2011 AICPA Newly Released Questions Financial

Following are multiple choice questions recently released by the AICPA. These questions were released by the AICPA with letter answers only. Our editorial board has provided the accompanying explanation. Please note that the AICPA generally releases questions that it does NOT intend to use again. These questions and content may or may not be representative of questions you may see on any upcoming exams.

2011 AICPA Newly Released Questions Financial

1. Fenn Museum, a nongovernmental not-for-profit organization, had the following balances in its statement of functional expenses: Education Fundraising Management and general Research $300,000 250,000 200,000 50,000

What amount should Fenn report as expenses for support services? a. b. c. d. $350,000 $450,000 $500,000 $800,000

Solution: Choice "b" is correct. The expenses of not for profit organizations are typically classified within generic functions as either program or support services. Program services relate to the mission or service delivery objectives of the organization, while support services relate to costs that indirectly support the organization's mission such as general and administrative costs, fund raising, membership development, etc. Of the four expenses listed in the fact pattern, two are clearly support services as follows: Fundraising Management and general Total $250,000 200,000 $450,000

Education and Research expenses are likely program services of the Fen Museum Choice "a" is incorrect. The proposed answer combines the likely program service amounts associated with Education and Research to arrive at $350,000. Program services would not be displayed as support services. Choice "c" is incorrect. The proposed answer either combines the likely program service amount associated with Education and the Support service of Management and General to arrive at $500,000 or combines the program service amount associated with Research and all Support services to arrive at $500,000. Program services would not be displayed as support services. Choice "d" is incorrect. The proposed answer combines all the amounts in the fact pattern, both program and support services, to arrive at $800,000. Program services would not be displayed as support services.

2011 AICPA Newly Released Questions Financial

2. In January, Stitch, Inc. adopted the dollar-value LIFO method of inventory valuation. At adoption, inventory was valued at $50,000. During the year, inventory increased $30,000 using base-year prices, and prices increased 10%. The designated market value of Stitch's inventory exceeded its cost at year end. What amount of inventory should Stitch report in its year-end balance sheet? a. b. c. d. $80,000 $83,000 $85,000 $88,000

Solution: Choice "b" is correct. Since inventory increased $30,000 using base-year prices, under dollar value LIFO we must restate this increase by the appropriate price-level index, in this case 10%. $30,000 times 10% equals $3,000, so this increase actually becomes $33,000 using current-year prices. Therefore, the amount of inventory Stitch should report in its year-end balance sheet is the $50,000 at adoption plus the $33,000 increase, so $83,000 in total since they are utilizing dollar-value LIFO for inventory valuation. Choice "a" is incorrect. $80,000 would only be correct if we were not utilizing dollar-value LIFO. Choice "c" is incorrect. $85,000 Is incorrect since we do not have to adjust the original $50,000. Choice "d" is incorrect. $88,000 is incorrect since we only have to adjust the $30,000 increase.

2011 AICPA Newly Released Questions Financial

3. Jonn City entered into a capital lease for equipment during the year. How should the asset obtained through the lease be reported in Jonn City's government-wide statement of net assets? a. b. c. d. General capital asset. Other financing use. Expenditure. Not reported.

Solution: Choice "a" is correct. Capital lease obligations associated with general governmental activities are recorded as an asset and as a liability on the full accrual government-wide financial statements. Governmental fund financial statements would record the asset financed by a capital lease as an expenditure and the lease financing as other financing sources under modified accrual accounting. Choice "b" is incorrect. Although governmental fund financial statements (GRaSPP funds) would initially record an asset financed by a capital lease as an expenditure and the lease financing as other financing sources under modified accrual accounting, capital lease obligations associated with governmental activities are recorded as an asset and as a liability on the full accrual government-wide financial statements. Choice "c" is incorrect. Although governmental fund financial statements (GRaSPP funds) would initially record an asset financed by a capital lease as an expenditure and the lease financing as other financing sources under modified accrual accounting, capital lease obligations associated with governmental activities are recorded as an asset and as a liability on the full accrual government-wide financial statements. Choice "d" is incorrect. Capital lease obligations associated with general governmental activities are recorded as an asset and as a liability on the full accrual government-wide financial statements. Capital outlay would be recorded as an expenditure in the modified accrual governmental fund financial statements. Lease financing would be recorded as other financing sources in the fund financial statements. Governments would report capital lease activity in both fund and government-wide financial statements.

2011 AICPA Newly Released Questions Financial

4. Jane Co. owns 90% of the common stock of Dun Corp. and 100% of the common stock of Beech Corp. On December 30, Dun and Beech each declared a cash dividend of $100,000 for the current year. What is the total amount of dividends that should be reported in the December 31 consolidated financial statements of Jane and its subsidiaries, Dun and Beech? a. b. c. d. $10,000 $100,000 $190,000 $200,000

Solution: Choice "a" is correct. Since Jane owns 90% of Dun and 100% of Beech, when they declare and pay dividends, the only amounts that should appear in their year-end consolidated financial statements are the dividends paid to outsiders or external parties. Intercompany dividends should be eliminated upon consolidation. In this case, the only non-controlling interest that exists is the 10% of Dun that Jane does not own. So all 100% of Beech's $100,000 dividend would be eliminated, but only 90% of Dun's $100,000 would be eliminated. Therefore, just 10% of Dun's $100,000 dividend, or $10,000, will appear in Jane and subs' year-end consolidated financial statements. Choice "b" is incorrect. $100,000 is incorrect since we do not present half the dividends just because we don't own 100% of one sub. Choice "c" is incorrect. $190,000 out of $200,000 in dividends are "eliminated", leaving us with $10,000 reported in the consolidated financial statements. Choice "d" is incorrect. $200,000 are the total dividends declared, but the $190,000 paid to Jane gets eliminated when the financial statements are consolidated.

2011 AICPA Newly Released Questions Financial

5. Lem Co., which accounts for treasury stock under the par value method, acquired 100 shares of its $6 par value common stock for $10 per share. The shares had originally been issued by Lem for $7 per share. By what amount would Lem's additional paid-in capital from common stock decrease as a result of the acquisition? a. b. c. d. $0 $100 $300 $400

Solution: Choice "b" is correct. Under the par value method, when the shares are (re)acquired by Lem, the treasury stock is recorded at par value ($6/share) and additional paid-in-capital is reduced by the $100 recorded when the shares were originally issued. The difference, in this case between the $10 buy-back price and the $7 initial issuance price, or $3/share, is assigned to retained earnings as a reduction. Here are the journal entries for additional clarification: At issuance: Cash Common Stock Add'l Paid-In-Capital At (re)acquisition: Treasury Stock Add'l Paid-In-Capital Retained Earnings-plug Cash 600 100 300 1,000 700 600 100

Choice "a" is incorrect. Under the par value method, the acquisition of treasury stock is recorded by reducing additional paid in capital by the amount recorded when the shares were originally issued to investors. Choice "c" is incorrect. The $300 difference between the $1,000 paid by the company to reacquire the shares and the $700 originally received when the shares were issued to investors is recorded as a reduction to retained earnings. Choice "d" is incorrect. The $400 is the amount of both the debit to APIC and the debit to retained earnings. This question asks only for the reduction in APIC.

