Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
Ques�on 1
Which of the following inventory methods is not allowed under IFRS?
A. LIFO.
B. FIFO.
C. Weighted average.
D. Specific iden�fica�on
Correct Answer: A
(Choice A)
This answer is correct because the LIFO method for inventory is not allowed under
IFRS. However, FIFO, weighted average, and specific iden�fica�on (for certain
inventory) are allowed.
(Choice B)
This answer is incorrect because FIFO is an allowable inventory method under IFRS.
(Choice C)
This answer is incorrect because weighted average is an allowable inventory method
under IFRS.
(Choice D)
This answer is incorrect because specific iden�fica�on (for certain inventory) is an
allowable inventory method under IFRS
Ques�on 2
A lease is considered a finance lease if any of five specific condi�ons are true. Which of
the following is not one of those condi�ons?
A. The lease contains a bargain purchase op�on.
B. The present value of the minimum lease payments exceeds approximately half
of the fair value of the underlying asset.
C. The underlying asset is so specialized for the lessee that it is expected to have no
alterna�ve future use to the lessor at the end of the lease term.
D. The lease automa�cally transfers ownership of the asset to the lessee at the end
of the lease term.
Correct Answer: B
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice A)
This answer is incorrect. This is one of the five condi�ons for a lease to be considered a
finance lease.
(Choice B) The correct criterion is if the present value of the minimum lease payments
exceeds substan�ally all of the fair value of the underlying asset. While no bright line
exists here, the FASB has given a guideline of 90% of the fair market value of the asset
when determining whether the minimum lease payments are for “substan�ally all” of
the asset's value.
(Choice C) This answer is incorrect. This is one of the five condi�ons for a lease to be
considered a finance lease.
(Choice D) This answer is incorrect. This is one of the five condi�ons for a lease to be
considered a finance lease
Ques�on 3
A company has the following liabili�es at year-end:
Mortgage note payable; $16,000 due within 12 months
Short-term debt that the company has refinanced with long-term
debt shortly a�er year-end but prior to the issuance of the financial
statements
Deferred tax liability arising from book and tax differences in
deprecia�on
$355,000
$175,000
$25,000
What amount should the company include in the current liability sec�on of the balance
sheet?
A. $0
B. $ 16,000
C. $ 41,000
D. $191,000
Correct Answer: B
(Choice A)
This answer is incorrect. The mortgage note payable has a por�on due within the next
year, which would be counted as a current.
(Choice B)
This answer is correct. Determine the amount to be included in the current liability
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
sec�on of the balance sheet. Although the mortgage note payable is a long-term
liability, the amount due within the next 12 months, $16,000, should be reclassified to
the current liability sec�on of the balance sheet. The short-term debt that the
company is refinancing with long-term debt is reclassified as a long-term liability
because the company has completed the refinancing prior to the issuance of the
financial statements. Deferred tax assets and liabili�es are classified as noncurrent by
defini�on. Therefore, the only item that should be included in the current liability
sec�on of the balance sheet is the $16,000 of long-term debt that is due within the
next 12 months.
(Choice C)
This answer is incorrect. This answer correctly counts the current por�on of the
mortgage note due within 12 months ($16,000), but incorrectly includes the deferred tax
liability arising from deprecia�on ($25,000). Deferred tax assets and liabili�es are
classified as noncurrent by defini�on.
(Choice D)
This answer is incorrect. This answer correctly counts the current por�on of the
mortgage note due within 12 months ($16,000), but incorrectly includes the short-term
debt that has been refinanced ($175,000). Because it is refinanced with long term debt,
it will not be counted as a current liability. Together, these two items total to
$191,000 = $16,000 + $175,000
Ques�on 4
A firm has just signed a 6-year lease on a new standardized machine, a�er which the
machine will be returned to the lessor.
•
•
•
•
•
Fair value of the machine is $450,000
Lease payments are $75,000 per year, payable at the end of the year.
The machine has a 10-year useful life.
The firm’s incremental borrowing cost is 8%.
The PV of an ordinary annuity having 6 payments of $1 at 8% is $4.6229.
The lease should be classified as:
A. opera�ng lease.
B. finance lease.
C. rental lease.
D. long-term lease.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
Correct Answer: A
(Choice A)
To be an opera�ng lease, a lease must not sa�sfy any of the five criteria for classifying
a lease as a finance lease established by the FASB. In this case, the lease fails all five
criteria. First, the firm does not take ownership of the machine at the end of the lease.
Second, the firm does not have the op�on to purchase the machine at the end of the
lease for substan�ally below expected market value (a bargain purchase op�on).
Third, the machine is not specialized or customized to the lessee, meaning the lessor
can s�ll use it a�er the end of the lease. Fourth, the present value of the minimum
lease payments is less than “substan�ally all” of the fair value of the asset. The FASB
guideline for this criterion is 90% of the fair value. The present value of the minimum
lease payments is $346,718 (75,000 × 4.6229). This represents 77% of the $450,000 fair
value of the machine. Fi�h, the lease term is less than “a major part” of the remaining
economic life of the asset. The FASB guideline for this criterion is 75% of the remaining
economic life. The lease is for 6 years and the machine has an expected useful life of
10 years. This represents 60% of the remaining economic life.
(Choice B)
This answer is incorrect. To be classified as a finance lease, a lease needs to sa�sfy one
of five criteria for classifying a lease as a finance lease established by the FASB.
(Choice C)
This answer is incorrect. The FASB does not classify leases as “rental leases.”’
(Choice D)
This answer is incorrect. The FASB does not classify leases as “long-term leases.”
Ques�on 5
Which of the following statements concerning the accoun�ng for intangible assets under
Interna�onal Financial Repor�ng Standards (IFRS) and US Generally Accepted
Accoun�ng Principles (GAAP) is correct?
A. Under both US GAAP and IFRS a company can carry intangible assets at
amor�zed cost or fair value.
B. Under both US GAAP and IFRS a company must carry intangible assets at
amor�zed cost.
C. Under US GAAP a company can carry intangible assets at amor�zed cost or fair
value, while under IFRS intangible assets must be carried at amor�zed cost.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
D. Under US GAAP intangible assets must be carried at amor�zed cost while IFRS
allows a company to carry intangible assets at amor�zed cost or fair value.
Correct Answer: D
(Choice A)
This answer is incorrect. US GAAP does not allow companies to revalue intangible assets
to fair value.
(Choice B)
This answer is incorrect. IFRS allows companies to revalue intangible assets to market
value if there is an ac�ve market for the assets.
(Choice C)
This answer is incorrect. US GAAP does not allow companies to revalue intangible assets
to fair value, but IFRS does allow companies to revalue intangible assets to fair value, as
long as there is an ac�ve market for the assets.
(Choice D)
Correct. While US GAAP and IFRS are similar in many ways, there are some differences
between the two approaches to accoun�ng. One difference is the accoun�ng for
intangible assets. Under US GAAP, companies must carry intangible assets at
amor�zed cost. On the other hand, IFRS allows companies to carry intangible assets at
either amor�zed cost or to revalue them to fair value. The only requirement to using
fair value is that there must be an ac�ve market for the assets.
Ques�on 6
An en�ty is in its first year of business. Business opera�ons are expected to be profitable
in the foreseeable future. The items being sold are covered by an atached warranty. No
items were reported by customers as defec�ve this year, but some are es�mated to fail
next year so the en�ty has accrued the related warranty expense in its financial records.
Which of the following is a result of this situa�on?
A. The en�ty will recognize a deferred tax asset.
B. The en�ty will not have deferred taxes this year.
C. The en�ty will recognize a deferred tax liability.
D. The en�ty will recognize both a deferred tax asset and a deferred tax liability.
Correct Answer: A
(Choice A)
This answer is correct. The expense is recorded in the current year for financial
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
repor�ng purposes. Since the sale is made this year, the related expense is
appropriately recognized this year. However, for taxes purposes, warranty costs can
only be deducted when a payment is made and that will not happen un�l the future.
Thus, taxable income currently will be higher (the deduc�on is not yet allowed) but
will be reduced in the future (when the warranty cost is finally deducted). That impact
is reported as a deferred income tax asset.
(Choice B)
This answer is incorrect. Because a temporary difference exists between the financial
books and the tax books (the financial books recorded an expense this year, while the
tax books will report a deduc�on next year), a deferred tax asset will exist. This is
because the future warranty cost will reduce taxable income when the deduc�on is
recognized. This is the defini�on of a deferred tax asset.
(Choice C)
This answer is incorrect. Because a temporary difference exists between the financial
books and the tax books (the financial books recorded an expense this year, while the
tax books will report a deduc�on next year), a deferred tax asset will exist. This is
because the future warranty cost will reduce taxable income when the deduc�on is
recognized. This is the defini�on of a deferred tax asset.
(Choice D)
This answer is incorrect. Because a temporary difference exists between the financial
books and the tax books (the financial books recorded an expense this year, while the
tax books will report a deduc�on next year), a deferred tax asset will exist. This is
because the future warranty cost will reduce taxable income when the deduc�on is
recognized. This is the defini�on of a deferred tax asset. It would not create a deferred
tax liability
Ques�on 7
A firm has just signed an 8-year lease on a typical new machine.
• Fair value of the machine is $100,000.
• Lease payments are $18,000 per year, payable at the end of the year.
• The machine has an es�mated salvage value of $5,000 at the end of the lease
term.
• The machine has a 10-year useful life.
• The firm's incremental borrowing cost is 8%.
This lease should be classified as:
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
A. Opera�ng.
B. Conven�onal.
C. Unable to determine from informa�on provided.
D. Finance
Correct Answer: D
(Choice A)
This answer is incorrect. The useful life of the machine is 10 years and the lease is for 8
years. Because the lease period is for a major part of the remaining economic life of the
underlying asset (greater than 75% of the expected useful life of the asset), this meets
the criteria for a finance lease.
(Choice B)
This answer is incorrect. This is not a classifica�on for a lease.
(Choice C)
This answer is incorrect. The fair value tests and useful life tests can be performed for
this lease, and those will determine if it is finance or opera�ng.
(Choice D)
This answer is correct. The useful life of the machine is 10 years and the lease is for 8
years. Because the lease period is for a major part of the remaining economic life of
the underlying asset (greater than 75% of the expected useful life of the asset), it must
be classified as a finance lease.
Ques�on 8
Which of the following statements concerning the accoun�ng for share-based
compensa�on under Interna�onal Financial Repor�ng Standards (IFRS) and US Generally
Accepted Accoun�ng Principles (GAAP) is correct?
A. US GAAP mandates that companies use the fair value method to measure sharebased compensa�on while IFRS allows companies to use the intrinsic value
method.
B. US GAAP allows companies to use the intrinsic value method to measure sharebased compensa�on in some situa�ons, while IFRS mandates the fair value
method.
C. Both US GAAP and IFRS mandate that companies use the fair value method to
measure share-based compensa�on.
D. Both US GAAP and IFRS mandate that companies use the intrinsic value method
to measure share-based compensa�on
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
Correct Answer: B
(Choice A)
This answer is incorrect. US GAAP allows companies to use the intrinsic value method in
limited circumstances, but IFRS mandates that companies use the fair value method.
(Choice B)
Correct. While US GAAP and IFRS are similar in many ways, there are some differences
between the two approaches to accoun�ng. One difference is the accoun�ng for
share-based compensa�on (for example, stock op�ons). Under US GAAP, companies
are allowed to use the intrinsic value method to value share-based compensa�on in
limited situa�ons. The intrinsic value method is (Market Price − Strike Price) × Number
of Op�ons. IFRS prohibits the use of the intrinsic value method and requires the fair
value method to value share-based compensa�on. If an ac�ve market does not exist
for the share-based award, the most common valua�on technique used in applying
the fair value method is a pricing model such as the Black-Scholes op�on valua�on
model.
(Choice C)
This answer is incorrect. US GAAP allows companies to use the intrinsic value method in
limited circumstances.
(Choice D)
This answer is incorrect. IFRS prohibits the use of the intrinsic value method to measure
share-based compensa�on.
Ques�on 9
All of the following statements concerning the Assurance Warranty approach to
accoun�ng for warran�es is correct except:
A. Under the Assurance Warranty approach, no revenue is recorded for warran�es.
B. Under the Assurance Warranty approach, no expense is recorded when warranty
services are performed.
