Conceptual Framework

Theory of Accounts Quizzer
Gloria/Moreno
Instruction: Select the best answer for each of the following items
relating to a variety of issues in financial accounting.
1
The International Accounting Standards Committee (IASC)

a. Directly influences governmental legislation regarding
accounting standards.
b. Develops binding pronouncements for its members.
c. Is composed of members from national standard-setting
bodies.
d. Establishes uniform accounting standards to eliminate
reporting differences among nations.
For international investors, which of the following is not a

potential benefit of a development and adoption of International
Accounting Standards (IASs)
a. Improved ability to make comparisons across enterprises.
b. Greater freedom in the flow of capital across borders.
c. Greater risk premiums for international investors.
d. Fewer competitive advantages due to varying treatments of
items affecting reported earnings.
The measurement basis most often used to report a long-term

payable representing a commitment to pay money at a
determinable future date is
a. Historical cost.
b. Current cost.
c. Net realizable value.
d. Present value of future cash flows.
In December 2004, catalogs were printed for use in a special

promotion in January 2005. The catalogs were delivered by the
printer on December 13, 2004, with an invoice for P70,000
attached. Payment was made in January 2005. The P70,000
should be reported as a deferred cost at the December 31,
2004 balance sheet date because of the
a. Matching principle.
b. Revenue recognition principle.
c. Reliability principle.
d. Cost principle.
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Because of inexact estimates of the service life and residual

value of a plant asset, a fully depreciated asset was sold in
2004 at a material gain. This gain most likely should be
reported
a. In the other revenues and gains section of the 2004 income
statement.
b. As part of sales revenue on the 2004 income statement.
c. In the extraordinary item section of the 2004 income
statement.
d. As an adjustment to prior periods depreciation on the
statement of changes in equity.
Assume that employees confessed to a P200,000 inventory

theft but are not able to make restitution. How should this
material fraud be shown in the financial statements?
a. Classified as a loss and shown as a separate line item in
the income statement.
b. Initially classifies as an account receivable because the
employees are responsible for the goods. Because they
cannot pay, the loss be recognized as a write-off of
accounts receivable.
c. Included in cost of goods sold because the goods are not
on hand, losses on inventory shrinkage are ordinary, and it
would cost the least amount of attention.
d. Recorded directly to retained earnings because it is not an
income-producing item.
The assets of a liquidating enterprise should be shown on the

balance sheet at their
a. Undepreciated historical cost.
b. Fair market value.
c. Realizable value.
d. Current cost.
An enterprise with total asset of P100,000,000 and net profit of

P9,000,000 purchases staplers with an estimated useful life of
10 years for P1,000. In connection with the purchase, the
enterprise debits miscellaneous expense. This scenario is most
Gloria/Moreno
closely associated with which of the following concepts or

principles?
a.
b.
c.
d.
9
Materiality and going concern.

Relevance and neutrality.
Reliability and comparability.
Materiality and the balance between cost and benefit.
An objective of financial reporting is

a. Providing information useful to investors, creditors, donors,
and other users for decision making.
b. Assessing the adequacy of internal control.
c. Evaluating management results compared with standards.
d. Providing information on compliance with established
procedures.
10
What are the effects of an adjusting entry used to accrue

revenue from credit sales?
Assets
Liabilities
Equity
a.
Decrease No effect
Decrease
b.
Increase
No effect
Increase
c.
No effect
Decrease
Increase
d.
No effect
Increase
Decrease
11
A manufacturer receives an advance payment for special-order

goods that are to be manufactured and delivered within the
next year. The advance payment should be reported in the
manufacturers current-year balance sheet as a(an)
a. Current liability.
b. Noncurrent liability.
c. Contra asset amount.
d. Accrued revenue.
12
An enterprise that owns a new professional basketball team

sells season tickets to its teams games. The season last from
November through April, with 10 games played each month. In
2001 the enterprise collected 3 million from season-ticket sales
for the 2001-2002 season. Its fiscal year-end is December 31.
Based on this information, the enterprise should
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a. Report a liability for unearned income for 2 million on its