2011 AICPA Newly Released Questions Financial

6. Abbott Co. is preparing its statement of cash flows for the year. Abbott's cash disbursements during the year included the following: Payment of interest on bonds payable Payment of dividends to stockholders Payment to acquire 1,000 shares of Marks Co. common stock 100,000 $500,000 300,000

What should Abbott report as total cash outflows for financing activities in its statement of cash flows under U.S. GAAP? a. b. c. d. $0 $300,000 $800,000 $900,000

Solution: Choice "b" is correct. The $300,000 dividend to stockholders should be classified as a financing cash outflow. Other financing activities would include the issuance of stock, the purchase of treasury stock, the issuance of bonds, borrowing funds, and paying back principal related to bonds and loans. The payment of interest on the bonds payable is an operating cash outflow under U.S. GAAP and the payment to acquire the common stock of Marks is an investing cash outflow. Choice "a" is incorrect. The $300,000 dividend to stockholders should be classified as a financing cash outflow. Choice "c" is incorrect. The $500,000 payment of interest, although related to a financing activity, is not reported in the financing section under U.S.GAAP. It is reported as an operating cash outflow. Choice "d" is incorrect. The $100,000 payment to acquire someone else's common stock should be classified as an investing activity.

2011 AICPA Newly Released Questions Financial

7. In preparing Chase City's reconciliation of the statement of revenues, expenditures, and changes in fund balances to the government-wide statement of activities, which of the following items should be subtracted from changes in fund balances? a. b. c. d. Capital assets purchases. Payment of long-term debt principal. Internal service fund increase in net assets. Book value of capital assets sold during the year.

Solution: Choice "d" is correct. The elimination of the book value of a previously acquired asset has no impact on fund financial statements but serves to reduce the changes in net assets of the government-wide financial statements as the asset is written off (net of proceeds and accumulated depreciation). The book value of capital assets is, therefore, essentially subtracted from change in fund balance to reconcile to the change in government-wide net assets. Actual reconciling items might focus more on the computation of a gain or loss and proceeds from the disposal rather than individual components such as the asset book value. Choice "a" is incorrect. Capital asset purchases are added back to the changes in fund balance to reconcile to the change in net assets displayed on the government-wide statement of activities. Capital asset purchases are displayed as an expenditure in fund financial statements but are capitalized in the government-wide financial statements. Capital outlay is the "E" in "GOES" and is added back, not subtracted. Choice "b" is incorrect. Payment of long term debt principal is added back to the changes in fund balance to reconcile to the change in net assets displayed on the government-wide statement of activities. Payment of long term debt principal is displayed as an expenditure in fund financial statements but is shown as a reduction liabilities in the government-wide financial statements. Principal payment on debt is part of the "E" in "GOES" and is added back, not subtracted. Choice "c" is incorrect. Increases in internal service fund net assets would be added to the changes in fund balance to reconcile to the change in net assets displayed on the government-wide statement of activities. A net loss in the internal service funds would be subtracted. Internal Service fund activity is the "S" in "GOES" and is added back.

2011 AICPA Newly Released Questions Financial

8. Neron Co. has two derivatives related to two different financial instruments, instrument A and instrument B, both of which are debt instruments. The derivative related to instrument A is a fair value hedge, and the derivative related to instrument B is a cash flow hedge. Neron experienced gains in the value of instruments A and B due to a change in interest rates. Which of the gains should be reported by Neron in its income statement? Gain in value of debt instrument A Yes Yes No No Gain in value of debt instrument B Yes No Yes No

a. b. c. d.

Solution: Choice "b" is correct. Fair value hedge gains and losses are recorded on the income statement, while cash flow hedge gains and losses, to the extent they are effective (which is assumed in this fact pattern), are recorded as a component of other comprehensive income (the E in our PUFER mnemonic.) Choice "a" is incorrect. Only fair value hedge gains and losses should be reported within the income statement. Choice "c" is incorrect. This selection is backwards. Fair value gains and losses appear on the income statement while cash flows gains and losses should be presented as a component of other comprehensive income (PUFER). Choice "d" is incorrect. Fair value hedge gains and losses are to be reported within the income statement.

2011 AICPA Newly Released Questions Financial

9. Fern Co. has net income, before taxes, of $200,000, including $20,000 interest revenue from municipal bonds and $10,000 paid for officers' life insurance premiums where the company is the beneficiary. The tax rate for the current year is 30%. What is Fern's effective tax rate? a. b. c. d. 27.0% 28.5% 30.0% 31.5%

Solution: Choice "b" is correct. The municipal bond income and keyperson life insurance premiums are both permanent differences. Therefore, pretax income must be adjusted for both items to compute taxable income: Pretax income - Municipal bond income + Life insurance premiums Taxable income $200,000 (20,000) 10,000 $190,000

The $20,000 of municipal bond income is subtracted because it is not taxable income. The insurance premiums are added back because they are not deductible. Because there are no temporary differences and no deferred taxes, income tax expense is equal to taxable income times the current period tax rate: Income tax expense = Taxable income x Tax rate = $190,000 x 30% = $57,000 The effective tax rate can then be calculated as income tax expense divided by pretax income: Effective tax rate = Income tax expense / Pretax income = $57,000 / $200,000 = 28.5% Choice "a" is incorrect. This answer choice would result if you computed $180,000 times 30% or $54,000 and divided this back by the $200,000. However, this is incorrect since you must remember to add back the $10,000 in insurance premiums. Choice "c" is incorrect. The effective tax rate is equal to income tax expense divided by pretax income. The effective tax rate is not equal to the current year tax rate of 30% due to the existence of the two permanent differences. Choice "d" is incorrect. This answer choice would result if the municipal bond income was added and the life insurance premiums were subtracted when calculating taxable income. The $20,000 of municipal bond income should be subtracted because it is not taxable income. The insurance premiums should be added back because they are not deductible.

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2011 AICPA Newly Released Questions Financial

10. Assuming constant inventory quantities, which of the following inventory-costing methods will produce a lower inventory turnover ratio in an inflationary economy? a. b. c. d. FIFO (first in, first out). LIFO (last in, first out). Moving average. Weighted average.

Solution: Choice "a" is correct. Since the inventory turnover ratio is computed by taking the cost of goods sold for the year and dividing this by the average inventory, then we're looking for an answer that would result in a lower COGS figure and/or a higher average inventory valuation. Keep in mind that we're assuming an inflationary environment or rising prices. Under FIFO, our COGS would be lower, and our ending inventory would be higher, causing our average inventory to be higher as well. Therefore, FIFO will result in a lowest inventory turnover in an inflationary environment assuming constant inventory quantities. Choice "b" is incorrect. LIFO's effects would be the reverse. LIFO results in a higher COGS figure and a lower ending inventory valuation amount which in turn causes a lower average inventory valuation amount as well. Therefore, LIFO would yield a higher inventory turnover ratio in an inflationary environment, not a lower one, assuming constant inventory quantities. Choice "c" is incorrect. The moving average inventory costing method would result in an inventory turnover ratio between those calculated using FIFO and LIFO. Choice "d" is incorrect. The weighted average inventory costing method would result in an inventory turnover ratio between those calculated using FIFO and LIFO.

