Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test Bank
Chapter 12 – Liabilities
1. Conceptually, liabilities constitute a present obligation as a result of a past event.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
2. Under IFRS, only legal obligations are recognized.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
Ans: True
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3. A reasonable expectation on the part of a company’s stakeholders arising from a company’s past
practices or behaviour may constitute a constructive obligation in certain instances.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
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4. A contingency may become a provision if the likelihood of the contingent event greatly
increases.
Ans: True
Difficulty: Easy
d
Level of Learning: Knowledge
Topic: LO2
5. For a small population, the best estimate for the amount of a provision that must be
recognized is the expected value of the possible outcomes.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 1
Chapter 12 – Liabilities
6. For a large population, the best estimate for the amount of a provision that must be
recognized is the most likely outcome with respect to the expected value and cumulative
probabilities.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
7. Discounting is not required when the time value of money is immaterial or if the amount
and timing of cash flows is highly uncertain.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
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8. For a small population, the best estimate for the amount of a provision that must be
recognized is the expected value of the possible outcomes.
Ans: False
Difficulty: Easy
zle
Level of Learning: Knowledge
Topic: LO2
9. Contingencies must be both accrued and disclosed.
Ans: False
d
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
10. Under proposed changes to current standards, amounts currently classified as
contingencies may need to be accrued rather than simply disclosed.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 2
Chapter 12 – Liabilities
11. An onerous contract is one where the unavoidable costs of meeting the contract may or
may not exceed the benefits derived from the contract.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 3
12. A lawsuit in progress wherein the defendant will probably be found guilty would likely
be accounted for as a provision.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
13. Warranties provisions may arise from legal or constructive obligations.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Ans: False
Difficulty: Easy
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14. Once a company has formally decided to restructure its operations, a provision must be
made for the restructuring.
Level of Learning: Knowledge
Topic: LO3
d
15. Loyalty points are provided (accrued) for and reversed once the points are redeemed.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 3
Chapter 12 – Liabilities
16. Self-insurance costs for expected losses must never be provided for.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
17. Current liabilities are usually discounted.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
18. The carrying value of a bond from the issuing corporation’s standpoint will always move closer
to its face value, regardless of whether the bond is issued at a premium or a discount.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
19. Under the effective interest method, interest expense is calculated by multiplying the
market interest rate by the carrying value of the bonds.
zle
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
d
20. Assume that a company issues bonds at a discount. Under the effective interest method,
the company will record progressively less interest with the passage of time.
21. Transaction costs are usually included in the carrying value of any financial liabilities.
Ans:
True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 4
Chapter 12 – Liabilities
22.
Long-term financial liabilities will usually be carried at amortized cost.
Ans:
True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
23. Adjustments to fair value relating to FVTPL liabilities will always flow through earnings.
Ans:
True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
24. Loan guarantees must be provided for; the amount of the provision is the probability of
payout multiplied by the fair value o the loan guarantee.
True
hz
Ans:
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Ans:
True
Difficulty: Easy
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25. When the market rate exceeds the stated or nominal rate, a bond’s carrying value will be
less than its fair value.
Level of Learning: Knowledge
Topic: LO4, 5
Ans:
True
d
26. The stated rate of interest is the interest rate used to determine the amount of cash interest that
will be paid on the principal.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4, 5
27. A short-term payable may be the current portion of a long-term liability, which arises when the
next payment on such a debt will be made out of current assets.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 5
Chapter 12 – Liabilities
28. Interest may be recognized on a note even though the note does not explicitly state an interest
rate.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4, 5
29. The principal amount of a debt is the cash or cash equivalent amount borrowed.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4, 5
30. A company may reclassify a current financial liability to a long-term one only if there is a
contractual agreement in place by the reporting date to replace the financing.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4, 5
31. Debt issue costs may be expensed or included in the cost of the debt.
zle
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4, 5
32. An administrative fee pertaining to a successful loan application is to be immediately expensed.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4, 5
d
Ans: False
33. An administrative fee pertaining to an unsuccessful loan application is to be immediately
expensed.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 6
Chapter 12 – Liabilities
34. Capitalization of borrowing costs on qualifying assets will continue even if work on the
asset has temporarily ceased.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
35. Accounts payable should include only obligations directly related to the primary and continuing
operations of an entity.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2
36. Capitalization of borrowing costs on qualifying assets is mandatory under both IFRS and
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ASPE.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6, 10
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37. Use of the effective interest method for amortizing bond premiums and discounts is
mandatory under IFRS but not under ASPE.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6, 10
d
38. Borrowing costs can only be capitalized on non-financial assets.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
39. The cost of any equity financing is included when calculating the cost of generalized
borrowings.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 7
Chapter 12 – Liabilities
40. Bonds are said to be redeemable when they can be prematurely retired at the discretion of
the issuing company and retractable when they can be prematurely retired at the
investor’s discretion.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO7
41. Under IRS, a loss contingency must be credited to a liability account only if the occurrence of
the contingent event is probable and if the amount of loss can be reasonably estimated.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 3, 10
42. A gain contingency will usually not be recorded in the accounts and reported in the financial
hz
statements even though its occurrence is probable.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 3
zle
43. Under ASPE, disclosure in the footnotes to the financial statements is the only way to properly
report contingent losses.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 3, 10
d
44. When the maturity date of a bond issue is within one year or the operating cycle (whichever is
longer) of the current balance sheet date, the bond liability should be reclassified as a current
liability (assuming the payment will be made out of current assets).
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
45. Callable bonds are callable at the option of the investor.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 8
Chapter 12 – Liabilities
46. A $1,000, 6%, 10-year bond purchased as a long-term investment at an effective rate at 7%, will
pay the investor $70 cash interest each year.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
47. When bonds are sold at a discount, interest-method amortization results in a schedule of interest
accruals, which increase in amount as maturity approaches.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
48. In-substance defeasance means that a debtor irrevocably places cash or other monetary assets in a
hz
trust fund to pay interest on an outstanding debt. In such situations, the debt is always recorded as
paid when the trust fund is set up.
Ans: False
zle
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO7
49. Hedging is one method of minimizing foreign exchange risk.
Ans: True
Difficulty: Easy
d
Level of Learning: Knowledge
Topic: LO8
50. Under IFRS, a continuity schedule must be provided for both provisions and
contingencies.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO9, 10
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 9
Chapter 12 – Liabilities
51. (Appendix) Blended payments are payments where the interest rate is fixed at the beginning of
the loan term and there are regular equal payments of principal and interest made.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO11, 12
52. A brewing company operating in an Ontario city experiencing water shortages received its water
bill for December 1999, on December 31, 1999. The bill ($8,000) represents the cost of water
used in December to make its product. The company will not publish the 1999 financial
statements until February 2000. Therefore, the adjusting entry as of December 31, 1999 includes
which of the following?
A)
cr. utilities payable $8,000
B)
cr. cash $8,000
C)
cr. utilities expense $8,000
D)
no adjusting entry needed because the bill will not be paid until January 2000
hz
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO1
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
d
zle
53. Bonds payable (due 5 years from the balance sheet date) should be classified as follows:
A)
A contingent liability.
B)
An element of the owners' equity.
C)
A long-term liability.
D)
A current liability.
54. A short-term note payable may include all of the following except:
A)
Trade notes payable.
B)
Nontrade notes payable.
C)
A current portion of a long-term liability.
D)
Unearned revenue.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 9
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 10
Chapter 12 – Liabilities
55. Which of the following statements is/are correct?
A)
Under IFRS, contingencies may be accrued, but not under ASPE.
B)
Litigation for which the company will probably be found guilty would normally be accrued
as a provision.
C)
Under IFRS, contingencies should be disclosed but not accrued.
D)
Both B & C are correct.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
56. A firm sold $100,000 worth of goods during 1999. The firm extends warranty coverage on these
Ans: C
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goods. Historically, warranty costs have averaged 2% of total sales. During 1999, the firm
incurred $1,000 to service goods sold in 1998 and $200 to service goods sold in 1999. What is
warranty expense for 1999?
A)
$200
B)
$1,200
C)
$2,000
D)
$3,200
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO1
57. You are an investor and have just purchased a bond on July 1 which pays interest every March 1
and September 1. When you receive your first interest cheque, you will receive and have earned
how many months interest?
A)
B)
C)
D)
E)
Earned
6
2
2
4
4
d
Received
6
6
2
4
6
1
2
3
4
5
Choice 1
Choice 2
Choice 3
Choice 4
Choice 5
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 11
Chapter 12 – Liabilities
58. On November 7, 1999 local residents sued Brimley Corporation for excess chemical emissions
that caused some of them to seek medical attention. The total lawsuit is $8,000,000. Brimley
Corporation's lawyers believe that the lawsuit will be successful and that the amount to be paid to
the residents will be $4,000,000. On its December 31, 1999 financial statements Brimley should:
A)
Accrue a provision loss of $8,000,000 with no financial statement disclosure necessary.
B)
Accrue a provision loss of $4,000,000 and note disclose.
C)
Do nothing as the lawsuit has not yet ended.
D)
Simply disclose the details regarding the lawsuit in a note.
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO1, 3
59. AB sold its 10-year bond at a discount. In reporting the bonds and the related discount on a
hz
balance sheet shortly thereafter, the discount should be:
A)
Added to the bonds.
B)
Recorded as expense in the period of sale.
C)
Reported as a deferred charge.
D)
Deducted from the bonds payable.
Ans: D
Difficulty: Medium
zle
Level of Learning: Knowledge
Topic: LO4, 5
d
60. JMR bought 15 Z Corporation $1,000 bonds for $15,270 total, on April 1, 2000, (five years prior
to maturity). The bonds pay 8% annual interest on April 1 and October 1. On December 31, 2000,
the bonds had a market value of $14,950 (not a permanent decline). JMR purchased these bonds
at:
A)
Par.
B)
Par plus accrued interest.
C)
A premium.
D)
A discount.
E)
A discount plus accrued interest.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 12
Chapter 12 – Liabilities
61. R Company was indebted to A Inc. at January 1, 2000. The note called for a $25,000 payment to
be made on December 31, 2000 and also on December 31, 2001. The note was non-interest
bearing yet 10% was the prevailing rate at the time the note was issued. What is the book value of
the note on R's January 1, 2000 balance sheet?
A)
$47,727
B)
$47,500
C)
$43,389
D)
$50,000
E)
$38,962
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
Ans: A
Difficulty: Medium
zle
hz
62. $5,000 (face value) of bonds with a book value of $4,300 was retired 4 years and 9 months prior
to maturity. The dollar amount (excluding interest) paid to retire the bonds was $4,700. The entry
to record the retirement would include:
A)
dr. bonds payable $5,000
B)
cr. cash $4,300
C)
dr. bonds payable $4,700
D)
cr. unusual gain $400
Level of Learning: Application
Topic: LO4, 5
63. ABC Inc has 50 pending lawsuits for which it may be found liable. The expected value
A)
B)
C)
D)
d
(sum of the probabilities of the outcomes multiplied by their respective payouts) amounts
to $100,000. However, the company’s controller believes that the most likely outcome
will be a payout of $120,000. Which of the following statements pertaining to the accrual
of the provision is correct?
There is a large population of lawsuits, so a provision of $100,000 must be accrued.
There is a large population of lawsuits, so a provision of $120,000 must be accrued.
There is a small population of lawsuits, so a provision of $100,000 must be accrued.
There is a small population of lawsuits, so a provision of $120,000 must be accrued.
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 13
Chapter 12 – Liabilities
64. ER issued for $2,060,000, two thousand of its 9%, $1,000 callable bonds. The bonds are dated
January 1, 1999, and mature many years from now. Interest is payable semi-annually on January
1 and July 1. The bonds can be called by the issuer at 102 on any interest payment date after
December 31, 2003. The unamortized bond premium was $28,000 at December 31, 2001, and the
market price of the bonds was 99 on this date. In its December 31, 2001, balance sheet, at what
amount should GC report the carrying value of the bonds?
A)
$1,980,000
B)
$2,028,000
C)
$2,032,000
D)
$2,040,000
E)
Cannot answer; the bond term is not given
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
hz
65. Gains or losses from the early extinguishment of debt, if material, should be:
A)
recognized in income as ordinary gains and losses or as unusual items.
B)
recognized as an extraordinary item in the period of extinguishment.
C)
amortized over the remaining original life of the extinguished issue.
D)
amortized over the life of the new issue.
Ans: A
Difficulty: Medium
zle
Level of Learning: Knowledge
Topic: LO4, 5
66. All of the following are true with respect to sinking funds except:
A sinking fund is a cash fund that is restricted for retiring the debt of a company.
A sinking fund may be handled by a trustee or by the individual company.
A sinking fund may make the investment more attractive to investors.
Once the sinking fund is established, the company has no more responsibility to the debt.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
d
A)
B)
C)
D)
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 14
Chapter 12 – Liabilities
67. Which one of the following items is not a liability?
A)
B)
C)
D)
Accrued estimated warranty costs
Dividends payable in shares
Advances from customers on contracts
The portion of long-term debt due within one year
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
68. Proposed changes to the IFRS definition of a liability include:
A)
B)
C)
D)
The addition of the requirement that a liability relate to a past event.
The removal of the requirement that a liability relate to a past event.
The addition of the requirement that a liability be a present obligation.
The addition of the requirement that a liability be a legal obligation.
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
69. The rate of interest specified on the face of the debt is called the:
Effective interest rate.
Stated interest rate.
Yield interest rate.
Market interest rate.
Ans: B
Difficulty: Medium
zle
A)
B)
C)
D)
Level of Learning: Knowledge
Topic: LO4, 5
d
70. The rate of interest used to discount the future cash payments on a debt to the cash equivalent
borrowed is least likely to be described by which of the following terms:
A)
Effective interest rate.
B)
Yield interest rate.
C)
Stated interest rate.
D)
Prevailing interest rate.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 15
Chapter 12 – Liabilities
71. A company has commenced work on a non-cancellable fixed price construction contract in the
amount of $6 million. Costs of $4 million have been incurred to date, and it is expected that $3.2
million in additional costs will have to be incurred to complete the contract. The company
adheres to IFRS. Which of the following statements with respect to the contract are correct?
A)
There is a constructive obligation to finish the contract.
B)
The company will have recognized $3 million in profit on the contract to date.
C)
The company has a constructive obligation to accrue a loss of $1.2 million plus any
previously recognized profit.
D)
This is an onerous contract, so the company must accrue a loss of $1.2 million plus any
previously recognized profit.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3
Ans: D
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72. Constructive obligations may arise from:
A)
Asset retirement obligations
B)
Warranty obligations.
C)
Notes Payable
D)
Both A & B
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3
73. A company is being sued by a competitor for $120,000. The company’s legal team
estimates that there is a 20% chance that the company will be sued. Under the
PROPOSED changes to current IFRS standards,
No provision or note disclosure will be required.
A provision of $24,000 will be required.
A provision of $96,000 will be required.
A provision of $120,000 will be required.
Ans: B
d
A)
B)
C)
D)
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 16
Chapter 12 – Liabilities
74. Long-term obligations (i.e., debts) that is callable for early payment:
A)
Must continue to be classified as a long-term liability by the debtor, if a provision of the
debt covenant has been violated.
B)
Must continue to be classified as a long-term liability in all situations.
C)
Must be reported as current liabilities by the debtor if callable on demand.
D)
Can be reported as current liabilities by the debtor only if callable because a provision of
the debt covenant has been violated.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
75. A company had sales of $1 million. Coupons in the amount of $1 per $10 in sales were
given to paying customers. History has shown that 50% of all coupons are redeemed.
Which of the following statements is correct?
A provision for $50,000 must be recognized.
A provision for $100,000 must be recognized.
A provision for $1 million must be recognized.
No provision is necessary.
Ans: A
hz
A)
B)
C)
D)
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3
76. By law, a fleet of aircraft must be subject to a major overhaul every 5 years as part of its
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3
d
scheduled maintenance program. Which of the following statements is correct?
A)
An accrual should be made in each of the 5 years preceding the overhaul.
B)
The costs of the overhaul should be expensed as incurred.
C)
The cost of the overhaul should be deferred and amortized.
D)
The estimated cost of the overhaul should be disclosed as part of a continuity schedule in
the notes to the financial statements.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 17
Chapter 12 – Liabilities
77. Which of the following statements is/are correct?
A)
B)
C)
D)
E)
For companies that are self-insured, a provision must be established for events taking place
prior to the reporting period but not for loss events that have happened during the year but
are not yet known.
For companies that are self-insured, a provision must be established for events taking place
prior to the reporting period and for loss events that have happened during the year but are
not yet known.
Contingent assets are only recorded when it is virtually certain that the benefits relating to
the contingent assets will be received.
Both A & C are correct.
Both B & C are correct.
Ans: E
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3
78. Information obtained prior to the issuance of the current period's financial statements of KG
Ans: C
Difficulty: Medium
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hz
Company indicates that it is probable that, at the date of the financial statements, a liability will
be incurred for obligations related to product warranties on products sold during the current
period. During the past three years, product warranty costs have been approximately 1 1/2 percent
of annual sales revenue. An estimated loss contingency should be:
A)
Neither accrued nor disclosed in the financial statements.
B)
Recognized as an appropriation of retained earnings.
C)
Accrued in the accounts and reported in the financial statements.
D)
Disclosed in the financial statements but not accrued.
Level of Learning: Knowledge
Topic: LO1, 3
A)
B)
C)
D)
d
79. Contingent liabilities will or will not become actual liabilities depending on:
Whether they are probable and estimable
The degree of uncertainty
The present condition suggesting a liability
The outcome of a future event
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 18
Chapter 12 – Liabilities
80. Under IFRS, which of the following will only require only a note disclosure as a contingency?
A)
Cash discounts given for early payment by customers; almost always taken
B)
Remote chance of loss from a lawsuit in process
C)
Probable claim for an income tax refund
D)
Loss from an investment in equity securities that is certain
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3
81. (Appendix) A Bank requires a client to maintain a certain debt-to-equity ratio, or else the client’s
loan will become immediately repayable. This is an example of a(an):
A)
Debt covenant.
B)
Indenture.
C)
Contingency.
D)
Retraction.
hz
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO13
Level of Learning: Knowledge
Topic: LO1, 3
d
Ans: A
Difficulty: Medium
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82. Which of the following contingencies should be accrued in the accounts and reported in the
financial statements?
A)
The estimated expenses of a one-year product warranty
B)
The company is forcefully contesting a personal injury suit and a loss is possible and
reasonably estimable
C)
An accommodation endorsement involving a remote loss
D)
It is probable that the company will receive $50,000 in settlement of a lawsuit
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 12 – Liabilities
83. KR Corporation was involved in a lawsuit with the Government alleging inadequate air pollution
control facilities at its Glowworm plant site during 1999. At December 31, 2002, it appeared
probable the Government would settle for approximately $150,000. This event should be
recorded (i.e., recognized) in 2002 as a(n):
A)
Loss on the lawsuit (operating expense).
B)
Unusual gain.
C)
Prior period adjustment.
D)
Unusual loss.
E)
Disclosure of contingency loss only in a note.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3
hz
84. Under IFRS, interest paid should be recorded on the Statement of Cash Flows as a(an):
A)
Operating activity.
B)
Financing Activity.
C)
Investing Activity
D)
A or B
Ans: D
Difficulty: Medium
zle
Level of Learning: Knowledge
Topic: LO4, 5
Ans: C
Difficulty: Medium
d
85. On January 1, 2000, DWW borrowed $400,000 cash and signed a one-year, 12 percent interestbearing note payable. Assuming a 40 percent average income tax rate for DWW Corporation, the
net effective interest rate on this note was:
A)
4.8 percent.
B)
6.0 percent.
C)
7.2 percent.
D)
12.0 percent.
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 20
Chapter 12 – Liabilities
86. XYZ borrowed $60,000 for one year and signed an 18 percent, interest-bearing note payable.
Assuming XYZ has an income tax rate of 45 percent, the net effective rate was:
A)
8.1 percent.
B)
9.9 percent.
C)
11.7 percent.
D)
18 percent.
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
87. On September 1, 1999, Company B signed a $7,392, two-year non-interest-bearing note payable
Ans: A
hz
in full on August 31, 2001. Company B received $6,000 cash. What was the yield or effective
rate of interest?
A)
11 percent
B)
14 percent
C)
18 percent
D)
23 percent
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
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88. VCR Company owed a $73,311 debt due on January 1, 2000. An agreement was reached to pay it
off in three equal annual payments of $30,000 each, starting on December 31, 2002. The interest
rate was 11 percent. The balance in the liability account of VCR Company on January 1, 2002 is:
A)
$27,027
B)
$51,875
C)
$73,321
D)
$90,000
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
d
Ans: A
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 21
Chapter 12 – Liabilities
89. XY Company owed a $45,489 due on January 1, 2000. An agreement was reached to pay it off in
five equal annual payments, starting on December 31, 2000. The interest rate was 10 percent. The
total amount of interest paid under the terms of the agreement was (round annual payment to
nearest $1):
A)
$25,000
B)
$22,745
C)
$14,511
D)
$ 6,000
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
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Ans: A
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90. A firm sells products covered by a three-year warranty. From the past experience of the other
firms in the industry, the firm expects to incur warranty costs equal to 1% of sales. Firm sales
were $40,000 and $50,000 in 1999 and 2000 respectively. In 2000, the firm spent $200 to repair
goods sold in 1999, and $300 to repair goods sold in 2000. The firm received no warranty
servicing demands from customers in 1999, the firm's first year of operations. What is the balance
in the warranty liability account on January 1, 2001?
A)
$400
B)
$500
C)
$300
D)
$0
Difficulty: Medium
Level of Learning: Application
Topic: LO1, 3
d
91. On January 1, 2000, JG purchased a machine and gave a $30,000 three-year, 8% note. The
market or "going" interest rate was 12%. The annual interest payments are to be paid on each
December 31. On January 1, 2000, JG should record the net liability amount determined as
follows:
A)
Compute the present value of its face amount and the three $2,400 interest amounts by
using a discount rate of 8%.
B)
Compute the present value of its face amount and the three $2,400 interest amounts by
using a discount rate of 12%.
C)
Use its face amount, $30,000 plus the $7,200 interest.
D)
Use its face amount, $30,000 minus $7,200 interest.
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 22
Chapter 12 – Liabilities
92. KR issued bonds payable with a face amount of $200,000 and a maturity date ten years from date
of issuance. If the bonds were issued at a premium, this indicated that:
A)
The effective and stated rates were the same.
B)
The stated rate of interest exceeded the effective rate.
C)
The stated rate and the market rate were the same.
D)
No necessary relationship exists between the two rates.
E)
The effective rate of interest exceeded the stated (nominal) rate.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
Ans: D
Difficulty: Medium
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hz
93. In theory (disregarding any other marketplace variables) the proceeds from the sale of a bond will
be equal to:
A)
The face amount of the bond plus the present value of the interest payments made during
the life of the bond discounted at the prevailing market rate of interest.
B)
The sum of the face amount of the bond and the periodic interest payments.
C)
The present value of the principal amount due at the end of the life of the bond plus the
present value of the interest payments made during the life of the bond, each discounted at
the stated rate of interest.
D)
The present value of the principal amount due at the end of the life of the bond plus the
present value of the interest payments made during the life of the bond, each discounted at
the prevailing market rate of interest.
Level of Learning: Application
Topic: LO4, 5
94. AB Company sold and issued a $100,000, 10%, bond at 99. Therefore, the bond:
D)
was sold at a premium because the stated interest rate was higher than the yield rate.
sold at a discount because the stated interest rate was lower than the market interest rate.
sold at a premium because the $1,000 accrued interest is added to the $100,000 face
amount.
was sold for $100,000 less $1,000 of accrued interest.
d
A)
B)
C)
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 23
Chapter 12 – Liabilities
95. For bonds payable, the cash interest paid in each interest period is:
A)
B)
C)
D)
The same amount regardless of whether the bond was sold at par, a discount, or a
premium.
Different depending upon the date of sale.
Not the same amount when the stated and yield interest rates are different.
Dependent on the initial amount of accrued interest.
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
96. Straight-line amortization of bond premium or discount:
A)
B)
C)
Ans: C
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D)
E)
Can be used as an optional method of amortization in all situations.
Provides the same amounts of interest expense and interest revenue each interest period as
the effective interest method.
Provides the same total amount of interest expense and interest revenue as the effective
interest method over the life of the bonds.
is appropriate when the bond term is especially long.
is appropriate for deep discount bonds.
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Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
97. If a bond was sold at 108, the stated rate of interest was:
A)
B)
C)
D)
Equal to market rate.
Not related to market rate.
Higher than market rate.
Lower than market rate.
Level of Learning: Application
Topic: LO4, 5
d
Ans: C
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 24
Chapter 12 – Liabilities
98. Bond A and Bond B both have a maturity value of $1,000 and pay annual interest of 9%. The
market rate of interest is also 9%. Bond A matures in 4 years and Bond B matures in 5 years.
Which of the following is correct?
A)
Both bonds sell for more than $1,000.
B)
Bond A will sell for more than Bond B.
C)
Both bonds sell for the same amount, $1,000.
D)
Bond B will sell for more than Bond A.
E)
There is not sufficient information to answer the question.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
99. Bonds payable should be reported as a long-term liability in the balance sheet of the issuer at:
Current market price.
lower-of-cost-or-market.
Issue price, excluding any accrued interest at purchase date.
Issue price less any unamortized bond premium or plus any unamortized discount.
Issue price plus any unamortized bond premium or less any unamortized discount.
Ans: E
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A)
B)
C)
D)
E)
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Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
d
100. When the interest payment dates of a bond are May 31 and November 30, and a bond issue is sold
on July 1, the amount of cash received by the issuer will be:
A)
Decreased by accrued interest from July 1 to November 30.
B)
Decreased by accrued interest from May 31 to July 1.
C)
Increased by accrued interest from May 31 to July 1.
D)
Increased by accrued interest from July 1 to November 30.
E)
Unaffected by accrued interest.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 25
Chapter 12 – Liabilities
101. When the interest payment dates of a bond are May 31 and November 30, and a bond issue is sold
on July 1, the price of the bond will be:
A)
Decreased by accrued interest from July 1 to November 30.
B)
Decreased by accrued interest from May 31 to July 1.
C)
Increased by accrued interest from May 31 to July 1.
D)
Increased by accrued interest from July 1 to November 30.
E)
Unaffected by accrued interest.
Ans: E
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
Ans: C
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102. A firm retired a long-term note by in-substance defeasance. This me
A)
the creditors have been paid
B)
the debtor has been released of its legal responsibility for all remaining debt payments
C)
there is only a remote chance that the debtor will be required to make further payments on
the liability
D)
the debt is shown as an offset against the assets used to retire the debt, in the debtor's
balance sheet
E)
the debtor will continue to recognize interest expense on the debt but will make no more
payments
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Difficulty: Medium
Level of Learning: Knowledge
Topic: LO 5
d
103. There are two methods for amortizing premiums and discounts on the sale of bonds. The
differences between the two methods are:
A)
Both methods charge a constant amount of interest to the financial statements each year;
however, the effective interest method charges a larger total amount of interest expense
over the life of the bond.
B)
The effective interest method charges a different interest expense each year while the
straight-line method results in a different amount of annual interest expense as a
percentage of beginning book value each year.
C)
There are no differences between the two
D)
None of these answers is correct
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 26
Chapter 12 – Liabilities
104. In-substance defeasance is sometimes used as a method of bond retirement. Choose the correct
statement about this practice.
A)
The bonds are legally retired as a result
B)
The firm may invest in any investment-grade debt security to retire the bonds as long as the
investment securities are transferred irrevocably to a trustee
C)
Neither the assets used to effect the defeasance, nor the bonds themselves, are reported in
the balance sheet, even though the bonds remain outstanding
D)
The process may require the company which issued the bonds to make substantial
payments in addition to the investments purchased for the defeasance
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
Ans: C
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105. Which of the following is not one of the conditions that must be met to qualify as extinguishment
of debt by in-substance defeasance?
A)
Trust must own monetary assets that are essentially risk free.
B)
Cash inflows into the trust must approximately coincide with required cash outflows.
C)
There is a reasonable possibility that the debtor will be called on to make additional
payments on the debt.
D)
The qualifying assets must not be used for trustee fees.
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Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
Ans: D
Difficulty: Medium
d
106. The result of an effective interest rate that is higher than the stated rate on a debt security is the:
A)
Carrying value of the debt will decrease each interest period.
B)
Security will sell at a premium.
C)
Cash interest paid on each interest date will be changed.
D)
Dollar amount of interest expense reported on the income statement, assuming the interest
method is used, will increase each interest period.
Level of Learning: Knowledge
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 27
Chapter 12 – Liabilities
107. Which of the following statements is true?
A)
If a bond is sold "at a discount," the effective interest rate on the bond is lower than the
stated interest rate.
B)
If a bond is sold between interest dates, it is necessary to record the interest accrued since
the last payment date before sale.
C)
If a bond is sold "at a premium," the effective interest rate on the bond is higher than the
stated interest rate.
D)
Bond price of 98 means that the yield rate is 98% of the stated rate.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
Ans: C
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108. If bonds are issued initially at a discount and the straight-line method of amortization is used for
the discount, interest expense in the earlier years will be:
A)
less than if the interest method is used.
B)
less than the amount of the interest payments.
C)
more than if the interest method is used.
D)
The same as if the interest method is used.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
Ans: B
d
109. VB owes a $200,000, 8%, five-year note payable dated January 1, 2000. It is the end of year
2000, and instead of making the interest payment now due, VB has made arrangements to pay the
debt and the 2000 interest payment in four equal instalments based on the same interest rate. The
first payment is to be made on January 1, 2001. The amount of the equal annual payments is
(rounded to the nearest dollar):
A)
$54,000
B)
$60,384
C)
$55,912
D)
$65,214
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 28
Chapter 12 – Liabilities
110. On January 1, 2000, ER signed a $120,000, 10%, three-year, note payable. The proceeds are to be
used to purchase a computer and related software for the company. The lending institution
advanced proceeds of $115,800 and took a mortgage on the computer. The note is payable in
three equal annual instalments starting on December 31, 2000. The effective interest rate to use
for this debt is (rounded to the nearest percent; do not interpolate):
A)
10%.
B)
11%.
C)
12%.
D)
13%.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
Ans: B
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111. On November 1, 1999, WC purchased CX, 10-year, 7%, bonds with a face value of $100,000 for
$96,000. The bonds are intended to be held to maturity. An additional $2,333 was paid for the
accrued interest. Interest is payable semi-annually on January 1 and July 1. The bonds mature on
July 1, 2006. WC uses the straight-line method of amortization. Ignoring income taxes, the
amount of interest revenue reported in WC's 1999 income statement (year-end December 31) as a
result of WC's long-term bond investment in CX was:
A)
$1,267
B)
$1,167
C)
$1,120
D)
$1,067
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
d
112. On March 1, 2000, WC issued 10% stated interest rate, 10 year debentures dated January 1, 2000,
in the face amount of $1,000,000, with interest payable on January 1 and July 1. The debentures
were sold to yield 12% plus accrued interest. How much should WC debit to cash on March 1,
2000?
A)
$ 901,963
B)
$ 903,003
C)
$1,016,667
D)
$1,033,333
E)
$ 902,336
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 29
Chapter 12 – Liabilities
113. On September 1, 2000, ER issued 11%, 10 year bonds dated June 1, 2000, in the face amount of
$140,000, with interest payable July 1 and December 31. The bonds were sold for $140,000. How
much should ER debit to cash on September 1, 2000?
A)
$140,000
B)
$142,567
C)
$147,700
D)
Cannot be determined from the information given
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
Ans: D
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114. Which of the following is true with respect to bond retirement?
A)
If interest rates increase, the issuer can retire bonds at a gain by buying them on the open
market.
B)
Gains and losses on bond retirements may be classified as ordinary gains and losses or
unusual gains and losses.
C)
On debt retirement all related accounts should be update.
D)
All of these answers are correct.
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Difficulty: Medium
Level of Learning: Knowledge
Topic: LO 5
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO8
d
115. Ryan Company borrow $45,000 US when the exchange rate for US $1.00 is Cdn. $1.46. When
the debt was repaid the exchange rate changes to US $1.00 = Cdn. $1.38. Ryan Company records
the amount on the date of exchange as:
A)
A foreign exchange loss of $3,600
B)
A foreign exchange gain of $3,600
C)
A foreign exchange gain of $62,100
D)
A foreign exchange loss of $62,100
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 30
Chapter 12 – Liabilities
116. ASPE and IFRS differ in their treatment of long-term Bonds Payable in that:
A)
Under IFRS, exchange gains and losses on short-term debt are recorded in the income
statement immediately.
B)
The straight-line method may be used under ASPE but not under IFRS..
C)
ASPE ignores foreign exchanges gains and losses.
D)
IFRS does not account for foreign exchange gains and losses on Bonds Payable.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 10
117. Which of the following is not a required disclosure for Bonds Payable under IFRS?
A)
Interest rate risk.
B)
Credit risk.
C)
Transaction risk.
D)
Liquidity risk.
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Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO9
(a)
(b)
(c)
(d)
(e)
(f)
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118. On January 1, 1999, a company borrowed $20,000 on a 10% interest-bearing note, due on
December 31, 2001. The interest is payable each December 31.
The principal amount of the note is
The face amount of the note is
The maturity amount of the note is
Total cash interest expense for the three years is
The balance in the note payable account on January 1, 1999 is
The balance in the note payable account on December 31, 19x2 is
$__________
$__________
$__________
$__________
$__________
$__________
d
Ans: (a) $20,000, (b) $20,000, (c) $20,000, (d) $6,000, (e) $20,000, (f) $20,000
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
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Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 12 – Liabilities
119. A company has been sued for damages as a result of illness caused to local residents due to the
emission of highly toxic chemicals from its plant. The company's legal firm advises that it is
probable that the company will lose the suit and that it probably will result in a judgment of $2
million to $10 million in damages. However, the legal firm believes that the most probable
amount of the loss will be $6 million, and that the suit will be terminated about three years hence.
The company has no other lawsuits pending.
(a) Should the company disclose this event in the year the suit was filed? (check one)_____ No;
_____ Note only; _____ A loss in the income statement.
(b) If a loss should be reported, give the journal entry required:
Ans: (a) a loss in the income statement.,
(b) Loss-pollution (lawsuit pending)
6,000,000
Estimated liability pollution lawsuit
6,000,000
Difficulty: Hard
Level of Learning: Application
Topic: LO3
d
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hz
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 12 – Liabilities
120. A firm issued a 16%, $1,000 bond issued and dated Jan. 1/2000 maturing
Jan. 1, 2011 paying interest each June 30 and December 31, and yielding 14%. One bond is used
for simplicity.
Required:
(a)Determine the price of the bond
(b)All Year 2000 entries and balance sheet presentations for the bond after each interest date in
Year A. Show the interest method and straight-line methods in parallel fashion.
Ans:
(a)Price = $1,000(PV1,7%,20)(.25842) + $80(PVA,7%,20)(10.59401)
= $1,105.94
(b)
Interest
SL
Jan. 1/00 Cash
1,105.94
(both methods)
Bond premium 105.94
Bonds payable 1,000.00
Balance sheet disclosure Jan. 1/00 (both methods)
$1,000.00
105.94
hz
Bonds payable
Bond premium
Book value of bonds
June 30/00
$1,105.94
Interest expense
Bond premium
Cash
77.42
2.58
80.00
74.70
5.30
80.00
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77.42 = $1,105.94(.07) 5.30 = $105.94/20
Balance sheet disclosure June 30/00
Bonds payable
Premium
Book value of bonds
77.24
Bond premium
Cash
d
Dec. 31/00 Interest expense
$1,000.00
103.36
$1,103.36
$1,000.00
100.64
$1,100.64
74.70
2.76
80.00
5.30
80.00
77.24 = $1,103.36(.07) 5.30 = $105.94/20
Balance sheet disclosure Dec. 31/00
Bonds payable
Premium
Book value of bonds
$1,000.00
100.60
$1,100.60
$1,000.00
95.34
$1,095.34
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 33
Chapter 12 – Liabilities
121. JV issued $10,000, 10% bonds payable (interest payable annually), which mature at the end of six
years from issue date. The effective rate of interest at issue date was 12%. The sale price of the
bonds was: $_________________.
Ans:
$10,000 x PV1, 12%, 6 (.50663)
=
$5,066
$1,000 x PVA, 12%, 6 (4.11141)
=
4,111
9,177
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Ans: 1:B, 2:C, 3:D, 4:A
Difficulty: Hard
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122. Match the "Characteristic" with the "Designation" by entering appropriate letters to the left.
Characteristic
A. Bonds supported by a lien (mortgage) on specific assets.
B. The entire bond issue matures at a single date.
C. The investor has the option to turn in the bonds and receive in exchange other specified
securities.
D. Issuer has the option to retire them at a stated price before the obligatory maturity date.
Designation
___ 1.
Ordinary bonds
___ 2.
Convertible bonds
___ 3.
Callable bonds
___ 4.
Secured bonds
Level of Learning: Application
Topic: LO4, 5
d
123. RX issued $1,000,000, 10% bonds payable (interest payable annually), which mature at the end
of five years from issue date. The effective rate of interest at issuance was 8%. The sale price of
the bonds was: $_________________.
Ans:
$1,000,000 x PV1, 8%, 5 (.68058)=
$ 680,580
$100,000 x PVA, 8%, 5 (3.99271)=
399,271
Total
$ 1,079,851
=========
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 34
Chapter 12 – Liabilities
124. A retail store has completed certain transactions that management believes may have caused
current liabilities. Indicate by check mark whether the following items should be classified as
current liabilities. Assume a December 31 year-end.
Classified as a Current Liability
Items
Yes
No
Unknown
(a) Dividend issuable in stock of the company.
___
___
___
(b) Interest for January through March, which is not payable ___
___
___
until July 1 next year.
(c) Amounts withheld in January for income tax from
___
___
___
employee pay cheques; amount not yet remitted.
(d) Bonds maturing in 11 months from the financial
___
___
___
statement date for which inadequate sinking fund exists.
(e) Obligation to service warranted (one year) products sold ___
___
___
with store's private label.
(f) Obligation on gift certificates redeemable during the
___
___
___
upcoming year.
(g) Shipping cost for goods sold, in transit, shipped f.o.b. ___
___
___
point of shipment.
hz
Ans: (a) No, (b) Yes, (c) Yes, (d) No, (e) Yes, (f) Yes, (g) No
Difficulty: Hard
Level of Learning: Application
Topic: LO1
d
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Chapter 12 – Liabilities
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hz
125. At the end of the current reporting period, a company which adheres to ASPE is involved in a
number of contingencies. The company seeks your advice as to how each contingency should be
recorded and reported. Below are listed four "Requirements for Recording and Reporting" and six
"Contingencies." Match each situation with one appropriate requirement code.
Requirements for Recording and Reporting:
Code
A = Record with entry
B = Disclosure note required
C = Disclosure note permitted
D = Disclosure not recommended
Contingencies:
___ 1.
The company has substantial assets in a foreign country and their
expropriation is reasonably possible; the amount of the loss can be estimated
reliably.
___ 2.
The company is the defendant in a lawsuit wherein the plaintiff seeks
damages; a loss is remote, however, if it does occur its amount can be
estimated reliably.
___ 3.
The company is the plaintiff in a lawsuit seeking damages; a gain is remote
and the amount of the gain, should it occur, cannot be estimated reliably.
___ 4.
The company is the defendant in a lawsuit wherein the plaintiff seeks
damages; a loss is likely but the amount of it cannot be estimated reliably.
___ 5.
The company gives a two-year warranty on all goods sold; the warranty cost
can be estimated reliably.
___ 6.
The company is the plaintiff in a lawsuit seeking damages; a gain is likely and
the amount can be estimated reliably.
Ans: 1: B, 2: C, 3: D, 4: B, 5: A, 6: B
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3
d
126. Indicate the correct financial statement treatment of each of the three situations listed below by
entering the identifying letter in the space provided.
Financial Statement
A. Report as a current or long-term liability.
B. Must report as a note to the financial statements.
C. May report in a note to the financial statements.
Situations
___ 1.
Short term obligation estimated amount.
___ 2.
Probable obligation estimated amount.
___ 3.
Short term obligation known amount.
___ 4.
Probable obligation known amount.
___ 5.
Reasonably possible obligation known amount.
___ 6.
Reasonably possible obligation unknown amount.
___ 7.
Remote obligation unknown amount.
___ 8.
Remote obligation known amount.
Ans: 1:A, 2:A, 3:A, 4:A, 5:B, 6:B, 7:C, 8:C
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 36
Chapter 12 – Liabilities
Difficulty: Hard
Level of Learning: Application
Topic: LO2 3
127. Use the identifying letters which appear below to classify the items listed.
Classification
A. Contingent liability
B. Current liability
C. Long-term liability
D. Owners' equity
E. None of these.
___ 7.
Premium on bonds payable.
Dividends payable in stock of the company.
Accounts receivable assigned.
Income tax withheld from employees' salaries.
Revenue collected in advance.
Estimated premium claims payable (in connection with sales promotion offer
involving redemption of proof of purchase premiums).
Estimated income tax payable.
hz
Items
___ 1.
___ 2.
___ 3.
___ 4.
___ 5.
___ 6.
Ans: 1:C, 2:D, 3:E, 4:B, 5:B, 6:B, 7:B
Difficulty: Hard
d
zle
Level of Learning: Application
Topic: LO1-8
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 37
Chapter 12 – Liabilities
128. Match each of the following items with its appropriate financial statement classification by
entering letters in the spaces provided.
Classification
A. Current liability
B. Long-term liability
C. Contingent liability
D. Owners' equity
E. None of these.
Items
___ 1.
Sales taxes collected.
___ 2.
Deferred repairs.
___ 3.
Cash dividends payable.
___ 4.
Appropriated retained earnings for bond sinking fund.
___ 5.
Accrued wages.
___ 6.
Bonds payable.
___ 7.
Stock dividends issuable.
___ 8.
Unearned rent revenue.
___ 9.
Notes Payable (due in 6 months) discounted.
___ 10. Premium on bonds payable.
hz
Ans: 1:A, 2:A, 3:A, 4:D, 5:A, 6:B, 7:D, 8:A, 9:A, 10:B
Difficulty: Hard
Level of Learning: Application
Topic: LO1-8
Items
___ 1.
___ 2.
___ 3.
___ 4.
___ 5.
___ 6.
___ 7.
___ 8.
d
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129. Classify each of the items listed below by entering the appropriate letter. Assume that IFRS is
adhered t.
Classification
A. Contingent liability
B. Current liability
C. Long-term liability
D. Owners' equity
E. Provision
Unearned rent revenue.
Deferred interest revenue.
Accrued wages.
Cash dividends payable.
Bonds payable (due in five years).
Accommodation endorsement (probable and
estimable).
Stock dividend issuable.
Estimated taxes payable.
Ans: 1:B, 2:B, 3:B, 4:B, 5:C, 6:E, 7:D, 8:B
Difficulty: Hard
Level of Learning: Application
Topic: LO1-8
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 38
Chapter 12 – Liabilities
130. On January 1, 2000, a company purchased a machine that had a list price of $23,500. The
purchase terms agreed upon were: cash down payment $12,000 plus a 15% note payable of
$9,132 (its present value). The note is payable in three equal annual instalments (interest plus
principal) on each December 31. Round to the nearest dollar.
Required:
(a)Give the entry to record the acquisition of the machine.
(b)Give the adjusting entry required on September 30, 20x2, for interest assuming this is the end
of the accounting period.
Ans:
(a) Machine
21,132
Cash
12,000
Note payable
9,132
(b) Interest expense
731
Interest payable (975 x 9/12)
731
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
hz
zle
131. On January 1, 2000, a corporation purchased a machine (10 year estimated useful life; no residual
value; straight-line method) by paying cash $1,500 and signing a note payable with a face amount
of $4,500, 8% interest payable each December 31. The maturity date is December 31, 2002. The
going market rate of interest was 10%. Give all required entry (entries) at each of the following
dates:
January 1, 2000:
December 31, 2000:
Ans: January 1, 2000:
Machine ($1,500 + $4,276)
5,776
Cash (given)
1,500
Note payable (net)*
4,276
* principal $4,500 x (PV1, 10%, 3) (.75131)
* Interest $ 360 x (PVA, 10%, 3) (2.48685)
Depreciation expense ($5,776 ÷ 10 years)
Accumulated depreciation
Interest expense ($4,276 x .10)
Cash ($4,500 x .08)
Note payable ($428 - 360)
d
December 31, 2000:
3,381
895
4,276
=====
578
578
428
360
68
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 39
Chapter 12 – Liabilities
132. On January 1, 1999, a company incurred a debt of $11,663, which is payable in four equal annual
instalments of $3,600, starting on December 31, 1999.
(a)The implicit interest rate is _______% (rounded to the nearest percent).
(b)Give the journal entry to record the second annual payment (on December 31, 2000).
Ans: (a) Implicit interest rate: 9%
$11,663 ÷ $3,600 = 3.23972, PVA for n = 4 shows 9%
(b) December 31, 2000
Liability
2,780
Interest expense
820
Cash
3,600
Date
Jan. 1/99
Dec.31/99
Dec.31/00
Cash
$11,663
$ 3,600
3,600
Interest Expense
Principal Reduction
$ 11,663 x.09 =
9,113 x.09 =
Principal Balance
$ 1,050 $3,600 - 1,050 =
820 3,600 – 820 =
$ 2,550 9,113
2,780 6,333
Difficulty: Hard
hz
Level of Learning: Application
Topic: LO4, 5
(b)
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133. X owed a debt dated January 1, 2000, amounting to $91,330. Arrangements were made to pay the
debt in three equal annual instalments, starting on December 31, 2000. The interest is 15% per
annum.
(a)Compute the amount of the annual cash payment to be made on each December 31.
Payment $______________.
(b)Prepare the related debt amortization schedule for the term of the debt.
Ans:
(a)$91,330 ÷ (PVA, 15%, 3) (2.28323)= $40,000
======
Cash –
Interest Expense (15%)
Jan. 1/00
Dec.31/00
Dec.31/01
Dec.31/02
40,000
40,000
40,000
13,700
9,755
5,218
d
Date
=
Principal
Reduction
26,300
30,245
34,782*
Principal
Balance
$91,330
65,030
34,785
_________
*$3 difference due to rounding
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 40
Chapter 12 – Liabilities
134. On September 1, 2000, a company signed a $19,800, one-year, non-interest-bearing note payable
and received $18,000 cash.
(a)What was the yield rate of interest?_________
(b)Give the entry required at September 1, 2000, in the accounts of the company (use the net
method).
(c)Give the adjusting entry required at the end of the accounting year for the company (December
31, 2000).
(d)Give the entry required on the due date, August 31, 2001, assuming no reversing entries were
made.
Ans: (a) $19,800 - $18,000 = $1,800 ÷ $18,000 = 10%
(b)September 1, 2000
Cash
18,000
Note payable
18,000
600
(d)August 31, 2001:
Note payable
Interest expense ($1,800 x 8/12)
Cash
18,600
1,200
hz
(c)December 31, 2000:
Interest expense ($1,800 x 4/12)
Note payable
600
19,800
Difficulty: Hard
d
zle
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 41
Chapter 12 – Liabilities
135. On September 1, 2000, a company purchased a machine and paid for it by signing a two-year
noninterest-bearing note, face $4,000. The note is payable August 31, 2002. The going rate of
interest was 18% per year. The accounting period ends December 31.
(a) Compute the cost of the machine.
(b) Give all appropriate entries throughout the term of the note.
Use the net method.
Ans: (a) $4,000 x (PV1, 18%, 2) (.71818) = $2,873
(b) September 1, 2000
Machine
2,873
Note payable
2,873
December 31, 2000
Interest expense ($2,873 x .18 x 4/12)
Note payable
December 31, 2001
Interest expense
Note payable
172
172
548*
548
hz
August 31, 2002
Note payable ($2,873 + $172 + $548)
Interest expense ($4,000 - $3,593)
Cash
3,593
407
4,000
=
=
($2,873 + $517) x .18 = $610 x 4/12
$548
=
Difficulty: Hard
zle
*$2,873 x .18 = $517 x 8/12
or ($2,873 + $172) x .18
$345
$548
====
203
Level of Learning: Application
Topic: LO4, 5
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 42
Chapter 12 – Liabilities
136. On September 1, 2000, a company signed a $6,540, one-year, non-interest-bearing note payable
and received $6,000 cash.
(a)What was the imputed rate of interest?______________ % .
(b)Give the entry required at September 1, 2000, to record the receipt of the cash (record on net
basis).
(c)Give the adjusting entry required at the end of the accounting year, December 31, 2000.
(d)Give the entry required on the due date, August 31, 2001, assuming no reversing entries were
made.
Ans: (a) $6,540 - $6,000 = $540 ÷ $6,000 = 9%
(b) September 1, 2000
Cash
6,000
Note payable
6,000
(c) December 31, 2000
Interest expense ($540 x 4/12)
180
Note payable
180
(d) Note payable ($6,000 + $180)
6,180
Interest expense ($540 x 8/12)
360
Cash
6,540
hz
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
d
zle
137. Quality 9000 International Inc., which began operations in 1996, sells 20,000 units of its product
each year under the following warranty: defective units will be fixed free of charge during the
calendar year of purchase and the next two calendar years. (This means it is best to buy from this
company early in the year.) Only 1% of units sold have required warranty service in the past. The
average cost has been $200 per unit for servicing. Units require service only once and the
likelihood of a unit requiring service is the same during each year in the warranty period. What is
the balance in the warranty liability account at December 31, 1999?
Ans: As of Dec. 31/99, the warranty for 1996, 1997 units is expired;
Dec. 31/99 liability =
For 1998 sales: 1/3(20,000)($200)(.01)
=
$13,333
For 1999 sales: 2/3(20,000)($200)(.01)
=
26,667
Total liability at Dec. 31/99
$40,000
======
Difficulty: Hard
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 43
Chapter 12 – Liabilities
138. A firm sells a remarkable product, which serves many household purposes. The firm is confident
about its product and is so anxious to sell a large number of units that it grants a 3-year warranty.
The warranty agreement specifies that any malfunction or other problem will be fixed at no cost
to the customer, unless the customer has abused the product. Based on experience with other
household products it has sold in the past, 3% of total units sold will require service over the
warranty period at an average cost of $200 per unit. The following information relates to the first
two years of the product's life:
Year 1
Year 2
Unit sales
20,000
5,000
Actual warranty costs incurred
$ 35,000
$ 80,000
What is the balance of the warranty liability account at January 1, Year 3? Assume that the
company did not revise its estimate of future warranty claims frequency.
Ans: January 1, 20x3 warranty liability balance =
(20,000 + 25,000).03($200) - $35,000 - $80,000 = $155,000
Difficulty: Hard
hz
Level of Learning: Application
Topic: LO3
d
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139. At December 31, 1999 ABC Company has the following three separate lawsuits pending against
it: Suit A-Plaintiffs seek damages of $40,000; Suit B-Plaintiff seeks damages of $200,000; and
Suit C-Plaintiff seeks damages of $20,000.
ABC management and legal counsel have made the assessments indicated below. For each suit,
taking into account the assessment, you are to (a) give the accrual entry if it is required (if not,
state why) and (b) indicate whether a disclosure note is required and explain the reason.
CASE A-Remote that ABC will lose the suit.
(a) Accrual entry:
(b) Disclosure note: _______ Yes ______ No. Explanation:
CASE B-Reasonably possible that ABC will lose; reasonable estimate of damages $4,000.
(a) Accrual entry:
(b) Disclosure note: ______ Yes _______ No. Explanation:
CASE C-Probable that ABC will lose; reasonable estimate of damages $10,000.
(a) Accrual entry:
(b) Disclosure note: ______ Yes ______ No. Explanation:
Ans: CASE A
(a) None permitted for remote loss contingencies
(b) No (permissible but not required)
CASE B
(a) None
(b) Yes (required for reasonably possible loss contingencies)
CASE C
(a) Estimated loss-Damages from lawsuit
20,000
Estimated liability-Damages from lawsuit
20,000
(b) Yes or no (Disclosure often required in addition to the journal entry) for full disclosure.
Difficulty: Hard
Level of Learning: Application
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 44
Chapter 12 – Liabilities
140. BRIEFLY explain how the treatment of contingencies differs under IFRS and ASPE.
Ans: Contingencies may or may not be accrued under ASPE but are never accrued under IFRS.
Both IFRS and ASPE require the disclosure of contingencies.
Difficulty: Hard
Level of Learning: Application
Topic: LO3, 10
zle
hz
141. Match the following bond classifications with the appropriate
statement by entering the appropriate letters in the spaces provided:
Bond Classifications
A. Government bonds
B. Corporate bonds
C. Serial bonds
D. Redeemable bonds
E. Convertible bonds
F. Callable bonds
G. Income bonds
H. Registered bonds
I. Coupon bonds
Statements
___ 1. Bonds that may be turned in to issuer in exchange for other securities.
___ 2. Issued by private companies.
___ 3. Interest is paid only to owners of record as reflected in the accounts of the issuer.
___ 4. Interest is paid only in years in which the issuer earns a profit.
___ 5. Investor has the option of turning in the bond for retirement before maturity date.
___ 6. Interest is paid only to investors who return a coupon.
___ 7. Issued by public entities.
___ 8. Principal paid off in steps (instalments).
___ 9. Issuer has the option to pay off the bonds before maturity date.
Ans: 1:E, 2:B, 3:H, 4:G, 5:D, 6:I, 7:A, 8:C, 9:F
Difficulty: Hard
d
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 45
Chapter 12 – Liabilities
142. For each of the following, indicate the appropriate balance sheet classification by entering the
applicable classification letter.
Classification
A. Current liability
B. Long-term liability
C. Contingent liability
D. Owners' equity
E. None of these
Item
___ 1. Premium on bonds payable
___ 2. Sales taxes collected
___ 3. Repairs expense payable
___ 4. Cash dividends payable
___ 5. Bond sinking fund
___ 6. Accrued wages payable
___ 7. Bonds payable
___ 8. Stock dividends declared
___ 9. Rent received in advance
hz
Ans: 1:B, 2:A, 3:A, 4:A, 5:E, 6:A, 7:B, 8:D, 9:A
Difficulty: Hard
Level of Learning: Application
Topic: LO1-8
Level of Learning: Application
Topic: LO4, 5
d
Difficulty: Hard
zle
143. On September 1, 2000, XYZ borrowed $100,000 on a 9%, two-year, note payable. Simple
interest is payable on August 31, 2001 and 2002. XYZ's reporting year ends December 31 and
the company does not use reversing entries for interest. The required entry on August 31, 2001,
is:
Ans:
Interest Expense
6,000
Interest Payable
3,000
Cash
9,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 46
Chapter 12 – Liabilities
144. A company wishes to finance a long-term construction project and in doing so, capitalize the
related interest expense. The company requires $2 million in financing.
The company currently has the following debt and equity items on its December 31st, 2009
Balance Sheet:
Bonds Payable (8%, Issue at Par)
Unsecured Line of Credit (6%)
$1,000,000
$3,000,000
Common Shares (Par Value $100)
$1,000,000
There are 10,000 common shares outstanding which pay an annual dividend of $ 5 per
share. The company can borrow a maximum of $5 million on its unsecured line of credit.
The company’s bank has indicated its willingness to extend an additional credit facility in
the amount of $1.5 million at an annual rate of 5% as of March 31st, Year 6. These
amounts remained outstanding throughout Year 6.
hz
On March 1st, Year 6 the company borrowed $600,000. On April 1st, Year 6, and
additional $1.4 million was wired to the company’s account, drawn on its new credit
facility.
Determine the amount of interest that the company would be able to capitalize as per
IFRS for Year 6.
zle
Ans: The company requires $2 Million. $500,000 was drawn from the company’s unsecured
line of credit – a generalized borrowing. The remainder was drawn on the purpose-specific credit
facility.
It is necessary to calculate the company’s weighted average cost of capital for its general
borrowings:
8%*$1 million + 6%*3 million =$260,000/ ($1 million + $3 million) = 6.5%.
d
The amount of interest to be capitalized would be adulated as follows:
Category
Portion of Year
Weighted Avg Borrowings
General
Specific
10/12
9/12
$600,000*10/12=$500,000*6.5%
$1.4 million*9/12=$1,050,000*5%
Total
Capitalized Interest
$32,500
$52,500
$85,000
Thus, $85,000 of interest would be capitalized.
The journal entry to reflect the capitalization of interest would be as follows:
Interest Expense
$85,000
Construction-in-process
$85,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 47
Chapter 12 – Liabilities
Difficulty: Hard
Level of Learning: Application
Topic: LO6
hz
145. On July 1, 2000, RC sold two of its $10,000, 9%, bonds payable at an effective interest rate of
8%. Interest is paid each June 30 and the bond matures in six years on June 30, 2006. Round all
amounts to the nearest dollar.
(a)What was the amount of the premium $_____________ or discount
$_______________________?
(b)The income statement for the accounting year ended December 31, 2000, should report interest
expense of, assuming:
(1) Straight-line amortization, $_____________________.
(2) Interest-method amortization, $___________________.
Ans:
(a) $20,000 x PV1, 8%, 6 (.63017)
$2,60
$1,800 x PVA, 8%, 6 (4.62288)
8,321
Cost
20,924
Par
20,000
Premium
$924
======
(b) Straight-line amortization:
zle
$823, interest expense
====
1,800 - ($924 ÷ 6 years = $154) = $1,646 x 6/12 = $823
(2) Interest-method amortization:
$837, interest expense
====
$20,924 x 8% x 6/12 = $837
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
d
146. It is often necessary to compute the book value of a bond issue several years into its term. Rather
than compute an amortization schedule for the entire term, it is possible to directly compute the
net bond liability at any interest date under either the interest method or straight-line method.
Assume that $100,000 of 8% bonds were issued to yield 10% on January 1, 2000, the bond date.
The bonds pay interest each December 31 and are scheduled to mature in ten years. Answer the
following questions without producing an amortization schedule.
(a) What is the book value of the bonds on January 1, 2006 if the firm uses the straight-line
method.
(b) What is the book value of the bonds on January 1, 2006 if the firm uses the interest (effective
interest) method.
Ans: (a) Original issue price = $100,000(PV1,.10,10)(.38554) + $8,000(PVA,.10,10)(6.14457) =
$87,711. Original discount = $12,289. At Jan. 1/06, 4 years of term are left so BV =
$100,000 -.4($12,289) = $95,084.
(b) BV = 100,000(PV1,.10,4)(.68301) + $8,000(PVA,.10,4)(3.16987) = $93,660.
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 48
Chapter 12 – Liabilities
147. A firm has two bonds outstanding today, each with: (1) $1,000 face value, (2) a term of 5 years at
issuance, (3) 3 years remaining to maturity, and (4) 10% yield rate at issuance. Bond A is a zero
coupon bond; bond B pays 10% annually and just paid interest yesterday. The yield rate today on
both bonds is 12%. Which bond has experienced the greatest percentage change in value since
issuance?
Ans: Bond A sold for 62: $1,000(PV1, .10, 5) (.62092).
Bond B sold for 100 as coupon and market rate were the same at issuance.
Market value of Bond A today = 71 = $1,000(PV1, .12, 3)(.71178).
Market value of Bond B today = 95 = $1,000(PV1, .12, 3) (.71178) +
$100(PVA,.12,3)(2.40183)
Bond A has increased 15% = (71 - 62)/62
Bond B has decreased 5% = (100 - 95)/100 (generally the price of zeros is more volatile
with interest rate changes)
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
d
zle
hz
148. On September 1, 2000, RC sold $10,000, 6% (payable semi-annually each March 1 and
September 1), 10-year bonds dated September 1, 2000, to yield 8%. RC uses straight-line
amortization. The accounting period ends December 31.
(a) The sale price of the bond was $________________.
(b) Interest expense for 2000, was $________________.
Ans: (a)
$10,000 x PV1, 4%, 20 (.45639)
=
$4,564
$300 x PVA, 4%, 20 (13.59033)
=
4,077
Sale price
=
$8,641
======
(b)
$10,000 x 3% x 4/6
=
$200
$1,359 x 4/120
=
45
Interest expense
=
245
====
149. (Appendix) Discuss some of the sources of short-term financing.
Ans: The answer should include the ability to use promissory notes as financing. These notes
can be interest or non-interest bearing. Companies can approach the banks for an operating
line of credit. Large companies can issue commercial paper. Companies can also sell their
receivables to a finance company.
Difficulty: Hard
Level of Learning: Application
Topic: LO11
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 49
Chapter 12 – Liabilities
150. On January 1, 2000, a company purchased a machine (an operational asset) with a list price of
$4,000. $2,000 was paid in cash and a three-year, noninterest-bearing note was signed. The note
was for $3,000 and required payment of equal amounts of $1,000 each December 31, 2000, 2001,
and 2002. The going rate of interest was 12%. Using this information, complete the following
requirements.
(a) Give the entry on January 1, 2000, to record the purchase of the machine (show computations
and round to the nearest dollar):
(b) Prepare the related debt amortization schedule.
(c) Give any adjusting entry related to the note payable required for 2001, assuming the
accounting period ends March 31. If none is required, state the reason.
(d) Assuming that the accounting period ends March 31 and there were no reversing entries, give
the entry to record the annual payment made on December 31, 2001.
Ans: (a)
January 1, 2000:
Machinery 4,402
Cash
Note payable
(b)
hz
______
*$1,000 x (PVA, 12%, 3) (2.40183) = 2,402
Cash
Interest
Expense
$ 1,000
1,000
1,000
288
203
107
Principal
Reduction
$ 2,402
712
797
893
zle
Date
Jan. 1/00
Dec.31/00
Dec.31/01
Dec.31/02
Principal
Balance
1,690
893
-0-
(c) March 31, 2001
51
51
152
51
797
d
Interest expense ($203 x 3/12)
Interest payable
(d) Interest expense ($203 x 9/12)
Interest payable
Note payable
Cash
1,000
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 50
Chapter 12 – Liabilities
151. AB owes a $100,000, 8%, five-year note payable dated January 1, 2000. It is the end of year
2000, and instead of making the interest payment now due, AB has made arrangements to pay the
debt and the 2000 interest payment, in four equal instalments based on the same interest rate. The
first payment is to be made on January 1, 2001. The amount of the equal annual payments,
rounded to the nearest dollar, is:
Ans: $100,000 + ($100,000 x .08) = $108,000 ÷ 3.57710 (PVAD, 8%, 4) =$30,192
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
hz
152. The management of PT authorized an issue of $120,000 bonds payable, 6% (annual interest rate),
dated January 1, 2000. The bonds mature on December 31, 2005 (5 years). Interest is payable
each June 30 and December 31. The bonds were sold on May 1, 2000, at an effective (yield) rate
of 8%.
(a) The bonds were sold at a____________ premium; ____________discount (check one).
(b) Give the entry for PT to record the sale of the bonds on May 1, 2000. Show computations for
the issue price.
Ans: (a) Discount, because the effective interest rate is higher than the stated rate.
(b)Cash ($110,807* + $2,400)
113,207
Discount on bonds payable ($120,000 - $110,807)
9,193
Interest expense ($120,000 x 3% x 4/6)
2,400
Bonds payable
120,000
=
=
=
$81,067
29,199
$110,266
========
June 30, 2000:
Principal: $120,000 x PV1, 4%, 9 (.70259)
Interest: $3,600 x PVA, 4%, 9 (7.43533)
Total
=
=
=
$ 84,311
26,767
$111,078
========
Interpolation:
($111,078 $110,266 = $812) x 2/6
($111,078 $271)
d
zle
* To compute issue price on May 1:
January 1, 2000:
Principal: $120,000 x PV1, 4%, 10 (.67556)
Interest: $3,600 x PVA, 4%, 10 (8.11090)
Total
=$271.00
=$10,807
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 51
Chapter 12 – Liabilities
153. On April 1, 2000, the DEF sold a $2,000,000 bond issue dated January 1, 2000, to yield 9% per
annum to maturity. The bonds were to be outstanding for twenty years from January 1, 2000, and
the stated rate of interest was 8%. Interest is paid each January 1.
(a) Give the entry to record the purchase of one-fourth of these bonds as a long-term investment
by NOP. Assume effective interest amortization and contra/adjunct accounts.
(b) Give the December 31, 2000, adjusting and closing entries for NOP.
Ans:
(a) Investment in bonds ($2,000,000 x 1/4)
Interest revenue ($500,000 x 8% x 3/12)
Discount on bond investment
Cash (See computation below.)
500,000
10,000
45,420
464,580
(b) Interest receivable ($500,000 x 8%)
Discount on bond investment (892 223)
Interest revenue
40,000
669
Interest revenue ($40,669 - $10,000)
Income summary
30,669
40,669
hz
PV @ n=20; i=9:
Prin. (500,000 x .17843 = 89,215) + Int. (40,000 x 9.12855
365,142)
zle
PV @ n=19; i=9:
Prin. (500,000 x .19449 = 97,245) + Int. (40,000 x 8.95011
358,004)
PV @ Apr. 1/00: $454,357 + (892 x 1/4 = 223)
plus accrued interest
=
=
=
=
Difference
=
454,357
455,249
892
======
454,580
10,000
d
Total Cash Paid
30,669
464,580
======
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 52
Chapter 12 – Liabilities
Use the following to answer questions 154-155:
In August 2005, Cummings Corporation, a calendar-year corporation that records adjusting
entries only once per year, issued bonds with the following characteristic:
a.
$50,000 total face value
b.
12% nominal rate
c.
16% yield rate
c.
Interest dates are 1 February, 1 May, 1 August, and 1 November
e.
Bond date is 31 October 2004
f.
Maturity date is 1 November 2009 $1,000 of bond issue costs were incurred.
154. Provide the entries required on 1 August 2007 under the effective interest method of
amortization.
Ans: 1 August 2007 - interest payment date
Interest expense
Discount on bonds payable
Cash
1,103
hz
203
900
Bond issue expense
Bond issue cost
35
35
zle
$1,103 = $27,567 x 4%
$900 = $30,000 x 3%
$35 = (60% of issue remaining) x ($1,000 / 17)
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
d
155. Provide the entries required on 1 August 2007 under the straight line method of amortization.
Ans: Interest expense
1,115
Discount on bonds payable
215
Cash
900
Bond issue expense
35
Bond issue cost
35
$215 = $358 x 60%
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 53
Chapter 12 – Liabilities
Use the following to answer questions 156-162:
Four year term loan, U.S. $500,000
Funds borrowed 1 January 20X6; due 31 December 20X9
Exchange rates:
1 January
20X6
U.S. $1 = Cdn.
31 December 20X6
U.S. $1 = Cdn.
31 December 20X7
U.S. $1 = Cdn.
31 December 20X8
U.S. $1 = Cdn.
31 December 20X9
U.S. $1 = Cdn.
$1.35
$1.40
$1.42
$1.36
$1.39
156. Based on the above information prepare entries to record receipt of loan proceeds for January
20X6.
Ans: Cash ($500,000 x 1.35)
$675,000
Long term debt
$675,000
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
hz
157. Based on the above information prepare entries to record the adjustment to spot rate for
December 20X6.
Ans: Exchange loss
$25,000
Long term debt 500,000($1.35 - $1.40)
$25,000
Difficulty: Hard
zle
Level of Learning: Application
Topic: LO4, 5
158. Based on the above information prepare entries to record adjustment to spot rate December 20X7
Ans: Exchange loss
$10,000
Long term debt 500,000($1.40 - $1.42)
$10,000
Difficulty: Hard
d
Level of Learning: Application
Topic: LO4, 5
159. Based on the above information prepare entries to record adjustment to spot rate December 20X8
Ans: Long term debt 500,000($1.42 - $1.36)
$30,000
Exchange gain
$30,000
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 54
Chapter 12 – Liabilities
160. Based on the above information prepare entries to record adjustment to spot rate December 20X9
Ans: Exchange loss
$15,000
Long term debt 500,000($1.36 - $1.39)
$15,000
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
161. Based on the above information prepare entries to record repayment of loan December 20X9
Ans: Long term debt 500,000($1.40 - $1.42)
$695,000
Cash
$695,000
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
hz
162. Based on the above information calculate the total accounting recognition of loss.
Ans: 20X6
$ 25,000 dr.
20X7
10,000 dr.
20X8
30,000 cr.
20X9
15,000 dr.
Total
$ 20,000 dr.
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5
Required:
zle
163. ABC Inc issued $10,000,000 worth of bonds on January 1st, 2008. The bonds mature on
December 31st, 2017 and carry a coupon rate of 6% payable semi-annually on June 30th and
December 31st of each year. A market interest rate of 8% was effective throughout 2008.
d
1) Were the bonds issued at a premium or a discount?
2) Prepare all journal entries required during 2008.
3) Assume that on January 1st 2009, ABC decided to retire half of the bonds for $4,800,000 in
cash. Prepare the required journal entry.
Ans:
1) The bonds were issued at a discount – market rate exceeds nominal (coupon) rate.
2) January 1st, 2008:
Cash
$8,640,999
Bond Discount
$1,359,001
Bonds Payable
$10,000,000
June 30th, 20X8
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 55
Chapter 12 – Liabilities
Interest Expense
$345,640
Bond Discount
Cash
$ 45,640
$300,000
Dec 31st, 20X8
Interest Expense
$359,466
Bond Discount
Cash
$ 59,466
$300,000
3)
Bonds Payable
$5,000,000
Loss on Bond Disposal $ 428,448
Bond Discount
Cash
Difficulty: Hard
$ 628,448
$4,800,000
hz
Level of Learning: Application
Topic: LO4, 5, 6
164. GHI Inc issued $5,000,000 worth of bonds on January 1st, 2008. The bonds mature on December
31st, 2017 and carry a coupon rate of 4% payable semi-annually on June 30th and December 31st
of each year. A market interest rate of 6% was effective throughout 2008.
Required:
zle
1) Were the bonds issued at a premium or a discount?
2) Prepare all journal entries required during 2008.
3) Assume that on January 1st 2009, ABC decided to retire ALL of the bonds for $5,500,000 in
cash. Prepare the required journal entry.
Ans:
d
1) The bonds were issued at a premium – market rate is less than nominal (coupon) rate.
2) January 1st, 2008:
Cash
$5,743,894
Bond Premium
Bonds Payable
$ 743,894
$5,000,000
June 30th, 20X8
Interest Expense
Bond Premium
Cash
$172,317
$ 27,683
$200,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 56
Chapter 12 – Liabilities
Dec 31st, 20X8
Interest Expense
Bond Premium
Cash
$170,509
$ 29,491
$200,000
3)
Bonds Payable
Gain on Bond Disposal
Bond Premium
Cash
Difficulty: Hard
$5,000,000
$ 186,720
$ 686,720
$5,500,000
Level of Learning: Application
Topic: LO4, 5, 6
d
zle
hz
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 57
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test Bank
Chapter 13 – Shareholders’ Equity
1. Businesses engage in many transactions that are unaffected by the form of the business:
proprietorship, partnership, or corporation.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
2. The primary sources of owners' equity must be separately identified in the accounts.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
hz
3. Preferred shareholders normally have the same voting rights as common shareholders.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
zle
4. Shareholders in a corporation usually have limited liability.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
d
5. The contributed capital accounts should be classified by source.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
6. Retained Earnings restrictions are usually imposed on a company by a third party.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 1
Chapter 13 – Shareholders’ Equity
7. Before a company can issue a property dividend in shares of another company, it must
ensure that the shares are recorded at market value. The dividend is then paid out of the
company’s contributed capital accounts rather than its retained earnings.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO21
8. Under IFRS, companies are required to disclose the components of their shareholders’
equity along with an explanation of any shareholder equity transactions during the year.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1, 9
hz
9. Preferred shares generally have fewer voting rights than common shareholders but
receive preferential treatment (relative to the common shareholders in the event of the
company’s liquidation.
Ans: True
zle
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
10. All unrealized gains and losses, regardless of origin, flow through Other Comprehensive
Income.
Ans: False
Difficulty: Easy
d
Level of Learning: Knowledge
Topic: LO 1, 9
11. Retained earnings, if not designated otherwise, represents the unappropriated portion of retained
earnings.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 2
Chapter 13 – Shareholders’ Equity
12. Total retained earnings include both appropriated and unappropriated retained earnings.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 5
13. Property dividends are dividends that the corporation distributes in the form of noncash assets.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 6
14. All Contributed Capital accounts may carry either a debit or a credit balance, depending
on the transactions from which the account balance originated.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 3
15. When a corporation declares a small stock dividend, it should capitalize the par value of the
shares.
zle
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 7
16. A large stock split should be accounted for by capitalizing the current market value of the stock.
Level of Learning: Knowledge
Topic: LO 7
d
Ans: False
Difficulty: Easy
17. A stock dividend and a stock split are identical in all respects for the corporation issuing the
dividend or splitting the stock.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6, 7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 3
Chapter 13 – Shareholders’ Equity
18. When stock rights are issued to current shareholders, it may require more than one such right to
later acquire one additional share of the stock covered by the rights.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6, 7
19. Liquidating dividends are similar to stock dividends because neither one reduces total
stockholders' equity.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO61
20. Dividends are paid when declared.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO61
Ans: False
Difficulty: Easy
zle
21. Par value is typically set at a low amount so that the corporation can pay a minimum amount in
dividends to the preferred shareholders.
Level of Learning: Knowledge
Topic: LO 6
Ans: False
Difficulty: Easy
d
22. Only certain unrealized gains flow through Other Comprehensive Income – any realized
gains flow through retained earnings.
Level of Learning: Knowledge
Topic: LO9
23. The shareholders of a corporation usually cannot be held legally liable for the debts of the
corporation except to the extent that legal capital is impaired.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 4
Chapter 13 – Shareholders’ Equity
24. Legal capital is related directly to the total number of shares issued.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 2
25. Both preferred and common shares may be cumulative.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
26. A Statement of Changes in Shareholder Equity is mandatory under both IFRS and ASPE.
Ans: False
Difficulty: Easy
hz
Level of Learning: Knowledge
Topic: LO8, 9
27. The position of common shareholders is less risky than the positions of both the creditors and
preferred shareholders.
zle
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
28. Issuing a common stock dividend decreases common shares and increases retained earnings.
Level of Learning: Knowledge
Topic: LO 6
d
Ans: False
Difficulty: Easy
29. Treasury shares held by management are considered to be issued but not outstanding.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 5
Chapter 13 – Shareholders’ Equity
30. The Treasury Share account is debited and credited at the cost of the shares repurchased.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 4
31. Common share subscriptions receivable should always be reported as a current asset.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 2
32. "Common shares subscribed" is credited in recording a common share subscription contract
because the shares are usually issued at the time the contract is signed.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
33. If a corporation only has one class of shares, that class must be common shares.
zle
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
34. A bad debt loss is recognized when a subscriber to common shares defaults.
Level of Learning: Knowledge
Topic: LO 2
d
Ans: False
Difficulty: Easy
35. Cumulative preferred shares usually carry the right, upon liquidation of the corporation, to
dividends in arrears to the extent the corporation has retained earnings.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 6
Chapter 13 – Shareholders’ Equity
36. Convertible preferred shares are convertible (usually to common shares) at the option of the
shareholder and not at the option of the corporation.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 3
37. The purchase of treasury stock reduces the number of outstanding shares, and if the treasury stock
is subsequently resold, it is again classified as outstanding.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 4
38. Treasury shares cannot be voted, nor paid dividends, pending resale.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO41
Ans: True
zle
39. The conversion of preferred shares into common shares results in no change in total shareholders'
equity.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 3
40. When retained earnings are restricted, they must also be appropriated.
Level of Learning: Knowledge
Topic: LO5
d
Ans: False
Difficulty: Easy
41. When a company issues to its shareholders some shares of another corporation's stock that
currently are held as an investment, the company is issuing a stock dividend.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 6, 7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 7
Chapter 13 – Shareholders’ Equity
42. Dividends in arrears on cumulative preferred shares must be paid at the end of the accounting
period if cash and retained earnings are available.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
43. Dividends in arrears on noncumulative preferred shares must be paid before dividends can be
paid to the common shareholders.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO61
44. Dividends in arrears on cumulative preferred shares constitute a liability to the corporation that
should be recorded (accrued).
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 6
Ans: False
Difficulty: Easy
zle
45. The date of record for a cash dividend follows the date of payment and precedes the date of
declaration.
Level of Learning: Knowledge
Topic: LO 6
Ans: False
Difficulty: Easy
d
46. In accounting for dividends, the declaration date is the most important date because dividends are
paid to whomever owns the shares on that date.
Level of Learning: Knowledge
Topic: LO6
47. A stock split results in the reduction of the par or stated value per share and a proportional
increase in the number of shares outstanding.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 8
Chapter 13 – Shareholders’ Equity
48. In a stock split, only the content of contributed capital is changed, whereas in a stock dividend the
amount of contributed capital is changed.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO7
49. The accounting treatment for ordinary and liquidating dividends differs. Ordinary dividends cause
a debit to retained earnings and liquidating dividends cause a debit to contributed capital.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 6
Ans: D
hz
50. Share issue costs may be charged to:
A)
Earnings.
B)
Share Capital.
C)
Retained Earnings.
D)
B or C.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
51. ABC Inc. issued 1,000 common shares and 3,000 preferred shares for a lump sum of
$25,000. The fair market value of each share on the date of issue was $6 per common share and
$8 per preferred share. How much of the proceeds received should be allocated to the preferred
shares on the date of issue?