C. Under the Assurance Warranty approach, a liability for deferred revenue is
recorded when a product is sold with an atached warranty.
D. The Assurance Warranty approach is used for warran�es that are automa�cally
included when a product is purchased.
Correct Answer: C
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice A)
This answer is incorrect. The Assurance Warranty approach is used when a warranty is
automa�cally included in the purchase of a product. As a result, no revenue is recorded
for the warranty.
(Choice B)
This answer is incorrect. Under the Assurance Warranty approach, the expense expected
to be incurred over the life of a warranty and an off-se�ng liability is accrued when the
product is sold. When services are performed, no expense is recorded because
expenditures reduce the liability ini�ally accrued.
(Choice C)
Under the Assurance Warranty approach, a warranty liability is recorded for the
expenditures expected to be incurred during the life of the warranty. No deferred
revenue is involved because the atached warranty is not separated from the product
sold.
(Choice D)
This answer is incorrect. The Assurance Warranty approach is used when a warranty is
automa�cally included when a product is purchased.
Ques�on 10
On December 31, Year 1, Taylor, Inc. signed a binding agreement with a bank for the
refinancing of an exis�ng note payable scheduled to mature in February, Year 2. The
terms of the refinancing included extending the maturity date of the note by three
years. On January 15, Year 2, the note was refinanced. How should Taylor report the
note payable in its December 31, Year 1, balance sheet?
A. A current liability
B. A long-term liability
C. A long-term note receivable
D. A current note receivable
Correct Answer: B
(Choice A)
This answer is incorrect. A note is normally considered a current liability if it is due and
payable in one year. However, if a company has both the intent and ability to refinance
the debt on a long-term basis, the note can be classified as a long-term liability in the
December 31, Year 1, balance sheet. Therefore, this answer is incorrect.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice B)
This answer is correct. A note is normally considered a current liability if it is due and
payable in one year. However, if a company has both the intent and ability to refinance
the debt on a long-term basis, the note can be classified as a long-term liability in the
December 31, Year 1, balance sheet. Therefore, this answer is correct.
(Choice C)
This answer is incorrect. This is a payable, not a receivable.
(Choice D)
This answer is incorrect. This is a payable, not a receivable
Ques�on 11
The HJK Company sells a product for $2,500. Because the product does not have a
manufacturer’s warranty, HJK Company offers a separate warranty for purchase.
Customers have the op�on of purchasing a three-year warranty at the �me of sale for
$180 and HJK expects that related warranty expenditures will be incurred evenly over
the three-year warranty period. All sales of this product are made near the beginning of
HJK’s fiscal year. HJK sold 1,000 units and 900 warran�es in its first year of opera�ons
and 1,500 units and 1,200 warran�es in its second year of opera�ons. HJK spent $24,000
on services covered under warran�es in its first year of opera�ons and $89,000 in its
second year of opera�ons. What amount of deferred warranty revenue should HJK
report at the end of Year 2?
A. $198,000
B. $252,000
C. $108,000
D. $126,000
Correct Answer: A
(Choice A)
Correct. There are two general approaches to accoun�ng for warran�es. If a warranty
is offered separately for an addi�onal fee when a product is sold, the service warranty
approach is used. Under this approach, the amount received for the separate warranty
is treated as a liability (deferred revenue) and is recorded into revenue over the period
of the warranty. In Year 1, HJK received $162,000 for the 900 warran�es sold (900 ×
$180). This is ini�ally recorded as deferred revenue and then recorded into revenue
evenly over the three-year warranty period ($54,000 in Year 1, Year 2, and Year 3). At
the end of Year 1, $108,000 would be reported as deferred revenue ($162,000 −
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
$54,000). In Year 2, HJK received $216,000 for the 1,200 warran�es sold (1,200 × $180).
This is ini�ally recorded as deferred revenue and then recorded into revenue evenly
over the three-year warranty period ($72,000 in Year 2, Year 3, and Year 4). These
transac�ons result in a deferred revenue balance of $198,000 ($108,000 + $216,000 −
$54,000 − $72,000).
(Choice B)
This answer is incorrect. Some of the deferred revenue collected in Year 1 will be
recognized as revenue in Year 2.
(Choice C)
This answer is incorrect. This is the deferred warranty revenue balance at the end of Year
1.
(Choice D)
This answer is incorrect. This is the amount of warranty revenue recognized in Year 2.
Ques�on 12
All of the following statements concerning valua�on allowances and deferred taxes are
correct except:
A. Valua�on allowances are most o�en required for deferred tax liabili�es.
B. Valua�on allowances are required when it is more likely than not that a company
will not have sufficient future taxable income for the tax benefit represented by a
deferred tax asset to be fully realized.
C. Income tax expense increases when a valua�on allowance for a deferred tax
asset is recorded.
D. Once established, a valua�on account for a deferred tax asset can be reduced if
new evidence indicates that more of the tax benefits of the deferred tax asset
will be received
Correct Answer: A
(Choice A)
Like any asset, the carrying value of deferred tax assets should reflect the benefits
expected to be received from that asset. If it is more likely than not that the full
benefit will not be received, the carrying value must be reduced. Deferred tax
liabili�es are not assessed for the likelihood that the full amount will be incurred and,
hence, no allowance is used for deferred tax liabili�es.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice B)
This answer is incorrect. Like any asset, the carrying value of deferred tax assets should
reflect the benefits expected to be received from that asset. If it is more likely than not
that the full benefit will not be received, the carrying value must be reduced. Rather
than directly reduce the value of the deferred tax asset, a valua�on allowance is created
to reduce its carrying value.
(Choice C)
This answer is incorrect. The increase in a deferred tax asset valua�on allowance results
in an increase to income tax expense.
(Choice D)
This answer is incorrect. At the end of each repor�ng period, the likelihood that the
benefits of deferred tax assets will be received must be evaluated. If the valua�on
allowance is too large, it must be reduced. The reduc�on in valua�on allowance also
reduces income tax expense for the period.
Ques�on 13
Which of the following statements concerning differences between US GAAP and IFRS is
correct?
A. US GAAP and IFRS account for capitalized interest for self-constructed assets in
the same way.
B. US GAAP and IFRS both consider asset impairment at the cash-genera�ng unit
(CGU) level.
C. A fixed asset comprised of separately iden�fiable components is generally
depreciated as one asset under US GAAP and as separate components under
IFRS.
D. Accoun�ng for research and development expenditures is the same under US
GAAP and IFRS.
Correct Answer: C
(Choice A)
This answer is incorrect. Under US GAAP interest that could have been avoided if the
produc�on or construc�on of an asset was not undertaken is capitalized. Under IFRS
only interest that is directly atributable to a project is capitalized.
(Choice B)
This answer is incorrect. Impairment is considered at the individual asset level under US
GAAP.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice C)
Under IFRS, assets that can be separated into component parts are separated when
determining deprecia�on expense. Under US GAAP, the asset is generally treated as
one item when determining deprecia�on expense.
(Choice D)
This answer is incorrect. Accoun�ng for research expenditures is the same but
accoun�ng for development expenditures differs. Under IFRS, development costs for
internally generated intangible assets can be capitalized once technological feasibility is
established. Under US GAAP, only development costs for so�ware development can be
capitalized. All other development costs are expensed as incurred
Ques�on 14
Which of the following statements concerning asset impairment under Interna�onal
Financial Repor�ng Standards (IFRS) and US Generally Accepted Accoun�ng Principles
(GAAP) is correct?
A. US GAAP and IFRS both use a two-step test for asset impairment.
B. US GAAP uses a two-step test for asset impairment, while IFRS uses a one-step
test for asset impairment.
C. US GAAP and IFRS both use a one-step test for asset impairment.
D. US GAAP uses a one-step test for asset impairment, while IFRS uses a two-step
test for asset impairment.
Correct Answer: B
(Choice A)
This answer is incorrect. IFRS uses a one-step test for asset impairment.
(Choice B)
Correct. While US GAAP and IFRS are similar in many ways, there are some differences
between the two approaches to accoun�ng. One difference involves asset impairment.
Under US GAAP, the test for asset impairment is a two-step process. The first step is
the recoverability test. The recoverability test compares the asset’s book value (Cost −
Accumulated Deprecia�on) to the sum of the undiscounted cash flows expected from
the asset. If the undiscounted cash flows are higher, the asset is “recoverable,” and no
impairment exists. In this case, the second step is not performed. In the second step,
the asset’s fair value is compared to its book value. Under IFRS the test for asset
impairment is a one step approach. In this one step, the recoverable amount of the
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
cash genera�ng unit (CGU) is compared to the carrying value of the CGU to determine
if asset impairment has occurred.
(Choice C)
This answer is incorrect. US GAAP uses a two-step test for asset impairment.
(Choice D)
This answer is incorrect. US GAAP uses a two-step test for asset impairment, while IFRS
uses a one-step test for asset impairment.
Ques�on 15
A company prepared the following journal entries at the end of its first two years in
business:
Year 1
Dr. Income tax
expense
Dr. Deferred tax
asset
Year 2
Dr. Income tax
expense
125,000
25,000
Cr. Income tax payable
150,000
125,000
Cr. Deferred tax asset
Cr. Income tax payable
7,500
117,500
Which of the following statements is correct about this company?
A. This company owed the IRS the same amount in Years 1 and 2.
B. This company had less future taxable amounts at the end of Year 2 than at the
end of Year 1.
C. This company reported a different tax expense on its GAAP income statement in
Years 1 and 2.
D. This company had higher future deduc�ble amounts at the end of Year 1 than at
the end of Year 2.
Correct Answer: D
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice A)
This answer is incorrect. Income tax expense is not the amount a company owes to the
IRS.
(Choice B)
This answer is incorrect. Deferred tax liabili�es measure future taxable amounts.
(Choice C)
This answer is incorrect. Income tax payable is not the amount reported on the GAAP
income statement.
(Choice D)
Correct. Temporary differences occur when revenue or expenses are recorded in
different periods under GAAP and the tax code. Deferred tax assets are created when
temporary differences create future deduc�ble amounts. Another way of looking at it
is deferred tax assets are created when current taxable income is higher than current
GAAP income. In this example, the deferred tax asset decreases in Year 2. This means
that the future deduc�ble amount decreases during Year 2. As a result, the company
had higher future deduc�ble amounts in Year 1.
Ques�on 16
Robbins, Inc., leased a machine from Ready Leasing Co. The lease qualifies as a finance
lease and requires 10 annual payments of $10,000, with the first payment due at the
end of the year. The lease specifies an interest rate of 12% and a purchase op�on of
$10,000 at the end of the tenth year, even though the machine's es�mated value on that
date is $20,000. Robbins’ incremental borrowing rate is 14%. What amount should
Robbins record as lease liability at the beginning of the lease term?
A. $59,722
B. $66,502
C. $53,282
D. $56,502
Correct Answer: A
(Choice A)
The present value of the lease payments:
Calculator steps: Clear All
Enter 10 in the N key
Enter 12 in the I/YR key
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
Enter 10,000 in the PMT key
Hit PV: –56,502 is the present value of the lease payments.
The present value of the bargain purchase op�on:
Calculator steps: Clear All
Enter 10 in the N key
Enter 12 in the I/YR key
Enter 10,000 in the FV key
Hit PV: –3,220 is the present value of the bargain purchase op�on.
The present value of the finance lease = $56,502 + $3,220 = $59,722.
Since the 12% interest rate implicit in the lease is known, the implicit rate is used
rather than the 14% incremental borrowing rate. The minimum lease payments
include the op�on payment since it is a bargain purchase op�on.
To calculate the present value of the lease payments with the Time Value Tables, select
the Present Value of an Annuity table and look for the factor where 10 Payments and
12% intersect, which is 5.6502. Mul�ply $10,000 by 5.6502 to get $56,502. To calculate
the present value of the bargain purchase op�on with the Time Value Tables, select
the Present Value of $1 table and look for the factor where 10 Periods and 12%
intersect, which is 0.3220. Mul�ply $10,000 by 0.3220 to get $3,220. The present value
of the finance lease = $56,502 + $3,220 = $59,722.
(Choice B) This answer is incorrect. This answer represents the present value of the lease
payments plus the current value of the bargain purchase op�on.
(Choice C) This answer is incorrect. This answer represents the present value of the lease
payments with the present value of the bargain purchase op�on subtracted instead of
added.
