FSA 3321 – Summer (2008)
Exam 2 – Version 1
Moore
Second Examination – Finance 3321
Summer 2008 (Moore) – Version 1
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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 asset 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 (2008)
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 medical testing equipment. ABC, however, used operating lease accounting in its
first year of operations. Assume the average lifespan of ABC’s leased equipment is 10 years
and that their annual cost of debt is 7.06%. The annual lease payments are $4,100,000.
The present value of the future lease payments is $28,717,000 (rounded). ABC’s industry
commonly uses straight-line depreciation and the effective tax rate is 30%.
5. Adjust ABC’s books to reflect the lease as being capitalized. The adjusted long term lease
liability at the end of the third year would be:
a. $41,000,000
b. $32,800,000
c. $28,717,000
d. $22,049,958
e. $23,084,042
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. $4,100,000
b. $2,871,700
c. $4,000,000
d. $758,804
e. $41,000,000
7. Adjust ABC’s books to reflect the lease as being capitalized. Compute the appropriate
charge for interest expense in the second year.
a. $2,072,580
b. $2,027,420
c. $2,218,904
d. $1,881,096
e. $1,724,441
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. $4,752,796 Lower
b. $3,326,957 Higher
c. $652,796 Lower
d. $559,384 Lower
e. $456,957 Lower
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FSA 3321 – Summer (2008)
Exam 2 – Version 1
Moore
9. Channel Stuffing is defined as:
a. Earnings Management
b. Shipping unordered merchandise and recording the revenues
c. Intense marketing plans
d. Flexible Accounting
e. Conservative Accounting
10. What is the first 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 third 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
12. Assume a company has been classified as belonging in a purely highly competitive
(commodity) industry. Which one of the following disclosures would be considered a key
accounting policy?
a. Net Sales/Warranty Liabilities
b. Inventory is measured on a Lifo basis at lower of cost or market
c. Disclosure regarding new product development R&D expenses
d. Disclosure regarding same store sales relative to prior year
e. Disclosure regarding the revenue recognition principle used
13. Assume a company has been classified as belonging in a purely differentiated product
(specialty) industry. Which one of the following disclosures would be not be considered
a key accounting policy?
a. Disclosure regarding product returns and warranties
b. Disclosure regarding R&D outcomes leading to new patents
c. Disclosure regarding cost cutting activities
d. Disclosure regarding new investment in marketing programs
e. Disclosure regarding new products introduced to the market
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FSA 3321 – Summer (2008)
Exam 2 – Version 1
Moore
Use the following information for problems 14 through 20
ABC Company was established in 2007 and sells both household appliances and product
warranty contracts on household appliances. These product service contracts last for 5
years. On June 30, 2007, ABC sold $15,000,000 of contract sales and credited all proceeds
to 2007 to revenue. In 2008, 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%. ABC has
a December 31 fiscal year end.
14. Adjust ABC’s 2007 books to reflect the recognition future service contract liabilities.
a. $15,000,000 increase to long-term liabilities and $15,000,000 decrease to revenues
b. $13,500,000 increase to long-term liabilities and $13,500,000 decrease to revenues
c. $9,000,000 increase to long-term liabilities and $12,000,000 decrease to revenues
d. $3,000,000 increase to current liabilities and $13,500,000 decrease to revenues
e. $3,000,000 increase to current liabilities and $9,000,000 increase to long-term
liabilities
15. Adjust ABC’s 2007 books to properly reflect service contract liabilities. The adjustment to
reduce net income would be:
a. $12,000,000
b. $9,450,000
c. $9,000,000
d. $6,300,000
e. $3,000,000
16. How much 2007 service contract sales should be recognized in 2008?
a. $9,000,000
b. $8,400,000
c. $6,000,000
d. $3,000,000
e. $1,500,000
17. The overall decrease to Owners’ Equity in 2007 for ABC after adjustment would be?
a. $12,000,000
b. $9,450,000
c. $9,000,000
d. $6,300,000
e. $3,000,000
18. Which organization has been delegated the responsibility to establish US accounting
standards?
a. AICPA
b. CPA
c. FASB
d. IASB
e. SEC
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FSA 3321 – Summer (2008)
19. In
a.
b.
c.
d.
e.
Exam 2 – Version 1
Moore
the earnings management literature, income smoothing will only result in:
Overstated reported earnings
Understated earnings
Companies taking the “big bath”
Either understated or overstated earnings
Cannot be answered
20. In the movie “The Control of Working Capital”, what type of business strategy (key
success factors) did John Cleese (tall guy) apply to his business?
a. Differentiated market strategies when operating in a commodity goods market
b. Differentiated market strategies when operating in a specialty goods market
c. Cost leadership market strategies when operating in a specialty goods market
d. Cost leadership market strategies when operating in a commodity goods market
e. Insufficient information to address question
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FSA 3321 – Summer (2008)
Exam 2 – Version 1
Moore
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 half the
proceeds from 4-year service contracts
sold in the current year
2
The company understated the
writedown (impairment) of plant assets
due to a corporate restructuring
3
The company took a big bath regarding
the write-down obsolete inventory
4
The company used too small a growth
rate in future medical costs in
estimating "other" post-retirement
benefits
5
The company improperly capitalized
equipment maintenance costs
6
Google failed to write down impaired
auction rate securities investments
7
The company improperly capitalized
R&D costs
8
The company depreciated assets over
a 5 year life when a 10 year life is
appropriate.
9
The company failed to increase its
allowance for doubtful accounts rate
when customer credit quality declined
10
The company shipped unordered
merchandise to a customer and
recorded the shipment as a sale
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Liabilities
Equity
Revenues Expenses Net Income