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2011 AICPA Newly Released Questions Financial

11. Hilltop Co.'s monthly bank statement shows a balance of $54,200. Reconciliation of the statement with company books reveals the following information: Bank service charge Insufficient funds check Checks outstanding Deposits in transit Check deposited by Hilltop and cleared by the bank for $125, but improperly recorded by Hilltop as $152 What is the net cash balance after the reconciliation? a. b. c. d. $52,363 $53,023 $53,050 $53,077 $10 650 1,500 350

Solution: Choice "c" is correct. This fact pattern provided us with the balance per the bank statement of $54,200. There are only two reconciling items for the balance per the bank statement, ignoring bank errors, and these are deposits in transit and outstanding checks. Any other reconciling items, namely service charges, NSF checks, credit memos (customer collections via wire transfer), interest income, and errors made by the company are only reconciling items to the balance per the books or general ledger balance, and this balance was not provided here. Therefore, starting with the $54,200, the only two things we can do are to add the deposits in transit of $350 and subtract the outstanding checks of $1,500. This yields us a corrected or adjusted cash balance of $53,050. Choices "a", "b", and "d" are incorrect. The bank service charge, NSF check, and recording error are only reconciling items to the book, or GL, balance, but the examiners did not provide us with this amount

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2011 AICPA Newly Released Questions Financial

12. A nongovernmental not-for-profit organization received a $2 million gift from a donor who specified it be used to create an endowment fund that would be invested in perpetuity. The income from the fund is to be used to support a specific program in the second year and beyond. An investment purchased with the gift earned $40,000 during the first year. At the end of the first year, the fair value of the investment was $2,010,000. What is the net effect on temporarily restricted net assets at year end? a. b. c. d. $0 $10,000 increase. $40,000 increase. $50,000 increase.

Solution: Choice "d" is correct. Temporarily restricted net assets would increase by $50,000, the amount of the investment earnings of $40,000 and the $10,000 increase in the market value of the underlying permanently restricted investment. Choice "a" is incorrect. Investment earnings and growth are accounted for as temporarily restricted. Choice "b" is incorrect. Temporarily restricted earnings would include both the investment growth of $10,000 as well as the $40,000 in earnings. Choice "c" is incorrect. Temporarily restricted earnings would include both the $40,000 in earnings as well as investment growth of $10,000.

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2011 AICPA Newly Released Questions Financial

13. When purchasing a bond, the present value of the bond's expected net future cash inflows discounted at the market rate of interest provides what information about the bond? a. b. c. d. Price. Par. Yield. Interest.

Solution: Choice "a" is correct. The issue price of a bond is a function of two different cash flows, one a lump sum and the other a regular stream of payments. First, we need to present value the eventual return of principal using present value tables and factors at the market or effective rate of interest, also known as the yield. Second, we need to present value the regular interest payments, whether annual or semiannual, using present value of an annuity tables and factors at the same market or effective interest rate (yield). Remember that the face rate of interest only has one job, and this is to compute the regular interest payments. It's the market rate of interest that will determine the bond's selling price. Choice "b" is incorrect. The par value of the bond is also known as the maturity value since this is the amount that must be paid back at maturity. Choice "c" is incorrect. The yield is another term for market or effective interest rate. It is this rate that will be used when using the PV table and the PV annuity table to determine the issue price of the bond. Choice "d" is incorrect. Interest will be paid semiannually (usually) or annually, and this interest must be present valued at the market rate along with the bond principal in order to come up with the bond price.

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2011 AICPA Newly Released Questions Financial

14. A company calculated the following data for the period: Cash received from customers Cash received from sale of equipment Interest paid to bank on note Cash paid to employees $25,000 1,000 3,000 8,000

What amount should the company report as net cash provided by operating activities in its statement of cash flows? a. b. c. d. $14,000 $15,000 $18,000 $26,000

Solution: Choice "a" is correct. Cash received from customers, interest paid to bank on note, and cash paid to employees are all operating activities within the direct method statement of cash flows. Cash received from customers is a cash inflow and interest paid to bank on note and cash paid to employees are cash outflows: Cash received from customers Cash paid to employees Interest paid Net cash provided by operating activities $25,000 (8,000) (3,000) $14,000

Choice "b" is incorrect. The $1,000 of cash received from sale of equipment would fall under the investing activities section along with any other capital expenditures or other investments. Choice "c" is incorrect. The $3,000 of interest paid to bank on note, while related to a financing activity, is actually classified as an operating activity within the statement of cash flows. Choice "d" is incorrect. The $8,000 of cash paid to employees is considered an operating activity and therefore must be deducted from this section. This section looks very much like a cash-basis income statement.

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2011 AICPA Newly Released Questions Financial

15. A company records items on the cash basis throughout the year and converts to an accrual basis for year-end reporting. Its cash-basis net income for the year is $70,000. The company has gathered the following comparative balance sheet information: Beginning of year Accounts payable Unearned revenue Wages payable Prepaid rent Accounts receivable $ 3,000 300 300 1,200 1,400 End of year $1,000 500 400 1,500 600

What amount should the company report as its accrual-based net income for the current year? a. b. c. d. $68,800 $70,200 $71,200 $73,200

Solution: Choice "c" is correct. One approach for converting from cash-basis to accrual-basis is as follows: 1) Add increases in current assets. For example, when AR increases, the increase is not considered to be income under the cash basis because the cash has not been collected, but the increase is income under the accrual basis. 2) Subtract decreases in current assets. Conversely, when AR decreases, then cash-basis counted it as revenue when the cash was collected, but under the accrual basis, the income was recognized in a prior period and should not be recognized again in the current period. 3) Add decreases in current liabilities. For example, when AP decreases, this represents a cash outflow that is recorded as an expense under the cash basis. However, under the accrual basis the paid expenses were recorded in a prior period and should not be recorded again in the current period. 4) Subtract increases in current liabilities. Conversely, when AP increases, this represents expenses incurred under the accrual basis method that have not been recorded under the cash basis method because they have not been paid. Therefore, starting with the $70,000, we add the $2,000 decrease in AP, subtract the $200 and $100 increases in unearned revenue and wages payable, add the $300 increase in prepaid rent, and finally subtract the $800 decrease in accounts receivable: $70,000 + $2,000 - $300 + $300 - $800 = $71,200

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2011 AICPA Newly Released Questions Financial

16. Under U.S. GAAP, restorations of carrying value for long-lived assets are permitted if an asset's fair value increases subsequent to recording an impairment loss for which of the following? a. b. c. d. Held for use Yes Yes No No Held for disposal Yes No Yes No

Solution: Choice "c" is correct. Under U.S. GAAP, long-lived assets that are impaired can only have their carrying value restored if they are held for disposal. Assets that are held for continued use that are impaired are not permitted to have any restoration of carrying value. Keep in mind that any write-ups are limited to previous write-downs. Choices "a", "b", and "d" are incorrect as per the rules above.

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2011 AICPA Newly Released Questions Financial

17. What are the components of the lease receivable for a lessor involved in a direct-financing lease? a. b. c. d. The minimum lease payments plus any executory costs. The minimum lease payments plus residual value. The minimum lease payments less residual value. The minimum lease payments less initial direct costs.

Solution: Choice "b" is correct. Lessors recording a lease receivable for a direct-financing lease should include the minimum lease payments PLUS any residual value. The reason for this is because the lessor can also expect to collect this residual value from the lessee at the culmination of the lease. Choice "a" is incorrect. Executory costs, like insurance, taxes, and maintenance, are always recorded separately and do not affect the computation of the minimum lease payments nor the lease receivable. Choice "c" is incorrect. The residual value needs to be added, not subtracted, since the lessee is obligated to pay this to the lessor at the culmination of the lease. Choice "d" is incorrect. Initial direct costs, like executory costs, do not affect the computation of the lease receivable.