A)
$5,000
B)
$20,000
C)
$6,250
D)
$19,750
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 9
Chapter 13 – Shareholders’ Equity
52. The conversion from one type of share to another is accounted for at:
A)
Book Value.
B)
Fair Market Value.
C)
A or B.
D)
A discounted amount.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO 2
53. Preferred shares, which have the most restrictive features, are:
A)
Noncumulative, non-participating, nonvoting.
B)
Fully participating, nonvoting.
C)
Noncumulative, fully participating, nonvoting.
D)
Non-participating, cumulative, nonvoting.
hz
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO 2
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO 4
55. Treasury shares are said to be:
A)
B)
C)
D)
Issued.
Outstanding.
A and B.
A or B.
d
zle
54. Gains on sale of treasury stock should be credited to:
A)
Additional contributed capital.
B)
Other income.
C)
Share capital.
D)
Retained earnings.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO 4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 10
Chapter 13 – Shareholders’ Equity
56. Ryan Corp. has the following share capital outstanding:
Common, 10,000 shares
Preferred $1.80 noncumulative, non-participating, 10,000 shares
Dividends are two years in arrears, excluding the current year. Total dividends of $90,000 will be
paid for the current year. The total amounts that will be received by the preferred shareholders
and common shareholders are:
1
2
3
4
A)
B)
C)
D)
Preferred Shareholders
$36,000
$18,000
$90,000
$54,000
Common Shareholders
$54,000
$72,000
$0
$36,000
Choice 1
Choice 2
Choice 3
Choice 4
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
57. The following owners' equity section of a firm's balance sheet relates to the current year (end-of-
zle
year data):
8%, $100 par cumulative preferred shares
$5 par common shares
Contributed capital in excess of par-preferred shares
Contributed capital in excess of par-common shares
Retained earnings
Treasury stock
Total owners' equity
$10,000
40,000
5,000
20,000
60,000
(10,000)
$125,000
========
d
How many common shares are issued?
A)
8,000
B)
6,000
C)
7,000
D)
There is insufficient information provided to answer the question.
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
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Chapter 13 – Shareholders’ Equity
58. LS issued 200 common shares to BH (last share transaction was a year prior when LS sold 10
shares at $4 per share), and received a patent in full payment. The patent had a current market
value of $2,000 and was carried on the books of TX at $1,500. Under ASPE, common shares
should be credited for:
A)
$800
B)
$1,500
C)
$1,800
D)
$2,000
E)
This transaction has no commercial substance, therefore no entry is required.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO 2, 9
59. SXC reported the following data on its 1999 statement of financial position:
Ans: C
Difficulty: Medium
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hz
Common shares no par
$202,000
Common shares subscribed
18,000
Retained earnings
175,000
If the average price paid for all of the common shares sold and subscribed were $5.00, the total
number of sold and subscribed shares was:
A)
$44,400
B)
$40,400
C)
$44,000
D)
$40,000
E)
None of these answers is correct
Level of Learning: Application
Topic: LO 2
d
60. DWWR purchased its own common shares for $20,000 and debited the treasury stock account for
the purchase price. The shares were subsequently sold for $17,000. The $3,000 difference
between the cost and sale price should be recorded as a reduction of:
A)
Contributed capital from treasury stock transactions without regard as to whether or not
there have been previous net "gains" from sales or retirements of the same class of shares.
B)
Contributed capital from treasury stock transactions to the extent of previous net "gains"
from sales or retirements of the same class of shares; otherwise retained earnings should be
reduced.
C)
The beginning balance of retained earnings.
D)
Revenues on the income statement.
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 13 – Shareholders’ Equity
61. XHC had only two share transactions. Initially, XHC issued 1,000 common shares, at $15 per
share. XHC later bought back 200 shares at $16 per share. Under the single-transaction method,
what is the amount that should be recorded in the treasury stock account?
A)
$2,000
B)
$3,000
C)
$3,200
D)
$3,600
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO 4
Ans: B
hz
62. Identify the missing component (X) in the following equation: Retained earnings, ending balance
= Net income to date + prior period adjustments to date - cash and property dividends to date - X
A)
Stock dividends and splits to date.
B)
Stock dividends to date.
C)
Stock splits to date.
D)
Net unrealized gain or loss on securities available for sale.
Difficulty: Medium
Level of Learning: Application
Topic: LO 6
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63. Cash dividends sometimes are declared in one reporting period and are payable in the next
reporting period. The dividend should be recorded on the:
A)
Payment date.
B)
Declaration date.
C)
Record date.
D)
Either the declaration, record, or payment date, as preferred by the company.
Level of Learning: Application
Topic: LO 6
d
Ans: B
Difficulty: Medium
64. A property dividend causes a debit to retained earnings equal to the ___________ of the property
distributed:
A)
Book value
B)
Fair market value
C)
Original cost
D)
Income tax basis
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO 6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 13 – Shareholders’ Equity
65. CB Corporation issued a 2 for 1 stock split. Which of the following is not a true statement
concerning the effect of the split?
A)
The number of shares outstanding is increased.
B)
There is a transfer of retained earnings to contributed capital.
C)
A proportionate reduction in the par value per share occurs.
D)
There is a continuation of retained earnings with no reduction in its balance.
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO 7
66. On December 31, 1999, when JR Corporation's shares were selling at $44 per share, its
shareholders' equity accounts were as follows:
Common shares (no par value) 100,000
shares issued and outstanding
Retained earnings (credit)
$2,700,000
4,450,000
hz
A 100 percent stock dividend was declared and issued. The effect of this dividend was:
A)
Total retained earnings did not change.
B)
Common shares increased to $5,600,000.
C)
Common shares increased to $6,460,000.
D)
Total shareholders' equity decreased.
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Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO6
67. Which of the following dividends does not reduce retained earnings?
Scrip dividend.
Stock dividend.
Cash dividend.
Property dividend.
Liquidating dividend.
d
A)
B)
C)
D)
E)
Ans: E
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 13 – Shareholders’ Equity
68. For dividends, the date of record is the date:
A)
B)
C)
D)
The market price of the shares drops due to the dividend.
On which the list of shareholders is prepared.
The dividend is actually paid.
The dividend is announced.
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO6
69. Major factors contributing to the growth of the corporate form of business includes all of the
following except:
A)
The facility to accumulate large amounts of resources.
B)
Limited liability of the shareholders.
C)
Easy transferability of ownership.
D)
The lack of government regulation.
hz
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
d
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70. Total equities of a corporation usually include:
A)
Assets plus contributed capital, and plus retained earnings.
B)
Contributed capital plus retained earnings.
C)
Contributed capital plus retained earnings, and plus creditors' interest.
D)
Total owners' equity less treasury stock at cost.
71. Owners' equity must equal the:
A)
Total contributed capital plus retained earnings less liabilities.
B)
Sum of the share capital account balances plus the total contributed capital in excess of par
(or stated value).
C)
Total assets minus total liabilities.
D)
Total contributed capital plus total retained earnings.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 13 – Shareholders’ Equity
72. ABC Inc. engages in a non-cash exchange with a third party whereby ABC Inc. issues common
shares to the third party in exchange for some highly specialized Machinery & Equipment. The
value of the shares issued was $15,000 while the appraised value of the Machinery & Equipment
was $12,000. At what amount would this transaction be valued on ABC’s books?
A) $12,000 under IFRS and $15,000 under ASPE.
B) $15,000 under IFRS and $12,000 under ASPE.
C) $12,000 under either ASPE or IFRS.
D) $15,000 under either ASPE or IFRS.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO 9
hz
73. Under IFRS, the treatment of any of a company’s foreign subsidiary is dependent upon:
A)
The functional currency of the subsidiary.
B)
The nature and extent of the parent company’s relationship with the subsidiary.
C)
A or B.
D)
Managerial judgement.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO 9
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d
74. Which of the following is not a basic right of shareholders?
A)
To inspect the books of account and to insist upon an audit in the event of dissatisfaction
with results revealed by such inspection
B)
To participate in the management of the corporation through taking part in and voting in
shareholders' meetings
C)
To participate in the profits of the corporation through dividends declared by the board of
directors
D)
To share in the distribution of assets of the corporation at liquidation or through liquidating
dividends
E)
To sell shares in the corporation at a price exceeding its cost.
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 13 – Shareholders’ Equity
75. Ownership of shares usually entitles the holders to all of the following rights except:
A)
B)
C)
D)
To elect the board of directors of the corporation.
To control the day-to-day operations of the corporation.
To purchase new shares when they are offered for sale.
To share in the profits of the corporation.
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
76. Authorized share capital refers to the total number of shares:
A)
B)
C)
D)
Outstanding.
Issued.
That can be issued in conformity with the corporation's charter.
Issued, less all treasury shares owned.
Ans: C
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
77. Issued share capital refers to the number of shares:
Outstanding.
Outstanding less all shares held as treasury shares.
Outstanding plus all shares held as treasury shares.
That may be issued according to the corporate charter.
Ans: C
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A)
B)
C)
D)
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
d
78. Share capital may be classified primarily as:
A)
B)
C)
D)
Par Value, Common; or Nopar, Preferred.
Nopar, Common; or Par Value, Preferred.
Par Value, Common; Nopar, Common; Par Value, Preferred; or Nopar, Preferred.
Par Value, Common; Stated Value Common; or Nopar, Preferred.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 13 – Shareholders’ Equity
79. At the date of the financial statements, common shares issued would exceed common shares
outstanding as a result of the:
A)
Payment in full of subscribed shares.
B)
Declaration of a stock split.
C)
Declaration of a stock dividend.
D)
Purchase of treasury stock.
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
80. Zygo sold 1,000 common shares (par $3) at $5 per share on a subscription basis. The entry to
record this transaction included a credit to:
A)
Accounts receivable.
B)
Contributed capital in excess of par.
C)
Common shares.
D)
Subscriptions receivable.
hz
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
d
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81. When a corporation sells some of its own common shares, all on credit, there should be a debit to
the account:
A)
Subscriptions receivable, common.
B)
Accounts receivable.
C)
Cash.
D)
Notes receivable, common.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 13 – Shareholders’ Equity
82. If preferred shares are noncumulative, then:
A)
The preferred shareholders are entitled to current dividends before common shareholders
can receive dividends.
B)
Cash dividends not declared in prior years are lost permanently.
C)
The preferred shareholders are only entitled to a specific percent of the cash dividends,
regardless of the amount declared.
D)
Prior years' cash dividends must be paid to the preferred shareholders before any dividends
may be paid to the common shareholders.
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
Ans: B
hz
83. If preferred shares are non-participating, then:
A)
Preferred shareholders are not entitled to vote.
B)
Preferred dividends for the year are limited to a specific rate.
C)
Preferred shareholders are not entitled to a prior year's dividend once that year has passed.
D)
Preferred shareholders may receive dividends in excess of a specific rate if common
stockholders receive more than that specific rate.
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
84. The redemption privilege on preferred shares provides that the preferred shareholders can:
A)
Purchase treasury shares any time they become available.
B)
Purchase enough shares of any new issue, so that their percentage ownership remains the
same.
C)
Turn in the preferred shares for a specified cash price.
D)
Exchange the preferred shares for common shares.
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
d
Ans: C
85. If preferred shares are callable, then:
A)
B)
C)
D)
The corporation may, at its option, purchase the preferred shares for a specified cash price.
The preferred shareholder can turn the preferred shares in for a specified cash price.
The shareholders can exchange the preferred shares owned for common shares.
There cannot be dividends in arrears.
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
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Chapter 13 – Shareholders’ Equity
86. The order in which dividends are allocated to common and preferred shares depends upon the
provisions in the respective stock contracts. Choose the correct statement regarding this
allocation.
A)
When noncumulative preferred shares are fully participating, the rate of dividends
allocated to preferred shares is the ratio of total par of preferred shares outstanding to total
par of both classes of shares outstanding
B)
When noncumulative preferred shares are not participating, the rate of dividends to
common shares are limited to the ratio of total par of common shares outstanding to total
par of both classes of shares outstanding
C)
When 8% cumulative preferred shares are participating to a total of 12%, any arrear
dividends are ignored in the allocation since they pertain to a previous year
D)
When 8% noncumulative preferred shares are participating to a total of 12%, the preferred
shares must receive all arrear dividends and 12% of total preferred shares par outstanding
prior to common shares receiving any dividends
Ans: A
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
87. As of January 1, 2011 there are 2 years of dividends in arrears on an issue of cumulative
Difficulty: Medium
Level of Learning: Application
Topic: LO6, 9
d
Ans: D
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nonconvertible preferred shares. No dividends on preferred shares were declared in 2011.
Therefore, under IFRS, on the Dec. 31, 2011 financial statements, the firm issuing the preferred
shares:
A)
Reports a liability equal to 3 years of dividends on preferred shares
B)
Reports a liability equal to 2 years of dividends on preferred shares
C)
Subtracts 3 years of dividends on preferred shares from earnings when computing earnings
per share for 2011
D)
Discloses in a footnote to 2011's balance sheet that there are 3 years of dividends on
preferred shares in arrears
E)
Discloses in a footnote to 2011's balance sheet that there are 2 years of dividends on
preferred shares in arrears
88. The number of treasury shares held by a corporation equals:
A)
B)
C)
D)
The difference between issued shares and outstanding shares.
The difference between authorized shares and outstanding shares.
All shares held by the treasurer of the corporation.
All shares purchased by shareholders due to their pre-emptive right.
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 13 – Shareholders’ Equity
89. Under the single transaction method, the difference between the cost of treasury stock and a
subsequent higher selling price of the treasury stock should be credited to:
A)
Retained earnings.
B)
Share capital.
C)
Gain from treasury stock transaction.
D)
Contributed capital.
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO4
90. How should a gain from the sale of treasury stock be reflected when using the single transaction
method of recording treasury stock transactions?
A)
As an extraordinary item shown on the income statement
B)
As ordinary earnings shown on the income statement
C)
As contributed capital from treasury stock transactions
D)
As an increase in the amount shown for common stock
hz
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO4
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91. Losses that a corporation suffers from dealing in its own stock may:
A)
Be recorded as a long-term loss.
B)
Be recorded in the retained earnings account.
C)
Be recorded as a loss from peripheral or incidental transactions (i.e., not from continuing
operations).
D)
Never be recorded in the retained earnings account.
Difficulty: Medium
Level of Learning: Application
Topic: LO4
d
Ans: B
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Chapter 13 – Shareholders’ Equity
92. Which of the following is NOT a true statement? Treasury stock is:
A)
Shares that cannot receive dividends nor vote.
B)
Shares that are held by the issuing company but has not been retired.
C)
Recorded in an equity account that has a debit balance.
D)
Shares that have been issued but are no longer outstanding.
E)
Shares that are included in earnings per share calculations.
Ans: E
Difficulty: Medium
Level of Learning: Application
Topic: LO4
93. When all of the preferred shares are purchased and formally retired by the issuing corporation for
less than its original issue price, accounting for the retirement increases:
A)
Retained earnings.
B)
Contributed capital in excess of par, common stock.
C)
Net income for the period.
D)
Contributed capital from retirement of preferred shares.
hz
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO 3
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94. The owners' equity section of a firm's balance sheet reflects the following at the end of the current
year:
$6 Preferred shares, 3,000 shares outstanding
Common shares, 100,000 shares outstanding
$300,000
500,000
d
(Matching dividend, if applicable, $.30)
The preferred shares participate up to a maximum of $8 ($2 additional participation). There were
two years of dividends in arrears on the preferred shares at the beginning of the current year. If
the firm declares $110,000 in dividends at the end of the current year, what portion of that
amount is distributed to the common shareholders?
A)
$50,000
B)
$30,000
C)
$54,000
D)
$60,000
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO 2, 6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 13 – Shareholders’ Equity
95. The increases in account balances of XYZ during 1999 are presented below:
Assets
Liabilities
$456,000
148,000
Common Shares
Other Contributed Capital
240,000
24,000
Assuming the only debit to retained earnings was for a dividend of $52,000, net income for 1999
was:
A)
$8,000
B)
$68,000
C)
$96,000
D)
$104,000
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO6
96. On December 31, 1999, TTX reported owners' equity of $150,000. During 2000, TTX declared
Ans: A
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hz
and paid cash dividends of $30,000; reported a net loss of $15,000; issued additional common
shares (nopar) for $70,000; and purchased treasury stock at a cost of $15,000 (cash), Therefore,
the 2000 ending amount of shareholders' equity was:
A)
$160,000
B)
$170,000
C)
$215,000
D)
$230,000
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
d
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Chapter 13 – Shareholders’ Equity
97. The following data is available for XAC:
Common shares, no par 10,000 shares authorized, 8,000 shares
outstanding
Common shares subscribed
Subscriptions receivables (40% uncollected)
$120,000
?
12,000
Find the number of shares subscribed and the subscription price per share?
Shares Outstanding
5,000
5,000
1,200
1,200
1
2
3
4
Choice 1
Choice 2
Choice 3
Choice 4
Ans: C
hz
A)
B)
C)
D)
Average Issue Price
$25.00
$12.00
$25.00
$12.00
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
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98. On January 1, 2000, DDB agreed to purchase 4,000 of CTC's common shares at $5 per share.
Cash payment in full, including 10% interest, is to be paid one year later at which time the shares
will be issued. The appropriate journal entry for CTC to record the transaction on January 1,
2000, would include a:
A)
Debit to Cash for $20,000.
B)
Credit to Common Shares Subscribed for $20,000.
C)
Credit to Cash $20,000.
D)
Debit to Subscriptions Receivable for $18,000.
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
d
Ans: B
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Chapter 13 – Shareholders’ Equity
99. During 1999, BV sold and issued the following shares for $20,000 cash:
Common shares, 600 shares (current market price per share, $23.50).
Preferred shares, 200 shares (no current market price available); original issue price, three years
earlier, $22 per share.
The total issue price of $20,000 that should be apportioned to the preferred shares is:
A)
$4,000
B)
$4,400
C)
$5,900
D)
$8,000
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO 2
Ans: B
Difficulty: Medium
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hz
100. ABC had 20,000 shares of treasury common stock, which it purchased for $7 per share. Until
now, this was ABC's only treasury stock transaction. The shares were originally sold and issued
at $5 per share. ABC uses the single-transaction method. ABC is now selling the treasury shares
for $5 per share. The entry to record the resale would include a:
A)
Credit to Treasury stock for $100,000.
B)
Debit to Retained earnings for $40,000.
C)
Debit to common shares for $140,000.
D)
Credit to common shares for $100,000.
Level of Learning: Application
Topic: LO4
d
101. TTSS Corporation had 1,000 common shares issued and outstanding (sold at $40 each). It then
made its first-ever purchase of treasury stock by buying 200 of its own shares for $50 per share.
Assume sufficient retained earnings. The entry to record this purchase using the singletransaction method would include:
A)
dr. common shares $8,000
B)
dr. common shares $10,000
C)
dr. contributed capital from treasury stock transactions $2,000
D)
dr. treasury stock $10,000
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO4
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Chapter 13 – Shareholders’ Equity
102. When treasury stock accounted for by the single-transaction method is subsequently sold for
more than its purchase price, the excess of the cash proceeds over the carrying value of the
treasury stock should be recognized as:
A)
an unusual gain.
B)
Income from continuing operations.
C)
Increase in contributed capital.
D)
Increase in retained earnings.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO4
103. A restriction of retained earnings is most likely to be required by the:
A)
payment of last maturing series of a serial bond issue.
B)
amortization of intangible assets.
C)
purchase of treasury stock.
D)
exhaustion of potential benefits of the investment credit.
hz
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO7
Ans: E
Difficulty: Medium
Level of Learning: Application
Topic: LO 7
d
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104. An appropriation of retained earnings of a significant amount:
A)
Means that specific assets actually have been set aside for a specific purpose.
B)
provides protection to the stockholders rather than to the creditors.
C)
Can have a significant impact on the total amount of retained earnings when recorded.
D)
Can be used to absorb extraordinary losses directly when of a significant amount.
E)
Should be reversed when the purpose of the appropriation has been achieved.
105. When noncash assets are issued as a dividend, those assets should be re-valued as of the:
A)
Announcement date.
B)
Recording date.
C)
Declaration date.
D)
Issuance date.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO 2, 6
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Chapter 13 – Shareholders’ Equity
106. Which of the following represents the interest period for a scrip dividend?
A)
Record date to payment date
B)
Declaration date to payment date
C)
Record date to ex-dividend date
D)
Declaration date to ex-dividend date
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO6
107. X Corporation owns 15% of the outstanding shares of Z Corporation. The Z stock is distributed to
the shareholders of X Corporation as a dividend at its current market value. This is an example of
a:
A)
scrip dividend.
B)
cash dividend.
C)
stock dividend.
D)
property dividend.
hz
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO6
d
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108. The declaration of a property dividend results in:
A)
a debit to retained earnings.
B)
a credit to retained earnings.
C)
either a debit or a credit to retained earnings.
D)
no effect on retained earnings.
109. If a company desires to pay a cash dividend, but does not want to increase its liabilities, it can:
A)
pay the dividend only out of retained earnings.
B)
issue a scrip dividend.
C)
pay the dividend on declaration date.
D)
pay the dividend on the ex-dividend date.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO6
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Chapter 13 – Shareholders’ Equity
110. The declaration and payment of a cash or property dividend requires:
A)
an appropriation of retained earnings.
B)
the distribution of a current asset.
C)
a reduction of both retained earnings and assets.
D)
a decrease in retained earnings and a change in contributed (paid-in) capital.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Ans: C
hz
111. On January 10, 1999, ZOE Corporation declared a cash dividend when the related shares were
selling for $10 per share. ZOE prepared the list of shareholders on February 10, 1999 at which
time the shares were still selling for $10 per share. However, on February 11, 1999 the shares
were selling for $8 per share. The dividend was paid on March 1, 1999 when the shares were
selling for $9 per share. The ex-dividend date must have been:
A)
January 10/99.
B)
February 10/99.
C)
February 11/99.
D)
March 1/99.
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO6
d
112. Cash dividends usually are declared on one date and paid on a subsequent date to shareholders of
record on some intermediate date. On which of the following dates should an accrual basis
shareholder recognize investment revenue?
A)
Record date
B)
Declaration date
C)
Payment date
D)
Either record date or declaration date
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
113. The declaration and issuance of a common stock dividend:
A)
Does not change the internal content of retained earnings.
B)
Does not change assets, liabilities or total owners' equity.
C)
Decreases total owners' equity and increases the related common stock account.
D)
Decreases assets and decreases total owner's equity.
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO6
114. A common stock dividend does not:
A)
Change a shareholder's proportionate interest in the corporation.
B)
Result in the shareholder receiving additional shares.
C)
Change the proportions among the different sources of shareholders' equity.
D)
Change the total amount in the related common shares account.
Ans: A
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO7
d
zle
115. Stock splits are often issued primarily to:
A)
Reduce the market price per share.
B)
Increase permanent capital.
C)
Decrease the liability for dividends in arrears.
D)
Give the shareholders more voting rights.
116. A stock dividend,
A)
If less than 20 to 25%, reduces retained earnings by the par value of shares distributed in
the dividend
B)
Increases the wealth of the recipient if the market value of the shares are unchanged by the
stock dividend
C)
Alters the par value of the common shares
D)
If 100%, has no effect on the market value of the shares
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
117. Choose the most correct statement regarding a 2-for-1 stock split and a 100% stock dividend.
A)
Neither affects par value
B)
Both cause the same reduction in retained earnings
C)
Both double the number of shares outstanding
D)
Both cause a significant increase in the common share account
E)
Only one affects contributed capital in excess of par on common shares
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO6
118. A 3-for-1 common stock split,
A)
Decreases retained earnings by the par value of shares distributed in the split
B)
Will likely not affect the market value of the stock
C)
Has no effect on common share account
D)
Will cause a change in the allocation of dividends to common stock relative to preferred
stock
hz
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO6, 7
Ans: C
Level of Learning: Application
Topic: LO6
d
Difficulty: Medium
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119. The effect of a stock dividend is to reduce:
A)
total stockholders' equity.
B)
retained earnings and the par value of each share.
C)
retained earnings and increase legal capital.
D)
total assets and reduce total stockholders' equity.
120. Which of the following statements concerning stock dividends is correct?
A)
The declaration of a stock dividend should not be recorded as a liability even though it has
not yet been issued.
B)
The issuance of a stock dividend increases total stockholders' equity.
C)
Courts generally have held that stock dividends, once declared, are irrevocable by the
board of directors; therefore, a stock dividend declared, but not yet issued is a liability.
D)
A stock dividend cannot use treasury stock.
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
121. XY Company: Common shares outstanding, 10,000; average issue price, $115; current market
price, $140. Shares sold on a stock subscription basis are not issued until the subscription price is
collected in full. Recording a declaration of a 10 percent stock dividend in conformity with
generally accepted accounting principles would change retained earnings:
A)
On the basis of the market value of shares.
B)
By 10 percent of its balance before the dividend.
C)
On the basis of an arbitrary value of shares.
D)
On the basis of the average paid-in value of shares.
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Ans: D
hz
122. Fractional share rights are usually issued:
A)
When a corporation issues a stock split.
B)
At the time a property dividend is declared.
C)
At the time a cash dividend is declared.
D)
At the time a stock dividend is declared.
Difficulty: Medium
Level of Learning: Application
Topic: LO6
zle
123. When a corporation issues a dividend in excess of the balance of its retained earnings account, it
is issuing a:
A)
Scrip dividend.
B)
Stock dividend.
C)
Property dividend.
D)
Liquidating dividend.
Difficulty: Medium
Level of Learning: Application
Topic: LO6
d
Ans: D
124. A dividend that constitutes a return of contributed capital rather than earnings is called a:
A)
Property dividend.
B)
Liability dividend.
C)
Liquidating dividend.
D)
Capital dividend.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
125. If a corporation has dividends in arrears on preferred shares, they should also:
A)
Capitalize retained earnings for the dividends.
B)
Declare the dividends.
C)
Record a liability for the dividends.
D)
Report the dividends in arrears.
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO6
126. If a corporation has dividends in arrears of $25,000 on its cumulative preferred shares, it must:
A)
Set aside cash for the amount of the dividends.
B)
Pay the dividends in arrears before it can pay dividends to its common shareholders.
C)
Capitalize this amount as a part of permanent capital.
D)
Appropriate retained earnings for this amount.
Ans: B
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Difficulty: Medium
Level of Learning: Application
Topic: LO7
d
Ans: A
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127. XYZ reported the following on its December 31, 1999, balance sheet: common shares, nopar,
$200,000; unappropriated retained earnings, $40,000; appropriation of retained earnings for bond
sinking fund, $10,000; and reserve for possible future inventory losses, $5,000. Therefore, the last
line on the retained earnings statement, total appropriated and unappropriated retained earnings
should be:
A)
$55,000
B)
$15,000
C)
$40,000
D)
$10,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
128. A firm declares a property dividend to its shareholders. The assets to be distributed in the
dividend have a combined book value of $40,000 and combined market value of $60,000. Before
taxes, the net change in retained earnings as a result of this nonreciprocal transfer is:
A)
$40,000
B)
$60,000
C)
$20,000
D)
$0
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Ans: C
hz
129. You happen across the balance sheet of a firm, which discloses $40,000 of ending retained
earnings, $10,000 of which is appropriated for plant expansion. This firm is not a natural
resources firm. Therefore:
A)
the firm has $30,000 of cash
B)
the firm has $40,000 of cash
C)
the maximum allowable dividend cannot exceed $30,000
D)
the firm has never distributed a stock dividend
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO7
Ans: A
d
130. ABC declared a common stock dividend on March 10, at which time its shares were selling for
$15 per share and 10,500 shares were outstanding. After the dividend, because only 13,650 were
outstanding, some shareholders received fractional share rights. If the provisions of the dividend
provided that one share was to be issued for each three shares previously owned, there must have
been:
A)
1,050 fractional share rights outstanding.
B)
350 fractional share rights outstanding.
C)
117 fractional share rights outstanding.
D)
Fractional shares outstanding not determinable based on the information given.
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
131. RST had the following shareholders and the shares owned by each on November 15:
Shareholder
a
b
c
d
e
Total
Shares Owned
1,999
1,555
1,699
2,132
1,900
9,285
On that date, RST declared a 1 for 2 common stock dividend. The stock was selling for $10 per
share. RST issued fractional share rights when necessary. RST had to issue the following number
of fractional share rights:
A)
More than three.
B)
Three.
C)
Two.
D)
One.
Ans: B
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO6
132. The December 31, 1999, the balance sheet of TXY reflected the following:
zle
Total assets (market value $298,000)
Total liabilities
Preferred shares,$.10 cumulative, non-participating, liquidation preference
per share, 20,000 shares outstanding
Common shares, nopar, 30,000 shares outstanding
Retained earnings (no dividends were declared or paid in 1998 - 1999)
Total
d
$252,000
========
$70,000
$ 2.20
50,000
120,000
12,000
$252,000
=======
Assume the company sold all of the assets at December 31, 1999, at market value for cash; paid
off the liabilities and distributed all of the remaining cash to the shareholders. The amount of cash
per share that each common shareholder would receive would be:
A)
$4.47
B)
$5.93
C)
$6.00
D)
$8.27
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
133. Effective April 8, 2000, the shareholders of Kim Corporation approved a 2 for 1 split of the
company's common shares, and an increase in authorized common shares from 100,000 shares to
200,000 shares. Kim's shareholders' equity accounts immediately before issuance of the stock
split shares were as follows:
Common shares, 100,000 shares authorized;
50,000 shares outstanding
$2,250,000
Retained earnings
2,150,000
What should be the balances in Bennett's common shares and retained earnings accounts
immediately after the stock split?
Common Shares
$ 2,300,000
$ 1,150,000
$ 2,300,000
$ 2,250,000
1
2
3
4
Choice 1
Choice 2
Choice 3
Choice 4
Ans: D
hz
A)
B)
C)
D)
Retained Earnings
$ 1,350,000
$ 200,000
$ 200,000
$ 2,150,000
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO6, 7
134. The dollar amount of total shareholders' equity remains the same for the:
A)
Issuance of preferred shares in exchange for convertible debentures.
B)
Issuance of nonconvertible bonds with detachable stock purchase warrants.
C)
Declaration of a cash dividend.
D)
Declaration of a stock dividend.
Difficulty: Medium
Level of Learning: Application
Topic: LO8
d
Ans: D
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
135. On January 1, 2000, WVC split its common shares 4 for 1 when the market value was $80 per
share. Prior to the split, WVC had 50,000 common shares issued and outstanding (average issue
price $12 per share). After the split, the average issue price of the shares was reduced:
A)
By $3 per share.
B)
To $3 per share.
C)
To $4 per share.
D)
To $2.40 per share.
E)
No change in the par value.
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO7
Ans: D
hz
136. Accounting recognition must be given to common share subscriptions on the subscription date:
A)
to guarantee the receipt of dividends subsequent to the subscription date.
B)
because the dollar amount is usually large.
C)
because all events relating to the common share accounts must be disclosed.
D)
because a legal contract is involved.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
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137. A company reacquires its own shares during the fiscal year and reports the transaction in the
theoretically correct manner. What effect will this transaction have on shareholders' equity and
earnings per share, respectively?
A)
Increase and decrease
B)
Decrease and decrease
C)
Decrease and increase
D)
Increase and no effect
Difficulty: Medium
Level of Learning: Application
Topic: LO4
d
Ans: C
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
138. XV Corporation has 1,000 shares of treasury stock (common shares). It was originally issued at
$15 per share and was reacquired at $10 per share. XV Corporation has decided to formally retire
these shares; the current market price is $9. The single-transaction method is used. The entry to
record the retirement of the shares should include the following:
A)
Contributed capital from common share retirement, credit, $5,000.
B)
Gain on retirement of common shares, $5,000.
C)
Unusual gain, $5,000.
D)
Retained earnings credit, $5,000.
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO4
Ans: B
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hz
139. The owners' equity section of a firm's balance sheet reflects the following at the end of the current
year:
$6 Preferred shares, 3,000 shares outstanding
$300,000
Common shares, 100,000 shares outstanding
500,000
(Matching dividend, if applicable, $.30)
The preferred shares participate up to a maximum of $8 ($2 additional participation). There were
two years of dividends in arrears on the preferred shares at the beginning of the current year. If
the firm declares $90,000 in dividends at the end of the current year, what portion of that amount
is distributed to the preferred shareholders?
A)
$54,000
B)
$56,250
C)
$60,000
D)
$55,250
Difficulty: Medium
Level of Learning: Application
Topic: LO6
d
140. BX had the following shares outstanding:
Preferred shares, $6, 2,000 shares
$100,000
Common shares, 2,000 shares
$200,000
(Matching dividend, if applicable, $12)
The preferred shares are cumulative, fully participating; dividends are three years in arrears,
excluding the current year; dividends declared in the current year amount to $87,000. The total
amount of dividends to which common shareholders are entitled is:
A)
$33,000
B)
$40,000
C)
$49,000
D)
$52,000
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
141. DX had the following shares outstanding:
Preferred shares, $3, 2,000 shares
$100,000
Common shares, 2,000 shares
$200,000
(Matching dividend, if applicable, $6)
The preferred shares are cumulative, fully participating; dividends are three years in arrears,
excluding the current year; dividends declared in the current year amount to $42,000. The total
amount of dividends to which preferred shareholders are entitled is:
A)
$16,000
B)
$20,000
C)
$24,500
D)
$26,000
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Ans: D
zle
hz
142. Lorella entered into a common share subscription contract for 1,000 shares at a subscription price
of $20. She paid 20% of the total price as a down payment and also paid the next two 20%
instalments (she paid 60% in all). Lorella then defaulted on the contract and refused to pay any
more. Assuming the company must issue shares in proportion to the cash paid, the entry to record
the default would include:
A)
dr. common shares $12,000
B)
dr. common shares subscribed $12,000
C)
dr. subscriptions receivable $8,000
D)
dr. common shares subscribed $20,000
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
143. CRC reported the following on its 1995 balance sheet:
$6 Preferred shares, no par $62,000
Common shares, no par
320,000
Retained earnings
240,000
Given common shares outstanding, what is the average issue price per common share?
1
2
3
4
5
Shares Outstanding
200,000
100,000
50,000
40,000
None of these
A)
B)
C)
D)
E)
Choice 1
Choice 2
Choice 3
Choice 4
Choice 5
hz
Ans: C
Average Issue Price
$1.41
$2.82
$6.40
$8.80
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
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144. YTC sold and issued 200 of its common shares, true no-par, at $12 per share. Assuming no
specific legal requirements, the common share account should be credited for:
A)
$200
B)
$240
C)
$2,000
D)
$2,400
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
145. ABC made the following entry to record the issuance of a dividend:
Retained earnings
Common shares
ABC must have declared a:
A)
stock split.
B)
Property dividend.
C)
Large stock dividend.
D)
Small stock dividend.
40,000
40,000
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Ans: D
hz
146. MNO declared a stock dividend when it had 40,000 shares outstanding. After issuing the
dividend, 7,200 additional shares and 4,000 fractional share rights were outstanding. If it required
five fractional share rights to acquire a new share, this dividend must have been a:
A)
5 percent stock dividend.
B)
10 percent stock dividend.
C)
15 percent stock dividend.
D)
20 percent stock dividend.
d
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
147. BAX declared a stock dividend, which provided that each shareholder would receive one share
for each ten shares currently owned. Fractional share rights were issued to each shareholder for
the number of shares issuable. The rights can be bought and sold, but must be exercised within 3
months. The equity accounts had the following balances on the declaration date:
Common shares (market price $15) $ 25,000
Treasury stock, single-transaction method (400 shares) 4,000
Retained earnings 140,000
Assuming an entry is made on declaration date, BAX would properly record the declaration as
follows:
1 Retained earnings
Common stock dividend issuable
2 Retained earnings
Common stock dividend issuable
3 Retained earnings
Common stock dividend issuable
4 Retained earnings
Common stock dividend issuable
2,100
3,150
3,150
2,500
2,500
3,750
3,750
hz
A)
B)
C)
D)
2,100
Choice 1
Choice 2
Choice 3
Choice 4
Ans: B
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO6
d
148. Match the following terms with the appropriate definitions.
A. Contributed capital
B. Legal capital
C. Shareholders' equity
D. Total equity
___ 1.
The investment made by the entrepreneurs; that is, the total amount "invested" by all
parties other than creditors.
___ 2.
The total equity at any given time of the legal owners of the enterprise. It is the total of
the proprietorship equity including both contributed capital and subsequent accretions
thereto.
___ 3.
Represents the total claims of all parties in the assets of the business. It is the sum of
the liabilities and owners' equity.
___ 4.
hat portion of corporate capital required by statute to be retained in the business for
protection of creditors.
Ans: 1: A, 2: C, 3: D, 4: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
149. XAC received a share subscription from J. Doe for 100 of its common shares, issue price $15;
one-third cash down payment. Provide the entry to record the subscription and partial payment.
Ans:
Cash ($1,500 x 1/3)
500
Subscription receivable, common ($1,500 x 2/3)
1,000
Common shares subscribed (100 shares x $10)
1,500
Difficulty: Medium
Level of Learning: Application
Topic: LO2
hz
150. YTC issued 200 of its preferred shares and 1,000 of its common shares, for a total cash
consideration of $15,000. The current market prices for its shares were: Preferred, $25; Common,
$20. The issue entry for the preferred and common shares combined would be as follows:
Ans: The total consideration paid equals the sum of the market values of the individual
securities sold; therefore no allocation is necessary.
Cash (given)
15,000
Preferred shares (20%)
3,000
Common shares (80%)
12,000
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
zle
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Chapter 13 – Shareholders’ Equity
Difficulty: Medium
Level of Learning: Application
Topic: LO5, 6, 7
d
zle
hz
151. Indicate the principle effects of a cash dividend (declared and paid), a stock dividend issued, and
a stock split issued, on the financial statements of the issuing corporation. Respond as follows: Ifor increase; D-for decrease; and N-no effect. Assume no stock warrants and no reverse stock
splits.
Stock
Cash
Stock
Stock
Financial Statement Item
Dividend
Dividend Split
(a) Contributed capital(exclusive of retained earnings)
____
____
____
(b) Par value per share outstanding
____
____
____
(c) Total amount of shares outstanding
____
____
____
(d) Retained earnings (at year-end)
____
____
____
(e) Number of shares outstanding
____
____
____
(f) Net income (for the year of issuance)
____
____
____
(g) Earnings per share (for the year of issuance)
____
____
____
(h) Total assets (at year-end)
____
____
____
(i) Total liabilities (at year end)
____
____
____
(j) Total shareholders' equity(at year-end)
____
____
____
Ans:
Cash
Stock
Stock
Dividend
Dividend
Split
a)
N
I
N
b)
N
N
D
c)
N
I
N
d)
D
D
N
e)
N
I
I
f)
N
N
N
g)
N
D
D
h)
D
N
N
i)
N
N
N
j)
D
N
N
152. On July 1, 1999, NTC had outstanding 10,000 common shares, (originally sold at $12); the
quoted market price currently is $16. The company declared and issued a 10% common stock
dividend. Give the entry.
Ans:
Retained earnings (1,000 sh. x $16)
16,000
Common shares
16,000
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
153. Match the following terms and definitions by entering the appropriate letters to the left.
Terms
A. Stock dividend
B. Liability dividend
C. Property dividend
D. Cash dividend
E. None of these.
Definitions
___ 1. Issuance of additional shares to each shareholder at no cost.
___ 2. Issuance of a dividend that decreases both retained earnings and noncash assets.
___ 3. Issuance of a stock split.
___ 4. A dividend that does not change total assets, liabilities, or shareholders' equity.
___ 5. A dividend that decreases cash and shareholders' equity when declared and paid.
___ 6. A dividend that decreases retained earnings and increases contributed capital.
Ans: 1: A, 2: C, 3: E, 4: A, 5: D, 6: A
Difficulty: Medium
hz
Level of Learning: Application
Topic: LO5, 6, 7
d
zle
154. Several types of dividends and other items are identified below by letter. Match the type of
dividends with its characteristic by entering letters in the spaces provided.
Type of Item
A. Cash dividend
B. Liquidating dividend
C. Property dividend
D. Stock dividend
E. Stock split
F. Stock dividend and stock split
G. None of these
Characteristic
___ 1.
Increases the number of shares outstanding by decreasing the book value per share
proportionately.
___ 2.
Creates a current liability and decreases retained earnings when declared (no gain or
loss recorded).
___ 3.
Decreases retained earnings and increases contributed capital accounts.
___ 4.
Decreases retained earnings and noncash assets.
___ 5.
Results in no change to assets, debt, or total shareholders' equity.
___ 6.
Represents a return of capital rather than a distribution of earnings.
Ans: 1: E, 2: A, 3: D, 4: C, 5: F, 6: B
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
155. Several years ago, a corporation set up a reserve for storm losses in the amount of $300,000 as an
appropriation of retained earnings. During the current year, the company suffered a $85,000
hurricane loss that was not covered by insurance. The firm reduces appropriations when their
purpose has been fulfilled. Give the entry(s) to record the loss and provide any appropriate
explanation.
Ans:
Casualty loss
85,000
Plant
85,000
Retained earnings, appropriated
85,000
Retained earnings
85,000
Difficulty: Medium
Level of Learning: Application
Topic: LO7
Difficulty: Medium
zle
hz
156. Propertee, Inc. declared a dividend on May 1 payable in shares of Milly, Inc. (original cost: $4
per share, acquired at the beginning of the current year) to Propertee shareholders of record on
June 1. The payment date is July 1. The dividend requires 20,000 shares of Milly to be
distributed. Market prices of Milly/share were: May 1: $6; June 1: $8; July 1: $9. Provide the
entry at declaration of the dividend.
Ans:
Retained earnings
120,000
$6(20,000)
Investment
40,000
($6-$4)(20,000)
Property dividend payable
120,000
Gain on investment
40,000
Level of Learning: Application
Topic: LO6
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 45
Chapter 13 – Shareholders’ Equity
157. On October 1, 1999, XBC declared a dividend to its common shareholders by issuing one share
of YTC, preferred share, $.60 nopar (held as a long-term investment) for each of the 15,000
common shares of XBC. On declaration date, the YTC shares were selling at $7 per share. The
YTC shares originally were purchased by XBC at $9 per share; they were transferred to the XBC
shareholders on January 30, 2000, when their quoted market price was $7.50 per share. Give the
following entries for XBC:
(a) At date of declaration:
(b) At date of payment:
Ans: (a)At date of declaration:
Retained earnings (15,000 sh. x $7)
105,000
Loss on disp. of investment
30,000
Investment in YTC preferred shares
30,000
Prop. dividend payable
105,000
(b)At date of payment:
Prop. div. payable
Investment in YTC preferred shares
105,000
105,000
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO6
d
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Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 46
Chapter 13 – Shareholders’ Equity
158. ATC's balance sheet on December 31, 20x1, showed the following:
Cash
Other current assets.
Operational assets (net)
Other assets
$30,000
70,000
200,000
100,000
Current liabilities
Long-term liabilities
Common shares, 5000
shares outstanding
Retained earnings
$400,000
========
$90,000
170,000
100,000
40,000
$400,000
========
Using this information, answer the following questions:
hz
(a) What is the absolute maximum amount of cash dividends that can be paid
immediately?_________________________________________.
(b) What is the book value per common share? $_________________.
(c) Assuming a $10,000 cash dividend is declared, what entries would be made on each of the
following dates:
(1) Declaration date:
(2) Date of record:
(3) Date of payment:
Ans: (a) $30,000 (cash balance).
(b) $140,000 ÷ 5,000 = $28
(2) None
zle
(c)
(1)Retained earnings
Dividends payable
(3) Dividends payable
Cash
Level of Learning: Application
Topic: LO6
10,000
10,000
10,000
d
Difficulty: Medium
10,000
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Chapter 13 – Shareholders’ Equity
159. On July 1, 1999, NDC had outstanding 20,000 common shares, (originally sold at $5 per share);
the current quoted market price is $7 per share. The company declared and issued a 10% common
stock dividend; however, stock rights for 100 fractional shares were issued (10 shares). The rights
currently had a quoted market price of $.80 each. Give the entry to record the dividend.
Ans:
Retained Earnings (2,000 sh. x $7)
14,000
Common shares (1,990 sh. x $7)
13,930
Common stock warrants outstanding (100 ÷ 10) x $7
70
Difficulty: Medium
Level of Learning: Application
Topic: LO3
hz
160. On July 1, 1999, the Board of Directors of BXC declared a stock dividend that required the
issuance of 5,000 common shares. The common shares had a market value at this date of $18 per
share. Retained earnings amounted to $900,000. Give the entry to record the stock dividend (the
shares were issued), assuming:
The 5,000 shares represented 10% of the previously outstanding shares.
Ans:
Retained earnings
90,000
Common shares (5,000 x $18 par value)
90,000
Difficulty: Medium
Level of Learning: Application
Topic: LO3
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161. During December 1999, BRC declared and issued a 1 for 5 stock dividend on its 100,000
outstanding common shares. The per share amounts were: original average issue price $16;
current market price (end 1999) $13; and the average market price for 1999, $15. Give the
required journal entry to record the simultaneous declaration and issuance of the stock dividend.
Ans: Small stock dividend-Use market value:
Retained earnings (100,000 sh. ÷ 5) x $13
260,000
Common shares
260,000
Level of Learning: Application
Topic: LO3
d
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 48
Chapter 13 – Shareholders’ Equity
162. Match the following terms with the appropriate definitions.
Terms
A. Common shares
B. Preferred shares
C. Preferred shares, non-participating
D. Par value shares
E. Preferred shares, cumulative
F. No-par shares
G. No-par, stated value shares
H. Shares purchased on credit
Definitions
___ 1
The basic issue of shares.
___ 2.
Shares on which dividends in arrears must be paid before current dividends can be paid.
___ 3.
No-par shares with an assigned "value," but not usually specified in the charter.
___ 4.
Shares with specified differences from the basic shares.
___ 5.
Shares with a minimum "value" always specified in the charter.
___ 6.
Subscribed shares.
___ 7.
Shares that are limited to a specified dividend rate per year.
___ 8.
Shares that have no minimum amount that must be paid in at first sale.
hz
Ans: 1:A, 2:E, 3:G, 4:B, 5:D, 6:H, 7:C, 8:F
Difficulty: Medium
Level of Learning: Application
Topic: LO1
d
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 49
Chapter 13 – Shareholders’ Equity
163. Match the following terms with the appropriate definitions.
Terms
A. Treasury shares
B. Convertible shares
C. Subscribed shares
D. Callable shares
E. Authorized shares
F. Unissued shares
G. Redeemable shares
H. Cumulative shares
hz
Definitions
___ 1.
Shares that have been sold under contract, but not yet issued because collection has not been
made.
___ 2.
The difference between total shares issued and total shares outstanding.
___ 3.
Shares on which dividends in arrears must be paid prior to payment of any current
dividends.
___ 4.
Shares that may, at the option of the holder, be turned in for another security.
___ 5.
Shares that have been issued, repurchased, and held.
___ 6.
Shares that, at the option of the issuer, may be called in and paid off.
___ 7.
The difference between authorized and issued shares.
___ 8.
Shares which, at the option of the shareholder, may be surrendered for a specified amount of
cash.
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Ans: 1: C, 2: A, 3: H, 4: B, 5: A, 6: D, 7: F, 8: G
Difficulty: Medium
Level of Learning: Application
Topic: LO1
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 50
Chapter 13 – Shareholders’ Equity
164. DXC has the following outstanding shares:
$5 Preferred, 2,000 shares issued at $100 per share common, no-par value, 5,000 shares issued at
$60 per share
(Matching dividend, if applicable $3)
Compute the amount of dividends per share payable to each class of shares for each independent
case. Show computations.
(a)
(b)
(c)
Ans:
Share
(b)
(i)
(ii)
(iii)
=
=
=
$300,000
$200,000
$500,000
=======
5,000 x $3
75,000 - (30,000 - 10,000) - 15,000
(200,000 ÷ [200,000 + 300,000])
20,000 x (300,000 ÷ [200,000 + 300,000])
Level of Learning: Application
Topic: LO6
$_________
$_________
=
=
=
=
=
=
$5.00
$6.00
$20.00
$5.00
$24.00
$5.40
= 20,000; 20,000 x
= 8,000
= $12,000
d
Difficulty: Medium
Common
$_________
(60
(40%)
(100%)
Preferred: $2,000 x $5 = $10,000 ÷ 2,000 shares
Common: $40,000 - $10,000 = $30,000 ÷ 5,000 shares
Preferred: $30,000 + $10,000 = 40,000 ÷ 2,000 shares
Common: $65,000 - $40,000 = $25,000 ÷ 5,000 shares
Preferred: $30,000 + $10,000 + $8,000(ii) = $48,000 ÷ 2,000
Common: $15,000(i) + $12,000(iii) = $27,000 ÷ 5,000
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(c)
capital common
preferred
total
hz
(a)
Per Share
Preferred Stock Provisions
Preferred
Preferred is noncumulative and non-participating. Dividends declared, $_________
$40,000
Preferred is cumulative and non-participating; in arrears three years $_________
(in addition to the current year). Dividends declared, $65,000
Preferred is cumulative, in arrears three years (in addition to the
$_________
current year); fully participating. Dividends declared, $75,000.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
165. SXC reported income during four successive years as follows: $1,000, $2,000, $3,000, and
$11,000. The share capital outstanding consisted of 3,000 common shares issued at $20 each, and
5,000, $.50 preferred shares issued at $10 each. (Matching common dividend, if applicable, $1).
If income in full were declared as dividends each year, determine the amount that would be paid
on each class of shares for each of the four years assuming:
(a) Preferred is noncumulative and
non-participating.
(b) Preferred is cumulative and
non-participating.
(c) Preferred is noncumulative and
fully participating.
hz
(d) Preferred is cumulative and
fully participating.
Year
1
2
3
4
1
2
3
4
1
2
3
4
1
2
3
4
Preferred
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
Preferred
$1,000
$2,000
$2,500
$2,500
$1,000
$2,000
$3,000
$4,000
$1,000
$2,000
$2,500
$5,000
$1,000
$2,000
$3,000
$5,818*
d
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Ans: Annual preferred dividend = $2,500 (5,000 x $.50)
Common
(a)
Year 1
$None
Year 2
$None
Year 3
$500
Year 4
$8,500
(b)
Year 1
$None
Year 2
$None
Year 3
$None
Year 4
$7,000
(c)
Year 1
$None
Year 2
$None
Year 3
$500
Year 4
$6,000
(d)
Year 1
$None
Year 2
$None
Year 3
$None
Year 4
$5,182
Common
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
$________
C
*
arrear dividends = 3($2,500) - $6,000 =
current year
remaining for participation: $4,000
$4,000 x (60,000 ÷ [60,000 + 50,000])
$4,000 x (50,000 ÷ [60,000 + 50,000])
$5,182
======
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Copyright © 2011 McGraw-Hill Ryerson Limited.
$3,000
P
$1,500
2,500
2,182
1,818
$5,818
======
Page 52
Chapter 13 – Shareholders’ Equity
Difficulty: Medium
Level of Learning: Application
Topic: LO6
166. On January 1, 1999, the accounts of CXC reflected the following:
The single-transaction method is used. On February 1, 1999, CXC purchased 5,000 of its own
shares at $2.10 per share. Later, on
December 1, 1999, CXC sold 2,000 of these treasury shares at $1.50 per share. Give the journal
entry on December 1, 1999, to record this sale of treasury stock.
hz
Common shares, 40,000 shares outstanding.
Contributed capital from treasury stock transactions.
Retained earnings.
Ans:
Cash (2,000 x $1.50)
Contributed capital from T.S. transactions
Treasury stock (2,000 x $2.10)
$80,000
1,500
50,000
3,000
1,200
4,200
Difficulty: Medium
Level of Learning: Application
Topic: LO4
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167. Explain the options available to a corporation that issues share subscriptions where partial
payment has been received but the subscriber defaults on the balance.
Ans: A corporation has three options available. They may issue shares in proportion to the cash
received. They may also return all payments to the subscriber and issue no shares. Finally,
the corporation may retain the money received. The third option is not common; however,
legislation does not prohibit it.
Difficulty: Medium
d
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 13 – Shareholders’ Equity
168. Brimley Corp. issued 5,000 common shares, no par, and 800 preferred shares. At the time of issue
the common shares were selling at $30 per share and the preferred at $25. Total cash received
was $162,000. Prepare the journal entry to record the issuance of the shares.
Ans: Since market prices are known the proportional method can be used.
Market value of common (5,000 shares x $30)
$150,000 (88% of total)
Market value of preferred (800 shares x $25)
20,000 (12% of total)
Total market value
$170,000
Allocation of lump-sum sale price of
Common ($162,000 x 88%)
Preferred ($162,000 x 12%)
$162,000
$142,560
19,440
$162,000
Journal Entry:
Dr. Cash
Cr. Common shares
Cr. Preferred shares
162,000
142,560
19,440
Difficulty: Medium
hz
Level of Learning: Application
Topic: LO6
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169. Brimley Corp. issued 5,000 common shares, no par, and 800 preferred shares. At the time of issue
the common shares were selling at $30 per. There is no current market value for the preferred
shares. Total cash received was $162,000. Prepare the journal entry to record the issuance of the
shares.
Ans: Since market values for preferred shares are not known, the incremental method should be
used.
Journal Entry:
Dr. Cash
Cr. Common shares (5,000 shares
Cr. Preferred shares
Level of Learning: Application
Topic: LO2
$150,000
12,000
d
Difficulty: Medium
162,000
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Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 54
Chapter 13 – Shareholders’ Equity
170. Explain what is meant by share issue costs and how they are treated for accounting purposes.
Ans: Share issue costs include legal fees, accounting fees, underwriting costs, printing, clerical
and other costs associated with the share issue. There are three methods to deal with share
issue costs:
Offset Method: Record the costs as a reduction in the amount received from the sale of the
shares as they are argued to be one-time costs. Share costs are debited to the share capital
account.
Retained earnings method: Share issue costs are charged directly to retained earnings.
Deferred Charge Method: Less common method. Costs are recorded as a deferred charge
and amortized over a reasonable time period.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
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171. Explain why companies may want to reacquire their own shares?
Ans: (1) To increase earnings per share
(2) To provide cash flow to shareholders in lieu of dividends
(3) To acquire shares when they appear to be undervalued
(4) To reduce the possibility of a takeover bid
(5) To reduce future dividend payments (i.e. less shares outstanding)
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3, 4
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Use the following to answer questions 172-178:
d
On 2 January 20X4, GHI Corporation was incorporated in the province of Ontario. It was authorized to
issue an unlimited number of no-par value common shares, and 10,000 shares of no-par, $8, cumulative
and non-participating preferred. During 20X4, the firm completed the following transactions:
8 Jan.
Accepted subscription for 40,000 common shares at $12 per share. Down payment on the
subscribed shares totalled $150,000.
30 Jan
Issued 4,000 preferred shares in exchange for the following assets:
Machinery With a fair market value of $35,000, a factory with a fair market value of
$110,000, and land with an appraised value of $295,000.
15 Mar.
Machinery with a fair market value of $55,000 was donated to the company.
25 Apr.
Collected the balance of the subscriptions receivable and issued common Shares.
30 Jun.
Purchased 2,200 common shares at $18. per share. The shares were retired.
31 Dec.
Declared sufficient cash dividends to allow a $1. Per share dividend for Outstanding
common shares. The dividend is payable on 10 January 20X2, To shareholders of record on
5 January 20X2.
31 Dec.
Closed the income summary to retained earnings. The income for the period. Was $98,000.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 55
Chapter 13 – Shareholders’ Equity
172. Prepare Journal entries to record the subscription of common shares
Ans: Cash
$ 150,000
Stock subscription receivable
$ 330,000
Common shares subscribed (40,000 shares)
Difficulty: Medium
$ 480,000
Level of Learning: Application
Topic: LO2
173. Prepare Journal entries to record the issuance of preferred shares in exchange for assets; recorded
at fair market value of the assets in the absence of a value for the preferred shares.
Ans: Machinery
$ 35,000
Factory
$ 110,000
Land
$ 295,000
Preferred shares (4,000 shares)
$440,000
Difficulty: Medium
Level of Learning: Application
Topic: LO2
hz
174. Prepare Journal entries to record the receipt of donated assets.
Ans: Machinery
$ 55,000
Contributed capital – donations
Difficulty: Medium
$55,000
Level of Learning: Application
Topic: LO2
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175. Prepare Journal entries to record the receipt of cash for subscribed shares and issuance of shares.
Ans: Cash
$ 330,000
Stock subscription receivable
$ 330,000
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
176. Prepare Journal entries to record the acquisition and retirement of common shares.
Ans: Common Shares ($480,000 / 40,000) x 2,200
26,400
Retained Earnings
13,200
Cash ($18 x 2,200)
39,600
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
177. Prepare Journal entries to record dividends declared.
Ans: Retained Earnings
Dividends payable, preferred shares
Dividends payable, common shares
Preferred dividend: 4,000 shares x 8
Common dividend: 37,800 shares x $1
Difficulty: Medium
69,800
32,000
37,800
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 56
Chapter 13 – Shareholders’ Equity
178. Prepare Journal entries to record the closing of the income summary account.
Ans: Income Summary
98,000
Retained earnings
98,000
Difficulty: Medium
Level of Learning: Application
Topic: LO6
179.
On December 31st, 2011, JKL Inc. had the following account balances:
Common Shares
(No par, 10,000 shares issued, 8,000 shares outstanding)
Preferred Shares
($1, non-cumulative, 10,000 shares issued and outstanding)
Retained Earnings
Treasury Shares (2,000 shares)
Total
$100,000
$ 50,000
$180,000
($20,000)
$310,000
▫
▫
▫
JKL Inc. had a total Comprehensive Income of $150,000.
During 2012, JKL Inc. bought 2,000 shares of MNO Inc. for $45 per share. On December
31st, 2012, these shares were trading at $60 per share. These shares, which were all on hand at
the end of 2012, were designated by management as FVTOCI.
Half of the treasury shares held by management at the start of 2012 were sold during the year
for $15,000.
JKL declared at total of $30,000 in dividends, which included a common stock dividend
valued at $10,000.
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▫
hz
During 2012, the following took place:
d
Required:
A) Prepare a Statement of Changes in Equity for JKL Inc. as per IFRS as at December 31st,
2012.
B) Briefly explain how JKL Inc’s reporting requirements would differ if it complied with ASPE
instead of IFRS.
Ans:
A)
JKL Inc.
Statement of Changes in Equity
For the year ended December 31st, 2012
Balances, January 1, 2012
Comprehensive Income
Common
Stock
Preferred
Shares
Retained
Earnings
100,000
50,000
180,000
120,000
Cumulative
OCI
30,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Treasury
Shares
20,000
Contributed
SurplusTreasury
Shares
Total
310,000
150,000
Page 57
Chapter 13 – Shareholders’ Equity
Treasury Share - resale
10,000
5,000
Dividends:
Common Stock Dividend
10,000
Balances, December 31st, 2012
110,000
20,000
20,000
10,000
Cash
50,000
270,000
15,000
30,000
10,000
5,000
455,000
B) Had JKL Inc. been following ASPE, only a Statement of Retained Earnings would be
required, not a Statement of Changes in Equity. Moreover, there is no Comprehensive
Income under ASPE. This would mean that the shares in MNO Inc. could not be designated
as FVTOCI. These shares would be designated as FVTPL.
Difficulty: Hard
Level of Learning: Application
Topic: LO8, 9
d
zle
hz
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test Bank
Chapter 14 – Complex Debt and Equity Instruments
1. The accounting classification of a financial instrument is determined by its tax status.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
2. Induced conversions of convertible debt arise when the debtor offers a "sweetener" to encourage
the creditor to promptly convert the debt.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 2
Ans: True
hz
3. When stock rights are issued to current shareholders, it may require more than one such right to
later acquire one additional share of the stock covered by the rights.
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Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
4. The measurement date of a compensatory stock option must precede the date of grant.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 3
d
5. General debt carries a firm commitment to interest payments and repayment of capital at
maturity.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
6. Options are ONLY for the purpose of buying or selling financial instruments.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 1
Chapter 14 – Complex Debt and Equity Instruments
7. If a financial instrument is an equity instrument in substance, but its legal form is debt,
any periodic payments made to investors will be accrued on the company’s financial
statements as interest expense.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
8. If cash payments to investors are dependent on one or more future events, the instrument
in question would be considered equity.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
hz
9. When interest is repayable to investors at a fixed amount per share, the financial
instrument in question would be considered debt.
Ans: False
Difficulty: Easy
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Level of Learning: Knowledge
Topic: LO 1
10. Retractable preferred shares are those which can be redeemed at the investor’s discretion.
Ans: False
Difficulty: Easy
d
Level of Learning: Knowledge
Topic: LO2
11. When preferred shares are classified as debt, their dividends are deducted from Retained
Earnings, thus bypassing earnings.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 2
Chapter 14 – Complex Debt and Equity Instruments
12. Securities issued as debt, but intended by the issuing corporation to be exchanged for shares by
the investors at some time prior to maturity, are known as "hybrid securities".
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1, 2
13. Perpetual Debt is accounted for as equity.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 2
14. Management of a company that has convertible bonds outstanding would likely force
Ans: True
hz
conversion of its bonds of the fair market value of the shares upon conversion exceeds
the fair value of the bonds.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 2
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 3, 4
d
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15. The conversion option attached to convertible bonds, which have a floating conversion price
per share, has an intrinsic value which is based on the fair market value of the shares at the time.
16. A financial instrument is any contract that gives rise to a financial asset of one party and a
financial liability or equity instrument of another party.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
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Chapter 14 – Complex Debt and Equity Instruments
17. Stock options have no intrinsic value when the market price of the share exceeds its
conversion price.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 2
18. The proceeds of any bonds sold with detachable stock warrants must be pro-rated
between the bonds and the warrants.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
Ans: True
hz
19. Share-based payments to suppliers are valued at the value of the goods or services
received.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
zle
20. Assume that a company wishes to grant stock options to a supplier in exchange for
services rendered. The company chose to value this exchange at the going market rate
charged by the suppliers’ competitors. This is an example of a Level 2 Fair Value
Hierarchy application.
Ans: False
Difficulty: Easy
d
Level of Learning: Knowledge
Topic: LO 6
21. Under ASPE, preferred shares must be classified as equity while shareholder loans must
be classified as debt.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 9
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 4
Chapter 14 – Complex Debt and Equity Instruments
22. Under ASPE, convertible debt must always be treated as debt in its entirety.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3, 4, 9
23. Under ASPE, forfeitures which occur under a stock-based compensation structure are
accrued throughout the vesting period.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 6, 9
24. Cash flow hedges do not exist under ASPE.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 8, 9
25. Embedded derivatives are those that can be detached and separately sold from their host
contracts.
zle
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO7
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6, 9
d
26. Under IFRS, forfeitures which occur under a stock-based compensation structure are
accrued throughout the vesting period.
27. The crucial aspect of debt is that the creditors can demand payment.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
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Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 14 – Complex Debt and Equity Instruments
28. An instrument may be classified as equity even though the investor can demand payment.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
29. One of the most common forms of hybrid security is convertible debt.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2, 3, 4
30. The conversion ratio for convertible bonds can be expressed either in the number of shares per
bond, or in a price per share.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3, 4
31. Even if the underlying share value of a convertible bond never reaches the conversion price,
management can still force conversion.
zle
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3, 4
32. Once the market price of shares rises above the conversion price on convertible bonds, the bond
ceases to trade as debt, and effectively is traded as equity.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3, 4
d
Ans: True
33. In splitting the bonds and the conversion feature, either the incremental or the proportional
method may be used.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3, 4
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Page 6
Chapter 14 – Complex Debt and Equity Instruments
34. With respect to convertible bonds, whose conversion is mandatory, only the interest
stream is valued as debt; the bond principal and conversion features are considered
equity.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
35. When bonds are converted, it is first necessary to update any accounts relating to bond premium
or discount, accrued interest, and foreign exchange gains and losses on foreign currency
denominated debt.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3, 4
hz
36. If it is the company's option to repay the debentures through the issuance of common shares, the
principal component of the bonds is debt.
Ans: False
Difficulty: Easy
zle
Level of Learning: Knowledge
Topic: LO3, 4
37. To be classified as retractable preferred shares, the cash repayment must either be contractually
required or at the option of the investor.
Ans: True
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 7
Chapter 14 – Complex Debt and Equity Instruments
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
38. When a bond matures, an investor will convert if the market price of the convertible bond is
higher than the conversion price of the bond.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
39. When a bond matures, an investor will cash it in if the market price of the convertible bond is
higher than the conversion price of the bond.
Ans: False
Difficulty: Easy
hz
Level of Learning: Knowledge
Topic: LO3, 4
40. An equity item is classified as debt in the financial statements and dividend payments were
shown on the financial statements. For income tax purposes, the amounts will not be tax
deductible.
zle
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2
41. Hedge accounting is often performed to minimize any accounting mismatch between the
hedged and hedging items and is strictly voluntary.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO7
d
Ans: True
42. If a company issues debt that is convertible at the corporation's option, in substance, the debt is
equity.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 8
Chapter 14 – Complex Debt and Equity Instruments
43. The fair value of a company’s share is equal to its intrinsic value.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
44. On January 1st, 20x2, ABC Inc. had invoiced a client in New York for $10,000 US for
services rendered that day. ABC did not hedge this receivable. The receivable is due in
60 days. On January 1st, 20x2, the spot rate was $1US=$1.02CDN. On January 31st,
20x2, the spot rate was $1US=$1.05CDN. What is the effect of the above information on
ABC’s January financial statements?
A)
B)
C)
D)
A $300 foreign exchange gain.
A $300 foreign exchange loss.
A $300 credit to OCI.
A $300 debit to OCI.
hz
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO7
zle
45. S Corporation created a stock option plan for its two top executives. The plan provided that each
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
d
executive would receive 1,000 options, which would enable him or her to purchase 100 shares at
75 percent of the market price on the date the options became exercisable. The options were
exercisable in two years. At the date of granting the options, the market price of the shares was
$12 per share. The date of measurement for the stock option plan was the:
A)
date of grant.
B)
end of the first year.
C)
end of the second year.
D)
date the employees' exercise their options.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Page 9
Chapter 14 – Complex Debt and Equity Instruments
46. JKC initiated a stock option plan for its three top executives. The plan provided that each
executive would receive 6,000 options that would enable each one to purchase 600 shares at the
option price.
The option price was set at 10 percent below market price at the first exercise date. The options
could be exercised after the executives remained as employees of the company for 3 more years.
The market price of the shares on the date that the options were granted was $10 per share. The
amount of compensation expense the company incurred for the three executives due to the option
plan was:
A)
$8,100
B)
$3,000
C)
$600
D)
$0
E)
Cannot be determined from the information provided.
Ans: E
d
zle
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 10
Chapter 14 – Complex Debt and Equity Instruments
47. Compensatory stock options were granted to executives on January 1, 20x3, with a measurement
date of June 30, 20x4, for services to be rendered during 20x3, 20x4, and 20x5. The excess of the
market value of the shares over the option price at the measurement date was reasonably
estimable at the date of grant. The stock option was exercised on October 31, 20x5.
Compensation expense should be recognized in the income statement in which of the following
years?
1
2
3
4
20x3
No
No
Yes
Yes
A)
B)
C)
D)
Choice 1
Choice 2
Choice 3
Choice 4
20x5
Yes
Yes
No
Yes
hz
Ans: D
20x4
No
Yes
No
Yes
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
48. Which of the following are requirements for hedge accounting?
An existing risk management strategy involving hedging.
Designation and documentation of the hedging relationship.
Reasonable expectation of hedge effectiveness.
all of the above
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
d
zle
A)
B)
C)
D)
49. ABC Inc. enters and interest rate swap agreement with a third party whereby the company agrees
to “swap” its variable interest debt on its $100,000 debt issue. In doing so, the company opted for
fixed annual interest payments of $8,000 per year. Assuming that the variable rate throughout the
last year was 6%, this would mean that:
A)
ABC must pay $6,000 to the other party in the swap agreement.
B)
ABC must pay $8,000 to the other party in the swap agreement.
C)
ABC must pay $2,000 to the other party in the swap agreement.
D)
ABC will receive $2,000 from the other party in the swap agreement.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge/Application
Topic: LO7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 11
Chapter 14 – Complex Debt and Equity Instruments
50. Preferred shares are likely to be classified as debt if any of the following conditions exist except:
A)
B)
C)
D)
Redemption is contractually required
Redemption can be forced by the investor
Terms of the shares are such that redemption is essentially forced, even if the entity is
financially sound
all of the above
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
51. Perpetual debt is issued for the following reason:
A)
B)
C)
D)
Cash flow
Income tax reasons
Redemption clauses
None of the above
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
A)
B)
C)
D)
zle
52. A stock option plan is a compensatory plan if:
The employee must have worked for the company for one year.
The employee must report the option on the employee's current tax return.
The employee must work for the company until retirement.
It involves a cost to the grantor.
Ans: D
Difficulty: Medium
d
Level of Learning: Knowledge
Topic: LO6
53. $10,000 (face value) of bonds was sold with a total of 200 detachable stock warrants attached.
Each warrant conveys the right to purchase one common share at a specified price during a
specified time period. The market immediately valued the warrants at $2 each. The issue sold for
102. The entry to record the bond issuance would include:
A)
dr. bond premium $200
B)
dr. an owners' equity account for $400
C)
cr. bonds payable $10,200
D)
dr. bond discount $200
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 14 – Complex Debt and Equity Instruments
54. All of the following are examples of derivative instruments except:
A)
B)
C)
D)
Foreign exchange forward contracts
Interest rate swaps
Currency swaps
Retractable preferred shares
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
55. Which of the following is an example of a financial asset?
A)
B)
C)
D)
Inventory
accounts receivable
Capital assets
Prepaid expenses
Ans: B
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
56. In order to determine if, in substance, a complex financial instrument is debt, the answer should
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
d
zle
be yes to all of the following except:
A)
Is the periodic return on capital obligatory?
B)
Is the debtor legally obligated to repay the principal at a fixed rate?
C)
Is the amount convertible into common shares?
D)
Is the debtor legally obligated to repay the principal at the option of the creditor?
57. In order to determine if, in substance, a complex financial instrument is equity, the answer should
be no to all of the following except:
A)
Is the periodic return on capital obligatory?
B)
Is the debtor legally obligated to repay the principal at a fixed rate?
C)
Is the amount convertible into common shares?
D)
Is the debtor legally obligated to repay the principal at the option of the creditor?
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 14 – Complex Debt and Equity Instruments
58. All of the following are common reasons for a company to issue convertible bonds except:
A)
B)
C)
D)
The company prefers to issue shares, but is unsure of the present stock market and the
timing.
The bonds are issued to controlling shareholders so that they can receive interest payments
in preference to other shareholders.
A bond that has a favourable component such as a conversion privilege, can carry a lower
interest rate than a "straight" bond.
All of the above.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
59. General characteristics of convertible bonds that will be converted include all of the following
Ans: D
hz
except:
A)
management fully intends that the conversion privilege will eventually be attractive to the
investors
B)
the investors will convert at or before maturity date
C)
the company will no longer have to repay the principal amount of the bonds
D)
the market price of the shares will drop below the conversion price
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
60. Why would a corporation issue retractable preferred share in a private placement rather than a
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
d
normal debt arrangement?
A)
Cash flow
B)
Income minimization
C)
The tax treatment of intercorporate dividends
D)
none of the above
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 14
Chapter 14 – Complex Debt and Equity Instruments
61. Why would a corporation issue retractable preferred share in a private placement rather than a
normal debt arrangement?
A)
Cash flow
B)
Income minimization
C)
The debt-to-equity ratio
D)
None of the above
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
62. Silo Corp. granted to Donna, its superstar accountant, the option to purchase Silo common shares
Ans: C
zle
hz
for $10, on Jan. 1, 20x1. The market price of the shares on that date was $20. The options can be
exercised during the period Jan. 1, 20x4 through Jan. 1, 20x6. The number of shares under option
is determined by a formula based on Silo earnings each year. The number of shares actually under
option will be the formula value on Dec. 31, 20x3. That formula estimated the following number
of shares under option at the end of years: 20x1, 200; 20x2, 300. The formula determined the
number of shares at Dec. 31, 20x3 to be 400.
The market prices for Silo shares at the end of years: 20x1, $25;
20x2, $40, 20x3, $50. What is the recorded compensation expense for 20x2, for Donna?
A)
$7,250
B)
$3,000
C)
$4,000
D)
$4,500
E)
$5,000
Difficulty: Medium
Level of Learning: Application
Topic: LO 6
d
63. A non-compensatory stock option plan means that:
A)
B)
C)
D)
Any employee can purchase shares at a discount from the prevailing market price
Top executives are given shares in the company
No shares are given but shareholders are allowed to purchased on the open market
None of the above
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 15
Chapter 14 – Complex Debt and Equity Instruments
64. All of the following are characteristics of stock rights except:
A)
B)
C)
D)
The warrants are usually detachable
Stock warrants never expire
Stock warrants can be exercised without having to trade in the bond
Stock warrants can be exercised without having to redeem the bond
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
65. JMR Ltd. Issued $300,000 of 7%, 8 year, non-convertible bond with detachable stock purchase
Ans: A
hz
warrants. KER Corp. purchased the entire issue. Each $1,000 bond carries 20 warrants. Each
warrant entitles KER to purchase one common share for $20. The bond issue sells for 104
exclusive of accrued interest. Shortly after issuance, the warrants trade for $5 each and the bonds
were quoted at 103 ex-warrants. The market value of the bonds and warrants using the
proportional method was:
A)
$339,000
B)
$321,000
C)
$605,000
D)
$350,000
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO5
66. JMR Ltd. issued $100,000 of 8%, 8 year, non-convertible bond with detachable stock purchase
d
warrants. KER Corp. purchased the entire issue. Each $1,000 bond carries 10 warrants. Each
warrant entitles KER to purchase one common share for $20. The bond issue sells for 104
exclusive of accrued interest. Shortly after issuance, the warrants trade for $5 each and the bonds
were quoted at 103 ex-warrants. The market value of the bonds and warrants using the
proportional method was:
A)
$107,000
B)
$321,000
C)
$605,000
D)
$108,000
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 16
Chapter 14 – Complex Debt and Equity Instruments
67. JMR Ltd. Issued $100,000 of 8%, 8 year, non-convertible bond with detachable stock purchase
warrants. KER Corp. purchased the entire issue. Each $1,000 bond carries 10 warrants. Each
warrant entitles KER to purchase one common share for $20. The bond issue sells for 104
exclusive of accrued interest. Shortly after issuance, the warrants trade for $5 each and the bonds
were quoted at 103 ex-warrants. The allocation of the proceeds to bonds using the proportional
method was:
A)
$107,000
B)
$99,185
C)
$100,000
D)
$108,000
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO5
68. JMR Ltd. Issued $300,000 of 7%, 8 year, non-convertible bond with detachable stock purchase
Ans: C
zle
hz
warrants. KER Corp. purchased the entire issue. Each $1,000 bond carries 20 warrants. Each
warrant entitles KER to purchase one common share for $20. The bond issue sells for 104
exclusive of accrued interest. Shortly after issuance, the warrants trade for $5 each and there was
no market value for the bond. In the journal entry, the amount of the payable for the bond is:
A)
$339,000
B)
$321,000
C)
$300,000
D)
$350,000
Difficulty: Medium
Level of Learning: Application
Topic: LO5
69. An option is:
An obligation to buy something in the future
An obligation to sell something in the future
A debt instrument
The right to buy something in the future
d
A)
B)
C)
D)
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
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Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 14 – Complex Debt and Equity Instruments
70. An option is:
A)
B)
C)
D)
An obligation to buy something in the future
An obligation to sell something in the future
The right to sell something in the future
A debt instrument
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
71. A forward contract is:
A)
B)
C)
D)
An obligation to buy or sell something in the future
The right to sell something in the future
A derivative instrument
Bothe A and C
Ans: D
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
72. A forward contract is:
A debt instrument
The right to sell something in the future
An obligation to sell something in the future
The right to buy something in the future
Ans: C
zle
A)
B)
C)
D)
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
d
73. A derivative has all of the following characteristics except:
A)
B)
C)
D)
E)
a derivative is a secondary financial instrument whose value is lined to a primary financial
instrument
a derivative is an option
a derivative is a forward contract
a derivative is an option and a forward contract
all of the above
Ans: E
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
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Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 14 – Complex Debt and Equity Instruments
74. For each type of financial instrument, the reporting enterprise should disclose:
A)
B)
C)
D)
The extent and nature of the financial instruments
Significant terms
Significant conditions
all of the above
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO8
75. Stock Appreciation Rights (SARS) earned by employees may be settled by issuing:
A)
B)
C)
D)
Cash
Shares
Promissory notes
A or B
Ans: D
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
76. Securities issued as debt but intended by the issuing company to be exchanged for shares by the
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
d
zle
investor prior to maturity are called:
A)
Hybrid securities
B)
Discount bonds
C)
options
D)
convertible debt
77. Primary securities that have both debt and equity characteristics are called:
A)
B)
C)
D)
Hybrid securities
Discount bonds
options
convertible debt
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 14 – Complex Debt and Equity Instruments
78. VB Ltd. raises $150,000 by issuing a financial instrument that pays interest at a rate of 8% per
year to the investor. At the end of the fourth year, the financial instrument is retired for $155,000.