December 31, 2001 balance sheet.
b. Report a liability for unearned income of 3 million on its
December 31, 2001 balance sheet.
c. Report income of 3 million on its 2001 income statement.
d. Report income of 1 million on its 2002 income statement.
13
An enterprise that sprays chemicals in residences to eliminate

or prevent infestation of insects requires that customers prepay
for 3 months service at the beginning of each new quarter.
Select the term that appropriately describes this situation from
the viewpoint of the enterprise.
a. Unearned income.
b. Earned income.
c. Accrued income.
d. Prepaid expense.
14
The correct order of the following steps of the accounting cycle

is
a. Posting, closing, adjusting, reversing.
b. Posting, adjusting, closing, reversing.
c. Posting, reversing, adjusting, closing.
d. Adjusting, posting, closing, reversing.
15
The purpose of an entry that contains a debit to prepaid

property taxes and a credit to property tax expense is to
recognize a(an)
a. Prepaid expense.
b. Accrued expense.
c. Prepaid income.
d. Expired cost.
16
An enterprise has made all necessary adjusting entries and is

now closing its accounts for the period. Dividends of 30,000
were declared and distributed during the year. The entry to
close the dividends account would be
a. Retained earnings
30,000
Dividends
30,000
b. Dividends
30,000
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Retained earnings
30,000
c. Income Summary
Dividends
d. Dividends
Income Summary
30,000
30,000
30,000
30,000
17
Which of the following statements is a correct description of

reversing entries?
a. The recording of reversing entries is a mandatory step in
the accounting cycle.
b. Reversing entries are made at the end of the next
accounting period, after recording regular transactions of
the period.
c. Reversing entries are identical to adjusting entries made in
the previous period.
d. Reversing entries are the exact opposite of the adjustments
made in the previous period.
18
The practice of recording advance payments from customers

as a liability is an example of applying the
a. Going concern assumption.
b. Monetary unit assumption.
c. Historical cost principle.
d. Revenue recognition principle.
19
An enterprise sells a durable good to a customer on January 1,

2002, and the customer is automatically given a 1-year
warranty. The customers also buy an extended warranty
package, extending the coverage for an additional 2 years to
the end of 2004. At the time of the original sale, the company
expects to be incurred evenly over the life of the warranty
contracts. The customers have only one warranty claim during
the 3-year period, and claim occurs during 2003. The company
will recognize income from the sale of the extended warranty
a. On January 1, 2002.
b. In years 2003 and 2004.
c. At the time of the claim in 2003.
d. December 31, 2004, when the warranty expires.
Gloria/Moreno
20
The major distinction between the multi-step and single-step

income statement formats is the separation of
a. Operating and nonoperating data.
b. Income tax expense and administrative expense.
c. Cost of goods sold expense and administrative expenses.
d. The effect on income taxes of extraordinary items and the
effect on income taxes of profit or loss from ordinary
activities.
21
Which combination below explains the impact of credit card

interest incurred during the period (1) equity on the balance
sheet and (2) the statement of cash flows?
(2)
(1)
Reflected on
Effect on Equity
Statement of
On Balance Sheet
Cash flow as a (n)
a.
Decrease
Investing outflow
b.
Decrease
Operating or financing
outflow
c.
No effect
Financing or investing
outflow
d.
No effect
Operating outflow
22
A reader of a statement of cash flows wishes to analyze the

major classes of gross cash receipts and gross cash payments
from operating activities. Which methods of reporting cash
flows from operating activities will supply that information?
a. Both the direct and indirect methods.
b. Only the direct method.
c. Only the indirect method.
d. Neither method.
23
In the statement of cash flows, the payment of cash dividends

appears in the <List A> activities section as a <List B> of cash.
List A
a.
List B
Operating or investing
6
Source

b.
c.
d.
Operating or financing
Investing or financing
Investing
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Use
Use
Source
Gloria/Moreno
24
In the determination of cost of goods sold, <List A> must be

<List B> cash payments for goods along with other
adjustments.
List A
List B
a.
An increase in
accounts payable
Added to
b.
A decrease in
accounts payable
Added to
c.
An increase in
inventory
Added to
d.
A decrease in
inventory
Subtracted from
25
In reconciling net profit on accrual basis to net cash from

operating activities, what adjustment is needed to net profit
because of (1) an increase during the period in prepaid
expenses and (2) the periodic amortization of premium on
bonds payable?
(1)
(2)
Increase in
Amortization of Premium
Prepaid Expenses
on Bonds Payable
a.
Add
Add
b.
Add
Deduct
c.
Deduct
Add
d.
Deduct
Deduct
26
An enterprise has publicly announced a detailed, formal plan to