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2011 AICPA Newly Released Questions Financial

18. When the effective interest method of amortization is used for bonds issued at a premium, the amount of interest payable for an interest period is calculated by multiplying the: a. b. c. d. Face value of the bonds at the beginning of the period by the contractual interest rate. Face value of the bonds at the beginning of the period by the effective interest rates. Carrying value of the bonds at the beginning of the period by the contractual interest rate. Carrying value of the bonds at the beginning of the period by the effective interest rates.

Solution: Choice "a" is correct. The interest payable on a bond is calculated by taking the face value of the bond at the beginning of the period and multiply this amount by the contractual interest rate. Choice "b" is incorrect. This calculation is not used in bond accounting. Choice "c" is incorrect. This calculation is not used in bond accounting. Choice "d" is incorrect. This is the formula used to calculate the interest expense on a bond.

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2011 AICPA Newly Released Questions Financial

19. In year 1, a company reported in other comprehensive income an unrealized holding loss on an investment in available-for-sale securities. During year 2, these securities were sold at a loss equal to the unrealized loss previously recognized. The reclassification adjustment should include which of the following? a. b. c. d. The unrealized loss should be credited to the investment account. The unrealized loss should be credited to the other comprehensive income account. The unrealized loss should be debited to the other comprehensive income account. The unrealized loss should be credited to beginning retained earnings.

Solution: Choice "b" is correct. In year 1, the company would have debited an unrealized holding loss within other comprehensive income (the U in PUFER) and they would have credited either the investment account itself or more likely a valuation allowance associated with this asset account. In Year 2 when these securities were sold for the exact same loss, the company would need to eliminate this unrealized loss from OCI by crediting it and record a realized loss on the income statement by debiting it. Choice "a" is incorrect. The investment account would need to be credited at the time of the sale for the carrying value of the investment. Choice "c" is incorrect. The unrealized loss was debited in Year 1 when the unrealized loss was initially recorded, so a credit is needed to eliminate it. Choice "d" is incorrect. The unrealized loss would not affect retained earnings, although the realized loss certainly would.

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2011 AICPA Newly Released Questions Financial

20. Toigo Co. purchased merchandise from a vendor in England on November 20 for 500,000 British pounds. Payment was due in British pounds on January 20. The spot rates to purchase one pound were as follows: November 20 December 31 January 20 $1.25 1.20 1.17

How should the foreign currency transaction gain be reported on Toigo's financial statements at December 31? a. b. c. d. A gain of $40,000 as a separate component of stockholders' equity. A gain of $40,000 in the income statement. A gain of $25,000 as a separate component of stockholders' equity. A gain of $25,000 in the income statement.

Solution: Choice "d" is correct. On November 20 , the company enter into an agreement to purchase merchandise for an amount that it expected to settle for $625,000 (500,000 pounds x $1.25/pound). On December st 31 , the spot rate had fallen to $1.20 per pound, at which rate the purchase could be settled for $600,000 (500,000 pounds x $1.20/pound). This represents a $25,000 foreign currency transaction gain that is recognized on the year-end income statement. Choices "a", "b", and "c" are incorrect. Since it's only December 31 , we will not recognize all $40,000 in the first year, and foreign currency transaction gains like these are reported on the income statement. Foreign currency translation gains and losses are reported in other comprehensive income and recognized as a separate component of stockholders' equity.
st th

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2011 AICPA Newly Released Questions Financial

21. A company enters into a three-year operating lease agreement effective January 1, year 1. The amounts due on the first day of each year are $25,000 in year 1, $30,000 in year 2, and $35,000 in year 3. What amount, if any, is the related liability on the first day of year 2? a. b. c. d. $0 $5,000 $60,000 $65,000

Solution: Choice "b" is correct. Operating lease expense must be recorded equally over the life of the lease. The average annual lease amount is $30,000 per year, or $2,500 per month. In year 1, the lease would be accounted for as follows: Beginning of Year 1: Prepaid rent Cash 25,000 25,000

Monthly AJE's for first 10 months: Rent Expense 2,500 Prepaid rent 2,500

Monthly AJE's for final 2 months: Rent Expense 2,500 Rent payable 2,500

After recording monthly AJE's for both November and December, our rent payable is $5,000 by 1/1/Y2.

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2011 AICPA Newly Released Questions Financial

22. Damon Co. purchased 100% of the outstanding common stock of Smith Co. in an acquisition by issuing 20,000 shares of its $1 par common stock that had a fair value of $10 per share and providing contingent consideration that had a fair value of $10,000 on the acquisition date. Damon also incurred $15,000 in direct acquisition costs. On the acquisition date, Smith had assets with a book value of $200,000, a fair value of $350,000, and related liabilities with a book and fair value of $70,000. What amount of gain should Damon report related to this transaction? a. b. c. d. $55,000 $70,000 $80,000 $250,000

Solution: Choice "b" is correct. Please see following journal entry with additional details and explanation: Investment in Smith Common Stock Add'l-paid-in-capital Contingent consideration Cash Gain 280,000 ($350,000 asset fair value less $70,000 liabilities fair value) 20,000 (20,000 shares times $1 par value) 165,000 (20,000 shares times $9 excess, less $15,000 in dir. acq. costs) 10,000 (given) 15,000 (direct acquisition costs) 70,000 (plug)

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2011 AICPA Newly Released Questions Financial

23. If a city government is the primary reporting entity, which of the following is an acceptable method to present component units in its combined financial statements? a. b. c. d. Consolidation. Cost method. Discrete presentation. Government-wide presentation.

Solution: Choice "c" is correct. Component units may be presented using either the discrete or blended method within the financial statements of the primary reporting entity. Discrete presentation is an acceptable method to present component units. Choice "a" is incorrect. Component units may be presented using either the discrete or blended method within the financial statements of the primary reporting entity. Consolidation is not an acceptable method to present component units. Choice "b" is incorrect. Component units may be presented using either the discrete or blended method within the financial statements of the primary reporting entity. The "cost method" is not an acceptable or recognized method to present component units. Choice "d" is incorrect. Component units may be presented using either the discrete or blended method within the financial statements of the primary reporting entity. Government-wide presentation is a component of basic financial statement presentation and is not an acceptable or recognized method to present component units.

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2011 AICPA Newly Released Questions Financial

24. Which of the following statements correctly describes the proper accounting for nonmonetary exchanges that are deemed to have commercial substance? a. b. c. d. It defers any gains and losses. It defers losses to the extent of any gains. It recognizes gains and losses immediately. It defers gains and recognizes losses immediately.

Solution: Choice "c" is correct. For nonmonetary exchanges that contain commercial substance, meaning that the amount and timing of future cash flows changes as a result of this exchange, gains and losses are recognized immediately. Choice "a" is incorrect. Losses are never deferred, no matter whether the exchange contains commercial substance or not. A portion of a gain can only be deferred for nonmonetary exchanges that do NOT contain commercial substance, meaning the amount and timing of future cash flows did not change as a result of this exchange, and only if boot (cash) is RECEIVED as a minor component (less than 25%) of this transaction. Choice "b" is incorrect. Losses are never deferred, no matter whether the exchange contains commercial substance or not. Choice "d" is incorrect. Losses are recognized immediately, but a portion of a gain can only be deferred for nonmonetary exchanges that do NOT contain commercial substance, meaning the amount and timing of future cash flows did not change as a result of this exchange, and only if boot (cash) is RECEIVED as a minor component (less than 25%) of this transaction.