(Choice D) This answer is incorrect. This answer represents the present value of the
lease payments only and does not include the present value of the bargain purchase
op�on.
Ques�on 17
Kaitlyn runs a public U.S. company that o�en does a lot of business with companies in
London and Ireland. Sean runs a public company in London that o�en does business
with many companies in the U.S. What is implied here about their repor�ng standards?
A. Kaitlyn will likely use GAAP, whereas Sean will likely use IFRS.
B. Kaitlyn will likely use IFRS, whereas Sean will likely use GAAP.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
C. Both Sean and Kaitlyn will likely use GAAP.
D. Both Sean and Kaitlyn will likely use IFRS
Correct Answer: A
(Choice A)
Public companies in the U.S. are required to use U.S. GAAP when preparing financial
statements, regardless of the amount of business they do with companies outside the
U.S. Public companies in London are required to use IFRS when preparing financial
statements regardless of the amount of business they do with companies in the U.S.
This means Kaitlyn will likely use U.S. GAAP and Sean will likely use IFRS. Therefore,
this is the correct answer.
(Choice B)
Public companies in the U.S. are required to use U.S. GAAP when preparing financial
statements, regardless of the amount of business they do with companies outside the
U.S. Public companies in London are required to use IFRS when preparing financial
statements regardless of the amount of business they do with companies in the U.S. This
means Kaitlyn will likely use U.S. GAAP, not IFRS, and Sean will likely use IFRS, not U.S.
GAAP. Therefore, this is an incorrect answer.
(Choice C)
Public companies in the U.S. are required to use U.S. GAAP when preparing financial
statements, regardless of the amount of business they do with companies outside the
U.S. Public companies in London are required to use IFRS when preparing financial
statements regardless of the amount of business they do with companies in the U.S.
While Kaitlyn will likely use U.S. GAAP, Sean will likely use IFRS, not U.S. GAAP. Therefore,
this is an incorrect answer.
(Choice D)
Public companies in the U.S. are required to use U.S. GAAP when preparing financial
statements, regardless of the amount of business they do with companies outside the
U.S. Public companies in London are required to use IFRS when preparing financial
statements regardless of the amount of business they do with companies in the U.S.
While Sean will likely use IFRS, Kaitlyn will likely use U.S. GAAP, not IFRS. Therefore, this
is an incorrect answer
Ques�on 18
The underlying asset for Lease A is so specialized for the lessee that it is expected to
have no alterna�ve future use to the lessor at the end of the lease term; however, Lease
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
A does not contain a bargain purchase op�on. The lease term for Lease B is less than
75% of the es�mated economic life of the leased property, but Lease B does transfer
ownership of the property to the lessee by the end of the lease term. How should the
lessee classify Lease A and Lease B, respec�vely?
A. Finance lease; Finance lease
B. Finance lease; Opera�ng lease
C. Opera�ng lease; Finance lease
D. Opera�ng lease; Opera�ng lease
Correct Answer: A
(Choice A)
Because the underlying asset for Lease A is so specialized for the lessee that it is
expected to have no alterna�ve future use to the lessor at the end of the lease term,
Lease A is classified as a finance lease. Because Lease B transfers ownership of the
property to the lessee by the end of the lease term, Lease B is classified as a finance
lease.
(Choice B)
This answer is incorrect. Because Lease B transfers ownership of the property to the
lessee by the end of the lease term, Lease B is classified as a finance lease.
(Choice C)
This answer is incorrect. Because the underlying asset for Lease A is so specialized for
the lessee that it is expected to have no alterna�ve future use to the lessor at the end of
the lease term, Lease A is classified as a finance lease.
(Choice D)
This answer is incorrect. Both leases are finance leases. Evaluate each lease based on the
five criteria to determine if a lease should be recorded as a finance lease.
Ques�on 19
Consider the following two leases for an asset that has an economic life of 12 years and
has a $200,000 fair value. What is the correct classifica�on of each lease?
Lease term
Present value of minimum
lease payments
Lease A
Lease B
7 years
8 years
$185,000 $175,000
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
A. Lease A is an opera�ng lease and Lease B is a finance lease.
B. Both are opera�ng leases.
C. Lease A is a finance lease and Lease B is an opera�ng lease.
D. Both are finance leases
Correct Answer: C
(Choice A)
This answer is incorrect. “Substan�ally all of the fair value of the underlying asset” is
generally understood to be at least 90% of the asset’s fair market value. In addi�on, “the
major part of the remaining economic life of the asset” is generally understood to be at
least 75% of the asset’s remaining economic life.
(Choice B)
This answer is incorrect. Minimum lease payments of 90% or more of an asset’s fair
market value qualifies as exceeding substan�ally all of the fair value of the underlying
asset.
(Choice C)
Correct. Leases are classified as either finance leases or opera�ng leases. Two of the
criteria used to classify leases are the lease term and the present value of the
minimum lease payments. Generally, if the lease term exceeds 75% of the asset’s
remaining economic life, the lease is a finance lease. Neither lease sa�sfies that
requirement. Generally, if the present value of the minimum lease payments is 90% or
more of the fair market value of the asset, the lease is a finance lease. Lease A sa�sfies
this requirement, but Lease B does not. Since Lease A sa�sfies one of the criteria, it is a
finance lease. Since Lease B does not, it is an opera�ng lease.
(Choice D)
This answer is incorrect. If a lease does not sa�sfy any of the specific criteria spelled out,
it is an opera�ng lease
Ques�on 20
Which of the following statements concerning accoun�ng for income taxes is correct?
A. Permanent differences do not result in deferred tax assets and liabili�es while
all temporary differences result in deferred tax assets and liabili�es.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
B. All permanent differences result in deferred tax assets and liabili�es while
temporary differences do not result in deferred tax assets and liabili�es.
C. All permanent differences and all temporary differences result in deferred tax
assets and liabili�es.
D. Some permanent differences and some temporary differences result in deferred
tax assets and liabili�es.
Correct Answer: A
(Choice A)
Correct. Taxable income under GAAP is calculated differently than taxable income
under the tax code. Differences between these two calcula�ons are classified as either
permanent differences or temporary differences. Permanent differences occur when
GAAP revenue is never taxable, or GAAP expenses are never deduc�ble. Permanent
differences are differences that never reverse or reconcile over �me. As a result, these
never result in deferred tax assets and liabili�es. Temporary or �ming differences
occur when revenues or expenses are recorded in different periods under GAAP and
the tax code. These differences will eventually reverse or reconcile over �me. As a
result, temporary differences always result in deferred tax assets and liabili�es.
(Choice B)
This answer is incorrect. No permanent differences reverse themselves and all
temporary differences reverse themselves.
(Choice C)
This answer is incorrect. No permanent differences reverse themselves.
(Choice D)
This answer is incorrect. No permanent differences reverse themselves and all
temporary differences reverse themselves
Ques�on 21
Clack Co. sold 3,000 televisions in Year 1, with a two-year assurance warranty. The
warranty was es�mated to cost $5 per television. Actual warranty costs were $8,000 in
Year 1, and $9,000 in Year 2.
How much warranty expense would Clack Co. report in Year 2 under the assurance
warranty method?
If the warranty had been sold separately for cash, how much warranty expense would
Clack Co. report in Year 2 under the service warranty method?
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
A. $1,000, $9,000
B. $2,000, $17,000
C. $2,000, $9,000
D. $1,000, $17,000
Correct Answer: C
(Choice A)
This answer is incorrect. Under the assurance warranty method, the expected warranty
expense is accrued at �me of sale. This answer incorrectly gives the difference between
Year 1 warranty costs and Year 2 warranty costs of $1,000 ($9,000 − $8,000). Under the
service warranty method, actual warranty costs are expensed as incurred; $9,000 in Year
2.
(Choice B)
This answer is incorrect. Under the assurance warranty method, the expected warranty
expense is accrued at �me of sale. Thus, $15,000 (3,000 televisions × $5/television). In
Year 2, the total warranty cost is $17,000 ($8,000 + $9,000). Thus, $2,000 ($17,000
− $15,000) is the expense amount needed to make total warranty costs equal the total
expense. Under the service warranty method, actual warranty costs are expensed as
incurred. This answer incorrectly adds both Year 1 ($8,000) and Year 2 ($9,000) costs
together when calcula�ng the expense amount.
(Choice C)
This answer is correct. Under the assurance warranty method, the expected warranty
expense is accrued at �me of sale. Thus, $15,000 (3,000 televisions × $5/television). In
Year 2, the total warranty cost is $17,000 ($8,000 + $9,000). Thus, $2,000 ($17,000
− $15,000) is the expense amount needed to make total warranty costs equal the total
expense. Under the sales method, actual warranty costs are expensed as incurred;
$9,000 in Year 2.
(Choice D) This answer is incorrect. Under the assurance warranty method, the expected
warranty expense is accrued at �me of sale. This answer incorrectly gives the difference
between Year 1 warranty costs and Year 2 warranty costs of $1,000 ($9,000 − $8,000).
Under the service warranty method, actual warranty costs are expensed as incurred.
This answer incorrectly adds both Year 1 ($8,000) and Year 2 ($9,000) costs together
when calcula�ng the expense amount
Ques�on 22
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
In 20X1 the ABC Company purchased inventory for $50,000. In December of 20X1, ABC
wrote down the inventory to $35,000 because it believed its value was permanently
impaired. In Q1 of 20X2, the value of the inventory increased to $51,000. How would
ABC value the inventory at the end of Q1 20X2 in accordance with US GAAP and IFRS,
respec�vely?
A. $35,000 and $35,000
B. $35,000 and $51,000
C. $51,000 and $35,000
D. $35,000 and $50,000
Correct Answer: D
(Choice A)
This answer is incorrect. IFRS allows companies to write up inventory that was previously
writen down because of lower of cost or net realizable value issues.
(Choice B)
This answer is incorrect. IFRS allows for inventory to be writen back up to original cost.
(Choice C)
This answer is incorrect. US GAAP does not allow companies to write up inventory that
was previously writen down because of lower of cost or net realizable value issues. In
addi�on, IFRS allows companies to write up inventory that was previously writen down
because of lower of cost or net realizable value issues.
(Choice D)
Correct. While US GAAP and IFRS are similar in many ways, there are some differences
between the two approaches to accoun�ng. One difference concerns wri�ng up
inventory that was previously writen down because of lower of cost or net realizable
value issues. Under US GAAP, write-ups are only allowed if the write-down and writeup occur within the same fiscal year. That is not the case here. On the other hand, IFRS
does allow recovery of previous write-downs (back to original cost) regardless of when
the recovery occurs
Ques�on 23
Which of the following statements concerning accoun�ng for long-lived tangible assets
under Interna�onal Financial Repor�ng Standards (IFRS) and US Generally Accepted
Accoun�ng Principles (GAAP) is correct?
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
A. Under US GAAP and IFRS a company can carry long lived tangible assets at
depreciated cost or fair value.
B. Under US GAAP a company must carry long-lived tangible assets at depreciated
cost, while under IFRS a company can carry long-lived tangible assets at
depreciated cost or fair value.
C. Under US GAAP and IFRS a company must carry long lived tangible assets at
depreciated cost.
D. Under US GAAP a company can carry long-lived tangible assets at depreciated
cost or fair value, while under IFRS a company must carry long-lived tangible
assets at depreciated cost
Correct Answer: B
(Choice A)
This answer is incorrect. US GAAP mandates that long lived tangible assets be carried at
depreciated cost.
(Choice B)
Correct. While US GAAP and IFRS are similar in many ways, there are some differences
between the two approaches to accoun�ng. One difference is the accoun�ng for longlived tangible assets. Under US GAAP long-lived tangible assets must be carried at
depreciated cost (unless they are impaired). On the other hand, IFRS gives companies
the choice between carrying long-lived tangible assets at depreciated cost or fair
value. The only s�pula�on to using fair value is that it must be possible to reliably
es�mate an asset’s fair value.
(Choice C)
This answer is incorrect. IFRS allows companies to revalue long-lived tangible assets to
fair value if the fair value can be reliably es�mated.
(Choice D)
This answer is incorrect. US GAAP mandates that long lived tangible assets be carried at
depreciated cost. In addi�on, IFRS allows companies to revalue long-lived tangible assets
to fair value if the fair value can be reliably es�mated.