If the financial instrument is treated as debt:
A)
The repayment will decrease owners' equity
B)
The interest payment decreases retained earnings
C)
Retained earning is reduced as the interest payment is treated as a dividend distribution
D)
Shareholders' equity is increased at issuance
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
79. VB Ltd. raises $150,000 by issuing a financial instrument that pays interest at a rate of 8% per
Ans: A
hz
year to the investor. At the end of the fourth year, the financial instrument is retired for $155,000.
If the financial instrument is treated as equity:
A)
The repayment will decrease owners' equity
B)
The interest payment decreases retained earnings
C)
If premium on repayment was not known, it is recorded as a loss on the income statement
D)
Long-term liabilities is increased at issuance
Difficulty: Medium
zle
Level of Learning: Knowledge
Topic: LO1, 2
80. On the statement of cash flows, a hybrid financial instrument should be:
A)
B)
C)
D)
Reported as an operating activity
Reported as a financial activity
Reported as an investing activity
Reported according to its individual components
Level of Learning: Knowledge
Topic: LO8
d
Ans: D
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 20
Chapter 14 – Complex Debt and Equity Instruments
81. The crucial aspect of debt is:
A)
B)
C)
D)
The legal agreement
The interest payments
That the creditors can demand payment
The maturity date
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
82. A company issues a convertible bond. Management can essentially force conversion as long as:
A)
B)
C)
D)
The share price is higher than the conversion price
The share price is lower than the conversion price
The share price is equal to the conversion price
None of the above
hz
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
83. The incremental method to accounting for convertible bonds means that:
B)
C)
D)
The proceeds of the bond are allocated on the basis of the relative market values of the
straight bond and imbedded stock option
The stock option is valued at the difference between the total proceeds of the bond issue
and the market value of an equivalent straight bond issue
Any of the above
None of the above
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3, 4
d
zle
A)
84. The incremental method to accounting for convertible bonds means that:
A)
B)
C)
D)
The proceeds of the bond are allocated on the basis of the relative market values of the
straight bond and imbedded stock option
The stock option is valued at the difference between the total proceeds of the bond issue
and the market value of an equivalent straight bond issue
Any of the above
None of the above
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3, 4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 21
Chapter 14 – Complex Debt and Equity Instruments
85. When convertible bonds are submitted for conversion, all of the following must be updated
except:
A)
Bond premium or discount
B)
Accrued interest
C)
Cash
D)
Foreign exchange gains and losses on foreign currency denominated debt
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3, 4
86. If a company issues debt that is convertible at the corporation's option, in substance, the debt is:
A)
B)
C)
D)
Debt
Equity
An Asset
Subordinated
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3, 4
A)
B)
C)
D)
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87. Credit risk is an issue for financial instruments because:
the company may default on its loan
the company may not have enough cash flow to pay suppliers
the other parties to financial instruments may not perform their obligations
the company may not perform their obligations
Ans: C
88. Derivatives are:
A)
B)
C)
D)
d
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3, 4
Legal contracts
Promissory notes
Common shares
Executory contracts
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
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Chapter 14 – Complex Debt and Equity Instruments
89. Derivatives are often used to reduce risk. All of the following risks can be covered by a derivative
contract except:
A)
Retractable preferred shares
B)
Exchange contracts
C)
Currency swaps
D)
all of the above
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
90. At the end of 20x2, interest on a perpetual loan is paid to the holder. The perpetual debt is shown
as an equity instrument. Based on the above the interest is:
A)
Deducted on the statement of retained earnings
B)
Added to the statement of retained earnings
C)
Deducted for income tax purposes
D)
Added for income tax purposes
hz
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
zle
91. At the end of 20x2, interest on a perpetual loan is paid to the holder. The perpetual debt is shown
as an equity instrument. Based on the above the interest is:
A)
Deducted on the income statement
B)
Added to the income statement
C)
Deducted for income tax purposes
D)
Added for income tax purposes
Level of Learning: Knowledge
Topic: LO1, 2
d
Ans: C
Difficulty: Medium
92. Which of the following forms part of the definition of a financial liability?
A)
B)
C)
D)
Cash
An equity instrument of another entity
To deliver cash or another financial asset to another party
A contractual right to receive cash or another financial asset from another party
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
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Chapter 14 – Complex Debt and Equity Instruments
93. A financial asset has any of the following characteristics except:
A)
B)
C)
D)
An equity instrument of another entity
A debt instrument of another entity
Cash
A contractual right to exchange financial instruments with another party under conditions
that are potentially favourable
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
94. The president of XBC was granted a stock option for 1,000 common shares. On the grant date,
the option price was $40 and the market value was $38 per share. Give the entry to record the
option at the date of the grant.
Ans: No entry is required because the option price exceeds the market price.
Difficulty: Medium
hz
Level of Learning: Knowledge/Application
Topic: LO5
95. A company issues a financial instrument for $40,000 paying interest of $4,000 per year. How
zle
would the interest be treated if the instrument was determined to be equity?
Ans: If the financial instrument was classified as equity, the interest payment would be treated
as a dividend distribution and retained earnings would be reduced. There is no impact on
the income statement.
Difficulty: Medium
Level of Learning: Application
Topic: LO1
96. A company issues a financial instrument for $40,000 paying interest of $4,000 per year. How
Difficulty: Medium
Level of Learning: Application
Topic: LO1
d
would the repayment of the financial instrument be treated if it was determined to be debt?
Ans: If the financial instrument was classified as debt, the repayment of the instrument would
decrease liabilities.
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Chapter 14 – Complex Debt and Equity Instruments
97. What are hybrid securities?
Ans: Hybrid securities have the characteristics of both debt and equity. Their use is gaining
popularity as companies look for more innovative ways to raise funds/minimize their cost
of capital.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
98. Match the brief description with the terms by entering the appropriate letters in the blank spaces
provided.
hz
Brief Description
A. Inventory, capital assets, prepaid expenses
B. Accounts receivable, loan receivable
C. Warranty liabilities, unearned revenue
D. Accounts payable, loans payable
Term
___ 1.
Financial Asset
___ 2.
Financial Liability
___ 3.
Non-financial Asset
___ 4.
Non-financial Liability
Ans: 1: B, 2: D, 3: A, 4: C
Difficulty: Medium
zle
Level of Learning: Knowledge
Topic: LO1, 2
99. An investor purchases a $10,000 bond convertible into common shares at a price of $50. How
many shares are available for conversion?
Ans: 10,000/50=200 shares
Difficulty: Medium
d
Level of Learning: Knowledge
Topic: LO3, 4
100. In substance, a complex financial instrument will be treated as debt if the answer is yes to two
basic criteria. What are they?
Ans: 1. Are there periodic returns on capital? (Interest payments)2. Is the borrower required to
repay the principal?
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
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Chapter 14 – Complex Debt and Equity Instruments
101. Elizabeth Corp. owned a major business building in a small Canadian city. The building has a
$1,345,000 mortgage that is held by a Canadian financial institution (FI). Elizabeth Corp. has had
recent cash flow problems, in part, due to the low vacancy rates in the business buildings. Interest
is 15 months in arrears and totals $145,000. After discussions with the FI, they agree to a
financial reorganization in that they accept $50 preferred shares at a value of $1,490,000,
retractable in 15 years time at book value. The shares have first claim on the proceeds of the
business building, should it be sold.
Required:
Prepare the journal entry to record the exchange.
Ans:
Mortgage payable
1,345,000
Interest payable
145,000
Preferred shares, $20
1,490,000
Difficulty: Medium
Level of Learning: Application
Topic: LO2
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
zle
102. Amanda Corp. owned a major business building in a small Canadian city. The building has a
$1,555,000 mortgage that is held by a Canadian financial institution (FI). Amanda Corp. has had
recent cash flow problems, in part, due to the low vacancy rates in the business buildings. Interest
is 15 months in arrears and totals $132,000. After discussions with the FI, they agree to a
financial reorganization in that they accept $50 preferred shares at a value of $1,490,000,
retractable in 15 years time at book value. The shares have first claim on the proceeds of the
business building, should it be sold.
Required:
Prepare the journal entry to record the exchange.
Ans:
Mortgage payable
1,555,000
Interest payable
132,000
Preferred shares, $20
1,490,000
Gain on financial reorganization
197,000
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Chapter 14 – Complex Debt and Equity Instruments
103. KIM Corp. owned a major business building in a small Canadian city. The building has a
$1,155,000 mortgage that is held by a Canadian financial institution (FI). KIM Corp. has had
recent cash flow problems, in part, due to the low vacancy rates in the business buildings. Interest
is 15 months in arrears and totals $132,000. After discussions with the FI, they agree to a
financial reorganization that results in the FI accepting $800,000 from the shareholders who agree
to inject this amount of cash into the business.
Required:
Prepare the journal entry to record the exchange. What is this called?
Ans:
Cash
800,000
Common shares
800,000
Mortgage payable
1,155,000
Interest payable
132,000
Cash
800,000
Gain on financial reorganization
487,000
This is called settlement of debt, as the loan will no longer exist after the transaction.
Difficulty: Medium
hz
Level of Learning: Application
Topic: LO 2
Difficulty: Medium
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104. List the criteria determining whether an asset is a financial asset. Give an example of a financial
asset and a non-financial asset.
Ans: 1. cash
2. A contractual right to receive cash or another financial asset from another party
3. A contractual right to exchange financial instruments with another party under
conditions that are potentially favourable
4. An equity instruments of another entity financial asset: accounts receivable nonfinancial asset: inventory
Level of Learning: Knowledge
Topic: LO1
d
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Chapter 14 – Complex Debt and Equity Instruments
105. Match the brief description with the terms by entering the appropriate letters in the blank spaces
provided.
1.
2.
3.
4.
5.
6.
7.
8.
hz
___
___
___
___
___
___
___
___
Brief Description
A. A type of derivative instrument.
B. A firm commitment to interest payments and repayment of capital at maturity.
C. A nonmonetary asset.
D. A loan that never has to be repaid.
E. A residual interest in net assets with rights only to dividends.
F. Securities that have both debt and equity characteristics.
G. Bonds stripped of interest as issued by the issuer.
H. At maturity the debt is settled by paying it in silver.
Term
Equity
Hybrid investment
Commodity-Linked debt
Zero coupon bonds
Inventory
Perpetual debt
Stock right
Debt
Ans: 1:E, 2:F, 3:H, 4:G, 5:C, 6:D, 7:A, 8:B
Difficulty: Medium
zle
Level of Learning: Knowledge
Topic: LO1-8
Level of Learning: Knowledge
Topic: LO6
d
123. List the criteria determining whether liability is a financial liability. Give an example of a
financial liability and a non-financial liability.
Ans: A financial liability is any liability that is a contractual obligation:
1) To deliver cash or another financial asset to another party
2) To exchange financial instruments with another party under conditions that are
potentially unfavourable
Financial liability: accounts payable
Non-financial liability: unearned revenue
Difficulty: Medium
107. If a financial instrument is determined to be in substance equity, what are the reporting
implications?
Ans: Any interest payments will be treated as dividend payments with retained earnings being
reduced – in other words the interest does not flow through the income statement. The
original proceeds will be recorded as equity.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
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Chapter 14 – Complex Debt and Equity Instruments
108. What is convertible debt? Why would a company issue convertible debt?
Ans: Convertible debt can be exchanged for shares, generally at a specified price. The issuing
company is hoping that the debt will be converted before maturity so that they will not
have to repay the loan. In order for conversion to happen, the market price of the shares
must be higher than the conversion price. The company is generally able to issue the debt
with a lower interest rate as there is a conversion feature attached. In some cases, when the
company is risky, the conversion feature is needed to entice investors. The stock market
may be slow and the company does not want to issue shares.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3, 4
109. JMR Ltd. purchased $100,000 of bonds convertible into common shares at a price of $50. The
bonds have a maturity date of 20x4. On the maturity date, the market price of the common shares
is $55. Assuming that JMR Ltd. is a knowledgeable investor, what will the company do?
Ans: The company will convert the bonds to common shares as the market price is greater than
the conversion price. JMR Ltd. will get 2,000 shares.
hz
Difficulty: Medium
Level of Learning: Knowledge/Application
Topic: LO3, 4
zle
110. JMR Ltd. purchased $100,000 of bonds convertible into common shares at a price of $50. The
bonds have a maturity date of 20x4. On the maturity date, the market price of the common shares
is $45. Assuming that JMR Ltd. is a knowledgeable investor, what will the company do?
Ans: The company will take the money from the bond (i.e. cash the bond in for $100,000) as the
market price is below the conversion price.
Difficulty: Medium
Level of Learning: Knowledge/Application
Topic: LO3, 4
d
111. DWWR Ltd. issues a $150,000, 6%, five-year debenture at par, repayable at maturity in common
shares at DWWR's option. Interest is repayable annually in cash. Prepare the journal entry at
issuance.
Ans:
$150,000 (pv,5,6%) = 150,000x0.74726=
$112,089
$9,000 (pva,5,6%) = 9,000x4.21236=
$37,911
$150,000
=======
Cash
Interest liability
Share equity – debenture
150,000
37,911
112,089
Difficulty: Medium
Level of Learning: Application
Topic: LO1, 2
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Chapter 14 – Complex Debt and Equity Instruments
112. WB Ltd. issues a $200,000, 6%, five-year debenture at par, repayable at maturity in common
shares at DWWR's option. Interest is repayable annually in cash. Prepare the journal entry at
issuance.
Ans:
$200,000 (pv,5,6%) = 200,000x0.74726
=
$149,452
$12,000 (pva,5,6%) = 12,000x4.21236
=
$ 50,548
$200,000
=======
Cash
Interest liability
Share equity – debenture
200,000
50,548
149,452
Difficulty: Medium
Level of Learning: Application
Topic: LO1, 2
zle
hz
113. JMR Ltd. issues a $150,000, 7%, five-year debenture at par, repayable at maturity in common
shares at DWWR's option. Interest is repayable annually in cash. Prepare the journal entry at
issuance.
Ans:
$150,000 (pv,5,7%) = 150,000x0.71299
=
$106,949
$10,500 (pva,5,7%) = 10,500x4.10020
=
$ 43,051
$150,000
=======
Cash
Interest liability
Share equity – debenture
Difficulty: Medium
150,000
43,051
106,949
Level of Learning: Application
Topic: LO1, 2
d
114. Why do companies issue retractable preferred shares?
Ans: There are two basic reasons why corporations issue retractable preferred shares. In some
cases, corporations want or need to keep a positive debt-to-equity ratio. In other situations,
corporations are attempting to structure their instruments for tax purposes. Therefore, they
issue retractable preferred shares due to the tax treatment of intercorporate dividends.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
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Chapter 14 – Complex Debt and Equity Instruments
115. KER Corp. issued 150,000 rights allowing the holder to acquire common shares in 3 years' time
at an acquisition price of $30 per share – the current market price. It takes 5 rights to acquire each
share. The corporation received $40,000 for the rights. Assuming all rights are exercised when
the market price was $35, prepare journal entries at: announcement date, issuance date and
exercise date
Ans: No entry on announcement date
Issuance date:
Cash
40,000
Stock rights outstanding
40,000
Exercise date:
Cash
Stock rights outstanding
Common shares
900,000
40,000
940,000
Difficulty: Medium
Level of Learning: Application
Topic: LO5
hz
zle
116. KER Corp. issued 150,000 rights allowing the holder to acquire common shares in 3 years' time
at an acquisition price of $25 per share – the current market price. It takes 10 rights to acquire
each share. The corporation received $30,000 for the rights. Assuming 100,000 rights are
exercised when the market price was $30 and the balance expire, prepare journal entries at:
announcement date, issuance date, exercise date and expiration date.
Ans: 1. Announcement Date: No entry
2. Issuance Date
Cash
30,000
Stock rights outstanding
30,000
3. Exercise date
Cash
Stock rights outstanding
Common shares
250,000
20,000
270,000
d
4. Stock rights outstanding
Contributed capital, lapse of rights
10,000
10,000
Difficulty: Medium
Level of Learning: Application
Topic: LO5
117. What is a "poison pill"?
Ans: Corporations may try to make it difficult for others to take them over (i.e. takeover bid). At
times they will issue rights that will make it very expensive and very difficult for someone
to obtain control. Generally the rights are issued to existing shareholders for no
consideration.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
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Chapter 14 – Complex Debt and Equity Instruments
118. JMR Corp. grants their top executive an option for 1,000 shares. The option price is $30 per
share. Prepare the journal entry if the current market price is $40 per share. What would happen if
instead the market price was $25?
Ans: Market price=$40
Compensation expense (40-30)x1000 shares
10,000
Common share options outstanding
10,000
Market price=$25
No entry when option granted as the market price is less than the option price
Difficulty: Medium
Level of Learning: Application
Topic: LO5
Liability comp.
Stock option
Mkt value
$321,301
$ 73,675
$394,976
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hz
119. JMR Ltd. sold $350,000 of 5 %( annual interest payments) convertible 5 year bonds at par. The
market interest rate on the sale date was 7%. Each $1,000 bond was convertible into 20 shares of
KER Ltd. no-par value common shares on any interest date after the end of the first year from the
date of issuance. Using IFRS, prepare the journal entry at issuance using the proportional method.
Assume that the option pricing model placed a value of $73,675 for the conversion feature.
Ans: PV of bond:
350,000x(pv,5,0.07)=350,000x0.71299=
$249,547
(350,000x0.05)x(pva,5,0.07)=$17,500x4.10020=
$ 71,754
$321,301
=======
Cash(350,000x1.01)
Discount on Bond
Bonds payable
Common stock conversion rights
Level of Learning: Application
Topic: LO3, 4
Allocation
$284,500
$ 65,450
$350,000
$350,000
$ 65,450
$350,000
$65,450
d
Difficulty: Medium
Proportion
81.3%
18.7%
100.0%
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Chapter 14 – Complex Debt and Equity Instruments
120. JMR Ltd. sold $350,000 of 5 %( annual interest payments) convertible 5 year bonds at 101. The
market interest rate on the sale date was 7%. Each $1,000 bond was convertible into 20 shares of
KER Ltd. no-par value common shares on any interest date after the end of the first year from the
date of issuance. Using IFRS, prepare the journal entry at issuance using the incremental method.
Ans: PV of bond:
350,000x(pv,5,0.07)=350,000x0.71299=
$249,547
(350,000x0.05)x(pva,5,0.07)=$17,500x4.10020=
$ 71,754
$321,301
=======
Cash(350,000x1.01)
Discount on Bond
Bonds payable
Common stock conversion rights
$353,500
$28,699
$350,000
$32,199
Difficulty: Medium
Level of Learning: Application
Topic: LO3, 4
hz
zle
121. Explain why a company would want to classify a financial instrument as debt instead of equity?
Ans: Many companies want to classify financial instruments as equity and not debt in order to
improve their debt-to-equity. By recording certain items as equity, they will avoid possible
loan covenant problems. In addition income is affected by the retirement and interest
payments if the item is classified as debt.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
Use the following to answer questions 122-125:
d
On January 20X2, ABC Corporation issued $1,000,000 face amount of 8%, five year, convertible
debentures. Interest is payable semi-annually on 30 June and 31 December. The debentures are
convertible at the holder's option at the rate of 20 common shares for each $1,000 bond. The market rate
of interest for non-convertible bonds of similar risk and maturity is 6%. The net proceeds received by
ABC Corporation amounted to $1,250,000.
122. Prepare a Journal entry to record the issuance of the bonds on 1 January 20X2.
Ans: Cash
10,000,000
Interest liability on subordinated debentures [$800,000(P/A, 8%, 10)
Share equity – subordinated debentures
Difficulty: Medium
5,368,064
4,631,936
Level of Learning: Application
Topic: LO1, 2
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Chapter 14 – Complex Debt and Equity Instruments
123. Prepare a Journal entry for interest expense on 30 June 20X2 and 31 December 20X2. Assume
that ABC uses straight-line amortization for bond premium and discount.
Ans: June 30 20x2
Interest expense
31,470
Premium on Bonds payable($85,298/10 periods)
8,350
Cash
$40,000
Dec. 31 20x2
Interest expense
Premium on Bonds payable
Cash
31,470
8,350
$40,000
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
hz
124. Indicate how all amounts relating to the bonds will be shown on ABC financial statements for the
year ending 31 December 20X2.
Ans: Income statement
Interest expense
$62,940
Balance Sheet
Long term debt
Bonds payable
1,000,000
Premium on bonds payable (85,298 x 4/5)
68,238
zle
Shareholders equity
Common share conversion rights
Cash flow statement
Financing activities
Proceeds from issuance of convertible bonds
Difficulty: Hard
1,250,000
d
Level of Learning: Application
Topic: LO3, 4, 8
164,702
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Chapter 14 – Complex Debt and Equity Instruments
125. Assume that the holders of $300,000 face value bonds exercise their conversion privilege on 1
January 20X5, when market value of the common shares is $65. Prepare the journal entry to
record the conversion, using the book value method.
Ans: Bonds Payable
300,000
Premium on bonds payable
10,236
Common share conversion rights (164,702 x 3/10)
49,411
Common shares
359,647
Difficulty: Hard
Level of Learning: Application
Topic: LO3, 4
Use the following to answer questions 126-127:
On January 1, 2004, ABC Incorporated issued $10,000,000 face amount of 8%, 10 year,
subordinated convertible debentures at face value in a private placement. The debentures pay
interest annually, in cash, on 31 December. The bonds are convertible into 50 common shares
for each $1,000 of the bonds’ face value. At maturity, ABC Incorporated has the option of
issuing common shares to redeem the bonds instead of paying cash.
hz
126. Prepare Journal entries to record the issuance of the bonds on January 1, 2004.
Ans: Cash
10,000,000
Interest Liability on subordinated debentures (800,000 x (PA, 8%, 10) 5,368,064
Share equity – subordinated debentures
4,631,936
Difficulty: Hard
zle
Level of Learning: Application
Topic: LO 4
127. Prepare Journal entry to record the interest payment on the first interest date of 31 December
20X4. Also record the related equity transfer.
Ans: Interest expense (5,368,064 x 8%)
429,445
Interest liability on subordinated debentures
429,445
800,000
d
Interest liability on subordinated debentures
Cash ($10,000,000 x 8%)
Retained earnings ($4,631,936 x 8%)
Share equity – subordinated debentures
Difficulty: Hard
800,000
370,555
370,555
Level of Learning: Application
Topic: LO 4
For questions 128 to 132 inclusively, assume the same information as questions 126 and 127 above,
except that the share conversion is not mandatory, the bonds were issued for $12 million, and that the
market rate was 6%:
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 14 – Complex Debt and Equity Instruments
128. Prepare Journal entries to record the issuance of the bonds on January 1, 2004.
Ans:
The carrying value of the bonds on the date of issue must be calculated, with the balance going to
equity:
Interest Liability on subordinated debentures (800,000 x (PA, 6%, 10)
5,888,072
Principal on subordinated debentures (10,000,000 x (PV, 6%, 10)
5,583,950
Present Value of Bonds:
$11,472,022
Cash
Bonds Payable
Bond Premium
Share equity – subordinated debentures
Difficulty: Hard
12,000,000
10,000,000
1,472,022
527,978
hz
Level of Learning: Application
Topic: LO 4
zle
129. Prepare Journal entry to record the interest payment on the first interest date of 31 December
20X4.
Ans: Interest expense (11,472,022 x6%)
688,321
Bond Premium
111,679
Interest liability on subordinated debentures
800,000
Interest liability on subordinated debentures
Cash ($10,000,000 x 8%)
Difficulty: Hard
800,000
800,000
Level of Learning: Application
Topic: LO 4
d
130.
Assume that on January 1st, 20x5, the shares were converted when the market price of the share
was $102. Prepare the required journal entry.
Ans: Bonds Payable
10,000,000
Bond Premium
1,360,343
Share equity – subordinated debentures
527,978
Common Shares
$11,888,321
Note: The book value method is used for conversion, so the market value of the shares is
irrelevant. The common shares amount is simply a plug.
Difficulty: Hard
Level of Learning: Application
Topic: LO 4
131.
Assume that the shares were never converted, and the principal was simply repaid at maturity.
Provide the required journal entry.
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Chapter 14 – Complex Debt and Equity Instruments
Ans:
Bonds Payable
10,000,000
Cash
10,000,000
Share equity – subordinated debentures
527,978
Contributed Capital – Lapsed Conversion rights
527,978
Difficulty: Hard
Level of Learning: Application
Topic: LO 4
132.
Assume that on January 1st, 20x5, the bonds were retired for $12.5 million. Valuation models
indicate that $500,000 of the proceeds is attributable to the equity portion, while the balance is
attributable to the bonds. Prepare the required journal entry.
Ans: Bonds Payable
10,000,000
Bond Premium
1,360,343
Share equity – subordinated debentures
527,978
Loss on Bond Retirement
639,657
Contributed Capital – Retirement of share conversion rights
27,978
Cash
12,500,000
Difficulty: Hard
hz
Level of Learning: Application
Topic: LO 4
The following information pertains to questions 133-136 inclusively:
133.
zle
On January 1st, 20x9, GHI Inc. granted options to its twenty employees allowing for the purchase
of 12,000 shares at $5 per share. The options vest evenly over the 3 years following the date of
issue. The options are only exercisable as of December 31st, 20x11. The fair value of these
options (using an Option Pricing model) is $30,000.
Level of Learning: Application
Topic: LO6
134.
d
Assume that all options have vested but that none were exercised on December 31st, 20x11.
Provide the required journal entry.
Ans:
Contributed Capital: Common share options outstanding
$30,000
Contributed Capital: share options expired
$30,000
Difficulty: Hard
Assume that all options have vested and all were exercised on December 31st, 20x11. Provide the
required journal entry.
Ans:
Cash
$60,000
Contributed Capital: Common share options outstanding
$30,000
Common shares
$90,000
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Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 14 – Complex Debt and Equity Instruments
Difficulty: Hard
Level of Learning: Application
Topic: LO6
135.
Suppose that some of the options were forfeited by the employees. Actual and estimated
forfeiture data are provided in the table below:
Year
Total employees
Employees expected to forfeit
Employees expected to remain until vesting
Employees actually forfeiting in the year
1
2
3
20
2
(10%)
18
(90%)
20
4
(20%)
16
(80%)
20
1
2
0
Employees receiving options
17
Ans:
hz
Provide the required journal entries to record the accrual of compensation expense and
the exercise of the options as per IFRS.
Although not required, students may find the following table helpful:
zle
Year 20x9:
1
2
3
30,000 30,000 30,000
=1/3
=2/3
=3/3
90%
80%
85%
9,000 16,000 25,500
0
9,000 16,000
9,000 7,000 9,500
d
Time Period
Fair value
x Cumulative vested fraction
x Estimated Retention
Required year-end equity account balance:
Opening balance
Expense (credit) for the period:
Compensation expense
$9,000
Contributed Capital: Common Share options outstanding
$9,000
Year 20x10:
Compensation expense
$7,000
Contributed Capital: Common Share options outstanding
$7,000
Year 20x11:
Compensation expense
$9,500
Contributed Capital: Common Share options outstanding
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
$9,500
Page 38
Chapter 14 – Complex Debt and Equity Instruments
To record the exercise of the options on December 31, 20x11:
Cash
Contributed Capital: Common Share options outstanding
Common Shares
Difficulty: Hard
$60,000
$25,500
$85,500
Level of Learning: Application
Topic: LO6
136.
Ans:
Year 20x9:
hz
Repeat question 135 above (using the same data) and provide the journal entries required under
ASPE.
Compensation expense
$10,000
Contributed Capital: Common Share options outstanding
zle
Year 20x10:
$10,000
Compensation expense
$10,000
Contributed Capital: Common Share options outstanding
Year 20x11:
$10,000
d
Compensation expense
$5,500
Contributed Capital: Common Share options outstanding
$5,500*
*=85%*$30,000-$10,000-$10,000
To record the exercise of the options on December 31, 20x11:
Cash
Contributed Capital: Common Share options outstanding
Common Shares
$60,000
$25,500
$85,500
Note: Although the accounting for employee stock options is similar under ASPE and IFRS, under ASPE,
no provision is made for forfeitures under ASPE. “Catch-up” is performed during the year in which the
options become exercisable. In this example, both IFRS and ASPE come to the same Contributed Capital
account balance of $51,000 just prior to the exercise of the options. However, the timing of the related
compensation expense differs under IFRS and ASPE, as show in exercises 135 and 136 above. The entry
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 14 – Complex Debt and Equity Instruments
to record the actual exercise of the options is identical under both IFRS and ASPE.
Difficulty: Hard
Level of Learning: Application
Topic: LO6, 9
137.
hz
On January 1st, 20x1, 20,000 units of stock appreciation rights were granted to JKL Inc’s 200
employees, each of which received 100 units which accrue evenly over the following three years.
The rights allow the employees to receive cash compensation for any stock price increase on
December 31st, 20x3, if they are still with the company at that time.
The cash to be distributed is the difference between the fair value of the share and the reference
price of $5 per share. Cumulative retention rates are expected to be 80% and 70% for 20x1 and
20x2 respectively. Twenty employees forfeited their rights in 20x1 and thirty forfeited their rights
in 20x2. On December 31st, 20x3 there were 150 employees working for JKL Inc.
zle
The following data applies to JKL’s SARS plan:
20x1
20x2
8
7
5
5
3
2
4.5
3
90,000 60,000
20x3
10
5
5
n/a
d
Year
Market value per share
Reference price per share
Intrinsic value per share
Estimated fair value per share
Total fair value (20,000 units)
Cash payout value (excluding forfeitures)
100,000
Required:
Prepare the required journal entries for 20x1, 20x2 and 20x3 to record the compensation expense
and ultimate cash payout related to the company’s SARS plan.
Ans:
Although not required, students may find the following table helpful:
Time Period
Fair value
1
2
3
90,000 60,000 100,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 14 – Complex Debt and Equity Instruments
x Cumulative vested fraction
x Estimated Retention
Required year-end equity account balance:
Opening balance
Expense (credit) for the period:
=1/3
=2/3
80%
70%
24,000 28,000
0
24,000
24,000 4,000
=3/3
75%
75,000
28,000
47,000
Year 20x1:
Compensation expense
$24000
Long-term compensation liability
$24,000
Year 20x2:
Compensation expense
$4000
Long-term compensation liability
hz
Year 20x3:
Compensation expense
$47,000
Long-term compensation liability
$4,000
$47,000
To record the cash payout on December 31, 20x3:
*=200*75%*100*5
Difficulty: Hard
zle
Long-term compensation liability
Cash
$75,000
$75,000*
Level of Learning: Application
Topic: LO6
d
138.
Assume that on January 1st, 20x1, Jane Smith is awarded units in an existing Phantom Stock Plan
whereby she can receive either 20,000 common shares or a cash payout equivalent to the value of
15,000 shares at the time.
The shares are worth $5 each upon the inception of the plan. The value of the shares rose to $8
and $10 each at the end of 20x1 and 20x2 respectively.
Option valuation models valued the company’s stock at $6 per share on January 1st, 20x1.
Jane is her company’s only full-time employee currently eligible under this plan and she has
signed a non-competition agreement which essentially forbids her from seeking employment
elsewhere.
Required:
Provide the company’s journal entries to record compensation expense for 20x1 and 20x2 and
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 41
Chapter 14 – Complex Debt and Equity Instruments
provide the necessary journal entries assuming that Jane:
a. Elects to receive shares and
b. Opts for the cash payment, allowing her options to expire.
Ans:
Equity alternative fair value at plan initiation: $100,000
Cash alternative, fair value, at plan initiation $75,000
Equity portion
$25,000
20x1:
Compensation Expense
$72,500
(15,000*8+$25,000)/2
Contributed Capital – Common Shares Outstanding
Long-Term Compensation Liability
20x2:
hz
Compensation Expense
$87,500
((15,000*9+$25,000)-72,500)
Contributed Capital – Common Shares Outstanding
Long-Term Compensation Liability
$12,500
$60,000
$12,500
$75,000
a. Jane receives shares:
zle
Contributed Capital – Common Shares Outstanding
Long-Term Compensation Liability
Common Shares
$ 25,000
$135,000
$160,000
b. Jane opts for the cash payout:
Level of Learning: Application
Topic: LO6
139.
$ 25,000
$135,000
d
Contributed Capital – Common Shares Outstanding
Long-Term Compensation Liability
Cash
Contributed Capital –Share options expired
Difficulty: Hard
$135,000
$ 25,000
On January 1st, 20x12, ABC Inc. agrees to a futures contract to buy 1,000 shares of DEF Inc. for
$20 per share in 60 days. The current value of the shares on January 1, 20x12 is $22 per share.
The broker requires a 20% margin payment. The fair value of the shares is $24 per share on
January 31st, 20x12 and $18 per share on February 29th, 20x12.
Required: Prepare all relevant journal entries.
Ans:
January 1st, 20x12
Derivative Instrument
$2,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 14 – Complex Debt and Equity Instruments
Gain on Derivative Instrument $2,000
Derivative Instrument $4,400
Cash
*(20 %*( $20,000+$2,000)
$4,400*
January 31st, 20x12
Derivative Instrument $2,000
Gain on Derivative Instrument $2,000
Derivative Instrument
Cash
*(20 %*$2,000)
$400
$400*
February 29th, 20x12
$6,000
hz
Loss on derivative instrument
Derivative Instrument
$6,000
zle
Investment in DEF Inc. Shares $18,000
($18*1,000 shares)
Cash
$15,200 ($20,000-$4,400-$400)
Derivative Instrument
$ 2,800 (balance)
Difficulty: Hard
Level of Learning: Application
Topic: LO7
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 43
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test Bank
Chapter 15 – Accounting for Corporate Income Tax
1. Future income tax liabilities are amounts owed to the government.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
2. The term “provision for income taxes” encompasses both income tax expenses and
liabilities.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
hz
3. Deferred taxes appear on a company’s balance sheet as a result of inter-period tax
allocation.
Ans: False
zle
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
4. Temporary differences occur only because accounting standards and income tax laws differ as to
when they recognize assets, liabilities, owners' equity, revenues, gains, expenses, and losses.
Ans: True
d
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
5. The use of inter-period income tax allocation is mandatory under ASPE.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO8
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 1
Chapter 15 – Accounting for Corporate Income Tax
6. Temporary differences relate only to items that will be recognized on both the income statement
and the tax return, but in different reporting periods.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
7. Temporary differences very seldom reverse (i.e., turnaround) in one or more future reporting
periods.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
8. Permanent differences are those that factor into the computation of both net income and
taxable income.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
accounting income.
Ans: True
zle
9. Income tax expense generally equals the product of the current period income tax rate and pretax
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
d
10. Under IFRS, the amount of taxes paid must be disclosed on the face of the cash flow
statement.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
11. The partial allocation approach has been adopted by IFRS to account for income tax
allocation.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 2
Chapter 15 – Accounting for Corporate Income Tax
12. Deferred taxes must be discounted under IFRS.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
13. Deferred taxes may be classified as either current or non-current under IFRS.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
14. Prepayments of future income tax expense may be viewed as a future tax asset.
Ans: True
hz
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
15. "Taxable amounts" include revenues and gains that are included in the tax return BEFORE they
are recognized for accounting purposes.
zle
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
16. "Taxable amounts" include expenses and losses that are included in the tax return BEFORE they
are recognized for accounting purposes.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
d
Ans: True
17. Under the indirect method or preparing sash flows from operating activities, future
income tax expense must be added back to net income.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 3
Chapter 15 – Accounting for Corporate Income Tax
18. Netting of deferred income tax assets and liabilities is forbidden under IFRS and ASPE.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3, 4, 8
19. During the originating period of a temporary difference, pretax accounting income is defined as
taxable income plus taxable amounts minus deductible amounts.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
20. All temporary differences are related to differences in the timing of accounting recognition
compared with income tax recognition.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
21. All temporary differences originate, then reverse, and eventually end with a zero net effect.
zle
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
22. Under the liability approach, deferred taxes on the balance sheet are valued at the tax rate in that
will be in effect when the temporary differences reverse.
23. Under the deferral approach, deferred taxes on the balance sheet are valued at the tax rate in that
will be in effect when the temporary differences reverse.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 4
Chapter 15 – Accounting for Corporate Income Tax
24. In Canada, tax rates are usually enacted in the year to which they pertain.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
25. Differences between accounting recognition and recognition for tax purposes are called
"temporary differences".
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
26. There are many types of organizations that are subject to income tax including corporations,
partnerships and proprietorships.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
27. Only corporations are subject to income tax.
zle
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
28. For inter-period tax allocation, the total income tax expense must be allocated to ongoing
operations, discontinued operations and extraordinary items on the income statement.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 5
Chapter 15 – Accounting for Corporate Income Tax
29. Income tax expense for continuing operations, discontinued operations and extraordinary items
must be disclosed separately on the income statement.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
30. Temporary differences and timing differences are terms that mean the same thing.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
31. Ryan Company paid the golf dues of one of its employees. This represents a temporary
difference.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: False
zle
32. If a company incurs $1,500 of expenditures for meals and entertainment, this amount represents a
permanent difference.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
represents a permanent difference.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
33. Amanda Company sold an asset and as a result had a capital gain of $15,000. This amount
34. Golf Corporation sold an asset and recorded a capital gain of $15,000. $3,750 of this amount
represents a permanent difference.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 6
Chapter 15 – Accounting for Corporate Income Tax
35. Comprehensive allocation recognizes the amount of taxes assessed in each year as the income tax
expense for that year.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
36. If the enacted tax rate is changed for the current and future years, the earnings effect of the
change in the beginning balances of the future tax assets is recognized in the current year.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
37. ABC Co. in its first year of business has taxable income of $2,000, book depreciation of $3,000
zle
Ans: C
hz
and tax depreciation of $4,600, and recognized $800 of warranty expense but performed no
warranty service. ABC's pretax accounting income would be:
A)
$1,200
B)
$2,000
C)
$2,800
D)
$2,200
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
38. Which of the following transactions does not cause a temporary income tax difference?
A)
C)
D)
d
B)
Revenues or gains that is included in taxable income one or more periods after they are
included in pretax accounting income
Expenses or losses that are deducted in determining taxable income one or more periods
after they are deducted in determining pretax accounting income
Revenues or gains that are included in pretax accounting income but are never included in
taxable income
Expenses or losses that are deducted in determining taxable income before they are
deducted in determining pretax accounting income
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 7
Chapter 15 – Accounting for Corporate Income Tax
39. Inter-period tax allocation accounts for
A)
B)
C)
D)
All differences between tax regulations and GAAP
Temporary differences
Permanent differences
Tax effects of specific income statement items in the same period
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
40. Company A had depreciation of $14,000 and CCA of $12,500. At the end of the year, they have:
A)
B)
C)
D)
Deferred income tax asset of $1,500
Deferred income tax liability of $1,500
Deferred income tax asset of $14,000
Deferred income tax liability of $14,000
Ans: C
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
41. Company B had depreciation of $13,000 and CCA of $18,000. At the end of the year, they have:
Deferred income tax asset of $13,000
Deferred income tax liability of $18,000
Deferred income tax liability of $5,000
Deferred income tax asset of $5,000
Ans: D
zle
A)
B)
C)
D)
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
d
42. The general terminology used to describe income tax expense when disclosed in the financial
statements is:
A)
Income tax expense
B)
Income tax benefit
C)
Provision for income tax expenses
D)
Tax expense
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 8
Chapter 15 – Accounting for Corporate Income Tax
43. A taxable amount is exemplified by:
A)
B)
C)
D)
Revenue that is included in the tax return before it is included in pretax accounting income.
Gain that is included in the tax return before it is included in pretax accounting income.
Expense that is included in the tax return after it is included in pretax accounting income.
Expense that is included in the tax return before it is included in pretax accounting income.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
44. A deductible amount is exemplified by all of the following except:
A)
B)
C)
D)
E)
Revenue that is included in the tax return before it is included in pretax accounting income.
Gain that is included in the tax return before it is included in pretax accounting income.
Expense that is included in the tax return after it is included in pretax accounting income.
Loss that is included in the tax return after it is included in pretax accounting income.
Expense that is included in the tax return before it is included in pretax accounting income.
hz
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
45. Golf dues paid for by a company is an example of:
A temporary difference
A timing difference
A permanent difference
A reversing difference
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
46. Choose the permanent difference
A)
B)
C)
D)
d
zle
A)
B)
C)
D)
dues (country club, etc.) paid on behalf of executives are not deductible for tax purposes,
are deductible under GAAP
carryback, carryforward option for taxes, no such option under GAAP
straight-line depreciation for the books, accelerated depreciation for taxes
point of sale revenue recognition for the books, instalment method for taxes
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 9
Chapter 15 – Accounting for Corporate Income Tax
47. At the end of 2099, the only expected future temporary difference is implied by the following
account found in the balance sheet:
Prepaid rent...........$22,000.
The footnotes reveal that the prepaid rent applies only to 2010. You would also expect to find
which of the following in the balance sheet:
A)
Current future tax liability
B)
Current future tax asset
C)
Noncurrent future tax liability
D)
Noncurrent future tax asset
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
48. In computing future tax assets and liabilities, which tax rates are used:
Current tax rate
Estimated future tax rates
Enacted future tax rates
Past years' tax rates
hz
A)
B)
C)
D)
Ans: B
Difficulty: Medium
zle
Level of Learning: Knowledge
Topic: LO2, 3
49. At most, how many future tax accounts will a firm report in its balance sheet?
A)
B)
C)
D)
1
2
3
4
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
d
Ans: D
50. Which of the following is the most likely item to result in a future tax asset?
A)
B)
C)
D)
Using straight-line depreciation for the books and accelerated depreciation for tax
Rent received in advance
Prepayment of insurance
Point of sale revenue recognition for the books, and cost recovery method of revenue
recognition for tax
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 10
Chapter 15 – Accounting for Corporate Income Tax
51. XYZ had taxable income of $4,000 during 2011. XYZ used accelerated depreciation for tax
purposes ($4,200) and straight-line depreciation for accounting purposes ($1,000). XYZ had no
other temporary differences. XYZ's pretax accounting income for 2001 would be:
A)
$800
B)
$5,000
C)
$7,200
D)
$8,200
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
52. During 2011, MJB has pretax accounting income of $8,400. MJB's only temporary difference for
Ans: C
hz
2001 was rent revenue collected in advance of $2,400. None of this amount is recognized for
book purposes. MJB's taxable income for 2011 would be:
A)
$6,000
B)
$8,400
C)
$9,600
D)
$10,800
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
53. MNO's taxable income was $900 during 2011. MNO had product warranty costs of $360
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
d
recognizable for tax purposes and $400 recognizable for financial accounting purposes. MNO had
no other temporary differences. MNO's pretax accounting income for 2011 would be:
A)
$860
B)
$900
C)
$940
D)
$1,260
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 11
Chapter 15 – Accounting for Corporate Income Tax
54. STR provided the following data related to income tax allocation:
Pretax accounting income
Taxable income
Income tax rate
2009
$4,000
4,400
34%
2010
$4,400
4,000
34%
The future tax account showed a zero balance at the start of 2009. There was only one temporary
difference, a revenue amount, which was taxable in 2009, but was recorded for accounting
purposes in 2001. There are no carry backs or carry forwards. The journal entry to record the
income tax consequences for 2009 would include a:
A)
Debit of $136 to STR's future tax liability account.
B)
Credit of $136 to STR's future tax liability account.
C)
Debit of $136 to STR's future tax asset account.
D)
Credit of $136 to STR's future tax asset account.
Ans: B
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
55. The following data of ABC Ltd. relates to the current year:
$20,000
4,000
2,000
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Pre-tax accounting income
Depletion
Tax
Books
Depreciation
Tax
Books
Dividends from a tax Canadian corporation
False advertising fine (not deductible)
Rent revenue
Tax
Books
16,000
12,000
d
Compute taxable income for the year.
A)
$13,000
B)
$15,000
C)
$17,000
D)
$19,000
E)
$11,000
10,000
8,000
6,000
1,000
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 15 – Accounting for Corporate Income Tax
56. A firm reported the following in its income statement for the current year: depletion expense,
$4,000; pollution violation fine, $12,000; pre-tax accounting income, $10,000. The tax rate is
40%. For tax purposes, the depletion deduction was $9,000. What amount of income tax expense
will be recognized for this year?
A)
$7,800
B)
$4,000
C)
$6,800
D)
$400
E)
$8,800
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
57. At the end of 2010, a firm reported $200,000 of credit sales for income statement purposes. Of
zle
Ans: C
hz
that amount, only $60,000 had been collected. In addition, $20,000 of credit sales from 2009 had
not been collected as of Dec. 31, 2010. Assume for tax purposes that only collected sales are
taxable. As of Dec. 31, 2010, this firm has a future
A)
$140,000 taxable difference
B)
$160,000 deductible difference
C)
$160,000 Taxable difference
D)
$ 60,000 taxable difference
E)
$140,000 deductible difference
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
58. Ryan Company paid golf dues on behalf of their two top employees. This is an example of a:
Temporary difference
Reversing difference
Permanent difference
Fully deductible for income tax purposes
Ans: C
d
A)
B)
C)
D)
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
59. Amanda Corporation incurred $10,000 of meals and entertainment expenses for the year ended
December 31. The amount that is deductible for tax purposes is:
A)
$5,000
B)
$7,500
C)
$10,000
D)
$0
Ans: A
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 13
Chapter 15 – Accounting for Corporate Income Tax
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
60. EGR just completed its first year end. During the year, EGR recorded $12,000 in depreciation
($18,500 CCA). In addition there was a deduction in the accounting records for meals and
entertainment amounting to $6,000. As a result taxable income will:
A)
Be lower than accounting income by $3,500
B)
Be lower than accounting income by $500
C)
Be higher than accounting income by $6,500
D)
Be lower than accounting income by $6,500
E)
Will be equal to accounting income
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
hz
61. KEG just completed its year end. During the year, KEG recorded $12,000 in depreciation ($9,000
Ans: A
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CCA). In addition there was a deduction in the accounting records for meals and entertainment
amounting to $5,000. As a result taxable income will:
A)
Be lower than accounting income by $3,000
B)
Be higher than accounting income by $3,000
C)
Be higher than accounting income by $5,500
D)
Be lower than accounting income by $5,500
E)
Will be equal to accounting income
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
recommended in the CICA Handbook is:
A)
Flow-through method
B)
Comprehensive allocation
C)
Partial allocation
D)
Any of the above
d
62. Temporary differences can be dealt with in a number of different ways. The method
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 15 – Accounting for Corporate Income Tax
63. A characteristic of comprehensive allocation is that:
A)
B)
C)
D)
Income tax expense = current income tax
inter-period income tax allocation is applied to some types of temporary differences but
not all
The matching principle is better served
It is called the taxes payable method
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
64. All of the following are characteristics of comprehensive allocation except:
A)
B)
C)
D)
Proponents say that a future cash flow impact arises from all temporary differences.
The matching principle is best served by using the comprehensive allocation method.
Income tax is an aggregate measure, applied to the overall operations of the company.
recommended by the CICA Handbook.
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
65. Which of the following could never be subject to inter-period tax allocation?
Proceeds from life insurance
Depreciation expense on operational assets
Estimated warranty expense
Rent revenue
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
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A)
B)
C)
D)
66. Which of the following is an example of a temporary difference, which would result in a future
tax liability?
A)
Use of straight-line depreciation for accounting purposes and an accelerated rate for
income tax purposes
B)
Rent revenue collected in advance when included in taxable income before it is included in
pre-tax accounting income
C)
Use of a shorter depreciation period for accounting purposes than is used for income tax
purposes
D)
Investment losses recognized earlier for accounting purposes than for tax purposes
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 15
Chapter 15 – Accounting for Corporate Income Tax
67. Which of the following is an example of a temporary difference, which could result in a deferred
tax asset?
A)
Gain on disposal of an asset when included in taxable income before it is included in pretax accounting income
B)
Use of straight-line depreciation for accounting purposes and an accelerated rate for
income tax purposes
C)
Gross margin on instalment sales is recognized for accounting purposes before it is
included in taxable income in the income tax return
D)
Prepayments of expenses in year of payment; recognition of expense for accounting
purposes occurs in a later year
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
68. Which of the following is an example of a temporary difference which would not result in a
Ans: B
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hz
deferred tax asset?
A)
Allowance method for doubtful accounts is used for accounting purposes while direct
write-off is required for tax purposes.
B)
Use of sales method of revenue recognition for accounting purposes, and instalment
method of revenue recognition for tax purposes.
C)
Unrealized loss on short term investment is recognized for accounting purposes during the
holding period while the actual loss on date of disposal is used for tax purposes.
D)
Estimated loss on disposal of a segment of a business recognized for accounting purposes
but reported on the income tax return later on the basis of the actual loss.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
A)
B)
C)
D)
d
69. The term "taxable amount" includes:
Gains that are included in the tax return AFTER they are recognized for accounting
purposes.
Revenues that are included in the tax return BEFORE they are recognized for accounting
purposes.
Losses that are included in the tax return AFTER they are recognized for accounting
purposes.
Warranty deductions for accounting purposes.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 16
Chapter 15 – Accounting for Corporate Income Tax
70. JMR Corp. incurred an expenditure that qualified for an investment tax credit. The expenditure
amounted to $150,000, the Corporation's tax rate is 44% and the expenditure qualifies for a 6%
tax credit. The Corporation had taxable income in the year. What is the amount of the tax
reduction?
A)
$66,000
B)
$9,000
C)
$0
D)
$6,000
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3
71. A temporary difference that is deductible in future years is called:
A temporary tax liability
A temporary tax asset
A permanent tax asset
A permanent tax liability
hz
A)
B)
C)
D)
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
zle
72. JMR Corporation has one asset worth $350,000. Depreciation accumulated to date is $200,000
and accumulated CCA is $230,000. Assuming the tax rate is 40% what is the income tax
implication?
A)
A Deferred income tax asset of $30,000
B)
A Deferred income tax liability of $30,000
C)
A Deferred income tax asset of $12,000
D)
A Deferred income tax liability of $12,000
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3, 4, 5
d
Ans: D
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 17
Chapter 15 – Accounting for Corporate Income Tax
73. JMR Corporation has one asset worth $350,000. Depreciation accumulated to date is $230,000
and accumulated CCA is $200,000. Assuming the tax rate is 40% what is the income tax
implication?
A)
A Deferred income tax asset of $30,000
B)
A Deferred income tax liability of $30,000
C)
A Deferred income tax asset of $12,000
D)
A Deferred income tax liability of $12,000
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3, 4, 5
74. EGR Corporation has one asset worth $450,000. Depreciation accumulated to date is $190,000
Ans: D
hz
and accumulated CCA is $220,000. The Corporation also recorded warranty expense of $30,000.
To date no customers have required warranty service. Assuming the tax rate is 40% what is the
income tax implication?
A)
A Deferred income tax asset of $30,000
B)
No temporary differences
C)
A Deferred income tax asset of $12,000
D)
A Deferred income tax liability of $12,000
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3, 4, 5
75. EGR Corporation has one asset worth $650,000. Depreciation accumulated to date is $230,000
Ans: A
d
and accumulated CCA is $200,000. The Corporation also recorded warranty expense of $35,000.
To date no customers have required warranty service. Assuming the tax rate is 40% what is the
income tax implication?
A)
A Deferred income tax asset of $65,000
B)
A Deferred income tax liability of $65,000
C)
A Deferred income tax asset of $26,000
D)
A Deferred income tax liability of $26,000
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3, 4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 18
Chapter 15 – Accounting for Corporate Income Tax
76. The following information is available for Ryan Corporation: Assets at cost - $260,000;
Accumulated depreciation - $80,000; Accumulated CCA - $90,000; meals and entertainment
recorded in the books - $12,000; golf dues paid - $5,000. Based on this information and a tax rate
of 45%, what is the amount of the temporary difference?
A)
$0
B)
$1,000
C)
$4,000
D)
$10,000
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
77. The following information is available for Ryan Corporation: Assets at cost - $260,000 (8 year
Ans: B
hz
life, straight-line depreciation and purchased 2 years ago); Accumulated depreciation - $65,000;
Accumulated CCA - $105,300; CCA rate – 30%; meals and entertainment recorded in the books $12,000; golf dues paid - $5,000; accounting income - $40,000. Based on this information and a
tax rate of 45%, what is taxable income?
A)
$10,000
B)
$18,000
C)
$17,200
D)
$102,500
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
78. The following information is available for Ryan Corporation: Assets at cost - $160,000 (5 year
d
life, straight-line depreciation and purchased 4 years ago); Accumulated depreciation - $128,000;
Accumulated CCA - $113,352; CCA rate – 30%; meals and entertainment recorded in the books $10,000; golf dues paid - $2,500; accounting income - $90,000. Based on this information and a
tax rate of 45%, what is taxable income?
A)
$102,008
B)
$114,508
C)
$104,508
D)
$109,508
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 19
Chapter 15 – Accounting for Corporate Income Tax
79. The following information is available for Ryan Corporation: Assets at cost - $160,000 (5 year
life, straight-line depreciation and purchased 4 years ago); Accumulated depreciation - $128,000;
Accumulated CCA - $113,352; CCA rate – 30%; meals and entertainment recorded in the books $10,000; golf dues paid - $2,500; accounting income - $90,000. Based on this information and a
tax rate of 45%, What should the future tax asset amount to?
A)
$6,591.60
B)
$14,548.00
C)
$3,216.60
D)
$5,466.60
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
80. The following information is available for Ryan Corporation: Assets at cost - $160,000 (5 year
zle
Ans: C
hz
life, straight-line depreciation and purchased 4 years ago); Accumulated depreciation - $128,000;
Accumulated CCA - $113,352; CCA rate – 30%; meals and entertainment recorded in the books $10,000; golf dues paid - $2,500; accounting income - $90,000. Based on this information and a
tax rate of 45%, what is the amount of the temporary difference?
A)
6,592
B)
$17,148
C)
$4,648
D)
$14,648
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
81. The following information is available for Ryan Corporation: Assets at cost - $160,000 (5 year
d
life, straight-line depreciation and purchased 4 years ago); Accumulated depreciation - $128,000;
Accumulated CCA - $113,352; CCA rate – 30%; meals and entertainment recorded in the books $10,000; golf dues paid - $2,500; accounting income - $90,000. Based on this information and a
tax rate of 45%, what is the amount of the permanent differences?
A)
6,592
B)
$7,500
C)
$4,648
D)
$14,648
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 20
Chapter 15 – Accounting for Corporate Income Tax
82. An example of a "deductible amount" occurs when:
A)
B)
C)
D)
A gain on instalment sales is recognized for tax purposes as the receivable is collected, but
was earlier recognized for accounting purposes when the sale was made.
Accelerated depreciation is used for tax purposes but straight-line depreciation is used for
accounting purposes.
Product warranty costs recognized for tax purposes as the warranty conditions are met but
recognized for accounting purposes earlier on the accrual basis.
Expenses are recognized more quickly for taxes than for accounting purposes.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
83. KER had recorded an accrual for warranty in its books during the year ended December 31, 2009
Ans: D
hz
amounting to $100,000. During the year 2000, customers required service from goods sold in
2009 amounting to $60,000. KER recorded an amount for possible warranty costs for goods sold
during the year in the amount of $95,000. KER has a temporary difference for the year 2000
amounting to:
A)
0
B)
Future tax asset $135,000
C)
future tax liability $135,000
D)
Cannot be determined from the information given
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Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3
84. KER had recorded an accrual for warranty in its books during the year ended December 31, 2010
d
amounting to $100,000. During the year 2011, customers required service from goods sold in
2010 amounting to $60,000. KER recorded an amount for possible warranty costs for goods sold
during the year in the amount of $95,000. Accounting income amounted to $80,000 and the tax
rate is 40%. Assuming that KER has no other differences between accounting and tax what is the
current and future income tax amounts?
A)
Current: $70,000; future tax liability: $135,000
B)
Current: $46,000; future tax liability: $135,000
C)
Current: $46,000; future tax asset: $135,000
D)
Cannot be determined from the information given
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 21
Chapter 15 – Accounting for Corporate Income Tax
85. Recommended disclosures for the provision for income tax expense include all of the following
except:
A)
Public companies should disclose the nature of temporary differences
B)
Income tax expense or benefit should be reported separately on the financial statements
C)
Income tax expense should not be grouped with other expenses
D)
Income taxes relating to discontinued items must be disclosed separately on the financial
statements
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
86. Which of the following does not help explain why (1) and (2) are different:
Ans: C
hz
(1) Income tax expense
(2) The product of pre-tax income and the current tax rate.
A)
Permanent differences
B)
Temporary differences
C)
The fact that future and current tax rates are different
D)
A change in the effective tax rate
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Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
87. During 2001, XZY had pre-tax accounting income of $420. XZY's only temporary difference for
d
2003 was the collection of a receivable, which resulted in $120 of income under the instalment
sales method of revenue recognition, which XZY uses, for tax purposes. The sale was originally
made in 2000 and recognized for accounting purposes at that time. XZY's taxable income for
2003 would be:
A)
$300
B)
$420
C)
$460
D)
$540
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 22
Chapter 15 – Accounting for Corporate Income Tax
88. CDE had taxable income of $1,500 during 2001. CDE used accelerated depreciation for tax
purposes ($2,000) and straight-line depreciation for financial accounting purposes ($800). On
December 30, 2001, CDE collected January 2002's $600 rent on a lot it rents on a month-bymonth basis to JCB. CDE's pre-tax accounting income for 2001 would be:
A)
$900
B)
$2,100
C)
$3,300
D)
$3,700
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
89. GFH had pre-tax accounting income of $1,400 during 2001. GFH used accelerated depreciation
Ans: A
hz
for tax purposes ($1,000) and straight-line depreciation for financial accounting purposes ($200).
During 2001 GFH accrued warranty expenses of $900 and paid cash to honour warranties of
$500. GFH's taxable income for 2001 would be:
A)
$200
B)
$1,000
C)
$1,800
D)
$2,600
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Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
90. Kate Corporation sold a truck resulting in a capital gain of $7,600. The amount to be reported for
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
tax purposes is:
A)
$7,600
B)
$0
C)
$5,700
D)
$3,800
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 23
Chapter 15 – Accounting for Corporate Income Tax
91. JMR Corporation sold a truck resulting in a capital gain of $11,000. $5,500 represents a:
A)
B)
C)
D)
Permanent difference
Temporary difference
Timing difference
None of the above
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
92. KAR Company sold a building resulting in a capital gain of $15,000. Choose the statement below
Ans: B
hz
that best describes what the impact of this is:
A)
Accounting income will be reduced by $7,500
B)
There will be a permanent difference of $7,500
C)
There will be a permanent difference of $11,250
D)
There will be a temporary difference of $7,500
E)
There will be a temporary difference of $3,750
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
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93. ABC has taxable income of $5,000, future taxable amounts of $4,000, and future deductible
amounts of $2,000 at the end of its first year of operations. Calculate ABC's pretax accounting
income for this first year.
Ans: $5,000 + $4,000 - $2,000 = $7,000 pre-tax accounting income
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
94. During 2001, JBC had pre-tax accounting income of $8,400, originating taxable amounts of
$4,800 and originating deductible amounts of $2,400. Calculate JBC's taxable income for 2001.
Ans: $8,400 - $4,800 + $2,400 = $6,000 taxable income
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
95. Explain the difference between a temporary and permanent difference.
Ans: A temporary difference will, at some point in time reverse. It is an amount that is
deductible for accounting purposes at a different time than for tax purposes. A permanent
difference never reverses. It is an item that is recorded for accounting purposes but will
never be accounted for in the calculation of taxable income. The reverse is also true.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 24
Chapter 15 – Accounting for Corporate Income Tax
96. List five amounts that are permanent differences.
Ans: 1. dividends received by Canadian corporations from other taxable Canadian corporations
2. 50% of capital gains
3. Equity in earnings of significantly influenced investors
4. Golf club dues
5. 50% of meals and entertainment expenses
6. Interest and penalties on taxes
7. Political contributions
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
97. List five amounts that are temporary differences.
hz
Ans: 1. depreciation for accounting purposes, CCA for tax
2. Amortization for capitalized development costs; immediate deduction for tax.
3. Gains and losses on inventories valued at market for accounting; taxed when realized.
4. Warranty costs accrued for accounting purposes in period of sale; tax deductible when
incurred.
5. Bond discount or premium amortized for accounting but realized for tax purposes only
when the principle is settled at maturity.
6. Percentage-of-completion accounting for contracts; completed contract reporting for tax
(for contracts lasting no more than two years).
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
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98. What tax rate should be used to measure a deferred income tax asset or liability?
Ans: Enacted tax rates
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: A Deferred income tax asset
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
d
99. What term is used to describe an amount that will eventually be tax deductible?
100. What term is used to describe an amount that will eventually be taxable?
Ans: A Deferred income tax liability
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 25
Chapter 15 – Accounting for Corporate Income Tax
101. Briefly explain the three basic issues with respect to inter-period income tax allocation.
Ans: 1. Extent of Allocation: There are discussions on whether the allocations of temporary
differences should be full, partial or none at all. The CICA handbook recommends
Comprehensive (full) allocation as it more closely meets the matching principle.
2. The measurement method: Discusses whether the tax rate used should be the current tax
rate or the enacted tax rate. The CICA Handbook recommends the use of using enacted tax
rates.
3. Discounting: There are discussions on whether discounting should be used to measure
the future tax amounts. The Handbook does not recommend discounting.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
102. What is the main conceptual issue regarding the recognition of deferred income taxes assets or
deferred income tax liabilities?
hz
Ans: Deferred income tax “assets’ do not meet the definition of an asset UNLESS they result in
a future benefit such as a tax loss carry-forward. Most deferred income tax assets and
liabilities, however, appear on the balance sheet as a result of cumulative temporary
differences over time and as such, do not embody future economic benefits (as in the case
of an asset) or a sacrifice of resources (as in the case of a liability).
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO7
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103. The following information is available to you: Income before tax; $80,000; depreciation,
$15,000; CCA, $13,500; tax rate, 44%. Calculate the Deferred income tax asset (liability).
Ans: temporary difference = $1,500x44%=$660
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
104. The following information is available to you: Income before tax $1,230,000, depreciation,
$350,000; CCA, $300,000; tax rate, 40%. Prepare the journal entry to record taxes for the year.
(Assume there are no previous tax differences.)
Ans: Taxable income = 1,230,000+350,000-$300,000=1,280,000x40%=$512,000
Deferred income tax asset = 350,000-300,000=50,000x40%=$20,000
Dr. current income tax expense
Cr. Income tax payable
Dr. Deferred income tax assets
Cr. Income tax expense
$512,000
$512,000
$20,000
$20,000
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 26
Chapter 15 – Accounting for Corporate Income Tax
105. The following information is available to you: Income before tax $1,540,000, depreciation,
$309,000; CCA, $350,000; tax rate, 40%. Prepare the journal entry to record taxes for the year.
(Assume there are no previous tax differences.)
Ans: Taxable income = 1,540,000+309,000-$350,000=1, x40%=$599,600
Deferred income tax liability = 309,000-350,000= (41,000) x40%=$16,400
Dr. current income tax expense
Cr. Income tax payable
Dr. Income tax expense
Cr. Deferred income tax liability
$599,600
$599,600
$16,400
$16,400
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1,2, 3
hz
106. JMR Corporation has income before tax of $500,000. Included in this amount are meals and
entertainment amounting to $10,000, warranty costs of $80,000 ($20,000 in warranty claims),
depreciation $78,000 and dividends from a taxable Canadian Corporation of $20,000. CCA for
the year amounted to $90,000. Calculate taxable income.
Ans: Taxable income: $500,000+$5,000+$80,000-$20,000+$78,000-$90,000$20,000=$533,000
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Level of Learning: Knowledge
Topic: LO1
d
zle
107. JMR Corporation has income before tax of $800,000. Included in this amount are meals and
entertainment amounting to $9,000, warranty costs of $100,000 ($65,000 in warranty claims),
depreciation $94,000 and dividends from a taxable Canadian Corporation of $15,000. CCA for
the year amounted to $90,000. Calculate taxable income.
Ans: Taxable income: $800,000+$4,500+$100,000-$65,000+$94,000-$90,000$15,000=$828,500
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 27
Chapter 15 – Accounting for Corporate Income Tax
108. JMR Corporation has income before tax of $800,000. Included in this amount are meals and
entertainment amounting to $9,000, warranty costs of $100,000 ($65,000 in warranty claims),
depreciation $94,000 and dividends from a taxable Canadian Corporation of $15,000. CCA for
the year amounted to $90,000 and the tax rate is 40%. Calculate income tax expense.
Ans: Taxable income: $800,000+$4,500+$100,000-$65,000+$94,000-$90,000$15,000=$828,500x40%=$331,400
Deferred income tax asset= 100,000-65,000+94,000-90,000=39,000x40%=15,600
Income tax expense=331,400-15,600=315,800
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
hz
109. JMR Corp. had one temporary difference during the year. The carrying value of its capital assets
for accounting purposes amounted to $350,000; the carrying value for CCA purposes was
$380,000. What is the temporary difference amount, what would it be called and where should it
be presented on the balance sheet?
Ans: The temporary difference is $30,000, which would appear as a future tax asset and should
be recorded as a non-current future tax asset on the balance sheet (tax rate is needed to
determine the amount of the future tax asset).
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
Ans: 2009:
Dr. Income tax expense
Cr. Income tax payable
Dr. Deferred income tax asset
Cr. Income tax expense
2010:
Dr. Income tax expense
Cr. Income tax payable
Dr. Deferred income tax asset
Cr. Income tax expense
d
zle
110. EGR Company provided you with the following information:
2009 Net Income: $1,500,000
2010 Net Income: $900,000
2009 Tax rate: 35%
2010 Tax rate: 40%
In addition, the only difference between accounting and tax are warranty costs accrued of
$100,000 in 2009. No actual warranty expenses were incurred in 2009 or 2010. Prepare journal
entries for 2009 and 2010 to record income tax expense.
$560,000
$560,000
$35,000
$35,000
$360,000
$360,000
$5,000
$5,000
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 28
Chapter 15 – Accounting for Corporate Income Tax
111. EGR Company provided you with the following information:
2009 Net Income: $1,500,000
2010 Net Income: $900,000
2009 Tax rate: 40%
2010 Tax rate: 35%
In addition, the only difference between accounting and tax are warranty costs accrued of
$100,000 in 2009. No actual warranty expenses were incurred in 2009 or 2010. Prepare journal
entries for 2009 and 2010 to record income tax expense.
Ans: 2009:
Dr. Income tax expense
$600,000
Cr. Income tax payable
$600,000
Dr. Deferred income tax asset
$40,000
Cr. Income tax expense
$40,000
2010:
Dr. Income tax expense
Cr. Income tax payable
Dr. Income tax expense
Cr. Deferred income tax asset
$315,000
$315,000
$5,000
$5,000
hz
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2, 3
zle
112. Define the effective tax rate.
Ans: The effective tax rate is the ratio of the income tax expense including those relating to
temporary differences divided by the pre-tax net income.
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2
Level of Learning: Knowledge
Topic: LO1, 2, 3
d
113. RG Corporation has a temporary difference of $40,000 in 2009. Its tax rate in 2009 is 40% and
the government enacted tax rate known at the end of 2009 for 2000 and subsequent years is 45%.
What tax rate should be used to calculate the deferred income tax asset or liability?
Ans: The enacted tax rate should be used (45%).
Difficulty: Easy
114. What is inter-period tax allocation?
Ans: Inter-period tax allocation is the process of allocating temporary differences between years.
There are three approached, the comprehensive allocation method is the one recommended
by the CICA as it promotes better matching.
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 29
Chapter 15 – Accounting for Corporate Income Tax
115. KG Company had capital assets with a carrying value of $1,670,000 and a tax value of
$1,560,000. In addition they had an accrued warranty liability of $80,000 of which $20,000 had
actually been incurred and golf club dues in the amount of $3,000. Calculate the temporary
difference deductible (taxable).
Ans: Temporary taxable = 1,560,000-1,670,000-20,000+80,000= (50,000)
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2, 3
116. KG Company had capital assets with a carrying value of $1,560,000 and a tax value of
$1,670,000. In addition they had an accrued warranty liability of $80,000 of which $20,000 had
actually been incurred and golf club dues in the amount of $3,000. Calculate the temporary
difference deductible (taxable).
Ans: Temporary deductible = 1,670,000-1,560,000-20,000+80,000=170,000
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2, 3
hz
117. Explain the income tax disclosures recommended by the CICA.
Ans: The amount of income tax expense or benefit that is included in net income before
extraordinary items and discontinued operations should be reported separately. The amount
that is attributable to future income taxes should be shown separately either in the
statements or in the notes. The amounts of income tax expense that relates to each of
discontinued operations, extraordinary items, and capital transactions should be disclosed.
Difficulty: Hard
zle
Level of Learning: Knowledge
Topic: LO4
Level of Learning: Knowledge
Topic: LO1, 2, 3
d
118. CDE had taxable income of $7,500 during
2009. CDE used accelerated depreciation for tax purposes ($10,000) and straight-line
depreciation for financial accounting purposes ($4,000). On December 30, 2009, CDE collected
January 2000's $3,000 rent on a lot it rents on a month-by-month basis to JCB. CDE's pre-tax
accounting income for 2009 would be (show calculations):
Ans: $7,500 + $10,000 - $4,000 - $3,000 = $10,500 pre-tax accounting income
Difficulty: Hard
119. GFH had pre-tax accounting income of $5,600 during 2009. GFH used accelerated depreciation
for tax purposes ($4,000) and straight-line depreciation for financial accounting purposes ($800).
During 2009 GFH accrued warranty expenses of $3,600 and paid $2,000 cash to honour
warranties. GFH's taxable income for 2009 would be (show calculations):
Ans: $5,600 - $4,000 + $800 + $3,600 - $2,000 = $4,000 taxable income
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2, 3
120. ABC Inc. purchased new machinery for $2 million on January 1st, 2011. For accounting
purposes, the company depreciates all machinery on a straight-line basis (no salvage value) over a
five year period. For tax purposes, CCA on all machinery is taken at a rate of 20%, with half a
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 30
Chapter 15 – Accounting for Corporate Income Tax
year’s CCA taken in the year of acquisition. The tax rate for 2011 is 40%. The tax rate for years
2012 and later is 35%. Assume that all rates are enacted in the year to which they pertain. Using
the shortcut approach, determine the deferred income tax asset or liability at the end of 2011.
Ans:
Tax Basis:
$2,000,000-0.5*20%*$2,000,000=$1,800,000
Accounting Basis: $2,000,000-$400,000=$1,600,000.
Difference: $1, 8 million-$1.6 million= $200,000*40%=$80,000 deferred income tax asset
Note that this is a deferred income tax asset since less CCA is taken than depreciation in the first
year, resulting in a larger future deductible amount. The 2012 rate is not known in 2011 so the
temporary difference will be valued at the 2011 rate of 40%.
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2, 3, 5
121.
Difficulty: Hard
zle
hz
Refer to question 120 above. How (if at all) would your answer change if the tax rate for all years
2011 and beyond were enacted in 2011?
Ans: In this case, the tax rates for years 2012 would be known in 2011. Since this temporary
difference will reverse out after 2011, the deferred income tax asset would be valued at the rate
that is expected to be in effect when the reversal is complete. In this case, the rate in effect will be
35%, thus, the difference between the tax and accounting bases calculated in question 120 above,
which was $200,000, will be multiplied by 35%. Thus the deferred income tax asset in this case
will be valued at $70,000 ($200,000*35%).
Level of Learning: Knowledge
Topic: LO1, 2, 3, 5
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 31
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test Bank
Chapter 16 – Accounting for Tax Losses
1. Under income tax laws and regulations a corporation that sustains a net operating loss for the
current year may elect to carry back and/or carry forward the loss for income tax purposes.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
2. Net operating tax carry backs and carry forwards never result in a cash refund of prior taxes paid
but may result in a reduction in taxes for subsequent years.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
hz
3. The use of a valuation allowance account is mandatory under IFRS.
Ans: False
Difficulty: Easy
zle
Level of Learning: Knowledge
Topic: LO3, 7
4. If a corporation incurs a taxable loss, they are entitled to carry the loss back for three years or
forward for twenty years.
Ans: True
d
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
5. Under ASPE, deferred income tax assets due to carry forwards may or may not be
realized, depending whether the company uses the taxes payable method.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 748
Chapter 16 – Accounting for Tax Losses
6. IFRS requires that deferred income taxes due to carry-forwards be recognized at the tax
rate enacted for the current year.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
7. Companies normally apply tax loss carry backs sequentially.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
8. A tax loss represents the present and deferred benefit that the company will be able to realize
from the tax loss through a reduction of income taxes paid to governments.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
9. A company will show the same income tax expense/benefit regardless of whether or not a
Ans: True
zle
valuation account is used.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 3
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
d
10. A tax benefit represents the present and deferred benefit that the company will be able to realize
from the tax loss through a reduction of income taxes paid to governments.
11. Under current law, at the end of the year of loss or anytime during the next 15 years, a company
may select to either carry back-carry forward the loss or carry forward-only the loss.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 749
Chapter 16 – Accounting for Tax Losses
12. In general, deferred income tax assets due to tax loss carry forwards only to the extent
that they are likely to be realized.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
13. The terms “probable” and “more likely than not” refer to probabilities that are greater
than or equal to 50%.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 6
Ans: True
hz
14. Under IFRS, the income tax expense pertaining to continuing operations must be
presented on the face of the income statement.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
Ans: True
zle
15. Taxes are recovered at the rate at which it was originally paid. The tax rate in the year the loss is
not relevant.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
d
16. Taxes are recovered at the tax rate in effect during the year of the loss.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
17. If any part of the loss recovered is attributable to discontinued operations or extraordinary, the
recovery must be allocated to the different components.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 750
Chapter 16 – Accounting for Tax Losses
18. The amount of any unused tax losses must be disclosed on the face of the income statement.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
19. The recovery of income tax expense is credited to income tax expense (recovery) account.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
20. A company carrying back a loss must use the earliest year first.
Ans: False
Difficulty: Easy
hz
Level of Learning: Knowledge
Topic: LO2
21. In the year in which a tax loss is incurred, the tax loss must equal the net loss reported on
the company’s financial statements.
zle
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
22. CCA is an optional deduction and may be adjusted downwards in order to create taxable income.
Ans: True
d
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
23. Better matching is achieved when deferred income tax assets due to carry forwards are
recognized in the year of the loss.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 751
Chapter 16 – Accounting for Tax Losses
24. The rules for a loss carry forward remain the same between the old Handbook section (3470) and
the new Handbook section (3465).
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
25. Existing sufficient taxable temporary differences, which will result in taxable income, is one
piece of evidence to support a more likely than not criteria.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
26. Existing sufficient taxable permanent differences, which will result in taxable income, is one
piece of evidence to support a more likely than not criteria.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Ans: True
zle
27. It is possible to amend prior years' tax returns in order to reduce or eliminate CCA.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Ans: False
Difficulty: Easy
d
28. Once it is deemed that a potential benefit of a loss carry forward does not meet the more likely
than not criteria, the benefit may not be set up until realized.
Level of Learning: Knowledge
Topic: LO4
29. If a potential benefit of a loss carry forward is determined not to meet the more likely than not
criteria in one year, it may still be set up in a deferred period if the criteria are subsequently met.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 752
Chapter 16 – Accounting for Tax Losses
30. If a potential benefit of a loss carry forward that was previously determined to meet the more
likely than not criteria has now been determined not to meet the criteria, it should be reversed.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
31. A deferred income tax asset that has been recorded for a tax loss carry forward must be
maintained at the tax rate that is expected to be in effect when the carry forward is utilized.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
32. The criteria of more likely or not must be met in order for a Company incurring a loss during the
year and upon carry back had a tax recovery of $135,000.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Ans: True
zle
33. An excess of fair value over the tax basis of the enterprise's net asset in an amount sufficient to
realize the deferred income tax asset is evidence to support recognition of a deferred income tax
benefit except:
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 753
Chapter 16 – Accounting for Tax Losses
34. When deferred benefits of a tax loss carry forward are recognized in the year of the loss, the
credit to income tax recovery will be given inter-period allocation.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
35. The current tax benefit from tax loss carry backs and carry forwards, segregated between
continuing operations and discontinued operations and extraordinary items should be disclosed.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
36. The amount and expiry date of unrecognized tax losses follow the same carry forward rules as
recognized tax losses.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
zle
37. Carry back and carry forward procedures for temporary differences are always applied, even
when there are no temporary differences for deductible items and there are no current income
taxes payable.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
38. Under one method of accounting, but not both, for the investment tax credit, ITCs obtained in
prior years may affect reported earnings in deferred years even though ITC is not available in
those deferred years.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 754
Chapter 16 – Accounting for Tax Losses
39. A Corporation that incurs a taxable loss is entitled to offset the loss as follows:
A)
B)
C)
D)
Carried back 7 years and forward 3 years
Carried back 3 years and forward 7 years
Carried back 3 years and forward 10 years
Carried back 10 years and forward 3 years
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
40. VB Corporation has a net loss of $50,000. Included in the loss are golf dues totalling $3,000. VB
has:
A)
A tax loss of $53,000
B)
A tax benefit of $50,000
C)
A tax loss of $47,000
D)
Cannot be determined from the information given
hz
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Ans: B
Level of Learning: Knowledge
Topic: LO2
d
Difficulty: Medium
zle
41. VB Corporation has a loss of $50,000 with a tax rate of 40%. Included in the loss are golf dues
totalling $3,000. VB has:
A)
a tax loss of $20,000
B)
a tax benefit of $18,800
C)
a tax loss of $18,800
D)
a tax benefit of $21,200
42. A tax benefit represents:
A)
the final number of the taxable loss on the tax return
B)
the amount of refund to be received in the year
C)
assistance from the government
D)
the present and deferred benefit that the company will be able to realize from the tax loss
through a reduction of income taxes
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 755
Chapter 16 – Accounting for Tax Losses
43. A tax loss represents:
A)
the final number of the taxable loss on the tax return
B)
the amount of refund to be received in the year
C)
assistance from the government
D)
the present and deferred benefit that the company will be able to realize from the tax loss
through a reduction of income taxes
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
44. VB Corporation incurred a tax loss of $86,000. Based on a tax rate of 45% what is the potential
tax benefit?