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2011 AICPA Newly Released Questions Financial

25. Campbell Corp. exchanged delivery trucks with Highway, Inc. Campbell's truck originally cost $23,000, its accumulated depreciation was $20,000, and its fair value was $5,000. Highway's truck originally cost $23,500, its accumulated depreciation was $19,900, and its fair value was $5,700. Campbell also paid Highway $700 in cash as part of the transaction. The transaction lacks commercial substance. What amount is the new book value for the truck Campbell received? a. b. c. d. $5,700 $5,000 $3,700 $3,000

Solution: Choice "c" is correct. The gain or loss can be derived by subtracting the net book value or carrying amount of the asset being surrendered with its fair value. The fair value of the asset being surrendered must always equals the fair value of the asset being received, even if only one of these amounts are given. In this fact pattern, Campbell's truck's carrying value was $3,000 ($23,000 less $20,000), and its fair value is $5,000. So there is a gain of $2,000. However, since this exchange lacks commercial substance, Campbell can only recognize a gain if it received boot/cash. If boot/cash is given, or there is no boot or cash in the transaction, then no gain is recognized. Because Campbell pays cash of $700, not gain is recognized. Therefore, the journal entry to record the transaction and "plug" for the book value of the Truck received by Campbell is: New truck Accumulated depreciation Old truck Cash 3,700 (plug) 20,000 23,000 700

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2011 AICPA Newly Released Questions Financial

26. The replacement cost of an inventory item is below the net realizable value and above the net realizable value less a normal profit margin. The inventory item's original cost is above the net realizable value. Under the lower of cost or market method, the inventory item should be valued at: a. b. c. d. Original cost. Replacement cost. Net realizable value. Net realizable value less normal profit margin.

Solution: Choice "b" is correct. The market value of the inventory is the middle value of the replacement cost, the market ceiling (net realizable value) and the market floor (net realizable value normal profit margin). Because replacement cost falls between the market ceiling and the market floor, it is considered to be the market value of the inventory. Under U.S. GAAP, the inventory is reported at the lower of cost or market. Because the cost is above the replacement cost (market value), the inventory is reported at replacement cost. Choice "a" is incorrect. The inventory is not reported at original cost because the original cost exceeds the market value (replacement cost). Under U.S. GAAP, inventory is reported at the lower of cost or market. Choice "c" is incorrect. The inventory is not reported at net realizable value because the net realizable value exceeds the replacement cost and the replacement cost exceeds net realizable value less normal profit margin. Therefore, the replacement cost is the market value of the inventory and is the amount used to determine lower of cost or market. Choice "d" is incorrect. The inventory is not reported at net realizable value less normal profit margin because this amount is less than the replacement cost and the replacement cost is less than net realizable value. Therefore, the replacement cost is the market value of the inventory and is the amount used to determine lower of cost or market.

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2011 AICPA Newly Released Questions Financial

27. Encumbrances would not appear in which fund? a. b. c. d. Capital projects. Special revenue. General. Enterprise.

Solution: Choice "d" is correct. An enterprise fund would not use encumbrance accounting. Encumbrance accounting is used in the governmental (GRaSPP) funds but is not used in the proprietary (SE) or fiduciary (PAPI) funds. Enterprise is the "E" in "SE". Choice "a" is incorrect. A capital projects fund would use encumbrance accounting. Encumbrance accounting is used in the governmental (GRaSPP) funds but is not used in the proprietary (SE) or fiduciary (PAPI) funds. Capital projects is the first "P" in "GRaSPP". Choice "b" is incorrect. A special revenue fund would use encumbrance accounting. Encumbrance accounting is used in the governmental (GRaSPP) funds but is not used in the proprietary (SE) or fiduciary (PAPI) funds. Special Revenue is the "R" in "GRaSPP". Choice "c" is incorrect. The general fund would use encumbrance accounting. Encumbrance accounting is used in the governmental (GRaSPP) funds but is not used in the proprietary (SE) or fiduciary (PAPI) funds. The General fund is the "G" in "GRaSPP".

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2011 AICPA Newly Released Questions Financial

28. Roy City received a gift, the principal of which is to be invested in perpetuity with the income to be used to support the local library. In which fund should this gift be recorded? a. b. c. d. Permanent fund. Investment trusts fund. Private-purpose trusts fund. Special revenue fund.

Solution: Choice "a" is correct. The gift will be accounted for in a permanent fund. Permanent funds are used to report resources that are legally restricted to the extent income, and not principal, may be used for purposes supporting the reporting government's programs for the benefit of the public. The library is to be supported by a gift endowment and the library is intended to support the needs of the general community, not a specifically identified individual. Choice "b" is incorrect. Investment trust funds are used to account for external investment pools. An endowment contributed in support of a library to benefit the public is not an external investment pool. Choice "c" is incorrect. Private purpose trust funds are fiduciary relationships that do not meet the definition of a pension, agency or investment trust fund and are intended for the benefit of specific individuals, private organizations or other governments. The library to be benefitted by the endowment is for the general public, not specific private individuals. Choice "d" is incorrect. Special revenue funds account for revenues from specific taxes or other earmarked sources that (by law) are restricted or committed to finance particular activities of a government. Roy City is accounting for income from a gift that is not appropriate for accounting within a special revenue fund.

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2011 AICPA Newly Released Questions Financial

29. Which of the following costs is unique to postretirement health-care benefits? a. b. c. d. Per capita claims. Service. Prior service. Interest.

Solution: Choice "a" is correct. Per capita claims are unique to postretirement health-care benefits. Choice "b" is incorrect. Service costs are one part of net pension expense and SIR-AGE. Choice "c" is incorrect. Prior service costs also affect net pension expense and SIR-AGE. Choice "d" is incorrect. Interest costs are also part of net pension expense and SIR-AGE.

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2011 AICPA Newly Released Questions Financial

30. During the current year, the Finn Foundation, a nongovernmental not-for-profit organization, received a $1,000,000 permanent endowment from Chris. Chris stipulated that the income must be used to provide recreational activities for the elderly. The endowment reported income of $80,000 in the current year. What amount of permanently restricted contribution revenue should Finn report at the end of the current year? a. b. c. d. $1,080,000 $1,000,000 $80,000 $0

Solution: Choice "b" is correct. Finn Foundation would report permanently restricted income in the amount of the $1,000,000 contribution. The permanently restricted amount cannot be spent but, instead, must be invested. The restrictions on the donation will never disappear or be satisfied by the Foundation by expenditure of the money. The $80,000 in earnings from the investment, however, would be accounted for as temporarily restricted revenue since it can be used to satisfy donor stipulations, a recreational program for the elderly. Choice "a" is incorrect. Although total revenue for the Finn Foundation would be $1,080,000, the company would only report permanently restricted income in the amount of the $1,000,000 contribution to establish the endowment in the year received. The $80,000 in earnings from the investment would be accounted for as temporarily restricted revenue since it can be used to satisfy donor stipulations, a recreational program for the elderly. Choice "c" is incorrect. Although the Finn Foundation would report $80,000 as temporarily restricted, the company would report the contributed endowment as permanently restricted income in the amount of the $1,000,000 contribution in the year received. Choice "d" is incorrect. Finn Foundation would report permanently restricted income in the amount of the $1,000,000 contribution. The $80,000 in earnings from the investment would be accounted for as temporarily restricted revenue.