Ques�on 24
The LMK Company includes a three-year warranty with each unit of the product it sells.
LMK es�mates that each unit will require an average of $60 of warranty services over
the three year warranty period. LMK sold 1,000 units in its first year of opera�ons and
1,200 in its second year of opera�ons. LMK spent $18,000 on services covered under
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
warran�es in its first year of opera�ons and $46,000 in its second year of opera�ons.
What amount of es�mated warranty liability should LMK record at the end of Year 2?
A. $42,000
B. $72,000
C. $68,000
D. $26,000
Correct Answer: C
(Choice A)
This answer is incorrect. This is the es�mated warranty liability at the end of Year 1.
(Choice B)
This answer is incorrect. This is the warranty expense for Year 2.
(Choice C)
Correct. There are two general approaches to accoun�ng for warran�es. If a warranty
is automa�cally included in the sale of a product, the assurance warranty approach is
used. An es�mate is made concerning future expenditures under the warranty. This
amount is recorded as an expense and a liability when the warranty begins. Actual
expenditures for warranty services reduce the es�mated liability. In Year 1, the
es�mated liability increased by $60,000 for 1,000 units sold (1,000 × $60) and
decreased by $18,000 for actual warranty expenditures. This results in an ending
balance of $42,000. During Year 2, the es�mated liability increased by $72,000 for
1,200 units sold (1,200 × $60) and decreased by $46,000 for actual warranty
expenditures. This results in an ending balance of $68,000 ($42,000 + $72,000 −
$46,000).
(Choice D)
This answer is incorrect. This is the increase in the es�mated warranty liability during
Year 2.
Ques�on 25
The OJY Company sells a product for $4,500. Customers have the op�on of purchasing a
three-year warranty at the �me of purchase for $240. OJY sold 2,000 units and 1,600
warran�es in its first year of opera�ons and 2,400 units and 1,800 warran�es in its
second year of opera�ons. OJY spent $80,000 on services covered under warran�es in its
first year of opera�ons and $240,000 in its second year of opera�ons. What amount of
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
deferred warranty revenue should OJY report at the end of Year 2 assuming it recognizes
warranty revenue on a straight-line basis?
A. $256,000
B. $272,000
C. $544,000
D. $416,000
Correct Answer: D
(Choice A)
This answer is incorrect. This is the deferred warranty revenue balance at the end of Year
1.
(Choice B)
This answer is incorrect. This is the amount of warranty revenue recognized in Year 2.
(Choice C)
This answer is incorrect. Some of the deferred revenue collected in Year 1 will be
recognized as revenue in Year 2.
(Choice D)
Correct. There are two general approaches to accoun�ng for warran�es. If a warranty
is offered separately for an addi�onal fee when a product is sold, the service warranty
approach is used. Under this approach, the amount received for the separate warranty
is treated as a liability (deferred revenue) and is recorded into revenue over the period
of the warranty. In Year 1, OJY received $384,000 for the 1,600 warran�es sold (1,600 ×
$240). This is ini�ally recorded as deferred revenue and then recorded into revenue
evenly over the three-year warranty period ($128,000 in Year 1, Year 2, and Year 3). At
the end of Year 1, $256,000 would be reported as deferred revenue ($384,000 −
$128,000). In Year 2, OJY received $432,000 for the 1,800 warran�es sold (1,800 ×
$240). This is ini�ally recorded as deferred revenue and then recorded into revenue
evenly over the three-year warranty period ($144,000 in Year 2, Year 3, and Year 4).
These transac�ons result in a deferred revenue balance of $416,000 ($256,000 +
$432,000 − $128,000 − $144,000).
Ques�on 26
All of the following statements concerning impairment are correct except:
A. Under US GAAP impairment is considered at the individual asset level, while
under IFRS impairment is considered at the cash-genera�on level unit.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
B. Under US GAAP goodwill is independently tested for impairment, while under
IFRS goodwill is not independently tested for impairment.
C. Reversals of previous asset impairments are not allowed under either US GAAP
or IFRS.
D. Under US GAAP depreciable assets are tested for impairment with a 2-step test,
while under IFRS CGU's are tested for impairment with a 1-step test
Correct Answer: C
(Choice A)
This answer is incorrect. US GAAP considers impairment at the individual asset level,
while IFRS considers impairment at the cash-genera�on level unit.
(Choice B)
This answer is incorrect. Since IFRS does not consider impairment at the individual asset
level, it does not independently test for goodwill.
(Choice C)
IFRS allows companies to reverse previous impairment losses on assets if the assets
recover at least part of their value. US GAAP does not allow this.
(Choice D)
This answer is incorrect. IFRS uses a 1-step impairment test.
Ques�on 27
A firm leases a piece of machinery having an 8-year expected life for 4 years. The lease
was properly classified as an opera�ng lease. A�er the ini�al lease ended, the company
signed a second lease for the same machinery for another 4 years with the same terms
as the ini�al lease (same annual payment, same implied discount rate, etc.). Assuming
the market value and the overall expected life of the machine has not materially
changed during the 4 years, how should this new lease be classified?
The lease should be classified as:
A. an opera�ng lease since the ini�al lease was classified as an opera�ng lease and
subsequent leasing of the same machinery would be automa�cally classified as
an opera�ng lease.
B. a finance lease since the ini�al lease was classified as an opera�ng lease and
subsequent leasing of the same machinery would be automa�cally classified as a
finance lease.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
C. a finance lease since it sa�sfies one of the criteria established by the FASB for
classifying a lease as a finance lease.
D. an opera�ng lease since the lease term is for only 50% of the machine’s
expected useful life.
Correct Answer: C
(Choice A)
This answer is incorrect. The classifica�on of a second lease is not based on the
classifica�on of the ini�al lease.
(Choice B)
This answer is incorrect. The classifica�on of a second lease is not based on the
classifica�on of the ini�al lease.
(Choice C)
To be classified as a finance lease, a lease only needs to sa�sfy one of five criteria for
classifying a lease as a finance lease established by the FASB. In this case, the lease
term is more than “a major part” of the remaining economic life of the asset. The FASB
guideline for this criterion is 75% of the remaining economic life. The lease is for 4
years and the machine has an expected useful life of 4 more years since it ini�ally was
expected to last 8 years. This represents 100% of the remaining economic life.
(Choice D)
This answer is incorrect. The lease term criterion should be applied to the remaining
expected useful life, not the original expected useful life
Ques�on 28
Loan
#
1
Start Date
Maturity
Date
6/14/20X1 6/13/20X6
2
3/12/20X5 3/12/20X6
3
5/10/20X2 5/10/20X6
Refinancing Details
Agreement to refinance for 6 years signed
2/1/20X6
Agreement to refinance for 1 year signed
3/1/20X6
Agreement to refinance for 4 years signed
12/1/20X5
Assuming the company’s opera�ng cycle is 94 days and financial statements are issued
on 2/25/20X6, which loan or loans would be classified as a long-term liability on the
December 31, 20X5 balance sheet?
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
A. Loans 1 and 3 only
B. Loan 3 only
C. Loans 1, 2, and 3
D. Loan 1 only
Correct Answer: A
(Choice A)
Correct. Liabili�es need to be classified as either current or long term. A current
liability is one that is expected to be sa�sfied with current assets or by providing
services within one year or one opera�ng cycle of the balance sheet date, whichever is
longer. Liabili�es that do not qualify as current are classified as long term. A liability
that appears to be current can be classified as long term if the company has the
inten�on and ability to refinance the liability such that the due date is beyond one
year or one opera�ng cycle (whichever is longer) of the balance sheet date. If the
refinancing is finalized a�er the balance sheet date but before the financial statements
are issued, then the liability is classified as long term. Loan 2 does not qualify as a
long-term liability since the refinancing agreement is not in place when the financial
statements are issued. Loans 1 and 3 qualify as long-term liabili�es even though they
are originally due within one year of the balance sheet date since the refinancing
agreements are in place before the financial statements are issued.
(Choice B)
This answer is incorrect. Refinancing agreements do not need to be in place prior to the
end of the fiscal year to qualify as a long-term liability.
(Choice C)
This answer is incorrect. To qualify as a long-term liability, a refinancing agreement that
extends the due date beyond one year a�er the balance sheet date must be signed
before financial statements are issued.
(Choice D)
This answer is incorrect. A refinancing agreement can be in place prior to the end of the
fiscal year to qualify a loan as a long-term liability
Ques�on 29
On January 1, 20X5, Blaugh Co. signed a lease for an office building. The terms of the
lease required Blaugh to pay $10,000 annually, beginning December 30, 20X5, and
con�nuing each year for 30 years. The lease qualifies as a finance lease. On January 1,
20X5, the present value of the lease payments is $112,578 at the 8% interest rate
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
implicit in the lease. In Blaugh’s December 31, 20X5, balance sheet, the finance lease
liability should be:
A. $111,584.
B. $102,578.
C. $112,578.
D. $121,584.
Correct Answer: A
(Choice A)
The finance lease liability is calculated below.
Present value at 1/1/X5
Payment made 12/30/X5
Interest por�on for 20X5 (8%
× $112,578)
$112,578
$10,000
$ 9,006
Por�on applied to the liability
Finance lease liability
12/31/X5
$ 994
$111,584
(Choice B)
This answer is incorrect. Remember to calculate the interest on the lease and subtract
that amount from the total payment made to find the amount of reduc�on in the
finance lease liability.
(Choice C)
This answer is incorrect. Remember to consider interest due to the passage of �me, the
payment made on December 30, 20X5 and how these affect the finance lease liability.
(Choice D)
This answer is incorrect. Remember that the amount owed in interest for 20X5 is
included in the payment made at 12/30/X5. Subtract the amount of interest calculated
from the total payment made to find the amount of reduc�on in the finance lease
liability
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
Ques�on 30
Consider the following two leases for an asset that has an economic life of 16 years and
has a $300,000 fair value. What is the correct classifica�on of each lease?
Lease term
Present value of minimum lease
payments
Bargain purchase op�on?
Lease X
Lease Y
11 years 16 years
$250,000 $300,000
YES
NO
A. Lease X is an opera�ng lease and Lease Y is a finance lease.
B. Both are opera�ng leases.
C. Lease X is a finance lease and Lease Y is an opera�ng lease.
D. Both are finance leases.
Correct Answer: D
(Choice A)
This answer is incorrect. “The major part of the remaining economic life of the asset” is
typically defined as at least 75% of the asset’s remaining economic life. In addi�on,
leases having a bargain purchase op�on are always finance leases.
(Choice B)
This answer is incorrect. A lease must sa�sfy only one of the specific criteria spelled out
to be classified as a finance lease. It does not need to sa�sfy all criteria.
(Choice C)
This answer is incorrect. A lease does not need to include a bargain purchase op�on to
be a finance lease.
(Choice D)
Correct. Leases are classified as either finance leases or opera�ng leases. Two of the
criteria used to classify leases are the lease term and the present value of the
minimum lease payments. Generally, if the lease term exceeds 75% of the asset’s
remaining economic life, the lease is a finance lease. Lease X does not sa�sfy this
requirement, but Lease Y does. If the present value of the minimum lease payments is
90% or more of the fair market value of the asset, the lease is a finance lease. Lease X
does not sa�sfy this requirement, but Lease Y does. If a lease has a bargain purchase
op�on, the lease is a finance lease. Lease X sa�sfies this requirement, but Lease Y does
not. Since each lease sa�sfies at least one of the criteria, they are both finance leases.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
Ques�on 31
A�er its first year of opera�ons, a company has a deferred tax liability of $30,000. If the
company’s marginal tax rate is 25%, what is the correct interpreta�on of this?
A. The company had $30,000 less taxable income than GAAP income.
B. The company’s future tax liability will be $30,000 lower than its GAAP tax
expense.
C. The company had $30,000 more taxable income than GAAP income.
D. The company’s future tax liability will be $30,000 higher than its GAAP tax
expense
Correct Answer: D
(Choice A)
This answer is incorrect. The company did have less taxable income than GAAP income.
However, the $30,000 is the tax implica�on of this difference, not the difference itself.
(Choice B)
This answer is incorrect. A deferred tax liability arises from future taxable amounts, not
future deduc�ble amounts.