dispose in its entirety of a component of the enterprise that
represents a separate major line of business that is distinct
operationally and financially. Which of the following is the
proper treatment of the disclosures that should be made after
the announcement?
a. As part of continuing operations.
b. As a discontinuing operations.
c. As an extraordinary item.
d. As a prior-period item.
Gloria/Moreno
27
Assuming all of the following involve material amounts, which is

most likely to be classified as an extraordinary item in the
income statement?
a. A loss because of an expropriation of assets by a foreign
government.
b. A loss because of adjustments of accruals on long-term
contracts.
c. A gain because of the disposal of assets associated with a
discontinuing operation of a business.
d. A loss because of a lawsuit that resulted from charges of
patent infringement. The company had unsuccessfully
defended a similar suit 5 years ago.
28
An enterprise changes its method of accounting for

depreciation during the current year because it believes that
the result will be a more appropriate presentation in the
financial statements. In its income statement for the year, how
should the enterprise report the adjustment resulting from the
change in accounting policy if the alternative treatment allowed
by the IASs is used?
a. Not disclosed in the financial statements.
b. Reported as an adjustment to beginning retained earnings.
c. Disclosed as a separate type of depreciation expense,
directly following depreciation expense for the current year.
d. Included in the determination of net profit or loss for the
current period.
29
Which of the following is a unique reporting problem associated

with the determination of the results of operations for an interim
period?
a. Advertising and similar costs expensed in one interim
period may benefit other interim periods in the same annual
period.
b. Cost of goods sold for an interim period reflects only the
amount of product cost applicable to sales revenue
recognized in the interim period.
c. Depreciation for an interim period represents an estimate.
d. An extraordinary loss occurring in the second quarter must
be prorated over the last three interim periods of the year.
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30
An extraordinary gain in the second fiscal quarter. How should

the gain be accounted for?
a. Recognized in full in the second quarter.
b. Recognized equally over the second, third and fourth
quarters.
c. Recognized only in the annual financial statements.
d. Recognized equally in each quarter, by restating the first
quarter.
31
A newly plant acquired plant asset is to be depreciated over its

useful life. The rationale for this process is the
a. Economic entity assumption.
b. Monetary unit assumption.
c. Materiality assumption.
d. Going concern assumption.
32
For effective internal control over the disbursement of payroll

checks, an enterprise makes a specific amount of cash
available in checking account for this limited purpose. The type
of account used for this purpose is called a(n)
a. General checking account.
b. Imprest bank account.
c. Lockbox account.
d. Compensating balance.
33
Who is responsible, at all times, for the amount of petty cash

fund?
a. The president.
b. The general office manager.
c. The general cashier.
d. The petty cash custodian.
34
Which of the following is not an appropriate procedure for

controlling the petty cash fund?
a. The petty cash custodian files receipts by category of
expenditure after their presentation to the general cashier
so that variations in different types of expenditures can be
monitored.
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b. Surprise counts of the fund are made from time to time by a

superior of the petty cash custodian to determine that the
fund is being accounted for satisfactorily.
c. The petty cash custodian obtains signed receipts from each
individual to whom petty cash is paid.
d. Upon receiving petty cash receipts as evidence of
disbursements, the general cashier issues a company
check to the petty cash custodian, rather than cash, to
replenish the fund.
35
On an enterprises December 31, 2001 balance sheet, which of

the following items should be included in the amount reported
as cash?
I. A check payable to the enterprise dated January 2, 2002, in
payment of a sale made in December 2001.
II. A check drawn on the enterprises account, payable to a
vendor, dated and recorded in the companys books on
December 31, 2001 but not mailed until January 10, 2002
a. I only.
b. II only.
c. I and II only.
d. Neither I nor II.
36
An enterprise offers its customers credit terms of a 2% discount

if paid within 10 days, or the full balance is due within 30 days
(2/10, n/30). If some customers take advantage of the cash
discount and others and others do not, which of the following
accounts will appear on the income statement if the net method
of recording receivables is employed?
Sales Discounts
Sales Discounts
Forfeited
a.
Yes
Yes
b.
Yes
No
c.
No
No
d.
No
Yes
37
When a right of return exists, an enterprise may recognize

revenue from a sale of goods at the time of sale only if
a. The amount of future returns can be reliably estimated.
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b. The seller retains the risks and rewards of ownership.