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2011 AICPA Newly Released Questions Financial

31. Larkin Co. has owned 25% of the common stock of Devon Co. for a number of years, and has the ability to exercise significant influence over Devon. The following information relates to Larkin's investment in Devon during the most recent year: Carrying amount of Larkin's investment in Devon at the beginning of the year Net income of Devon for the year Total dividends paid to Devon's stockholders during the year 400,000 $200,000 600,000

What is the carrying amount of Larkin's investment in Devon at year end? a. b. c. d. $100,000 $200,000 $250,000 $350,000

Solution: Choice "c" is correct. Since Larkin is utilizing the equity method due to its ability to exercise significant influence over Devon, it will record a proportionate share of Devon's earnings (25% x $600,000 = $150,000) as an increases to the investment account and a proportionate share of Devon's dividends (25% x $400,000 = $100,000) as a reduction in the investment account: Initial carrying amount + Share of earnings - Share of dividends Ending carrying amount $200,000 150,000 (100,000) $250,000

Choice "a" is incorrect. Under the equity method, the ending carrying amount is equal to the initial carrying amount plus the investor's share of earnings minus the investor's share of dividends. This answer fails to add the investor's share of earnings. Choice "b" is incorrect. Under the equity method, the ending carrying amount is equal to the initial carrying amount plus the investor's share of earnings minus the investor's share of dividends. The ending carrying amount is not equal to the beginning carrying amount, unless the investee had no earnings and paid no dividends. Choice "d" is incorrect. Under the equity method, the ending carrying amount is equal to the initial carrying amount plus the investor's share of earnings minus the investor's share of dividends. This answer fails to subtract the investor's share of dividends.

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2011 AICPA Newly Released Questions Financial

32. Which of the following transactions qualify as a discontinued operation? a. b. c. d. Disposal of part of a line of business. Planned and approved sale of a segment. Phasing out of a production line. Changes related to technological improvements.

Solution: Choice "b" is correct. The planned and approved sale of a segment qualifies as a discontinued operation. Because a segment is a component of the entity. Segments may be functional in nature, like a major product category or service division, or they can be geographical as well. Choice "a" is incorrect. The disposal of part of a line of business would not qualify as a discontinued operation, although it's possible that the elimination of the "entire" line could qualify as one if the business line meets the definition of a component of the entity. Choice "c" is incorrect. Phasing out a production line is not the discontinuation of a component of the entity and does not qualify as a discontinued operation. Choice "d" is incorrect. Changes related to "technological" improvements are not the discontinuation of a component of the entity and does not qualify as discontinued operations.

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2011 AICPA Newly Released Questions Financial

33. Rowe Inc. owns 80% of Cowan Co.'s outstanding capital stock. On November 1, Rowe advanced $100,000 in cash to Cowan. What amount should be reported related to the advance in Rowe's consolidated balance sheet as of December 31? a. b. c. d. $0 $20,000 $80,000 $100,000

Solution: Choice "a" is correct. All intercompany transactions, including loans and advance, should be eliminated upon consolidation. Therefore, none of the $100,000 advance should appear in the consolidated balance sheet. The percentage ownership here is irrelevant. Therefore, the correct answer is zero. Choices "b", "c", and "d" are incorrect as per the rule above.

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2011 AICPA Newly Released Questions Financial

34. Chape Co. had the following information related to common and preferred shares during the year: Common shares outstanding, Common shares repurchased, Conversion of preferred shares, Common shares repurchased, 1/1 3/31 6/30 12/1 700,000 20,000 40,000 36,000

Chape reported net income of $2,000,000 at December 31. What amount of shares should Chape use as the denominator in the computation of basic earnings per share? a. b. c. d. 684,000 700,000 702,000 740,000

Solution: Choice "c" is correct. When computing the weighted average number of common shares outstanding (WACSO), shares issues, repurchased or converted must be time-weighted for the number of months outstanding: 1/1 3/31 6/30 12/1 The 20,000 common shares repurchased (treasury stock) on 3/31 were only outstanding for 9 months. The conversion of 40,000 preferred shares on 6/30 were only outstanding for 6 months. The 36,000 common shares repurchased (treasury stock) on 12/1 were only outstanding for 1 month. 700,000 x 12/12 = 700,000 20,000 x 9/12 = (15,000) 40,000 x 6/12 = 20,000 36,000 x 1/12 = (3,000)

WACSO = 700,000 15,000 + 20,000 3,000 = 702,000 shares

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2011 AICPA Newly Released Questions Financial

35. Marr Co. had the following sales and accounts receivable balances, prior to any adjustments at year end: Credit sales Accounts receivable Allowance for uncollectible accounts (debit balance) $10,000,000 3,000,000 50,000

Marr uses 3% of accounts receivable to determine its allowance for uncollectible accounts at year end. By what amount should Marr adjust its allowance for uncollectible accounts at year end? a. b. c. d. $0 $40,000 $90,000 $140,000

Solution: Choice "d" is correct. Since Marr uses the percentage of accounts receivable method for estimating bad debts, the ending allowance is calculated by multiply 3% by $3,000,000, for a required allowance of $90,000. Note that the unadjusted balance in the allowance account right now is a debit balance of $50,000. The allowance should be a credit balance, or contra-asset. A debit balance in the allowance account means that last year was a particularly bad year for Marr and they wrote off so many bad accounts receivable that they didn't have enough in their allowance to account for it all. To adjust from a debit balance in the allowance account of $50,000 to a credit balance of $90,000, the following journal entry must be recorded: Uncollectible Accounts Expense Allowance for Doubtful Accounts ($50,000) + $140,000 = $90,000 Choice "a" is incorrect. An adjusting journal entry is required to report an allowance of $90,000 ($3,000,000 x 3%), so zero is incorrect. Choice "b" is incorrect. The $40,000 would be correct had the $50,000 balance in the allowance account been a credit balance instead. Choice "c" is incorrect. The $90,000 is the required ending balance, but the fact pattern is asking for the amount of the adjustment required. 140,000 140,000

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2011 AICPA Newly Released Questions Financial

36. On April 1, year 1, Hall Fitness Center leased its gym to Dunn Fitness Center under a four-year operating lease. Hall normally charges $6,000 per month to lease its gym, but as an incentive, Hall gave Dunn half off the first year's rent, and one quarter off the second year's rent. Dunn's rental payments were as follows: Year 1 Year 2 Year 3 Year 4 12 x $3,000 = $36,000 12 x $4,500 = $54,000 12 x $6,000 = $72,000 12 x $6,000 = $72,000

Dunn's rent payments were due on the first day of the month, beginning on April 1, year 1. What amount should Dunn report as rent expense in its monthly income statement for April, year 3? a. b. c. d. $3,000 $4,500 $4,875 $6,000

Solution: Choice "c" is correct. Rent expense must be reported on a straight-line basis. When lease rates fluctuate and when reduced rent is given, the average lease rate must be computed. In this case, total rent expense over the life of the lease is $234,000 ($36,000 + $54,000 + $72,000 + $72,000) and the average rent expense is $58,500 per year ($234,000 / 4 years). $58,500 divided by 12 months equals $4,875 per month. Choice "a" is incorrect. Under accrual accounting, we do not divide the first $36,000 by 12 months to report as monthly rental expense. Rent expense must be reported on a straight-line basis over the life of the lease. Choice "b" is incorrect. Under accrual accounting, we do not divide the second $54,000 by 12 months to report as monthly rental expense. Rent expense must be reported on a straight-line basis over the life of the lease. Choice "d" is incorrect. Under accrual accounting, we do not divide the third and fourth year $72,000 by 12 months to report as monthly rental expense. Rent expense must be reported on a straight-line basis over the life of the lease.