(Choice C)
This answer is incorrect. A deferred tax liability arises when a company has less taxable
income than GAAP income. In addi�on, the $30,000 is the tax implica�on of the
difference between GAAP income and taxable income, not the difference itself.
(Choice D)
Correct. Temporary differences occur when revenue or expenses are recorded in
different periods under GAAP and the tax code. Deferred tax liabili�es arise when
temporary differences create future taxable amounts. Deferred tax liabili�es are
created when current taxable income is lower than current GAAP income. This means
that the company’s future tax liability will be higher by the amount of the deferred tax
liability when the temporary difference reverses itself. In this example, the company’s
current taxable income is $120,000 lower than its GAAP pretax income ($30,000 ÷
25%)
Ques�on 32
A consul�ng company won a $20.8 million three-year contract. The contract requires
so�ware development, hos�ng, and maintenance over three years. The total es�mated
cost of the project is $17 million, with $10 million expected in Year 1, $5 million in Year
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
2, and $2 million in Year 3. The billing schedule shows that $5 million will be billed upon
start of the work, and then $5 million at each year end. At the end of the first year, the
actual cost incurred is $9 million, and total es�mated costs are unchanged at $17
million. Using the percentage-of-comple�on method, how much revenue should be
recognized at the end of the first year?
A. $11 million
B. $10 million
C. $5 million
D. No revenue
Correct Answer: A
(Choice A)
Under the percentage-of-comple�on method of revenue recogni�on, revenue is
recognized based on the ra�o of actual costs incurred to complete a contract to the
total costs expected to be incurred to complete a contract. The amount billed is not
related to the amount of revenue recognized. At the end of the first year, $9 million of
the total expected cost to complete the contract of $17 million has been incurred. This
means that revenue of $11 million should be recognized at the end of the first year
[($9 ÷ $17) × $20.8 million].
(Choice B)
This answer is incorrect. The total billings at the end of the first year of the contract are
$10 million. However, revenue recogni�on is not based on billings under the percentageof-comple�on method.
(Choice C)
This answer is incorrect. $5 million is billed at the end of the first year of the contract.
However, revenue recogni�on is not based on the amount billed at the end of the year
under the percentage-of-comple�on method.
(Choice D)
This answer is incorrect. No revenue would be recognized at the end of the first year
under the completed-contract method
Ques�on 33
Which statement concerning accoun�ng for warran�es is correct?
A. The Assurance Warranty approach is used to account for warran�es that are
automa�cally included in the purchase of a product and the Service Warranty
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
approach is used to account for extended warran�es that are sold separately
from the product for addi�onal revenue.
B. The Service Warranty approach is used to account for warran�es that are
automa�cally included in the purchase of a product and the Assurance Warranty
approach is used to account for extended warran�es that are sold for addi�onal
revenue separately from the product.
C. Firms must use either the Service Warranty approach or the Assurance Warranty
approach for all of its warran�es (whether included in the purchase of the
product or sold separately for addi�onal revenue) when accoun�ng for
warran�es.
D. Firms can elect, on a warranty by warranty basis, whether to use the Service
Warranty approach or the Assurance Warranty approach for any warranty.
Correct Answer: A
(Choice A)
Under the Assurance Warranty approach, the expected expense to be incurred under a
warranty automa�cally included in the purchase of a product is expensed and a
liability accrued when the product is sold. Under the Service Warranty approach, the
revenue from an extended warranty is recorded as a liability when sold and then
recorded as revenue over the life of the warranty.
(Choice B)
This answer is incorrect. Under the Service Warranty approach, the revenue from an
extended warranty is deferred and earned over the extended warranty period. Under
the Assurance Warranty approach, no revenue from a warranty is recorded separately
from the revenue from the product.
(Choice C)
This answer is incorrect. There is no requirement that firms use the same accoun�ng
approach for all its warran�es (whether included in the purchase of the product or sold
separately for addi�onal revenue).
(Choice D)
This answer is incorrect. The Service Warranty approach is not appropriate for all types
of warran�es and the Assurance Warranty approach is not appropriate for all types of
warran�es
Ques�on 34
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
Consider the following two leases for an asset that has an economic life of 20 years and
has a $400,000 fair value. What is the correct classifica�on of each lease?
Lease term
Present value of minimum lease
payments
Type of asset
Lease 1
13 years
$275,000
Lease 2
16 years
$300,000
Specialized General
purpose
A. Both are finance leases.
B. Lease 1 is a finance lease and Lease 2 is an opera�ng lease.
C. Lease 1 is an opera�ng lease and Lease 2 is a finance lease.
D. Both are opera�ng leases.
Correct Answer: A
(Choice A)
Correct. Leases are classified as either finance leases or opera�ng leases. Three of the
criteria used to classify leases are the lease term, the present value of the minimum
lease payments, and the specializa�on of the asset. Generally, if the lease term
exceeds 75% of the asset’s remaining economic life, the lease is a finance lease. Lease
1 does not sa�sfy this requirement, but Lease 2 does. If the present value of the
minimum lease payments is 90% or more of the fair market value of the asset, the
lease is a finance lease. Neither lease sa�sfies this requirement. If a lease involves a
specialized asset, the lease is a finance lease. Lease 1 sa�sfies this requirement, but
Lease 2 does not. Since each lease sa�sfies at least one of the criteria, they are both
finance leases.
(Choice B)
This answer is incorrect. “A major part of the remaining economic life of the asset” is
typically defined as at least 75% of the asset’s remaining economic life.
(Choice C)
This answer is incorrect. Leases involving specialized assets are finance leases.
(Choice D)
This answer is incorrect. A lease must only sa�sfy one of the specific criteria spelled out
to be classified as a finance lease. It does not need to sa�sfy all criteria.
Ques�on 35
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
A company has the following loans:
Loan
#
1
Start Date
Maturity
Date
2/12/20X5 2/12/20X6
2
5/10/20X1 5/10/20X6
3
6/14/20X2 6/13/20X6
Refinancing Details
Agreement to refinance for 2 years signed
3/1/20X6
Agreement to refinance for 2 years signed
3/1/20X6
Agreement to refinance for 4 years signed
2/18/20X6
Assuming the company’s opera�ng cycle is 112 days and financial statements are issued
on 2/27/20X6, which loan or loans would be classified as a long-term liability on the
December 31, 20X5 balance sheet?
A. Loan 2 only
B. Loans 1, 2, and 3
C. Loans 2 and 3 only
D. Loan 3 only
Correct Answer: C
(Choice A)
This answer is incorrect. Refinancing agreements do not need to be in place prior to the
end of the fiscal year to qualify as a long-term liability.
(Choice B)
This answer is incorrect. To qualify as a long-term liability, a refinancing agreement that
extends the due date beyond one year a�er the balance sheet date must be signed
before financial statements are issued.
(Choice C)
Correct. Liabili�es need to be classified as either current or long term. A current
liability is one that is expected to be sa�sfied with current assets or by providing
services within one year or one opera�ng cycle of the balance sheet date, whichever is
longer. Liabili�es that do not qualify as current are classified as long term. A liability
that appears to be current can be classified as long term if the company has the
inten�on and ability to refinance the liability such that the due date is beyond one
year or one opera�ng cycle (whichever is longer) of the balance sheet date. If the
refinancing is finalized a�er the balance sheet date but before the financial statements
are issued, then the liability is classified as long term. Loan 1 does not qualify as a
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
long-term liability since the refinancing agreement is not in place when the financial
statements are issued. Loans 2 and 3 qualify as long-term liabili�es even though they
are originally due within one year of the balance sheet date, since the refinancing
agreements are in place before the financial statements are issued.
(Choice D)
This answer is incorrect. A refinancing agreement can be in place prior to the end of the
fiscal year to qualify a loan as a long-term liability
Ques�on 36
In its first year of opera�ons, the XYZ Company reported taxable income on its tax return
of $400,000. Addi�onal informa�on from XYZ is below:
Excess of tax deprecia�on over book
deprecia�on
Life insurance proceeds on its CFO
Interest expense paid on its bonds
Es�mated bad debt expense over actual
write-offs
Fines paid
$20,000
$25,000
$6,000
$1,000
$2,000
How much pretax income was reported on XYZ’s GAAP income statement?
A. $442,000
B. $419,000
C. $423,000
D. $436,000
Correct Answer: A
(Choice A)
There are two types of differences between GAAP pretax income and taxable income
on a tax return. The first type are permanent differences. These are GAAP revenues
that are never taxable and GAAP expenses that are never deduc�ble. Examples include
life insurance proceeds on the death of an insured execu�ve and fines paid due to
viola�ons of the law. The second type are temporary differences. These occur when
revenue or expenses are recorded in different periods for GAAP and tax purposes. The
$25,000 life insurance proceeds and the $2,000 in fines are permanent differences and
the $20,000 excess deprecia�on and the $1,000 es�mated bad debt expense are
temporary differences. The $25,000 in life insurance proceeds is added to the taxable
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
income because it was not included in the taxable income calcula�on but is included in
GAAP income, the $2,000 in fines is subtracted from taxable income because it was
not included in the taxable income calcula�on but is an expense for GAAP purposes,
the $20,000 in excess deprecia�on is added to taxable income because it is not
currently an expense for GAAP purposes, and the $1,000 es�mated bad debt expense
over actual write-offs is subtracted from taxable income because it is currently an
expense for GAAP purposes. This results in pretax income on XYZ’s GAAP income
statement of $442,000 ($400,000 + $25,000 – $2,000 + $20,000 – $1,000).
(Choice B)
This answer is incorrect. Permanent differences also impact the difference between
GAAP pretax income and taxable income on a tax return.
(Choice C)
This answer is incorrect. Temporary differences also impact the difference between
GAAP pretax income and taxable income on a tax return.
(Choice D)
This answer is incorrect. Interest expense on bonds is not a temporary or permanent
difference
Ques�on 37
If a company recognizes total lease-related expense of $50,000 in the first year of a
finance lease, how much expense would it recognize in the second year of the lease,
assuming lease payments are the same each year?
A. $50,000
B. More than $50,000
C. Whether it is more or less than $50,000 depends on the lease details (for
example, annual lease payments, lease term, and the interest rate used).
D. Less than $50,000
Correct Answer: D
(Choice A)
This answer is incorrect. One component of the lease-related expense changes from
year to year for a finance lease.
(Choice B) This answer is incorrect. No component of the lease-related expense
increases from year to year for a finance lease.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice C)
This answer is incorrect. Whether total lease-related expense for a finance lease
increases or decreases from year to year is not based on lease details.
(Choice D)
There are two components of the lease-related expense recognized for a finance lease.
One component is the amor�za�on of the right-of-use asset created at the beginning
of the lease. This amount does not change from year to year. The second component is
interest on the lease liability. Since the lease liability decreases each year (by the
difference between the lease payment and the annual interest on the liability), the
interest expense decreases each year.
Ques�on 38
Which of the following statements concerning asset impairment under Interna�onal
Financial Repor�ng Standards (IFRS) and US Generally Accepted Accoun�ng Principles
(GAAP) is correct?
A. US GAAP and IFRS measure asset impairment at the individual asset level.
B. US GAAP and IFRS measure asset impairment at the CGU level.
C. US GAAP measures asset impairment at the CGU level while IFRS measures asset
impairment at the individual asset level.
D. US GAAP measures asset impairment at the individual asset level, while IFRS
measures asset impairment at the CGU level
Correct Answer: D
(Choice A)
This answer is incorrect. IFRS measures asset impairment at the cash genera�ng unit
(CGU) level.
(Choice B)
This answer is incorrect. US GAAP does not use the CGU concept when assessing asset
impairment.
(Choice C)
This answer is incorrect. US GAAP does not use the CGU concept when assessing asset
impairment. In addi�on, IFRS measures asset impairment at the CGU level.
(Choice D)
Correct. While US GAAP and IFRS are similar in many ways, there are some differences
between the two approaches to accoun�ng. One difference involves asset impairment.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
Under US GAAP asset impairment is measured at the individual asset level. Under IFRS
asset impairment is measured at the CGU level. A CGU is defined as the smallest level
of assets that generates cash independently of other assets in the company. A CGU
typically consists of more than one asset, typically a division or business line.
Ques�on 39
A manufacturer produced 80,000 units and sold them for $1,200 each. The company
es�mates that 4% of the units will have a defect which will cost an es�mated $95 each
to repair. During this year, the company honored $159,000 in actual assurance-type
warranty costs. Using the assurance warranty approach, what would be the balance of
the warranty liability account at the end of its first year of opera�ons?