A)
$86,000
B)
$38,700
C)
$0
D)
cannot be determined
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
zle
45. KG Corporation incurred a tax loss of $345,000. Based on a tax rate of 38% what is the potential
tax benefit?
A)
$131,100
B)
$345,000
C)
$0
D)
cannot be determined
46. JG Corporation incurred a tax loss of $945,000. Based on a tax rate of 38% what is the potential
tax benefit?
A)
$0
B)
$945,000
C)
$359,100
D)
cannot be determined
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 756
Chapter 16 – Accounting for Tax Losses
47. The following information for JMR Corporation is available:
Year
20x11
20x12
20x13
20x14
Taxable
Income
$30,000
$90,000
$85,000
$(125,000)
Tax
Rate
40%
38%
38%
35%
Income taxes
Paid
$12,000
$34,200
$32,300
-
The taxes recovered for the year ended 20x14 amounted to:
A)
$150,000
B)
$0
C)
$48,100
D)
$43,750
Ans: C
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
48. The following information for LAS Corporation is available:
Year
Tax
Rate
35%
38%
38%
40%
Income taxes
Paid
$10,500
$34,200
$32,300
-
zle
20x11
20x12
20x13
20x14
Taxable
Income
$30,000
$90,000
$85,000
$(125,000)
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
d
The taxes recovered for the year ended 20x14 amounted to:
A)
$46,600
B)
$0
C)
$52,660
D)
$43,750
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 757
Chapter 16 – Accounting for Tax Losses
49. The following information for KEG Corporation is available:
Year
20x11
20x12
20x13
20x14
Taxable
Income
$60,000
$90,000
$85,000
$(125,000)
Tax
Rate
45%
38%
38%
40%
Income taxes
Paid
$27,000
$34,200
$32,300
-
The taxes recovered for the year ended 20x14 amounted to:
A)
$46,600
B)
$51,700
C)
$52,660
D)
$43,750
Ans: B
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
50. The following information for JG Corporation is available:
Year
Tax
Rate
45%
38%
38%
40%
Income taxes
Paid
$13,500
$34,200
$32,300
-
zle
20x11
20x12
20x13
20x14
Taxable
Income
$30,000
$90,000
$85,000
$(150,000)
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
d
The taxes recovered for the year ended 20x14 amounted to:
A)
$48,600
B)
$46,600
C)
$52,660
D)
$59,100
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 758
Chapter 16 – Accounting for Tax Losses
51. The following information for KAR Corporation is available:
Year
20x11
20x12
20x13
20x14
Taxable
Income
$30,000
$90,000
$85,000
$(205,000)
Tax
Rate
35%
38%
38%
40%
Income taxes
Paid
$10,500
$34,200
$32,300
-
The taxes recovered for the year ended 20x14 amounted to:
A)
$82,000
B)
$77,000
C)
$75,850
D)
$43,750
Ans: B
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
Ans: D
zle
52. A Company incurred a loss during the year and upon carry back had a tax recovery of $114,000.
All of the following are true except:
A)
debit to income tax receivable for $114,000
B)
credit to income tax expenses for $114,000
C)
the taxes were recovered at the rate paid
D)
the criteria of more likely than not must have been met
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
53. A Company incurred a loss during the year and upon carry back had a tax recovery of $135,000.
All of the following are true except:
A)
debit to income tax receivable for $114,000
B)
credit to income tax expenses for $114,000
C)
the taxes were recovered at the rate paid
D)
the criteria of more likely than not must have been met
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 759
Chapter 16 – Accounting for Tax Losses
54. Geisler Corp. provided you with the following information for the year ending December 31,
20x17:
Net Income before taxes of - $150,000
Depreciation (included in above) - $90,000
CCA - $250,000
Net book value of capital assets of $1,100,000 and UCC of $900,000 on January 1, 20x17, a
temporary difference of $200,000 that is reflected in an accumulated deferred income tax liability
balance of $90,000 at January 1, 20x17
No permanent differences
Taxable income in the three-year carry back period of $400,000
Tax rate of 45% in the current and previous years
Based on the above information, what is the tax recovery for 20x17?
A)
$4,500
B)
$0
C)
$180,000
D)
$40,500
E)
cannot be determined
Ans: A
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
d
zle
55. Brimley Corp. provided you with the following information for the year ending December 31,
20x17:
Net Income before taxes of - $100,000
Depreciation (included in above) - $90,000
CCA - $260,000
Net book value of capital assets of $1,100,000 and UCC of $900,000 on January 1, 20x17, a
temporary difference of $200,000 that is reflected in an accumulated deferred income tax liability
balance of $80,000 at January 1, 20x17
No permanent differences
Taxable income in the three-year carry back period of $400,000
Tax rate of 40% in the current and previous years
Based on the above information, what is the tax recovery for 20x17?
A)
$4,500
B)
$0
C)
$180,000
D)
$40,500
E)
none of the above
Ans: E
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 760
Chapter 16 – Accounting for Tax Losses
56. Ryan Corp. provided you with the following information for the year ending December 31,
20x17:
Net Income before taxes of - $100,000
Depreciation (included in above) - $67,000
CCA - $250,000
Net book value of capital assets of $1,100,000 and UCC of $900,000 on January 1, 20x17, a
temporary difference of $200,000 that is reflected in an accumulated deferred income tax liability
balance of $80,000 at January 1, 20x17
No permanent differences
Taxable income in the three-year carry back period of $400,000
Tax rate of 40% in the current and previous years
Based on the above information, what is the tax recovery for 20x17?
A)
$4,500
B)
$0
C)
$33,200
D)
$40,500
E)
cannot be determined
hz
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
57. Elizabeth Corp. provided you with the following information for the year ending December 31,
d
zle
20x17:
Net Income before taxes of - $150,000
Depreciation (included in above) - $90,000
CCA - $250,000
Net book value of capital assets of $1,100,000 and UCC of $900,000 on January 1, 20x17, a
temporary difference of $200,000 that is reflected in an accumulated deferred income tax liability
balance of $76,000 at January 1, 20x17
No permanent differences
Taxable income in the three-year carry back period of $400,000
Tax rate of 38% in the current and previous years
Based on the above information, what is the tax recovery for 20x17?
A)
$4,500
B)
$0
C)
$3,800
D)
$40,500
E)
cannot be determined
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 761
Chapter 16 – Accounting for Tax Losses
58. JMR Corp. provided you with the following information for the year ending December 31,
20x17:
Net Income before taxes of - $160,000
Depreciation (included in above) - $80,000
CCA - $290,000
Net book value of capital assets of $1,200,000 and UCC of $800,000 on January 1, 20x17, a
temporary difference of $400,000 that is reflected in an accumulated deferred income tax liability
balance of $176,000 at January 1, 20x17
No permanent differences
Taxable income in the three-year carry back period of $400,000
Tax rate of 44% in the current and previous years
Based on the above information, what is the tax recovery for 20x17?
A)
$4,500
B)
$0
C)
$18,000
D)
$22,000
E)
cannot be determined
hz
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
59. Ryan Corp. provided you with the following information for the year ending December 31,
d
zle
20x17:
Net Income before taxes of - $100,000
Depreciation (included in above) - $67,000
CCA - $250,000
Net book value of capital assets of $1,100,000 and UCC of $900,000 on January 1, 20x17, a
temporary difference of $200,000 that is reflected in an accumulated deferred income tax liability
balance of $80,000 at January 1, 20x17
No permanent differences
Taxable income in the three-year carry back period of $400,000
Tax rate of 40% in the current and previous years
Based on the above information, what is the income tax expense for 20x17?
A)
$4,500
B)
$46,800
C)
$33,200
D)
$40,500
E)
cannot be determined
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 762
Chapter 16 – Accounting for Tax Losses
60. Elizabeth Corp. provided you with the following information for the year ending December 31,
20x17:
Net Income before taxes of - $150,000
Depreciation (included in above) - $90,000
CCA - $250,000
Net book value of capital assets of $1,100,000 and UCC of $900,000 on January 1, 20x17, a
temporary difference of $200,000 that is reflected in an accumulated deferred income tax liability
balance of $76,000 at January 1, 20x17
No permanent differences
Taxable income in the three-year carry back period of $400,000
Tax rate of 38% in the current and previous years
Based on the above information what is the tax recovery for 20x17?
A)
$4,500
B)
$72,200
C)
$3,800
D)
$40,500
E)
cannot be determined
Ans: C
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
d
zle
61. JMR Corp. provided you with the following information for the year ending December 31,
20x17:
Net Income before taxes of - $160,000
Depreciation (included in above) - $80,000
CCA - $290,000
Net book value of capital assets of $1,200,000 and UCC of $800,000 on January 1, 20x17, a
temporary difference of $400,000 that is reflected in an accumulated deferred income tax liability
balance of $176,000 at January 1, 20x17
No permanent differences
Taxable income in the three-year carry back period of $400,000
Tax rate of 44% in the current and previous years
Based on the above information what is the tax recovery for 20x17?
A)
$4,500
B)
$105,600
C)
$154,000
D)
$22,000
E)
cannot be determined
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 763
Chapter 16 – Accounting for Tax Losses
62. A company that has sustained a tax loss during the year and is not able to carry it back may
potentially do all of the following except:
A)
File amended tax returns for previous years changing CCA
B)
Choose not to claim CCA in the current year
C)
Carry forward the amount for 10 years
D)
Do nothing
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
63. JMR Corporation incurred a tax loss in 20x15 of $900,000. After carrying back the tax loss to
previous years, there remains $100,000. This amount
A)
can be recovered through a cash payment from the government
B)
represents a deferred income tax loss
C)
represents a deferred income tax benefit
D)
cannot be recovered
hz
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
zle
64. JMR Corporation incurred a tax loss in 20x15 of $900,000. After carrying back the tax loss to
previous years, there remains $150,000. This amount:
A)
can be recovered through a cash payment from the government
B)
represents a deferred income tax benefit
C)
represents a deferred income tax loss
D)
cannot be recovered
65. All of the following are evidence to support recognition of a deferred income tax benefit except:
A)
It is acceptable industry practice to recognize the deferred income tax benefit
B)
There are existing taxable temporary differences to absorb the loss
C)
An excess of fair value over the tax basis of the enterprise's net assets in an amount
sufficient to realize the deferred income tax asset
D)
A strong earnings history suggesting that the loss is not expected to continue
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 764
Chapter 16 – Accounting for Tax Losses
66. The following data represents the complete taxable income history for a firm:
20x11
20x12
20x13
20x14
20x15
Taxable income
$20,000
$16,000
$12,000
$ 4,000
$(40,000)
Tax rate
.30
.30
.35
.40
.40
What amount of refund will it receive for tax year 20x15?
A)
$10,600
B)
$12,200
C)
$13,000
D)
$15,000
Ans: A
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
67. A firm's complete taxable income history follows. The tax rate has always been .30.
Taxable income
$15,000
$5,000
$30,000
$10,000
$(50,000)
$(10,000)
$25,000
$25,000
zle
20x11
20x12
20x13
20x14
20x15
20x16
20x17
20x18
d
The firm always chooses the carry back, carry forward option. What is the tax liability for 20x18?
A)
$3,000
B)
$7,500
C)
$4,500
D)
$0
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 765
Chapter 16 – Accounting for Tax Losses
68. The following data represents the complete taxable income history for a firm:
20x11
20x12
20x13
20x14
20x15
Taxable income
$20,000
$25,000
$12,000
$ 4,000
$(50,000)
Tax rate
.30
.30
.35
.40
.40
What amount of refund will it receive for tax year 20x15?
A)
$10,600
B)
$12,200
C)
$13,300
D)
$15,000
Ans: C
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
69. The following data represents the complete taxable income history for a firm:
Taxable income
$20,000
$16,000
$12,000
$ 4,000
$(18,000)
Tax rate
.35
.30
.30
.38
.30
zle
20x11
20x12
20x13
20x14
20x15
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
What amount of refund will it receive for tax year 20x15?
A)
$6,300
B)
$6,840
C)
$13,000
D)
$5,400
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 766
Chapter 16 – Accounting for Tax Losses
70. The following data represents the complete taxable income history for a firm:
20x11
20x12
20x13
20x14
20x15
Taxable income
$20,000
$16,000
$12,000
$ 4,000
$(40,000)
Tax rate
.30
.30
.35
.40
.40
What is the amount of carry forward left at the end of 20x15?
A)
$0
B)
$12,000
C)
$4,000
D)
$8,000
Ans: D
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
71. The following data represents the complete taxable income history for a firm:
Taxable income
$20,000
$56,000
$12,000
$ 4,000
$(90,000)
Tax rate
.30
.30
.35
.40
.40
zle
20x11
20x12
20x13
20x14
20x15
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
What amount of the tax carry forward left at the end of 20x15?
A)
$18,000
B)
$90,000
C)
$0
D)
$4,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 767
Chapter 16 – Accounting for Tax Losses
72. All of the following are evidence that recognition is not likely except:
A)
History of tax losses expiring before they have been used
B)
An expectation of losses in carry forward period
C)
Unsettled circumstances that may adversely affect the company
D)
They all constitute unfavourable evidence
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
73. All of the following are evidence that recognition is not likely except:
A)
Changes in management
B)
An expectation of losses in carry forward period
C)
Unsettled circumstances that may adversely affect the company
D)
History of tax losses expiring before they have been used
Ans: A
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
zle
74. JMR Corp. sustained taxable income in 20x11 of $50,000 when the tax rate was 40%. In 20x12
they suffered a tax loss of $80,000 when the tax rate was 38%. All of the following are true
except:
A)
JMR Corp. has a potential carry forward of $30,000
B)
A more likely than not criteria is needed to set up the benefit
C)
The tax refund will amount to $19,000
D)
Prior years' tax returns may be amended to create more taxable income.
75. KER Corp. sustained taxable income in 20x11 of $50,000 when the tax rate was 40%. In 20x12
they suffered a tax loss of $80,000 when the tax rate was 45%. All of the following are true
except:
A)
KER Corp. has a potential carry forward of $30,000
B)
A more likely than not criteria is needed to set up the benefit
C)
The tax refund will amount to $20,000
D)
KER may carry forward for 10 years
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 768
Chapter 16 – Accounting for Tax Losses
76. EGR Corp. sustained taxable income in 20x11 of $70,000 when the tax rate was 40%. In 20x12
they suffered a tax loss of $85,000 when the tax rate was 38%. All of the following are true
except:
A)
EGR Corp. has a potential carry forward of $30,000.
B)
A more likely than not criteria is needed to set up the benefit.
C)
The tax refund will amount to $28,000.
D)
Prior years' tax returns may be amended to create more taxable income.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
77. JMR Corp. sustained taxable income in 20x11 of $50,000 when the tax rate was 40%. In 20x12
Ans: D
hz
they suffered a tax loss of $80,000 when the tax rate was 38%. All of the following are true
except:
A)
JMR Corp. has a potential carry forward of $30,000
B)
A more likely than not criteria is needed to set up the benefit
C)
The tax refund will amount to $20,000
D)
Depreciation may be reduced to create a higher income to absorb the loss
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
78. RG Corp. sustained taxable income in 20x11 of $65,000 when the tax rate was 40%. In 20x12
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
they suffered a tax loss of $80,000 when the tax rate was 38%. All of the following are true
except:
A)
RG Corp. has a potential carry forward of $25,000.
B)
Virtual certainty is needed to set up the benefit.
C)
The tax refund will amount to $24,700.
D)
Prior years' tax returns may be amended to create more taxable income.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 769
Chapter 16 – Accounting for Tax Losses
79. Choose the best statement with respect to tax rates.
A)
B)
C)
D)
The tax rate used to record a deferred income tax asset or liability should be the enacted
tax rate at the balance sheet date.
The current tax rate should be used to record a deferred income tax asset or liability.
The projected tax rate should be used to record a deferred income tax asset or liability.
None of the above.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: D
hz
80. Choose the best statement with respect to tax rates.
A)
The tax rate used to record a deferred income tax asset or liability should be the enacted
tax rate at the beginning of the year.
B)
The current tax rate should be used to record a deferred income tax asset or liability.
C)
The projected tax rate should be used to record a deferred income tax asset or liability.
D)
Once recorded, the deferred income tax asset must be maintained at a rate expected to be in
effect when the carry forward is utilized.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
zle
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
81. JMR Corporation suffered a loss in 20x13. As a result, the Corporation has a $87,000
accumulated tax loss carry forward at the tax rate of 40%. The benefit was recorded in the
accounts as JMR believed it was more likely than not to be realized. In 20x14 the tax rate goes
down to 38% and JMR has not yet used the benefit. Which of the following statements is true?
A)
No change to the accounts is necessary
B)
Income tax expense should be increased by $1,740
C)
Deferred income tax asset – benefit should be increased by $1,740
D)
Deferred income tax asset – benefit will not change
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 770
Chapter 16 – Accounting for Tax Losses
82. JMR Corporation suffered a loss in 20x13. As a result, the Corporation has a $87,000
accumulated tax loss carry forward at the tax rate of 40%. The benefit was recorded in the
accounts as JMR believed it was more likely than not to be realized. In 20x14 the tax rate goes
down to 45% and JMR has not yet used the benefit. Which of the following statements is true?
A)
No change to the accounts is necessary
B)
Income tax expense should be increased by $1,740
C)
Deferred income tax asset – benefit should be increased by $1,740
D)
Income tax expense should be decreased by $4,350
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Ans: D
hz
83. Disclosure related to tax loss carry forwards and carry backs include all of the following except:
A)
current tax benefit from tax loss carry backs and carry forwards should be segregated
between continuing operations, discontinued operations and extraordinary items
B)
there should be disclosure of the amount of unrecognized tax losses
C)
disclosure of the expiry date of unrecognized tax losses
D)
all of the above
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
84. Disclosure related to tax loss carry forwards and carry backs include all of the following except:
A)
current tax benefit from tax loss carry backs and carry forwards need not be segregated
between continuing operations, discontinued operations and extraordinary items
B)
there should be disclosure of the amount of unrecognized tax losses
C)
disclosure of the expiry date of unrecognized tax losses
D)
all of the above
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
d
Ans: A
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 771
Chapter 16 – Accounting for Tax Losses
85. The following data represents the complete taxable income history for a firm:
20x11
20x12
20x13
20x14
20x15
20x16
Taxable income
$20,000
$16,000
$12,000
$ 4,000
$(40,000)
$20,000
Tax rate
.30
.30
.35
.40
.40
.45
What is the tax liability for 20x16?
A)
$9,000
B)
$5,400
C)
$8,000
D)
$6,000
Ans: B
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
86. Reducing CCA is one tax strategy that a company may employ. All of the following are true
Ans: A
zle
except:
A)
CCA not claimed in one year is only partially lost for deferred years.
B)
Minimizing CCA can create taxable income so that losses may be used.
C)
CCA may be eliminated in the carry forward years.
D)
Returns may be amended for the previous three years.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
87. Reducing CCA is one tax strategy that a company may employ. All of the following are true
except:
A)
CCA is an optional deduction and is not lost if not used.
B)
Minimizing CCA can create taxable income so that losses may be used.
C)
CCA may be eliminated in the carry forward years.
D)
Returns may be amended for the previous seven years.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 772
Chapter 16 – Accounting for Tax Losses
88. All of the following are true regarding loss carry forwards except:
A)
B)
C)
D)
the probability of realization needs to be greater than 50%
the carry forward benefit is set up on the balance sheet
management may choose not to set up the benefit
any deferred income tax benefit set up should not be subsequently written down
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
89. In 20x11, JMR Corp. set up a deferred income tax benefit of a tax loss carry forward as the
probability of realization was greater than 50%. It is now the end of 20x12 and management has
determined that 50% of the benefit will not be realized. Management should:
A)
continue to carry the total deferred income tax benefit of the tax loss carry forward
B)
write down the entire benefit
C)
write down 50% of the benefit
D)
none of the above
hz
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
zle
90. All of the following are true regarding loss carry forwards except:
A)
the more likely than not criteria must be met
B)
the carry forward benefit cannot be set up in deferred years
C)
any deferred income tax benefit should be reviewed yearly for potential write downs
D)
deferred income tax benefits may still be used even if not set-up
91. A company, which operated pro-deferred income tax assets during its first five years, sustained a
loss in the sixth year which equalled its pre-tax income of any four of the first five years of its
operations. The company can choose to obtain a refund of income taxes paid by filing an
amended return for:
A)
any of the first three years of operations.
B)
any years before the loss, provided the loss equals or exceeds profits of those years.
C)
the four most pro-deferred income tax asset years preceding the loss.
D)
the three years immediately preceding the loss.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 773
Chapter 16 – Accounting for Tax Losses
92. The maximum number of years a tax loss can be carried forward is:
A)
3 years.
B)
20 years.
C)
10 years.
D)
17 years.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Ans: D
hz
93. What factor would most likely cause a firm to choose the carry forward only option for a net
operating loss?
A)
expectations of lower earnings in the deferred relative to the past
B)
expectations of higher earnings in the deferred relative to the past
C)
expectations of lower tax rates in the deferred relative to the past
D)
expectations of higher tax rates in the deferred relative to the past
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
94. CJM provided the following data related to income tax allocation:
Pre-tax accounting income
Taxable income
Income tax rate
20x13
$5,300
5,000
34%
20x14
$5,000
5,300
34%
d
The deferred income tax account showed a zero balance at the start of 20x13. There was only one
temporary difference, an expense, which was deductible for tax purposes in 20x13, but was
recorded for accounting purposes in 20x14. There are no carry backs or carry forwards and no
originating temporary differences in 20x14. The journal entry to record the income tax
consequences for 20x14 would include a:
A)
debit of $102 to CJM's deferred income tax liability account.
B)
credit of $102 to CJM's deferred income tax liability account.
C)
debit of $102 to CJM's deferred income tax asset account.
D)
credit of $102 to CJM's deferred income tax asset account.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 774
Chapter 16 – Accounting for Tax Losses
95. FGH had a $1,200 temporary difference for deferred gross margin on instalment sales at the end
of 20x12. This temporary difference will reverse equally during 20x13, 20x14 and 20x15. The
enacted corporate income tax rate is 48% and government is discussing a reduction in the
corporate income tax rates for 20x14 and 20x15 to 38%. The deferred income tax liability related
to this temporary difference at the end of 20x12 would be:
A)
$192
B)
$248
C)
$516
D)
$576
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
96. MDB had a $1,200 temporary tax difference for deferred gross margin on instalment sales at the
zle
Ans: B
hz
end of 20x12. This temporary difference will reverse equally during 20x13, 20x14, and 20x15.
The enacted corporate income tax rate is 25% and Congress is discussing an increase in the
corporate income tax rates for 20x14 and 20x15 to 35%. The deferred income tax liability related
to this temporary difference at the end of 20x12 would be:
A)
$100
B)
$300
C)
$380
D)
$420
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
97. XYZ Ltd., a taxable Canadian corporation, reported the following revenues and expenses in these
amounts for both taxes and financial reporting (the tax rate is 40%).
d
Operating revenues
Operating expenses
Dividend revenue from a taxable Canadian corporation
Insurance proceeds from life insurance on CEO
$10,000
4,000
2,000
3,000
What is income tax expense for the year?
A)
$4,400
B)
$3,600
C)
$4,000
D)
$2,400
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 775
Chapter 16 – Accounting for Tax Losses
98. JR Company incurred a loss in 20x11, due in part to a fire at one of its plants. The deferred
benefit of a loss carry forward was not recognized in the year as the probability of realization was
less than 50%. In 20x12, JR Company incurred a small loss, but due to large contracts upcoming,
it was determined that the probability of realization was greater than 50%. The tax rate for 20x11
was 40% and 20x12 45%. JR Company should:
A)
record the deferred income tax benefit for 20x12 only
B)
record the deferred income tax benefit for both years using the 40% rate
C)
record the deferred income tax benefit for both years using the 45% rate
D)
record the deferred income tax benefit for 20x11 only
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
99. JG Ltd. provided you with the following information:
Year
hz
20x11
20x12
20x13
20x14
20x15
Taxable
Income (loss)
$300,000
($150,000)
$330,000
$80,000
($400,000)
Tax
rate
38%
40%
45%
40%
40%
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
zle
There are no temporary differences. What is the tax recovery in 20x15?
A)
$160,000
B)
$169,500
C)
$176,000
D)
None
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 776
Chapter 16 – Accounting for Tax Losses
100. JR Ltd. provided you with the following information:
Year
20x11
20x12
20x13
20x14
20x15
Taxable
Income (loss)
$300,000
($150,000)
$330,000
$80,000
($400,000)
Tax
rate
38%
40%
45%
40%
40%
There are no temporary differences. What will be the credit to the income tax expense account
assuming a greater than 50% probability of realization?
A)
$32,000
B)
$0
C)
$196,000
D)
$80,000
Ans: A
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
101. JR Ltd. provided you with the following information:
Year
Tax
rate
38%
40%
45%
40%
40%
zle
20x11
20x12
20x13
20x14
20x15
Taxable
Income (loss)
$300,000
($150,000)
$330,000
$80,000
($400,000)
d
There are no temporary differences. What will be the credit to the income tax expense account
assuming a less than 50% probability of realization?
A)
$32,000
B)
$0
C)
$196,000
D)
$80,000
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 777
Chapter 16 – Accounting for Tax Losses
102. ER Ltd. provided you with the following information:
Year
20x11
20x12
20x13
20x14
20x15
Taxable
Income (loss)
$190,000
($150,000)
$330,000
$80,000
($580,000)
Tax
rate
38%
40%
45%
38%
38%
There are no temporary differences. What will be the credit to the income tax expense account
assuming a greater than 50% probability of realization?
A)
$194,100
B)
$0
C)
$220,000
D)
$64,600
Ans: D
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
103. ER Ltd. provided you with the following information:
Year
Tax
rate
38%
40%
45%
38%
38%
zle
20x12
20x13
20x14
20x15
20x16
Taxable
Income (loss)
$190,000
($150,000)
$330,000
$80,000
($580,000)
d
There are no temporary differences. What will be the credit to the income tax expense account
assuming a less than 50% probability of realization?
A)
$194,100
B)
$0
C)
$220,000
D)
$64,600
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 778
Chapter 16 – Accounting for Tax Losses
104. VB Ltd. provided you with the following information:
Year
20x11
20x12
20x13
20x14
20x15
Taxable
Income (loss)
$190,000
($150,000)
$330,000
$80,000
($580,000)
Tax
rate
38%
40%
45%
38%
38%
There are no temporary differences. The deferred income tax benefit of the loss carry forward
was set up in 20x15 as the probability of realization was greater than 50%. In 20x16 it was
determined that the probability of realization was less than 50%. What would be the carrying
amount of the deferred income tax benefit – loss carry forward on the balance sheet at the end of
20x16?
A)
$194,100
B)
$0
C)
$220,000
D)
$64,600
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Year
Taxable
Income (loss)
$190,000
($150,000)
$330,000
$80,000
($580,000)
Tax
rate
38%
40%
45%
38%
38%
d
20x11
20x12
20x13
20x14
20x15
zle
105. VB Ltd. provided you with the following information:
There are no temporary differences. The deferred income tax benefit of the loss carry forward
was set up in 20x15 as the probability of realization was greater than 50%. In 20x16 a further loss
of $140,000 was incurred. Management determined that they were still more likely than not to
realize the loss. The tax rate for 20x16 was 45%. What would be the carrying amount of the
deferred income tax benefit – loss carry forward on the balance sheet at the end of 20x16?
A)
$273,600
B)
$127,600
C)
$139,500
D)
some other amount
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 779
Chapter 16 – Accounting for Tax Losses
106. How far can a tax loss be carried back?
Ans: 3 years
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
.
107. How far can a tax loss be carried forward?
Ans: 20 years
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
108. Describe the difference between a tax loss and a tax benefit.
Ans: A tax loss is the final number of the taxable loss on the return. The tax benefit is the
present and deferred benefit that the company may realize from the tax loss through
reductions in income taxes.
Difficulty: Medium
hz
Level of Learning: Knowledge
Topic: LO1
109. How does the existence of a loss in the year impact the accounting of temporary differences?
Ans: Tax losses do not impact the accounting of temporary differences. The recording of them
remains the same whether there is a loss or taxable income.
Difficulty: Medium
zle
Level of Learning: Knowledge
Topic: LO1
110. JMR has a tax loss of $970,000 and a tax rate of 38%. What is the potential benefit of the tax
loss?
Ans: Potential tax benefit = $970,000x38%=$386,600
Difficulty: Medium
d
Level of Learning: Knowledge
Topic: LO1
111. KAR has a tax loss of $563,000 and a tax rate of 44%. What is the potential benefit of the tax
loss?
Ans: Potential tax benefit = $563,000x44%=$247,720
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 780
Chapter 16 – Accounting for Tax Losses
112. JMR's taxable income for the first five years was as follows:
Year
20x11
20x12
20x13
20x14
20x15
Taxable
Income
$125,000
$190,000
$225,000
$298,000
(400,000)
Tax
rate
40%
40%
38%
35%
38%
Income taxes
paid
$ 50,000
$ 76,000
$ 85,500
$104,300
-
Calculate the tax recovery in 20x15.
Ans:
Year
Carry back
Tax rate
20x12
190,000
40%
20x13
210,000
38%
400,000
======
Difficulty: Hard
Tax recover
76,000
79,800
155,800
======
hz
Level of Learning: Knowledge
Topic: LO1, 2
113. KAR's taxable income for the first five years was as follows:
Year
Tax
rate
40%
40%
38%
35%
38%
Income taxes
paid
$ 50,000
$ 76,000
$ 85,500
$104,300
-
zle
20x11
20x12
20x13
20x14
20x15
Taxable
Income
$125,000
$190,000
$225,000
$298,000
(500,000)
Tax recover
76,000
85,500
29,750
191,250
======
d
Calculate the tax recovery in 20x15.
Ans:
Year
Carry back Tax rate
20x12
190,000
40%
20x13
225,000
38%
20x14
85,000
35%
500,000
======
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 781
Chapter 16 – Accounting for Tax Losses
114. AG's taxable income for the first five years was as follows:
Year
Taxable
Income
$125,000
$190,000
$225,000
$298,000
(80,000)
20x11
20x12
20x13
20x14
20x15
Tax
rate
40%
40%
38%
35%
38%
Income taxes
paid
$50,000
$76,000
$85,500
$104,300
-
Calculate the tax recovery in 20x15.
Ans:
Year
Carry back
Tax rate
20x12
80,000
40%
80,000
======
Difficulty: Hard
Tax recover
32,000
32,000
======
hz
Level of Learning: Knowledge
Topic: LO1, 2
115. JMR's taxable income for the first five years was as follows:
Year
Tax
rate
40%
40%
38%
35%
38%
Income taxes
paid
$50,000
$76,000
$9,500
$104,300
-
zle
20x11
20x12
20x13
20x14
20x15
Taxable
Income
$125,000
$190,000
$25,000
$298,000
(460,000)
Tax rate
40%
38%
35%
Tax recover
76,000
9,500
85,750
171,250
======
d
Calculate the tax recovery in 20x15.
Ans:
Year
Carry back
20x12
190,000
20x13
25,000
20x14
245,000
460,000
======
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 782
Chapter 16 – Accounting for Tax Losses
116. JMR's taxable income for the first five years was as follows:
Year
20x11
20x12
20x13
20x14
20x15
Taxable
Income
$125,000
$90,000
$125,000
$298,000
(400,000)
Tax
rate
40%
40%
38%
35%
38%
Calculate the tax recovery in 20x15.
Ans:
Year
Carry back
20x12
90,000
20x13
125,000
20x14
185,000
400,000
======
Difficulty: Hard
Income taxes
paid
$50,000
$36,000
$47,500
$104,300
-
Tax rate
40%
38%
35%
Tax recover
36,000
47,500
64,750
148,250
======
hz
Level of Learning: Knowledge
Topic: LO1, 2
zle
117. How can a company use CCA to fully utilize losses that have been incurred?
Ans: CCA is an optional deduction. Tax returns for the previous three years may be amended in
order to create enough taxable income to absorb tax losses. CCA may also be eliminated or
reduced in the current or deferred years in order to use up losses that may be about to
expire. CCA is not lost if it is not used.
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2
d
118. Based on Handbook Section 3465, when may a deferred benefit of tax loss carry forwards be
recognized?
Ans: Deferred benefits of tax loss carry forwards may be recognized if it is more likely than not
that they will be realized. More likely than not occurs when the probability is greater than
50%.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 783
Chapter 16 – Accounting for Tax Losses
119. In order to help companies and their auditors determine whether the criteria "more likely than
not" has been realized, the Handbook has set out some guidelines for favourable evidence. List
two of these.
Ans: 1. existing sufficient taxable temporary differences which would result in taxable amounts
against which the unused tax losses can be utilized;
2. existing contracts or firm sales backlog that will produce more than enough taxable
income to realize the deferred income tax asset based on existing sales prices and cost
structures;
3. an excess of fair value over the tax basis of the enterprise's net assets in an amount
sufficient to realize the deferred income tax asset; or
4. a strong earnings history exclusive of the loss that created the deferred deductible
amount together with evidence indicating that the loss is an aberration rather than a
continuing condition.
[CICA 3465.28
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2
zle
hz
120. In order to help companies and their auditors determine whether the criteria "more likely than
not" has been realized, the Handbook has set out some guidelines for unfavourable evidence. List
two of these.
Ans: 1. a history of tax losses expiring before they have been used;
2. an expectation of losses in the carry forward period; and
3. unsettled circumstances that, if unfavourable resolved, would adversely affect deferred
operations and profit levels on a continuing basis in deferred years.
[CICA 3465.27]
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2
Level of Learning: Knowledge
Topic: LO1, 2
d
121. How should a deferred income tax benefit of a tax loss carry forward be treated on a yearly basis?
Ans: According to the handbook, the benefit should be reviewed each year that it remains on the
books. If the probability of realization has been reduced below 50%, then it should be
written down to the most probable amount. It is possible to continue to adjust the amount
up and down to the maximum possible benefit.
Difficulty: Hard
122. What options are open to a company that did not previously set up a deferred income tax benefit
of a tax loss carry forward but has now determined that the probability of realization is greater
than 50%?
Ans: Companies may continue to adjust the deferred benefit throughout the carry forward
benefit. This includes setting up a deferred benefit that was previously thought not to be
realizable.
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 784
Chapter 16 – Accounting for Tax Losses
123. What options are open to a company that had previously set up a deferred income tax benefit of a
tax loss carry forward but has now determined that the probability of realization is less than 50%?
Ans: Companies must determine whether all or only part of the deferred benefit has fallen below
the 50% probability. The amount, which is now, less than 50% should be written down
through a credit to the deferred income tax asset account and a debit to income tax
expense.
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO4
hz
124. JMR Corp. incurred a loss in 20x15 after several years of taxable income. After the carry back,
JMR still had losses to use up in the amount of $500,000. The applicable tax rate was 40%. In
20x16, the tax rate goes down to 38%. Assuming that losses have not been used but it is still
probable that they will be used, prepare the journal entry to set up the deferred benefit in 20x15
and any other entries applicable to the deferred benefit.
Ans: 20x15
Deferred income tax asset – carry forward benefit
200,000
Income tax expense
200,000
(500,000x.40)
20x16
Income tax expense
Deferred income tax asset – carry forward benefit
(500,000x.40)- (500,000x.38)
Difficulty: Hard
10,000
10,000
zle
Level of Learning: Knowledge
Topic: LO1, 2
d
125. KER Corp. incurred a loss in 20x15 after several years of taxable income. After the carry back,
KER still had losses to use up in the amount of $357,000. The applicable tax rate was 40%. In
20x16, the tax rate goes up to 45%. Assuming that losses have not been used but it is still
probable that they will be used, prepare the journal entry to set up the deferred benefit in 20x15
and any other entries applicable to the deferred benefit.
Ans: 20x15
Deferred income tax asset – carry forward benefit
142,800
Income tax expense
142,000
(357,000x.45)
20x16
Deferred income tax asset – carry forward benefit
Income tax expense
(357,000x.45)- (500,000x.40)
Difficulty: Hard
17,850
17,850
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 785
Chapter 16 – Accounting for Tax Losses
126. EGR Ltd. has been in business for five years and incurs a loss of $320,000 in 20x15. The
company has no temporary differences. The history of the company's earnings since they began
operations is as follows:
Year
20x11
20x12
20x13
20x14
Taxable
Income (loss)
$30,000
($15,000)
$130,000
$30,000
Taxes
paid (recovered)
$12,000
6,000
52,000
12,000
The tax rate has been constant at 40%.
hz
Required:
Prepare journal entries to record the recovery of taxes and any journal entries necessary for any
loss carry forwards. Assume probability of recovery is greater than 50%
Ans: 20x15
Income tax receivable – carry back
64,000
Income tax expense (recovery)
64,000
(130,000+30,000) x.40
deferred income tax asset – carry forward benefit
64,000
Income tax expense (recovery)
64,000
(320,000-160,000) x.40
Difficulty: Hard
d
zle
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 786
Chapter 16 – Accounting for Tax Losses
127. KAR Ltd. has been in business for five years and incurs a loss of $320,000 in 20x15. The
company has no temporary differences. The history of the company's earnings since they began
operations is as follows:
Year
20x11
20x12
20x13
20x14
Taxable
Income (loss)
$30,000
($15,000)
$130,000
$30,000
Taxes
paid (recovered)
$12,000
6,000
52,000
12,000
The tax rate has been constant at 40%.
hz
Required:
Prepare journal entries to record the recovery of taxes and any journal entries necessary for any
loss carry forwards. Assume probability of recovery is less than 50%
Ans: 20x15
Income tax receivable – carry back
64,000
Income tax expense (recovery)
64,000
(130,000+30,000)x.40
No entry to record carry forward benefit as the probably of realization is less than 50%
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO1, 2
d
zle
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 787
Chapter 16 – Accounting for Tax Losses
128. JG Ltd. has been in business for five years and incurs a loss of $520,000 in 20x15. The company
has no temporary differences. The history of the company's earnings since they began operations
is as follows:
Year
20x11
20x12
20x13
20x14
Taxable
Income (loss)
$300,000
($150,000)
$330,000
$80,000
Taxes
paid (recovered)
$114,000
57,000
125,400
30,400
The tax rate has been constant at 38%.
hz
Required:
Prepare journal entries to record the recovery of taxes and any journal entries necessary for any
loss carry forwards. Assume probability of recovery is greater than 50%
Ans: 20x15
Income tax receivable – carry back
155,800
Income tax expense (recovery)
155,800
(410,000x.38)
Deferred income tax asset – carry forward benefit
34,200
Income tax expense (recovery)
34,200
(520,000-410,000) x.38
Difficulty: Hard
d
zle
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 788
Chapter 16 – Accounting for Tax Losses
129. JG Ltd. has been in business for five years and incurs a loss of $520,000 in 20x15. The company
has no temporary differences. The history of the company's earnings since they began operations
is as follows:
Year
20x11
20x12
20x13
20x14
Taxable
Income (loss)
$300,000
($150,000)
$330,000
$80,000
Taxes
paid (recovered)
$114,000
(57,000)
125,400
30,400
The tax rate has been constant at 38%.
Level of Learning: Knowledge
Topic: LO1, 2
d
zle
hz
Required:
Prepare journal entries to record the recovery of taxes and any journal entries necessary for any
loss carry forwards. In 20x16, JG incurs a further loss of $40,000. The tax rate changed to 40%.
Assume probability of recovery is greater than 50%.
Ans: 20x15
Income tax receivable – carry back
155,800
Income tax expense (recovery)
155,800
(410,000x.38)
Deferred income tax asset – carry forward benefit
41,800
Income tax expense (recovery)
41,800
(520,000-410,000) x.38
20x16
Deferred income tax asset – carry forward benefit
16,000
Income tax expense (recovery)
16,000
(40,000x.40)
Deferred income tax asset – carry forward benefit
2,200
Income tax expense (recovery)
2,200
(410,000x.38)- (410,000x.40)
Difficulty: Hard
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 789
Chapter 16 – Accounting for Tax Losses
130. JG Ltd. has been in business for five years and incurs a loss of $520,000 in 20x15. The company
has no temporary differences. The history of the company's earnings since they began operations
is as follows:
Year
Taxable
Income (loss)
$300,000
($150,000)
$330,000
$80,000
20x11
20x12
20x13
20x14
Taxes
paid (recovered)
$114,000
57,000
125,400
30,400
The tax rate has been constant at 38%.
Difficulty: Hard
zle
hz
Required:
Prepare journal entries to record the recovery of taxes and any journal entries necessary for any
loss carry forwards. In 20x16, JG incurs a further loss of $40,000. The tax rate changed to 40%.
Assume probability of recovery is greater than 50% in 20x15 but less than 50% in 20x16.
Ans: 20x15
Income tax receivable – carry back
155,800
Income tax expense (recovery)
155,800
(410,000x.38)
Deferred Income Tax Asset – carry forward benefit
41,800
Income tax expense (recovery)
41,800
(520,000-410,000) x.38
20x16
No deferred benefit record as probability of realization less than 50%
Income tax expense (recovery)
41,800
Deferred Income Tax Asset – carry forward benefit
41,800
Level of Learning: Knowledge
Topic: LO1, 2
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 790
Chapter 16 – Accounting for Tax Losses
131. Once a deferred benefit of a tax loss carry forward has been recorded, does it have to remain on
the balance sheet until realized? Explain.
Ans: The deferred benefit should be analyzed every year to determine whether the probability of
realization is still greater than 50%. If it is not, a portion, or all (depending on whether the
probability for all of the amount or just a portion has gone below 50%) should be written
down.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
hz
132. There is some question as to whether there should be early recognition of the deferred benefit of a
loss carry forward. Discuss.
Ans: The new Handbook is now consistent with the US as they permit early recognition,
although this was permitted after some lobbying by industry. Supporters argue that the
deferred benefits should be matched to the loss that created it. Others argue that there has
been no transaction that establishes the right to the benefit. In addition, the recognition is
based strongly on management's judgment that may be biased
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
d
zle
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 791
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test Bank
Chapter 17 – Leases
1. Typically, the lessee owns the leased assets in a finance lease situation.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
2. All long-term leases should be capitalized in the accounts by the lessee.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
hz
3. Operating leases are usually of shorter duration than finance leases and under this type of
lease, the risks and rewards of asset ownership remain with the lessor.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
zle
4. The use of contingent lease payments is one method companies use to avoid lease
capitalization.
Ans: True
d
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
5. A lessee is usually motivated to report a lease liability as a finance lease because the lessee can
capitalize the "cost" of the leased asset.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 1
Chapter 17 – Leases
6. Companies that opt for finance leases usually do so because of the tax advantages finance
leases provide.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
7. The lessee's incremental borrowing rate is the rate that, at the inception of the lease, the lessee
would have incurred to borrow over a similar term the funds necessary to purchase the leased
asset.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
hz
8. The lessee should use the lessor’s borrowing rate (if known) to account for a finance
lease, even if this provides a present value of lease payments that is higher than the fair
value of the asset at the inception of the lease.
Ans: False
Difficulty: Easy
zle
Level of Learning: Knowledge
Topic: LO2
9. Both guaranteed and unguaranteed residual values should be included in the calculation of the
lessee’s minimum lease payments.
Ans: False
Difficulty: Easy
d
Level of Learning: Knowledge
Topic: LO2
10. The same quantitative thresholds for determining the existence of finance leases apply
under both IFRS and ASPE.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 9
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 2
Chapter 17 – Leases
11. Geisler Company leased a building from Ryan Company for 5 years. The first year of the lease
was forgiven with payments beginning in the second year. No journal entry is required until the
second year.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 3
12. The term of a finance lease includes the initial lease term and any bargain renewal terms.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
13. To qualify as a lessor for tax purposes, a company must derive at least 90% of its
revenues from leasing.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Ans: True
zle
14. If a lease transfers the residual value of the leased asset to the lessee at the end of the lease term,
the lessee has permanent ownership of the leased asset.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
d
15. If the straight-line method is used by the lessee to amortize the non-refundable down payment in
an operating lease, a constant dollar amount of the prepayment is allocated as expense to each
period covered by the lease.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
16. The lessor’s internal rate of return is normally the rate implicit in the lease.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 3
Chapter 17 – Leases
20. A lessee’s insurance expense throughout the term of a finance lease is usually an estimate
as opposed to an actual expense amount.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
21. The effective interest method must always be used to compute the lessee’s interest
expense related to a finance lease.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
hz
22. For an operating lease, the amount initially capitalized by the lessee is the present value of the
lease rents to be paid over the lease term.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: True
zle
23. Any operating or executory costs should be excluded from the calculation of the
minimum lease payments.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
d
24. A finance lease is accounted for "as if" it transfers a material interest in the leased asset from the
lessor to the lessee.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
25. To be classified as a finance lease by the lessee, no important uncertainties surrounding the
amount of unreimbursable costs yet to be incurred by the lessor may exist.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 4
Chapter 17 – Leases
26. Company enters into a renewable 5 year lease (renewable for another 5 years) at $20,000 per
year. There is an initial upfront cost of $5,000. This amount should be amortized over 10 years.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
27. A finance lease is based upon the view that there was a sale/purchase (between the parties) of the
leased asset at the inception date of the lease.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
hz
28. A lease which contains a bargain purchase option, but which has a term equal to only 70% of the
estimated economic life of the leased property cannot properly be classified as a finance lease by
a lessee.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
zle
29. Under both operating and finance leases, periodic rent expense for a lessee is likely to be the
same over successive periods.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
30. Contingent rent is a bargaining tool used by the lessee in order to negotiate a more favourable
lease agreement.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
31. Contingent rent is one of three common methods used to avoid capitalization.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 5
Chapter 17 – Leases
32. One of the most common methods of avoiding the capitalization of a lease is to enter into lease
agreements that provide year-by-year renewal.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
33. A sale and leaseback occurs when one party sells an asset to a second party who then leases it
back to the first party.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
34. A lessee's debt to equity ratio is not increased if the lease is a finance lease, whereas, it would be
if the asset were purchased outright.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
Ans: True
zle
35. Under ASPE, if a lessor’s estimated future cash flow collections under finance leases are
in doubt, an impairment loss may have occurred.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO9
d
36. Under ASPE, if a leased asset’s fair value is less than its carrying value at the date of sale
under a sale-and-lease-back transaction, the lessor has experienced an impairment loss.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO9
37. For a finance lease, the amount initially capitalized by the lessee is the sum of the future value of
the periodic lease payments, plus the future value of any bargain purchase option.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 6
Chapter 17 – Leases
38. Both the lessee’s interest and depreciation expense should be added back to net income to
calculate cash flows from operating activities under the indirect method.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO8
39. Off-balance sheet financing occurs when a company makes use of assets but does not record the
asset or corresponding liability on the financial statements.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
hz
40 Leased assets treated as a finance lease for accounting purposes and an operating lease for tax
purposes will create a temporary difference.
Ans: True
zle
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO7
41. The distinction between a sales-type lease and a direct financing lease is based on whether there
is a dealer's or manufacturer's profit.
Ans: True
d
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
42. The basic distinction between direct financing leases and sales-type leases is that in a direct
financing lease, a gross margin (i.e., manufacturer's or dealer's profit or loss) is recognized by the
lessor at inception of the lease.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 7
Chapter 17 – Leases
43. The lessor recognizes two different kinds of earnings for a sales-type lease, that is, dealer's profit
and interest revenue.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
44. Under a sales-type lease, the lessor recognizes a dealer's or manufacturer's profit on the date of
inception of the lease.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
45. The same lease may be classified differently by the lessor as compared to the classification used
by the lessee.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2
zle
46. Non-refundable payments made in advance on operating leases may be amortized either over the
term of the lease, or any other period consistent with the GAAP guidelines for amortizing
intangible assets.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
47. In an operating lease, if a non-refundable down payment is made in advance, the lessor should
initially debit Cash and credit Unearned Rent (liability).
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 8
Chapter 17 – Leases
48. A journal entry is not required for either the lessor or lessee when an operating lease is initiated
unless there is an advance payment, such as a lease bonus or prepayment of rent in addition to the
periodic rents.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
49. Each periodic rent collected on a finance lease by the lessor is usually part principal and part
interest revenue.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
50. Interest revenue is recognized on a finance lease because the leased asset is considered sold at the
hz
inception of the lease, and the lease is a way of financing the lease.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
zle
51. On January 1, 20x11, WXY signed an operating lease agreement, which required $5,800 annual
rentals to be paid at the end of each year. The accounting period ends December 31. At the end of
20x11, WXY (lessee) should make the following entry:
1
2
4
A)
B)
C)
D)
5,800
5,800
5,800
5,800
d
3
Leased asset
Cash
Rent paid in advance
Cash
Rent expense
Lease liability
Rent expense
Cash
5,800
5,800
5,800
5,800
Choice 1
Choice 2
Choice 3
Choice 4
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 9
Chapter 17 – Leases
52. While only certain leases are currently accounted for as a sale or purchase, there is theoretical
justification for considering all leases to be sales or purchases. The principle reason that supports
this idea is that:
A)
a lease reflects the purchase or sale of a quantifiable right to the use of the property.
B)
during the life of the lease, the lessee can effectively treat the property as if it were owned
by the lessee.
C)
all leases are generally for the economic life of the property and the residual value of the
property at the end of the lease is minimal.
D)
at the end of the lease, the property usually can be purchased by the lessee.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
53. The term usually used to describe the situation where a lessee has an option to purchase the
Ans: C
hz
leased property at a price that is sufficiently lower than its fair market value so that the exercise of
the option appears reasonably assured is:
A)
assured purchase option.
B)
bargain buy-out option.
C)
bargain purchase option.
D)
bargain renewal option.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
54. The classifications of leases, from the standpoint of the lessee, are:
capital, direct financing, or sales-type.
capital or operating.
direct financing, sales-type or operating.
direct financing, or sales-type.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
d
A)
B)
C)
D)
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 10
Chapter 17 – Leases
55. The appropriate valuation of an operating lease on the balance sheet of a lessee is:
A)
B)
C)
D)
the present value of the sum of the lease payments discounted at an appropriate rate.
the market value of the asset at the date of the inception of the lease.
the absolute sum of the lease payments.
zero unless the lessee made a prepayment of rent.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
56. The straight-line method is frequently used to amortize non-refundable rental payments made in
advance on leased assets because:
A)
it is less complex, therefore, less costly.
B)
the interest method may result in unreliable amounts being recognized as expense.
C)
it is more theoretically sound.
D)
GAAP requires that it be used in all situations.
hz
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
57. ABC signed a 5-year operating lease agreement whereby WXY Rentals will provide a truck
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO1
d
zle
which cost WXY $20,000. The lease payments are $2,500, payable at the end of each year. The
truck has a 10-year useful life. At the inception of the lease, ABC should:
A)
make no journal entry.
B)
record rental expense of $2,500 for the first year's rental.
C)
record the leased asset at its current market value.
D)
record the asset at the present value of the five equal annual lease payments.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 11
Chapter 17 – Leases
58. Assume the following facts relating to a lease:
Leased asset, new at inception of lease term.
Estimated useful life, 14 years.
Lease term, 8 years; asset returns to lessor.
Interest rate implicit in the lease, 10 percent (known by lessee).
Lessee's marginal borrowing rate, 12 percent.
Amount of each lease payment, $2,000.
Lessor's cost of the leased asset, $15,164.
Market value of leased asset at inception of the lease term, $15,164
Lease payments are due at the end of each period.
From the perspective of the lessee, this lease should be classified
as a(n):
A)
sales-type lease.
B)
direct financing lease.
C)
operating lease.
D)
finance lease.
Ans: C
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
59. What is the cost basis of an asset acquired by a lease, which is in substance an instalment
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
d
zle
purchase?
A)
The present value of the market price of the asset discounted at an appropriate rate as an
amount to be received at the end of the lease
B)
The present value of the future minimum lease payments under the lease (exclusive of
executory costs and any profit thereon) discounted at an appropriate rate
C)
The net realizable value of the asset determined at the date of the lease agreement plus the
sum of the future minimum lease payments under the lease
D)
The sum of the future minimum lease payments under the lease
60. What are the three types of period costs that a lessee experiences with finance leases?
A)
B)
C)
D)
Depreciation expense, executory costs, lease expense
Executory costs, interest expense, lease expense
Lease expense, interest expense, depreciation expense
Interest expense, depreciation expense, executory costs
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 12
Chapter 17 – Leases
61. At the inception of a finance lease which calls for payments on an annuity due basis, the lessee
typically debits:
A)
leased asset.
B)
lease expense.
C)
rent expense.
D)
lease receivable.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
64. The lessee measures the cost of a leased asset, and the corresponding lease liability of a finance
lease, as the:
A)
fair market value of the leased asset.
B)
future value of the periodic rental payments.
C)
sum of the annual cash payments to be made during term of the lease.
D)
present value of the periodic rental payments.
hz
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
A)
B)
C)
D)
zle
65. The depreciation period used by the lessee for a depreciable leased asset must be:
the same period that was used by the lessor.
the remaining life of the asset from the lease inception.
the term of the lease.
at least the term of the lease but possibly longer.
Ans: D
d
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
66. For a finance lease, an amount equal to the present value at the beginning of the lease term of
minimum lease payments during the lease term, excluding that portion of the payments
representing executory costs such as insurance, maintenance, and property taxes to be paid by the
lessor, together with any profit thereon, should be recorded by the lessee as a(n):
A)
expense.
B)
asset but not a liability.
C)
liability but not an asset.
D)
asset and a liability.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 13
Chapter 17 – Leases
67. The estimated residual value of a depreciable leased asset at the end of the lease term is:
A)
B)
C)
D)
added to the bargain purchase option at the expiration of the lease.
always guaranteed by either the lessor or the lessee.
an important factor in how the lessor and lessee must account for the lease.
used by the lessor to compute the annual amount of depreciation expense.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
68. When the lessee guarantees the residual value at the end of the lease term, the:
A)
B)
C)
D)
lessor will use this amount in computing periodic depreciation expense.
lessor will receive an additional cash flow at the end of the lease term.
lessee may have to pay the lessor additional cash if the actual residual value is not equal to
the estimated residual value.
lessee will have to pay the lessor additional cash because the guaranteed residual value was
included in computing the annual rental amounts.
hz
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
zle
69. If the residual value of a leased asset turns out to be more than the amount guaranteed by the
lessee, the:
A)
lessee may reduce depreciation expense for the prior year, through a prior period
adjustment, to take into account the excess.
B)
lessor is under no obligation to compensate the lessee for the excess.
C)
lessor must pay the lessee the amount of the excess.
D)
lessee may reduce the annual rentals for the excess.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
Ans: B
70. Which of the following would be excluded from both the minimum lease payments and net lease
liability at inception for the lessee?
A)
lessee guarantee of residual
B)
bargain purchase option
C)
third party guarantee of residual
D)
annual lease payments
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 14
Chapter 17 – Leases
71. A lessee wants to lease an asset on a long-term non-cancellable basis, but wants to avoid
capitalizing the lease. Which of the following strategies has the best chance of achieving the
lessee's goal?
A)
use a lessee guarantee of residual value
B)
make it impossible for the lessee, who has a very low borrowing rate, to determine the
lessor's implicit rate, which is much higher than the lessee's borrowing rate
C)
include a bargain purchase option in the lease agreement
D)
use a third-party guarantee of residual value
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
72. A lessee is attempting to circumvent the accounting rules, which require lease capitalization.
Ans: B
hz
Which of the following is most likely to lead to classification of a lease as an operating lease for
the lessee?
A)
contract provides that lessee pays executory costs
B)
contract provides for a third-party guarantee of residual value
C)
attempt to reduce the lessee's borrowing rate
D)
increase the term of the lease. decrease annual executory costs
d
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 15
Chapter 17 – Leases
73. A company became a lessee by leasing equipment on January 1, 20x11 from a lessor. The lease
has the following characteristics:
Original useful life of asset
Both lessor and lessee use 10% for lease capitalization
Market value of equipment at lease inception
Book value of equipment at lease inception
Remaining useful life of equipment at inception
A third party guarantees the entire residual value of
Six end-of-year lease payments are due beginning
December 31, 20x11 in the amount of
14 years
$200,000
$150,000
10 years
$31,887
$41,788
Ans: D
hz
The lease term ends December 31, 20x16
Assume this is a finance lease for both parties. Over what number of years will the lessee
amortize the leased asset?
A)
14
B)
10
C)
7
D)
6
E)
40
Difficulty: Medium
Level of Learning: Application
Topic: LO2
zle
74. On January 1, 20x11, MU Corporation leased an asset, under an operating lease, to obtain the use
Ans: E
d
of a special machine for three years. The lease payments were $9,000 per year payable at each
year-end; the lessee must pay all operating expenses. At the inception date, MU Corporation
should:
A)
record the asset at $27,000.
B)
record the rent expense of $27,000.
C)
record the asset at its fair market value.
D)
record the asset at the present value of the annual lease payments.
E)
make no entry.
Difficulty: Medium
Level of Learning: Application
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 16
Chapter 17 – Leases
75. A 5-year lease contract is signed 1/1/x1 calling for $4,000 to be paid by the lessee on 12/31/x1,
and $6,000 on 12/31/x2, x3, and x4. Total lease payments over the lease term are therefore
$22,000. The lessee expects to use the leased asset evenly throughout the lease term, which ends
12/31/x5. No payment is due in 20x15. The entry recorded by the lessee for this operating lease,
on 12/31/x1 includes which of the following:
A)
cr. rent payable $200
B)
dr. rent expense $4,400
C)
dr. prepaid rent $400
D)
dr. rent expense $4,000
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO1
76. Lessee ABC leased from Lessor QRS a machine that cost $35,000, which was properly classified
Ans: C
zle
hz
as a finance lease by both parties. Assume the lessor used a 12 percent implicit interest rate and
that the lessee was informed of that rate. The lease did not include a bargain purchase option and
the estimated residual value at termination of the lease was zero. Equal semi-annual lease
payments are to be made at the start of each such period, including one on the date the lease was
signed. The amount of each semi-annual payment, assuming a five-year lease term, would be:
A)
$2,074
B)
$2,916
C)
$4,486
D)
$4,755
E)
$9,709
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 17
Chapter 17 – Leases
77. The following information relates to a lease contract:
Inception: 1/1/x1
Annual lease payments of $3,000 due each 12/31 beginning 12/31/x1
End of lease term: 1/1/x5
There are 4 lease payments in all
Useful life of asset at inception: 10 yrs
Expected residual value at 1/1/x5: $6,000
Lessee is given option to purchase asset at 1/1/x5 for $1,000
Using an interest rate of 10%, what is the present value of minimum lease payments for the lessee
at inception?
A)
$10,193
B)
$ 9,510
C)
$10,419
D)
$13,608
E)
$13,000
Ans: A
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO2
78. A lessor and lessee enter into a lease agreement with the following characteristics:
zle
Inception: 1/1/x0
6 annual lease payments of $10,000 are due each Jan. 1 beginning
1/1/x0
End of lease term:
12/31/x5
Book value of equipment under lease, at inception:
$35,000
Market value of equipment under lease at inception:
$50000
Remaining useful life of equipment at inception:
9 yrs
Expected residual value at end of lease term:
$4,000
Interest rate used by lessor and lessee:
10%
d
Assuming the lessee will capitalize this lease, what is the amount of the net lease liability at
inception, before the first payment is made?
A)
$47,908
B)
$60,000
C)
$50,166
D)
$64,000
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 18
Chapter 17 – Leases
79. An asset with a market value of $100,000 is leased on 1/1/x0. Five annual lease payments are due
each January 1 beginning 1/1/x0. The unguaranteed residual value on 12/31/x4, the last day of the
lease term, is estimated at $40,000. The lessor's implicit interest rate is 8%. What is the annual
lease payment?
A)
$18,227
B)
$16,877
C)
$23,191
D)
$25,046
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO2
80. An asset with a market value of $100,000 is leased on 1/1/x0. Five annual lease payments are due
Ans: B
hz
each January 1 beginning 1/1/x0. The lessee guarantees the $40,000 residual value as of 12/31/x4,
the last day of the lease term. The lessor's implicit interest rate is 8%. What is the annual lease
payment?
A)
$18,227
B)
$16,877
C)
$23,191
D)
$25,046
d
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 19
Chapter 17 – Leases
81. A company became a lessee by leasing equipment on January 1, 20x11 from a lessor. The lease
has the following characteristics:
Original useful life of asset
Both lessor and lessee use 10% for lease capitalization
Market value of equipment at lease inception
Book value of equipment at lease inception
Remaining useful life of equipment at inception
A third party guarantees the entire residual value of
14 years
$200,000
$150,000
10 years
$31,887
Ans: B
hz
Six end-of-year lease payments are due beginning
December 31, 20x11 in the amount of
$41,788
The lease term ends December 31, 20x16
Assume this is a finance lease for both parties. What is the present value of minimum lease
payments for the lessee?
A)
$200,000
B)
$181,998
C)
$180,000
D)
$194,566
E)
$178,233
Difficulty: Medium
Level of Learning: Application
Topic: LO2
zle
82. XYZ leased a tract of land for a 20-year term. The lease agreement did not contain a bargain
d
purchase option, and consequently, the land will revert back to the lessor at the end of the lease
term. At the inception of the lease, XYZ initiated construction on a small building on the land.
The building was completed at the end of the third year of the lease, at a cost of $60,000. The
building was a permanent structure on the land. Its estimated life was 20 years and was expected
to have no residual value. XYZ should record annual depreciation (straight-line) on the building
of:
A)
$2,400
B)
$3,000
C)
$3,529
D)
$6,000
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 20
Chapter 17 – Leases
83. CDE leases land and secures the landowner's permission to erect a warehouse on the leased site.
The lease has 25 years to run from the time CDE completes the warehouse at a cost of $300,000.
The warehouse is expected to last 50 years. In connection with the warehouse, CDE's annual
depreciation should be:
A)
$6,000
B)
$7,500
C)
$12,000
D)
The entire $300,000 should be expensed the first year.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO2
84. Equal monthly rental payments for a particular lease should be charged to rental expense by the
lessee for which of the following?
Choice 1
Choice 2
Choice 3
Choice 4
Ans: B
zle
A)
B)
C)
D)
Operating lease
No
Yes
No
Yes
hz
Finance lease
No
No
Yes
Yes
1
2
3
4
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 21
Chapter 17 – Leases
85. Lease Y contains a bargain purchase option and the lease term is equal to 75 percent of the
estimated economic life of the leased property. Lease Z contains a bargain purchase option and
the lease term is less than 75 percent of the estimated economic life of the leased property. How
would the lessee classify these leases?
Lease Y
Finance lease
Finance lease
Operating lease
Operating lease
1
2
3
4
A)
B)
C)
D)
Lease Z
Finance lease
Operating lease
Operating lease
Finance lease
Choice 1
Choice 2
Choice 3
Choice 4
Ans: A
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2
86. On December 31, 20x12, JKL leased a new machine from MNO. The following information
Ans: D
d
zle
relates to the lease transaction:
*the machine has an estimated useful life of seven years, which coincides with the lease term.
*lease rentals consist of seven equal annual payments of $100,000, the first of which was paid on
December 31, 20x12.
*MNO's implicit interest rate is 12 percent, which is known by JKL.
*JKL's incremental borrowing rate is 14 percent at December 31, 20x12.
*present value of an annuity of $1 in advance for seven periods at 12 percent is 5.11.
*present value of an annuity of $1 in advance for seven periods at 14 percent is 4.89.
At the inception of the lease, JKL should record a capitalized lease liability of:
A)
$411,000
B)
$489,000
C)
$500,000
D)
$511,000
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 22
Chapter 17 – Leases
87. ABC leased a new machine from QRS on July 1, 20x19, under a lease with the following
pertinent information:
lease term
10 years
annual rental payable at the beginning of each lease year
$30,000
useful life of the machine
12 years
implicit interest rate
14 percent
present value of an annuity of $1 in advance for 10 periods at 14 percent
5.95
Present value of $1 for 10 periods at 14 percent.
0.27
ABC has the option to purchase the machine at the end of the lease term, by paying $40,000,
which approximates the expected fair value of the machine on the option exercise date. The cost
of the machine on QRS's accounting records is $150,000. On July 1, 20x19, ABC should record a
net capitalized leased asset of:
A)
$150,000
B)
$178,500
C)
$189,300
D)
$190,000
Ans: B
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO2
88. CDE leased equipment from HIJ on December 31, 20x11, for a 10-year period (also the useful
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
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life of the asset). Equal annual payments under the lease are $50,000 and are due on December 31
of each year. The first payment was made on December 31, 20x11, and the second payment was
made on the next due date. The present value at December 31, 20x11, of the minimum lease
payments over the lease term discounted at 10 percent (the implicit rate computed by HIJ and
known by CDE) was $338,000. CDE's incremental borrowing rate was 12 percent at December
31, 20x11. The lease is appropriately accounted for as a finance lease by CDE. What should be
the balance in CDE's liability under finance lease account at December 31, 20x12?
A)
$266,800
B)
$272,560
C)
$303,980
D)
$400,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 23
Chapter 17 – Leases
89. On December 1, 20x11, XYZ leased office space for its own use for 10 years at a monthly rental
of $15,000. On December 31, 20x11, XYZ paid the lessor the following amounts:
Refundable rent deposit (for possible property damage)
$20,000
First month's rent
15,000
Rent for last month of year 10 (paid in advance)
15,000
Installation of new walls and offices
96,000
Total
$146,000
========
The entire amount of $146,000 was reported as rent expense in 20x11 because it is an operating
lease. What amount should XYZ have reported as expense for the year ended December 31,
20x11?
A)
$15,000
B)
$15,800
C)
$30,800
D)
$96,000
Ans: B
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO1
90. Amanda Company leased an office building for six years for an annual rent of $170,000. The
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO1
d
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lessor agreed to forgive the first year of the lease (i.e. payments would not begin until the second
year). The entry in the second year would include a debit to:
A)
deferred liability - $28,333
B)
deferred liability - $141,667
C)
rent expense - $170,000
D)
rent expense – some other amount
91. Amanda Company leased an office building for six years for an annual rent of $170,000. The
lessor agreed to forgive the first year of the lease (i.e. payments would not begin until the second
year). The entry in the second year would include a debit to:
A)
rent expense - $28,333
B)
rent expense - $141,667
C)
rent expense - $170,000
D)
rent expense – some other amount
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 24
Chapter 17 – Leases
92. JMR Company leases an asset from KAR Company. The rate implicit in the lease is 11% and
JMR's incremental borrowing rate is 12%. JMR is aware of the implicit rate. The rate that JMR
should use for discounting the net lease payment is:
A)
11.5%
B)
12%
C)
9%
D)
11%
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO2
93. JMR Company leases an asset from KAR Company. The rate implicit in the lease is 11% and
Ans: B
hz
JMR's incremental borrowing rate is 12%. JMR is not aware of the implicit rate. The rate that
JMR should use for discounting the net lease payment is:
A)
11.5%
B)
12%
C)
9%
D)
11%
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO2
94. All of the following are true of off-balance sheet financing except:
A)
B)
C)
D)
lessees obtain full use of the assets
assets and debt obligations are not reported on the statements of the lessee
a new IASB guideline has eliminated the use of off-balance sheet financing
new leasing sub-industries have developed to ensure that the three guidelines for finance
leases are not met
Level of Learning: Knowledge
Topic: LO6
d
Ans: C
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 25
Chapter 17 – Leases
95. Which of the following is not a possible advantage of long-term leases?
A)
B)
C)
D)
100% financing
flexibility
protection from interest rate changes
ability to always claim CCA and depreciation
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
96. KER leased an asset from EGR for 5 years. The lease met the conditions of a finance lease. The
Ans: B
hz
present value of the minimum lease payments using a rate of 11% was calculated at $65,017. The
asset should be set up on the books of KER Company with a debit of:
A)
$66,017
B)
$65,017
C)
$325,085
D)
cannot be determined from the information given
Difficulty: Medium
Level of Learning: Application
Topic: LO3
zle
97. KER leased an asset from EGR for 5 years on January 2, 20x11. The lease met the conditions of a
finance lease. The present value of the minimum lease payments using a rate of 11% was
calculated at $65,017. Assuming a calendar year end, the interest expense to be recorded is:
A)
$8,000
B)
$7,152
C)
$0
D)
cannot be determined from the information given
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
Ans: B
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 26
Chapter 17 – Leases
98. Ryan Company leased an asset that qualified as a finance lease for accounting purposes and an
operating lease for Canada Revenue Agency (CRA) purposes. Ryan Company assumed all
maintenance costs. Selected financial data for the company include insurance $2,500; interest
$7,657; amortization $11,234 and general office supplies $1,500. The annual lease payment
amounts to $25,000. The temporary difference for tax purposes during the year amounts to:
A)
0
B)
$2,109
C)
$3,609
D)
cannot be determined
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO6
99. Ryan Company leased an asset that qualified as a finance lease for accounting purposes and an
zle
Ans: B
hz
operating lease for Canada Revenue Agency (CRA) purposes. Ryan Company assumed all
maintenance costs. Selected financial data for the company include insurance $4,700; interest
$5,347; amortization $8,540 and cost of goods sold $5,000. The annual lease payment amounts to
$23,000. The temporary difference for tax purposes during the year amounts to:
A)
0
B)
$4,413
C)
$587
D)
cannot be determined
Difficulty: Medium
Level of Learning: Application
Topic: LO6
d
100. Brimley Corp. leased an asset from Geisler Corp. At the end of the first year Brimley Corp.
reported a leased asset of $87,098, accumulated amortization of $8,710 and a lease liability of
$74,567. The temporary difference for tax purposes is:
A)
$8,710
B)
$11,241
C)
$3,821
D)
$21,241
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 27
Chapter 17 – Leases
101. Brimley Corp. leased an asset from Geisler Corp. At the end of the first year Brimley Corp.
reported a leased asset of $54,051, accumulated amortization of $10,810 and a lease liability of
$40,537. The temporary difference for tax purposes is:
A)
$4,821
B)
$2,911
C)
$3,821
D)
$2,704
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO6
Ans: D
hz
102. Brimley Corp. leased an asset from Geisler Corp. At the end of the first year Brimley Corp.
reported a leased asset of $87,098, accumulated amortization of $8,710 and a lease liability of
$74,567. Assuming an income tax rate of 40%, the impact on Brimley Corp. financial statements
is:
A)
$8,710
B)
$11,241
C)
$3,821
D)
$1,528
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO3
103. All of the following are methods of avoiding capitalization except:
A)
legal agreement
B)
use of contingent rent
C)
use of a third party
D)
shorten the lease term
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
d
Ans: A
104. In a sale and leaseback arrangement, the lessee is also:
A)
the new owner of the property
B)
the seller
C)
the buyer
D)
a third party guarantor
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 28
Chapter 17 – Leases
105. In a sale and leaseback situation
A)
all gains and losses are deferred and amortized by the seller
B)
if the present value of the lease payments is equal to or less than 90% of the fair value of
the property, the lessee recognizes the entire gain or loss on sale immediately
C)
the lessee immediately recognizes any loss on sale up to the amount of the difference
between carrying value and fair value
D)
the lessor recognizes all losses on the sale immediately but must defer and amortize all
gains
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: D
hz
106. Generally accepted accounting principles require that certain lease agreements be accounted for
as purchases. The theoretical basis for this treatment is that a lease of this type:
A)
provides the use of the leased asset to the lessee for a limited period of time.
B)
must be recorded in accordance with the concept of cause and effect.
C)
is an example of form over substance.
D)
effectively conveys all of the benefits and risks incident to the ownership of property.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
Ans: D
d
107. When a lessee measures the present value of future rentals to be capitalized under a finance lease,
identifiable payments expected to be paid by the lessee to cover taxes, insurance, and
maintenance should be:
A)
capitalized, but at a different discount rate and reported in a different account than the
present value of the future rental payments.
B)
capitalized, but at a different discount rate and for a relevant period that usually is different
than for the future rental payments.
C)
included in the present value of the future rentals to be capitalized.
D)
excluded from the present value of the future rentals to be capitalized.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 29
Chapter 17 – Leases
108. A bargain purchase option in a finance lease affects the:
A)
incremental target rate of return.
B)
dealer's profit in a sales-type lease.
C)
guaranteed residual value.
D)
lessee's capitalized cost of the leased asset.
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
Ans: C
hz
109. When the lessee guarantees the residual value at the end of the lease term, for accounting
purposes, the:
A)
annual rentals will always be more than they would have been if the residual value was not
guaranteed.
B)
guaranteed residual value does not affect the annual rentals because it is a cash flow at the
end of the lease term.
C)
annual rentals will be the same as they would have been if the residual value was not
guaranteed.
D)
annual rentals will always be less than they would have been if the residual value was not
guaranteed.
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
d
110. When the lessee guarantees only a portion of the estimated residual value, the:
A)
lessee only takes into account the guaranteed portion when computing depreciation
expense.
B)
guaranteed portion is disregarded when computing the annual rentals.
C)
lessor's and lessee's accounting entries will be symmetrical.
D)
lessee will never have to compensate the lessor for the excess of the guaranteed amount
over the actual residual value.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 30
Chapter 17 – Leases
111. Choose the correct statement regarding including the terms listed in the lessee's (1) minimum
lease payments and (2) lease liability for a capitalized lease:
1
2
3
4
A)
B)
C)
D)
unguaranteed residual
lessee guarantee of residual
third party guarantee of residual
bargain purchase option
(1)
no
yes
no
yes
(2)
yes
yes
yes
no
Choice 1
Choice 2
Choice 3
Choice 4
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
hz
Ans: E
zle
112. Which of the following is included in only one or the other, but not both, of the lessee's minimum
lease payments and net lease receivable?
A)
bargain purchase option
B)
unguaranteed residual value
C)
third party guarantee of residual
D)
lessee guarantee of residual value
E)
none of the above
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
d
113. A lessee wants to lease an asset on a long-term non-cancellable basis, but wants to avoid
capitalizing the lease. The lessee is considering several strategies: 1) use a lessee guarantee of
residual value; 2) make it impossible for the lessee, who has a very low borrowing rate, to
determine the lessor's implicit rate, which is much higher than the lessee's borrowing rate; 3)
include a bargain purchase option in the lease agreement; 4) include title transfer in the lease
agreement. Which of the above strategies will provide the desired result?
A)
none
B)
1 and 3
C)
1 and 4
D)
2 and 3
E)
only 2
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO63
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 31
Chapter 17 – Leases
114. If a lessee does not exercise a bargain purchase option prior to its lapse date, the:
A)
lessee continues to record depreciation on the lease asset because it was assumed from the
beginning that the lessee would retain ownership of the asset.
B)
bargain purchase option cannot lapse because this option was included in computing the
annual rental amounts.
C)
lessee recognizes a loss due to the lapse.
D)
lessee recognizes a gain due to the lapse.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
hz
115. LMN signed a finance lease for a special railroad tank car. The lease specified 10 annual rentals
at each year-end. The lessor's implicit interest rate was 18 percent and is known to the lessee, and
the lessee's incremental borrowing rate was 20 percent. The annual rental was $12,000. The lease
provided for a bargain purchase option; that is, at the termination of the lease, the lessee could
purchase the car for $20,000, even though its estimated value at that date was $36,000. At
inception date, LMN will make the following entry:
Leased asset (tank car)
Lease liability
XXX
XXX
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
d
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The amount in the above entry should be:
A)
$50,108
B)
$51,928
C)
$57,750
D)
$120,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 32
Chapter 17 – Leases
116. A lessee capitalized a lease with a 1/1/x1 inception and which required annual lease payments of
$5,000 to be paid each December 31 beginning 12/31/x1. The lessee is to pay an additional $200
each December 31 for maintenance and insurance for the year ending on that date. The last lease
payment is due 12/31/x6, on which date the title to the asset transfers to the lessee. The asset is
expected to be used by the lessee until 12/31/x9 at which time the asset will have no residual
value. What is the total expense related to the lease recognized by the lessee in 20x11? Both
lessor and lessee use 10%.