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2011 AICPA Newly Released Questions Financial

37. Which of the following activities should be excluded when governmental fund financial statements are converted to government-wide financial statements? a. b. c. d. Proprietary activities. Fiduciary activities. Government activities. Enterprise activities.

Solution: Choice "b" is correct. Fiduciary activities are excluded from the government-wide financial statements. Transactions with fiduciary funds are treated as if those transactions were conducted with an independent trustee for purposes of display in the government-wide financial statements. Choice "a" is incorrect. Proprietary activities may show up in both governmental and business type activities displayed in the government-wide financial statements. Enterprise funds will be displayed as business type activities while internal services funds will generally be included in governmental type activities, presuming that the internal service funds provide support to general governmental activities. Choice "c" is incorrect. Governmental activities would be displayed in the government-wide financial statements. Generally speaking governmental activities include governmental funds (GRaSPP) and the internal service funds. Choice "d" is incorrect. Enterprise funds are displayed as business type activities in the government-wide financial statements.

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2011 AICPA Newly Released Questions Financial

38. Frame construction company's contract requires the construction of a bridge in three years. The expected total cost of the bridge is $2,000,000, and Frame will receive $2,500,000 for the project. The actual costs incurred to complete the project were $500,000, $900,000, and $600,000, respectively, during each of the three years. Progress payments received by Frame were $600,000, $1,200,000, and $700,000, respectively. Assuming that the percentage-of-completion method is used, what amount of gross profit would Frame report during the last year of the project? a. b. c. d. $120,000 $125,000 $140,000 $150,000

Solution: Choice "d" is correct. The expected gross profit from this contract is $500,000 ($2,500,000 sales price $2,000,000 anticipated costs). The actual project costs are $2,000,000 ($500,000 + $900,000 + $600,000). In the first year, the percentage of completion was 25% ($500,000 / $2,000,000), so gross profit of $125,000 (25% x $500,000) was recognized. In the second year, the percentage of completion was 70% [($500,000 + $900,000) / $2,000,000], so cumulative gross profit was $350,000. Finally, in the third year, the project was completed, so the remaining 30% of the profit is recognized: $500,000 x 30% = $150,000. Choices "a", "b", and "c" are incorrect as per the explanation above.

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2011 AICPA Newly Released Questions Financial

39. Pann, a nongovernmental not-for-profit organization, provides food and shelter to the homeless. Pann received a $15,000 gift with the stipulation that the funds be used to buy beds. In which net asset class should Pann report the contribution? a. b. c. d. Endowment. Temporarily restricted. Permanently restricted Unrestricted.

Solution: Choice "b" is correct. Pann would report a $15,000 gift restricted as to purpose for the purchase of beds as temporarily restricted. Temporarily restricted net assets are subject to donor imposed stipulations that either expire by passage of time or can be fulfilled and removed by actions of the organization. Pann can satisfy the donor's restrictions by purchasing beds. Choice "a" is incorrect. Pann would report a $15,000 gift restricted as to purpose for the purchase of beds as temporarily restricted. There is no "endowment" classification for net assets. Choice "c" is incorrect. Pann would report a $15,000 gift restricted as to purpose for the purchase of beds as temporarily restricted. Temporarily restricted net assets are subject to donor imposed stipulations that either expire by passage of time or can be fulfilled and removed by actions of the organization. Pann can satisfy the donor's restrictions by purchasing beds. Permanent restrictions neither expire by passage of time nor can be fulfilled by the actions of the organization. Choice "d" is incorrect. Pann would report a $15,000 gift restricted as to purpose for the purchase of beds as temporarily restricted. Temporarily restricted net assets are subject to donor imposed stipulations that either expire by passage of time or can be fulfilled and removed by actions of the organization. Pann can satisfy the donor's restrictions by purchasing beds. Unrestricted net assets are available to finance general operations and may be expended as the discretion of the governing board. Pann does not have that latitude, they must purchase beds.

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2011 AICPA Newly Released Questions Financial

40. Grayson Co. incurred significant costs in defending its patent rights. Which of the following is the appropriate treatment of the related litigation costs? a. b. c. d. Litigation costs would be capitalized regardless of the outcome of the litigation. Litigation costs would be expensed regardless of the outcome of the litigation. Litigation costs would be capitalized if the patent right is successfully defended. Litigation costs would be capitalized only if the patent was purchased rather than internally developed.

Solution: Choice "c" is correct. Litigation costs can only be capitalized as a part of the patent asset account if they result in a successful patent defense so that the patent can be retained and continue to provide benefit. Choice "a" is incorrect. Litigation costs would be expensed immediately if the outcome was unfavorable since the patent would be lost and would no longer be able to provide benefit to the company. Choice "b" is incorrect. Litigation costs are capitalized if the litigation results in a successful patent defense. Choice "d" is incorrect. The issue of whether the patent was developed internally or whether it was purchased is irrelevant when it comes to determining what to do with litigation costs. The real key and determining factor is whether the litigation is successful or not.

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2011 AICPA Newly Released Questions Financial

41. A company decided to sell an unprofitable division of its business. The company can sell the entire operation for $800,000, and the buyer will assume all assets and liabilities of the operations. The tax rate is 30%. The assets and liabilities of the discontinued operation are as follows: Buildings Accumulated depreciation Mortgage on buildings Inventory Accounts payable Accounts receivable $5,000,000 3,000,000 1,100,000 500,000 600,000 200,000

What is the after-tax net loss on the disposal of the division? a. b. c. d. $140,000 $200,000 $1,540,000 $2,200,000

Solution: Choice "a" is correct. The value of the assets is $2,000,000 building + 500,000 inventory + 200,000 AR, or $2,700,000. The value of the liabilities, which are to be assumed by the buyer, is $1,100,000 mortgage + 600,000 AP, or $1,700,000. So the value of the net assets, or assets less liabilities, is $1,000,000. The before tax loss from the sale is $200,000 ($800,000 sales price - $1,000,000 book value of division), and the after-tax loss is $140,000 [$200,000 x (1 30%)]. Choices "b", "c", and "d" are incorrect as per explanation above.

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2011 AICPA Newly Released Questions Financial

42. On January 1, year 1, Newport Corp. purchased a machine for $100,000. The machine was depreciated using the straight-line method over a 10-year period with no residual value. Because of a bookkeeping error, no depreciation was recognized in Newport's year 1 financial statements, resulting in a $10,000 overstatement of the book value of the machine on December 31, year 1. The oversight was discovered during the preparation of Newport's year 2 financial statements. What amount should Newport report for depreciation expense on the machine in the year 2 financial statements? a. b. c. d. $9,000 $10,000 $11,000 $20,000

Solution: Choice "b" is correct. This error should be corrected by restating the opening balance of retained earnings by $10,000 for Year 2, if only Year 2 financial statements are being presented. If Year 1 financial statements are being presented, then they should be corrected to reflect the proper Year 1 depreciation expense. In either case, this would have NO effect on the Year 2 depreciation expense, which is $10,000. Choices "a", "c", and "d" are incorrect. An error is not correct by spreading the difference into future years or by double-counting the error in the following year. The error is corrected by adjusting beginning retained earnings if the year of the error is not presented, or by correcting the error in the year of the error if that year is presented. Year 2 depreciation expense should be shown as if the error did not occur.