A. $463,000.
B. $304,000.
C. $159,000.
D. $145,000
Correct Answer: D
(Choice A)
Incorrect. Expenditures from honoring warran�es reduces the liability, not increases it.
(Choice B)
Incorrect. The warranty expense is $304,000.
(Choice C)
Incorrect. The actual warranty cost incurred is not the same as the ending balance of the
es�mated liability.
(Choice D)
Correct. There are two general approaches to accoun�ng for warran�es. If a warranty
is automa�cally included in the sale of a product, the assurance warranty approach is
used. An es�mate is made concerning future expenditures under the warranty. This
amount is recorded as an expense and a liability when the warranty begins. Actual
expenditures for warranty services reduce the es�mated liability. From the 80,000
units sold, approximately 3,200 will have the defect (80,000 × 4%). The es�mated
liability increased by $304,000 for these 3,200 units (3,200 × $95). Since $159,000 in
claims were honored, the ending balance of the liability is $145,000 ($304,000 −
$159,000).
Ques�on 40
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
Coveted Candy (CC), a well-known candy manufacturer and distributor, follows IFRS. CC
recently entered into a lease for a new commerical mixer. The mixer is worth $2,000
which is less than 1% of the fair value of the assets of CC. How should CC treat this
lease?
A. CC should record an asset as part of the lease signing, but not a liability because
the lease is for an immaterial asset.
B. CC should record a liability as part of the lease signing, but not an asset because
the lease is for an immaterial asset.
C. CC is required to record an asset and a liability for all leases under IFRS.
D. CC should expense the payments under the lease as incurred because the
leased asset is immaterial.
Correct Answer: D
(Choice A)
IFRS does not require the recording of an asset or liability for leases of immaterial assets.
(Choice B)
IFRS does not require the recording of an asset or liability for leases of immaterial assets.
(Choice C)
IFRS does not require the recording of an asset or liability for leases of immaterial assets.
(Choice D)
IFRS does not require the recording of an asset or liability for leases of immaterial
assets. Rather, the payments under these leases are expensed as incurred.
Ques�on 41
Which of the following statements concerning the Service Warranty approach to
accoun�ng for warran�es is correct?
A. Under the Service Warranty approach, a liability for the es�mated expected
expenses over the life of the warranty is recorded when the warranty is sold.
B. Under the Service Warranty approach, a liability for deferred revenue is
recorded when a warranty is sold.
C. Under the Service Warranty approach, no expense is recorded over the life of
the warranty.
D. The Service Warranty approach is used for warran�es that are automa�cally
included when a product is purchased
Correct Answer: B
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice A)
This answer is incorrect. Under the Service Warranty approach, expenses are recorded
because services are performed under the warranty. Because expenses are not recorded
un�l services are performed, no liability for future expenses is accrued when the
warranty is sold.
(Choice B)
The Service Warranty approached is used when an extended warranty is sold
separately from the underlying product. Since the seller promises to provide services
under the warranty for a period of �me, the revenue from the warranty will be earned
over that period of �me. This means that the seller has a liability for deferred revenue
when the warranty is sold.
(Choice C)
This answer is incorrect. Under the Service Warranty approach, expenses are recorded
because services are performed under the warranty.
(Choice D)
This answer is incorrect. The Assurance Warranty approach is used when a warranty is
automa�cally included when a product is purchased.
Ques�on 42
Which of the following statements is not an example of something that results in a lease
being classified as a finance lease?
A. The lessee has the right to purchase the asset at the end of the lease for
significantly below its expected market value.
B. The lease term is for 50% of the asset’s remaining economic life.
C. The present value of the minimum lease payments exceeds substan�ally all of
the fair value of the underlying asset.
D. The leased asset is very specialized and customized for the lessee.
Correct Answer: C
(Choice A)
This answer is incorrect. When a lease has a bargain purchase op�on, the lessee is
receiving some of the rights and benefits of ownership of the asset.
(Choice B)
Correct. Leases are classified as either finance leases or opera�ng leases. A finance
lease is treated like the lessee is borrowing money and purchasing an asset, while an
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
opera�ng lease is where the lessee is receiving the right to use (rent) an asset for a
period of �me. If a lease sa�sfies at least one of the following criteria, it is classified as
a finance lease. Otherwise, it is an opera�ng lease. The five criteria are: (1) the lease
term is for a major part of the remaining economic life of the asset, (2) the present
value of the minimum lease payments exceeds substan�ally all of the fair value of the
underlying asset, (3) ownership of the asset is transferred to the lessee at the end of
the lease term, (4) the underlying asset is so specialized for the lessee that it is
expected to have no alterna�ve future use to the lessor, and (5) there is an op�on to
purchase the asset at a price significantly below expected market value (a “bargain
purchase op�on”). Fi�y percent of the asset’s remaining economic life does not qualify
as “a major part” of the remaining economic life of an asset. The guideline for “a major
part” is 75% or more of the asset’s remaining economic life.
(Choice C)
This answer is incorrect. When the present value of the minimum lease payments
exceeds substan�ally all of the fair value of the underlying asset, the lessee is receiving
some of the rights and benefits of ownership of the asset.
(Choice D)
This answer is incorrect. A specialized and customized asset is expected to have no
alterna�ve future use to the lessor at the end of the lease term.
Ques�on 43
Big Seller Co. sells a TV and Speaker combina�on for $510 dollars. The TV is delivered
immediately, and the speakers are shipped to the customer later that week. The TV sells
alone for $380 dollars, and the speakers sell alone for $190 dollars. How much revenue
should Big Seller Co. recognize from the TV when sold as part of the combo?
A. $400
B. $170
C. $340
D. $380
Correct Answer: C
(Choice A)
This is an incorrect answer. Some por�on of the selling price would be allocated to the
speakers.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice B)
This is an incorrect answer. This is the amount of revenue that would be allocated to the
speakers.
(Choice C)
To calculate breakdown of the revenue by item, the standalone selling prices are used.
The TV’s propor�on of the standalone selling prices is ($380) ÷ ($380 + $190) = 66.67%.
This percentage is then mul�plied by the selling price of the combina�on; 66.67% ×
$510 = $340.
(Choice D)
This is an incorrect answer. This is the standalone selling price of the TV, not the amount
of revenue that would be recognized from selling it as part of a bundle.
Ques�on 44
In January of 20X1 the ABC Company purchased equipment for $50,000. On December
31, 20X3, the depreciated cost of the equipment was $40,000, but ABC wrote down the
equipment to $24,000 as a result of an impairment review. In 20X4, ABC determined
that the impairment was recovered and the depreciated cost of the equipment on
December 31, 20X4 would be $35,000 based on the original cost of the asset, or $21,000
based on the impaired value. Further, the fair value of the equipment on December 31,
20X4 is $38,000. How would ABC value the equipment at the end of 20X4 in accordance
with US GAAP and IFRS (cost model), respec�vely?
A. $21,000 and $21,000
B. $35,000 and $38,000
C. $38,000 and $21,000
D. $21,000 and $35,000
Correct Answer: D
(Choice A)
This answer is incorrect. IFRS allows companies to write up equipment that was
previously writen down because of impairment issues.
(Choice B)
This answer is incorrect. IFRS allows for equipment to be writen back up to depreciated
cost using the original cost under the cost model. In addi�on, US GAAP does not allow
for reversals of prior impairment losses.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice C)
This answer is incorrect. US GAAP does not allow for reversals of prior impairment
losses. In addi�on, IFRS allows for equipment to be writen back up to depreciated cost
using the original cost under the cost model.
(Choice D)
Correct. While US GAAP and IFRS are similar in many ways, there are some differences
between the two approaches to accoun�ng. One difference concerns reversal of
impairment losses that were previously recognized. Under US GAAP reversal of
impairment losses is not allowed. On the other hand, IFRS does allow recovery of
previous impairment losses under the cost model, up to the original cost of the asset
less the accumulated deprecia�on that would have been recognized to date.
Ques�on 45
IER Corpora�on sells outdoor recrea�onal supplies and equipment to wholesale and
retail customers. Products sold to the wholesale customers are shipped FOB Des�na�on.
Products sold to the retail customers are sold in IER’s stores. IER had the following
transac�ons for the year ended 12/31/X1.
Wholesale products shipped 11/20/X1 - received
12/31/X1
Wholesale products shipped 12/31/X1 - received
1/3/X2
Wholesale products shipped 1/1/X2
Wholesale products on consignment
In-store sales
$40,000
75,000
500
10,000
65,000
How much should IER recognize as revenue this year?
A. $65,000.
B. $105,000.
C. $180,000.
D. $115,000.
Correct Answer: B
(Choice A)
Incorrect. Goods shipped as FOB Des�na�on can be recognized as revenue when the
buyer receives them.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice B)
Correct. When determining when revenue should be recognized, the focus is on when
legal �tle to the goods passes from the seller to the buyer. The $65,000 in-store sales
are recorded as revenue as the �tle passes immediately for in-store sales. Shipping
terms are used to determine when ownership passes from the seller to the buyer for
sales that occur out of a store. When goods are shipped FOB Des�na�on, ownership
does not transfer to the buyer un�l the goods arrive at the buyer’s des�na�on. This
means the seller does not record revenue un�l the goods reach the buyer’s
des�na�on. When goods are shipped FOB Shipping Point, ownership transfers when
the goods leave the seller’s shipping point. This means the seller records revenue as
soon as the goods leave the seller’s shipping point. For IER, the $40,000 in products
shipped on 11/20/X1 are recorded as revenue since they arrive at the buyer’s
des�na�on by the end of X1. The other 2 shipments do not arrive by the end of X1.
This results in a total of $108,000 in revenue for IER ($65,000 + $40,000).
(Choice C)
Incorrect. Goods shipped as FOB Des�na�on are recognized as revenue when goods are
received by the buyer, not when they are shipped.
(Choice D)
Incorrect. Goods delivered on consignment are not counted as revenue un�l they are
sold by the consignee.
Ques�on 46
Which of the following statements concerning warranty accoun�ng is correct?
A. Both the service warranty approach and the assurance warranty approach
involve liabili�es related to warran�es.
B. Both the service warranty approach and the assurance warranty approach
involve revenue from warran�es.
C. The service warranty approach requires the use of es�mates of warranty
expenditures, but the assurance warranty approach does not.
D. Companies can choose between the service warranty approach and the
assurance warranty approach for the same transac�on.
Correct Answer: A
(Choice A)
Correct. There are two general approaches to accoun�ng for warran�es. The
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
appropriate approach depends on the type of warranty involved. If a warranty is
offered separately from a product for an addi�onal price, the service warranty
approach is used. The amount received for the separate warranty is treated as a
liability (deferred revenue) and is earned over the period of the warranty. If a warranty
is automa�cally included in the sale of a product, the assurance warranty approach is
used. An es�mate is made concerning future expenditures under the warranty. This
amount is recorded as an expense and a liability (warranty liability) when the warranty
begins. Therefore, both approaches involve liabili�es related to warran�es.
(Choice B)
This answer is incorrect. The assurance warranty approach is used with warran�es that
are automa�cally included in the sale of a product and no warranty-specific revenue is
recorded.
(Choice C)
This answer is incorrect. Warranty expenditures are expensed as incurred under the
service warranty approach while warranty expense is es�mated and accrued at the �me
of sale under the assurance warranty approach.
(Choice D)
This answer is incorrect. The appropriate warranty accoun�ng approach to use depends
on the type of warranty involved
Ques�on 47
On January 1, Year 1, Harrow Co., as lessee, signed a five year non-cancellable
equipment lease with annual payments of $100,000 beginning December 31, Year 1.
Harrow properly treated this transac�on as a finance lease. The five lease payments
have a present value of $379,000 at January 1, Year 1, based on the implicit interest rate
of 10%. What amount should Harrow report as interest expense for the year ended
December 31, Year 1?
A. $27,900
B. $10,000
C. $37,900
D. $0
Correct Answer: C
(Choice A)
The amount of interest owed at December 31, Year 1, is calculated using the implicit
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
interest rate mul�plied by the January 1, Year 1, present value. This amount should not
be reduced by the $100,000 annual payment prior to calcula�ng the interest.