A)
$4,797
B)
$2,378
C)
$7,620
D)
$6,008
E)
$4,598
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
d
zle
hz
117. A lease with a three-year term calls for a $5,000 payment at the end of each of those years. The
three payments are the only ones required in the lease. The residual value at the end of the lease
term is not guaranteed. The asset reverts to the lessor at the end of the term. The lessee has no
way of knowing the unguaranteed residual value at the end of the lease term, or the one at the end
of the asset's useful life, or the total useful life of the asset at inception. However, the lessee does
know the lessor's implicit rate (10%), and the asset's fair market value at inception ($14,000). The
lessee's borrowing rate on similar debt is 8%. Therefore:
A)
lessee has an operating lease as none of the four criteria are fulfilled
B)
lessee has a finance lease as the present value of lessee minimum lease payments exceeds
90% of the asset's fair market value at inception
C)
lessee has a finance lease as the lease term is at least 75% of the asset's remaining life at
inception
D)
lessee has an operating lease as the present value of lessee minimum lease payments is less
than 90% of the asset's fair market value at inception
E)
the 90% criterion does not apply in this case
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 33
Chapter 17 – Leases
118. LOR leased a computer to LES which cost the lessor $8,000. The terms of the lease specify four
years, an annual interest rate of 15 percent, and four year-end rental payments. The lease qualifies
as a finance lease (direct financing). The lessor will get the computer after the fourth year and its
residual value at that time is estimated to be $1,000. The amount of each rental payment is (round
to the nearest dollar):
A)
$2,000
B)
$2,335
C)
$2,501
D)
$2,602
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO7
119. Which of the following are the required operating lease note disclosure requirements for
the lessee?
hz
1.
2.
3.
4.
5.
1, 2, 3, 4, & 5.
1, 2, & 5.
1, 2, 3 & 4.
1& 2.
1, 2 & 3.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
d
zle
A)
B)
C)
D)
E)
Minimum lease payments
Contingent Rents
Scheduled lease payments for the next year
Scheduled lease payments in total for the next four years
Scheduled lease payments in total for all years.
120. One incentive for entering into sale-and-leaseback arrangements is:
A)
tax implications are favourable for the lessor.
B)
improvement in cash flow for the lessor.
C)
lessee may be able to reduce interest expense through the refinancing aspects of the saleleaseback.
D)
lessor has an abundance of cash.
E)
lessee wants to increase return on investment.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 34
Chapter 17 – Leases
121. If the lessor and lessee use different interest rates to account for a finance lease, then:
A)
the lessor will use different account titles to record the leasing transaction.
B)
total expenses (or revenues) will be equal for each.
C)
total expenses (or revenues) will be different for each.
D)
the lessee and lessor cannot use different interest rates.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
Ans: B
hz
122. LAS owns a building in North Bay. LAS enters into an agreement with BH as follows: LAS sells
the building to BH for $2,900,000 and immediately leases it back for $500,000 per year for 10
years. The historical cost of the building was $9,000,000 and accumulated amortization amounted
to $7,000,000. Part of the journal entry to record these transactions includes:
A)
credit to building for $2,000,000
B)
credit to deferred gain for $2,000,000
C)
credit to gain on sales for $2,000,000
D)
credit to lease liability for $5,000,000
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
zle
Ans: C
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
123. STU made the following journal entry at the end of the first lease year:
Rent expense..............1,500
Cash..................................1,500
STU must have a(n):
A)
direct financing lease.
B)
lease with a bargain purchase option.
C)
operating lease.
D)
sales-type lease.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 17 – Leases
124. The lessor recognizes a profit at the inception of the lease when the lease is classified as a(n):
A)
operating lease.
B)
non-finance lease.
C)
direct financing lease.
D)
sales-type lease.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3, 4
125. The basic accounting issue for lessors is:
A)
computing depreciation on the leased asset.
B)
determination of the cost of the leased asset.
C)
revenue recognition during the lease term.
D)
expense recognition during the lease term.
Ans: C
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
Ans: C
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126. Which of the following is the complete list of classifications of leases from the standpoint of the
lessor:
A)
direct financing and operating.
B)
direct financing and sales-type.
C)
direct financing, sales-type and operating.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
d
127. When a non-refundable down payment on a leased asset is made in advance under an operating
lease, at the payment date, the lessor credits:
A)
lease liability.
B)
rent revenue.
C)
cash.
D)
unearned rent.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 36
Chapter 17 – Leases
128. If the lessor records unearned rent at the inception of a lease, then the lease must:
A)
be an operating lease.
B)
be a direct financing lease.
C)
contain a bargain purchase option.
D)
be an annuity due.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
129. JKL received an $8,000 advance, non-refundable, bonus payment on a 5-year operating lease. An
acceptable accounting treatment for this lease bonus is:
A)
recognize $8,000 revenue at the end of the lease term.
B)
recognize $8,000 revenue when the cash is received.
C)
recognized $1,600 revenue at the end of the first year of the lease term.
D)
to record an $8,000 deferred charge until the other rental payments are assured.
hz
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO1
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130. Under a finance lease that includes a bargain purchase option (BPO), how is depreciation on the
asset under lease recognized by:
Lessor
not recognized
depreciate over remaining life
not recognized
depreciate over remaining life
A)
B)
C)
D)
Choice 1
Choice 2
Choice 3
Choice 4
Lessee
depreciate over lease term
depreciate over remaining life
depreciate over remaining life
not recognized
d
1
2
3
4
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3, 7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 37
Chapter 17 – Leases
131. LMN made the following journal entry relating to a finance lease:
Cash...........................
Lease receivable..............
Interest revenue..............
Therefore, LMN must be the:
A)
third party guarantor.
B)
lessee.
C)
lessor.
D)
either the lessee or lessor.
XXXX
XXXX
XXXX
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
Ans: A
hz
132. The amount of each rental payment on a direct financing lease is based on the:
A)
cost of the leased asset.
B)
cost of the asset plus interest.
C)
cost of the asset plus profit.
D)
cost of the asset, profit, and interest.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
d
133. In a direct financing lease, the present value of the periodic rental payments must equal the
amount of the:
A)
lessor's cost of the leased asset.
B)
lessee's total rent expense.
C)
guaranteed residual value.
D)
bargain purchase option.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 17 – Leases
134. WXY leased an asset from CDE that cost $104,974 (i.e., the present value of the lease rentals).
The contract required ten $20,125 annual payments to be made each year-end. This rental amount
was necessary in order for CDE to earn a 14 percent rate of return. (Assume a present value factor
of 5.216116). To CDE, the lease was most likely a(n):
A)
operating lease.
B)
sale-type lease.
C)
direct financing lease.
D)
leveraged lease.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
Ans: C
hz
135. TUV Leasing Company entered into an agreement to lease a computer which cost $113,534.
There was no bargain purchase option, nor a guaranteed residual value. The lease term was for 6
years and payments of $30,000 are payable at the end of the year. The target rate of return was 15
percent. (Assume the present value of an ordinary annuity, for six years, at 15 percent equals
3.78448.) The lease must have been classified by the lessor as a(n):
A)
sales-type lease.
B)
operating lease.
C)
direct financing lease.
D)
Cannot be determined.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
d
136. The amount of each rental payment on a sales type lease is based on the:
A)
cost of the leased asset.
B)
cost of the asset plus interest.
C)
cost of the asset plus profit.
D)
cost of the asset, profit, and interest.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 39
Chapter 17 – Leases
137. The amount of each rental payment on a sales type lease includes:
A)
a return of cost.
B)
a return of cost, and interest.
C)
a return of cost, interest, and profit.
D)
interest and profit.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
138. For the lessor, under a sales-type lease, the excess of the normal sales price (i.e., current market)
of the leased asset over its cost (or carrying amount) should be recognized as revenue by the
lessor:
A)
in decreasing amounts during the lease term.
B)
in increasing amounts during the lease term.
C)
in equal amounts during the lease term.
D)
in full at the inception date of the lease.
hz
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1,2,3, 4
d
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139. The market value of an asset to be leased exceeds the original cost of the asset. The lease will
contain a bargain purchase option. The collectability of lease payments is assured, and there are
no material cost uncertainties for the lessor. Therefore the lease will be accounted for by the
lessor as a
A)
direct financing lease
B)
operating lease
C)
rental lease
D)
sales type lease
E)
unguaranteed lease
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 40
Chapter 17 – Leases
140. Among the following types of finance leases, for the lessor, which likely recognizes the greatest
amount of revenue at inception?
A)
Operating
B)
Direct financing
C)
Sales-type
D)
Among those in this list, there would be no material difference
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
141. Under a sales-type lease, the difference between the cost of the leased asset and the lease
receivable is accounted for by the lessor and lessee as follows:
Lessor
gross margin
interest revenue
gross margin
interest revenue
gross margin
A)
B)
C)
D)
E)
Choice 1
Choice 2
Choice 3
Choice 4
Choice 5
zle
Ans: E
Lessee
not recognized
not recognized
interest expense
included in capitalization of the leased asset
included in capitalization of the leased asset
hz
1
2
3
4
5
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3, 4, 7
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 41
Chapter 17 – Leases
142. LMN correctly recorded a 5-year lease on a special machine by making the following entry on the
date the lease was signed:
Lease receivable.......................
Asset-machine under lease.............
Gross margin (dealer's profit)........
Unearned interest revenue.............
XXXX
XXX
XX
X
The lease was the following:
A)
direct financing lease.
B)
operating lease.
C)
sales-type lease.
D)
could be either a direct financing or sales-type lease.
E)
cannot determine with confidence based on the limited data given.
Ans: C
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: B
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143. Which of the following is included in only one or the other, but not both, of the lessor's minimum
lease payments and net lease receivable?
A)
bargain purchase option
B)
unguaranteed residual value
C)
third party guarantee of residual
D)
lessee guarantee of residual value
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3, 7
d
144. In a sales-type lease with an unguaranteed residual value, the gross margin recognized by the
lessor in the year of inception is:
A)
market value of asset less book value of asset
B)
market value of asset less book value of asset less the present value of the unguaranteed
residual value
C)
market value of asset less book value of asset less the nominal value of the unguaranteed
residual valued.
D)
0 (zero)
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 42
Chapter 17 – Leases
145. Material gains resulting from sale-and-leaseback transactions usually should be accounted for:
A)
by crediting the gain to the cost of the related property.
B)
by amortizing the gain over the life of the lease.
C)
as an ordinary gain of the period of the transaction.
D)
as an unusual gain of the period of the transaction.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
146. A company sold property at a price in excess of book value and then leased back the property for
a ten-year term. The gain resulting from the sale of the property should be recognized:
A)
over the lease term.
B)
as a prior period adjustment in the period of sale.
C)
in the year of the sale.
D)
at the end of the ten-year period or termination of the lease, whichever is earlier.
hz
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
d
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147. For which party is finance lease accounting affected most when the property is first sold and then
leased back:
A)
lessor
B)
lessee
C)
both lessor and lessee accounting are affected to the same extent
D)
neither lessor nor lessee accounting are affected to a significant extent
148. The lessor must classify a sale-and-leaseback arrangement as a(n):
A)
direct financing lease or an operating lease.
B)
direct financing lease or a sales-type lease.
C)
operating lease or a guaranteed lease.
D)
operating lease or a sales-type lease.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 43
Chapter 17 – Leases
149. One incentive for entering into sale-and-leaseback arrangements is:
A)
tax implications are favourable for the lessor.
B)
improvement in cash flow for the lessor.
C)
lessee may be able to reduce interest expense through the refinancing aspects of the saleleaseback.
D)
lessor has an abundance of cash.
E)
lessee wants to increase return on investment.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: C
hz
150. One incentive for entering into sale-and-leaseback arrangements is:
A)
tax implications are favourable for the lessor.
B)
improvement in cash flow for the lessor.
C)
lessee may be able to reduce interest expense through the refinancing aspects of the saleleaseback.
D)
lessor has an abundance of cash.
E)
lessee wants to increase return on investment.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
151. In a sale-and-leaseback agreement, the lessor is also:
A)
the buyer.
B)
a third party guarantor.
C)
the lessee.
D)
the seller.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
d
Ans: A
152. In a sale and leaseback arrangement, the lessee is also:
A)
the new owner of the property
B)
the seller
C)
the buyer
D)
a third party guarantor
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 44
Chapter 17 – Leases
153. In a sale and leaseback situation
A)
all gains and losses are deferred and amortized by the seller
B)
if the present value of the lease payments is equal to or less than 90% of the fair value of
the property, the lessee recognizes the entire gain or loss on sale immediately
C)
the lessee immediately recognizes any loss on sale up to the amount of the difference
between carrying value and fair value
D)
the lessor recognizes all losses on the sale immediately but must defer and amortize all
gains
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: A
hz
154. RST leased equipment from MNO to be used in its warehouse. The lease term is five years. RST
spent $5,000 for ordinary repairs during the second year of the lease. RST should:
A)
expense the $5,000 immediately.
B)
write the $5,000 off at the end of the lease term.
C)
capitalize the $5,000 permanently in the lease account.
D)
amortize the $5,000 over the life of the lease on a reasonable basis.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
155. Executory costs include:
A)
interest expense incurred.
B)
annual lease rentals paid.
C)
insurance premiums.
D)
leasehold improvements.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
d
Ans: C
156. Initial direct costs are:
A)
insurance, property taxes, and maintenance costs.
B)
interest and annual lease rental paid.
C)
non-refundable down payments made by the lessee.
D)
incremental costs incurred by the lessor in negotiating and consummating the lease
agreement.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 45
Chapter 17 – Leases
157. If the title to a leased asset does not transfer to the lessee at the end of the lease term, but the
lessee guarantees the residual, what is the period and residual value used by the lessor to
depreciate the leased asset?
1
2
3
4
Period
lease term
lease term
remaining life at inception
remaining life at inception
A)
B)
C)
D)
Choice 1
Choice 2
Choice 3
Choice 4
Residual value
0
lessee guarantee
lessee guarantee
0
Ans: B
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
Ans: A
zle
158. What amount of sales is recognized by the lessor in a sales type lease when the residual value is
guaranteed?
A)
market value of the asset leased
B)
cost of asset leased
C)
market value of asset leased less present value of unguaranteed residual value
D)
cost of asset leased less present value of unguaranteed residual value
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
d
159. What amount of sales is recognized by the lessor in a sales type lease when the residual value is
unguaranteed?
A)
market value of the asset leased
B)
cost of asset leased
C)
market value of asset leased less present value of unguaranteed residual value
D)
cost of asset leased less present value of unguaranteed residual value
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 46
Chapter 17 – Leases
160. Initial direct costs include lessor costs incurred:
A)
before obtaining the commitment of a potential lessee to enter into a lease contract
B)
after obtaining the commitment of a potential lessee to enter into a lease contract
C)
before and after obtaining the commitment of a potential lessee to enter into a lease
contract
D)
for the purpose of upgrading an existing lease contract
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3
Ans: C
zle
hz
161. On the first day of its fiscal year, Lessor, Inc., leased certain property at an annual rental of
$100,000 receivable at the beginning of each year for ten years. The first payment was received
immediately. The leased property, which is new, had cost $650,000 and has an estimated useful
life of thirteen years and no salvage value.
Lessor's borrowing rate is 8 percent. The present value of an annuity of $1 payable at the
beginning of the period at 8 percent for ten years is 7.247. Lessor had no other costs associated
with this lease. Lessor should have accounted for this lease as a sales-type lease, but it mistakenly
treated the lease as an operating lease. What was the effect on net earnings during the first year of
the lease by having treated this lease as an operating lease rather than as a sales-type lease?
A)
Overstated
B)
No effect
C)
Understated
D)
The effect depends on the method selected for income tax purposes
Difficulty: Medium
Level of Learning: Application
Topic: LO4
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 17 – Leases
162. On January 1, 20x11, CDE Company leased an asset from LMN which originally cost the lessor
$75,000. The lease agreement was an operating lease and specified that three $10,500 annual
rentals were to be paid at the beginning of each year. LMN should make the following entry on
January 1, 20x11:
1 Cash
10,500
Unearned rent revenue
2 Cash
10,500
10,500
Lease receivable
10,500
3 Cash
10,500
Rent revenue
4 Rent receivable
Rent revenue
10,500
A)
B)
C)
D)
10,500
10,500
Choice 1
Choice 2
Choice 3
Choice 4
hz
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
163. A lease agreement includes the following provisions:
d
zle
Inception: 1/1/x0
Annual lease payments of $6,000 are due 12/31/x0, x1, x2
Annual lease payments of $4,000 are due 12/31/x3, x4, x5
There are 6 lease payments in all
Lessor's implicit rate of return: 12%
This is a finance lease to the lessor
How much interest revenue is recognized in 20x10 by the lessor (assume a calendar year fiscal
year)?
A)
$3,600
B)
$3,419
C)
$2,550
D)
$2,118
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 17 – Leases
164. A lessor and lessee enter into a lease agreement with the following characteristics:
Inception: 1/1/x0 6 annual lease payments of $10,000 are due each Jan. 1 beginning1/1/x0
End of lease term: 12/31/x5
Book value of equipment under lease, at inception: $35,000
Market value of equipment under lease, at inception: $50,000
Remaining useful life of equipment at inception: 9 yrs
Expected residual value at end of lease term: $4,000
Interest rate used by lessor and lessee: 10%
This lease is:
A)
an operating lease for both lessor and lessee
B)
a finance lease for lessee because the lease term is sufficiently long
C)
a finance lease for lessee because the present value of minimum lease payments is
sufficiently large
D)
a direct financing lease for the lessor
Ans: C
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO2
165. A lessor and lessee enter into a lease agreement with the following characteristics:
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO7
d
zle
Inception: 1/1/x06 annual lease payments of $10,000 are due each Jan. 1 beginning1/1/x0
End of lease term: 12/31/x5
Book value of equipment under lease, at inception: $35,000
Market value of equipment under lease, at inception: $50,000
Remaining useful life of equipment at inception: 9 yrs
Expected residual value at end of lease term: $4,000
Interest rate used by lessor and lessee: 10%
Assuming the lessor will capitalize this lease, what is the amount of the net lease receivable for
the lessor, before the first payment is made?
A)
$47,908
B)
$60,000
C)
$64,000
D)
$50,166
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 49
Chapter 17 – Leases
166. ABC entered into a direct financing lease with QRS to rent a machine that cost $18,000. The
lease term was for six years. The annual rentals are payable at the beginning of each year, and
ABC expects to earn a 14 percent rate of return. The required amount of the annual rentals is
(rounded to the nearest dollar):
A)
$30,000
B)
$36,600
C)
$40,604
D)
$46,288
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO7
167. RST entered into a direct financing lease agreement, which required rentals of $9,600, each year-
Ans: A
hz
end. The lease term was for ten years and a 14 percent rate of return is expected by RST. The cost
of the machine for RST was (rounded to the nearest dollar):
A)
$50,075
B)
$82,560
C)
$96,000
D)
$109,440
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO2
168. XYZ agreed to lease an industrial machine that cost $108,000 to RST for six years. The lease was
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
a direct financing lease and a 12 percent interest rate was used to calculate the annual lease
payments, which were payable at the end of each year. The amount of each annual rental was:
A)
$18,000
B)
$20,160
C)
$26,268
D)
$44,402
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 17 – Leases
169. On January 1, 20x11, ABC leased a machine to MNO. The lease was for a 10-year period, which
approximated the useful life of the machine. ABC purchased the machine for $120,000 and
expects to earn a 10 percent return on its investment, based upon an annual rental of $17,754
payable in advance each January 1st. Assuming that the lease was a direct financing lease, what
should be the interest entry on ABC's books on December 31, 20x11?
1 Cash..................................
Interest revenue.....................
2 Unearned interest revenue..............
Interest revenue......................
3 Unearned interest revenue..............
Interest revenue......................
4 Cash...................................
Interest revenue......................
Equipment.............................
5,754
10,225
10,225
12,000
12,000
17,754
12,000
5,754
Choice 1
Choice 2
Choice 3
Choice 4
Ans: B
hz
A)
B)
C)
D)
5,754
Difficulty: Medium
Level of Learning: Application
Topic: LO7
zle
170. XYZ Rental leased a special crane to ABC that originally cost $40,000. The lease was for six
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO7
d
years and the rentals were $10,000 per year, payable at each year-end. The implicit interest rate
was 10 percent. XYZ Rental recognized a gross margin (dealer's profit) of (rounded to nearest
dollar):
A)
$3,553
B)
$4,000
C)
$20,000
D)
$24,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 17 – Leases
171. RST entered into a sales-type lease with EFG to rent special equipment for six years. The
equipment cost $40,000 and RST will earn a $4,000 dealer's profit and 12 percent interest
revenue. Therefore, RST will receive year-end lease payments of:
A)
$7,333
B)
$8,213
C)
$10,702
D)
$12,090
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 7
172. ABC entered into a sales-type lease to lease JKL an asset that cost ABC $120,000. The lease
Ans: B
hz
agreement requires five annual year-end rentals of $40,000 each. ABC used a 15 percent interest
rate to compute the rentals. The dealer's profit (or loss) that ABC recognized was:
A)
$14,086 loss.
B)
$14,086 gain.
C)
$18,000 gain.
D)
$80,000 gain.
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Difficulty: Medium
Level of Learning: Application
Topic: LO2
173. LMN leases construction equipment on sales-type leases. LMN wants to record a $7,000 dealer's
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 7
d
profit on assets leased, each of which cost $60,000. What annual year-end rentals should LMN
quote to earn a 12 percent return on 8-year leases?
A)
$6,625
B)
$8,375
C)
$9,380
D)
$13,487
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 17 – Leases
174. JKL leased an asset to RST that cost $100,000 when purchased by JKL. The lease term was for
six years and specified year-end rentals. JKL earns a $12,000 dealer's profit and uses an interest
rate of 14 percent to compute the annual rentals. The amount of each annual rental must be:
A)
$16,666
B)
$18,666
C)
$21,280
D)
$28,802
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO2
175. BCD leased special equipment to QRS on January 1, 20x11. The lease is for an eight-year period
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Ans: A
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ending December 31, 20x18. The first of eight equal annual payments of $300,000 was made on
January 1, 20x11. BCD had purchased the equipment on December 29, 20x10, for $1,600,000.
The lease is appropriately accounted for as a sales-type lease by BCD. Assume that the present
value at January 1, 20x11, of all rent payments over the lease term discounted at a 10 percent
interest rate was $1,760,000. What amount of interest revenue should BCD record at the end of
20x12 (the second year of the lease period) as a result of the lease?
A)
$130,600
B)
$146,000
C)
$160,000
D)
$163,600
Difficulty: Medium
Level of Learning: Application
Topic: LO7
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 53
Chapter 17 – Leases
176. A lessee that enters into a finance least must disclose which of the following?
1. Any significant finance lease arrangements.
2. Any contingent rent recognized as expense during the period.
3. The net carrying value of each class of leased asset at the reporting date.
4. Total future minimum lease payments.
5. A reconciliation between total minimum future lease payments and their present value.
A)
B)
C)
D)
1, 2 & 3.
1, 2 & 4.
1, 2, 3 & 4.
1, 2, 3, 4 & 5.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
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177. Based solely upon the following sets of circumstances indicated below, which set gives rise to a
sales-type or direct financing lease of a lessor?
1
2
3
4
Choice 1
Choice 2
Choice 3
Choice 4
Collectability
of lease
payments
assured?
No
No
Yes
Yes
Any
Important
Uncertainties?
Yes
No
Yes
No
d
A)
B)
C)
D)
Contains
bargains
purchase
provision?
No
No
Yes
Yes
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Transfers
ownership
by end of
lease?
Yes
Yes
No
No
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 54
Chapter 17 – Leases
178. Which of the following statements best describes the finance lease guidelines under
ASPE from the lessee’s point of view?
A)
B)
C)
D)
The lease term must be at least 75% of the asset’s life.
The present value of the minimum lease payments must be equal to 90% or more of the
asset’s fair value.
The criteria for finance leases is met if either A or B are met.
The criteria for finance leases are met if A AND B are met.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO9
179. Which interest rate must be used by the lessee to account for a finance lease under
ASPE?
The lessor’s implicit rate if known, otherwise the lessee’s incremental borrowing rate.
The lessor’s implicit rate.
The lessee’s incremental borrowing rate.
The lower of B & C above.
Ans: D
hz
A)
B)
C)
D)
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO9
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180. Under ASPE, a lessor may classify a lease as a finance lease if:
A)
B)
C)
D)
The credit risk relating to the lease and lessee are normal.
The lessor’s unreimbursable costs can be reasonably estimated.
Either A or B must be met to meet the finance lease criteria under ASPE.
Both A and B must be met to meet the finance lease criteria under ASPE.
Ans: D
d
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO9
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 55
Chapter 17 – Leases
181. ABC leased equipment to XYZ on January 1, 20x10. The lease is for a 9-year period expiring
January 1, 20x18. The first equal annual payment of $400,000 was made on January 1, 20x10.
The cash selling price of the equipment is $2,347,500, which is equal to the present value of the
lease payments at 10 percent. ABC had purchased the equipment for $2,100,000. The lease is
appropriately recorded as a sales-type lease by ABC. What amount of interest income should
ABC record in 20x10 as a result of the lease?
A)
$194,750
B)
$210,000
C)
$234,750
D)
$280,000
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO7
182. MNO Company leased equipment from RST Corporation on July 1, 20x19, for an 8-year period.
Ans: C
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hz
Equal payments under the lease are $600,000 and are due on July 1 of each year. The first
payment was made on July 1, 20x19. The rate of interest contemplated by MNO and RST is 10
percent. The cash selling price of the equipment is $3,520,000 and the cost of the equipment on
RST's accounting records is $2,800,000. Assuming that the lease is appropriately recorded as a
sales-type lease, what is the amount of profit on the sale and interest income that RST should
record for the year ended December 31, 20x19?
A)
$0 and $0
B)
$0 and $146,000
C)
$720,000 and $146,000
D)
$720,000 and $160,000
Difficulty: Medium
Level of Learning: Application
Topic: LO7
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 56
Chapter 17 – Leases
183. Choose the correct statement regarding the terms listed in the lessor's (1) minimum lease
payments and (2) net lease receivable for a capitalized lease:
1
2
3
4
A)
B)
C)
D)
unguaranteed residual
lessee guarantee of residual
third party guarantee of residual
bargain purchase option
(1)
yes
no
no
no
Include in:
(2)
yes
yes
yes
no
Choice 1
Choice 2
Choice 3
Choice 4
Ans: A
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
184. If the title to a leased asset does not transfer to the lessee at the end of the lease term, but a third
party guarantees the residual, what is the period and residual value used by the lessor to
depreciate the leased asset?
Choice 1
Choice 2
Choice 3
Choice 4
Residual value
0
residual value at end of term
residual value at end of term
0
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
d
A)
B)
C)
D)
Period
lease term
lease term
remaining life at inception
remaining life at inception
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1
2
3
4
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Chapter 17 – Leases
185. If the title to a leased asset does not transfer to the lessee at the end of the lease term, and no party
guarantees the residual, what is the period and residual value used by the lessor to depreciate the
leased asset?
1
2
3
4
A)
B)
C)
D)
Period
lease term
lease term
remaining life at inception
remaining life at inception
Residual value
0
residual value at end of term
residual value at end of term
0
Choice 1
Choice 2
Choice 3
Choice 4
Ans: A
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
186. If the title to a leased asset transfers to the lessee at the end of the lease term, what is the period
and residual value used by the lessor to depreciate the leased asset?
Period
remaining life at inception
original useful life
remaining life at inception
lease term
A)
B)
C)
D)
Choice 1
Choice 2
Choice 3
Choice 4
Residual value
residual value at end of term
residual value at end of life
residual value at end of life
residual value at end of term
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
d
zle
1
2
3
4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Page 58
Chapter 17 – Leases
187. With respect to a lessor’s indirect costs, under ASPE:
A)
B)
C)
D)
These should be expensed for both direct financing and sales-type leases.
These should be capitalized for both direct financing and sales-type leases.
These should be expensed under direct financing leases and capitalized under sales-type
leases.
These should be capitalized under direct financing leases and expensed under sales-type
leases.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO9
188. An asset was purchased by a lessor several years ago. At date of purchase, the asset was expected
Ans: D
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to have a 40-year useful life. Today, the asset has only 8 years of remaining service life. The asset
is leased today. The lease has a term of 5 years starting today and the present value of minimum
lease payments is $18,000 for the lessor. What is the minimum book value of the asset to the
lessor for this lease to qualify as a direct financing lease?
A)
$20,000
B)
$16,200
C)
$18,000
D)
this lease is not a direct financing lease
d
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Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 59
Chapter 17 – Leases
189. On January 1, 20x11, BE Company collected a $15,000 cash, non-refundable, bonus payment on
an operating lease. Assuming a 12 percent interest rate and a five-year lease term, the lease bonus
amortization journal entry for 20x11, if the interest method is used, is:
1 Cash..................................
Rent revenue.........................
2 Lease receivable......................
Rent revenue.........................
3 Unearned rent revenue.................
Rent revenue.........................
4 Unearned rent revenue.................
Rent revenue.........................
A)
B)
C)
D)
15,000
15,000
3,000
3,000
3,000
3,000
2,361
2,361
Choice 1
Choice 2
Choice 3
Choice 4
hz
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO7
190. The inception of a lease is 1/1/x1. A third party guarantees the residual value of the asset under
A)
B)
C)
D)
E)
Net asset (lessor)
$45,359
$37,908
$45,359
$37,908
$47,119
Net liability (lessee)
$45,359
$37,908
$37,908
$45,359
$38,339
d
1
2
3
4
5
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lease, estimated to be $12,000 at 1/1/x6, the end of the lease term. Annual lease payments are
$10,000 due each December 31 beginning 12/31/x1. The last payment is due 12/31/x5. Both the
lessor and lessee use 10% as the interest rate. The remaining useful life of the asset was 6 years at
inception. What is the net asset balance for the lessor and net liability balance for the lessee, at
inception?
Choice 1
Choice 2
Choice 3
Choice 4
Choice 5
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3, 7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 60
Chapter 17 – Leases
191. WXZ entered into a direct financing lease with TUV for the use of an asset which cost WXZ
$240,000. The lease agreement contained a bargain purchase option effective immediately after
the fifth rental, which provided that TUV could purchase the asset at that time. The estimated life
of the asset was 10 years with an estimated residual value of $400. TUV's annual depreciation
expense is (use straight- line):
A)
$22,200
B)
$23,960
C)
$44,400
D)
$48,000
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3, 7
192. XYZ agreed to lease a computer, at cost, to ABC for $36,000 each year-end for seven years
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Ans: A
hz
without a bargain purchase option, or, as an equivalent alternative, for $33,000 per year with a
bargain purchase option, after the seventh rental. If the lease is a direct financing lease, and XYZ
expects to earn a 12 percent rate of return, the amount of cash ABC would have to remit for the
bargain purchase option is:
A)
$30,266
B)
$26,340
C)
$21,000
D)
$9,498
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
193. WXY entered into a direct financing lease (interest rate 12 percent) to lease ABC an asset that
d
cost WXY $90,000. The lease specified annual year-end payments for seven years. The lease also
specified that, along with the last payment, ABC could purchase the asset for $8,000 cash. ABC
will have to pay equal annual payments of:
A)
$11,714
B)
$12,858
C)
$17,966
D)
$18,928
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 61
Chapter 17 – Leases
194. RST entered into a direct financing lease with ZAB, which called for seven annual rentals of
$3,500 (interest rate 12 percent) to be paid at the end of each year. The lease also contained a
bargain purchase option allowing ZAB to purchase the asset for $2,500 after making the seventh
annual rental payment. The cost of the asset must have been:
A)
$17,104
B)
$18,473
C)
$25,631
D)
$27,000
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
195. LMO leased an asset for use in its factory. The lease specified that LMO was to make annual
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Ans: B
hz
payments of $2,818 payable at the end of each year. The lessor classified the lease as a direct
financing lease because LMO was allowed to lease the asset at cost of $14,000 (i.e., the present
value of the lease payments). The lessor received a 12 percent rate of return on the lease. The
estimated residual value at the end of the lease term is zero. If the lease was classified as a finance
lease by LMO, how much annual depreciation (using SL) should LMO record?
A)
$1,400
B)
$1,750
C)
$1,310
D)
$2,818
Difficulty: Medium
Level of Learning: Application
Topic: LO7
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 62
Chapter 17 – Leases
196. On January 1, 20x11, LOR leased a machine (original cost $60,000) to LES for a 5-year period at
an implicit interest rate of 15 percent. The lease qualified as a direct financing lease and the
annual lease payments ($17,306) are made each December 31. LOR retained the $4,000 estimated
unguaranteed residual value (i.e., the machine reverts to LOR at the end of the lease term).
Therefore, at inception date (January 1, 20x11), LOR's net receivable and LES's liability would
be (round to the nearest dollar):
LOR Receivable
$60,000
$58,011
$60,000
$58,011
1
2
3
4
A)
B)
C)
D)
LES Liability
$60,000
$58,011
$58,011
$60,000
Choice 1
Choice 2
Choice 3
Choice 4
hz
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3, 7
197. On December 10, 20x11, LMN purchased a special machine for leasing purposes; it cost $10,000.
zle
On January 1, 20x12, the machine was leased to ABC under the following terms (it is a direct
financing lease): a. lease term 4 years; interest rate 10 percent; rentals payable at year-end. b.
LMN retains the residual value of $1,000 (i.e., the RV when the machine is returned to LMN at
the end of year 4). There is no guarantee on the residual value.
On January 1, 20x12, when the lease term starts, the following accounting amounts should be
used:
1
2
3
4
A)
B)
C)
D)
ABC's Lease
Receivable
Liability
$ 9,317
$ 9,317
10,000
9,317
9,317
10,000
10,000
10,000
d
LMN's net Lease
Lease payment
$2,939
2,939
3,155
3,155
Choice 1
Choice 2
Choice 3
Choice 4
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3, 7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 63
Chapter 17 – Leases
198. Company A enters into a lease agreement with Company B. The fair value of the asset is
$100,000. The present value of the minimum lease payments is $90,000. The yearly payment is
$10,000, depreciation amounts to $5,000 and the lease meets the requirement of an operating
lease. What is the journal entry at the end of the first year assuming a full 12 months have passed?
Ans: A lease is operating therefore only record the payment.
Dr. Lease/Rent expense
Cr. Cash
$10,000
$10,000
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
199. What guidelines are used under IFRS to determine whether a lease is an operating lease?
Ans: A lease is an operating lease if it does not meet the criteria established for a finance lease
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
hz
Difficulty: Medium
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200. Ryan Corp. enters into an sale and leaseback agreement with Geisler Corp. Ryan Corp. sold its
building to Geisler Corp. for $400,000. The building had a historical cost of $600,000 and
accumulated depreciation of $300,000. Ryan Corp. then leased it back from Geisler corp. for
$80,000 per year for 10 years. Prepare the journal entry to record the sale.
Ans:
Dr. Cash
$400,000
Dr. Accumulated depreciation
$300,000
Cr. Building
$600,000
Cr. Deferred gain on sale and leaseback of building
$100,000
Level of Learning: Application
Topic: LO4
d
201. Ryan Corp. enters into an sale and leaseback agreement with Geisler Corp. Ryan Corp. sold its
building to Geisler Corp. for $400,000. The building had a historical cost of $600,000 and
accumulated depreciation of $300,000. Ryan Corp. then leased it back from Geisler corp. for
$80,000 per year for 8 years. The lease qualifies as a finance lease. It is Ryan Corp's policy to
depreciate buildings over 10 years. Prepare the journal entry to record the amortization for the
first year. (assume a January 1 transaction and a December 31 year end).
Ans: Deferred gain = $100,000 ($400,000 received less the BV $300,000). The deferred gain
should be amortized in proportion to the amortization of the leased asset and the lease
payments. Therefore amortization should be $10,000/yr
Dr. Deferred gain on sale and leaseback of building
Cr. Amortization expense, leased building
$10,000
$10,000
Difficulty: Medium
Level of Learning: Application
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 17 – Leases
202. Leasing assets can result in much time and effort on the part of the lessee. Contracts, details,
complex calculations and journal entries are all required to accurately track each lease. Why then,
with all the extra work involved would a company be inclined to lease instead of buy?
Ans: Many companies lease due to the nature of their business. They acquire the right to use the
asset but the risks associated with ownership remains with the lessor. Other companies
enter into a lease with the hope of improving or maintaining their cash flow. Often leases
can be structured so that the payments are less than if the asset were purchased via
financing.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
d
zle
hz
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 65
Chapter 17 – Leases
203. Lessor Company rented a machine to Lessee Company on January 1, 20x11, for a period of 3
years. Rent of $6,000 is due January 1, of each year (starting in 20x11). The lease qualified as an
operating lease for both the lessor and lessee. In addition to the monthly rentals, the lease contract
required Lessee Company to pay $1,000 on January 1, 20x11 (this is non-refundable). The
accounting period ends December 31. Complete the entries required for Lessee Company on the
following dates, using the straight-line method.
(a) January 1, 20x11:
(b) December 31, 20x11:
Ans: (a) January 1, 20x11:
Prepaid rent expense
1,000
Rent expense
6,000
Cash
7,000
(b) December 31, 20x11:
Rent expense ($1,000/3)
Prepaid rent expense
333
333
Difficulty: Medium
hz
Level of Learning: Application
Topic: LO2, 3
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204. On January 1, 20x11, LE Corporation leased a machine from LOC for a period of three years and
paid $4,800 at the inception of the lease.
In addition, five equal rentals of $4,800 are to be paid at the beginning of each six-month period
thereafter. The effective annual interest rate was 8%. The lease qualifies as a finance lease.
(a) Compute the amount of the lease liability at 1/1/x1.
(b) Complete LEC's partial amortization schedule given below.
Round amounts to the nearest dollar.
Rent
Payment
Date
Interest
Expense
Liability
Balance
d
1/1/20x11
Start
1/1/x1 $ 4,800
6/30/20x11
7/1/20x11
4,800
Ans: (a) $4,800 x PVAD, 4% 6 (5.45182) =
Reduction
of Liab.
$26,169
(b) Annuity date basis:
Date
1/1/20x11
1/1/x1
6/30/20x11
7/1/20x11
Rent
Payment
Start
$4,800
$21,369 x 4% = $855
4,800
Interest Expense
(855)
4,800
Reduction
of Liab.
$4,800
22,224
17,424
Liability
Balance
$26,169
$21,369
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 66
Chapter 17 – Leases
205. A lessee rented a machine that had a market value (cost new to the lessor) of $26,132, for a 6year term, with annual year-end rentals (ordinary annuity situation) of $6,000 each. The annual
implicit interest rate would be _______________%
Ans: 10%, computed as follows:
$26,132 ÷ $6,000 = 4.35533; (PVA, 6) for n=6; implicit interest rate, 10%
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3, 7
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hz
206. The following information relates to a lease contract:
Lease inception
1-1-x1
Market value and book value (to lessor) of
new equipment under lease
$10,000
Interest rate used by both lessee and lessor
for lease accounting
10%
Lease payments due
12-31-x1 , x2, x3
End of lease term
1-1-x4
Expected residual value at 1-1-x4
$1,000
Expected residual value at 1-1-x7 (end of useful life)
$100
The lease allows the lessee to purchase the asset for $200 on 1-1-x4.
There are no uncertainties with respect to collectability of lease payments, or performance by
lessor.
(a) Determine the annual lease payment
(b) Classify the lease for the lessee
(c) Record the 20x11 entries
Ans: (a) $10,000 = LP (PVA, .10, 3) + $200(PV1, .10, 3); LP = $3,961
2.48685 .75131
(b) Minimum lease payments for = 3($3,961) + $200 = $12,083
PV of min lease payments = $10,000
Lessee: capitalize (fulfills criteria 2, 4)
d
(c) Lessee
Jan. 1
Leased asset
Lease liability
Dec. 31
Lease liability
Interest expense
Cash
Dep. Expense
Accum. dep.
$1,650 = ($10,000-$100)/6
Difficulty: Hard
10,000
10,000
2,961
1,000
3,961
1,650
1,650
Level of Learning: Application
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 67
Chapter 17 – Leases
207. A finance lease signed on January 1, 20x11, calls for 5 annual lease payments of $40,000 starting
January 1, 20x11. The asset reverts to the lessor on December 31, 20x15 at which time it is
expected to be worth $25,000. The lessor's implicit interest rate is 10%. What is the market value
of the asset at inception?
Ans: Market value = $40,000 + $40,000(PVA, 10%, 4) (3.16987) +
$25,000(PV1, 10%, 5) (.62092) = $182,318
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3
d
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Chapter 17 – Leases
208. On January 1, 20x11, LOR Company rented a machine (3-year life, no residual value, straightline) to LEE Company for a cash rental payable each December 31, 20x11, x2, and x3. The rental
is based on the regular sales price: cost, $35,665; sale price, $45,665. The agreed interest rate
was 15% and the lessee retains the machine at the end of the lease term at no additional cost.
(a) The annual rental is $_____________________.
(b) Complete the following lease amortization schedule:
Lease
Date
Payments
Amortization
Balance
(c) Give the lessor's and lessee's entries on the following dates:
LOR
LEE
January 1, 20x11:
December 31, 20x11:
Ans:
(a) Annual rental:
OR
Lease receivable
CGS
Asset (inventory)
Sales
Unearned int.
60,000
35,665
LOR
December 31, 20x11:
Cash
20,000
Unearned int.
6,850
Lease receivable
Interest revenue
Amortization
Balance
$13,150
15,123
17,392
32,515
17,392
-0-
45,665
45,665
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hz
$20,000
=======
$45,665 ÷ PVA, 15%, 3 = 2.28323, = $20,000
(b)
Lease
Date
Payments
1/01/x1
$45,665
12/31/x1
$20,000
$45,665 x 15% = $6,850
12/31/x2
20,000
32,515 x 15% = 4,877
12/31/x3
20,000
17,392 x 15% = 2,608*
*Rounded
(c)
LOR
LEE
January 1 20x11:
Lease receivable
60,000
Leased machine
Asset
35,665
Lease liability
Gross margin
10,000
Unearned int.
14,335
35,665
45,665
14,335
LEE
20,000
6,850
Lease liability
Interest expense
Cash
Depr. expense
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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13,150
6,850
20,000
15,222
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Chapter 17 – Leases
Accum.
epr.,machine
* $45,665/3
15,222*
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3, 7
209. On January 1, 20x11, TA acquired a machine (for leasing purposes) for $52,000 cash. The
machine had an estimated eight-year useful life and no residual value. On January 1, 20x11, the
machine was leased to LTB on an eight-year direct financing lease that required year-end annual
rentals of $9,395 starting on December 31, 20x11. The lessor's implicit interest rate was (rounded
to the nearest percent): __________%.
Ans: 9%; $52,000 ÷ $9,395 = 5.53486 (PVA, 8); 9% is the nearest %.
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
d
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Chapter 17 – Leases
210. LAC has negotiated a lease agreement with LEC effective January 1, 20x11. LAC will provide
LEC with a special-purpose building for ten (10) years. The lease is non-cancellable; requires
LEC to provide maintenance, insurance, taxes, etc.; and stipulates that the building reverts back to
LAC's control at the end of the lease. The building cost LAC $200,000 and is expected to have no
residual value at the end of the lease. LAC expects a 15% return on investments and the lease
qualifies as a direct financing lease. Rents are paid each December 31 starting in 20x11.
(a) How much annual rent will the lessee pay (rounded to the nearest dollar)?
$______________________________.
(b) Complete the following schedule of lease amortization for the lessee for the first two years:
Annual
Liability
Liability
Date
Rental
Interest Expense
Reduction
Balance
1/01/20x11
12/31/20x11
12/31/20x12
hz
(c) Complete the following entries for the lessee: January 1, 20x11, inception of lease.
December 31, 20x11, first rental payment and lessee's year-end entries (end of the accounting
period).
December 31, 20x11, accrual by lessee of $4,000 taxes on the building and payment of $800 for
repairs on the building.
Ans: (a) $200,000 ÷ PVA, 15%, 10 (5.01877) = $39,850
(b)
Annual
Rental
$200,000
$39,850
39,850
Interest at 15%
Liability
Reduction
Liability
Balance
$30,000
28,523
$ 9,850
11,327
190,150
178,823
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Date
1/01/20x11
12/31/20x11
12/31/20x12
(c)January 1, 20x11:
Leased Asset
Lease liability
200,000
d
December 31, 20x11:
Depreciation expense ($200,000 ÷ 10)
Accumulated depreciation
Interest expense
Lease liability
Cash
200,000
December 31, 20x11:
Property tax expense
Repair expense
Property taxes payable
Cash
20,000
20,000
30,000
9,850
39,850
4,000
800
4,000
800
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 17 – Leases
211. You are analyzing the balance sheet of a large manufacturing company and come across the
following account in the property, plant and equipment section:
Equipment acquired under finance lease................$400,000
The footnotes indicate that the lease was signed three years ago, that there are several years left in
the finance lease, and that the equipment reverts to the lessor at the end of the lease term. The
reporting company does not use the accumulated depreciation account for assets under finance
leases.
Explain (a) what this account and (b) amount means, and (c) how it came to be included as a
long-term asset.
Ans: (a) The account came about through capitalizing the present value of the future cash flows
expected under the lease.
(b) The amount is the original present value less amortization to date.
(c) The lease term must have been at least 3/4 of the remaining useful life of the asset at
inception, or the present value of minimum lease payments must have been 90% or more
of the market value of the asset at inception.
Difficulty: Hard
hz
Level of Learning: Knowledge
Topic: LO2, 3
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212. What interest rate does a lessee use for lease capitalization purposes? Be as specific as possible.
Also, once this rate is decided, specifically what does the lessee use the interest rate for?
Ans: The lessee's interest rate for lease capitalization purposes is the lower of the lessor's
implicit rate (if known or determinable by lessee) and the lessee's incremental borrowing
rate. It is used for criterion 4 to determine the present value of the minimum lease
payments; and for computing interest expense.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 3
d
213. In order for a lessee to capitalize a lease, at least one of four criteria must be met. Answer the
following questions about the third criterion, the one having to do with the useful life of the
leased asset.
(a) State the criterion itself, specifically.
(b) Why does fulfilling this criterion imply a capitalized lease (i.e. why is this one of the criteria)?
(c) When is this criterion not applicable (i.e. when can it not be used to test whether a lease
should be capitalized)?
Ans: (a) If the lease term is at least equal to 75% of the remaining useful life at inception, the
lease is a finance lease.
(b) If the term is 3/4 or more of the life, the lessee has most of the use of the asset and the
lease is therefore similar in substance to an instalment purchase.
(c) When the asset is in its last 1/4 of total life at inception.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 17 – Leases
214. State completely criterion 2 (bargain purchase option) and criterion 4 (90%) as they pertain to
capitalizing leases under ASPE. Then, explain why fulfilling either constitutes a capitalized lease
for the lessee.
Ans: Criterion 2: if the lease contains the option for the lessee to purchase the asset at a bargain,
the lease is a finance lease. Such an option is likely to be taken by the lessee, making the
lease a purchase in-substance.
Criterion 4: if the present value of minimum lease payments equal or exceed 90% of the
market value of the asset, the lease is a finance lease. If the present value of payments
made by the lessee are essentially equal to the cost of the asset, the lessee is essentially
committing to purchasing the asset. This implies that, for the lessee to do so, the lessee
must be getting substantially all the benefits (and has taken most of the risk because of the
cost) of a purchase otherwise lessee would not have committed to such an agreement.
Difficulty: Hard
Level of Learning: Knowledge
Topic: LO2, 9
hz
215. Ryan Corp. enters into an agreement with Montgomery Corp. to lease some office space in a very
popular part of town. The agreement called for payments of $100,000 per year for five years and
an upfront payment of $85,000. Explain the proper accounting treatment for the above situation.
Ans: The upfront payment should be amortized over the term of the lease instead of recognizing
it in the first year. Therefore the $85,000 should be deferred on the books and amortized at
a rate of $17,000 per year.
Difficulty: Medium
d
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Level of Learning: Knowledge
Topic: LO1
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Chapter 17 – Leases
216. Ryan Corp. enters into an agreement with Montgomery Corp. to lease some office space in town.
There are currently a large number of vacant units which allowed Ryan Corp. to obtain
favourable lease terms. The agreement called for payments of $150,000 per year for five years;
however, given the large number of vacancies, Montgomery Corp. forgave the first year's lease
payment. Prepare the journal entries for the five years of the lease.
Ans: Year 1
Dr. rent expense
Cr. Deferred rent liability
$120,000
$120,000
$120,000
30,000
Year 3
Dr. Rent expense
Dr. Deferred rent liability
Cr. Cash
$120,000
30,000
Year 4
Dr. Rent expense
Dr. Deferred rent liability
Cr. Cash
$120,000
30,000
Year 5
Dr. Rent expense
Dr. Deferred rent liability
Cr. Cash
Difficulty: Hard
$150,000
$150,000
$150,000
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Year 2
Dr. Rent expense
Dr. Deferred rent liability
Cr. Cash
$150,000
d
Level of Learning: Application
Topic: LO2, 3
$120,000
30,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 17 – Leases
217. Match the typical characteristics with the type of lease by entering the appropriate letters in the
spaces provided.
Type of Lease
A. Operating lease
B. Finance lease
Typical Characteristics
___ 1.
Long-term financing.
___ 2.
Special property rights are transferred.
___ 3.
The lease term often approximates the useful life of the property.
___ 4.
Non-cancellable during the term.
___ 5.
Lessor pays taxes, insurance, and similar costs without specific reimbursement therefore.
___ 6.
Lease may include a bargain purchase option.
___ 7.
Collectability of the lease payments is reasonably assured.
Ans: 1: B, 2: B, 3: B, 4: B, 5: A, 6: B, 7: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
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Difficulty: Medium
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218. Define the following terms:
(1) bargain renewal option
(2) incremental borrowing rate
(3) lease term
Ans: (1) The lessee has the option of extending the lease at a substantially reduced rate.
(2) The interest rate that the lessee would receive from a financial institution if the asset
were to be purchased.
(3) The lease term includes all terms prior to the exercise date of a bargain purchase
option; all bargain renewal terms; and all renewal terms at the lessor's option
Level of Learning: Knowledge
Topic: LO2, 3
d
219. Explain what is meant by off-balance sheet financing?
Ans: Off-balance sheet financing occurs essentially when leases are treated as operating leases.
Neither the asset nor the liability is recorded on the books of the lessee. In some cases this
enables companies to improve their return on assets and debt-to-equity ratio. The CICA
Handbook attempted to eliminate this advantage by instituting the guidelines for finance
leases; however, companies are finding ways around the current guidelines
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 75
Chapter 17 – Leases
220. Ryan Corp. leased an asset from Amanda Corp. under a finance lease. The original entry for
finance lease included a debit to leased asset for $75,000. Amortization on the asset amounted to
$7,500. At the end of the year, the lease liability on the books was $64,567. What is the
temporary difference?
Ans:
Asset under finance lease – net (75,000-7,500)
67,500
Lease liability
(64,567)
Net temporary difference
$2,933
=====
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
hz
221. Explain what a temporary difference is and how it arises?
Ans: Leases are normally taxed according to their legal form, which means that Canada
Revenue Agency (CRA) normally allows a deduction for tax purposes equal to the
payment made during the year. Therefore, Canada Revenue Agency (CRA) treatment may
differ from accounting treatment. This gives rise to a temporary difference. This difference
arises because there is no tax carrying value when the lease is treated as an operating lease
by Canada Revenue Agency (CRA).
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
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222. Ryan Corp. leased an asset from Amanda Corp. under a finance lease. The original entry for
finance lease included a debit to leased asset for $75,000. Amortization on the asset amounted to
$7,500. At the end of the year, the lease liability on the books was $64,567. What is the after tax
impact assuming a tax rate of 40%?
Ans:
Asset under finance lease – net (75,000-7,500)
67,500
Lease liability
(64,567)
Net temporary difference
$2,933
Tax rate
40%
After tax impact
$1,173
======
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
223. Ryan Corp. enters into a finance lease agreement with a 5-year term and a bargain renewal option
of 3 years. Over what period should the asset be amortized?
Ans: 8 years
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 17 – Leases
224. Explain the most common methods of avoiding lease capitalization?
Ans: Contingent Rent: this is a rent that depends on future events. The most common example is
a retail store that pays, in addition to a regular lease payment, a payment based on a
percentage of sales. This agreement results in a lower lease payment.
Third Party: A third party (generally formed by the lessee) enters into an agreement with
the lessor and then leases to the operating company on a year-by-year basis
Shorten the lease term: By making the lease term one year at a time or considerably shorter
than the economic life, lease capitalization can be avoided.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
hz
225. Company A enters into a lease agreement with Company B. The going lease payment for a
similar agreement is $90,000 per year. Company A negotiates a lease whereby they pay $40,000
per year and 6% of annual sales revenues. This is an example of what method?
Ans: Contingent Rent
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
226. How is the cash flow statement impacted if the lease is deemed to be an operating lease versus a
finance lease?
Ans: If the lease is an operating lease, the payment represents a cash flow from operations.
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If the lease is a finance lease the amortization of the asset is included in the income
statement but added back on the cash flow statement as a non-cash item. The portion that
represents interest is shown on the cash flow statement as part of interest expense. The
principal repayment portion is shown on the cash flow statement as a financing activity.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO8
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 77
Chapter 17 – Leases
Use the following to answer questions 227-229:
ABC Inc. leased a computer to the Lennox Silver Company on 1 April 20x15. The terms of the lease are
as follows:
hz
Lease term (fixed and non cancellable)
Estimated economic life of the computer
Fair market value at lease inception
Bargain purchase offer
Transfer of title
Guaranteed residual value by lessee, 1 April 20x18
Lessee's normal depreciation method
Lessee's incremental borrowing rate
Executory costs included in lease payments
Initial direct costs
Annual lease payment, beginning of each lease year
Lessor's implicit interest rate
Lessee's fiscal year – end
3 years
5 years
$ 5,000
None
None
$ 2,000
straight line
11%
none
none
$1,620
unknown to lessee
31 December
*** ABC Inc. company charges a half-year depreciation in the year of acquisition and a half-year in the
year of disposition, regardless of the actual dates of acquisition and disposal.
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227. From the above information classify the lease from the perspective of the lessee.
Ans: This lease qualifies as a finance lease because the present value of the minimum lease
payments, $5,856 exceeds 90% if the fair market value of the leased property.
P = $1,620 (P/A due, 11%, 3) + $2,000 (P/F, 11%, 3)
= $4,394 + $1,462 = $5,856
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
d
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Chapter 17 – Leases
228. From the above information, show how the leased asset and the lease obligation will be shown on
the lessee's balance sheet at 31 December 20x16.
Ans: The Lessee’s balance sheet at 31 December 20x16 will include the following
amounts:
Capital assets
Asset under finance lease
Less accumulated amortization
$ 5,000
1,500
$ 3,500
Current Liabilities
Current portion of finance lease liability
[$477 accrued interest at 31 December 20x16, plus $984 principal portion
of the next payment (from amortization table)
$1,461
Long Term Liabilities
Obligation under finance lease (from amortization table)
$1,606
hz
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3
Cash (received from sale)
Lease Liability
Accumulated Amortization
Asset under finance lease
Cash (paid to lessor)
Gain on disposal of leased asset
2,100
2,000
3,000
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229. Suppose that at the end of the lease, the lessor tells the lessee to dispose of the asset, and to keep
any proceeds in excess of the guaranteed residual value. Provide entries for the lessee on 1 April
20x18, assuming that the lessee sells the asset for $2,100 and remits the required $2,000 payment
to the lessor.
Ans: 1 April 20x18 – Sale of asset
5,000
2,000
100
This entry assumes that adjustments have already been made to (1) accrued the last of the
interest and (2) record amortization for 20x18.
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
Use the following to answer questions 230-233:
Over the life of a lease, ABC Inc. received a total cash inflow of $73,000; $65,000 from lease payments
plus the $8,000 estimated residual value. The present value of the future cash flow is $55,000. The
$18,000 difference between the gross cash flows and the discounted present value is the interest income
(or finance revenue) that will be reported by ABC Inc.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 17 – Leases
230. Using the gross method, record the cash inflow from lease payment of $73,000.
Ans: 2 January 20x12
Lease payments receivable
73,000
Cash
55,000
Unearned finance revenue
18,000
Difficulty: Medium
Level of Learning: Application
Topic: LO7
231. Record the unearned finance revenue as it would appear on the balance sheet.
Ans: 31 December 20x12
Unearned finance revenue
6,967
Finance revenue
6,967
Difficulty: Medium
Level of Learning: Application
Topic: LO7
hz
232. Record the full amount of the lease payment that will be credited to the lease receivable.
Ans: 2 January 20x13
Cash
20,000
Lease payments receivable
20,000
Difficulty: Medium
Level of Learning: Application
Topic: LO7
Difficulty: Medium
Level of Learning: Application
Topic: LO7
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233. Provide calculation to show the net balance of the lease receivable after the payment is received
and recorded.
Ans:
Lease payments receivable, 31 December 20x12
* $45,665/3
Payment received, 2 January 20x13
* $45,665/3
Remaining lease payments receivable
* $45,665/3
Unearned finance revenue ($18,000 - $6,967)
* $45,665/3
Net lease receivable
* $45,665/3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Page 80
Chapter 17 – Leases
234. Match the following (there may be more than one response for each type of lease):
Standpoint of:
A. Lessor
B. Lessee
C. Lessor and Lessee
Type of Lease Standpoint of:
___ 1.
Capital
___ 2.
Operating
___ 3.
Sales-type
___ 4.
Direct financing
Ans: 1: C, 2: C, 3: A, 4: A
Difficulty: Medium
Level of Learning: Application
Topic: LO1, 2, 3, 7
hz
235. What is the interest rate used for discounting the net lease payments by the lessor?
Ans: The rate implicit in the lease
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2,3, 7
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236. What is a direct financing lease?
Ans: The lessor is acting solely as a financial intermediary. There is only one profit component
– the interest earned on the lease
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3, 7
237. What is a sales-type lease?
Ans: In a sales-type lease, there are two profit components: the profit (or loss) on the sale and
the interest revenue from the lease. Manufacturers often use this type of lease.
Difficulty: Medium
d
Level of Learning: Knowledge
Topic: LO2, 3, 7
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Chapter 17 – Leases
238. Lessor Company rented a machine to Lessee Company on January 1, 20x11, for a period of 3
years. Rent of $8,000 is due January 1, of each year (starting in 20x11). The lease qualified as an
operating lease for both the lessor and lessee. In addition to the monthly rentals, the lease contract
required Lessee Company to pay $2,000 on January 1, 20x11 (this is non-refundable). The
accounting period ends December 31. Complete the entries required for Lessor Company on the
following dates, using the straight line method.
(a) January 1, 20x11:
(b) December 31, 20x11:
Ans: (a) January 1, 20x11:
Cash. . . . . . . . . . . . . . . . . .
10,000
Unearned rent revenue. . . . . . . . .
2,000
Rent revenue . . . . . . . . . . . . .
8,000
(b) December 31, 20x11:
Unearned rent revenue ($2,000/3). . . .
Rent revenue . . . . . . . . . . . . .
667
667
Difficulty: Medium
hz
Level of Learning: Application
Topic: LO7
d
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Chapter 17 – Leases
239. LOR leased to LEE a computer that cost LOR $20,000. The explicit interest rate is 20%; rentals
are paid at each year-end; and the lease term is three years. Residual value at the end of the lease
term is $2,000. Assume a direct financing lease.
Requirement 1:
LEE retains the computer at the end of the lease term at a BPO cost of $1,500.
(a) The rental amount computed by LOR is $_______________________.
(b) The amount LEE should capitalize is $________________________.
Requirement 2:
How much interest should be recognized at the end of year 1, in the above situation, by: (a) LOR?
$____________ (b) LEE? $____________
Requirement 3:
At the end of year 1, in the above situation, how much would the
principal be reduced for (a) LOR's lease receivable?
$_________________ and (b) LEE's lease liability?
$_________________.
hz
Ans: Requirement 1:
(a)
The rental amount computed by the lessor is
$9,082
======
$20,000
868
=======
$19,132
=======
$9,082
======
$20,000
=======
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Cost of leased asset......................
Less: BPO, $1,500 x PV1, 20%, 3 (.57870)..
Net investment to recover
Rental: $19,132 ÷ PVA, 20%, 3 (2.10648) =
(b) The amount the Lessee should capitalize is
d
Check:
PV of rentals: $9,082 x PVA, 20%, 3 (2.10648).
Add: BPO, $1,500 x PV1, 20%, 3 (.57870).......
Capitalize....................................
Requirement 2:
Interest recognized at end of Year 1:
(a)LOR $4,000
$20,000 x 20% =
Requirement 3:
Reduction of principle at end of Year 1:
(a)LOR's lease receivable
(b)LEE's lease liability
$9,082 - $4,000 =
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
$19,132
868
$20,000
=======
(b)LEE
======
$4,000
======
$4,000
$5,082
======
$5,082
======
$5,082
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Chapter 17 – Leases
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3, 7
d
zle
hz
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 17 – Leases
240. If a lessor has property that has a market value (cost if new) of $89,718 and leases it on a finance
lease for 5 years and desires a 20% annual return (assuming an ordinary annuity situation
annually), the annual rentals would be $_____________________.
Ans: $30,000, computed as follows:
=======
$89,718 ÷ PVA, 20%, 5 (2.99061) = $30,000
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
241. The following information relates to a lease contract:
Lease inception
Market value and book value (to lessor) of new equipment under lease
Interest rate used by both lessee and lessor for lease accounting
Lease payments due 12-31-x1, x2, x3
End of lease term
Expected residual value at 1-1-x4
Expected residual value at 1-1-x7 (end of useful life)
1-1-x1
$10,000
10%
1-1-x4
$1,000
$100
hz
The lease allows the lessee to purchase the asset for $200 on 1-1-x4.
There are no uncertainties with respect to collectability of lease payments or performance by
lessor.
zle
(a) Determine the annual lease payment
(b) Classify the lease for the lessor
(c) Record the 20x11 entries
Ans: (a) $10,000 = LP(PVA,.10,3) + $200(PV1,.10,3); LP = $3,961
2.48685 .75131
(b)
Minimum lease payments = 3($3,961) + $200 = $12,083
PV of min lease payments = $10,000
Lessor: direct financing lease (fulfills criteria 2,4,5,6)
d
(c) Lessor
Lease Rec
Unearn. Int
Equipment
Dec. 31
Cash
Unearn int
Interest rev
Lease Rec
12,083
2,083
10,000
3,961
1,000
1,000
3,961
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3, 7
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Chapter 17 – Leases
242. The following information relates to a lease contract:
The lessor contracted with an insurance company, which guaranteed the residual value at 1-1-x4.
Lease inception
1-1-x1
Market value and book value (to lessor) of new equipment under lease
$10,000
Interest rate used by both lessee and lessor for lease accounting
10%
Lease payments due 12-31-x1, x2, x3
End of lease term
1-1-x4
Expected residual value at 1-1-x4
$1,000
Expected residual value at 1-1-x7 (end of useful life)
$100
There are no uncertainties with respect to collectability of lease payments or performance by
lessor.
(a) Determine the annual lease payment
(b) Classify the lease for both lessee and lessor
(c) Record the 20x11 entries for both parties
Ans: (a) $10,000 = LP(PVA,.10,3) + $1,000(PV1,.10,3); LP = $3,719
2.48685 .75131
zle
hz
(b)
Minimum lease payments for lessee = 3($3,719) = $11,157
Minimum lease payments for lessor = $11,157 + $1,000 = $12,157
PV of minimum lease payments for lessee = $3,719(PVA,3,.10) =$9,248 [ > (.90)$10,000]
PV of minimum lease payments for lessor = $10,000
Lessee: capitalize (fulfills criterion 4)
Lessor: direct financing lease (fulfills criteria 4,5,6)
Lessee
Jan. 1
Leased asset
Lease liability
9,428
Lease liability
Interest expense
Cash
2,794
925
3,719
Dec. 31
Lessor
9,428
d
(c)
Lease Rec
Unearn int
Equipment
12,157
Cash
Unearn int
Interest rev
Lease Rec
Dep expense
Accum dep.
3,719
1,000
12,157
10,000
1,000
3,719
3,083
3,083
$3,083 = $9,248/3
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3, 7
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Chapter 17 – Leases
243. The following information relates to a lease contract:
The lessee guarantees the residual value at 1-1-x4.
Lease inception
1-1-x1
Market value and book value (to lessor) of new equipment under lease
$10,000
Interest rate used by both lessee and lessor for lease accounting
10%
Lease payments due 12-31-x1, x2, x3
End of lease term
1-1-x4
Expected residual value at 1-1-x4
$1,000
Expected residual value at 1-1-x7 (end of useful life)
$100
There are no uncertainties with respect to collectability of lease payments or performance by
lessor.
(a) Determine the annual lease payment
(b) Classify the lease for both lessee and lessor
(c) Record the 20x11 entries for both parties
Ans: (a) $10,000 = LP(PVA,.10,3) + $1,000(PV1,.10,3); LP = $3,719
2.48685 .75131
(c)
hz
(b)
Minimum lease payments for both parties = $11,157 + $1,000 = $12,157
PV of minimum lease payments for both parties = $10,000
Lessee: capitalize (fulfills criterion 4)
Lessor: direct financing lease (fulfills criteria 4,5,6)
Dec. 31
Lessor
Leased asset
Lease liability
10,000
Lease liability
Interest expense
Cash
2,719
1,000
zle
Jan. 1
Lessee
3,719
d
3,000 = ($10,000 - $1,000)/3
Difficulty: Hard
10,000
Lease Rec
Unearn int
Equipment
12,157
2,157
10,000
Cash
Unearn int
Interest rev
Lease Rec
Dep expense
Accum dep.
3,719
1,000
1,000
3,719
3,000
3,000
Level of Learning: Application
Topic: LO2, 3, 7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 87
Chapter 17 – Leases
244. On January 1, 20x11, a lessor and lessee signed a lease calling for 5 annual payments of $10,000
to be made starting on December 31, 20x11. The market value and book value of the asset at
inception is $41,013. The lessee also guarantees the full $5,000 residual value at December 31,
20x15, the end of the lease term. Both parties use 10%. The lessee uses straight-line depreciation.
Provide the first year (20x11) entries for both lessor and lessee. Assume there are no uncertainties
concerning collection of lease payments by lessor, nor unreimbursable costs of lessor.
Ans: $41,013 = $10,000(PVA,10%,5) (3.79079) + $5,000(PV1,10%,5) (.62092)
Present value of minimum lease payments for both parties = market value of the asset
leased; therefore this is a finance lease for both parties.
Lessor:
1/1/x1
Lease receivable
Unearned interest revenue
Asset
hz
12/31/x1
Cash
Unearned interest revenue
Interest revenue
Lease receivable
10,000
4,103
4,103
10,000
7,203
7,203
41,013
d
Lessee:
1/1/x1
Leased asset
Lease liability
12/31/x1
Lease liability
Interest expense
Cash
13,987
41,013
zle
Depreciation expense
Accumulated dep.
.10($41,013) = $4,103
($41,013 - $5,000)/5 = $7,203
55,000
41,013
5,891
4,103
10,000
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3, 7
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Chapter 17 – Leases
hz
245. A lessor leased equipment to a lessee on January 1, 20x11. The lease has the following
characteristics:
Book value of the asset to the lessor: $100,000
Market value: $167,417 on that date.
Lessor's implicit rate: 10%
Lessee's borrowing rate: 12%
Lessee knows the lessor's implicit rate.
Five equal payments of $40,000 are due each January 1, beginning
20x11
Lease term ends: December 31, 20x15
Remaining useful life of equipment at January 1, 20x11: 8 years (at
the end of which time the equipment will have no residual value)
Estimated residual value on December 31, 20x15: $30,000
Lessee has the option to buy the asset on December 31, 20x15 for
$1,000.
Assume there is no uncertainty as to payment of lease payments by
lessee or unreimbursable costs for lessor.
Assume straight-line depreciation or amortization.
(a) Is this an operating or finance lease for the lessee, and why?
(b) Prepare all the required journal entries for the lessor and lessee for 20x11.
Ans: (a) This is a finance lease because of the bargain purchase option.
Also, the present value of the minimum lease payments = 100% of the market value:
$40,000 + $40,000(PVA,10%,4) (3.16987) +
$1,000(PV1,10%,5) (.62092) = $167,417
zle
Lessor:
1/1
Lease receivable 5($40,000) + $1,000
Cost of goods sold
Unearned interest
Sales
Inventory or equipment
33,583
167,417
100,000
d
1/1
Cash
Lease receivable
201,000
100,000
12/31
Unearned interest ($167,417 - $40,000).10
Interest revenue
Lessee:
1/1
Equipment
Lease liability
1/1
Lease liability
Cash
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
40,000
40,000
12,742
12,742
167,417
167,417
40,000
40,000
Page 89
Chapter 17 – Leases
12/31
Interest expense
Lease liability
12,742
12/31
Depreciation expense ($167,417/8)
Accumulated depreciation
20,927
12,742
20,927
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3, 7
d
zle
hz
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Page 90
Chapter 17 – Leases
246. LXR leased to LXE a computer that cost the lessor $15,000. The explicit interest rate is 15%;
rentals are paid at each year-end; and the lease term is 3 years. Residual value at the end of the
lease term is $3,000. Assume this is a direct financing lease.
Requirement 1:
LXE retains the computer at the end of the lease term at a BPO cost of $2,000.
(a) The rental amount computed by lessor is, $___________________.
(b)The amount the lessee should capitalize is, $________________.
Requirement 2:
How much interest should be recognized at the end of year 1, in the above situation, by the:
(a) lessor? $_________________ (b) lessee? $________________.
Requirement 3:
At the end of year 1, in the above situation, how much would the principal be reduced for the
(a) lessor's lease receivable? $____________________ and (b) lessee's lease liability?
$_________________________.
hz
Ans: Requirement 1:
(a) Rental amount computed by lessor
Cost of leased asset............................
Less: BPO, $2,000 x PV1, 15%, 3 (.65752)........
Net investment to recover.......................
zle
Rental: $13,685 ÷ PVA, 15%, 3 (2.28323) =
(b) Amount the lessee should capitalize,
Check:
PV of rentals: $5,994 x PVA, 15%, 3 (2.28323)....
Add: BPO, $2,000 x PV1, 15%, 3 (.65752)..........
Capitalize.......................................
d
Requirement 2: Interest recognized at end of Year 1:
(a) Lessor
(b) Lessee
$5,944
======
$15,000
1,315
13,685
=======
$5,994
======
$15,000
=======
$13,685
1,315
$15,000
=======
$2,250
======
$2,250
======
$15,000 x 15% = $2,250
Requirement 3: principle reduced at end of Year 1:
(a) Lessor's lease receivable
(b) Lessee's lease liability
$3,744
======
$3,744
======
$5,994 - $2,250 = $3,744
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3, 7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 17 – Leases
247. Lessor Company leases small computers on three-year leases at the end of which the residual
value is not material in amount. Rents are collected at year-end. On January 1, 20x11, Lessor
signed a 3-year lease with Lessee Company that called for annual rents of $12,063, which was a
return to Lessor of 10% on the $30,000 cost (market value at date of lease). Assume the lease
qualifies as a direct financing lease to the lessor and a finance lease to the lessee. There was no
bargain purchase option or residual value. The lessee's incremental borrowing rate is 12%.
(a) Complete the following amortization schedule for the lease.
Round to the nearest dollar.
Periodic
Reduction
Unrecovered
Period
Cash Rent
Annual Interest
of Balance
Balance
Start
20x11
20x12
20x13*
hz
Total
*May have slight rounding error.
(b) Can both the lessor and lessee use the amortization schedule values in this instance?
Yes__________________ No___________________
zle
Explain why__________________________________________________.
(c) Give the entries for the lessor and lessee on the following dates (assume the accounting period
ends December 31). Use the abbreviated account titles.
January 1, 20x11-Inception of the lease:
LESSOR LESSEE
d
a. December 31, 20x11-Interest date and end of accounting period (give
all entries except closing entries):
Ans: (a) Amortization schedule:
Periodic
Reduction
Unrecovered
Period Cash Rent
Annual Interest
of Balance
Start
$30,000
20x11 $12,063
$30,000 x 10% = $3,000
$ 9,063
20x12 12,063
20,937 x 10% = 2,094
9,969
20x13* 12,063
10,968 x 10% = 1,095*
10,968
=====
======
Total
$36,189
$6,189
$30,000
=======
======
=======
*Small rounding to come out even.
Balance
20,937
10,968
-0-0-
(b) Yes. If both use the same interest rate.
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Chapter 17 – Leases
(c) Entries:
LESSOR
LESSEE
January 1, 20x11-Inception of the lease:
Lease receivable
Leased Asset
Unearned int.
36,189
30,000
6,189
Asset Leased
30,000
Lease liability
30,000
December 31, 20x11-Interest date and end of accounting period
Cash
Unearned int
Lease rec.
Int. rev.
12,063
3,000
12,063
3,000
Lease liability
Int. expense
Cash
Depr. expense
Acc. Depr.-L.A.
9,063
3,000
12,063
10,000
10,000
Difficulty: Hard
d
zle
hz
Level of Learning: Application
Topic: LO2, 3, 7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 93
Chapter 17 – Leases
248. Lamont Company leases computers for a three-year term, at the end of which they are regarded as
obsolete with no residual value because Lamont donates them to schools. Rents are collected at
the end of each six-month period; the leases qualify as direct financing leases to Lamont (lessor).
The computers cost Lamont $20,000 each. Lamont bases the rents on a 16% annual rate.
(a) The semi-annual rental on one computer, rounded to the nearest
dollar, is $________________________.
(b) Complete the following amortization schedule for the lease of
one computer.
Period
Rental
Receivable
Interest Revenue
Receivable
Reduction
Balance
Start
1
2
3
5
6
zle
hz
4
(c) Give the entries that should be made by the lessor on the following dates:
(1) At the date the lease is signed:
(2) At the date of collection of the first rental payment:
(d) Show the lessor's income statement and balance sheet amounts with respect to the lease
immediately after the first rental collection:
Ans: (a) $20,000 ÷ PVA, 8%, 6 (4.62288) = $4,326
d
(b)
Period
Rental
Receivable
Interest Revenue
Receivable
Reduction
Balance
Start
1
$20,000
$4,326
$20,000 x 8% = $1,600
$2,726
17,274
2
4,326
17,274 x 8% = 1,382
2,944
14,330
3
4,326
14,330 x 8% = 1,146
3,180
11,150
4
4,326
11,150 x 8% = 892
3,434
7,716
5
4,326
7,716 x 8% = 617
3,709
4,007
6
4,326
4,007 x 8% = 319*
4,007
-0-
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Chapter 17 – Leases
*Rounded
(c) Entries:
(1) Date lease is signed:
Lease receivable..............................
Equipment (on direct financing lease)........
Unearned interest revenue....................
(2) Date of collection of first rental:
Cash..........................................
Unearned interest revenue.....................
Lease receivable.............................
Interest revenue.............................
25,956
20,000
5,956
4,326
1,600
4,326
1,600
hz
(d) Financial statements; immediately after first rental:
Income Statement:
Interest revenue.............................
$ 1,600
Balance Sheet:
Lease receivable.............................
$21,630
Unearned interest............................
4,356
Net lease receivable
17,274
Difficulty: Hard
Level of Learning: Application
Topic: LO7
d
zle
249. List the guidelines required under ASPE that are used to determine whether a lease is a finance
lease from the lessors point of view?
Ans: (1) reasonable assurance that lessee will obtain ownership through bargain purchase option
or automatic transfer.
(2) Lessee will obtain substantially all the benefits of the asset generally defined as 75% of
its economic life.
(3) Lessor assured of recovering the investment in the leased property, plus a return on the
investment, over the lease term. This is defined as the present value of the minimum net
lease payments = to at least 90% of the fair value of the asset at the inception of the lease
(4) Credit risk is normal
(5) Amounts of unreimbursable costs that are likely can be reasonably estimated
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
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Chapter 17 – Leases
250. Match the following for the LESSOR:
Type of Lease
A. Sales-type
B. Direct financing
A Manufacturer's or Dealer's Profit is:
___ 1.
Recognized
___ 2.
Not recognized
Ans: 1: A, 2: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3, 7
zle
hz
251. Associate the term or phrase below with the general description by entering the appropriate letters
in the spaces provided.
Term or Phrase
A. Lessee
B. Sale and leaseback
C. Calls for use of incremental borrowing rate.
D. Lessor
E. Synonymous with operating lease.
F. Initial direct costs
G. Executory costs
H. Calls for use of annuity due present values
I. Direct financing lease
J. Associated with third party guarantors.
d
General Description
___ 1.
Three-party lease.
___ 2.
Tenant in a lease contract transaction.
___ 3.
Asset owner in a lease contract transaction.
___ 4.
Insurance, property taxes, and maintenance.
___ 5.
Incremental direct costs incurred by a lessor in negotiating and consummating a lease
contract.
___ 6.
Lease payments precede each period of usage of leased asset.
___ 7.
A form of finance lease.
Ans: 1: J, 2: A, 3: D, 4: G, 5: F, 6: H, 7: I
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3, 7
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Chapter 17 – Leases
252. This question relates to the different types of finance leases. To the left are listed eight different
items related to such leases. To the right are three columns that identify the types of leases. Place
one or two check marks on each line to identify the item with the type of lease to which it
primarily relates.