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2011 AICPA Newly Released Questions Financial

43. Four years ago on January 2, Randall Co. purchased a long-lived asset. The purchase price of the asset was $250,000, with no salvage value. The estimated useful life of the asset was 10 years. Randall used the straight-line method to calculate depreciation expense. An impairment loss on the asset of $30,000 was recognized on December 31 of the current year. The estimated useful life of the asset at December 31 of the current year did not change. What amount should Randall report as depreciation expense in its income statement for the next year? a. b. c. d. $20,000 $22,000 $25,000 $30,000

Solution: Choice "a" is correct. The acquisition cost of this asset is $250,000, and it is depreciated at the rate of $25,000 per year using the straight-line method based on a 10-year life. After four years, the accumulated depreciation would be $100,000 and the net book value would be $150,000 ($250,000 $100,000). In Year 5, an impairment loss of $30,000 is recorded and the net book value of the asset is $120,000 ($150,000 - $30,000). With 6 years remaining, the straight-line depreciation is $120,000 / 6 years = $20,000 per year. Choices "b", "c", and "d" are incorrect as per explanation above.

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2011 AICPA Newly Released Questions Financial

44. Which of the following items would best enable Driver Co. to determine whether the fair value of its investment in Favre Corp. is properly stated in the balance sheet? a. b. c. d. Discounted cash flow of Favre's operations. Quoted market prices available from a business broker for a similar asset. Quoted market prices on a stock exchange for an identical asset. Historical performance and return on Driver's investment in Favre.

Solution: Choice "c" is correct. Quoted market prices on a stock exchange for an identical asset are considered to be a Level One input, the most reliable of all. Choice "a" is incorrect. The discounted cash flow of Favre's operations are considered to be a Level Two input, not as reliable as those coming from a stock exchange for an identical asset. Choice "b" is incorrect. Quoted market prices available from a business broker for a similar asset are considered to be a Level Two input, not as reliable as those coming from a stock exchange for an identical asset. Choice "d" is incorrect. The historical performance and return on Driver's investment in Favre are considered to be Level Three unobservable inputs, the least reliable of all.

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2011 AICPA Newly Released Questions Financial

45. A company has a defined benefit pension plan for its employees. On December 31, year 1, the accumulated benefit obligation is $45,900, the projected benefit obligation is $68,100, and the fair value of the plan assets is $62,000. What amount, if any, related to the defined benefit plan should be recognized in the balance sheet at December 31, year 1? a. b. c. d. An asset of $16,100. A liability of $6,100. Nothing, as the fair value of the plan assets exceeds the accumulated benefit obligation. An unrealized loss of $6,100.

Solution: Choice "b" is correct. Since the projected benefit obligation (PBO) of $68,100 exceeds the fair value of the plan assets of $62,000, the pension is underfunded and a $6,100 liability should be recognized in the year-end balance sheet. Choices "a" is incorrect. The ABO is not used to compute the funded status of the pension plan. Choice "c" is incorrect. The ABO is not used to compute the funded status of the pension plan. Choice "d" is incorrect. This pension plan is underfunded by $6,100 ($68,100 PBO - $62,000 fair value of plan assets). An underfunded pension plan is reported as a liability on the balance sheet, not as an unrealized loss.

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2011 AICPA Newly Released Questions Financial

46. A company's activities for year 2 included the following: Gross sales Cost of goods sold Selling and administrative expense Adjustment for a prior-year understatement of amortization expense Sales returns Gain on sale of available-for-sale securities Gain on disposal of a discontinued business segment Unrealized gain on available-for-sale securities $3,600,000 1,200,000 500,000 59,000 34,000 8,000 4,000 2,000

The company has a 30% effective income tax rate. What is the company's net income for year 2? a. b. c. d. $1,267,700 $1,273,300 $1,314,600 $1,316,000

Solution: Choice "c" is correct. Net sales Cost of goods sold Gross profit Selling and administrative Operating income Other income (gain on sale) Income from continuing operations Income tax expense Income before discontinued operations 3,566,000 = $3,600,000 gross sales - $34,000 sales returns (1,200,000) 2,366,000 (500,000) 1,866,000 8,000 1,874,000 (562,200) = $1,874,000 x 30% 1,311,800 2,800 = $4,000 x (1 30%)

Gain from discontinued segment (after tax) Net income

1,314,600

The adjustment for the prior year understatement of amortization expense is a prior period adjustment that will be reflected in beginning retained earnings, not on the income statement. The unrealized gain on the available for sale security will be reported in other comprehensive income.

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2011 AICPA Newly Released Questions Financial

47. How should plan investments be reported in a defined benefit plan's financial statements? a. b. c. d. At actuarial present value. At cost. At net realizable value. At fair value.

Solution: Choice "d" is correct. Pension plan investment assets must be reported at fair value in a defined benefit plan's financial statements. Choices "a", "b", and "c" are incorrect. Actuarial present value, cost, and net realizable value are not appropriate bases for measuring pension plan asset investments.

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2011 AICPA Newly Released Questions Financial

48. What is the purpose of reporting comprehensive income? a. b. c. d. To summarize all changes in equity from nonowner sources. To reconcile the difference between net income and cash flows provided from operating activities. To provide a consolidation of the income of the firm's segments. To provide information for each segment of the business.

Solution: Choice "a" is correct. Comprehensive income represents all changes in stockholders' equity that come from nonowner sources. Therefore, comprehensive income includes all net income plus any and all components of other comprehensive income, the PUFER items. However, comprehensive income would not include investments by stockholders (owners) nor would it include distributions or dividends to stockholders (owners) Choices "b", "c", and "d" are incorrect per the explanation above.

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2011 AICPA Newly Released Questions Financial

49. Which of the following is a component of other comprehensive income? a. b. c. d. Minimum accrual of vacation pay. Cumulative currency-translation adjustments. Changes in market value of inventory. Unrealized gain or loss on trading securities.

Solution: Choice "b" is correct. Cumulative currency translation adjustments are reported in other comprehensive income. Choice "a" is incorrect. Vacation pay is a standard operating item that properly affects net income, not OCI. Choice "c" is incorrect. Changes in market value of inventory, in accordance with lower of cost or market (GAAP) or lower of cost or realizable value (IFRS) would also properly affect net income, not OCI. Choice "d" is incorrect. Unrealized gains and loss on trading securities go directly to the income statement. Its unrealized gains and losses on available-for-sale securities that would affect OCI.

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2011 AICPA Newly Released Questions Financial

50. Nongovernmental not-for-profit organizations are required to provide which of the following external financial statements? a. b. c. d. Statement of financial position, statement of activities, statement of cash flows. Statement of financial position, statement of comprehensive income, statement of cash flows. Statement of comprehensive income, statement of cash flows, statement of gains and losses. Statement of cash flows, statement of comprehensive income, statement of unrelated business income.

Solution: Choice "a" is correct. A not for profit organization is required to produce a statement of financial position, statement of activities and statement of cash flows. Voluntary health and welfare organizations must produce a statement of functional expenses as well, however, that statement is not mandatory for other not for profit organizations. Choice "b" is incorrect. A not for profit organization is required to produce a statement of financial position, statement of activities and statement of cash flows. Not for profit organizations do not contemplate the concept of comprehensive income. Choice "c" is incorrect. A not for profit organization is required to produce a statement of financial position, statement of activities and statement of cash flows. Not for profit organizations do not contemplate the concept of comprehensive income. There is no statement of gains and losses. Choice "d" is incorrect. A not for profit organization is required to produce a statement of financial position, statement of activities and statement of cash flows. Not for profit organizations do not contemplate the concept of comprehensive income. Unrelated business income, while highly significant to tax reporting, is not a required component of external GAAP reporting.

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