(Choice B)
The amount of interest owed at December 31, Year 1, is calculated using the implicit
interest rate mul�plied by the January 1, Year 1, present value, not mul�plied by the
annual payment.
(Choice C)
The interest expense for Year 1 is $37,900, the implicit interest rate (10%) mul�plied by
the January 1, Year 1, present value ($379,000).
(Choice D)
Because the finance lease began on January 1, Year 1, a full year of interest is owed by
the �me the payment is made at December 31, Year 1. The amount of interest is
calculated using the implicit interest rate mul�plied by the January 1, Year 1, present
value
Ques�on 48
A company has the following loans:
Loan
#
1
2
3
Start Date
Maturity
Date
6/15/20X5 6/15/20Y1
3/12/20X7 3/12/20Y1
7/10/20X8 7/10/20Y1
Refinancing Details
Agreement to refinance for 6 addi�onal years signed 3/1/20Y1
Agreement to refinance for 4 addi�onal years signed
2/18/20Y1
Agreement to refinance for 3 addi�onal years signed
12/28/20Y0
Assuming the company’s opera�ng cycle is 88 days and financial statements are issued
on 2/27/20Y1, which loan or loans would be classified as a long-term liability on the
December 31, 20Y0 balance sheet?
Correct Answer: C
(Choice A)
This answer is incorrect. Refinancing agreements do not need to be in place prior to the
end of the fiscal year in order to qualify as a long-term liability.
(Choice B)
This answer is incorrect. To qualify as a long-term liability, a refinancing agreement that
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
extends the due date beyond one year a�er the balance sheet date must be signed
before financial statements are issued.
(Choice C)
Correct. Liabili�es need to be classified as either current or long term. A current
liability is one that is expected to be sa�sfied with current assets or by providing
services within one year or one opera�ng cycle of the balance sheet date, whichever is
longer. Liabili�es that do not qualify as current are classified as long term. A liability
that appears to be current can be classified as long term if the company has the
inten�on and ability to refinance the liability such that the due date is beyond one
year or one opera�ng cycle (whichever is longer) of the balance sheet date. If the
refinancing is finalized a�er the balance sheet date but before the financial statements
are issued, then the liability is classified as long term. Loan 1 does not qualify as a
long-term liability since the refinancing agreement is not in place when the financial
statements are issued. Loans 2 and 3 qualify as long-term liabili�es even though they
were originally due within one year of the balance sheet date since the refinancing
agreements are in place before the financial statements are issued.
(Choice D)
This answer is incorrect. A refinancing agreement can be in place prior to the end of the
fiscal year in order to qualify a loan as a long-term liability.
Ques�on 49
Which of the following statements concerning Interna�onal Financial Repor�ng
Standards (IFRS) and US Generally Accepted Accoun�ng Principles (GAAP) is not correct?
A. Under US GAAP and IFRS research costs are expensed as incurred.
B. Under US GAAP a company must carry long-lived tangible assets at depreciated
cost, while under IFRS a company can carry long-lived tangible assets at
depreciated cost or fair value.
C. US GAAP and IFRS allow companies to capitalize interest from general purpose
loans in the cost of long lived assets.
D. Companies can use LIFO (Last-In, First-Out) under US GAAP but not under IFRS
Correct Answer: C
(Choice A)
This answer is incorrect. Under both systems research costs are expensed as incurred.
(Choice B)
This answer is incorrect. Under US GAAP long-lived tangible assets must be carried at
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
depreciated cost (unless they are impaired). On the other hand, IFRS gives companies
the choice between carrying long-lived tangible assets at depreciated cost or fair value,
as long as it is possible to reliably es�mate the asset’s fair value.
(Choice C)
Correct. While US GAAP and IFRS are similar in many ways, there are some differences
between the two approaches to accoun�ng. One difference involves capitalizing
interest. US GAAP allows companies to capitalize interest from general purpose loans
in the cost of long-lived assets, but IFRS only allows interest from loans specifically
atributable to the construc�on or produc�on of a long-lived asset to be capitalized.
(Choice D)
This answer is incorrect. Under US GAAP companies can choose to use LIFO. On the
other hand, companies cannot use LIFO under IFRS.
Ques�on 50
In its first year of opera�ons, the NMT Company reported pretax income on its GAAP
income statement of $500,000. Addi�onal informa�on from NMT is shown below.
Cash collected from customers and taxed in advance of providing
services
Premiums paid on life insurance on insured execu�ves
Interest revenue received on corporate bonds
Fines paid
Excess of tax deprecia�on over book deprecia�on
What is NMT’s taxable income?
A. $569,500
B. $509,500
C. $501,000
D. $459,500
Correct Answer: B
$25,000
$8,500
$12,000
$6,000
$30,000
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice A)
This answer is incorrect. Since tax deprecia�on was higher than book deprecia�on,
taxable income is lower than pretax GAAP income based on this factor.
(Choice B)
Correct. Taxable income under GAAP is calculated differently than taxable income
under the tax code. Differences between the two calcula�ons are classified as either
permanent or temporary. Permanent differences occur when GAAP revenue is never
taxable, or GAAP expenses are never deduc�ble. Temporary differences occur when
revenue or expenses are recorded in different periods under GAAP and the tax code. In
NMT’s case, cash collected and taxed in advance (deferred revenue) and deprecia�on
create temporary differences while the premiums paid on life insurance on insured
execu�ves and fines paid are permanent differences. The interest received on
corporate bonds is treated the same for GAAP and tax purposes. Since the cash
collected in advance is not part of GAAP income but is included in taxable income. The
$25,000 must be added to pretax GAAP income to determine taxable income. The
$30,000 excess of tax deprecia�on must be subtracted from pretax GAAP income to
determine taxable income. Since the $8,500 in life insurance premiums is not
deduc�ble for tax purposes, it must be added back to determine taxable income. In a
similar way, the $6,000 in fines paid must be added back to determine taxable income.
All of these adjustments result in taxable income of $509,500 ($500,000 + $25,000 −
$30,000 + $8,500 + $6,000).
(Choice C)
This answer is incorrect. Premiums paid on life insurance on insured execu�ves are not
deduc�ble for tax purposes.
(Choice D)
This answer is incorrect. The $25,000 cash collected in advance is taxable but not yet
included in GAAP income. This means taxable income is higher than pretax GAAP income
based on this factor.
Ques�on 51
Rachel, Inc. has a $500,000 airport construc�on project contract. The es�mated total
costs are $400,000. In the first year, incurred costs are $200,000 and the project is 45%
complete. Rachel will be recognizing revenue over �me. What amount of revenue will
Rachel recognize if the company u�lizes the following to recognize revenue: output
method based on percentage completed and input method based on costs incurred,
respec�vely?
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
A. $225,000; $250,000
B. $250,000; $225,000
C. $225,000; $0
D. $0; $250,000
Correct Answer: A
(Choice A)
This answer is correct. Using an output method based on percentage completed,
revenue of $225,000 is recognized. This is calculated as $500,000 total contract
revenue mul�plied by 45% complete. Using an input method based on costs incurred,
revenue of $250,000 is recognized. This is calculated by first dividing costs incurred of
$200,000 by es�mated total costs of $400,000 to get 50%. The 50% is then mul�plied
by $500,000 total contract revenue.
(Choice B)
This answer is incorrect. This answer mixed up the two methods.
(Choice C)
This answer is incorrect. Some revenue will be recognized using an input method based
on costs incurred.
(Choice D)
This answer is incorrect. Some revenue will be recognized using an output method based
on percentage completed
Ques�on 52
The NTD Company includes a three-year warranty with each unit of the product it sells.
NTD es�mates that each unit will require an average of $45 of warranty services over
the three year warranty period. NTD sold 1,000 units in its first year of opera�ons and
1,800 in its second year of opera�ons. NTD spent $12,000 on services covered under
warran�es in its first year of opera�ons and $39,000 in its second year of opera�ons.
What amount of es�mated warranty liability should NTD record at the end of Year 2?
A. $33,000
B. $75,000
C. $42,000
D. $81,000
Correct Answer: B
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice A)
This answer is incorrect. This is the es�mated warranty liability at the end of Year 1.
(Choice B)
Correct. There are two general approaches to accoun�ng for warran�es. If a warranty
is automa�cally included in the sale of a product, the assurance warranty approach is
used. An es�mate is made concerning future expenditures under the warranty. This
amount is recorded as an expense and a liability when the warranty begins. Actual
expenditures for warranty services reduce the es�mated liability. In Year 1, the
es�mated liability increased by $45,000 for 1,000 units sold (1,000 × $45) and
decreased by $12,000 for actual warranty expenditures. This results in an ending
balance of $33,000. During Year 2, the es�mated liability increased by $81,000 for
1,800 units sold (1,800 × $45) and decreased by $39,000 for actual warranty
expenditures. This results in an ending balance of $75,000 ($33,000 + $81,000 −
$39,000).
(Choice C)
This answer is incorrect. This is the increase in the es�mated warranty liability during
Year 2.
(Choice D)
This answer is incorrect. This is the warranty expense for Year 2.
Ques�on 53
Which of the following statements concerning accoun�ng for income taxes is correct?
A. Deferred income taxes represent the future tax implica�ons of permanent
differences.
B. The income tax expense recognized on the income statement consists of an
amount currently payable under tax law and a deferred amount related to
changes in tax-affected cumula�ve temporary differences.
C. The deferred por�on of income tax expense is the net of the ending balances of
deferred tax assets and deferred tax liabili�es.
D. The “income tax expense” number on the income statement is the amount the
company owes that year for income taxes.
Correct Answer: B
(Choice A)
This answer is incorrect. There are no future tax implica�ons of permanent differences.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice B)
Accoun�ng for income taxes is based on accrual accoun�ng. According to the accrual
concept, the income tax expense recorded in a period should reflect the ac�vity of
that period regardless of when the tax laws result in an obliga�on. The income tax
expense recognized on the income statement consists of the amount currently payable
under tax law and an amount caused by temporary differences between when GAAP
measures revenues and expenses and when tax law measures revenues and expenses.
This second component is referred to as inter-period tax alloca�on and can either
increase or decrease the income tax expense recognized on the income statement.
(Choice C)
This answer is incorrect. The deferred por�on of income tax expense is determined by
the change in the net of the balances of deferred tax assets and deferred tax liabili�es.
(Choice D)
This answer is incorrect. “Taxes payable” is the amount the company owes that year for
income taxes
Ques�on 54
Which of the following is a permanent difference?
A. Deferred revenue
B. Bad debt expense
C. Interest received from municipal bonds
D. Interest received from corporate bonds
Correct Answer: C
(Choice A)
This answer is incorrect. Deferred revenue is taxable under GAAP and the tax code, but
in different periods. This is a temporary difference.
(Choice B)
This answer is incorrect. Bad debt expense is deduc�ble under GAAP and the tax code,
but in different periods. This is a temporary difference.
(Choice C)
Correct. Taxable income under GAAP is calculated differently than taxable income
under the tax code. Differences between the two calcula�ons are classified as either
permanent or temporary. Permanent differences occur when GAAP revenue is never
taxable, or GAAP expenses are never deduc�ble. Permanent differences are
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
differences that never reverse. Consequently, these do not result in deferred tax assets
and liabili�es. Temporary differences occur when revenue or expenses are recorded in
different periods under GAAP and the tax code. These differences will eventually
reverse. These result in deferred tax assets and liabili�es. Interest received from
municipal bonds is included in GAAP income, but it is never included in taxable income
under the tax code. Therefore, it is a permanent difference.
(Choice D)
This answer is incorrect. Interest received from corporate bonds is taxable under GAAP
and the tax code.
Ques�on 55
The PKZ Company sells a product for $5,000. Customers have the op�on of purchasing a
four-year warranty at the �me of purchase for $180. PKZ sold 3,000 units and 2,500
warran�es in its first year of opera�ons and 3,600 units and 3,300 warran�es in its
second year of opera�ons. PKZ spent $150,000 on services covered under warran�es in
its first year of opera�ons and $320,000 in its second year of opera�ons. What amount
of warranty revenue should PKZ recognize in Year 2 assuming it recognizes warranty
revenue on a straight line basis?
A. $594,000
B. $670,500
C. $261,000
D. $320,000
Correct Answer: C
(Choice A)
This answer is incorrect. The amount collected from the sale of service warran�es is not
the same as warranty revenue from service warran�es.