Item Separately Recognized by:
Lessor
Lessee
Direct
Financing
Item
Sales-Type
Capital
Lease
1. Dealer's profit (i.e., gross
margin)
2. Interest revenue
3. Interest expense
hz
4. Depreciation expense
5. Lease receivable
6. Lease liability
zle
7. Asset lease (cost per
lease contract)
8. Expense for operating and ownership expenditures
Ans:
Item Separately Recognized by:
Lessor
1. Dealer's profit (i.e., gross
margin)
2. Interest revenue
d
Item
Direct
Financing
X
Lessee
Sales-Type
Capital
Lease
X
X
3. Interest expense
X
4. Depreciation expense
X
5. Lease receivable
X
6. Lease liability
X
X
7. Asset lease (cost per
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Chapter 17 – Leases
lease contract)
X
8. Expense for operating
and ownership expenditures
X
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3, 7
253. What are the income tax implications for the lessor with respect to a finance lease?
Ans: Net income will include an imputed amount for interest as finance revenue. On the tax
return the lessor will include the full payment as revenue and will deduct the CCA charge.
Therefore, there will be a difference between the revenue reported on the income statement
and that reported on the tax return. This is a temporary difference (future income tax
liability).
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
hz
254. What disclosures are recommended by the CICA for lessors?
Ans: (1) the lessor's net investment – (lease receivable less unearned revenue)
(2) the amount of finance income
(3) lease revenue recognition policy
Difficulty: Medium
zle
Level of Learning: Knowledge
Topic: LO7
d
255. Ryan Corp. is a manufacturer of high tech golf carts. On December 31, 1999, Ryan Corp. leases
100 golf carts to a local golf course for five years at $95,000 per year payable at the beginning of
the lease term. The normal cash sales price of the carts is $4,000 each. The carts cost Ryan Corp.
$2,000 each to manufacture. The lease meets all the conditions necessary to be a sales-type lease
from the lessor's point of view. Provide the journal entry(ies) on December 31 to account for the
lease.
Ans:
Lease payment receivable
475,000
Unearned finance revenue
75,000
Sales revenue
400,000
Cost of goods sold
Golf cart inventory
200,000
200,000
Difficulty: Medium
Level of Learning: Application
Topic: LO7
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Chapter 17 – Leases
256. Ryan Corp. is a manufacturer of high tech golf carts. On December 31, 1999, Ryan Corp. leases
100 golf carts to a local golf course for five years at $95,000 per year payable at the beginning of
the lease term. The normal cash sales price of the carts is $3,500 each. The carts cost Ryan Corp.
$3,000 each to manufacture. The lease meets all the conditions necessary to be a sales-type lease
from the lessor's point of view. Provide the journal entry(ies) on December 31x1 to account for
the lease and the first payment on December 31x2
Ans:
Lease payment receivable
475,000
Unearned finance revenue
125,000
Sales revenue
350,000
Cost of goods sold
Golf cart inventory
300,000
300,000
December 31x2
Cash
Lease payments receivable
95,000
95,000
Difficulty: Medium
hz
Level of Learning: Application
Topic: LO7
257. ML leased a computer to LH on January 1, 20x11. The lease was a five year fixed, non-
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cancellable agreement. The payments were finalized at $2,380 per year with the first payment on
January 1, 20x11 and ML paid $9,500 for the computer. Carrying value is equal to fair value. The
lease is deemed a finance lease. Based on the above information, what type of lease is this for the
lessor. Prepare the journal entries for at the inception of the lease using the gross method.
Ans: (a) this is a financing lease as the carrying value is equal to the fair value.
(b) January 1 20x11
Lease receivable (2,380x5)
11,900
Unearned finance revenue
2,400
Cash, Inventory, etc.
9,500
2,380
d
Cash
Lease receivable
2,380
Difficulty: Medium
Level of Learning: Application
Topic: LO7
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Chapter 17 – Leases
258. ML leased a computer to LH on January 1, 20x11. The lease was a five year fixed, noncancellable agreement. The payments were finalized at $2,380 per year with the first payment on
January 1, 20x11 and ML paid $9,500 for the computer. Carrying value is equal to fair value and
there was a guaranteed residual value by lessee of $2,000. The lease is deemed a finance lease.
Based on the above information, what type of lease is this for the lessor? Prepare the journal
entries for at the inception of the lease using the gross method.
Ans: (a) this is a financing lease as the carrying value is equal to the fair value.
(b) January 1 20x11
Lease receivable (2,380x5)+2,000
13,900
Unearned finance revenue
4,400
Cash, Inventory, etc.
9,500
Cash
Lease receivable
2,380
2,380
Difficulty: Medium
Level of Learning: Application
Topic: LO7
hz
259. What is the difference between the net method and gross method of accounting for leases by the
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lessor?
Ans: The net method is the same method used by the lessee and it shows the net present value of
the remaining lease payments. The gross method is undiscounted. The offset amount goes
to an account called unearned finance revenue. For reporting purposes only the net method
is shown on the balance sheet. The CICA Handbook assumes that the lessor is using the
gross method. Both however ultimately produce the same results.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3, 7
260. Why is the gross method used by the lessor in most cases instead of the net method if both
d
produce the same results?
Ans: In accounting the reconciliation of accounts receivable is very important. The gross
method allows for easier reconciliation because the amounts can be traced quickly back to
the subsidiary records. Under the net method it would be necessary to present value each
lease at a particular point of time in order to perform the reconciliation. Companies with
very few leases will not find this a problem. Companies with a substantial number of leases
will find this time consuming.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 100
Chapter 17 – Leases
261. Company X leased an asset to Y on December 31 20x11 with the first payment occurring on that
date. The lease was a sales-type lease (it met all the conditions). The cash payment on December
31, 20x11 was $1,582 representing 1/5th of the lease arrangement. Assuming that the profit on the
sales amounted to 11% of the total lease receivable and the unearned finance revenue was 1.57
times the profit on the sale, prepare the journal entry at the inception of the lease (use the gross
profit method).
Ans: Total lease receivable: 1,582x5 = 7,910
Profit on sales = 7,910x11%=870
Unearned finance revenue = 870x1.58=1,375
Dr. Lease payment receivable
Cr. Unearned finance revenue
Cr. Sales Revenue
7,910
Dr. Cost of goods sold
Cr. Computer inventory
5,665
Dr. Cash
Cr. Lease payment receivable
1,582
1,375
6,535
5,665
hz
1,582
Difficulty: Medium
Level of Learning: Application
Topic: LO7
d
zle
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 101
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test Bank
Chapter 18 – Post-employment Benefits
1. In a defined contribution pension plan the retirement benefits to the employee are not defined.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
2. In a defined contribution plan, employers run the risk of high pension contributions.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2
hz
3. Employees are not allowed to make contributions to a defined contribution pension plan.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2
zle
4. The formula used to calculate pension expense must necessarily be the same as the
formula used to calculate funding to the plan.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
d
5. The accumulated benefit and projected unit credit methods both result in increasing employer
contributions to the pension plan over time.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 1
Chapter 18 – Post-employment Benefits
6. The accumulated benefit and projected unit credit methods both take into account employee
salary changes over time.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
7. A non-funded pension plan is one where the employee must bear a part of the cost of the plan.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
8. All three funding approaches result in full funding of a pension plan over time.
Ans: False
hz
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
9. Current service cost is usually the largest single component of pension expense under a
defined benefit pension plan..
zle
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4, 5, 10
d
10. Under ASPE, Past service costs are amortized over the vesting period or the expected
remaining service life of the employee group, whichever is longer.
11. The accumulated and vested benefit obligations typically are different amounts.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 2
Chapter 18 – Post-employment Benefits
12. Any transitional asset or obligation may be applied retroactively or prospectively under IFRS.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO7
13. Post retirement benefits other than pensions must now be accounted for in a manner
similar the way pensions are accounted for
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO8, 9
14. In order to be registered, a pension plan must be trusteed.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
15. Actuarial gains and losses to be amortized must always be computed using the 10%
corridor approach.
zle
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO7
d
16. Gains and losses from plan settlements and curtailments should be recognized in income
immediately.
17. An employee of XYZ will receive retirement benefits of $1,000 per month if the employment
period is 15 years. However, if the employment period is 20 years, the retirement benefits will be
$1,300 per month. This is an example of a defined contribution pension plan.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2, 4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 3
Chapter 18 – Post-employment Benefits
18. Contributions made by an employer to a qualified pension plan usually are taxable to the
employee at that time.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2, 4
19. A pension plan that gives an employee the right to retirement benefits which are not contingent
upon the employee remaining with the company provides vesting benefits to the employee.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
20. Pension plans that are registered meet Revenue Canada requirements and hence qualify for tax
advantages.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Ans: False
zle
21. Usually, the amount of funding by an employer will exceed the benefits to be paid out to
employees.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Ans: False
d
22. A pension plan is fully funded when the assets in the pension fund are adequate to pay the current
retirees.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
23. Defined benefit pension plans do not specify benefits per period after retirement, but base the
pension benefits directly on the specified contributions.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 4
Chapter 18 – Post-employment Benefits
24. Past service costs that have vested must be amortized immediately through pension
expense under both ASPE and IFRS.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3, 4, 9
25. Under the simplified approach to accounting for defined benefit pension plans under
ASPE, the actuarial cost method used for pension accounting will be different than that
used for funding.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO9
Ans: True
hz
26. Under the simplified approach to accounting for defined benefit pension plans under
ASPE, all Past service costs and unrecognized actuarial gains and losses must all flow through
pension expense immediately.
Difficulty: Easy
zle
Level of Learning: Knowledge
Topic: LO9
27. Under the simplified approach to accounting for defined benefit pension plans under
ASPE there may be a limit on any pension plan asset.
Ans: True
d
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO9
28. Under proposed changes to IASB standards for pension accounting, service costs and net
interest (finance) revenue or expense will both be recognized in income, but separately.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO10
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 5
Chapter 18 – Post-employment Benefits
29. Under proposed changes to IASB standards for pension accounting, re-measurement of
actuarial gains and losses will flow through equity reserves or Other Comprehensive
Income.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO10
30. Under the standard approach to defined benefit plan accounting, Past service costs are
amortized over the expected period to full eligibility of pension benefits.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO9
hz
31. When a pension plan is not trusteed, a company must report its pension plan assets and
accrued pension liability on the balance sheet.
Ans: True
zle
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
32. Under a defined contribution pension plan, forfeitures are estimated in advance.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
33. A change in actuarial assumptions is the only possible cause for an actuarial gain or loss.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
34. If the actuarial gains and losses exceed 10% of the greater of the accrued obligation at the
beginning of the year or the value of the plan assets at the beginning of the year, the maximum
amortization is calculated using the average remaining service period.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 6
Chapter 18 – Post-employment Benefits
35. For income tax purposes, an employee would prefer to make contributions to a qualified pension
plan than to a nonqualified pension plan.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
36. Total net pension expense recognized over the life of a pension plan will be in excess of the total
amount paid into the pension fund.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
37. Pension plans are drafted to meet Revenue Canada requirements so that the benefits received after
Ans: True
hz
retirement are not subject to income tax and the contributions by the employer are not a taxable
benefit to the employee.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
zle
38. In a non-contributory, defined benefit pension plan, the plan assets are composed of the
employer's cumulative contributions less cumulative pension benefits paid from the fund.
Ans: False
d
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
39. A trustee is independent and receives the pension contribution from the employer and invests it in
accordance with provincial regulations.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 7
Chapter 18 – Post-employment Benefits
40. Pension plans are normally registered with the pension commissioner in the province of
jurisdiction.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
41. In accounting for pension costs, any difference between current service pension expense and the
payment into the pension trust should be reported as an:
A)
offset to pension plan assets.
B)
accrued actuarial liability.
C)
deferred pension liability/cost.
D)
operating expense of the current period.
hz
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
A)
B)
C)
D)
zle
42. The vested benefit of an employee in a pension plan represents benefits:
accumulated in the pension plan (at fair value).
that are not contingent on the employee continuing in the service of the employer.
to be paid to the retired employee in the current year.
to be paid to the retired employee in the next year.
Ans: B
d
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
43. Benefits pursuant to a pension plan that are not contingent upon an employee's continuing service
are referred to as:
A)
funded.
B)
underfunded.
C)
insured.
D)
vested.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 8
Chapter 18 – Post-employment Benefits
44. ABC's pension plan has a provision that employees will receive benefits upon retirement even
though the employees are not working for ABC at the time of retirement. Such a benefit is
characterized as:
A)
defined benefit.
B)
defined contribution.
C)
nonvesting.
D)
vested.
E)
non-contributory.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
45. RST's pension plan provides retirement benefits of $8,000 per year to all employees who have
Ans: A
hz
worked for the company for at least 10 years. Contributions to the plan are made 75 percent by
RST and 25 percent by the employees. The pension plan is characterized as both:
A)
contributory and defined benefit.
B)
funded and defined contribution.
C)
defined contribution and defined benefit.
D)
defined contribution and contributory.
d
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 9
Chapter 18 – Post-employment Benefits
46. Current costs of a pension plan that occur each year due to service credits earned after the
inception of the plan are called:
A)
Interest costs.
B)
actuarial losses.
C)
Past service costs.
D)
service cost.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
47. Conceptually, the employer's current pension obligation if the pension plan is discontinued is the:
A)
B)
C)
D)
accrued pension obligation.
accumulated benefit obligation.
vested benefit obligation.
underfunded pension cost.
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
48. Choose the most complete description of the possible relationship(s) between the discount rate
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
d
zle
(D) and the expected long-term rate of return on plan assets (R) used for defined benefit pension
plans.
A)
D>R
B)
D<R
C)
D=R
D)
D can be equal to, greater than, or less than R for any given firm
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 10
Chapter 18 – Post-employment Benefits
49. A pension fund may be:
Fully funded
*
*
*
*
1
2
3
4
A)
B)
C)
D)
Over funded
Under funded
*
*
*
*
Choice 1
Choice 2
Choice 3
Choice 4
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
hz
50. Costs related to a new pension plan that are necessary to "catch up" for services rendered prior to
the inception of the pension plan are classified as:
A)
actuarial losses.
B)
Past service costs.
C)
retroactive deferred charge.
D)
service costs.
E)
transition costs.
zle
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
51. Under IFRS, the straight-line amount of periodic amortization of Past service costs is applied by
d
dividing total Past service costs by the:
A)
ratio of service years rendered in an accounting year to total future service years of
qualified employees.
B)
vesting period.
C)
total future service years of qualified employees.
D)
total number of qualified employees.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 11
Chapter 18 – Post-employment Benefits
52. Changes in defined benefit pension plans that eliminate or reduce, for a significant number of
employees, the accrual of defined benefits for some or all of their future services are:
A)
settlements.
B)
eliminations.
C)
curtailments.
D)
terminations.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
53. When a settlement gain or loss arises due to closing a business segment it is recognized as a debit
or credit to (in):
A)
accrued pension obligation.
B)
other costs within discontinued operations.
C)
pension expense.
D)
accrued/prepaid pension cost.
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
zle
54. ABC has decided to pay retirement benefits to its president for 10 years after retirement in the
amount of $40,000 per year. The payments will be made at the end of each year, starting at the
end of the first year of retirement. Assuming a 9 percent interest rate, what is the minimum
necessary balance that must be in the pension fund at the beginning of the retirement period?
A)
$256,706
B)
$364,000
C)
$366,972
D)
$400,000
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
Ans: A
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 12
Chapter 18 – Post-employment Benefits
55. On January 1, 20x12, HIJ offered special termination benefits of $7,500 cash to 100 employees in
connection with a reduction in operations. Employees had three months to accept or reject the
termination benefit offer. How much loss due to termination benefits should HIJ recognize on
January 1, 20x12?
A)
$0
B)
$250,000
C)
$750,000
D)
Cannot be determined from the information given.
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO7
56. XYZ has a pension plan with the following characteristics: XYZ makes all contributions and
Ans: D
hz
employees receive benefits upon retirement that are based upon the balance in the accumulated
fund account. This pension plan may be characterized as:
A)
contributory and defined benefit.
B)
contributory and defined contribution.
C)
non-contributory and defined benefit.
D)
non-contributory and defined contributions.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
57. Choose the correct statement concerning accounting for pensions:
D)
E)
APO is reduced by amortization of Past service costs
Interest cost does not include interest on Past service costs
The difference between accumulated benefit obligation and vested benefit obligation is
attributed to differences in assumed compensation levels
One of the purposes of the corridor is to allow gains and losses to cancel each other before
affecting pension expense
The sum of accrued pension cost and additional minimum pension liability completely
describes the total unfunded obligation for pension benefits to which a sponsor has
committed, assuming the benefit formula incorporates future compensation levels
d
A)
B)
C)
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 13
Chapter 18 – Post-employment Benefits
58. Interest cost represents:
A)
B)
C)
D)
the increase in projected pension obligation as a result of recomputing the firm's pension
obligation when estimated turnover and other relevant pension factors are reassessed.
the increase in accrued pension obligation from the beginning of the year to the end of the
year solely due to the passage of time.
the increase in accrued pension obligation during the year resulting from all factors
affecting accrued pension obligation.
expected return on plan assets for the year.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
59. A firm has a $40,000 balance in its pension liability account. This me
the plan is underfunded
accrued pension obligation is less than plan assets at fair value
pension expense recognized to date exceeds total contributions to the pension plan to date
pension expense recognized to date exceeds plan assets at fair value
Ans: C
hz
A)
B)
C)
D)
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
zle
60. A firm has a $40,000 balance in its deferred pension cost account. This me
A)
B)
C)
D)
the plan is underfunded
accrued pension obligation is less than plan assets at fair value
pension expense recognized to date exceeds total contributions to the pension plan to date
pension expense recognized to date exceeds plan assets at fair value
Ans: D
d
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 14
Chapter 18 – Post-employment Benefits
61. How many of the following pension expense components could be negative (i.e. reduce pension
expense)?
Service cost
Interest cost
Amortization of net unrecognized gain or loss
Amortization of transition amount
A)
1
B)
2
C)
3
D)
4
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 4, 5
62. Recognition of pension expense is primarily based on the:
cost principle.
revenue principle.
matching principle.
full disclosure principle.
Ans: C
hz
A)
B)
C)
D)
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
63. The components of pension expense that involve delayed recognition are:
A)
B)
C)
D)
interest cost, Past service costs, transition cost, and expected return on plan assets.
service cost, transition cost, and gains and losses.
gains and losses, transition cost, and Past service costs.
transition cost, Past service costs, and expected return on plan assets.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
d
Ans: C
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 15
Chapter 18 – Post-employment Benefits
64. Pension data for ABC for three separate cases were:
Case 1
$300,000
$315,000
APO
Plan assets at fair value
Case 2
$300,000
$300,000
Case 3
$300,000
$280,000
The funded status of the APO for each case is:
1
2
3
4
Case 1
fully funded
underfunded
overfunded
overfunded
A)
B)
C)
D)
Choice 1
Choice 2
Choice 3
Choice 4
Case 3
underfunded
overfunded
fully funded
underfunded
hz
Ans: D
Case 2
overfunded
fully funded
underfunded
fully funded
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
65. The balance of pension plan assets at fair value, as of any measurement date, reflects the
cumulative:
Choice 1
Choice 2
Choice 3
Choice 4
Employer contributions
Benefits paid
*
*
*
*
*
d
A)
B)
C)
D)
zle
Plan earnings
*
*
*
1
2
3
4
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 16
Chapter 18 – Post-employment Benefits
66. The amount of the expected return on plan assets is computed by multiplying the:
A)
B)
C)
D)
ending market-related value of the plan assets by the expected long-term rate of return on
plan assets.
beginning carrying value of the plan assets by the actuary's interest rate.
average carrying value of the plan assets by the expected long-term rate of return on plan
assets.
beginning market-related value of the plan assets by the expected long-term rate of return
on plan assets.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
67. When a pension plan is adopted subsequent to organizing the company and credit for past service
Ans: D
hz
is granted, there will be a Past service costs which must be:
A)
debited directly to expense of the first year of the pension plan.
B)
debited directly to retained earnings.
C)
debited to expense as funded (with cash).
D)
unrecognized, then amortized in the future as part of pension expense.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
68. Which of the following statements is not correct?
A)
B)
C)
d
D)
As of a measurement date, accrued pension obligation minus plan assets at fair value
equals underfunded or overfunded accrued pension obligation.
During an accounting period, beginning pension liability/asset plus pension expense equals
ending deferred pension liability/asset.
As of a measurement date, APO minus plan assets plus or minus unrecognized pension
amounts equals deferred pension liability/cost.
During an accounting period, beginning plan assets at fair value plus or minus actual return
on plan assets plus pension plan contributions minus pension benefits paid equals ending
plan assets at fair value.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 17
Chapter 18 – Post-employment Benefits
69. Factors affecting estimates of benefits under a postretirement health care plan include all of the
following except:
A)
per capita claims cost by age.
B)
health care cost trend rates.
C)
plan demographics.
D)
discount rate.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
70. Choose the correct statement concerning pensions (defined benefit) and other post employment
Ans: C
hz
benefits.
A)
pension expense has six components; other post employment benefits expense has only
five
B)
Only pensions require a reconciliation of funded status to be disclosed
C)
Other post employment benefits payments are more difficult to predict than are pension
payments
D)
the entire other post employment benefits obligation must be recognized in the balance
sheet whereas, in most cases, the pension obligation is not
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
71. The full eligibility date for an employee covered in a non-pay related other post employment
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
d
benefits plan is
A)
the retirement date
B)
the date the employee is eligible for the maximum benefit the plan has to offer
C)
the date the employee is eligible for the benefits he or she is expected to receive
D)
the date the employee attains his or her final salary
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 18
Chapter 18 – Post-employment Benefits
72. Changes in defined benefit pension plans that reduce the expected years of future service of
present employees are:
A)
settlements.
B)
adjustments.
C)
terminations.
D)
curtailments.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
73. The total gain or loss due to a curtailment should be recognized:
A)
B)
C)
D)
Ans: B
hz
when it is probable that a curtailment will occur and the effects are reasonably estimable,
for either a gain or a loss.
immediately.
if a loss, when the employees terminate or the curtailment occurs.
if a gain, when it is probable that a curtailment will and the effects are reasonably
estimable.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
zle
74. Employers who provide contractual termination benefits must recognize a loss and a related
liability when:
A)
the employees accept the termination benefit offer.
B)
the termination benefit can be reasonably estimated.
C)
it is probable that employees will be entitled to the benefit and the amount of the benefit
can be reasonably estimated.
D)
the termination occurs.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
d
Ans: A
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 18 – Post-employment Benefits
75. ABC has a non-contributory, defined benefit pension plan. Data for 20x12 were as follows:
Pension plan assets (at fair value) January 1, 20x12, $240,000, and December 31, 20x12,
$285,000; APO, January 1, 20x12, $243,000 and December 31, 20x12, $345,000. The accrued
pension obligation was underfunded at the end of 20x12 in the amount of:
A)
$15,000
B)
$30,000
C)
$45,000
D)
$60,000
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO5
76. The corridor method is an approach that refers to:
expected return on plan assets
actuarial gains and losses
experience gains and losses
pension obligations
Ans: B
hz
A)
B)
C)
D)
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
zle
77. You are given the following information about JMR Ltd.'s defined benefit plan:
Accrued pension obligation, beginning of 20x12
Value of plan assets, beginning of 20x12
Unamortized actuarial loss, beginning of 20x12
Vesting/Average remaining service period
$675,765
$774,300
$89,000
8 years
d
The amount of amortization for the year ended 20x12 is:
A)
$0
B)
$11,125
C)
$11,570
D)
$1,446
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 18 – Post-employment Benefits
78. You are given the following information about KER Ltd.'s defined benefit plan:
Accrued pension obligation, beginning of 20x12
Value of plan assets, beginning of 20x12
Unamortized actuarial loss, beginning of 20x12
Vesting/Average remaining service period
Amortization expense in 20x11
$101,765
$119,300
$13,000
10 years
$300
The amount of amortization for the year ended 20x12 is:
A)
$0
B)
$407
C)
$107
D)
$1,446
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO5
hz
79. You are given the following information about KAR Ltd.'s defined benefit plan:
Accrued pension obligation, beginning of 20x12
Value of plan assets, beginning of 20x12
Unamortized actuarial loss, beginning of 20x12
Vesting/Average remaining service period
$675,765
$623,300
$89,000
8 years
zle
The amount of amortization for the year ended 20x12 is:
A)
$0
B)
$11,125
C)
$11,570
D)
$1,446
Ans: A
d
Difficulty: Medium
Level of Learning: Application
Topic: LO5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 21
Chapter 18 – Post-employment Benefits
80. Under the corridor method when the accumulated amount of actuarial gains and losses exceed
10% of the greater of the accrued obligation at the beginning of the year or the value of the plan
assets at the beginning of the year, the excess must be amortized over:
A)
at a maximum, the average remaining service period
B)
at a minimum, the average remaining service period
C)
10 years
D)
a rational and systematic amount chosen by management
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
81. The accrued pension obligation at the beginning of the year is $340,000; the value of the plan
Ans: C
hz
assets at the beginning of the year is $420,000. Assuming an interest factor of 7% what is the
interest cost for the year?
A)
$29,400
B)
$21,000
C)
$23,800
D)
$26,500
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO5
82. The accrued pension obligation at the beginning of the year is $340,000; the value of the plan
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
d
assets at the beginning of the year is $420,000. Assuming an interest factor of 7% what is the
expected return for the year?
A)
$29,400
B)
$21,000
C)
$23,800
D)
$26,500
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 22
Chapter 18 – Post-employment Benefits
83. The expected return on plan assets was $8,700; the actual return was $9,400. The difference
represents:
A)
unrealized gain
B)
realized gain
C)
interest revenue
D)
experience gain
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
84. The expected return on plan assets was $7,700; the actual return was $6,400. The difference
represents:
A)
unrealized loss
B)
realized loss
C)
interest expense
D)
experience loss
hz
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
A)
B)
C)
D)
zle
85. The corridor test for actuarial gains and losses looks at two items. One of them is:
the accrued obligation at the beginning of the year
the accrued obligation at the end of the year
the expected return at the beginning of the year
the expected return at the end of the year
Ans: A
d
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
86. The corridor test for actuarial gains and losses looks at two items. One of them is:
A)
B)
C)
D)
the value of the plan assets at the end of the year
the value of the plan assets at the beginning of the year
the expected return at the beginning of the year
the expected return at the end of the year
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 23
Chapter 18 – Post-employment Benefits
87. The accrued obligation at the beginning of the year was $456,000 and the current service cost for
the year is $67,000. Assuming an interest factor of 6% what is the accrued obligation at the end of
the year?
A)
$523,000
B)
$389,000
C)
$550,360
D)
$554,380
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
88. The accrued obligation at the beginning of the year was $289,000 and the current service cost for
Ans: A
hz
the year is $92,000. Assuming an interest factor of 8% what is the accrued obligation at the end of
the year?
A)
$404,120
B)
$381,000
C)
$403,860
D)
$363,660
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
89. The accrued obligation at the beginning of the year was $289,000, current service cost for the
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
d
year is $92,000, plan assets at the beginning of the year was $300,000. Assuming an interest rate
of 8% for all factors, what is the pension expense for the year?
A)
$681,000
B)
$380,120
C)
$404,120
D)
$363,660
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 24
Chapter 18 – Post-employment Benefits
90. The accrued obligation at the beginning of the year was $589,000, current service cost for the
year is $122,000, plan assets at the beginning of the year was $560,000. Assuming an interest rate
of 6% for all factors, what is the pension expense for the year?
A)
$681,000
B)
$151,000
C)
$404,120
D)
$712,740
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
91. When a pension plan is ended, the obligation is settled by transferring the assets to:
each individual
a financial bank
a trustee
none of the above
Ans: C
hz
A)
B)
C)
D)
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
92. Gains and losses from plan settlements and curtailments should be:
A)
B)
C)
D)
amortized over the average remaining service period
amortized over a systematic and rational manner
recognized in income immediately
deferred to the balance sheet
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
d
Ans: C
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 25
Chapter 18 – Post-employment Benefits
93. When a company offers termination benefits as the result of a restructuring plan, the special
termination benefits should be:
A)
recognized with normal pension expense
B)
amortized over the average remaining service period
C)
amortized over a systematic and rational manner
D)
included with the restructuring costs on the income statement
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
94. Pension related estimates (not funding data) are provided by the:
A)
B)
C)
D)
employer company.
independent actuary.
pension fund trustee.
employee union.
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
95. Choose the best description of the components of pension expense.
B)
C)
D)
Service cost + interest cost + pension benefits paid to retirees + amortization of Past
service costs + gain or loss recognized + amortization of transition asset or liability.
Service cost + interest cost + pension benefits paid to retirees + expected return on plan
assets + amortization of Past service costs + gain or loss recognized.
Service cost + interest cost +/- expected return on plan assets + amortization of past/Past
service costs + amortization of excess\ actuarial loss/gain.
Service cost + interest cost +/- expected return on plan assets + expected return on plan
assets + amortization of Past service costs + gain or loss recognized.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
d
zle
A)
96. Under IFRS, unrecognized transition costs are accounted for:
A)
B)
C)
D)
straight-line method using any systematic and rational approach.
retroactively.
interest method using the actuary's discount rate.
the service method similar to Past service costs amortization.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 18 – Post-employment Benefits
97. Funding a pension plan may be handled as follows:
1
2
3
4
independent
pension fund
*
*
*
*
A)
B)
C)
D)
Choice 1
Choice 2
Choice 3
Choice 4
retirement
annuity
*
*
internally
managed
*
*
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
hz
98. Timu joined the firm 12 years ago and is 42 today. The firm has a postretirement health care plan
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
d
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with the following coverages for retirees:
Age 65 at retirement and 30 years of service
100% coverage
Age 60 at retirement and 30 years of service
75% coverage
Timu is expected to retire at age 63. The present value today of 100% postretirement health care
coverage for Timu is $20,000, considering life expectancy and other factors. The present value of
75% coverage is $14,000. What is the accumulated postretirement benefit obligation for Timu
today?
A)
$20,000
B)
$14,000
C)
$ 8,000
D)
$ 5,600
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 18 – Post-employment Benefits
99. Today is John's 57th birthday and he has served 14 years for his firm. John is expected to retire
on his 65th birthday. His firm expects to incur $5,000 of annual net health care claims costs for
John beginning one year after his retirement date and continuing each year for a total of seven
years (assume seven end of year payments in all). To be fully eligible for these benefits, John
must work 20 years. Compute expected postretirement benefit obligation for John today if the
discount rate is 8%.
A)
$15,244
B)
$12,322
C)
$18,916
D)
$14,064
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
100. Bonnie joined a firm at age 25 and is expected to retire at 57. The postretirement benefit plan
provides the following coverage given the indicated years of service after age 30.
hz
% of full coverage
25%
50%
100%
Years of service after age 30
15
25
35
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
d
zle
What is Bonnie's full eligibility date (her age when fully eligible)?
A)
57
B)
55
C)
50
D)
60
101. All of the following are relevant policy disclosures suggested by the AcSB except:
A)
a reconciliation of relevant pension amounts
B)
amount of pension expense for the period, broken down by component
C)
the number of employees
D)
a reconciliation of the defined benefit obligation from the beginning to the end of the year
E)
changes to reserves and other comprehensive income if any
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO9
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 18 – Post-employment Benefits
102. All of the following are relevant policy disclosures suggested by the AcSB except:
A)
a reconciliation of pension plan assets from the beginning to the end of the year
B)
description of how expected return on pension plan assets is calculated
C)
actual return on plan assets during the year
D)
principle actuarial assumptions
E)
the risk profile of the employee group
Ans: E
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO9
103. The following pension data relates to a non-contributory, defined-benefit pension plan (000s):
hz
Pension obligation
Accumulated benefit obligation
Vested benefit obligation
Service cost
Unrecognized Past service costs
Pension plan assets (at fair value)
December 31
20x12
20x13
$190
$210
140
150
100
118
110
115
6
5
160
225
Difficulty: Medium
zle
Compute the under (or over) funded pension obligation at the end of each year.
Ans: 20x12: Pension obligation, $190 - Plan assets, $160 = $30 underfunded.
20x13: Pension obligation, $210 - Plan assets, $225 = $15 overfunded.
Level of Learning: Application
Topic: LO1
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 18 – Post-employment Benefits
104. What is the most critical value or amount in a defined benefit pension plan from the point of view
of the financial statement user, and is this amount generally reported in the balance sheet for most
firms? Explain.
Ans: Funded status of the plan is the most critical amount because it represents the degree to
which funds have been accumulated to pay promised benefits. Generally this amount is not
reported in the balance sheet because of delayed recognition of Past service costs, net
unrecognized gain or loss, and transition item. These amounts cause the balance sheet
account, accrued pension cost, to differ from funded status.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
105. What is a defined contribution plan?
Ans: A defined contribution plan places the risk of the future amount to be received by the
employee on the employee. The employer agrees to make specific contributions with the
amount to be received by the employee dependent on the interest rate earned.
Difficulty: Medium
hz
Level of Learning: Knowledge
Topic: LO2
Level of Learning: Knowledge
Topic: LO1
d
zle
106. How does a trustee impact upon accounting for defined pension plans?
Ans: A trustee is independent and receives the contributions from the employer. The trustee
invests the money (unless an independent money manager is hired to perform the
investment function) and pays the benefits to the employees. Trustees are not individuals
but may be financial institutions. If the pension plan is administered by the company
instead of a trustee, the company must report the plan assets and the accrued pension
liability on the balance sheet because the plan is under the control of the company. If the
trustee administers the plan, the company no longer has control and neither the plan assets
nor the pension plan liabilities are reported on the company's statements.
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Chapter 18 – Post-employment Benefits
hz
107. Match the brief description with the terms by entering the appropriate letters in the blank spaces
provided.
Brief Description
A. Pension expense is the sum of certain pension costs, losses, and gains.
B. The relationship between the accrued pension obligation and the pension plan assets at fair
value.
C. Certain changes in the employer's pension obligations and the value of plan assets are not
recognized when they occur.
D. Actuary's report of pension plan estimates.
E. Reporting on the balance sheet of certain recognized pension assets and liabilities as a single
amount.
F. Employer's pension obligation that is not contingent on future employment of employees.
G. The date that pension plan assets and obligations are determined.
H. Cumulative employer's contributions in excess of recognized net pension expense.
Term
___1.
Netting
___2.
Underfunded, overfunded, or fully funded
___3.
Measurement date
___4.
Delayed recognition
___5.
Accrued pension obligation report
___6.
Vested benefit obligation
___7.
Offsetting
___8.
Prepaid pension cost
zle
Ans: 1:A, 2:B, 3:G, 4:C, 5:D, 6:F, 7:E, 8:H
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3, 4
d
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Chapter 18 – Post-employment Benefits
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hz
108. Match the brief definitions with the terms by entering the appropriate letters in the blank spaces
provided.
Brief Definition
A. Actuarial present value of all future pension benefits including the effects of current and
future compensation levels.
B. Beginning accrued pension obligation multiplied by the actuary's discount rate.
C. Specifies the retirement benefits in conformity with the pension plan.
D. Resources related to the pension that is administered by the independent trustee.
E. The employer provides all of the required funding.
F. Actuarial present value of all future pension benefits excluding the effects of future
compensation levels.
G. The interest rate used by the actuary to adjust for the time value of money.
H. Beginning balance of plan assets at fair value multiplied by the long-term expected rate of
return on plan assets.
I. Allocation (assignment) of pension costs to periodic pension expense.
J. Amount computed by the employer as total pension expense; may be comprised of six
components.
Term
___1.
Discount rate
___2.
Pension plan assets
___3.
Accrued pension obligation
___4.
Expected return on plan assets
___5.
Accumulated benefit obligation
___6.
Non-contributory pension plan
___7.
Pension benefit formula
___8.
Attribution of pension plan costs
___9.
Interest cost (component)
___10. Net periodic pension expense
Ans: 1:G, 2:D, 3:A, 4:H, 5:F, 6:E, 7:C, 8:I, 9:B, 10:J
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3, 4
d
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Chapter 18 – Post-employment Benefits
zle
hz
109. Match the brief description with the terms by entering the appropriate letters in the blank spaces
provided.
Brief Description
A. Transaction that is irrevocable, relieves employer of some pension plan obligations, and
eliminates significant risk related to the plan obligation and assets.
B. Net of any unrecognized gain or loss and any unrecognized net transition asset (i.e., gain).
C. Plan to which two or more employers contribute and for which pension assets are not
separately identified for each employer.
D. Compensation offered for a short period of time when an employee is terminated prior to
expected retirement date.
E. Increase or decrease in the accrued pension obligation.
F. Compensation to employees required by a pension plan only if a specified event occurs which
causes an employee to be terminated prior to expected retirement date.
G. Any unrecognized Past service costs and unrecognized transition cost related to curtailed
years of service.
H. Event that either reduces the expected years of future service of present employees, or
eliminates accrual of defined benefits for some or all future services.
Term
___1.
Contractual termination benefit
___2.
Maximum gain or loss for a settlement
___3.
Accrued pension obligation gain or loss due to a curtailment
___4.
Past service and transition loss due to a curtailment
___5.
Multiemployer pension plan
___6.
Curtailment
___7.
Settlement
___8..
Special termination benefit
Ans: 1:F, 2:B, 3:E, 4:G, 5:C, 6:H, 7:A, 8:D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 2, 3, 4
d
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Chapter 18 – Post-employment Benefits
110. JTD began working for XYZ at age 45 and immediately qualified for the company pension plan.
The retirement age in the company is 65 (i.e., 20 full years of employment for JTD). The pension
specifies a $30,000 annual (year-end) pension benefit for JTD and the life expectancy is age 80
(i.e., the pension benefit will be paid for 15 years). Assume a constant 8% interest rate during the
20 working years, and a 7% constant rate during the retirement years per the actuarial estimates
(assume all cash flows at year-end). XYZ plans to fund a constant amount per period at each
year-end during the employment period.
Required:
(a) What amount of funds should be in the pension fund at the beginning of the first retirement
year?
(b) What amount should XYZ pay to the funding agency each year-end during the employment
period?
(c) Is it possible to determine pension expense for the first year of the plan?
Ans: (a) $30,000 x (PVA, 7%, 15) (9.10791) = $273,237.
(b) $273,237 ÷ (FVA, 8%, 20) (45.76196) = $5,971.
(c) There is not sufficient data to determine pension expense; the amount in (b) is only the
required annual funding amount needed to reach the company's goal.
Difficulty: Medium
hz
Level of Learning: Application
Topic: LO4, 5
zle
111. What are past service costs and how should they be amortized (if at all)?
Ans: Past service costs are incurred when a company implements a new defined pension plan
and employees already working receive past credit for their employment. In other words,
the employees would be eligible for an immediate pension entitlement. The amount is a
liability but should not be set up on the balance sheet. It should remain off the balance
sheet and amortized on a straight-line basis over a reasonable time period (recommended
to be the expected period to full eligibility of the employee group).
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
d
112. What is the corridor method?
Ans: The corridor method refers to the treatment given to actuarial gains and losses. Actuarial
gains and losses must be amortized if the accumulated amount exceeds 10% of the greater
of the accrued obligation at the beginning of the year, or the value of the plan assets at the
beginning of the year. If amortized, the amount by which the accumulated actuarial gains
and losses exceeds the above is amortized over the average remaining service period. If the
threshold is not met no amortization is required although companies may amortize if they
wish to be conservative. Note that the corridor method represents a minimum amortization
amount of actuarial gains and losses.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 18 – Post-employment Benefits
113. You are given the following information about AG Ltd.:
Accrued pension obligation, beginning of 20x12
Value of plan assets, beginning of 20x12
Unamortized actuarial loss, beginning of 20x12
Average remaining service period
Total
$567,432
$612,349
$72,340
8 years
Required:
Calculate the amount of amortization, if any for 20x12.
Ans: 10% x $567,432 (accrued pension obligation) = $56,743
10% x $612,349 (plan assets) = $61,235
Excess (72,340-61,235) =11,105. 11,105/8=$1,388
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
114. You are given the following information about JG Ltd.:
hz
Accrued pension obligation, beginning of 20x13
Value of plan assets, beginning of 20x13
Unamortized actuarial loss, beginning of 20x13
Vesting/Average remaining service period
Total
$567,432
$612,349
$42,340
8 years
zle
Required:
Calculate the amount of amortization, if any for 20x12.
Ans: 10% x $567,432 (accrued pension obligation) = $56,743
10% x $612,349 (plan assets) = $61,235
Actuarial loss is less than above therefore no amortization is necessary.
Difficulty: Medium
Level of Learning: Application
Topic: LO4, 5
d
115. What are plan settlements and curtailments and how should the gains and losses be accounted
for?
Ans: Plan settlements and curtailments occur when an employer ends a pension plan. This may
also happen when a company closes down a portion of their operations. In the event that a
pension is settled there may be significant gains and losses due to the funding of the plan
versus the accounting for that plan. Gains and losses on settlement or curtailment are not
amortized, as the employees related to the plan are no longer employed. These gains and
losses are recognized immediately. Unlike a settlement, where obligations are paid, the
benefits earned to date remain unpaid in a curtailment
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 18 – Post-employment Benefits
116. When should the cost of termination benefits be recognized?
Ans: The cost of termination benefits should be recognized immediately after the employees
have accepted the offer. Amortization is not appropriate, as employment has ceased.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO7
d
zle
hz
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Page 36
Chapter 18 – Post-employment Benefits
The following information applies to questions 117 to 120 inclusively:
ABC Inc. had the following balances pertaining to its defined benefit pension plan:
Balances, end of 20x10:
Defined benefit obligation, end of 20x10:
Pension plan assets at fair value, end of 20x10:
$12,000,000
$ 9,000,000
Unrecognized past service costs, recognized at the
end of 20x10 (to be amortized as of 20x11)
$1,000,000
Unrecognized actuarial gains:
Accrued pension asset in the financial statements
$1,500,000
$3,500,000
The following additional information is provided:
hz
zle
Current service cost, 20x11
Benefit payments to retired employees in 20x11
Funding contributions by employer in 20x11
Actual return on plan assets
Expected return on plan assets
Interest rate on long-term debt
Employee average remaining service life
Vesting period for past service costs (Note 1)
$300,000
$60,000
$400,000
$600,000
9%
6%
10 years
5 years
Note 1:
25% of the unrecognized past service costs above have vested by the end of 20x11
117.
d
Use the data above to prepare a pension worksheet assuming that ABC Inc. adheres to IFRS. Also
assume that ABC uses the 10% corridor method for amortization of unrecognized actuarial gains
and losses.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 37
Chapter 18 – Post-employment Benefits
Ans:
Memo
Accounts
Statement accounts
Values
Unrecognized pension costs
20x11
Defined Benefit
Obligation
Plan
Assets
Unrecognized
Loss (Gain)
Past Service
cost
Pension
expense
Accrued
Pension
Asset
(Liability)
20x11
Beginning Balances
-12,000,000
9,000,000
Current service cost
-300,000
300,000
Interest on Obligation
-720,000
720,000
Expected return on plan assets
600,000
hz
-600,000
30,000
-13,020,000
400,000
-30,000
580,000
600,000
10,200,000
-580,000
600,000
zle
Ending balances
3,500,000
-810,000
-400,000
Excess actuarial gain amortization**
Funding
1,000,000
810,000
Actual return on plan assets
PSC Amortization*
-1,500,000
-1,260,000
600,000
3,520,000
* $250,000 VESTED +$750,000/5 YEAR VESTING PERIOD
**1,5 million-10%*12 million=$300,000/10 years=$30,000
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 38
Chapter 18 – Post-employment Benefits
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5, 6, 10
118.
Refer to question 117 above. Explain how the data in the spreadsheet above would appear on
ABC’s financial statements under the proposed IASB changes to pension accounting.
Ans:
Pension expense would include only current service costs as well as amortization of any past
service cost (i.e. $300,000+$400,000) on the statement of comprehensive income.
There would also be a net finance charge of (-$12 million+$9 million)*6% of $180,000 on the
statement of comprehensive income.
hz
Finally, any unrecognized actuarial and experience gains and losses 9excluding unamortized past
service costs) would be recorded on ABC’s statement of financial position as an asset or liability
with the offset increasing or decreasing reserves and other comprehensive income respectively.
The rationale for this is partly due to the fact that any experience or actuarial gains or losses may
ultimately be realized or compensated by the company (thus meeting the definition of an asset or
liability).
Difficulty: Hard
d
zle
Level of Learning: Application
Topic: LO4, 5, 6, 10
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 39
Chapter 18 – Post-employment Benefits
119.
Use the data above to prepare a pension worksheet assuming that ABC Inc. adheres to ASPE and
uses the standard approach to account for its defined benefit pension plan. Also assume that ABC
uses the 10% corridor method for amortization of unrecognized actuarial gains and losses.
Ans:
Memo
Accounts
Statement accounts
Values
Unrecognized pension costs
20x11
20x11
Beginning Balances
Interest on Obligation
Expected return on plan assets
Actual return on plan assets
PSC Amortization*
Excess actuarial gain amortization**
12,000,000
9,000,000
Past Service
cost
-1,500,000
-810,000
-600,000
-100,000
30,000
10,200,000
-1,260,000
100,000
-30,000
280,000
d
13,020,000
3,500,000
720,000
810,000
600,000
Accrued
Pension
Asset
(Liability)
300,000
-720,000
600,000
Pension
expense
1,000,000
-300,000
Funding
Ending balances
Unrecognized
Loss (Gain)
zle
Current service cost
Plan
Assets
hz
Defined
Benefit
Obligation
900,000
-280,000
600,000
3,820,000
* $1 million/10 YEAR AVERAGE REMAINING SERVICE LIFE
**1,5 million-10%*12 million=$300,000/10 years=$30,000
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5, 6, 10
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 40
Chapter 18 – Post-employment Benefits
120.
Use the data above to prepare a pension worksheet assuming that ABC Inc. adheres to ASPE and
uses the simplified approach to account for its defined benefit pension plan.
Ans:
Memo
Accounts
Statement accounts
Values
Unrecognized pension costs
20x11
Defined
Benefit
Obligation
Plan
Assets
Unrecognized
Loss (Gain)
Pension
expense
Past Service cost
Accrued
Pension
Asset
(Liability)
20x11
Current service cost
Interest on Obligation
12,000,000
hz
Beginning Balances
9,000,000
-300,000
300,000
-720,000
720,000
600,000
Funding
600,000
13,020,000
3,500,000
-600,000
420,000
zle
Actual return on plan assets
Ending balances
-500,000
10,200,000
0
-420,000
600,000
0
3,680,000
Difficulty: Hard
Level of Learning: Application
Topic: LO4, 5, 6, 10
d
* Note that the Unrecognized loss and past service cost columns are not necessary.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 41
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test Bank
Chapter 19 – Earnings per Share
1. An anti-dilutive effect means that EPS is decreased as a result.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
2. Only firms with a complex capital structure must compute diluted EPS.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO 1
Ans: True
hz
3. Stock dividend and stock splits are treated as though they had been in effect for the entire
period.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
zle
4. Convertible securities and options are always included in the calculation of diluted EPS.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
d
5. Reporting earnings per share for public companies is optional; however, its presentation is
strongly recommended.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 1
Chapter 19 – Earnings per Share
6. When a midyear stock dividend increases the number of common shares outstanding for the
period, the new shares resulting from the dividend are weighted by one-half a year for purposes
of computing EPS.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
7. Earnings per share refer to the amount of earnings attributable to each share of common and
preferred stock.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
8. When a midyear stock dividend increases the number of common shares outstanding for the
Ans: True
hz
period, the average number of common shares outstanding is computed as if the stock dividend
was distributed at the beginning of the year.
zle
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
9. The treasury stock method is only used for options, and only the denominator is affected..
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
d
10. Provided that the conditions for share issuance are met at the end of a period and the date
of the contingency period has not expired, contingently issuable shares will be included
in EPS calculations.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
11. For purposes of computing the average number of common shares outstanding, stock dividends
are treated in the same manner as stock splits.
Ans: True
Difficulty: Easy
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 2
Chapter 19 – Earnings per Share
Level of Learning: Knowledge
Topic: LO3
12. Nonconvertible, cumulative preferred shares affect the computation of EPS (for simple capital
structure), basic EPS and diluted EPS.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
13. A simple capital structure refers to a shareholders' equity section which only has common shares
and no potentially dilutive securities that, upon their conversion or exercise in the aggregate,
would dilute earnings per share.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
14. A simple capital structure is one in which the shareholders' equity consists only of common
shares or includes no potentially dilutive securities.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
15. Corporations with simple capital structures are required to present two sets of EPS data.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
16. In some cases, diluted earnings per share amounts may be the same as the basic earnings per
share amounts.
Ans: True
Difficulty:
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 3
Chapter 19 – Earnings per Share
17. Anti-dilution must be considered only with complex capital structures.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
18. The basic EPS can be compared with basic EPS numbers from the past years to see whether the
company is earning more or less for its common shareholders.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
19. The diluted EPS does not have to be disclosed in the financial statements.
Ans: False
hz
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
20. The diluted EPS should be disclosed in the financial statements only if it is materially different
from basic EPS.
zle
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
21. Basic EPS is an historical amount.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
Ans: True
22. Diluted EPS is meant to be a worst-case scenario.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 4
Chapter 19 – Earnings per Share
23. A reverse split may be used to increase the value per share of a company.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
24. Where there are significant changes in a corporation's capital structure after year end but before
the financial statement date, the transaction must be disclosed and described.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
25. EPS figures must be disclosed under both ASPE and IFRS.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
26. Diluted EPS indicate long-run impact that the likely conversion will have on the earnings
attributable to common shares.
zle
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
27. Company A has an EPS of $6 and Company B has an EPS of $23. Based on this information,
Company B is the better investment.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
d
Ans: False
28. When there has been a retrospective change in Accounting policy or a restatement, EPS
figures must be recalculated accordingly.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 5
Chapter 19 – Earnings per Share
29. Options are in-the-money if the exercise price is higher that the market value of common shares.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
30. Option adjustments are based on the treasury stock method.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
31. Bonds and preferred share adjustments are based on the if-converted method.
Ans: True
Difficulty: Easy
hz
Level of Learning: Knowledge
Topic: LO3
32. When computing diluted earnings per share, convertible securities are a sale of additional
common stock.
zle
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
33. For purposes of computing the weighted average number of shares outstanding during the year, a
midyear event that must be treated as occurring at the beginning of the year is the purchase of
treasury stock.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
d
Ans: False
34. EPS figures must be disclosed on the face of the financial statements for discontinued operations.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 6
Chapter 19 – Earnings per Share
35. Wholly-owned subsidiaries are required to disclose earnings per share.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO6
36. ABC Inc. has 20,000 common shares outstanding throughout the year. It also had 20,000, 6
percent preferred shares, par $20, (cumulative and nonconvertible) outstanding throughout the
year. Net income was $300,000. The earnings per share amount would be $13.80
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
37. Diluted EPS recalculates EPS as though the conversions of different instruments had taken place
at the beginning of the year.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
zle
38. Diluted earnings per share recalculate EPS as though the conversions of different instruments had
taken place at the end of the year.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
d
39. At December 31, 20x2, the shareholders' equity of ABC Inc. reported as outstanding: 100
common shares and 30 nonconvertible preferred shares. On July 1, 20x3, ABC Inc. issued a 10
percent stock dividend on its common shares and paid a cash dividend of $2.00 per share on its
preferred (the full year's requirement). Income for the year ended December 31, 20x3 was
$1,170. The 20x3 EPS, rounded to the nearest cent, for ABC Inc. should be $8.58.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 7
Chapter 19 – Earnings per Share
40. When computing the weighted average number of shares outstanding, an actual conversion of
convertible preferred shares is assumed to have occurred on the first day of the year, regardless of
when it was converted.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
41. If the corporation purchases common treasury stock, those shares would be included in the EPS
computation only for the fraction of the year that they were outstanding.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
hz
42. If nonconvertible preferred shares are noncumulative, subtraction of the current year's dividend
must be made whether preferred dividends are declared or not for the current year.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
zle
43. Nonconvertible, cumulative, preferred shares affect the computation of EPS (for a simple capital
structure), basic EPS, but not diluted EPS.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2
d
44. Stock rights, options, and warrants determined to be dilutive when computing fully diluted
earnings per share may be anti-dilutive when computing basic earnings per share.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
45. In computing EPS for a simple capital structure, net income is reduced by cumulative preferred
dividends on nonconvertible preferred shares, whether dividends are declared or not.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 8
Chapter 19 – Earnings per Share
46. Dilutive securities potentially increase EPS.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
47. Earnings per share is computed on the basis of:
A)
B)
C)
C)
A weighted average of the number of common shares outstanding during the year.
A weighted average of the number of preferred and common shares outstanding during the
year.
The number of common shares outstanding at the end of the year.
The number of common and preferred shares outstanding at the end of the year.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
hz
48. Earnings per share figures are required to be reported:
A)
B)
C)
D)
On the face of the income statement.
They need not be presented, however, it is recommended.
At an undesignated place in the financial statements.
In the notes to the financial statements or at the bottom of the income statement.
zle
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
49. If net income is $10,000 and there were 8,000 common shares issued and outstanding the entire
d
year, and $100,000 of noncumulative, nonconvertible 6% $100 par preferred shares outstanding
the entire year, what is EPS if no dividends were declared during the year?
A)
$1.18
B)
$1.23
C)
$1.25
D)
$1.16
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 9
Chapter 19 – Earnings per Share
50. The annual dividend on nonconvertible cumulative preferred shares is $10,000. At the beginning
of the current year, there were 3 years of dividends in arrears. During the current year, $38,000 of
dividends on the preferred shares were declared, and $35,000 were paid. What amount of
dividends on preferred shares will be subtracted from earnings when computing basic EPS for the
current year?
A)
$40,000
B)
$10,000
C)
$38,000
D)
$35,000
E)
$30,000
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Ans: B
Difficulty: Medium
zle
hz
51. The annual dividend on nonconvertible cumulative preferred shares is $10,000. At the beginning
of the current year, there were 3 years of dividends in arrears. During the current year, $38,000 of
dividends on the preferred shares were declared, and $35,000 were paid. What amount of
dividends on preferred shares will be subtracted from earnings when computing diluted EPS for
the current year?
A)
$40,000
B)
$10,000
C)
$38,000
D)
$35,000
E)
$30,000
Level of Learning: Application
Topic: LO2
d
52. At December 31, 20x2, XYZ had 40,000 common shares issued and outstanding and 10,000
nonconvertible preferred shares issued and outstanding. XYZ's net income for the year ended
December 31, 20x3, was $120,000. During 20x3, XYZ declared and paid $50,000 cash dividends
on common and $8,000 cash dividends on the nonconvertible preferred (the annual requirement).
There were no common share or preferred share transactions during the year. The earnings per
common share for the year ended December 31, 20x3, should be:
A)
$1.75
B)
$2.40
C)
$2.80
D)
$3.00
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 10
Chapter 19 – Earnings per Share
53. When computing diluted earnings per share, convertible securities are:
A)
Ignored.
B)
Recognized only if they are dilutive.
C)
Recognized only if they are anti-dilutive.
D)
Recognized whether they are dilutive or anti-dilutive.
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO2
54. Dilutive convertible securities must be used in the computation of:
A)
Diluted and basic earnings per share.
B)
diluted earnings per share.
C)
Basic earnings per share.
D)
Dilutive convertible securities are not used in any computations of earnings per share.
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
zle
55. ABC paid $5,000 in dividends to its preferred shareholders. The 5 percent preferred shares
(10,000 shares outstanding) are nonconvertible and noncumulative. The $5,000 dividend:
A)
Will be added to the numerator of the EPS calculation.
B)
Will be subtracted from the numerator of the EPS calculation.
C)
Will be added to the denominator of the EPS calculation.
D)
May not affect the EPS calculation, depending on the declaration date of the dividends.
56. In computing the weighted average number of shares outstanding, the following is considered
outstanding only as of the date issued or sold:
A)
Stock splits.
B)
Reverse stock splits.
C)
Stock dividends.
D)
Common shares issued.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 11
Chapter 19 – Earnings per Share
57. A preferred dividend claim should be subtracted from income to compute basic EPS if the
preferred shares are:
A)
Noncumulative, nonconvertible, and a dividend has not been declared; however, a dividend
was paid this year in fulfillment of the obligation from last year's declaration.
B)
Noncumulative, nonconvertible, and the company would like to declare a dividend;
however, by law they can't because of a debit balance in the retained earnings account.
C)
Noncumulative, nonconvertible, non-participating, and the dividend has been declared.
D)
Participating, nonconvertible, noncumulative, and the dividend has not been declared.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
58. A simple capital structure could have, in addition to common shares, a security that is a:
Stock right.
Stock warrant.
Convertible preferred shares.
Convertible bond.
Nonconvertible preferred shares.
hz
A)
B)
C)
D)
E)
Ans: E
Difficulty: Medium
zle
Level of Learning: Knowledge
Topic: LO2
59. Which of the following statements is correct?
A)
B)
C)
D)
Basic EPS is hypothetical figure while diluted EPS is a historical figure.
Basic EPS is a historical figure while diluted EPS is a hypothetical figure.
Basic and diluted EPS are both historical figures.
Basic and diluted EPS are both hypothetical figures.
Level of Learning: Knowledge
Topic: LO2
d
Ans: B
Difficulty: Medium
60. With respect to the computation of earnings per share, which of the following would be most
indicative of a simple capital structure?
A)
Ownership interests consisting only of common shares
B)
Equity represented only by common and convertible preferred shares
C)
Common shares, preferred shares, and convertible securities outstanding in lots of even
thousands
D)
Earnings derived from one primary product segment of business
Ans: A
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 12
Chapter 19 – Earnings per Share
Level of Learning: Knowledge
Topic: LO2
61. When a company has negative net income and potentially dilutive securities, the calculation of
EPS results in:
A)
Diluted EPS i.e. all potentially dilutive securities are included in the calculation (whether
dilutive or anti-dilutive)
B)
No EPS being reported
C)
Diluted EPS being reported and it will be more than basic EPS
D)
None of the above
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Ans: D
Difficulty: Medium
zle
hz
62. The classification of a security as a convertible security should be based on information available
at the time:
A)
The security would be the most dilutive.
B)
The security would be the most anti-dilutive.
C)
The EPS calculation is made each year.
D)
The security is issued.
Level of Learning: Knowledge
Topic: LO2
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
63. A basic earnings per share figure is presented for:
A)
A complex capital structure.
B)
A simple capital structure.
C)
Both simple and complex structures.
D)
Neither simple nor complex structures.
64. Convertible noncumulative preferred stock for which the current year's dividend has not been
declared does not affect the EPS figures if it:
A)
Has been converted.
B)
is anti-dilutive.
C)
Is a common convertible security.
D)
None of the above.
Ans: B
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 13
Chapter 19 – Earnings per Share
Level of Learning: Knowledge
Topic: LO2
65. The reported diluted earnings per share figure may be:
A)
less than the basic earnings per share figure.
B)
More than the basic earnings per share figure.
C)
Equal to the basic earnings per share figure.
D)
More than or less than the basic earnings per share figure.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
66. Concerning earnings per share for a complex capital structure, which of the following statements
Ans: E
zle
hz
is incorrect?
A)
Basic earnings per share must be based on the weighted average number of common shares
outstanding.
B)
Both basic and diluted earnings per share must be presented on the face of the financial
statements.
C)
A "convertible security" is a security which is not, in form, a common share but which
contains provisions to enable its holder to become a common shareholder.
D)
"Basic earnings per share" is never reported at less than "diluted earnings per share."
E)
If the only potentially dilutive security outstanding is an employee stock option plan, then
primary and diluted EPS must be equal.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
A)
B)
C)
D)
d
67. When computing diluted earnings per share, convertible securities are:
Incorporated into diluted EPS only if they are dilutive.
Incorporated into diluted EPS only if they are anti-dilutive.
Ignored for EPS purposes.
Incorporated into diluted EPS whether they are dilutive or anti-dilutive.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 14
Chapter 19 – Earnings per Share
68. For purposes of computing the weighted average number of shares outstanding during the year, a
midyear event that must be treated as occurring at the beginning of the year is the:
A)
sale of additional common shares.
B)
Issuance of stock warrants.
C)
Purchase of treasury stock.
D)
Declaration and issuance of stock dividend.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
69. ABC experienced the following changes in its capital structure during 20x3:
Ans: C
hz
Outstanding on January 1, 20x3, 90 common stock shares
Sold 120 common shares on February 1, 20x3
Sold 60 common shares on April 1, 20x3
Issued a 2 for 1 split on August 1, 20x3
ABC's weighted average number of common shares outstanding for 20x3 would be:
A)
245
B)
315
C)
490
D)
540
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
70. WXY had the following common share transactions:
January 1
60 shares outstanding
April 1
2 for 1 split
August 1
10 percent stock dividend
September 1
Purchased 10 shares of treasury stock
The weighted average number of shares outstanding for the year was:
A)
95 shares.
B)
110.13 shares.
C)
115.33 shares.
D)
128.67 shares.
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 15
Chapter 19 – Earnings per Share
71. ABC has 20,000 common shares outstanding throughout the year. It also had 20,000, 6 percent
preferred shares, par $20, (cumulative and nonconvertible) outstanding throughout the year. Net
income was $300,000. The earnings per share amount would be:
A)
$9.20
B)
$10.00
C)
$13.80
D)
$15.00
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO3
hz
72. XYZ reported the following equity accounts on December 31 of this year:
Liabilities:
Bonds payable, 12 percent, nonconvertible
Shareholders' equity:
Preferred shares, $15 par, 7 percent, non convertible, non cumulative
Common shares, no par, 40 shares outstanding
Retained earnings
$200
300
400
120
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
Ans: C
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Additional Information:
(1) The Board of Directors declared a 10 percent stock dividend on all classes of shares on April
1, and issued these shares on August 1.
(2) Income for the period was $88.
(3) There were no share transactions during the year, other than the stock dividend.
The basic earnings per share amount is:
A)
$1.52
B)
$1.68
C)
$2.00
D)
$2.20
E)
There would not be a basic earnings per share figure for XYZ this year.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 16
Chapter 19 – Earnings per Share
73. RST's net income for the year ended December 31, 20x3, was $30,000. During 20x3, RST
declared and paid $3,000 cash dividends on preferred shares (the full year's requirement) and
$5,250 cash dividends on common shares. At December 31, 20x3, 36,000 common shares were
issued and outstanding, 30,000 of which had been outstanding throughout the year and 6,000 of
which were issued on July 1, 20x3. No other common share transactions were completed during
the year, and there is no potential dilution of earnings per share. The 20x3 earnings per common
share of RST, rounded to the nearest penny, should be:
A)
$.75
B)
$.82
C)
$.91
D)
$1.00
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Ans: A
zle
hz
74 At December 31, 20x2, MNO had 50,000 common shares issued and outstanding. On April 1,
20x3, an additional 10,000 common shares were issued. MNO's net income for the year ended
December 31, 20x3, was $1,035,000. During 20x3, MNO declared and paid $600,000 cash
dividends on its nonconvertible preferred shares (the full year's requirement). The earnings per
common share, rounded to the nearest cent, for the year ended December 31, 20x3, should be:
A)
$7.57
B)
$7.92
C)
$18.00
D)
$18.84
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
75 At December 31, 20x2, the shareholders' equity of LMN reported as outstanding: 100 common
shares and 30 nonconvertible preferred shares. On July 1, 20x3, LMN issued a 10 percent stock
dividend on its common shares and paid a cash dividend of $2.00 per share on its preferred (the
full year's requirement). Income for the year ended December 31, 20x3 was $1,170. The 20x3
EPS, rounded to the nearest cent, for LMN should be:
A)
$10.09
B)
$10.58
C)
$10.64
D)
$11.70
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 17
Chapter 19 – Earnings per Share
76 At December 31, 20x3, QRS had 500 common shares issued and outstanding, 400 of which had
been issued and outstanding throughout the year and 100 of which were issued on October 1,
20x3. Net income for the year ended December 31, 20x3, was $4,288. What should be QRS's
20x3 earnings per common share, rounded to the nearest cent?
A)
$8.58
B)
$9.53
C)
$10.09
D)
$10.72
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO3
77. firm that earned $20,000 (after tax) had the following securities outstanding all year during
Ans: A
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which the tax rate was 40%:
20,000 common shares
1,000, 6%, $100 par cumulative nonconvertible preferred shares
2,000, 4%, $50 par cumulative preferred shares, each share convertible into 5 common shares
100, 8%, $1,000 convertible bonds, each convertible into 10 common shares (bonds were issued
at face)
What is basic EPS?
A)
$ .50
B)
$ .70
C)
$1.00
D)
$ .75
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
78. PPO Inc. discloses the following results and information at the end of the current year:
Earnings
Dividends on preferred shares declared and paid
Common shares outstanding Jan. 1
The shares were split 4-for-1 August 1
Common dividends declared and paid
$400,000
$100,000
50,000
$200,000
What are BEPPO's earnings per share for the current year?
A)
$1.50
B)
$6.00
C)
$2.00
D)
$8.00
Ans: A
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 18
Chapter 19 – Earnings per Share
Level of Learning: Application
Topic: LO3
79. JUNK BONDS Inc. began operations Jan. 1, 20x3. The following events related to common
shares took place on the indicated dates during 20x3.
Jan. 1 Issued 25,000 common shares
Apr. 1 Purchased 4,000 treasury shares
May 1 Split the common shares 4-for-1
Aug. 1 Issued 20,000 common shares
Dec. 1 Issued a 25% stock dividend
Assuming no potentially dilutive securities, what is the weighted average shares for EPS in 20x3?
A)
96,333
B)
37,917
C)
120,417
D)
118,345
Ans: C
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Ans: A
d
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80. Jimbo Co. began operations Jan. 1, 20x3. The following events related to common stock took
place on the indicated dates during 20x3.
Jan. 1 Issued 5,000 common shares
Apr. 1 Purchased 400 treasury shares
May 1 Split 2-for-1
Aug. 1 Issued 2,000 common shares
Dec. 1 issued a 20% stock dividend
Assuming no potentially dilutive securities, what are the weighted average shares for EPS in
20x3?
A)
12,280
B)
10,233
C)
6,640
D)
12,080
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 19
Chapter 19 – Earnings per Share
81. If net income is $25,000 and there were 18,000 common shares issued and outstanding the entire
year, and 100 cumulative, nonconvertible, 6% $100 par preferred shares outstanding the entire
year, what is EPS if no dividends were declared during the year. There are two years' dividends in
arrears on the preferred shares.
A)
$1.39
B)
$1.18
C)
$1.25
D)
$1.16
E)
$1.36
Ans: E
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Ans: C
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hz
82. WEIGHTY Inc. started the current year with 2,000 common shares issued, but only 1,500 were
outstanding at that time. The following events took place during the current year:
March 30 issued 200 previously unissued shares
June 1 sold 400 treasury shares
December 1 purchased 100 treasury shares
December 31 issued 500 previously unissued shares
What is WEIGHTY's denominator of earnings per share for the current year?
A)
1,917
B)
2,375
C)
1,875
D)
2,125
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
83. A firm has 10,000 common shares outstanding on January 1 of the current year. The following
events take place during the current year:
May 1 issued 3,000 new common shares
June 30 purchased 4,000 shares for the treasury
October 31 distributed a 20% stock dividend
December 1 reissued the June 30 treasury stock
What is the weighted-average number of shares to be used for computing EPS?
A)
8,333
B)
14,133
C)
10,000
D)
12,333
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 20
Chapter 19 – Earnings per Share
84. Given the following sequence of events, determine the weighted average number of shares for
earnings per share purposes:
January 1 100 common shares issued and outstanding
April 1 Issued 50 previously unissued shares
May 1 Split the stock 2-for-1
June 30 Purchased 100 shares for the treasury
July 30 distributed a 20% stock dividend
December 31 Split the stock 3-for-1
A)
1,125
B)
475
C)
270
D)
810
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
zle
hz
85. Last year, TUV had 40,000 $15 par, 7 percent, cumulative, convertible preferred shares
outstanding. The Board of Directors did not declare a dividend for the current period because all
of these shares were converted to common shares on the first day of the period. What is the effect
on the numerator of the EPS calculation for this year due to the preferred shares? (Tax rate is 40
%.)
A)
$0
B)
Add $42,000
C)
Subtract $42,000
D)
Subtract $25,200
E)
Not determinable from the information given.
86. On January 1, 20x3, WXY had stock warrants outstanding to purchase 6,000 shares at an option
price of $10. The common shares' market price was $15 the entire year. The firm has 200,000
common shares outstanding at the end of the year. The effect of the warrants on EPS is to:
A)
Increase the denominator of all EPS calculations by 6,000 shares.
B)
Increase the denominator of all EPS calculations by 2,000 shares.
C)
Affect the diluted EPS calculation, but not the basic EPS calculation.
D)
Have no potentially dilutive effect on the EPS calculation.
E)
Increase the denominator of all EPS calculations by 4,000 shares.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 21
Chapter 19 – Earnings per Share
87. The balance sheet at the beginning of the current year for GHI Inc. reflected the following:
Liabilities:
Bonds payable, 7 percent, nonconvertible
Discount on bonds payable
Shareholders' equity:
Preferred shares, $20 par, 5 percent cumulative,
convertible one for one
Common shares, no par, 100 shares issued
Retained earnings
Treasury stock, common (8 shares)
$400
20
300
1,040
28
80
No transactions affecting the denominator of EPS occurred during the year. Assume the
preferred shares are dilutive. The number of potential common shares to be included in the
denominator of fully diluted EPS is:
15.
14.
13.
10.
0.
Ans: A
hz
A)
B)
C)
D)
E)
Difficulty: Medium
Level of Learning: Application
Topic: LO3
zle
88. At December 31, 20x2, HIJ had 2,000 common shares outstanding. On January 1, 20x3, HIJ
d
issued 1,000 convertible preferred (one share of common for one share of preferred) shares.
During 20x3, HIJ declared and paid $4,000 cash dividends on the common and $4,000 cash
dividends on the preferred (the annual requirement). Net income for the year ended December 31,
20x3, was $36,000. Assuming an income tax rate of 50 percent, what should be diluted earnings
per share for the year ended December 31, 20x3?
A)
$12
B)
$16
C)
$17
D)
$18
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 22
Chapter 19 – Earnings per Share
89. FGH had 5,000 common shares outstanding on December 31, 20x2. An additional 1,000 common
shares were issued on April 1, 20x3, and 500 more on July 1, 20x3. On October 1, 20x3, FGH
issued 10, $1,000 maturity value, 7 percent convertible bonds. Each bond is convertible into 40
common shares. No bonds were converted into common shares in 20x3. What was the number of
shares that should be used to compute basic earnings per share and diluted earnings per share,
respectively, for the year ended December 31, 20x3 (ignore anti-dilution)?
A)
5,750 and 5,950 shares
B)
5,750 and 6,150 shares
C)
6,000 and 6,100 shares
D)
6,000 and 6,400 shares
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Ans: B
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hz
90. On January 2, 20x3, CBA issued at par $10,000 of 8 percent bonds convertible into 2,000 of
CBA's common shares. No bonds were converted during 20x3. Throughout 20x3, CBA had 2,000
common shares outstanding. CBA's net income after tax was $1,000. CBA's income tax rate is 50
percent. No potentially dilutive securities other than the convertible bonds were outstanding
during 20x3. CBA's basic EPS and diluted EPS for 20x3 would be:
A)
Basic EPS $0.30; diluted EPS $0.45
B)
Basic EPS $0.50; diluted EPS $0.35
C)
Basic EPS $0.70; diluted EPS $0.25
D)
Basic EPS $0.90; diluted EPS $0.15
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
d
91. At December 31, 20x2, BCD had 700 common shares outstanding. On September 1, 20x3, an
additional 300 common shares were issued. In addition, BCD had $20,000 of 8 percent,
convertible bonds outstanding December 31, 20x2, which are convertible into 400 common
shares. No bonds were converted into common shares in 20x3. Net income for the year ended
December 31, 20x3, was $6,000. Assuming the income tax rate was 50 percent, what should be
the basic earnings per share for the year ended December 31, 20x3?
A)
$7.50
B)
$5.67
C)
$5.00
D)
$4.33
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 23
Chapter 19 – Earnings per Share
92. The accountant for a firm has computed the numerator and denominator effects for the following
potentially dilutive securities outstanding all year, allowing you to determine the D/A ratio of
each and to finish the calculation of EPS:
Security
Numerator Denominator
A
$2,000
1,800
B
5,000
4,600
C
7,000
2,100
D
1,000
1,200
Basic EPS has been computed as: ($15,000 - $3,000)/3,000 = $4.00.
What is the diluted EPS (rounded)?
A)
$3.10
B)
$2.05
C)
$1.89
D)
$2.13
Ans: C
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
d
zle
93. A firm has correctly computed the following values: (Its shares are trading on the Vancouver
Stock Exchange)
Basic EPS
$4.32
Diluted EPS
4.17
Which of the following correctly states the EPS amounts to be reported?
A)
Basic EPS
B)
Diluted EPS
C)
Basic and diluted EPS
D)
No EPS need be reported
94. For purposes of computing the weighted-average number of shares outstanding during the year, a
mid-year event that must be treated as occurring at the beginning of the year is the:
A)
stock split.
B)
Sale of additional common shares.
C)
Issuance of stock warrants.
D)
Purchase of treasury stock.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 24
Chapter 19 – Earnings per Share
95. A company with a simple capital structure would include which of the following in the
computation of earnings per share?
A)
Convertible securities
B)
Number of shares of nonconvertible cumulative preferred shares
C)
Dividends on nonconvertible cumulative preferred shares
D)
Dividends on common shares
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
96. DCE had 900 common shares outstanding on January 1, 20x3, issued 600 shares on May 1 and
Ans: B
hz
had income applicable to common shares of $5,200 for the year ending December 31, 20x3.
Earnings per common share for 20x3 would be:
A)
$5.78
B)
$4.00
C)
$3.60
D)
$3.46
Difficulty: Medium
Level of Learning: Application
Topic: LO2
zle
97. In determining basic earnings per share, the annual dividend on nonconvertible cumulative
preferred shares should be:
A)
Added back to net income whether declared or not.
B)
Disregarded.
C)
Deducted from net income only if declared.
D)
Deducted from net income whether declared or not.
Level of Learning: Knowledge
Topic: LO2
d
Ans: D
Difficulty: Medium
98. In determining basic earnings per share, the annual dividend on convertible cumulative preferred
shares, which are not a dilutive convertible security, should be:
A)
Added back to net income whether declared or not.
B)
Disregarded.
C)
Deducted from net income only if declared.
D)
Deducted from net income whether declared or not.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 25
Chapter 19 – Earnings per Share
99. Anti-dilutive convertible securities would generally be used in the calculation of:
A)
B)
C)
D)
Basic earnings per share.
diluted earnings per share.
Basic earnings per share and diluted earnings per share.
Neither basic earnings per share nor diluted earnings per share.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
100. When computing diluted earnings per share, convertible securities are:
A)
Incorporated whether they are dilutive or anti-dilutive.
B)
Incorporated only if they are anti-dilutive.
C)
Incorporated only if they are dilutive.
D)
Ignored.
hz
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
d
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101. Which one of the following organizations are required to disclose EPS?
A)
Corporations that do not have share capital
B)
Public corporations
C)
government-owned corporations
D)
Companies with few shareholders
102. Steps in calculating diluted EPS include the following except:
A)
Identify options outstanding at the end of the period
B)
Identify any convertible senior debt or shares that actually converted during the period.
C)
Rank the items from the least dilutive to the most dilutive.
D)
Determine if the options exercised were in-the-money and thus dilutive.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 26
Chapter 19 – Earnings per Share
103. Transactions that take place in the period between the end of the fiscal year and the financials
statement released must be disclosed and described when which of the following happens:
A)
When a subsequent event would significantly change the number of commons shares or the
potential common shares used in basic or diluted EPS.
B)
When common shares are issued after the fiscal year end and the proceeds were used to
retire preferred shares.
C)
When common shares are issued after the fiscal year end for cash, on the exercise of
options.
D)
All of the above.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
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104. ABC Inc. began business on January 1, 20x3. Due to difficulties in getting the business started,
30 common shares were issued on January 1, 20x3 to the organizers and 15 additional shares
were sold on that date. The company wanted the market to hear about the shares. Therefore, the
following share transactions were implemented during the year 20x3:
February 1: 2 for 1 stock split
April 1: 10 percent stock dividend
August 1: 5 for 1 stock split
December 1: 2 for 1 reverse stock split
The weighted average number of shares outstanding for 20x3 was:
A)
64.08 shares.
B)
146.25 shares.
C)
180.00 shares.
D)
247.50 shares.
105. FED had 100 common shares issued and outstanding at December 31, 20x2. On July 1, 20x3,
FED issued a 10 percent stock dividend. Unexercised stock options to purchase 20 common
shares (adjusted for 20x3 stock dividends) at $20 per share were outstanding at the beginning and
end of 20x3. The average market price of FED'S common shares (which was not affected by the
stock dividend) was $25 per share during 20x3. The ending market price was $30. Net income
for the year ended December 31, 20x3, was $2,200. What was FED'S 20x3 basic earnings per
share, rounded to the nearest cent?
