4,000,000. The present value of the future lease payments is $36,000,000 (rounded).
ABC’s industry commonly uses straight-line depreciation and the effective tax rate is 35%.
5. Adjust ABC’s books to reflect the lease as being capitalized. Adjust for the initial
recognition of the capital lease would have the following impact on the balance sheet
(Asset and Liability Accounts) in terms of debits and credits
a. Debit Lease Liabilities for $80,000,000 and Credit Leased Assets for $80,000,000
b. Debit Leased Assets for $80,000,000 and Credit Lease Liabilities for $80,000,000
c. Debit Lease Liabilities for $36,000,000 and Credit Leased Assets for $36,000,000
d. Debit Leased Assets for $36,000,000 and Credit Lease Liabilities for $36,000,000
e. Debit Leased Assets for $7,360,000 and Credit Lease Liabilities for $7,360,000
6. Adjust ABC’s books to reflect the lease as being capitalized. The depreciation expense
that should be charged against income in the 8th year is:
a. $200,000
b. $1,800,000
c. $4,000,000
d. $7,360,000
e. $36,000,000
7. Adjust ABC’s books to reflect the lease as being capitalized. Compute the appropriate
charge for interest expense in the third year.
a. $3,104,107
b. $3,179,585
c. $3,248,704
d. $3,312,000
e. $4,000,000
8. Compute the overall effect on Net Income in the second year for ABC (had the lease
been capitalized) would be (relative to the reported Net Income, net of tax).
a. $5,112,000 Lower
b. $3,322,800 Higher
c. $2,600,000 Lower
d. $1,112,000 Higher
e. $722,800 Lower
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FSA 3321 – Summer (2007)
Exam 2 – Version 1
Moore
9. Channel Stuffing is defined as:
a. Earnings Management
b. Selling unwanted merchandise
c. Intense marketing plans
d. Flexible Accounting
e. Conservative Accounting
10. What is the second step of the method for a structured accounting analysis (per text)
a. Identify potential “red flags”
b. Assess the degree of potential accounting flexibility
c. Evaluate the actual accounting strategy
d. Undo accounting distortions
e. Identify key accounting policies
f. Evaluate the quality of disclosure
11. What is the fourth step of the method for a structured accounting analysis (per text)
a. Identify potential “red flags”
b. Assess the degree of potential accounting flexibility
c. Evaluate the actual accounting strategy
d. Undo accounting distortions
e. Identify key accounting policies
f. Evaluate the quality of disclosure
Use the following for questions 12-13
- Net Sales/Cash from sales
- Net Sales/Net Accounts Receivable
- Net Sales/Warranty Liabilities
- CFFO/OI
- CFFO/NOA
- Asset Turnover (Sales/Total Assets)
2001
0.99
12.0
104
0.88
0.35
1.50
2002
0.98
10.0
106
0.81
0.38
1.49
2003
1.01
11.0
118
0.82
0.37
1.48
2004
1.40
11.2
112
0.98
0.24
1.72
12. Which of the expense diagnostic ratios would provide a “red flag” raising concerns that
expenses may have been understated for the purpose of overstating net income in 2004?
a. Net Sales/Cash from sales
b. Net Sales/Warranty Liabilities
c. CFFO/OI (Cash Flow from Operating Activities)/(Operating Income)
d. CFFO/NOA (Cash Flow from Operating Activities)/(Net Operating Assets)
e. Asset Turnover
13. Which of the revenue diagnostic ratios would provide a “red flag” raising concerns that
revenues may have been overstated for the purpose of overstating net income?
a. Net Sales/Cash from sales
b. Net Sales/Net Accounts Receivable
c. Asset Turnover
d. CFFO/OI (Cash Flow from Operating Activities)/(Operating Income)
e. CFFO/NOA (Cash Flow from Operating Activities)/(Net Operating Assets)
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FSA 3321 – Summer (2007)
Exam 2 – Version 1
Moore
Use the following information for problems 14 through 20
ABC Company was established in 2005 and sells product warranty contracts on household
appliances. These product service contracts last for 4 years. In the first year (2005), all
$12,000,000 of contract sales were credited to revenue. In 2006, the auditor caught the
error in accounting and forced ABC to adjust its accounts to reflect service contract liabilities.
Assume a tax rate of 30%.
14. Adjust ABC’s 2005 books to reflect the recognition future service contract liabilities.
a. $12,000,000 increase to long-term liabilities and $12,000,000 decrease to revenues
b. $9,000,000 increase to long-term liabilities and $9,000,000 decrease to revenues
c. $3,000,000 reduction of long-term liabilities and $9,000,000 decrease to revenues
d. $3,000,000 increase to current liabilities and $9,000,000 decrease to revenues
e. $3,000,000 increase to long-term liabilities and $9,000,000 decrease to revenues
15. Adjust ABC’s 2005 books to properly reflect service contract liabilities. The adjustment to
reduce net income would be:
a. $12,000,000
b. $9,000,000
c. $8,400,000
d. $6,300,000
e. $3,000,000
16. How much 2005 service contract sales should be recognized in 2006?
a. $9,000,000
b. $8,400,000
c. $6,300,000
d. $3,000,000
e. $2,100,000
17. The overall decrease to Owners’ Equity in 2005 for ABC after adjustment would be?
a. $12,000,000
b. $9,000,000
c. $8,400,000
d. $6,300,000
e. $3,000,000
18. Which organization has the legal authority to establish US accounting standards?
a. AICPA
b. CPA
c. FASB
d. IASB
e. SEC
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FSA 3321 – Summer (2007)
Exam 2 – Version 1
Moore
19. Which organization has the legal authority to establish US accounting standards?
a. AICPA
b. CPA
c. FASB
d. IASB
e. SEC
20. In the movie “The Balance Sheet Barrier”, what type of business was used for the
purpose of relating financial statement accounts to business activities?
a. Fork Manufacturer
b. Spoon Manufacturer
c. Knife Manufacturer
d. Plate Manufacturer
e. Cup Manufacturer
Problem 1 – Overs and Unders (20 Points)
Analyze the following transactions (omissions or incorrect accounting treatments) and assess
whether the accounts are Overstated, Understated, or No Effect. Fill in the appropriate
boxes as (O), (U), (N)
Assets
1
The company recorded all proceeds
from service contracts sold in the
current year, despite the fact that
service contracts have a 4-year
contract life
2
The company overstated the
writedown (impairment) of plant
assets due to a corporate
restructuring
3
The company failed to write-down
obsolete inventory
4
The company used too large a
growth rate in future medical costs in
estimating "other" post-retirement
benefits
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Liabilities
Equity
Revenues
Expenses
Net Income