(Choice B)
This answer is incorrect. This is the balance of the deferred (unearned) warranty revenue
at the end of Year 2.
(Choice C)
Correct. There are two general approaches to accoun�ng for warran�es. If a warranty
is offered separately for an addi�onal fee when a product is sold, the service warranty
approach is used. Under this approach, the amount received for the separate warranty
is treated as a liability (deferred revenue) and is recorded into revenue over the period
of the warranty. In Year 1, PKZ received $450,000 for the 2,500 warran�es sold (2,500 ×
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
$180). This is recorded into revenue evenly over the four-year warranty period
($112,500 in Year 1, Year 2, Year 3, and Year 4). In Year 2, PKZ received $594,000 for the
3,300 warran�es sold (3,300 × $180). This is recorded into revenue evenly over the
four-year warranty period ($148,500 in Year 2, Year 3, Year 4, and Year 5). This results
in a total of $261,000 in warranty revenue recognized in Year 2 ($112,500 + $148,500).
(Choice D)
This answer is incorrect. This is the warranty expense for Year 2
Ques�on 56
A firm has just signed an 8-year lease on a new standardized machine a�er which, the
machine will be returned to the lessor.
•
•
•
•
•
Fair value of the machine is $420,000.
Lease payments are $72,000 per year, payable at the end of the year.
The machine has a 12-year useful life.
The firm’s incremental borrowing cost is 10%.
The PV of an ordinary annuity having 8 payments of $1 at 10% is $5.3349.
The lease should be classified as:
A. opera�ng lease.
B. finance lease.
C. either opera�ng or finance since the firm does not keep the asset at the end of
the lease.
D. purchase lease
Correct Answer: B
(Choice A)
This answer is incorrect. To be an opera�ng lease, a lease must not sa�sfy any of the five
criteria for classifying a lease as a finance lease established by the FASB.
(Choice B)
To be classified as a finance lease, a lease only needs to sa�sfy one of five criteria for
classifying a lease as a finance lease established by the FASB. In this case, the present
value of the minimum lease payments is greater than “substan�ally all” of the fair
value of the asset. The FASB guideline for this criterion is 90% of the fair value. The
present value of the minimum lease payments is $384,113 (72,000 × 5.3349). This
represents 91.5% of the $420,000 fair value of the machine.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
(Choice C)
This answer is incorrect. Whether the firm keeps the asset at the end of the lease is only
one criterion established by the FASB.
(Choice D)
This answer is incorrect. The FASB does not classify leases as “purchase leases.”
Ques�on 57
Sandy Inc. prepares financial statements under IFRS. At December 31, Year 4, Sandy's
income for financial (book) purposes equaled $100,000 and Sandy's only temporary
difference related to deprecia�on. For financial (book) purposes, deprecia�on equaled
$10,000 and for tax purposes, deprecia�on equaled $15,000. The difference is expected
to reverse evenly over the next two years. The enacted tax rate for the current year, Year
4, is 30% and the enacted tax rate for all future years is 40%. In its year-end balance
sheet, what amount should Sandy report as a deferred tax asset (liability)?
A. $1,500 deferred tax asset
B. $1,500 deferred tax liability
C. $2,000 deferred tax asset
D. $2,000 deferred tax liability
Correct Answer: D
(Choice A)
This answer is incorrect. Because Sandy paid lower taxes now, it will have to pay higher
taxes in the future. This is a deferred tax liability. In addi�on, this answer uses the
current tax rate, rather than the enacted future tax rate that will be in effect when the
temporary differences become taxable.
(Choice B)
This answer is incorrect. While Sandy would have a deferred tax liability, this answer
uses the current tax rate, rather than the enacted future tax rate that will be in effect
when the temporary differences become taxable. This was incorrectly calculated as
$5,000 ($15,000 − $10,000) × 30%.
(Choice C)
This answer is incorrect. Because Sandy paid lower taxes now, it will have to pay higher
taxes in the future. This is a deferred tax liability.
(Choice D)
This answer is correct. A �ming difference where, in the future, taxable income will be
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
greater than financial (book) income is reported as a deferred tax liability. The amount
to be recorded as the deferred tax liability is the temporary difference mul�plied by
the future enacted tax rate ($5,000 × 40% = $2,000).
Ques�on 58
Decora�ve Décor (DD), a company that manufactures and sells home decora�ons to
supermarkets, follows IFRS. On January 1, 20X1, DD purchased a $500,000 machine that
creates realis�c silk flowers. The fair value of the machine can be reliably es�mated and
DD elected to account for the machine at fair value under the revalua�on model. The
machine will be depreciated straight-line over the next 20 years. On December 31, 20X1,
DD determined that the es�mated fair value of the machine was $513,000. On
December 31, 20X2, DD determined that the es�mated fair value of the machine was
$430,000. What is the revalua�on gain or loss in Year 1 and Year 2 and where is the
amount recorded?
A. $38,000 gain in Year 1 recorded in other comprehensive income. $56,000 loss in
Year 2 recorded in other comprehensive income.
B. $38,000 gain in Year 1 recorded in other comprehensive income. $56,000 loss in
Year 2, $38,000 of which is recorded in other comprehensive income while the
other $18,000 is recorded in income.
C. $38,000 gain in Year 1 recorded in other comprehensive income. $58,000 loss in
Year 2recorded in other comprehensive income.
D. $38,000 gain in Year 1 recorded in other comprehensive income. $56,000 loss in
Year 2 recorded in net income.
Correct Answer: B
(Choice A)
Losses on revalua�on are recorded in income unless they are a reversal of a previous
revalua�on surplus recorded in other comprehensive income, in which case they are
recorded in other comprehensive income un�l the en�re previous surplus is consumed,
which is the case in this situa�on. A�er the $38,000 surplus is used up, the revalua�on
loss is recorded in income.
(Choice B)
Correct. At December 31, 20X1, the machine was depreciated by $25,000 ($500,000 ÷
20 years), to arrive at a book value of $475,000 ($500,000 − $25,000). The machine was
then revalued to $513,000. Gains on revalua�on are recorded in other comprehensive
income unless they are a reversal of a loss on revalua�on previously recorded in
income, in which case they are recorded in income un�l the en�re loss is reversed. In
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
this situa�on, the revalua�on gain of $38,000 ($513,000 − $475,000) in Year 1 will be
recorded in other comprehensive income. Once a revalua�on occurs, the new
deprecia�on expense is calculated based on the new value of the asset divided by the
remaining life. At December 31, 20X2, the machine was depreciated by an addi�onal
$27,000 ($513,000 ÷ 19 years), to arrive at a book value of $486,000
($513,000 − $27,000). The machine was then revalued to $430,000. Losses on
revalua�on are recorded in income unless they are a reversal of a previous revalua�on
surplus recorded in other comprehensive income, in which case they are recorded in
other comprehensive income un�l the en�re previous surplus is consumed. In this
situa�on, $38,000 of the $56,000 ($486,000 − $430,000) revalua�on loss in Year 2
offset the surplus of $38,000 in other comprehensive income from Year 1 while the
remaining $18,000 revalua�on loss is recorded in income.
(Choice C)
The gain in Year 1 is correct. However, once a revalua�on occurs, the new deprecia�on
expense must be calculated using the revalued amount. The Year 2 loss must be
calculated from the new book value. At December 31, 20X2, the machine was not
depreciated by $25,000, but instead $27,000 ($513,000 ÷ 19 years), to arrive at a book
value of $486,000 ($513,000 − $27,000). The machine was then revalued to $430,000.
Losses on revalua�on are recorded in income unless they are a reversal of a previous
revalua�on surplus recorded in other comprehensive income, in which case they are
recorded in other comprehensive income un�l the en�re previous surplus is consumed.
In this situa�on, $38,000 of the $56,000 ($486,000 − $430,000) revalua�on loss in Year 2
offset the surplus of $38,000 in other comprehensive income from Year 1 while the
remaining $18,000 revalua�on loss is recorded in income.
(Choice D) Losses on revalua�on are recorded in income unless they are a reversal of a
previous revalua�on surplus recorded in other comprehensive income, in which case
they are recorded in other comprehensive income un�l the en�re previous surplus is
consumed, which is the case in this situa�on. $38,000 of the Year 2 loss is recorded in
other comprehensive income. A�er the $38,000 surplus is used up, the remaining
$18,000 ($56,000 $38000) revalua�on loss is recorded in income
Ques�on 59
The OJY Company sells a product for $4,500. Customers have the op�on of purchasing a
three-year warranty at the �me of purchase for $240. OJY sold 2,000 units and 1,600
warran�es in its first year of opera�ons and 2,400 units and 1,800 warran�es in its
second year of opera�ons. OJY spent $80,000 on services covered under warran�es in its
first year of opera�ons and $240,000 in its second year of opera�ons. What amount of
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
warranty revenue should OJY recognize in Year 2 assuming it recognizes warranty
revenue on a straight line basis?
A. $432,000
B. $416,000
C. $272,000
D. $240,00
Correct Answer: C
(Choice A)
This answer is incorrect. The amount collected from the sale of service warran�es is not
the same as warranty revenue from service warran�es.
(Choice B)
This answer is incorrect. This is the balance of the deferred (unearned) warranty revenue
at the end of Year 2.
(Choice C)
Correct. There are two general approaches to accoun�ng for warran�es. If a warranty
is offered separately for an addi�onal fee when a product is sold, the service warranty
approach is used. Under this approach, the amount received for the separate warranty
is treated as a liability (deferred revenue) and is recorded into revenue over the period
of the warranty. In Year 1, OJY received $384,000 for the 1,600 warran�es sold (1,600 ×
$240). This is recorded into revenue evenly over the three-year warranty period
($128,000 in Year 1, Year 2, and Year 3). In Year 2, OJY received $432,000 for the 1,800
warran�es sold (1,800 × $240). This is recorded into revenue evenly over the threeyear warranty period ($144,000 in Year 2, Year 3, and Year 4). This results in a total of
$272,000 in warranty revenue recognized in Year 2 ($128,000 + $144,000).
(Choice D)
This answer is incorrect. This is the warranty expense for Year 2
Ques�on 60
Under which set of facts would a company be able to classify a liability due within the
next 12 months as a long-term liability under US GAAP?
A. On 12/31/20X6 a company has a liability due on 2/15/20X7. On 11/30/20X6, the
company’s board of directors voted to seek to refinance the debt with the lender.
It plans to talk to the lender at the beginning of 20X7 about refinancing the debt
for 3 more years. The company issued its financial statements on 2/15/20X7.
Part 1 Recogni�on, Measurement, Valua�on & Disclosures (Liabili�es, Equity)
B. Never, US GAAP requires all liabili�es to be sa�sfied within the next 12 months or
one opera�ng cycle (whichever is longer) to be classified as current liabili�es.
C. On 12/31/20X6 a company has a liability due on 8/15/20X7. On 11/30/20X6, the
company’s board of directors voted to seek to refinance the debt with the lender.
On 12/20/20X6, the lender agreed to refinance the debt with a new due date of
12/20/20X7. The company issued its financial statements on 2/15/20X7.
D. On 12/31/20X6 a company has a liability due on 6/15/20X7. On 11/30/20X6,
the company’s board of directors voted to seek to refinance the debt with the
lender. On 2/1/20X7, the lender agreed to refinance the debt with a new due
date of 12/31/20X9. The company issued its financial statements on 2/15/20X7
Correct Answer: D
(Choice A)
This answer is incorrect. The company intends to refinance the debt, but it has not
established the ability to refinance it.
(Choice B)
This answer is incorrect. Under US GAAP, companies can classify a debt due within the
next 12 months or one opera�ng (whichever is longer) as a long-term liability if it has
the intent and ability to refinance the debt on a long-term basis.
(Choice C)
This answer is incorrect. While the debt is refinanced, the new due date is s�ll within 12
months of the balance sheet date.
(Choice D)
Under US GAAP, companies can classify a debt due within the next 12 months or one
opera�ng (whichever is longer) as a long-term liability if it has the intent and ability to
refinance the debt on a long-term basis. Intent must be formally documented in some
way. The ability to refinance can be demonstrated by an actual agreement with the
lender a�er the balance sheet date, as long as the agreement occurs prior to the
financial statements being issued.