A)
$16.92
B)
$18.33
C)
$20.00
D)
$22.00
Ans: C
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 27
Chapter 19 – Earnings per Share
Level of Learning: Application
Topic: LO3
106. FED had 100 common shares issued and outstanding at December 31, 20x2. On July 1, 20x3,
FED issued a 10 percent stock dividend. Unexercised stock options to purchase 20 common
shares (adjusted for 20x3 stock dividend) at $20 per share were outstanding at the beginning and
end of 20x3. The average market price of FED'S common shares (which was not affected by the
stock dividend) was $25 per share during 20x3. The ending market price was $40. FED earned
interest at 8% and had a 50% tax rate. Net income for the year ended December 31, 20x3, was
$2,200. What was FED'S 20x3 diluted earnings per share, rounded to the nearest cent?
A)
$17.05
B)
$17.17
C)
$18.47
D)
$18.60
Ans: A
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
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107. At December 31, 20x2, BCD had 700 common shares outstanding. On September 1, 20x3, an
additional 300 common shares were issued. In addition, BCD had $20,000 of 8 percent
convertible bonds outstanding December 31, 20x2, which are convertible into 400 common
shares. No bonds were converted into common shares in 20x3. Net income for the year ended
December 31, 20x3, was $6,000. Assuming the income tax rate was 50 percent, what should be
the diluted earnings per share for the year ended December 31, 20x3?
A)
$7.50
B)
$5.67
C)
$5.00
D)
$4.33
108. The 20x3 net income of MNO was $300,000, and 100,000 of its common shares were outstanding
during the entire year. In addition, outstanding options existed to purchase 10,000 common shares
at $10 per share. These options were granted in 20x1 and none had been exercised by December
31, 20x3. MNO earned interest at 8% and had a 50% tax rate. The amount, which should be
shown as MNO's basic earnings per share for 20x3, is (rounded to the nearest cent).
A)
$2.96
B)
$3.00
C)
$3.04
D)
$3.08
Ans: B
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 28
Chapter 19 – Earnings per Share
Level of Learning: Application
Topic: LO2
109. The 20x3 net income of MNO was $300,000, and 100,000 of its common shares were outstanding
during the entire year. In addition, outstanding options existed to purchase 10,000 common shares
at $10 per share. These options were granted in 20x1 and none had been exercised by December
31, 20x3. MNO earned interest at 8% and had a 50% tax rate. The amount, which should be
shown as MNO's diluted earnings per share for 20x3, is (rounded to the nearest cent).
A)
$2.69
B)
$2.73
C)
$2.76
D)
$2.80
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
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110. At December 31, 20x2, GHI had 400 common shares outstanding. On October 1, 20x3, an
additional 100 common shares were issued. In addition, GHI had $40,000 of 8 percent,
convertible bonds outstanding at December 31, 20x2, which are convertible into 225 common
shares. No bonds were converted into common shares in 20x3. Net income for the year ended
December 31, 20x3, was $14,000. Assuming the income tax rate was 50 percent, the basic
earnings per share for the year ended December 31, 20x3, should be: (rounded to the nearest cent)
A)
$24.00
B)
$25.54
C)
$32.94
D)
$36.71
111. At December 31, 20x2, GHI had 400 common shares outstanding. On October 1, 20x3, an
additional 100 common shares were issued. In addition, GHI had $40,000 of 8 percent,
convertible bonds outstanding at December 31, 20x2, which are convertible into 225 common
shares. No bonds were converted into common shares in 20x3. Net income for the year ended
December 31, 20x3, was $14,000. Assuming the income tax rate was 50 percent, the diluted
earnings per share for the year ended December 31, 20x3 should be (rounded to the nearest cent):
A)
$24.00
B)
$25.54
C)
$32.94
D)
$36.71
Ans: A
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 29
Chapter 19 – Earnings per Share
Level of Learning: Application
Topic: LO3
112. A firm had 8,000 common shares outstanding at the end of the current period and earned $8,000
that period (net of tax). Also, options to purchase 5,000 shares at $5 each were outstanding all
year. For the entire year the firm had $20,000 of 6% debt and $10,000 of 8% debt outstanding.
The 8% debt is convertible into 500 common shares. The firm earns interest at 7 percent and has
a 50 percent tax rate. The diluted earnings per share for the current year should be (rounded to the
nearest cent):
A)
$1.00
B)
$.68
C)
$.69
D)
$.72
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO3
hz
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
zle
113. A firm that earned $20,000 (after tax) had the following securities outstanding all year during,
which the tax rate was 40%:
20,000 common shares
1,000, 6%, $100 par cumulative nonconvertible preferred shares
2,000, 4%, $50 par noncumulative preferred shares, each share convertible into 5 common shares
100, 8%, $1,000 convertible bonds, each convertible into 10 common shares (bonds were issued
at face)
No dividends were paid for the year.
The diluted earnings per share for the year should be (rounded to the nearest cent):
A)
$.70
B)
$.47
C)
$.73
D)
$.86
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Page 30
Chapter 19 – Earnings per Share
114. A company had 50,000 common shares and the following 3 convertible securities outstanding the
entire year:
1. 6%, $100 par cumulative preferred shares, 200 shares outstanding, each convertible into
5 common shares
2. 200 6% convertible bonds, face $1,000, each bond convertible into 40 common shares
3. 2,000 stock options to purchase one common share each at $40.
The company earns interest at 6%. Its net income after tax income was $75,000. The tax rate is
40%. What is the diluted EPS (rounded to the nearest cent):
A)
$1.39
B)
$1.40
C)
$1.45
D)
$1.48
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
zle
hz
115. Assume a company had net income of $20,000 and 8,000 common shares were outstanding the
entire year. Also assume there were 2 convertible securities outstanding the entire year:
Effect of Assumed
Conversion
Numerator
Denominator
#1
$8,000
6,000
#2
12,000
5,000
What is the diluted EPS?
A)
$2.50
B)
$2.40
C)
$2.11
D)
$2.00
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
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Page 31
Chapter 19 – Earnings per Share
116. A company earned $20,000 in 20x3 and had 20,000 common shares outstanding the entire year.
The following four potentially dilutive securities were also outstanding the entire year. The
numerator and denominator of the D/A ratios are as indicated.
Effect of
Assumed Conversion
Numerator
Denominator
#1
$8,000
12,000
#2
4,000
25,000
#3
6,000
10,000
#4
1,000
12,000
What is the diluted EPS?
A)
$ .44
B)
$ .32
C)
$1.00
D)
$ .81
Ans: A
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
zle
117. LASTEPS Co. had granted 20,000 options to buy one common share at $10 per share several
years ago. The company earned $200,000 this year and had 300,000 common shares outstanding
the entire year. The company earns interest at 8% and has a 40% tax rate. Given only the above
information, what are basic EPS and diluted EPS respectively that should be reported?
A)
$.67, $.66
B)
$.65, $.63
C)
$.63, $.62
D)
$.65, $.64
E)
Only basic EPS need be reported
118. The following information relates to the SPE company in 20x3.
Net income: $50,000
Common shares outstanding on January 1: 30,000
On June 30 issued 2,000 8% cumulative convertible preferred shares
$100 par, each convertible into 10 common shares
Issued a 40% stock dividend on Sept. 30
What is the diluted EPS?
A)
$1.00
B)
$ .89
C)
$ .81
D)
$ .76
Ans: B
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 32
Chapter 19 – Earnings per Share
Level of Learning: Application
Topic: LO3
119. Earnings for a firm for the current year are $20,000 and the weighted average number of common
shares before considering potentially dilutive securities is 18,000. The firm has no preferred
shares but has 100, 8%, $1,000 convertible bonds which were issued at face value many years
ago. Each bond is convertible into 50 common shares. The tax rate is 40%. Compute EPS to be
reported for this firm.
A)
Basic EPS $1.11 diluted EPS $1.08
B)
Basic EPS $1.08 diluted EPS $1.08
C)
Basic EPS $1.11 diluted EPS $1.11
D)
Basic EPS $1.14 diluted EPS $1.11
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
Ans: A
Difficulty: Medium
zle
hz
120. Assume basic EPS has been determined. In determining the diluted earnings per share, the annual
dividend on convertible cumulative preferred shares, which are a dilutive convertible security,
should be:
A)
Added back to the numerator of basic EPS whether declared or not.
B)
Disregarded.
C)
Added back to the numerator of basic EPS only if declared.
D)
Deducted from the numerator of basic EPS whether declared or not.
Level of Learning: Knowledge
Topic: LO3
d
121. Assume basic EPS has been determined. In determining the diluted earnings per share, the annual
dividend on convertible noncumulative preferred shares, which are a dilutive convertible security,
should be:
A)
Added back to the numerator of basic EPS whether declared or not.
B)
Disregarded.
C)
Added back to the numerator of basic EPS only if declared.
D)
Deducted from the numerator of basic EPS whether declared or not.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 33
Chapter 19 – Earnings per Share
122. At December 31, 20x3 and 20x2, GHI had 90 common shares and 20 convertible preferred shares
outstanding, in addition to 9% convertible bonds payable in the face amount of $4,000. During
20x3, GHI paid dividends of $2.50 per share on the preferred shares (the annual requirement).
The preferred shares are convertible into 20 common shares. The 9% convertible bonds are
convertible into 30 common shares. Net income for 20x3 was $1,940. Assume an income tax rate
of 40%. The earnings per share amounts would be:
A)
Basic $21.00; diluted $15.40
B)
Basic $21.00; diluted $15.76
C)
Basic $21.56; diluted $15.40
D)
Basic $21.56; diluted $15.76
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO3
hz
123. Choose the correct statement concerning EPS.
A)
Usually, reported EPS is the actual historical income per weighted average share
outstanding during the period
B)
EPS can never be negative
C)
If net income is less than zero, all potentially dilutive securities are anti-dilutive.
D)
All convertible securities must be incorporated into diluted EPS
Ans: C
Difficulty: Medium
zle
Level of Learning: Knowledge
Topic: LO3
Ans: C
d
124. What would be the effect on book value per share and earnings per share if the corporation
purchased its own shares in the open market at a price greater than book value per share?
A)
Increase both book value per share and earnings per share
B)
Decrease both book value per share and earnings per share
C)
Decrease book value per share and increase earnings per share
D)
No effect on book value per share but increase earnings per share
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
125. Basic earnings per share represent the amount of earnings attributable to:
A)
All common shares and dilutive securities.
B)
Common shares, preferred shares, and all dilutive securities.
C)
Each common share outstanding, including dilutive securities.
D)
Each common share outstanding.
Ans: D
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 34
Chapter 19 – Earnings per Share
Level of Learning: Knowledge
Topic: LO2
126. In computing EPS, convertible preferred shares may increase the number of shares outstanding:
A)
In a complex capital structure only if they have been converted.
B)
Only in a complex capital structure, whether or not they have been converted.
C)
In a simple capital structure, whether or not they have been converted.
D)
In a complex capital structure and a simple capital structure, whether or not they have been
converted.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
hz
127. On January 1, 20x1, JMR had 30,000 common shares issued and outstanding. On July 1, JMR
sold 500 shares. The net income for the year was $300,000. Calculate the basic earnings per
share.
Ans:
30,000 x 12/12
=
30,000
500 x 6/12
=
250
30,250
EPS = 300,000/30,250= $9.91
zle
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
128. On January 1, 20x1 JMR had 30,000 common shares issued and outstanding. On July 1, JMR
sold 500 shares. The net income for the year was $100,000. Calculate the basic earnings per
share.
Ans:
25,000 x 12/12
=
25,000
5,000 x 6/12
=
2,500
27,500
=====
EPS = 800,000/27,500= $29.09
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 35
Chapter 19 – Earnings per Share
129. On January 1, 20x1, KER had 25,000 common shares issued and outstanding. On July 1, KER
sold 5,000 shares. The net income for the year was $800,000. Calculate the basic earnings per
share.
Ans:
25,000 x 12/12
=
25,000
5,000 x 6/12
=
2,500
27,500
EPS = 800,000/27,500= $29.09
Difficulty: Medium
Level of Learning: Application
Topic: LO2
hz
130. On January 1, 20x1, KAR had 60,000 common shares issued and outstanding. On July 1, KAR
sold 1,000 shares. KAR The net income for the year was $80,000. Calculate the basic earnings
per share.
Ans:
60,000 x 12/12
=
60,000
1,000 x 6/12
=
500
60,500
EPS = 80,000/60,500= $1.32
Difficulty: Medium
zle
Level of Learning: Application
Topic: LO2
131. You calculate basic EPS to be $15.87 and diluted EPS to be $11.65. From a disclosure point,
what needs to be disclosed?
Ans: Both basic EPS and diluted EPS must be disclosed on the face of the Statement of
Comprehensive Income.
Level of Learning: Knowledge
Topic: LO6
d
Difficulty: Medium
132. You calculate basic EPS to be $15.87 and diluted EPS to be $16.65. From a disclosure point,
what needs to be disclosed?
Ans: Both basic EPS and diluted EPS must be disclosed on the face of the Statement of
Comprehensive Income.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
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Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 36
Chapter 19 – Earnings per Share
133. For earnings per share purposes, the capital structure of the company is classified as either simple
or complex. Indicate the types of securities that are included in each category (a complete answer
may require more than one letter).
Capital Structure
A. Simple
B. Complex
C. Simple and Complex
Types of Securities
___ 1
Common shares
___ 2.
Bonds, convertible to common shares
___ 3.
Preferred shares, nonconvertible
___ 4.
Common stock warrants outstanding
___ 5.
Preferred shares, convertible to common shares
Ans: 1: C, 2: B, 3: C, 4: B, 5: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
hz
134. Given the following information, EPS is, $__________________ .
Net income.
Common shares outstanding, January 1-April 30
May 1, sold and issued common shares
October 1, purchased common treasury shares
November 1, sold and issued common shares
zle
Ans:
EPS: $63,750 ÷ 12,750*
*Average shares outstanding:
Level of Learning: Application
Topic: LO2
$5.00
=====
10,000 x 4 =
15,000 x 5 =
12,000 x 1 =
13,000 x 2 =
d
Difficulty: Medium
=
$63,750
10,000
5,000
3,000
1,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
40,000
75,000
12,000
26,000
Page 37
Chapter 19 – Earnings per Share
135. On January 1, 20x3, XZC had outstanding 6,000 common shares and 1,000, $3 nonconvertible
cumulative preferred shares. On March 1, 20x3, the corporation sold and issued an additional
6,000 common shares. At year-end, there were common stock warrants outstanding for 200
common shares; the option price was $15. The company earns interest at 10% and has a 40% tax
rate. Net income was $41,675. Compute the diluted EPS that would be reported and show your
computations.
Diluted EPS: $___________________________ .
Ans: Diluted EPS $3.47
Computations:
Weighted Shares
Jan. 1 6,000 x 12/12
Mar. 1 6,000 x 10/12
6,000
5,000
11,000 shares
======
Pref. Dividend
1,000 shares x $3 =
$3,000
======
hz
Warrants income (net of tax)
200 x $15 x 10% x (1-.4) =
D/A Warrants $180 ÷ 200 =
$180
====
$.90
====
Diluted
Difficulty: Hard
zle
Basic EPS
($41,675 - $3,000) ÷ 11,000 = $3.52
NI
Basic
Warrants
÷
$38,675
180
38,855
=
EPS
$3.52
$3.47
d
Level of Learning: Application
Topic: LO2, 3
SHARE
11,000
200
11,200
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Page 38
Chapter 19 – Earnings per Share
136. SKZ reported the following capital structure on December 31, 20x3, and the related results of
operations for 20x3:
Preferred shares, $.50, cumulative,
25,000
shares outstanding all year
$250,000
Common shares, 10,000 shares outstanding all year
250,000
Common stock warrants outstanding (from January 1) for 1,000 common shares
25,000
Retained earnings
365,000
Net income for 20x3
93,300
Additional data:
(a)
(b)
(c)
(d)
Company earns interest at 10%
Option price of common shares for holders of common stock warrants, $54.
No preferred dividends were declared or paid during 20x3.
The tax rate is 40%.
hz
Compute
Basic EPS $___________
Diluted EPS $___________
Ans:
Basic EPS
Diluted EPS
$8.08
$7.64
Computations:
Pref. Dividend 25,000 x $.50 =
zle
Warrant Interest (Net of tax)
1,000 x $54 x 10% (1-.4) =
$12,500
=======
$3,240
======
Basic EPS (93,300 - 12,500) ÷ 10,000 = $8.08
D/A Warrant $3,240 ÷ 1,000 =
d
Diluted EPS ($80,800 + $3,240) ÷ (10,000 + 1,000) =
Difficulty: Hard
$3.24
=====
$7.64
=====
Level of Learning: Application
Topic: LO2, 3
137. Calculate the weighted average shares for EPS purposes if a firm started the year with 100
common shares outstanding, reissued 80 treasury shares March 1, split 2 for 1 on April 1,
purchased 50 shares for the treasury on July 1, issued a 40% stock dividend on November 1, and
issued 120 shares under a stock option plan on December 1.
Ans: WA = {[100 + 80(10/12)] 2 - 50(1/2)} 1.4 + 120(1/12) = 442
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Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 39
Chapter 19 – Earnings per Share
Difficulty: Hard
Level of Learning: Application
Topic: LO2
138. You are given the following information about JG Ltd.
Class A preferred shares, 1,000 shares issued and outstanding; annual dividend rate of $500 per
share, cumulative, paid at the end of each quarter; each share is convertible into 40 shares of
Class B common
Class B common shares, 80,000 shares issued and outstanding
There are no other senior securities
Net Income for 20x1, the year of the conversion, is $1,650,000; there are no discontinued
operations.
All 1,000 shares of Class A are converted into 40,000 Class B shares on October 1 20x1;
dividends for the first three quarters of the year were fully paid. Calculate the basic EPS.
hz
Ans: Basic:
Net Income
Less Preferred dividends 1,000 @ 125 for 3 quarters
Earnings available to common
zle
WACS
80,000 common shares x 12/12
1,000x40x3/12
weighted average
Basic EPS: 1275 000/90000 =
Difficulty: Hard
$80,000
10,000
$90,000
=====
$14.17
======
d
Level of Learning: Application
Topic: LO2
$1,650,000
(375,000)
$1,275,000
========
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Page 40
Chapter 19 – Earnings per Share
139. You are given the following information about VB Ltd.:
Class A preferred shares, 800 shares issued and outstanding; annual dividend rate of $100 per
share, cumulative, paid at the end of each quarter; each share is convertible into 50 shares of
Class B common
Class B common shares, 90,000 shares issued and outstanding
There are no other senior securities
Net Income for 20x1, the year of the conversion, is $850,000; there are no discontinued
operations.
All 1,000 shares of Class A are converted into 40,000 Class B shares on October 1 20x1;
dividends for the first three quarters of the year were fully paid. Calculate the basic EPS.
Ans: Basic:
Net Income
Less Preferred dividends 800 @ 25 for 3 quarters
Earnings available to common
$850,000
(60,000)
$790,000
=======
hz
WACS
90,000 common shares x 12/12
800x50x3/12
weighted average
Basic EPS: 790,000/100,000 =
90,000
10,000
$100,000
======
zle
$7.90
====
Difficulty: Hard
Level of Learning: Application
Topic: LO2
d
140. You are given the following information about KER Ltd.:
30,000 common shares outstanding on January 1, 20x1
2,000 shares sold on March 1, 20x1
1,000 shares sold on September 1, 20x1
2 for 1 Stock split recorded on October 1, 20x1
Net Income for the year $340,000
Required:
Calculated the basic EPS.
Ans: WACS:
January 1
March 1
September 1
EPS:
340,000/64,000=
30,000 x 12/12 x 2
2,000 x 10/12 x 2
1,000 x 4/12 x 2
60,000
3,333
667
$64,000
=====
$5.31
====
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Page 41
Chapter 19 – Earnings per Share
Difficulty: Hard
Level of Learning: Application
Topic: LO2
141. You are given the following information about JMR Ltd.:
80,000 common shares outstanding on January 1, 20x1
6,000 shares sold on March 1, 20x1
3,000 shares sold on September 1, 20x1
3 for 1 Stock split recorded on October 1, 20x1
Net Income for the year $1,040,000
Required:
Calculated the basic EPS.
Ans: WACS:
January 1
March 1
September 1
80,000 x 12/12 x 3
6,000 x 10/12 x 3
3,000 x 4/12 x 3
hz
EPS:
1,040,000/258,000=
240,000
15,000
3,000
$258,000
======
$4.03
====
Difficulty: Hard
zle
Level of Learning: Application
Topic: LO2, 3
142. You are given the following information about DWWR Ltd.:
130,000 common shares outstanding on January 1, 20x1
12,000 shares sold on March 1, 20x1
11,000 shares sold on September 1, 20x1
4 for 1 Stock split recorded on October 1, 20x1
Net Income for the year $2,340,000
d
Required:
Calculated the basic EPS.
Ans: WACS:
January 1
130,000 x 12/12 x 4
March 1
12,000 x 10/12 x 4
September 1
11,000 x 4/12 x 4
EPS:
2,340,000/184,667=
130,000
40,000
14,667
$184,667
======
$12.67
======
Difficulty: Hard
Level of Learning: Application
Topic: LO2
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Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 42
Chapter 19 – Earnings per Share
143. You are given the following information about DWWR Ltd.:
130,000 common shares outstanding on January 1, 20x1
$100,000 8% preferred shares, cumulative, nonconvertible dividends paid at the end of the year
12,000 shares sold on March 1, 20x1
11,000 shares sold on September 1, 20x1
4 for 1 Stock split recorded on October 1, 20x1
Net Income for the year $2,340,000
Required:
Calculate the basic EPS.
Ans: WACS:
January 1
130,000 x 12/12 x 4
130,000
March 1
12,000 x 10/12 x 4
40,000
September 1
11,000 x 4/12 x 4
14,667
$184,667
======
EPS:
2,340,000-8,000/184,667=
$12.63
======
hz
Difficulty: Hard
Level of Learning: Application
Topic: LO2
d
zle
144. You are given the following information about KER Ltd.:
30,000 common shares outstanding on January 1, 20x1
5,000 preferred shares, no-par, $1.30 (cumulative, nonconvertible) outstanding on January 1
2,000 shares sold on March 1, 20x1
1,000 shares sold on September 1, 20x1
2 for 1 Stock split recorded on October 1, 20x1
Net Income for the year $340,000
Required:
Calculated the basic EPS.
Ans: WACS:
January 1
30,000 x 12/12 x 2
60,000
March 1
2,000 x 10/12 x 2
3,333
September 1
1,000 x 4/12 x 2
667
$64,000
=====
EPS:
340,000-6500/64,000=
$5.21
=====
Difficulty: Hard
Level of Learning: Application
Topic: LO2
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Page 43
Chapter 19 – Earnings per Share
145. What does diluted EPS take into account?
Ans: Diluted EPS takes into account the impact on EPS that occurs if the convertible securities
outstanding at the end of the fiscal year are exercised, and all options to purchase shares
that are outstanding at the end of the year are exercised.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO 3
146. What does the term anti-dilution mean?
Ans: When diluted EPS is calculated, any security that would result in increasing EPS is term
anti-dilutive and should not be used in the calculation.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO 3
147.
What is diluted EPS?
Ans: Diluted EPS is similar to basic earnings per share but the weighted average number of
shares is adjusted to reflect all of the shares that would be outstanding if the common share
entitlements of dilutive convertible senior securities and stock options were issued. The
numerator also is adjusted to reflect the potential impact of conversions.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO 3
148. At the beginning of the year, a firm issued (1) $100,000 of 5% bonds (at face value) convertible
into a total of 2,000 of the firm's common shares, and (2) $1,000, $9 cumulative preferred shares
convertible into a total of 1,000 of the firm's common shares. The tax rate is 40%. There were no
conversions during the year; the firm earned $100,000, and had 20,000 common shares
outstanding the entire year. Compute basic EPS and diluted EPS.
Basic EPS
Diluted EPS
$__________
$__________
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Page 44
Chapter 19 – Earnings per Share
Ans:
Basic EPS
$4.55
====
$4.27
====
Diluted EPS
Pref. Dividend 1,000 x $9 =
$9,000
======
$3,000
======
Bond Interest (net of tax) ( 100,000 x 5% x [1-.4]) =
D/A Pref. $9,000 ÷ 1,000 = $9.00*
Anti-dilutive
D/A Bond $3,000 ÷ 2,000 = $1.50
Basic EPS
($100,000 - $9,000) ÷ 20,000 = $4.55
Diluted
÷
hz
NI
Basic
Bond
SHARE =
$91,000
3,000
94,000
=====
EPS
20,000
2,000
22,000
====
$4.55*
$4.27
=====
Difficulty: Hard
d
zle
Level of Learning: Application
Topic: LO2, 3
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Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 45
Chapter 19 – Earnings per Share
149. A company reported the following capital structure on December 31, 2002, and the related results
of operations for the year then ended.
Bonds payable, 7%, convertible into common shares at the rate of
40 shares per 1,000 face value of bonds
Common shares, no par
Shares outstanding on January 1-15,000
Shares issued for cash on June 30-1,000
Income from continuing operations
Income from discontinued operations
Net income
$200,000
500,000
193,000
(3,000)
$190,000
=======
A 2 for 1 stock split was issued on December 31, 2002.
The tax rate for the year is 40%.
hz
Show the earnings per share of the company as it would appear on the income statement of the
company for 2002. Show all computations.
Ans:
Basic EPS Diluted EPS
Income from continuing operations
$6.23
$5.16
Income from discontinued operations
(.10)
(.08)
Net income
$ 6.13
$5.08
=====
====
zle
Computations:
Bond interest (net of tax)
$200,000 x 7% x (1-.4) =
$8,400
======
Shares on conversion
($200,000 ÷ $1,000) x 40 =
Basic EPS
30,000
1,000
31,000 shares
==========
d
Weighted common shares
Jan. 1 15,000 x 12/12 x 2 =
June 30 1,000 x 6/12 x 2 =
8,000 shares
======
$193,000 ÷ 31,000
($3,000) ÷ 31,000
$190,000 ÷ 31,000
Diluted EPS
($193,000 + $8,400) ÷ (31,000 + 8,000)
($3,000) ÷ (31,000 + 8,000)
($190,000 + $8,400) ÷ (31,000 + 8,000)
= $6.23
= $(.10)
= $6.13
=
=
=
$5.16
$(.08)
$5.08
* Note: Disclosure on the face of the Statement of Comprehensive Income is NOT required for
Discontinued Operations. Under IFRS, these figures may also be presented in the notes to the financial
statements.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 46
Chapter 19 – Earnings per Share
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3
Computations:
Pref. Dividends
Shares on Conversion
zle
hz
150. ABC reported the following capital structure on December 3, 2002, and the related results of
operations for the year then ended:
Preferred shares, $6, cumulative, convertible into common shares at the rate of two
$ 200,000
common shares for each share of preferred; 2,000 shares outstanding all year
Common shares, 10,000 shares outstanding on January 1; 20,000 additional shares issued
2,000,000
on January 31 in 200% stock dividend; 10,000 additional shares issued for cash on
September 30
Income from continuing operations
195,000
Income from discontinued operations
5,000
Net income
$200,000
=======
Show earnings per share of ABC as it should appear on the income statement of the company for
2002. Show all computations.
Ans:
Basic EPS
Diluted EPS
Income from continuing operations
$5.63
$5.34
Income from discontinued operations
.15
.14
Net income
$ 5.78
$ 5.48
=====
=====
Weighted Common Shares
Jan. 1
10,000 x 12/12 x 3
Sept.30
10,000 x 3/12
($195,000 - 12,000)
5,000
(200,000 - 12,000)
=====
2,000 x 2=
$12,000
=======
4,000 shares
=====
30,000
2,500
32,500 shares
=======
d
Basic EPS
2,000 x $6=
÷ 32,500
÷ 32,500
÷ 32,500
= $5.63
= $ .15
= $5.78
÷ (32,500 + 4,000)
÷ (32,500 + 4,000)
÷ (32,500 + 4,000)
= $5.34
= .14
= 5.48
Diluted EPS
(183,000 + 12,000)
5,000
(188,000 + 12,000)
====
* Note: Disclosure on the face of the Statement of Comprehensive Income is NOT required for
Discontinued Operations. Under IFRS, these figures may also be presented in the notes to the financial
statements.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 47
Chapter 19 – Earnings per Share
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3
151. Selected accounting data for JCB for 20x3 were:
(a) Common shares, outstanding shares on January 1, 20x3, 80,000.
(b) Preferred shares, $.24, nonconvertible; cumulative; outstanding 5,000 shares.
(c) Preferred shares, $.15, cumulative; convertible-one share of preferred for two shares of
common; outstanding 1,500 shares.
(d) Stock options outstanding for 4,000 common shares; option price $20;
(e) Bonds payable, 6%; each $1,000 bond is convertible to 50 common shares, par value
outstanding $40,000.
(f) Net income was $202,400 average income tax rate, 40%.
(g) Company earns interest at 5%.
hz
Required: Determine basic and diluted EPS.
Ans: $2.51 Basic EPS
====
$2.30 Diluted EPS
====
Computations:
Pref. Dividends
Nonconvertible
=
1,500 x $.15
=
zle
Convertible
5,000 x $.24
$1,200
======
225
===
=
=
$2,400
$1,440
Shares on conversion
Pref.1,500 x 2
Bond (40,000 ÷ 1,000) x 50
=
=
3,000
2,000
d
Interest (net of tax)
Stock Rights 4,000 x $20 x 5% x (1.4)
Bond $40,000 x 6% x (1.4)
Basic EPS (202,400 - 1,200 - 225) ÷ 80,000
D/A Pref
D/A Rights
D/A Bond
=
$225
$2,400
$1,440
÷ 3,000
÷ 4,000
÷ 2,000
=
=
=
$.08
$.60
$.72
Diluted EPS
(200,975 + 225 + 2,400 + 1,440) ÷ (80,000 + 3,000 + 4,000 + 2,000) = $2.30
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 48
Chapter 19 – Earnings per Share
d
zle
hz
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 49
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test Bank
Chapter 20 – Accounting Changes
1. A change from inventory costed using FIFO to inventory costed using LIFO is an example of a
change in accounting principle.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
2. Revised estimates of the useful life or residual value of a depreciable asset are examples of a
change in accounting principle.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
hz
3. A change, for depreciation purposes, of either estimated useful life or estimated residual value
usually is referred to as a change in accounting estimate.
Ans: True
Difficulty: Easy
zle
Level of Learning: Knowledge
Topic: LO1
4. Accounting policy changes are only justifiable when there is a change to a primary source of
GAAP.
Ans: False
Difficulty: Easy
d
Level of Learning: Knowledge
Topic: LO2
5. Accounting policy changes must always be handled retrospectively.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
6. The failure to expense a prepaid asset is an example of a counterbalancing error.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 1
Chapter 20 – Accounting Changes
7. Accounting changes reported by using the current approach, require that the "catch-up
adjustment" include the effect on earnings in the year of the change.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2
8. If a change in estimate and a change in principal occur on the same item and at the same time, the
one that is dominant is reported.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
9. Changes in accounting policy are always voluntary in nature.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: True
zle
10. A change in the useful life of an asset requires an accounting estimate change, which affects only
periods after the change, is made.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
11. When an asset's residual value estimate is changed, the entire depreciation schedule for the asset
is recomputed all the way back to the date of acquisition.
12. A company switching from straight-line depreciation to sum-of-the-years'-digits depreciation
should report the change prospectively.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 2
Chapter 20 – Accounting Changes
13. If a corporation changes from reporting investments on the cost basis to reporting on the equity
basis, the prospective approach of reporting must be used.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
14. Some changes in accounting principle must be reported by using the retrospective approach.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
15. A change from a non-GAAP procedure to a GAAP accounting principle usually is referred to as a
change in accounting principle.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: False
zle
16. A change, for depreciation purposes, of either estimated useful life or from one GAAP to another
GAAP accounting method, usually is referred to as a change in accounting principle.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
17. A change in accounting principle occurs when a company adopts a principle that is different from
a previously used principle that is also generally accepted.
18. Most changes in accounting principle are recognized by using the current approach.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 3
Chapter 20 – Accounting Changes
19. A voluntary change in accounting policy is only justifiable when it results information that is both
more reliable and more relevant.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
20. A change in accounting principle occurs when a company adopts a principle different from an
approved principle previously used.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
21. An overstatement of opening inventory will result in an understatement of operating cash
flows in the current period.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4, 5
Ans: True
zle
22. A misstatement of opening inventory is an example of a counterbalancing error.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
23. A change in an accounting estimate should be reported on the financial statements on a
retrospective basis.
24. The fact that most accounting changes are not disclosed may lead to ethical concerns among
stakeholders.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 4
Chapter 20 – Accounting Changes
25. If a change in an accounting estimate affects the current period and future periods, the
retrospective reporting approach must be used.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 3
26. An overstatement of opening inventory will result in an understatement of Cost of Goods Sold
and therefore an overstatement of the current period’s earnings.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
27. Change in accounting estimate requires that a "catch-up adjustment" be recorded and reported in
the year of the change.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 3
zle
28. All changes in accounting estimates should be accounted for only in the period of the change;
there is no effect on future periods.
Ans: False
Difficulty: Easy
d
Level of Learning: Knowledge
Topic: LO3
29. Many changes in accounting estimates are accounted for both in the period of change and in some
future period.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 5
Chapter 20 – Accounting Changes
30. Changing from an insupportable (bad faith) estimate to a supportable estimate is classified as a
change in estimate.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3, 5
31. The correction of an accounting error affecting prior years' income is reported and recorded by
using the retrospective approach.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
32. Accounting policy changes may be mandatory or voluntary.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Ans: True
Difficulty: Easy
zle
33. The overstatement of ending inventories in a given year is an example of a
counterbalancing error, which will correct itself in the following year.
Level of Learning: Knowledge
Topic: LO4
d
34. If a $1,000 purchase on credit last year was not recorded until this year and these goods
purchased were not included in any year's ending inventory, the purchase error is
counterbalancing.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
35. An understatement of ending inventory will result in a credit to Future Income Taxes.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 6
Chapter 20 – Accounting Changes
36. If it is impracticable to determine the cumulative effect at the beginning or the current
period or, if it is allowed by the creation of a new accounting standard, an accounting
change may be applied prospectively
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 3
37. If it is not feasible to restate prior period, this means that the financial statements of the
current period will not be affected.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 3
Ans: True
hz
38. A change in an estimate, which was not determined reasonable (i.e., not in good faith) to a good
faith estimate, is accounted for as an accounting error.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3, 5
zle
39. A change in accounting principle occurs when a company adopts a principle different from an
inappropriate procedure that was used previously.
Ans: False
d
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3, 5
40. Accounting errors require the restatement or previous years’ financial statements.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
41. An understatement of accrued wages will, if not corrected, cause income for the current and
following reporting period, separately, to be overstated.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 7
Chapter 20 – Accounting Changes
42. Failure to record depreciation expense in one-year results in what is usually called a
counterbalancing error.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
43. With respect to a retrospectively applied change in accounting policy, the effects on prior years’
income is treated as an adjustment to opening retained earnings.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1, 2
44. When an error is discovered, it should be corrected as of the end of the year in which the error
was made.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Ans: True
zle
45. Te failure to accrue revenues for services rendered but not billable until future periods would be
considered a self-correcting error.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Ans: True
d
46. Failure to record accrued wages at year-end (an adjusting entry) results in what usually is called a
counterbalancing error.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
47. An error in the inventory amount recorded involves a self-correcting error.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 8
Chapter 20 – Accounting Changes
48. An overstatement of opening inventory entails an overstatement of Cost of Goods Sold in the
current period.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
49. A retrospectively applied change in accounting policy relating to fixed assets where a company
changes from the straight-line amortization method to the double-declining balance method
would result in a decrease to opening retained earnings.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Ans: True
hz
50. When an accounting change is recorded and reported using the retrospective approach, the
cumulative effect on Retained Earnings is recorded in that account.
zle
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
51. An increase in assets relating to a retrospective change in accounting policy will result in
a credit to the related future tax accounts.
Ans: True
Difficulty: Easy
d
Level of Learning: Knowledge
Topic: LO2
52. On comparative financial statements, all errors must be corrected for each year presented, rather
than only for the current year.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 9
Chapter 20 – Accounting Changes
53. Which of the following is not a change in accounting policy?
A)
Change in depreciation method from straight-line to declining balance.
B)
Change from completed contract to percentage of completion.
C)
Change from LIFO to FIFO.
D)
Change in depreciation from eight years to five years.
E)
They are all changes in accounting policy.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
hz
54. A change from an accelerated depreciation method to the straight-line depreciation method
should be accounted for as a:
A)
Change in accounting entity.
B)
Change in accounting principle.
C)
Change in accounting estimate.
D)
Correction of accounting error.
E)
B or C, depending on the degree of practicality.
Ans: E
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
zle
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 10
Chapter 20 – Accounting Changes
55. A change from the sum-of-the-years'-digits depreciation method to the straight-line depreciation
method should be accounted for as a(n):
A)
Change in accounting policy.
B)
Prospective change.
C)
Change in accounting estimate.
D)
Accounting error.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: B
hz
56. When a firm changes only the estimated residual value of equipment,
A)
Depreciation must be recomputed for each previous year based on the new residual
B)
The remaining book value, reduced by the new residual value, is the basis for subsequent
depreciation
C)
The original cost, reduced by the new residual value, is the basis for subsequent
depreciation
D)
No adjustment is needed
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
zle
Ans: B
d
57. On January 1, 20x9, JTC changed to the weighted-average cost method from the first-in, first-out
(FIFO) cost method for inventory cost flow purposes. JTC can justify the change, which was
made for both financial statement and income tax reporting purposes. The change will result in a
$120,000 decrease in the beginning inventory at January 1, 20x9. Ignoring income taxes, the
cumulative effect of changing to the weighted-average method from the FIFO method must be
reported by JTC in the 20x9:
A)
Income statement as a $120,000 debit.
B)
Statement of retained earnings as a $120,000 debit adjustment to the beginning balance.
C)
Income statement as a $120,000 credit.
D)
Statement of retained earnings as a $120,000 credit adjustment to the beginning balance.
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 11
Chapter 20 – Accounting Changes
58. Which of the following events would require disclosure in the current financial statements?
A)
Change in the method used to calculate bad debt expense
B)
Change from LIFO to FIFO for merchandise inventory
C)
Change in the estimated amortization period for an intangible asset
D)
Change in recording the income for long-term construction contracts
E)
All of the above
Ans: E
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
59. A change in the unit depletion rate would be accounted for as a:
A)
Correction of an accounting error.
B)
Change in accounting estimate.
C)
Change in accounting principle.
D)
Change in accounting entity.
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
zle
60. Which one of the following statements is not correct?
A)
A change from an inappropriate accounting principle to a proper one should be accounted
for as an accounting error.
B)
Assets purchased on the 14th of the month may be depreciated from the first of the month
for practical reasons.
C)
Depreciation accounting is a process of allocation of periodic expense, rather than one of
asset valuation.
D)
Use of straight-line depreciation gives a higher total expense than accelerated methods
over the total useful life of the asset.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 12
Chapter 20 – Accounting Changes
61. Choose the correct statement regarding accounting changes.
A)
All changes in accounting principle require a cumulative effect to be recognized in the
income statement.
B)
Changing from FIFO to LIFO is a retrospective accounting principle change.
C)
Income statements numbers are required to be disclosed for most accounting principle
changes.
D)
The amount of the correction for an error affecting previous earnings will be disclosed in
current earnings.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: B
hz
62. Choose the correct statement.
A)
A change in estimated useful life for a building should cause a correction to prior years’
retained earnings.
B)
A change in method of accounting for depreciation should cause an adjustment to current
year's depreciation expense and a Cumulative Effect for the effect of the change on prior
year's earnings.
C)
An error affecting prior year’s depreciation is treated as a change in estimate.
D)
A Cumulative Effect will never be accompanied by a related tax effect.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
d
63. The concept of consistency is sacrificed in the accounting for which of the following items?
A)
Change is the estimated salvage value of an asset
B)
Cumulative effect of change in accounting principle
C)
Discontinued operations
D)
Loss on disposal of a segment of a business
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 13
Chapter 20 – Accounting Changes
64. Which of the following changes would be accounted for prospectively?
A)
Changing from declining-balance depreciation to straight-line depreciation
B)
Change in the expected life of a depreciable asset
C)
First time presentation of assumption financial statements with the FIFO cost flow
D)
Error corrections
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Ans: E
hz
65. Which of the following changes would be accounted for using the approach of a retrospective
approach without restatement?
A)
Change in the estimated life of a depreciable asset
B)
Change from a non-GAAP accounting method to a GAAP method of accounting for bad
debts
C)
Overstatement of unearned revenue of the prior period
D)
Change in the method of accounting for long-term construction contracts
E)
Change to LIFO with previous year's information unavailable
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
zle
66. The effects for a change in accounting principle would usually be reported on the face of the
income statement for a change:
A)
From the straight-line method of depreciation to the declining-balance method.
B)
From presenting statements for errors which effect only one of the financial statements.
C)
In the service lives of depreciable assets.
D)
In the residual value of a depreciable asset.
E)
None of the above.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
Ans: E
67. When an accounting change is to be recorded and reported under the retrospective approach, the:
A)
Retained earnings is adjusted for the cumulative effect of the change.
B)
Cumulative effect of the change is reported as a special item in the income statement in the
year of the change.
C)
Effect of the change is spread over the past, current, and future accounting periods.
D)
Pro forma financial statements for future years must be disclosed.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 14
Chapter 20 – Accounting Changes
68. The primary principle addressed by recent changes to ASPE and IFRS on accounting changes and
error corrections is the:
A)
Going-concern principle.
B)
Matching principle.
C)
Comparability principle.
D)
Full-disclosure principle.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
69. A change in the salvage value of a depreciable asset should be accounted for as a:
A)
Change in accounting entity.
B)
Correction of an accounting error.
C)
Change in accounting estimate.
D)
Change in accounting principle.
hz
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
A)
B)
C)
D)
20x2
PC
PC
CC
either CC or PC
Choice 1
Choice 2
Choice 3
Choice 4
d
20x1
PC
CC
CC
CC
1
2
3
4
zle
70. In 20x2, a firm changed from the completed contract (CC) method of accounting for revenue on
long-term contracts to the percentage of completion (PC) method. The firm's 20x1 and 20x2
comparative financial statements will reflect which method or methods.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 15
Chapter 20 – Accounting Changes
71. In 20x2, a firm changed from the straight-line (SL) method of depreciation to double declining
balance (DDB) to conform to long-standing industry practice. The firm's 20x1 and 20x2
comparative financial statements will reflect which method or methods.
20x1
SL
SL
DDB
SL
1
2
3
4
A)
B)
C)
D)
20x2
SL
DDB
DDB
either SL or DDB
Choice 1
Choice 2
Choice 3
Choice 4
Ans: C
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
72. In 20x2, a firm changed from the FIFO method of accounting for inventory to LIFO based on
new experience. The firm's 20x1 and 20x2 comparative financial statements will reflect which
method or methods.
Choice 1
Choice 2
Choice 3
Choice 4
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
A)
B)
C)
D)
20x2
LIFO
FIFO
LIFO
either LIFO or FIFO
zle
20x1
LIFO
FIFO
FIFO
LIFO
1
2
3
4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 16
Chapter 20 – Accounting Changes
73. In 20x2, a firm changed from the LIFO method of accounting for inventory to FIFO to conform
to long-standing industry practice. The firm's 20x1 and 20x2 comparative financial statements
will reflect which method or methods.
20x1
LIFO
FIFO
LIFO
LIFO
1
2
3
4
A)
B)
C)
D)
20x2
LIFO
FIFO
FIFO
either LIFO or FIFO
Choice 1
Choice 2
Choice 3
Choice 4
Ans: B
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: E
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
d
zle
74. Which of the following is treated as a retrospective accounting principle change? (Assume that
prior information is available)
A)
A change in an inventory method for a natural resources company
B)
A change in revenue recognition method for a construction company
C)
A change from LIFO to FIFO
D)
Correction of an error affecting prior year income
E)
All of the above
75. Which type of accounting change should always be accounted for in current and future periods?
A)
Change in accounting estimate
B)
Correction of an error
C)
Change in accounting principle
D)
Change in inventory costing methods
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 17
Chapter 20 – Accounting Changes
76. Which of the following is characteristic of a change in accounting estimate?
A)
Requires the reporting of income statements amounts for prior periods
B)
Does not affect the financial statements of prior periods
C)
Never needs to be disclosed
D)
Should be reported through restatement of the financial statements
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
77. Which of the following is not an example of a change in accounting estimate?
A)
Change in the estimated loss rate on receivables
B)
Change in the residual value of natural resources subject to depletion
C)
Change in the expected warranty costs on goods sold under a warranty
D)
Change in the expected recovery of a deferred charge
E)
Change in the composition of inventory cost
hz
Ans: E
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
d
zle
78. A change in an amortization rate, such as on a copyright, should be accounted for:
A)
Retrospectively.
B)
By recording an amount in retained earnings only.
C)
Prospectively.
D)
Currently.
79. Which of the following is an example of a change in accounting estimate?
A)
Change from the percentage-of-completion method to the completed-contract method of
income recognition for long-term construction contracts
B)
Change from capitalizing research and development costs to expensing such costs
C)
Change from the gross margin method to the retail method of estimating the ending
inventory
D)
Change from the LIFO method to the FIFO inventory method
E)
Change in the estimate of future warranty costs
Ans: E
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 18
Chapter 20 – Accounting Changes
80. If the estimated useful life of an asset was originally 10 years and then later changed to 12 years,
the effects of this change should be:
A)
Reported as a special item on the income statement in the year it occurs.
B)
Spread over the current and future periods.
C)
Reported and recorded retrospectively, including pro forma financial statements in the year
of change.
D)
Recorded in an adjustment to the Accumulated Depreciation account and the Retained
Earnings account in the year of change.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Ans: C
hz
81. Reported income during the early years of the estimated life of a depreciable asset usually would
be understated the most as a result of:
A)
High estimates of residual value and useful life.
B)
Using actual residual value and actual useful life.
C)
Low estimate of residual value and useful life.
D)
Low estimate of residual value and high estimate of useful life.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
d
82. WZ acquired some machinery on January 2, 20x1. WZ used straight-line depreciation with an
estimated life of 15 years with no residual value. On January 1, 20x6, WZ estimated that the
remaining life of this machinery was 6 years with no residual value. How should this change be
accounted for by WZ?
A)
Revising future depreciation per year, computed by dividing the book value on January 1,
20x6 by six.
B)
Revising future depreciation per year, computed by dividing the original cost by six.
C)
Estimating the effect of the change on each year's net earnings, but maintaining the method
of depreciation as originally determined.
D)
None of the above.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 19
Chapter 20 – Accounting Changes
83. A change in the estimated useful life of a building
A)
Is not allowed under ASPE or IFRS
B)
Affects depreciation on the building beginning with the year of the change
C)
Must be handled as a retrospective adjustment to all accounts affected, back to the year of
building acquisition
D)
Creates a new account to be recognized on the income statement, and reflects the
depreciation difference up to the beginning of the year of change
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Ans: D
hz
84. Under which of the following changes would no "catch-up" entry be required, because the
remaining accounting value is allocated over the present and future periods?
A)
Correction of an error
B)
Change to new tax laws
C)
Change in accounting principle
D)
Change in accounting estimate
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
zle
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
d
85. An accounting clerk working for DBB neglected to record the purchase of merchandise in 20x1,
which was, shipped f.o.b. shipping point on December 20, 20x1, and which arrived on December
31. The goods were included in the ending 20x1 inventory. What was the effect on DBB's 20x1
cost of goods sold?
A)
Cost of goods sold was correct.
B)
Cost of goods sold was understated.
C)
Cost of goods sold was overstated.
D)
Data are not available to determine effect on cost of goods sold.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 20
Chapter 20 – Accounting Changes
86. Which of the following types of errors will not self-correct in the next year?
A)
Accrued expenses not recognized at year-end
B)
Accrued revenues (but not collected) not recognized at year-end
C)
Depreciation expense overstated for the year
D)
Prepaid expenses not recognized at year-end
E)
Prepaid revenues (collected in advance) not recognized at year-end
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: B
hz
87. On December 25, 20x2, JKL ordered merchandise for resale from QRS that cost $7,000 (terms
cash within 10 days). QRS shipped the merchandise f.o.b. shipping point on December 28, 20x2,
and the goods arrived on January 2, 20x3. The invoice was received on December 30, 20x2. JKL
did not record the purchase in 20x2 and did not include the goods in the 20x2 ending inventory.
The effects on JKL's 20x2 financial statements were:
A)
Income and owners' equity were correct; liabilities were incorrect, assets were correct.
B)
Income and owners' equity were correct; assets and liabilities were incorrect.
C)
Income, assets, liabilities, and owners' equity were correct.
D)
Income, assets, liabilities and owners' equity were incorrect.
E)
No errors because the goods were not on hand.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: C
d
88. In reporting the effect of an accounting change on comparative financial statements,
recommended accounting procedure requires that the following be used for correcting an
accounting error:
A)
Prospective application.
B)
Future application.
C)
Retrospective application.
D)
Retrospective, no restatement application.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 21
Chapter 20 – Accounting Changes
89. Which of the following should not be reported retrospectively?
A)
Use of an unacceptable accounting principle, then changing to an acceptable accounting
principle
B)
Correction of an overstatement of ending inventory two years ago
C)
Use of an unrealistic accounting estimate, then changing to a realistic estimate
D)
Change from a good faith but erroneous estimate to a new estimate
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
90. Which of the following is a counterbalancing error?
A)
Understated depletion expense
B)
Bond premium under-amortized
C)
Prepaid expense adjusted incorrectly
D)
Overstated depreciation expenses
hz
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
d
zle
91. If BJC's beginning inventory in the current year is overstated, and that is the only error in the
current year, then BJC's income for the current year will be:
A)
Understated and assets correct.
B)
Understated and assets overstated.
C)
Overstated and assets overstated.
D)
Understated and assets understated.
92. Which of the following is not an example of an accounting error, as distinguished from a change
in accounting principle or change in estimate?
A)
Misstatement of an accounting value, such as inventory, deferred charge or credit,
liabilities, or owners' equity.
B)
Incorrect classification of an expenditure as between expense and an asset.
C)
Incorrect or unrealistic allocations of accounting values.
D)
Failure to recognize accruals and deferrals.
E)
Recognition of a gain on disposal of fully depreciated property.
Ans: E
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 22
Chapter 20 – Accounting Changes
93. Which of the following would cause income of the current period to be understated?
A)
Capitalizing research and development costs
B)
Failure to recognize unearned rent revenue
C)
Changing from LIFO to FIFO for merchandise inventory
D)
Understating estimates of asset residual values
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
94. Which of the following would cause income to be overstated in the period of occurrence?
A)
Overestimated bad debt expense
B)
Understated beginning inventory
C)
Overstated purchases
D)
Understated ending inventory
Ans: B
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: E
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3, 4
d
zle
95. XYZ decided to change its depreciation policy by (1) discontinuing to record depreciation on
land, and (2) changing the estimated useful life on all autos used in the business from five years
to four years. Choose the correct statement concerning these two changes:
A)
Both are changes in accounting principle.
B)
Both are changes in estimate.
C)
Both are error corrections.
D)
One is an error correction, and one is a change in principle.
E)
One is an error correction, and one is a change in estimate.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 23
Chapter 20 – Accounting Changes
96. MMC changed depreciation methods from straight-line to sum-of-the-years'-digits on two of its
machines. Data on the machines are as follows:
Machine
A
B
Cost
$100,000
$160,000
Residual Value
$4,000
$10,000
Useful Life
4
5
If MMC makes the change at the beginning of Year 2 of the life on each machine, what is the
total amount of the catch-up adjustment for this change?
A)
$56,000 debit to Accumulated depreciation.
B)
$34,400 debit to Accumulated depreciation.
C)
$34,400 credit to Accumulated depreciation.
D)
The effects of this change are accounted for prospectively; therefore, a catch-up adjustment
is not recorded.
E)
$34,400 credit to retained earnings.
Ans: C
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO4
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO4
d
zle
97. A corporation has a machine that cost $100,000, with an estimated useful life of 5 years and a
residual value of $25,000. Immediately after the end of the second year, the company decided to
change from SYD to straight-line depreciation. The entry to record the change would include an
effect on accumulated depreciation which would be a:
A)
$15,000 debit.
B)
$15,000 credit.
C)
$30,000 debit.
D)
$30,000 credit.
98. An asset that cost $66,000 was being depreciated on a SYD basis over 5 years with an estimated
residual value of $6,000. After the end of the third year, it was decided to change to straight-line
depreciation. What change would be made to the balance of accumulated depreciation?
A)
$12,000 debit
B)
$12,000 credit
C)
$13,200 Debit
D)
$13,200 credit
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 24
Chapter 20 – Accounting Changes
99. We have been using straight-line depreciation over the last several years, which has amounted to
a total of $20,000 depreciation before tax for those past years. This year we decide to change to
units of production, which would have caused $30,000 of depreciation to be recognized in those
past years, before tax. The tax rate has always been 40%. This year's depreciation under both
methods is:
Straight-Line
Units of Production
$5,000
6,000
The Cumulative Effect account resulting from this change will decrease net income by
A)
$ 6,600
B)
$10,000
C)
$ 4,000
D)
$ 6,000
Ans: D
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
d
zle
100. On July 1, 20x1, PRC purchased a delivery truck for $116,000 cash. Its estimated useful life was
7 years with a residual value of $4,000. Straight-line depreciation is used. On January 1, 20x4,
PRC revised the estimated useful life of the truck to 6 years and projected a residual value of
$7,400. The accounting period ends December 31. What amount of depreciation should PRC
recognize on the truck at December 31, 20x4?
A)
$16,000
B)
$18,000
C)
$19,600
D)
$20,200
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 25
Chapter 20 – Accounting Changes
101. On January 1, 20x1, MBC purchased a pattern-making machine for $400,000 cash. The machine
had an estimated useful life of 25 years and a residual value of $10,000. At the beginning of
20x6, the machine was given a major overhaul, which cost $28,000. The overhaul cost was
properly debited to the asset account. The overhaul did not change the estimated residual value
but did change the total estimated life to 30 years. The accounting period ends December 31.
MBC should recognize 20x6 depreciation of:
A)
$13,600
B)
$14,000
C)
$16,000
D)
$17,000
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
zle
Ans: C
hz
102. An asset that originally cost $6,000 is being depreciated on the straight-line basis over an
estimated useful life of 5 years. The estimated residual value was $1,500. Near the end of year 3,
it was decided that better estimates would have been a total life of 6 years and a residual value of
$800. Depreciation expense for year 3 would be:
A)
$900
B)
$750
C)
$850
D)
$825
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
d
103. The following errors were made in 20x3: An understatement of purchases of $500 and an
understatement of ending inventory of $500. The net effect on the 20x3 ending amount of
retained earnings is:
A)
$1,000 understatement.
B)
$1,000 overstatement.
C)
no effect, the errors offset.
D)
No effect, the errors affect income, not retained earnings.
E)
$500 understatement.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 26
Chapter 20 – Accounting Changes
104. BVC began operations January 1, 20x1. Financial statements for the year ended December 31,
20x1, and 20x2, contained the following errors:
December 31
20x1
20x2
$30,000 overstated
$12,000 understated
$20,000 overstated
$20,000 understated
Ending inventory
Depreciation expense
Insurance expense
In addition, on December 26, 20x2, fully depreciated machinery was sold for $21,600 cash, but
the sale was not recorded until 20x3.
There were no other errors during 20x1 or 20x2, and no corrections have been made for any of
the errors.
What is the total pretax effect of the errors on 20x2 net income?
A)
$28,400 overstated
B)
$50,000 overstated
C)
$53,600 Overstated
D)
$71,600 overstated
hz
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO4
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO4
d
zle
105. At the end of the accounting year, December 31, 20x4, adjusting entries were not made for wages
that had been earned but not yet paid, $1,800, and rent revenue of $1,400 that had been earned but
not yet collected. As a consequence, the 20x4 amount of pretax earnings was:
A)
Overstated by $3,200.
B)
Understated by $3,200.
C)
Overstated by $400.
D)
Understated by $400.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 27
Chapter 20 – Accounting Changes
106. The following accounting errors occurred in 20x3, but were not discovered until 20x4:
Purchases for 20x3 overstated by
Ending 20x3 inventory overstated by
Depreciation expense for 20x3 overstated by
$400
400
400
The combined effect of these three errors caused 20x3 pretax income to be:
A)
Overstated by $400.
B)
Overstated by $800.
C)
Understated by $400.
D)
Understated by $1,200.
Ans: C
. Difficulty: Medium
Level of Learning: Application
Topic: LO4
hz
107. The following errors were discovered during January 20x3 (prior to any reversing entries). The
accounting period ends December 31.
20x2 Ending inventory overstated
20x3 Insurance premium paid in 20x2 for 20x3 was expensed in full in 20x2
20x2 Accounts receivable overstated
$8,000
6,000
2,000
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO4
d
zle
What effect did these errors have on the 20x2 pretax income?
A)
Overstated $2,000
B)
Understated $2,000
C)
Overstated $1,000
D)
Understated $1,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 28
Chapter 20 – Accounting Changes
108. The following errors were discovered during January 20x3 (prior to any reversing entries):
20x2 Ending 20x2 inventory overstated
20x2 Annual insurance premium paid in advance at the end of 20x2; expensed in full in
20x2
20x2 Accounts receivable ending balance (from sales) overstated
$4,000
3,000
1,000
The accounting period ends December 31. What effect would these errors have on 20x3 pretax
income?
A)
Overstated $2,000
B)
Understated $2,000
C)
Overstated $1,000
D)
Understated $1,000
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO4
hz
Ans: A
zle
109. The only errors BGC made were in the valuation of ending inventory amounts. As a result, in
20x3, cost of goods sold was overstated by $1,000. In 20x4, cost of goods sold was understated
by $500. What ending inventory error was made at the end of 20x4?
A)
Understated $500
B)
Overstated $500
C)
Overstated $1,500
D)
Overstated $1,000
Difficulty: Medium
Level of Learning: Application
Topic: LO4
d
110. An asset that costs $4,000 on January 1, 20x1, is being depreciated on the basis of a 10% straightline rate. On January 1, 20x2, an ordinary repair of $600 was debited to the asset account and also
was depreciated in the same way. As a result, 20x2 pretax income was:
A)
Overstated $600.
B)
Understated $600.
C)
Overstated $540.
D)
Understated $60.
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 29
Chapter 20 – Accounting Changes
111. Reported income for CXC was incorrect due to two errors. One error was the overstatement of
ending inventory by $2,000. Which of the following errors, in combination with the inventory
error, could cause income to be overstated by $2,500?
A)
Purchases were understated $4,500
B)
Beginning inventory was understated $500
C)
A prepaid expense of $500 was capitalized
D)
Accounts receivable was overstated $4,500
E)
Expenses were overstated by $500
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO4
zle
Ans: A
hz
112. The errors listed below occurred in 20x3 but were not discovered until much later in 20x4. The
accounting period ends December 31.
Purchases understated $400
Ending inventory overstated 400
Rent expense overstated 400
What net effect did these errors have on 20x3 pretax income?
A)
Overstated by $400
B)
Overstated by $800
C)
Understated by $400
D)
Understated by $1,200
Difficulty: Medium
Level of Learning: Application
Topic: LO4
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 30
Chapter 20 – Accounting Changes
113. The GXC made the following errors during 20x1, its first year of operations:
Recorded $800 of interest expense as a debit to prepaid expense and a credit to cash.
Recorded $2,000 of unearned revenue as a debit to revenue receivable and a credit to revenues.
No adjusting entries were made related to these transaction entries.
The effect of these errors is as follows: 20x1:
Pretax Income
Understated $1,200
Overstated $2,800
Overstated $2,800
Overstated $1,200
1
2
3
4
A)
B)
C)
D)
Current Assets
overstated $2,800
overstated $2,800
overstated $2,000
overstated $2,800
Choice 1
Choice 2
Choice 3
Choice
Ans: B
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO4
114. MGC reported $50,000 in income for 20x2. The following deferrals and accruals were not
recorded in the 20x1 and 20x2 adjusting entries:
zle
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO4
End of
20x2
$0
800
d
Prepaid interest
Unearned rent revenue (collected in advance)
MGC's correct 20x2 income was:
A)
$51,300
B)
$50,500
C)
$49,300
D)
$48,500
End of
20x1
$1,000
300
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 31
Chapter 20 – Accounting Changes
115. At the beginning of the current year, a capital expenditure of $24,000 for equipment with an
estimated useful life of six years (and no residual value) was debited erroneously to maintenance
expense. Straight-line depreciation is used. This error will cause the current year's ending retained
earnings to be:
A)
Overstated by $4,000.
B)
Understated by $28,000.
C)
Understated by $24,000.
D)
Understated by $20,000.
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO4
Ans: C
hz
116. The correction of an error in the financial statements of a prior period should be reflected, net of
applicable income taxes, in the current:
A)
Income statement after income from continuing operations and before discontinued
operations.
B)
Income statement after income from continuing operations and after discontinued
operations.
C)
Statement of retained earnings as an adjustment of the opening balance.
D)
Statement of retained earnings after net income but before dividends.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
117. When a cumulative effect type change in accounting principle is made during the year, the
cumulative effect on retained earnings is determined:
A)
During the year using the weighted-average method.
B)
As of the date of the change.
C)
As of the beginning of the year in which the change is made.
D)
As of the end of the year in which the change is made.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 20 – Accounting Changes
118. An example of a special change in accounting principle that should be reported by restating the
financial statements of prior periods is the change from the:
A)
Straight-line method of depreciating plant equipment to the sum-of-the-years'-digits
method.
B)
sum-of-the-years'-digits method of depreciating plant equipment to the straight-line
method.
C)
FIFO method of inventory valuation to the LIFO method.
D)
All of the above.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Ans: A
hz
119. A change in the salvage value of an asset depreciated on a straight-line basis and arising because
additional information has been obtained is:
A)
An accounting change that should be reported in the period of change and future periods if
the change affects both.
B)
An accounting change that should be reported by restating the financial statements of all
prior periods presented.
C)
A correction of an error.
D)
Not an accounting change.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
120. The records of CTC reported rent expense for 20x5 (paid in cash during 20x5) of $53,500. An
audit revealed that the following accrued and prepaid amounts were not recorded in the adjusting
entries for 20x4 and 20x5:
End of 20x4
$6,000
$7,000
d
Accrued rent expense
Prepaid rent expense
End of 20x5
$ 3,500
$11,500
What amount should have been reported for 20x5 rent expense?
A)
$46,500
B)
$53,500
C)
$60,500
D)
$64,000
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 33
Chapter 20 – Accounting Changes
121. The 20x4 income of MXC was understated by $3,000. This was due to three separate errors. One
error was the overstatement of purchases by $2,000; the second error was the understatement of
depreciation expense by $1,000. Which of the following errors, in combination with the other
two, would cause the $3,000 understatement of income?
A)
These two errors alone caused the misstatement
B)
Prepaid expenses was overstated $2,000
C)
Revenue earned but not yet collected of $2,000 was not properly recognized
D)
Interest expense was understated $2,000
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO4
Ans: C
hz
122. Which of the following changes would be disclosed as a change in accounting principle but
reported by applying the new method retrospectively as restatements of prior periods?
A)
Change from the first-in, first-out method to the last-in, first-out method of inventory
pricing
B)
Change in the composition of elements included in inventory
C)
Change from completed-contract accounting to percentage of completion
D)
Change from the straight-line method to an accelerated method of depreciation
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
123. A firm, in business just a few years, decided to change from FIFO to LIFO for inventory
measurement purposes. The firm carries only a few items of inventory, but sells in large volume.
An excellent historical record is kept of inventory purchases, quantities and costs. In making the
accounting change, the firm
A)
Must report the cumulative effect of the change on all previous years' income
B)
Need not report the cumulative effect of the change on all previous years' income even
though it is able to do so
C)
Cannot make the change unless it is able to determine the cumulative effect of the change
on all previous years' income
D)
Should report the cumulative effect of the change on all previous years' income if it is not
prohibitively expensive to do so
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 34
Chapter 20 – Accounting Changes
124. A retailing firm changed from FIFO to LIFO in 20x6. Beginning inventory in the year of the
change is $300,000. After weeks of part-time work by the accounting department, it has become
apparent that, had LIFO been used in previous years, many layers of inventory would exist
reflecting costs from several years in the past. The information required to determine the cost of
these layers is difficult if not impossible to obtain. Therefore, in terms of making the change, the
firm
A)
May make the change, use $300,000 as the beginning inventory under LIFO, and disclose
the effect of the change on 20x5 and 20x6 earnings
B)
May make the change, use $300,000 as the beginning inventory under LIFO, and disclose
the effect of the change on 20x6 earnings
C)
May not make the change, because the cumulative effect on all previous years' income is
not feasibly determinable
D)
May make the change, and report a reasonable estimate of the cumulative effect on all
previous years' income in the income statement
E)
May make the change, and report a reasonable estimate of the cumulative effect on all
previous years' income as an adjustment to the beginning 20x6 balance of retained earnings
Ans: B
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
d
Ans: D
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125. When a firm changed its method of accounting for inventory from LIFO to FIFO in 20x4, it
decided that the 20x4 financial statements should be shown comparatively with 20x3 results.
Choose the correct statement concerning reporting the change in the retained earnings (RE)
statement.
A)
There is no direct adjustment to RE because earnings for both years has been adjusted to
reflect the change
B)
Only the 1/1/x3 RE balance is adjusted for the effects of the change on earnings
C)
Only the 1/1/x4 RE balance is adjusted for the effects of the change on earnings
D)
Both the 1/1/x3 and 1/1/x4 RE balances are adjusted for the effects of the change on
earnings before those respective dates
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 35
Chapter 20 – Accounting Changes
126. The September 30, 20x1, physical inventory of JCB appropriately included $3,800 of
merchandise purchased on account, which was not recorded in purchases until October 20x1.
What effect will this error have on September 30, 20x1, assets, liabilities, retained earnings, and
earnings for the year then ended, respectively?
A)
Understate; no effect; overstate; overstate
B)
No effect; overstate; understate; understate
C)
No effect; understate; overstate; overstate
D)
No effect; understate; understate; overstate
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: E
hz
127. The ending inventory of XZW was overstated by $6,000 in 20x4. The overstatement will cause
XZW's:
A)
Retained earnings to be understated on the 20x4 balance sheet.
B)
Cost of goods sold to be understated on the 20x5 income statement.
C)
Cost of goods sold to be overstated on the 20x4 income statement.
D)
Income to be overstated on the 20x5 income statement.
E)
No misstatements on the 20x5 balance sheet.
d
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Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 36
Chapter 20 – Accounting Changes
128. A retailing firm changed from LIFO to FIFO in 20x5. Inventory valuations for the two methods
appear below:
1/1/x4
$10,000
7,000
FIFO
LIFO
1/1/x5
$20,000
16,000
12/31/x5
$25,000
18,000
Purchases in 20x4 and 20x5 were $60,000 in each year. In the comparative 20x4 and 20x5
income statements, what amounts would be shown for cost of goods sold?
20x4
$50,000
$51,000
$50,000
$51,000
1
2
3
4
Choice 1
Choice 2
Choice 3
Choice 4
Ans: C
hz
A)
B)
C)
D)
20x5
$58,000
$55,000
$55,000
$58,000
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
zle
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 37
Chapter 20 – Accounting Changes
129. A firm changed from completed contract to percentage of completion for revenue recognition on
long-term construction contracts in 20x7. This change had the following effects on earnings:
Increase in earnings
20x7
20x6
$20,000
30,000
All years before 20x6 100,000
By what amounts are the beginning retained earnings balances for 20x6 and 20x7 adjusted, if the
20x6 and 20x7 statements are shown comparatively.
20x6
$130,000
$100,000
$100,000
no adjustment
no adjustment
1
2
3
4
5
Choice 1
Choice 2
Choice 3
Choice 4
Choice 5
Ans: B
hz
A)
B)
C)
D)
E)
20x7
$150,000
$130,000
no adjustment
$130,000
no adjustment
d
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 38
Chapter 20 – Accounting Changes
130. Jenell Inc. decides to change its method of accounting for inventory from LIFO to FIFO, for
accounting purposes only in 20x1. Data for Jenell:
Retained earnings, January 1, 20x0
Income tax rate
$160,000
30%
Effect of change on pretax net income in:
20x1:
20x0:
$20,000 increase
30,000 increase
Years before 20x0 in total: $120,000 increase
20x0 net income (after tax) under LIFO
20x1 net income (after tax) under LIFO
$80,000
105,000
Ans: B
hz
The entry to record the accounting change will include which of the following.
A)
cr. expense $105,000
B)
cr. retained earnings $105,000
C)
cr. cumulative effect of change in accounting principle $105,000
D)
dr. retained earnings $150,000
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Ans: B
d
131. A plant asset was purchased for $19,000 on 1/1/x0 with a residual value of $2,000 and useful life
of five years. In 20x3, the total useful life is re-estimated to be seven years and the estimated
salvage value is assumed to be zero. Sum of year's digits depreciation is used. What is
depreciation expense in 20x3?
A)
$2,340
B)
$2,160
C)
$1,350
D)
$1,210
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 39
Chapter 20 – Accounting Changes
132. Depreciation expense for the most recent fiscal year on equipment purchased a few years ago is
$10,000. The balance sheet at the end of the same year disclosed the following:
Equipment
Accumulated depreciation
Net book value
$300,000
(40,000)
$260,000
The asset is not expected to have a salvage value and the firm depreciates the asset on the
straight-line basis. In March of the NEXT year (the year of change), the firm decided to reduce
the original total useful life 20% and that a salvage value of $30,000 is a reasonable estimate.
What is depreciation in the year of the change?
A)
$11,500
B)
$13,000
C)
$10,000
D)
$12,000
E)
$12,500
Ans: A
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
Ans: D
zle
133. Super-Mineral began operations last year (year 1) on a mineral tract and expected a yield of
2,000,000 tons of a valuable ore used in the semiconductor industry. The total balance in the
Depletion Base account (or "Natural Resources" account) was $2,000,000 before any depletion
was recognized. During year 1, 400,000 tons of the ore were removed. Then, early in year 2, a
new vein of ore was discovered holding an estimated additional 1,600,000 tons of ore. 800,000
tons were removed in year 2. What is depletion in year 2?
A)
$1,600,000
B)
$ 800,000
C)
$ 600,000
D)
$ 400,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 20 – Accounting Changes
134. In 20x4, a firm discovered that $10,000 of equipment purchased on 1/1/x1 was expensed in full.
The equipment has a ten-year life, has no residual value, and should have been depreciated on the
straight-line basis. The error is corrected. As a result, the comparative 20x3 and 20x4 financial
statements will show what amounts as adjustments to the beginning balances of retained earnings
dated:
1/1/x3
$7,000
$8,000
0
$8,000
1
2
3
4
A)
B)
C)
D)
1/1/x4
$7,000
0
$7,000
$7,000
Choice 1
Choice 2
Choice 3
Choice 4
Ans: D
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO4
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO4
d
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135. Which of the following combinations of errors would cause a $2,000 overstatement of pretax
income?
A)
$4,000 overstated beginning inventory and $2,000 understated ending inventory
B)
$4,000 understated beginning inventory and $2,000 understated ending inventory
C)
$4,000 overstated ending inventory and $2,000 understated depreciation expense
D)
$4,000 understated depreciation expense and $2,000 understated beginning inventory
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 41
Chapter 20 – Accounting Changes
136. On January 1, 1999, Ryan Ltd. purchased equipment for $30,000 cash. Ryan Ltd's fiscal year end
is December 31. At the time of acquisition, the equipment was expected to last 8 years and had an
estimated salvage value of $1,200. Ryan Ltd. uses the straight-line method to depreciate its assets.
On January 1, 2000, Ryan Ltd. changed its total estimated useful life of the vehicle from 8 years
to 5 years and the estimated salvage value was changed to $2,000. Prepare the journal entry to
record the depreciation on December 31, 2000.
Ans: Original depreciation = ($30,000-$1,200)/8 = $3,600
January 1, 2000 NBV = 30,000- $3,600 = $26,400
Revised depreciation = ($26,400-$2,000)/5 = $4,880
Depreciation expense
Accumulated depreciation
$4,880
$4,880
Difficulty: Medium
Level of Learning: Application
Topic: LO3
zle
hz
137. Match each example with the type of accounting change (or error) by entering a letter in each
blank space to the left of the statement.
Type of Change
A. Accounting error correction.
B. Change in accounting principle.
C. Change in accounting estimate.
D. None of the above.
Ans: 1: B, 2: D, 3: C, 4: A, 5: B
Difficulty: Medium
d
Example
___ 1.
Change from percentage-of-completion to completed-contract method of
accounting for long-term construction contracts.
___ 2.
Change of the expense groupings included in combined financial statements.
___ 3.
Change in the expected warranty cost on goods sold under guarantee.
___ 4.
Change from a "bad faith" accounting estimate to a realistic estimate.
___ 5.
Change from expensing certain costs to capitalizing the costs and depreciating
them.
Level of Learning: Knowledge
Topic: LO1-4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 42
Chapter 20 – Accounting Changes
138. Match the kind of change with each event by entering the appropriate letter in the blanks
provided.
Kind of Change
A. Error correction.
B. Change in principle.
C. Change in estimate.
Event
___ 1.
Change of inventory costing method from FIFO to average cost.
___ 2.
Debited the cost of a machine to expense when acquired.
___ 3.
Change of residual value from $2,000 to $3,000.
___ 4.
Forgot to record prepaid insurance, $600.
___ 5.
Change the estimated useful life of a depreciable asset from 5 years (not a good faith
estimate) to a 15-year reliable estimate.
Ans: 1: B, 2: A, 3: C, 4: A, 5: A
Difficulty: Medium
Level of Learning: Application
Topic: LO1-4
hz
d
zle
139. Enter a check mark on each line to indicate the proper classification of each example listed to the
left.
Acct.
Estimate
Acct.
Principle
Change
Error
Change
Correction
(a)Change in amortization period for a patent
______
______
______
(b)Changed from completed contract to percentage-of-completion for ______
______
______
long-term construction contract
(c)Change in residual value for depreciation
______
______
______
(d)Change from FIFO to LIFO for inventory
______
______
______
(e)Discovered mistake in computing depreciation expense which was ______
______
______
made 3 years ago
Ans:
(a)
_____
(b)
__X__
(c)
_____
(d)
__X__
(e)
_____
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1-4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 43
Chapter 20 – Accounting Changes
140. There are three kinds of accounting changes (including error corrections) as follows:
A. Correction of an accounting error.
B. Change in accounting principle.
C. Change in accounting estimate.
D. None of the above.
In the space to the left, enter one of the above letters to indicate the classification of the item in
terms of the kind of change involved (enter A, B, C, or D).
___ 1.
Changed from straight-line to declining-balance depreciation method.
___ 2.
Used a non-GAAP procedure to record a transaction.
___ 3.
Debited an expense amount to an operational asset account.
___ 4.
For depreciation purposes, changed either useful life and/or residual value.
___ 5.
During the current year, Company P acquired 90% of the common voting
stock of Company S.
___ 6.
Changed from "bad faith" insupportable estimate of bad debt losses to a
"good faith" supportable estimate.
___ 7.
Changed from a non-GAAP procedure to a GAAP procedure.
Ans: 1: B, 2: A, 3: A, 4: C, 5: D, 6: A, 7: A
Difficulty: Medium
hz
Level of Learning: Application
Topic: LO1-4
d
zle
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 44
Chapter 20 – Accounting Changes
141. For each item listed below, enter a check mark under the appropriate column to indicate the
proper accounting treatment. Explain how any item should be handled that does not correspond
with any one of the three treatments listed.
(a)
Item
Change from percentageof-completion to
completed contract
method for long-term
construction.
Changed amortization of
goodwill from 40 year
total life to 25 year
total life.
(c)
Change in the amount of
the residual value of an
operational asset.
(d)
Change the estimated
useful life from a "bad
faith" estimate to a
"good faith" estimate.
(e)
Change from a non-GAAP
accounting approach to a
GAAP approach.
(f)
Change from straightline to decliningbalance depreciation.
(g)
A change from weighted
average inventory cost
flow method to LIFO.
(h)
A change in the
estimated useful life
of an operational asset.
(i)
Correction of an
accounting error in a
prior period; recording
depletion.
(j)
Change from LIFO to FIFO
for inventory costing.
Accounting Treatment
Prospectively Retrospective
d
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hz
(b)
Retrospective no restate
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 20 – Accounting Changes
Ans:
(a) Retrospective
(b) Prospectively
(c) Prospectively
(d) Retrospective (error)
(e) Retrospective (error)
(f) Current
(g) Current
(h) Prospectively
(i) Retrospective (error)
(j) Retrospective
Difficulty: Hard
Level of Learning: Application
Topic: LO1-4
zle
hz
142. Match each example with the type of accounting change or error correction.
Type of Change or Error Correction
A. Accounting error correction.
B. Change in accounting principle.
C. Change in accounting estimate.
D. None of the above.
Example
___ 1.
Change from FIFO to LIFO.
___ 2.
Change due to understatement of inventory.
___ 3.
Change due to differences in asset groupings on prior statements.
___ 4.
Change in rate used to compute doubtful accounts.
___ 5.
Change from percentage-of-completion to completed contract method on
construction contracts.
___ 6.
Change in definition of cash equivalents on statement of cash flows.
___ 7.
Change in residual value of an operational asset.
___ 8.
Change due to failure to recognize a prepaid expense.
___ 9.
Change because of deliberate understatement of useful life of operational
asset.
Ans: 1: B, 2: A, 3: D, 4: C, 5: B, 6: B, 7: C, 8: A, 9: A
Difficulty: Hard
d
Level of Learning: Application
Topic: LO1-4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 46
Chapter 20 – Accounting Changes
143. Listed below are a number of errors. Indicate the effect of each error on the reported net income
for 20x1 and 20x2; use an "X" to respond.
Errors
20x1:
(a)
Ending inventory
understated.
20x1 Net Income was:
Over
Under
stated
stated
No
Eff.
20x2 Net Income was:
Over
Under
No
Eff.
stated
stated
(b)
Accrued wages
payable not recorded
at year-end.
hz
(c)
20x1 purchase not
recorded until 20x2,
included in 20x1 inv.
(d)
Unearned rent
rev. not recognized
at year-end.
d
20x2:
(f)
Ending inventory
overstated.
zle
(e)
Prepaid insurance
not recorded; the full
amount of insurance
premium was reported
(as expense in 20x1).
(g)
Patent not amort.
at year-end.
(h)
Accrued interest
revenue (earned) not
recorded at year-end
(i)
December sales
return for credit not
recorded in 20x2.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 20 – Accounting Changes
(j)
Beginning inv.
understated.
Ans:
Under
stated
X
No
Eff.
Over
stated
X
Under
stated
No
Eff.
X
X
X
X
hz
Over
Errors
stated
(a) 200x1 Ending inventory understated.
(b) Accrued wages payable not recorded X
at year-end.
(c) 20x1 purchase not recorded until 20x2 X
included in 20x1 inv.
(d) Unearned rent rev. not recognized at X
year-end.
(e) Prepaid insurance not recorded; the
full amount of insurance premium was
reported (as expense in 20x1).
(f) 20x2: Ending inventory overstated.
(g) Patent not amort. at year-end.
(h) Accrued interest revenue (earned) not
recorded at year-end.
(i) December sales return for credit not
recorded in 20x2.
(j) Beginning inv. understated.
X
X
X
X
X
X
X
X
X
X
X
Difficulty: Hard
d
zle
Level of Learning: Application
Topic: LO1-4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 48
Chapter 20 – Accounting Changes
144. In 20x1, an asset was purchased for $45,000 and has been depreciated using sum-of-the-years'digits based on an estimated useful life of five years and no residual value. In 20x3 (before the
adjusting and closing entries), the company decided to change to straight-line depreciation. The
estimated useful life was not to be changed.
(a) Give the entry required when the decision was made.
(b) Give the entry for depreciation expense for 20x3.
Ans: (a)
Accumulated depreciation
Cumulative effect of change in accounting principle
18,000
18,000
Depreciation taken, 90,000 x 9/15
Depreciation under new method: $90,000 x 2/5
Change in accumulated depreciation
$54,000
36,000
$18,000
======
(b)
Depreciation expense
Accumulated depreciation($90,000 x 1/5 = $18,000)
18,000
18,000
hz
Difficulty: Hard
Level of Learning: Application
Topic: LO3
SYD: $45,000 x 12/15
Straight-line: $45,000 x 3/5
Difference
d
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145. An asset that cost $49,500 was being depreciated on a sum-of-the-years'-digits basis over five
years with an estimated residual value of $4,500. After the end of the third year, it was decided to
change to straight-line depreciation (ignore income taxes).
(a) Give any required entry as of the beginning of year 4.
(b) Give the adjusting entry to record depreciation at the end of the fourth year, taking into
account the new decision.
Ans: (a)
Entry to record the accounting change:
Accumulated depreciation
9,000
Cumulative effect of accounting change
9,000
(b)
Adjusting entry:
Depreciation expense
Accumulated depreciation
($49,500 - $4,500) ÷ 5 years
=$36,000
= 27,000
$ 9,000
=======
9,000
9,000
=$9,000
=====
Difficulty: Hard
Level of Learning: Application
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 49
Chapter 20 – Accounting Changes
146. A firm changes from accelerated depreciation to straight-line depreciation in 20x1:
Depreciation: Total before 20x1 20x1
Accelerated
$4,200
$400
SL
3,600
300
Provide the 20x1 entries to record the accounting change and to record 20x1 depreciation
expense, ignoring taxes.
Ans:
Accumulated depreciation
600
Cumulative effect of accounting change
600
Depreciation expense
300
Accumulated depreciation
300
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3
zle
hz
147. An asset cost $190,000; it is being depreciated, straight-line, $30,000 residual value, over 10
years. At the start of Year 7, it was decided that the residual value should be $14,000. Give the
entries required on the following dates (if none explain why):
January 1, Year 7:
December 31, Year 7:
Ans: January 1, Year 7:
None - a change in estimate; accounted for prospectively.
December 31, Year 7:
Depreciation expense
20,500
Accumulated depreciation
20,500
Cost
Depreciation to date ($190,000 - $30,000). x 6/10
Revised residual value
To be depreciated
Annual depreciation $82,000 ÷ (10 - 6)
Level of Learning: Application
Topic: LO3
d
Difficulty: Hard
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
$190,000
96,000
(14,000)
$ 82,000
=======
$ 20,500
=======
Page 50
Chapter 20 – Accounting Changes
148. KEC has a machine that cost $75,000 (no residual value) that was being depreciated over a 15year estimated life, using SL. On the basis of more experience, during the 9th year, management
decided to use a revised total estimate of 20 years.
(a) What kind of accounting change does this represent?___________.
(b) Give entry in 9th year to reflect the change; if none is required, explain.
(c) Give the depreciation entry (year-end adjusting entry) for the 9th year. Show computations.
Ans: (a) Change in estimate.
(b) None required for a change in estimate. The effects are reflected prospectively.
(c) Depreciation expense
2,917
Accumulated depreciation
2,917
Computations:
Undepreciated balance: $75,000 x 7/15 = $35,000.
Depreciation per period: $35,000 ÷ 12 years = $2,917.
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3
hz
149. An asset cost $12,000 when acquired and had an estimated useful life of 10 years with no
estimated residual value. Use straight-line depreciation. During Year 7, the overall life was
changed to 12 years.
(a) What should be recorded as depreciation expense for Year 7?
$_________________________.
(b) What would the balance of accumulated depreciation be at the start of Year 8?
$_____________________________
zle
(c) Would a correcting entry be made during Year 7 for the change?
Yes____________ No______________ Explain why. _______________
Ans: (a)
$12,000 ÷ 10 years = $1,200.
$1,200 x 6 years = $7,200.
$12,000 - $7,200 = $4,800; $4,800 ÷ (12 - 6 years) =
$800.
====
d
(b) $7,200 + $800 = $8,000.
(c) No. There is a change in accounting estimate; depreciate remaining undepreciated
balance over remaining life.
Difficulty: Hard
Level of Learning: Application
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 51
Chapter 20 – Accounting Changes
150. On January 1, 20x1, DB purchased equipment that cost $48,000. It was depreciated on the
straight-line basis for the years 20x1, 20x2 and 20x3 (estimated useful life 5 years and no residual
value). During early 20x4, DB changed the estimated total useful life to 7 years and the residual
value to $3,200 at the end of year 7.
(a) Give any entry required during 20x4 by DB to reflect the change. If none is required, explain
why.
(b) Give the adjusting journal entry required on December 31, 20x4.
Ans: a. None - This is a change in estimate.
b. Depreciation expense........................... 4,000
Accumulated depreciation...................... 4,000
$48,000 - $28,000* - $3,200 = $16,000 ÷ 4 = 4,000
_________
*$48,000 x 3/5 = $28,800
Difficulty: Hard
Level of Learning: Application
Topic: LO3
hz
151. An asset that cost $9,000 on January 1, 20x1, was being depreciated using the straight-line
method over five years with an estimated residual value of $1,500. At the beginning of 20x3, the
company decided to use a six-year life and a residual value of $600.
(a) Give any correcting entry at January 1, 20x3.
(b) Give the 20x3 adjusting entry to record depreciation.
Ans: (a) This is a change in estimate; therefore, no correcting entry is needed.
zle
(b)
Adjusting entry:
Depreciation expense
Accumulated depreciation
1,350
Undepreciated balance $9,000 - ($1,500 x 2)
New residual value
Balance to be depreciated
Depreciation expense: $5,400 ÷ 4 years =
Level of Learning: Application
Topic: LO3
d
Difficulty: Hard
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
1,350
$6,000
600
$5,400
$1,350
=====
Page 52
Chapter 20 – Accounting Changes
152. The following accounting errors occurred in 20x1; they were discovered in 20x2: Purchases for
20x1 overstated by $600; ending 20x1 inventory overstated by $600; and depreciation expense
for 20x1 overstated by $600. The combined effect of these errors caused 20x1 pre-tax income to
be:
Overstated by $________ ; or Understated by $________ ; or No
Effect________.
Computations:
Ans: Pretax income: Understated by $600. (Purchases, understatement,$600; ending inventory
overstatement, $600; depreciation expense, understatement, $600.)
Difficulty: Hard
Level of Learning: Application
Topic: LO4
153. The records of CDF reflected the following data for 20x1:
Cash paid during 20x1 for expenses, $10,000.
hz
January 1
Prepaid expenses not recognized at year-end
$600
Accrued expenses not recognized at end of prior year
$60
The amount of expense that CDF should report on the 20x1 income statement is
$_____________________.
Ans: $10,000 + ($200 - $60) - ($800 - $600) = 9,940.
Difficulty: Hard
December 31
$800
$200
d
zle
Level of Learning: Application
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 53
Chapter 20 – Accounting Changes
154. Following are five separate and completely independent cases:
CASE A: A $700 item was excluded incorrectly from the ending inventory; the related purchase
was not recorded.
CASE B: A $200 item was included incorrectly in the ending inventory; the related purchase was
recorded.
CASE C: A $900 item was included incorrectly in the ending inventory; the related purchase was
not recorded.
CASE D: A $500 item was excluded incorrectly from ending inventory; the related purchase was
recorded.
CASE E: The beginning inventory was overstated by $400.
Enter dollar amounts where appropriate in the following tabulation to indicate the effect on the
financial statements of each of the items given above (disregard income tax).
CASE A
CASE B
CASE C
CASE D
CASE E
Item
Over Under Over Under Over Under Over Under Over Under
Bal. sheet $
$
$
$
$
$
$
$
$
$
Inventory
Other
assets
Retained
earnings
Beg. inv.
Purchases
Inc.(net)
d
End. inv.
zle
Inc. state
Sales
hz
Accts.
payable
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 54
Chapter 20 – Accounting Changes
Ans:
CASE A
CASE B
CASE C
CASE D
CASE E
Item
Over Under Over Under Over Under Over Under Over
Under
Bal. Sheet: $
$700 $200 $
$900 $
$
$500 $
$
Inventory
Other assets
Accts. pay. 700
200
Ret. earnings
900
500
Inc. Statement
Sales
Beg. inv.
400
Purchases
700
200
Ending inv. 700
200
900
500
Income (net)
900
500
400
Difficulty: Hard
Level of Learning: Application
Topic: LO4
hz
Ans:
zle
155. Give the correct response to each of the following events:
(a) An overstatement of accrued wages payable by $2,000 at the end of 20x1 would cause
retained earnings at the end of 20x2 to be _____ overstated; _____ understated; _____ correct
(assuming no correcting entry).
(b) A $6,000 purchase of merchandise on credit in 20x1 was not recorded in 20x1; but it was
recorded in 20x2 when the cash was paid. It was discovered during 20x3. The merchandise was
not included in the 20x1 ending inventory. Therefore, 20x1 income was: _____ overstated; _____
understated; _____ correct.
(c) The 20x2 ending inventory was overstated by $4,000 and no correcting entry has been made.
Therefore the 20x3 net income is: _____ overstated; _____ understated; _____ correct.
Level of Learning: Application
Topic: LO2-4
d
(a) Correct; the error self-corrected at the end of 20x2.
(b) Correct; the two errors (purchases and ending inventory) offset in 20x1.
(c) Understated; because the beginning 20x3 inventory was overstated.
Difficulty: Hard
156. On January 1, 20x3; a company purchased an operational asset for $44,000. At the date of
purchase, the full amount was debited to expense. At the end of 20x6, the audit discovered this
error. The asset had no residual value and should be depreciated over 10 years, using the sum-ofyears'-digits method. Give the entry at the end of 20x6 to correct the accounts. Assume the
accounts for 20x6 have not been closed.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 55
Chapter 20 – Accounting Changes
Ans:
Asset
Depreciation expense
Accumulated depreciation
Retained earnings, error correction
$44,000 x 7/55 = $5,600.
$44,000 x 34/55 = $27,200.
Difficulty: Hard
44,000
5,600
27,200
22,400
Level of Learning: Application
Topic: LO2
hz
157. The records for OTC showed the following for 20x2:
January 1
December 31
Prepaid expenses.
$260
$300
Accrued expenses
100
30
Cash paid during the year on expenses, $4,000.
The amount of expense that should be reported on the income statement is:
$__________________________.
Ans:
$4,000 - $300 - $100 + $30 + $260 =
$3,890.
=====
Difficulty: Medium
Level of Learning: Application
Topic: LO1-4
d
zle
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 56
Chapter 20 – Accounting Changes
158. Indicate how the following errors would affect income and owners' equity. Use the symbol +
(plus) for overstated, - (minus) for understated, and 0 (zero) for no effect or error offset.
(a)Overstated 20x1 depreciation expense. 20x2 depreciation
____ ____
____
____
expense was correct.
(b)Purchase of goods made late in 20x1, recorded in 20x2 and ____ ____
____
____
included in 20x1 ending inventory.
(c)An expenditure for factory equipment with a five-year useful ____ ____
___
____
life was debited in full to maintenance expense in 20x1.
(d)Failed to record the office supplies inventory at the end of
____ ____
____
____
20x1. The office supplies were purchased for cash and were
debited in full to office supplies expense during 20x1 when paid
for.
(e)Failed to accrue 20x1 wages payable at year-end.
____ ____
____
____
(f)Ending inventory in 20x1 understated.
____ ____
____
____
(g)Ending inventory in 20x1 overstated.
____ ____
____
____
(h)Failed to accrue 20x1 interest revenue earned (not yet
____ ____
____
____
collected at year-end).
Ans:
hz
20x1
Net
Errors
Difficulty: Hard
Net
Equity
+
+
+
-
Owners'
Income
0
+
+
+
+
Level of Learning: Application
Topic: LO1-4
Equity
0
0
0
0
0
0
d
zle
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
Owners'
Income
+
+
+
-
20x2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 57
Chapter 20 – Accounting Changes
159. Complete the following tabulation by inserting in each square the appropriate code as follows:
"O" for overstated; "U" for understated; and "N" for no effect. Complete all squares. Each
transaction (but not years) is a separate situation independent of the others.
20x1
Transaction
Net
Inc.
Assets
20x2
Owners' Net
Liab. Equity
Inc.
Assets
Owners’
Liab. Equity
Ex: Accrued
wages not
recognized
at end of
20x1.
(a) Prepaid
expenses
overstated
at end of
20x2.
(e) Accrued
wages
understated
$100 at end
of 20x1 and
also
understated
at end of
20x2 by $300
d
(d) Deferred
income under
-stated at
end of 20x2.
zle
(c) Accrued
income
understated
at end of
20x2.
hz
(b) Accrued
expenses
under-stated
at end of
20x2.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 58
Chapter 20 – Accounting Changes
20x1
Transaction
Net
Inc.
Assets
20x2
Owners'
Liab. Equity
Net
Inc.
Assets
Owners’
Liab. Equity
(f) Prepaid
expenses
under-stated
at end of
20x1. All
payments on
exp. were
debited in
full to
expense when
paid.
zle
(h) Accrued
exp. overstated at
end of 20x2.
hz
(g) Ending
inventory
20x1 overstated.
(i) Beg.
inventory
for 20x2
understated.
d
(j) Deprec.
exp. understated in
20x1.
Ans:
20x1
Transaction
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
Net
Inc.
N
N
N
N
O
U
O
N
U
O
Assets
N
N
N
N
N
U
O
N
U
O
Owners'
Liab. Equity
N
N
N
N
N
N
N
N
U
O
N
U
N
O
N
N
N
U
N
O
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
20x2
Net
Inc.
O
O
U
O
O
O
U
U
O
N
Assets
O
N
U
N
N
N
N
N
N
O
Liab.
N
U
N
U
U
N
N
O
N
N
Owners
Equity
O
O
U
O
O
N
N
U
N
O
Page 59
Chapter 20 – Accounting Changes
Difficulty: Hard
Level of Learning: Application
Topic: LO1-4
160. Depreciation expense for the most recent fiscal year on equipment purchased a few years ago is
$10,000. The balance sheet at the end of the same year disclosed the following:
Equipment
$300,000
Accumulated depreciation
(40,000)
Net book value
$260,000
=======
hz
The asset is not expected to have a salvage value and the firm depreciates the asset on the
straight-line basis. In March of the NEXT year (the year of change), the firm decided to reduce
the original total useful life 20% and that a salvage value of $30,000 is a reasonable estimate. The
firm also decided that the double declining balance method is a more appropriate depreciation
method for this asset.
Required:
(a) The entry to record the accounting change.
(b) The entry to record depreciation expense in the year of change.
Ans: (a) Original total life = $300,000/$10,000 = 30
Depreciation under DDB through beginning of year of change:
zle
$300,000(2/30) =
($300,000 - $20,000)(2/30) =
($300,000 - $20,000 - $18,667)(2/30) =
($300,000 - $20,000 - $18,667 - $17,422)(2/30) =
d
Total difference in depreciation for first four years = $72,350 $40,000 = $32,350.
Cumulative effect of accounting principle change
32,350
Accumulated depreciation
(b) Book value after recording accounting principle change =
$300,000 - $72,350 = $227,650
New total life = .80(30) = 24
Years depreciated = $40,000/$10,000 = 4 at beginning of year of change.
Remaining useful life at beginning of year of change = 24 - 4 = 20
(2/20)($227,650) = $22,765
Depreciation expense
22,765
Accumulated depreciation
$20,000
18,667
17,422
16,261
$72,350
32,350
22,765
Difficulty: Hard
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 60
Chapter 20 – Accounting Changes
161. Liftoff Co. changed its method of accounting for inventory from LIFO to FIFO in 20x3. Ignore
tax effects. Relevant information follows:
20x2
20x3
FIFO
LIFO
FIFO
LIFO
Beginning inventory
$470
$450
$600
$500
Ending inventory
600
500
800
680
Beginning RE
860
Reported earnings
1,600
Required:
(a) Record the entry in 20x3 to effect the accounting change.
(b) Provide the comparative retained earnings statement for 20x3 and 20x2.
Ans: (a)
NI effect of change to 1/1/x2: 470-450=20 increase in RE
NI effect of change to 1/1/x3: 600-500=100 increase in RE
NI effect of change for x2: BI effect decrease NI
20
EI effect increase NI
100
NI effect increase
80
(b)
100
hz
Inventory
Retained earnings
Difficulty: Hard
zle
RE 1/1 as prev. reported
Adjust. for accy. change
RE 1/1 as restated
NI
RE 12/31
100
20x2
$860
20
880
1,680
$2,560
=====
20x3
$2,460
100
2,560
1,760
$4,320
=====
Level of Learning: Application
Topic: LO2
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 61
Chapter 20 – Accounting Changes
162. Information for a firm making an accounting change follows:
20x0
$1,000
600
Revenues
Expenses other than depreciation and tax
Tax rate: 30%
Common shares outstanding entire year for both years: 100;
Retained earnings, 1/1/x0: $6,000
The firm changes from SYD to SL depreciation in 20x1 for financial
reporting purposes only.
Depreciation: Total before
20x0
20x0
SYD
$4,000
$200
SL
3,500
100
20x1
$2,500
1,100
20x1
$400
300
hz
Required:
(a) The 20x1 entries to record the accounting change and depreciation expense for 20x1.
(b) The comparative 20x0 and 20x1 income statements including pro forma disclosures if needed,
EPS, and any disclosure footnote required.
Ans: (a)
Accumulated depreciation
600
Deferred taxes
180
Cumulative effect of accounting change
420
Depreciation expense
Accumulated depreciation
300
300
zle
EPS: Inc. fr. cont. op. $1.40
Net income
Pro forma earnings:
Net income
EPS: Net income
20x0
$1,000
(600)
(200)
200
(60)
140
$1.40
20x1
$2,500
(1,100)
(300)
1,100
(330)
770
420
$1,190
=====
$7.70
$11.90
$210
$2.10
$770
$7.70
d
Income statement:
Revenues
Expenses other than....
Depreciation
Income from cont. op before tax
Income tax expense
Income from cont. op
Cumul. effect, net of $180 tax
Net income
$140
====
Changed to SL from SYD, which increased 20x1 income before cont. op $70 [($400$300).70] ($.70/share) and 20x1 net income $490 420 + $70 ($4.90/share)
Difficulty: Hard
Level of Learning: Application
Topic: LO1-5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 62
Chapter 20 – Accounting Changes
163. AME did not account properly for the deferrals and accruals given below:
20x1
20x2
Income
$5,000 $4,000
Items omitted at year-end:
Prepaid expenses
250
225
Accrued expenses
200
280
Unearned revenue
275
230
Accrued revenue
325
360
(a) The correct income for 20x1 was $ __________________.
(b) The correct income for 20x2 was $ _________________ .
Ans: (a) $5,000 + $250 - $200 - $275 + $325 = $5,100.
(b) $4,000 - $250 + $200 + $275 - $325 + $225 - $280 - $230 + $360
= $3,975.
======
Difficulty: Hard
Level of Learning: Application
Topic: LO4
hz
164. The following errors were discovered during 20x3:
End of
20x1
$500
$400
$550
$650
zle
Prepaid expense not recorded
Accrued wages payable not recorded
Revenue collected in advance not recorded
Revenue earned but not collected; not recorded
End of
20x2
$450
$560
$460
$720
Therefore, the pre-tax income for 20x2 was overstated or understated by
$______________________________.
Ans: Overstated by $50 computed as follows:
$50 (O)
160 (O)
90 (U)
($720 - $650)
$50
====
d
Prepaid expense not recorded ($500 - $450)
Accrued wages not recorded ($560 - $400)
Revenue collected in advance, not recorded ($550 - $460)
Revenue earned, but not collected nor recorded
Pretax income, overstated
70 (U)
Difficulty: Hard
Level of Learning: Application
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 63
Chapter 20 – Accounting Changes
165. Ending inventory for 20x0 is overstated in error by $4,000 due to a faulty count and costing. The
tax rate is 30%. Assume the same accounting methods for both financial reporting and taxes. The
error is discovered late in 20x1. Retained earnings at 1/1/x0 was $20,000, and reported earnings
(both before correction of error) are: 20x0, $5,000; 20x1, $6,000.
Prepare the comparative retained earnings statements for 20x0 and 20x1.
The error overstates 20x0 earnings $4,000 before tax and $2,800 after tax.
Ans:
Retained earnings, 1/1 as previously reported
Error Correction
Retained earnings, 1/1 as adjusted
Net income $5,000 - $2,800 for 20x0
Retained earnings, 12/31
$20,000
(2,800)
20,000
2,200
$22,200
======
$25,000*
22,200
8,800**
$31,000
======
* $20,000 + $5,000
** $6,000 + $2,800
Difficulty: Hard
d
zle
hz
Level of Learning: Application
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 64
Chapter 20 – Accounting Changes
166. MKC is being audited for the years 20x1 and 20x2, and the errors listed below were found (have
not been corrected in the accounts).
(a) You are to complete the following schedule to compute the correct income for each year
(disregard income tax):
Item
20x1
20x2
(1)
Income reported by MKC
$28,000
$30,000
(2)
(3)
(4)
(5)
Accruals and deferrals omitted at year-end:
Prepaid expenses(paid in advance)
Accrued revenue(earned but not collected)
Accrued expenses (incurred but not paid)
Unearned revenue (collected in advance)
(6)
(7)
Ending inventory:
Overstated
Understated
(8)
200
240
700
600
300
140
400
900
900
100
Correct income
hz
(b) Assuming the books are already closed for 20x2, give the single journal entry required to
correct all of the accounts on January 25, 20x3:
Ans: (a)
(1)
20x1
$28,000
Prepaid expenses
+200
(3)
Accrued revenue
+240
(4)
Accrued expenses
-700
(5)
Unearned revenue
-600
(6)
20x1 End. inv.
overstated
20x2 End. inv. understated
Correct income
(b)
-900
+300
-200
+140
-240
-400
+700
-900
+600
+900
$26,240
+100
$31,000
d
(7)
(8)
20x2
$30,000 -$760
zle
(2)
Item
Income reported by MKC
Prepaid expense
Accrued revenue receivable
Inventory
Retained Earnings
Accrued expenses
payable
Unearned revenue
Proof
$57,240
=
=
$57,240
300
140
100
760
400
900
Difficulty: Hard
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 65
Chapter 20 – Accounting Changes
Level of Learning: Application
Topic: LO4
167. The following errors were discovered in the financial statements of CBK.
(a) Ending inventories at December 31, were incorrect as follows: December 31, 20x1,
understated by $4,000; December 31, 20x2 overstated by $3,600.
(b) Depreciation expense (straight-line) for 20x1 was overstated by $800.
(c) Insurance premium of $3,000 covering for 20x1, 20x2 and 20x3 was prepaid on January,
20x1 and expensed in full at the time.
(d) On December 31, 20x2, fully depreciated machinery was sold for $6,400 on credit, but the
sale was not recorded until January 1, 20x3.
The accounting year ends December 31, and none of the above errors were corrected with journal
entries prior to January 2, 20x3.
Give the journal entry to correct the accounts on Januar2, 20x3 (after the 20x2 closing entries and
before any reversing entries).
Debits
Credits
(AICPA Adapted)
hz
Ans:
Debits
Accumulated depreciation
Prepaid insurance
Gain on sale
800
1,000
6,400
Credits
Inventory
Retained earnings
3,600
4,600
zle
These can be made as four separate entries. (AICPA Adapted)
Difficulty: Hard
Level of Learning: Application
Topic: LO4
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 66
Chapter 20 – Accounting Changes
zle
hz
168. On January 1, 20x1, CR purchased a special machine for use in the business that cost $110,000.
The estimated useful life was 10 years with no residual value.
Three separate and independent cases, involving accounting changes with respect to the machine,
are given. For each case, two dates are specified upon which you are to give any required entry (if
no entry is required, so state). Disregard income taxes.
CASE A: At the end of the fifth year, it was discovered that no depreciation had ever been
recorded. Assume the straight-line method is used and that the adjusting entries for 20x5 have not
been made.
(1) Entry at the date the omission was discovered:
(2) Entry at December 31, 20x5, the end of the accounting period:
CASE B: At the end of the fifth year, the estimated life was changed from 10 to 15 years.
Assume the straight-line method is used and that the adjusting entries for 20x5 have not been
made.
(1) Entry at the date the decision to change was made:
(2) Entry at December 31, 20x5, the end of the accounting period:
CASE C: At the end of the fifth year, the company changed from the straight-line depreciation
method to sum-of-the-years'-digits depreciation method. The adjusting entries for 20x5 have not
been made.
(1) Entry at the date of the change.
(2) Entry at December 31, 20x5 the end of the accounting period.
Ans: CASE A:
(1) Retained earnings - error correction
44,000
Accumulated depreciation ($110,000 x 4/10)
44,000
(2) Depreciation expense ($110,000 ÷ 10 years)
11,000
Accumulated depreciation
11,000
CASE B:
(1) No entry is required because this is a change in estimate.
(2) Depreciation expense
Accumulated depreciation
$110,000 x 6/10 = $66,000, book value at beginning of year 5
$ 66,000 ÷ 11 years remaining = $6,000 per year.
d
CASE C:
(1) Cumulative effect of accounting change
Accumulated depreciation
SYD: $110,000 x 34/55 = $68,000, under new method
St.-line $110,000 x 4/10 = $44,000 under old method
Difference is $24,000, catch up adjustment.
(2) Depreciation expense ($110,000 x 6/55)
Accumulated depreciation
6,000
6,000
24,000
24,000
12,000
12,000
Difficulty: Hard
Level of Learning: Application
Topic: LO1-4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 67
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition, Volume 2 – Test Bank
Chapter 21 – Financial Statement Analysis
1. Financial statement analysis is only used to determine whether a company is worth investing in.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
2. A prospective investor in common shares is primary interested in the long-run profitability of the
company.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
hz
3. A trade creditor will be primarily interested in the long-run profitability of the company.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
zle
4. A clean opinion is another term to describe a company that has received an unqualified audit
report.
Ans: True
5. All companies are required to have audits.
Ans: False
d
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
6. Information about the significant accounting policies of an entity is not necessary because GAAP
prescribes uniform accounting treatment of all items, and it is widely understood.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 1
Chapter 21 – Financial Statement Analysis
7. The statement of significant accounting policies, which is included in the notes to the financial
statements, must include reasons for the selection of one generally accepted accounting method
over another generally accepted accounting method.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
8. A statement of accounting policies must be included in the annual financial statements.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
9. A statement of accounting policies is required to be clearly enunciated in the notes to the financial
statements.
hz
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: False
zle
10. Published financial statements are always the best source of timely information on practically all
financial items relevant to investors and creditors.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: True
d
11. A primary reason for the analysis of financial statements is identification of major changes and to
provide relative relationships among dollar amounts.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
12. One of the most important steps in an analysis of financial statements is the wording of the
auditors' report.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 2
Chapter 21 – Financial Statement Analysis
13. A qualified auditors' opinion is given when the financial statements present information in
conformity with GAAP.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
14. Examination of comparative financial statements does not enable financial statement users to
better identify long-term trends.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
15. GAAP requires the presentation of financial statements for the current year and the two
immediately preceding reporting periods.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: False
zle
16. Vertical analysis of financial statements refers to the development of percentages indicating the
proportionate changes in selected financial statements for two or more reporting periods.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: True
d
17. In horizontal analysis of financial statements, the base amounts used for purposes of comparison
are the financial results of a previous time period.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
18. Ratios that measure current position are useful for assessing the ability of a company to pay its
short-term obligations.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 3
Chapter 21 – Financial Statement Analysis
19. The current ratio is one measure of the adequacy of a company's working capital.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
20. A high working capital ratio is always a favourable situation from the shareholders' viewpoint.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
21. Generally, an acid-test ratio of 2 to 1 is preferable to a working capital ratio of 2 to 1.
Ans: True
hz
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
22. For both the accounts receivable turnover and the inventory turnover ratios, the numerator of the
fraction is credit sales.
zle
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
23. Book value per common share is particularly useful for predicting the expected market value per
share.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
d
Ans: False
24. A debt-equity ratio in excess of 1 indicates that a majority of the entity's resources was provided
by the shareholders' or is reflected in shareholders' equity.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 4
Chapter 21 – Financial Statement Analysis
25. Profit margin on sales is very relevant for purposes of comparison, both between periods and
between similar companies.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
26. Return on total assets and return on owners' equity are used to compute financial leverage.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
27. Book value per share is based upon all voting common and preferred shares.
Ans: False
hz
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
28. To calculate the book value per common share, total shareholders' equity (including retained
earnings) must be allocated to the respective common and preferred equities.
zle
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO4
29. The quick (or acid-test) ratio always will be less than, or equal to, the current ratio.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
d
Ans: True
30. A price earnings ratio of 10 to 1 implies an earnings rate on market value per share of 10%.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 5
Chapter 21 – Financial Statement Analysis
31. Return on investment (of a corporation) is affected by the market price of its shares.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
32. A high current ratio is not always viewed as advantageous to the company.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO5
33. When data used in ratio analysis are based on historical book values, the resulting ratios reflect
price-level effects and real economic values.
Ans: False
hz
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
34. A company which offers "n/30" credit terms would be expected to have a receivable turnover of
about 12 times a year.
zle
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO3
35. The use of an accelerated depreciation method rather than the straight-line method may have an
unfavourable effect on some ratios.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 3, 4, 5
d
Ans: True
36. Return on total assets is generally considered to be a better measure of the overall profit
performance of a business than is profit margin on sales.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 6
Chapter 21 – Financial Statement Analysis
37. If a company's ratio of net income to net sales (generally referred to as profit margin on sales) is
low, then its return on investment will be low.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO2, 3
38. A review engagement provides more reliance for the users of the financial statements than an
audit engagement.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
39. The section on significant accounting policies describes where deviations from GAAP have
occurred.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: False
zle
40. A company may decide not to follow GAAP if it does not present them in a favourable position.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
41. An unqualified opinion is given if an audit has not been completed.
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
d
Ans: False
42. An adverse opinion is given if the auditor disagrees with the company on decisions made. This is
generally not a serious condition as it relates only to a difference of opinion.
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 7
Chapter 21 – Financial Statement Analysis
43. The negotiating of a collective agreement is a contractual decision that may necessitate the use of
financial analysis.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
44. It is possible for companies with revenues totalling in excess of $10 million dollars to be exempt
from an audit.
Ans: True
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
45. Data must be compared to be useful. Longitudinal comparisons look at the company in relation to
other companies. Cross sectional analysis looks at the company over time.
hz
Ans: False
Difficulty: Easy
Level of Learning: Knowledge
Topic: LO1
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
zle
46. Disclosure of significant accounting policies results from application of the:
A)
full disclosure principle.
B)
consistency principle.
C)
reliability principle.
D)
matching principle.
47. To apply a vertical analysis to the balance sheet, the base amount usually selected is:
A)
total assets.
B)
total liabilities.
C)
total shareholders' equity.
D)
total revenues.
E)
either b or c.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 8
Chapter 21 – Financial Statement Analysis
48. GAAP requires presentation of comparative financial statements by most companies for:
A)
five years.
B)
three years.
C)
two years.
D)
one year.
E)
none of the above.
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
49. Which of the following ratios is an indicator of liquidity?
A)
Total current asset to total current assets
B)
Inventory turnover
C)
Age of receivables
D)
Creditor's equity in total assets
hz
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
Ans: C
d
zle
50. RST has provided the following information in 000's on selected cash transactions for 20x12:
Purchase of operating assets
$6,400
Purchase of inventories
16,000
Proceeds from short-term borrowing
2,400
Proceeds from long-term borrowing
8,000
Proceeds from sale of RST's common shares
4,000
What is the increase in working capital for the year ended December 31, 20x12, as a result of the
above information?
A)
$400
B)
$4,000
C)
$5,600
D)
None of the above
Difficulty: Medium
Level of Learning: Application
Topic: LO5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 9
Chapter 21 – Financial Statement Analysis
51. All of the following are decisions that may be made with financial statement analysis except:
A)
Share investment decisions
B)
Regulatory decisions
C)
Share offering decisions
D)
Lending decisions
E)
Contractual decisions
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
52. All of the following are examples of lending decisions except:
A)
finance the takeover of another corporation
B)
extend normal credit terms
C)
buy corporate bonds on the open market
D)
accepting employment
hz
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
zle
53. All of the following are examples of regulatory decisions except:
A)
negotiating collective agreements
B)
need for rate or price increases
C)
impact of past regulatory decisions
D)
ability to withstand competition
54. All of the following are examples of contractual decisions except:
A)
negotiating collective agreements
B)
accepting employment
C)
ability to withstand competition
D)
entering into a joint venture
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 10
Chapter 21 – Financial Statement Analysis
55. Disclosure of significant accounting policies should include all of the following items except:
A)
amortization methods.
B)
valuation method used for operational assets.
C)
depreciation methods.
D)
inventory costing methods.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
56. A company issuing financial statements would most prefer to receive an auditor's opinion that is:
A)
adverse.
B)
qualified.
C)
a disclaimer.
D)
unqualified.
E)
either b or d.
hz
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
zle
57. The "best" opinion that an auditor can give is a(n):
A)
adverse opinion.
B)
unqualified opinion.
C)
qualified opinion.
D)
disclaimer of opinion.
E)
b and d are equally good.
58. A qualified auditor's opinion means that in the judgment of the auditor:
A)
the audit was not completed.
B)
all items on the financial statements are in conformity with GAAP.
C)
a number of substantive items on the financial statements are doubtful as to their ultimate
outcome.
D)
one, or only a few minor, items on the financial statements are doubtful as to their ultimate
outcome.
E)
none of the above.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 11
Chapter 21 – Financial Statement Analysis
59. Which of the following is a list of the types of auditors' opinions going from worst to best?
A)
Unqualified, qualified, adverse, disclaimer
B)
Qualified, disclaimer, adverse, unqualified
C)
Disclaimer, unqualified, adverse, qualified
D)
Disclaimer, unqualified, qualified, adverse
E)
None of the above
Ans: E
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: A
hz
60. Horizontal analysis:
A)
refers to the development of percentages indicating the proportionate change in the same
item over time.
B)
is exactly the same as "vertical analysis."
C)
is useful for balance sheet but not for income statement.
D)
involves the expression of each item on a particular period's financial statements as a
percent of one specific item which is referred to as a base.
E)
none of the above.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
61. Vertical analysis of financial statements refers to a comparison of amounts which are expressed in
terms of a base amount that is from a:
A)
financial summary.
B)
previous time period.
C)
common size statement.
D)
specific amount that is on the same financial statement.
E)
either b or c.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 12
Chapter 21 – Financial Statement Analysis
62. Quick assets, as usually defined, include:
A)
cash, accounts receivable, short-term investments in marketable securities, only.
B)
cash, accounts receivable, short-term investments in marketable securities, and inventories.
C)
cash only.
D)
cash and accounts receivable only.
E)
none of the above.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
Ans: A
hz
63. The effect of recording a 100 percent stock dividend would be to:
A)
leave working capital unaffected, decrease earnings per share, and decrease book value per
share.
B)
leave working capital unaffected, decrease earnings per share, and decrease the debt to
equity ratio.
C)
decrease the current ratio, decrease working capital, and decrease book value per share.
D)
leave inventory turnover unaffected, decrease working capital, and decrease book value per
share.
E)
none of the above.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
d
64. If current assets exceed current liabilities, payments to creditors made on the last day of the
month will:
A)
decrease net working capital.
B)
increase net working capital.
C)
decrease current ratio.
D)
increase current ratio.
E)
have no effect on either the current ratio or net working capital.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 13
Chapter 21 – Financial Statement Analysis
65. A company has a current ratio of 2 to 1. This ratio will decrease if the company:
A)
borrows cash on a six-month note.
B)
sells merchandise for more than cost and records the sale using the perpetual inventory
method.
C)
receives a 5 percent stock dividend on one of its marketable securities.
D)
pays a large account payable which had been a current liability.
E)
none of the above.
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
Ans: D
hz
66. If a company converted a short-term note payable into a long-term note payable, this transaction
would:
A)
decrease only working capital.
B)
decrease both working capital and the current ratio.
C)
increase only working capital.
D)
increase both working capital and the current ratio.
E)
have no effect on either the current ratio or net working capital.
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
67. Which of the following transactions would increase a company's positive current ratio?
A)
Borrow money on a short-term note
B)
Repay the principal on a short-term note
C)
Sell a temporary investment at a loss
D)
Use the equity method to reflect earnings of an investee
E)
None of the above would increase a company's positive current ratio
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
d
Ans: B
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 14
Chapter 21 – Financial Statement Analysis
68. The amount of working capital would not be affected by which of the following transactions?
A)
Sale of long-term investments for cash at a loss
B)
Transfer of a long-term investment for cash
C)
Issuance of a long-term note in exchange for cash
D)
Issuance of common shares of the corporation in exchange for noncurrent assets
E)
All of the above would affect working capital
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4, 5
69. A company with sales terms of n/30 would prefer a receivable turnover of:
A)
2
B)
5
C)
10
D)
20
E)
All of the above are equally desirable if sales terms are n/30.
hz
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
d
zle
70. Overall management performance is better measured by use of the:
A)
return on total assets.
B)
debt-equity ratio.
C)
current ratio.
D)
profit margin on sales.
E)
none of the above.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 15
Chapter 21 – Financial Statement Analysis
71. HIJ reported the following data for 20x12 in 000s:
Current assets
Operational assets
Other assets
$100
$260
$ 40
Assuming vertical analysis, what is the relationship between current assets, operational assets,
and other assets, respectively? (Rounded to the nearest percent)
Current Assets
100 percent
40 percent
25 percent
36 percent
None of the above
1
2
3
4
5
Other Assets
40 percent
100 percent
10 percent
14 percent
Choice 1
Choice 2
Choice 3
Choice 4
Choice 5
Ans: C
hz
A)
B)
C)
D)
E)
Operational Assets
36 percent
14 percent
65 percent
100 percent
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
72. STU reported the following ratios:
Return on total assets
Return on owners' equity
20x110
30 percent
45 percent
20x11
35 percent
35 percent
20x12
45 percent
30 percent
20x110
7.5 percent
( 7.5 percent)
15 percent
(15 percent)
None of the above.
1
2
3
4
5
A)
B)
C)
D)
E)
d
The financial leverage factors in 20x110, 20x11, and 20x12 respectively, are (the parentheses
indicate negative):
20x11
0
0
0
0
20x12
( 7.5 percent)
7.5 percent
(15 percent)
15 percent
Choice 1
Choice 2
Choice 3
Choice 4
Choice 5
Ans: C
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 16
Chapter 21 – Financial Statement Analysis
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3
73. CDE reported the following 20x12 data in 000s:
Sales revenue (1/3 cash)
Average monthly inventory
Cost of goods sold
Average monthly receivables
$300
40
120
50
CDE's inventory turnover for 20x12 was:
A)
0.33
B)
2.50
C)
3.00
D)
6.00
E)
None of the above.
hz
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO3
74. Selected information from the accounting records of CDE is as follows in 000's:
zle
Cost of goods sold for 20x12
Inventories at December 31, 20x11
Inventories at December 31, 20x12
$3,000
550
650
Ans: B
Difficulty: Medium
Level of Learning: Application
Topic: LO3
d
What was the inventory turnover for 20x12?
A)
4.61
B)
5.00
C)
5.45
D)
None of the above.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 17
Chapter 21 – Financial Statement Analysis
75. DEF wrote off a $300 uncollectible account receivable against the $3,600 balance in its
allowance account. Compare the current ratio before the write-off with the current ratio after the
write-off.
A)
The current ratio before the write-off is greater than the current ratio after the write-off.
B)
The current ratio before the write-off is equal to the current ratio after the write-off.
C)
The current ratio before the write-off is less than the current ratio after the write-off.
D)
Cannot be determined from information given.
E)
None of the above.
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
76. LMN reported the following 20x12 data in 000's:
hz
Sales revenue (1/3 cash)
Average monthly inventory
Cost of goods sold
Average monthly receivables
$150
10
60
25
Ans: C
zle
LMN's average age of the receivables was (in days):
A)
37 days.
B)
61 days.
C)
91 days.
D)
115 days.
E)
None of the above.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 18
Chapter 21 – Financial Statement Analysis
77. Information concerning XYZ's common shares is as follows:
Book value at December 31, 20x12
Quoted market value on Toronto Stock Exchange on December 31, 20x12
Earnings for 20x12
Dividend for 20x12
Per Share
$36
27
9
3
What was the price-earnings ratio on common shares for 20x12?
A)
2 to 1
B)
2.67 to 1
C)
3 to 1
D)
4 to 1
E)
None of the above
Ans: C
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Ans: D
zle
78. All of the following represent situations where financial statements should be recast:
A)
Income statement and balance sheet are revised to reflect a different capitalization policy.
B)
Interest expense is removed from net income.
C)
Amortization or depreciation is removed yielding earnings before interest taxes and
depreciation.
D)
All of the above.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
79. Ryan Company analyzed its financial statements for the year ended December 31. During its
analysis, Ryan Company compared the accounts receivable balance from 1999 to 1998. This type
of analysis is called:
A)
Cross sectional comparison
B)
Sectional comparison
C)
Account comparison
D)
Longitudinal comparison
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 19
Chapter 21 – Financial Statement Analysis
80. Which of the following analytical techniques would best be used to compare a company’s
performance to that of its competitors over time?
A)
B)
C)
D)
Cross sectional comparison
Time- series analysis
Residual analysis
Statistical multivariate ratio analysis
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
81. Which of the following analytical techniques uses statistical models in an attempt to
predict a certain outcome?
A)
B)
C)
D)
Cross sectional comparison
Time- series analysis
Residual analysis
Statistical multivariate ratio analysis
hz
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
analysis?
A)
B)
C)
D)
zle
82. Which of the following analytical techniques could be most likened to a form of trend
Vertical analysis
Time- series analysis
Residual analysis
Statistical multivariate ratio analysis
Ans: B
d
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
83. Which of the following is not known as a solvency ratio?
A)
Debt-to-equity
B)
Times interest earned
C)
Debt-to-total assets
D)
Defensive-interval ratio
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 20
Chapter 21 – Financial Statement Analysis
84. Which of the following is not known as a liquidity ratio?
A)
Current ratio
B)
Debt-to-equity
C)
Quick ratio
D)
Defensive-interval ratio
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
85. There still remain problems when accounting policies are disclosed for choices made among
acceptable alternatives. All of the following are problems except:
A)
There is no disclosure of crucial policies, such as revenue recognition
B)
Disclosure is generally too vague to be of use without additional information
C)
Some industries do not have to disclose accounting policies
D)
The disclosure is specific, but the numerical information is missing
hz
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
zle
86. The main place to look for clues as to management's reporting objectives is:
A)
in the financial statements
B)
in the management discussion and analysis section
C)
in the financial statement highlights
D)
in the notes to the financial statements
87. Upon reading the notes to the financial statements of JMR Ltd., you notice that the policies they
have chosen tend to recognize revenue early in the earnings cycle while deferring costs to later
periods. This approach leads you to believe that JMR Ltd. is employing a(n):
A)
Smoothing strategy
B)
Income tax minimization strategy
C)
Income tax maximization strategy
D)
Profit maximization strategy
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 21
Chapter 21 – Financial Statement Analysis
88. Upon reading the notes to the financial statements of KAR Ltd., you notice that the policies they
have chosen tend to be deferring and amortizing both revenue and expenses. This approach leads
you to believe that KAR Ltd. is employing a(n):
A)
Smoothing strategy
B)
Income tax minimization strategy
C)
Income tax maximization strategy
D)
Profit maximization strategy
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: B
hz
89. Upon reading the notes to the financial statements of KAR Ltd., you notice that the policies they
have chosen tend to be deferring revenue but expensing operating costs as incurred. This
approach leads you to believe that KAR Ltd. is employing a(n):
A)
Smoothing strategy
B)
Income tax minimization strategy
C)
Income tax maximization strategy
D)
Profit maximization strategy
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
90. Upon analyzing the financial statements of KER Ltd., you notice that there have been few capital
asset acquisitions and that capital assets seem low relative to the type of business the company is
in. This observation may mean that KER Ltd. is engaged in a(n):
A)
Smoothing strategy
B)
Income tax minimization strategy
C)
Off-balance sheet financing
D)
Profit maximization strategy
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 22
Chapter 21 – Financial Statement Analysis
91. A financial statement analyst will look at the cash flow statement for all of the following except:
A)
If earnings with amortization added back are significantly larger than cash flow from
operations, the company may be maximizing net income
B)
If cash flow is significantly larger than earnings, the company may be very conservative in
its accounting practices
C)
To see if the cash flow statement excludes certain operating expenditures
D)
To determine the depreciation add back
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: C
hz
92. There are certain situations where it is necessary to recast the financial statements in order to
analyze them. All of the following are examples of the need to recast except:
A)
The income statement contains a number of gains not expected to occur in the future
B)
There have been a number of temporary differences. They remain on the balance sheet
C)
Asset purchases were made during the year
D)
Interest on long-term debt amounted to $1,000,000
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
zle
93. In a popular business journal, JMR Ltd. was compared to KAR Corp. for the year ended
December 31, 20x14. This is an example of:
A)
Cross sectional comparison
B)
Historical comparison
C)
Yearly comparison
D)
Longitudinal comparison
E)
Industrial comparison
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
d
Ans: A
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 23
Chapter 21 – Financial Statement Analysis
94. In a popular business journal, JMR Ltd. financial data for the last five years was compared. This
is an example of:
A)
Cross sectional comparison
B)
Yearly comparison
C)
Longitudinal comparison
D)
Industrial comparison
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO6
95. Vertical analysis is a(n):
A)
Longitudinal ratio
B)
Cross sectional ratio
C)
Historical ratio
D)
Industrial ratio
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
97. Historical analysis is part of a(n):
A)
Longitudinal ratio
B)
Cross sectional ratio
C)
Historical ratio
D)
Industrial ratio
d
zle
96. Common-size analysis is a(n):
A)
Longitudinal ratio
B)
Cross sectional ratio
C)
Historical ratio
D)
Industrial ratio
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 24
Chapter 21 – Financial Statement Analysis
98. Trend analysis is part of a(n):
A)
Longitudinal ratio
B)
Cross sectional ratio
C)
Historical ratio
D)
Industrial ratio
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
99. All of the following represent groups of ratios except:
A)
Profitability ratios
B)
Effectiveness ratios
C)
Solvency ratios
D)
Liquidity ratios
Ans: B
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Ans: D
zle
100. Efficiency ratios are also known as:
A)
Profitability ratios
B)
Effectiveness ratios
C)
Solvency ratios
D)
Turnover ratios
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
d
101. The accounts receivable turnover ratio is a measure of:
A)
The number of days that it takes to collect the receivables
B)
The amount of time that it takes to create more receivables
C)
The average length of time that it takes to collect the accounts receivable
D)
None of the above
Ans: C
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 25
Chapter 21 – Financial Statement Analysis
102. A short accounts receivable turnover ratio may mean all of the following except:
A)
That customers are dictating the payment terms
B)
That the company is realizing cash from sales in a short time period
C)
Fewer old receivables that may prove to be uncollectible
D)
All of the above
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
103. Solvency ratios can be further classified as:
A)
Liquidity ratios
B)
Leverage ratios
C)
Asset ratios
D)
Fixed ratios
Ans: B
hz
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Ans: D
zle
104. All of the following may be included in the numerator of the debt-to-equity ratio except:
A)
Short-term bank loans
B)
Retractable preferred shares
C)
Current portion of long-term debt
D)
Shareholder loans
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
d
105. Current monetary assets divided by annual operating expenditures, which is itself divided by 365,
is:
A)
Defensive-interval ratio
B)
Debt-to-total capitalization ratio
C)
Debt-to-capital employed
D)
None of the above
Ans: A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 26
Chapter 21 – Financial Statement Analysis
106. You are given the following information about JMR Corp.:
Cash
Accounts Receivable
Inventory
Prepaids
Fixed assets
Current liabilities
$45,000
$100,000
$150,000
$96,000
$670,000
$634,000
What is JMR's current ratio?
A)
1.67:1
B)
1.23:1
C)
0.46:1
D)
0.37:1
Ans: C
hz
Difficulty: Medium
Level of Learning: Application
Topic: LO5
107. You are given the following information about JMR Corp.:
$45,000
$100,000
$150,000
$96,000
$670,000
$634,000
What is JMR's quick ratio?
A)
1.67:1
B)
1.23:1
C)
0.46:1
D)
0.23:1
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO5
d
zle
Cash
Accounts Receivable
Inventory
Prepaids
Fixed assets
Current liabilities
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 27
Chapter 21 – Financial Statement Analysis
108. The rule of thumb for the current ratio is 2:1. When would a current ratio below this threshold not
necessarily be a concern for a company?
A)
When accounts receivable balances are high
B)
When cash flows are steady and reliable
C)
When inventories are high
D)
None of the above
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
109. The rule of thumb for the quick ratio is 1:1. When would a current ratio below this threshold not
necessarily be a concern for a company?
A)
When accounts receivable balances are high
B)
When cash flows are steady and reliable
C)
When inventories are high
D)
None of the above
hz
Ans: B
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
zle
110. It is important for the user to understand the financial statements in order to make an informed
decision. A user must generally do all of the following except:
A)
If an equity investor, will generally use consolidated statements
B)
If a lender, will generally use unconsolidated statements
C)
All users must be able to evaluate risks
D)
All of the above are true
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 28
Chapter 21 – Financial Statement Analysis
111. If business conditions are stable, an increase in the number of accounts receivable turnover from
one year to the next (based upon a company's accounts receivable at year-end) might indicate:
A)
that a longer discount period and a more distant due date were extended to customers in the
second year.
B)
a significant decrease in the volume of sales of the second year.
C)
that the second year's sales were made at lower prices than the first year's sales.
D)
a stiffening of the company's credit policies.
E)
none of the above.
Ans: D
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Ans: C
hz
112. Recording the payment (as distinguished from the declaration) of a cash dividend whose
declaration was already recorded will:
A)
increase both the current ratio and working capital.
B)
have no effect on the current ratio or earnings per share.
C)
increase the current ratio but have no effect on working capital.
D)
decrease both the current ratio and working capital.
E)
none of the above.
d
zle
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO5
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 29
Chapter 21 – Financial Statement Analysis
113. Information from LMN's balance sheet at December 31, 20x12, is as follows in millions:
Current assets:
Cash
Marketable securities, at cost which approximates market
Accounts receivable, net of allowance for doubtful accounts
Inventories, lower of cost or market
Prepaid expenses
Total current assets
Current liabilities:
Notes payable
Accrued expenses
Income taxes payable
Payments due within one year on long-term debt
Accounts payable
Total current liabilities
Long-term debt
$12
28
400
520
8
$968
====
hz
$16
120
4
24
160
$324
====
$720
====
Ans: B
zle
What is the quick (acid-test) ratio?
A)
$440/$204
B)
$440/$324
C)
$448/$204
D)
$968/$1,044
E)
None of the above.
Difficulty: Medium
Level of Learning: Application
Topic: LO5
d
114. ABC's net accounts receivable were $1,000 at December 31, 20x11 and $1,200 at December 31,
20x12. Net cash sales for 20x12 were $400. The accounts receivable turnover for 20x12 was 5.0.
What were ABS's total net sales for 20x12?
A)
$5,900
B)
$6,000
C)
$6,400
D)
$11,000
E)
None of the above.
Ans: A
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 30
Chapter 21 – Financial Statement Analysis
115. Selected information for HIJ in 000's is as follows:
Preferred shares, $8, no-par, nonconvertible, noncumulative
Common shares
Retained earnings
Dividends paid on preferred shares for year ended
Net income for year ended
December 31
20x11
20x12
$375
$375
900
1,200
225
555
30
30
180
360
HIJ's return on average common shareholders' equity, rounded to the nearest percentage point, for
20x12 is:
A)
17 percent.
B)
19 percent.
C)
23 percent.
D)
15 percent.
E)
None of the above.
hz
Ans: C
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
zle
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 31
Chapter 21 – Financial Statement Analysis
116. Assume the following facts for XYZ in 000's:
Total assets
Total liabilities
Total revenue
Total expense (including income tax)
Income tax rate
Interest expense (included in expenses above)
$120
50
220
204
30 percent
6
XYZ's return on owners' equity, return on total assets, and leverage percentages (rounded to the
nearest percent) are:
1
2
3
4
5
Return on
Total Assets
17 percent
5 percent
5 percent
17 percent
Financial
Leverage
8 percent positive
8 percent negative
6 percent negative
6 percent positive
hz
A)
B)
C)
D)
E)
Return on
Owner's equity
8 percent
13 percent
23 percent
23 percent
None of the above
Choice 1
Choice 2
Choice 3
Choice 4
Choice 5
zle
Ans: D
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 4
Level of Learning: Knowledge
Topic: LO1
d
117. What are the possible decisions that can be made with the use of financial analysis?
Ans: A clean opinion is another term used to describe an unqualified audit report, which is
mandatory for public companies
Difficulty: Medium
118. Explain the differences between looking at a company as a new or prospective shareholder and as
an existing shareholder?
Ans: An existing shareholder already has a stake in the company. Analysis must be made to
determine the loss (either financial or operational) incurred if the investment is terminated.
A new investor is concerned with the long-run profitability.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 32
Chapter 21 – Financial Statement Analysis
119. When would a qualified audit opinion not necessarily be a concern to a company?
Ans: When a company chooses policies that are primarily in the interests of the shareholders, for
example reporting assets at a restated value.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
zle
hz
120. Determine whether each of the following statements is true or false.
T. True
F. False
___ 1. The allocation to the respective common and preferred equities in calculation of the book
value per common share will depend upon the preferential rights of preferred shares.
Liquidation, cumulative and participating preferences of the preferred shares must be
satisfied; the balance of owners' equity then becomes the common share equity.
___ 2. Earnings per share is computed by dividing the number of shares issued into the net income
for the period.
___ 3. A price-earnings ratio of 10 to 1 implies an earnings rate on market value per share of 10%.
___ 4. A company's return on investment is affected by the market price of its shares.
___ 5. Ratio analysis is aided by the presentation of comparative statements.
___ 6. If a company's ratio of net income to net sales (generally referred to as profit margin) is low,
then return on investment will be low.
___ 7. The quick ratio will always be less than or equal to the current ratio.
___ 8. A company which offers "n/30" credit terms would be expected to have a receivable turnover
of about 12 times a year.
___ 9. Where there is a deficit in total owners' equity, the ratio of total liabilities to total assets will
be greater than 1 to 1; e.g., 1.2 to 1.
___ 10. If treasury stock is purchased and retired at a cost in excess of its book value, book value per
share (for the remaining shares) will decrease.
___ 11. The current ratio is a measure of the adequacy of a company's working capital.
___ 12. In calculating the book value per common share, total owners equity must be allocated to the
respective common and preferred.
Level of Learning: Knowledge
Topic: LO1-6
d
Ans: 1:F, 2:F, 3:T, 4:F, 5:T, 6:F, 7:T, 8:T, 9:F, 10:T, 11:T, 12:T
Difficulty: Medium
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 33
Chapter 21 – Financial Statement Analysis
121. Indicate which company characteristic is reflected best by the company indicators listed below.
The characteristics are as follows:
Characteristic:
A. Profitability
B. Short-term solvency
C. Management efficiency
Company Indicators:
___ 1. Current ratio
___ 2. Sales to total assets
___ 3. Earnings per share
___ 4. Return on investment (on total assets)
___ 5. Inventory turnover
___ 6. Price earnings ratio
Ans: 1:B, 2:C, 3:A, 4:A, 5:C, 6:A
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2, 3, 5
hz
Change from 20x11 to 20x12
20x11
20x12
Increase
$50,000
$ 58,000
$8,000
140,000
101,000
(39,000)
20,000
23,400
3,400
$210,000
$182,400
($27,600)
========
========
========
(b) Vertical analysis
Assets
Current assets
Operational assets
Other assets
Total assets
d
Current assets
Operational assets
Other assets
Total assets
zle
122. The summarized and partial balance sheet of XYZ showed the following:
Item
20x11
20x12
Current assets
$50,000
$58,000
Operational assets
140,000
101,000
Other assets
20,000
23,400
(a) Prepare a horizontal analysis.
(b) Prepare a vertical analysis for 20x11:
Ans: (a) Horizontal analysis
Amount
$50,000
140,000
20,000
$210,000
========
(Decrease)
16%
(28%)
17%
(13%)
====
Percentage
24%
67%
9%
100%
====
Difficulty: Medium
Level of Learning: Application
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 34
Chapter 21 – Financial Statement Analysis
123. Explain the differences between the types of audit reports.
Ans: Unqualified Audit Report: Amounts are fairly stated and are in accordance with GAAP.
Best report that a company can have.
Qualified Audit Report: There are one or more deviations from GAAP. These differences
have been disclosed in the statements.
Adverse opinion: Results from a serious difference of opinion between management and
auditors. This report is not acceptable for a public company.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
124. There is a section in every annual report that detail the accounting policies used by a company.
Explain why this is important to users and what some of the limitations are.
Ans: There are many different but acceptable methods of reporting amounts under GAAP.
These differences can cause significant differences in the financial statements. Disclosure
of these items can help investors and potential investors analyze the company.
hz
However, sometimes the information is too vague to be of any use. In addition, there may
be a description but little in the way of numbers to enable the user to see the impact.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
d
zle
125. What are some advantages to using ratio analysis? What are some of its limitations?
Ans: Advantages
Ratios allow the user compare different companies
Downplay the importance of size
Allow for comparison over time
Serve as benchmarks
Disadvantages
Some users do not understand the ratios and what they mean
Ratios are only as useful as the numbers that they are drawn from
Ratios must be compared to something to be useful
Ratios are clues, but rarely provide answers
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
126. What is vertical analysis?
Ans: Vertical analysis or common size analysis are cross sectional ratios. The components of the
years' financial information are compared to a base. For example, the base for the balance
sheet may be total assets.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 35
Chapter 21 – Financial Statement Analysis
127. What is horizontal analysis?
Ans: Horizontal or trend analysis use a base year. i.e. 20x11 may be the base year – set at 100
and every other year is compared to that base year.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
128. Ratios, like the accounts receivable turnover ratio, can be difficult to interpret. Explain some of
the problems associated with this ratio.
Ans: Under normal circumstances, a short period is better than a long one as it shows that cash
is being collected. However, in some situations, there may be valuable customers that take
more time to pay but collectability is assured. In addition, the amount of receivables on the
balance sheet at year-end may not be typical of its normal balance.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
hz
129. JMR Company has a current ratio of 1.3:1. What does this tell you about the Company? What
other information would you like to know?
Ans: Although a general rule of thumb for the current ratio is 2:1, it is impossible with the little
information given above to know whether JMR's ratio is too low or not. The ratio may be
satisfactory especially if they have a steady cash flow. In order to properly analyze the
company, it is necessary to have more than one year. In addition, knowing the industry that
JMR Company is in, industry averages, etc. will help to gain a better understanding.
Difficulty: Medium
zle
Level of Learning: Knowledge
Topic: LO1, 5
130. You are given the following information about KER Corp.:
$45,000
$100,000
$150,000
$96,000
$670,000
$634,000
d
Cash
Accounts Receivable
Inventory
Prepaids
Fixed assets
Current liabilities
Required:
Calculate KER's quick ratio.
Ans: (45,000+100,000)/634,000 = 0.23:1
Difficulty: Medium
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 21 – Financial Statement Analysis
131. You are given the following information about KER Corp.:
Cash
Accounts Receivable
Inventory
Prepaids
Fixed assets
Current liabilities
$45,000
$100,000
$150,000
$96,000
$670,000
$634,000
Required:
Calculate KER's current ratio.
Ans: (45,000+100,000+150,000+96,000)/634,000 = 0.62:1
Difficulty: Medium
Level of Learning: Application
Topic: LO2
132. You are given the following information about EGR Corp.:
$135,000
$210,000
$150,000
$23,000
$670,000
$334,000
hz
Cash
Accounts Receivable
Inventory
Prepaids
Fixed assets
Current liabilities
zle
Required:
Calculate EGR's current ratio.
Ans: (135,000+210,000+150,000+23,000)/334,000 = 1.55:1
Difficulty: Medium
Level of Learning: Application
Topic: LO2
d
133. What do the liquidity ratios focus on? Name two liquidity ratios.
Ans: Current ratio, quick ratio, defensive-interval ratio
Liquidity ratios focus on the company's ability to meet short-term obligations. Although
there are rules of thumb attached to the ratios, it is important to note that in some industries
and for some companies it is more important to have a liquidity ratio different from the
rule of thumb.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 21 – Financial Statement Analysis
134. What are multi-industry corporations and what problems, if any are associated with them (i.e.
when analyzing their statements)?
Ans: Multi-industry corporations operate in more than one area in the economy. They have a
broad spectrum of activities; for example, a company in the food industry that is also
involved in rentals. It is sometimes difficult to place a company in a certain industry
segment and gaining comparable information may be difficult. However, ratios, like the
profitability ratios, can still be used as an investor is expecting a certain return on their
investment at a given level of risk regardless of the industry. In order to evaluate risks,
public, multi-industry corporations provide segmented information.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1, 6
135. What is the purpose of the times interest earned ratio?
Ans: The times interest earned ratio indicates whether the company can still pay its interest
payments on its debts (thus avoiding default), should their earnings decrease.
Difficulty: Medium
hz
Level of Learning: Knowledge
Topic: LO4
zle
136. Define the debt-to-equity ratio. What is its purpose?
Ans: Total long-term debt/total owners' equity
This ratio indicates how much of the permanent investment is financed through debt vs.
through shareholders. Items such as retractable preferred shares and loans from
shareholders should be classified in accordance with their substance.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO4
137. What do solvency ratios measure?
Ans: Solvency ratios are used to measure the ability of the company to make both interest and
principal payments on its long-term obligations.
Difficulty: Medium
d
Level of Learning: Knowledge
Topic: LO4
138. What do efficiency ratios measure?
Ans: Efficiency ratios attempt to measure operating efficiency. Included in this group – accounts
receivable turnover ratio and inventory turnover ratio.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 38
Chapter 21 – Financial Statement Analysis
139. The following information for JG Ltd. is available to you:
Cash
Average accounts receivable
Average inventory
Accounts payable
Sales on account
Cost of goods sold
$85,000
$546,000
$678,000
$345,000
$1,300,000
$1,000,000
Required:
1. Calculate the accounts receivable turnover ratio
2. You determined that the industry average was 4.5 and that JG Ltd. had turnovers in previous
years of 3.5, 3.8, 4.4, and 4.7. Based on this information, can you make any conclusions?
Ans: 1. 1,300,000/546,000=2.38
2. JG's ART ratio is decreasing and is much lower than the industry average. This may
mean that they are having a hard time collecting. It would be nice to see an aging schedule
to see if the receivables are old or if the balance is due to timing.
Difficulty: Medium
hz
Level of Learning: Application
Topic: LO3
140. The following information for JG Ltd. is available to you:
$85,000
$546,000
$678,000
$345,000
$1,300,000
$1,000,000
zle
Cash
Average accounts receivable
Average inventory
Accounts payable
Sales on account
Cost of goods sold
d
Required:
1. Calculate the inventory receivable turnover ratio
2. You determined that the industry average was 3.5 and that JG Ltd. had turnovers in previous
years of 2.4, 2.6, 3.4, and 3.7. Based on this information can you make any conclusions?
Ans: 1. 1,000,000/678,000= 1.47 times
2. It appears as though JG Ltd. is having trouble turning over its stock and is significantly
slower than the industry average and has been for several years. This may indicate that JG
Ltd. is overstocked. However, we must use caution as the high balance may be due to the
timing of deliveries to JG Ltd. In other words, deliveries of stock around the measurement
date will cause the ratio to be lower.
Difficulty: Medium
Level of Learning: Application
Topic: LO3
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
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Chapter 21 – Financial Statement Analysis
zle
hz
141. Enter a letter in each blank space to the left to indicate what each ratio is designed to measure.
Ratio
A. Accounts receivable turnover
B. Book value per share
C. Inventory turnover
D. Payout ratio
E. Current ratio
F. Owners' equity to liabilities
G. Acid test ratio
H. Return on owners' equity
I. Return on total assets
J. Earnings per share
K. Price earnings ratio
L. Financial leverage factor
M. None of the above
Measurement of
___ 1. Effect of borrowing on return earned for shareholders.
___ 2. Rate that goods sold move into and out of stock.
___ 3. Length of period for investor to recover the share cost.
___ 4. Proportion of income paid out as dividends (per share basis).
___ 5. Short-term solvency.
___ 6. Equity position.
___ 7. Profit earned on each common share.
___ 8. Severe test of short-term solvency.
___ 9. Amount each shareholder would receive if all assets, liabilities, and other "claims" were
liquidated at their carrying values.
___10. Relationship of market price to earnings per share.
___11. A measure of the movement of trade receivables.
___12. Rate earned on total resources employed.
Ans: 1:L, 2:C, 3:M, 4:D, 5:E, 6:F, 7:J, 8:G, 9:B, 10:K, 11:A, 12:I
Difficulty: Medium
d
Level of Learning: Knowledge
Topic: LO1-7
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 40
Chapter 21 – Financial Statement Analysis
142. Given the following year-end information, compute the required ratios:
Sales (2/3 on credit)
Cost of goods sold
Operating expenses (includes interest expense of $150, net of tax
Pretax income
Income tax (40%)
Net Income
Assets:
Cash
Accounts receivable, (beginning balance, $2,600)
Inventory (beginning balance, $3,000)
Prepaid expenses
Operational assets (net)
Total assets
$15,000
(9,000)
(1,000)
$5,000
(2,000)
$3,000
========
$1,500
2,000
3,500
200
3,800
$11,000
=======
hz
Liabilities & Owners' Equity:
Liabilities:
Current liabilities
Long-term liabilities
Shareholders' Equity:
Common shares (500 shares issued)
Retained earnings
Total Liabilities & Shareholders' Equity
$2,000
3,000
zle
Answer
d
Required ratios (round to two decimal places):
Ratio
Computation
(a) Current ratio
(b) Receivable turnover
(c) Profit margin
(d) Return on total assets
(e) Return on owners' equity
(f) Financial leverage
Ans: (a) Current ratio:
($1,500 + $2,000 + $3,500 + $200 = $7,200) ÷ $2,000 =
5,000
1,000
$11,000
=======
(b)Receivable turnover
($15,000 x 2/3 = $10,000) - [($2,600 + $2,000) ÷ 2 = $2,300] =
3.6
===
4.3 turnover
====
(c) Profit margin on sales: $3,000 ÷ $15,000 =
20%
===
(d) Return on total assets:
($3,000 + $150 = $3,150) ÷ $11,000 =
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
28.6%
====
Page 41
Chapter 21 – Financial Statement Analysis
(e) Return on owners' equity:
$3,000 ÷ ($5,000 + $1,000 = $6,000) =
50%
===
(f) Financial leverage: 50% - 28.6% =
21.4% positive.
====
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3, 4, 5
hz
143. The following data was taken from the 20x12 financial statements of
WXC:
Income Statement
Sales
$580,000
Cost of goods sold
(293,000)
Depreciation expense
( 40,000)
Interest expense
( 12,000)
Remaining expenses
( 45,000)
Income tax expense (30%)
( 57,000)
Income before E.O. items
E.O. loss (net of tax)
$ 130,000
=========
zle
Net Income
$ 133,000
( 3,000)
Balance Sheet
Total assets
$500,000
Total liabilities
300,000
Shares outstanding, 20,000
Based on the above data, compute the following (round to nearest percent):
Computation
d
Ratio
(a) Profit margin on sales
(b) ROI (on owners equity)
(c) EPS
(d) ROI (on total equities)
(e) Debt to owners equity
(f) Financial leverage
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Answer
Page 42
Chapter 21 – Financial Statement Analysis
Ans:
(a) $133,000 ÷ $580,000
(b) $133,000 ÷ $200,000
(c) $130,000 ÷ 20,000 shares
(d) 133,000 + ($12,000 x 70%) ÷ $500,000
(e) $300,000 ÷ $200,000
(f) 67% (per b) - 28% (per d)
23%
67%
$6.50
28%
150%
39%
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3, 4, 5
d
zle
hz
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 43
Chapter 21 – Financial Statement Analysis
144. The following data was reported by JSB for a two-year period:
Sales revenue (one-fourth on credit)
Cost of goods sold
Operating expenses*
Income tax (20%)
Net income
20x11
$84,000
(51,000)
(23,000)
(2,000)
$8,000
=========
20x12
$120,000
(65,000)
(27,000)
(5,600)
$ 22,400
=========
$15,000
20,000
35,000
40,000
$110,000
========
$11,000
26,000
39,000
44,000
$120,000
========
Assets:
Cash
Accounts receivable (net)
Inventory
Operational assets (net)
Total assets
zle
hz
Liabilities:
Current liabilities
Long-term liabilities
Shareholders' equity:
Common shares, 5,000 shares issued
Retained earnings
Total liabilities & shareholders' equity
$30,000
23,000
$29,000
20,000
50,000
7,000
$110,000
========
50,000
21,000
$120,000
========
d
*Includes interest expense, $2,500 (pretax)
(a) Compute the following ratios for 20x12:
(1) Receivable turnover
(2) Inventory turnover
(3) Creditors' equity to total assets
(4) Acid test ratio
(5) Return on owners' equity
(6) Profit margin on sales
(7) Current ratio
(8) Return on total assets
(9) Owners' equity to total assets
(10) Financial leverage
(b) Briefly explain and interpret financial leverage.
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 44
Chapter 21 – Financial Statement Analysis
Ans:
(a)
(1) ($120,000 x .25) ÷ [($20,000 + $26,000) ÷ 2] =
(2) $65,000 ÷ [($35,000 + $39,000) ÷ 2] =
(3) $49,000 ÷ $120,000 =
(4) $37,000 ÷ $29,000 =
(5) $22,400 ÷ $64,000 =
(6) $22,400 ÷ $120,000 =
(7) $76,000 ÷ $29,000 =
(8) 22,400 + ($42,500 x 80%) ÷ $115,000 =
(9) $71,000 ÷ $120,000 =
hz
(10) Favourable. 35% - 21% =
1.30
====
1.76
====
41%
===
1.28
====
35%
===
19%
===
2.63
====
21%
===
59%
===
14%
===
zle
(b) The measure of financial leverage is the difference between return on owners' equity
and return on total assets. If the former is larger, the leverage is positive. Leverage is the
advantage accruing to owners when return earned on total assets is greater than the rate of
interest (net of taxes) paid on debt.
Difficulty: Medium
Level of Learning: Application
Topic: LO2, 3, 4, 5
d
145. What is the purpose of consolidated financial statements?
Ans: Many companies operate through the use of subsidiaries. If the company is public, they are
required to prepare consolidated statements. This means that all of the assets, liabilities,
revenues and expenses are combined. The purpose of consolidated financial is in part to
show users and potential users the entire picture of the company, which is very important
when the investor is purchasing shares in the company. The problem with consolidated
statements is the fact that they give few insights into each individual company and how
they are doing.
Difficulty: Medium
Level of Learning: Knowledge
Topic: LO1
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 45
Chapter 21 – Financial Statement Analysis
146. As an industry analyst comparing a firm to the industry, are you likely to praise or criticize the
firm in terms of Net Income / Total Asset
Ans: Net Income / Total Assets
Year
GHI Inc. Ratio
Industry Ratio
2000
12.0%
11.0%
2001
11.2%
8.0%
2002
10.0%
5.0%
Although the company has shown a declining return on assets since 2000, it has performed
much better than the industry. Praise may be more appropriate than criticism.
Difficulty: Medium
Level of Learning: Application
Topic: LO1, 2
Year
2000
2001
2002
hz
147. As an industry analyst comparing a firm to the industry, are you likely to praise or criticize the
firm in terms of Debt / Total Asset.
Ans: Debt / Total Asset
GHI Inc. Ratio
53.3%
51.5%
50.0%
Industry Ratio
52.0%
40.0%
31.0%
zle
While the company's debt ratio is improving, it is not improving nearly as rapidly as the industry
ratio. Criticism may be more appropriate than praise.
Difficulty: Medium
Level of Learning: Application
Topic: LO1, 5
Use the following to answer questions 148-151:
Sales
Net Income (after taxes)
Assets
d
GHI Inc. Corporation has three subsidiaries
Computers
$16,000,000
1,000,000
5,000,000
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Magazines
$4,000,000
160,000
2,000,000
Cable TV
$8,000,000
600,000
5,000,000
Page 46
Chapter 21 – Financial Statement Analysis
148. Which division has the lowest return on sales?
Net Income / Sales
Computers
6.25 %
Magazines
4.00
Cable TV
7.50%
Ans:
The magazine division has the lowest return on sales
Difficulty: Medium
Level of Learning: Application
Topic: LO2
149. Which division has the highest return on assets?
Computers
20.00%
Net Income / Total Assets
Magazines
8.00%
Cable TV
12.00%
hz
Ans:
The Computer division has the highest return on assets.
Difficulty: Medium
Level of Learning: Application
Topic: LO2
150. Compute the return on assets for the entire corporation.
zle
Ans:
Corporate net income
= $1,000,000 + $160,000 + $600,000
= $1,760,000
Corporate total assets
= $5,000,000 + $2,000,000 + $5,000,000
= $12,000,000
ROA = $1,760,000/ $12,000,000 = 0.1467 = 14.67%
Difficulty: Medium
d
Level of Learning: Application
Topic: LO2
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 47
Chapter 21 – Financial Statement Analysis
151. If the five million dollar investment in the Cable TV division is sold and redeployed in the
computer subsidiary at the same rate of return on assets currently achieved in the computer
division, What will be the new return on assets for the entire corporation?
Ans: Return on redeployed assets in computers:
20% x $5,000,000
= $1,000,000
Return on assets for the entire corporation:
New corporate net income
= $1,000,000 + $160,000+$1,000,000
= $2,160,000
ROA = $2,160,000 / $12,000,000
= 0.1800 = 18%
Difficulty: Medium
Level of Learning: Application
Topic: LO2
152. Calculate the balance sheet item Marketable securities
hz
Ans: Capital Assets = $600,000 - $2,500,000
Difficulty: Medium
Level of Learning: Application
Topic: LO1, 4
153. Calculate the balance sheet item Long-Term Debt
zle
Ans: Total Debt = $2,400,000 - $1,400,000
Difficulty: Medium
Level of Learning: Application
Topic: LO1, 4
d
Beechy, Conrod & Farrell Intermediate Accounting Fifth Edition - Vol. 2
Copyright © 2011 McGraw-Hill Ryerson Limited.
Page 48