c. The buyer resells the goods.
d. The seller believes returns will not be material.
38
If a transfer of receivables with recourse qualities to be

recognized as sale, the proceeds from the sale are
a. Accounted for as a collateralized borrowing.
b. Recorded at fair value for the assets obtained and liabilities
incurred.
c. Recorded at the historical cost of the assets obtained.
d. Reduced by the fair value of the recourse obligation.
39
A transferor enterprise most likely should continue to recognize

a transferred financial asset if
a. The transferor may reacquire the asset, and the asset is
readily obtainable in the market.
b. The transferee may sell or pledge the full fair value of the
asset.
c. The transferor may reacquire the asset, and the
reacquisition price is fair value.
d. The transferor is entitled and obligated to repurchase the
asset, and the transferee receives a lenders return.
40
Which inventory pricing method generally approximates current

costs for each of the following?
Ending
Cost of
Inventory
Goods Sold
a.
FIFO
FIFO
b.
LIFO
FIFO
c.
FIFO
LIFO
d.
LIFO
LIFO
41
The cost of materials has risen steadily over the year. Which of
the following methods of estimating the ending balance of the
materials inventory account will result in the highest net profit,
assuming all other variables remain constant.
a. Last-in, first out (LIFO).
b. First-in, first-out (FIFO).
c. Weighted average.
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d. Specific identification.
42
When a perpetual inventory system is used and a difference

exists between the perpetual inventory amount balance and the
physical inventory count, a separate entry is needed to adjust
the perpetual inventory amount. Which of the following
demonstrates that adjusting entry?
a. Inventory over and short
Inventory
b. Extraordinary loss due to write-down of inventory
Inventory
c. Extraordinary loss due to write-down of inventory
Allowance for inventory shortages
d. Cost of goods sold
Retained earnings appropriated for shortages.
43
When the equity method is used to account for the investment

in an associate, the recording of the receipt of a cash
distribution from the investee will result in
a. The recognition of investment income.
b. A reduction in the investment balance.
c. An increase in a liability account.
d. An increase in a special equity account.
44
Derivatives that are not hedging instruments are always

classified in which category of financial instruments?
a. Financial assets or liabilities held for trading.
b. Held-to maturity investments.
c. Loans and receivables originated by the enterprise.
d. Available-for-sale financial assets.
45
Assuming an available-for-sale financial asset that is not part of

a hedge is remeasured to fair value at the balance sheet, the
gain or loss
a. Must be recognized in net profit or loss.
b. Must be recognized directly in equity.
c. May be recognized in net profit or loss or directly in equity.
d. Must be recognized in net profit or loss if the result is a loss
and directly in equity if the result is a gain.
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Which of the following is not an appropriate basis for measuring

the cost of property, plant, and equipment?
a. The purchase price, freight costs, and installation costs of a
productive asset should be included in the assets cost.
b. Proceeds obtained in the process of readying land for its
intended purpose, such as form the sale of cleared timber,
should be recognized immediately as income.
c. The costs of improvements to equipment incurred after its
acquisition should be added to the assets cost if they
increase future service potential.
d. All costs incurred in the construction of a plant building,
from excavation to completion, should be considered as
part of the assets cost.
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47
In the years after mid-service point of a depreciable asset,

which of the following depreciation methods will result in the
highest depreciation expense?
a. Sum-of-the-years-digits.
b. Diminishing-balance.
c. 200% diminishing-balance.
d. Straight-line.
48
A depreciable asset has an estimated 20% residual value. At

the end of the assets estimated useful life, the accumulated
depreciation will equal the original cost of the asset under
which of the following depreciation methods?
DiminishingSum-of-the-YearsBalance
Digits (SYD)
a.
Yes
Yes
b.
Yes
No
c.
No
Yes
d.
No
No
49
If an enterprise employs the sum-of-the-years-digits (SYD)

method of depreciation for an asset with an estimated useful
life of 4 years, the percentage of the total depreciable cost that
will be expensed in the third year is
a. 10%.
b. 25%.
c. 20%.
d. 70%.
50
An enterprise sells a piece of machinery, for cash, prior to the

end of its estimate useful life. The sale price is less than the
carrying amount of the asset on the date of sale. The entry that
the enterprise uses to record the sale is
a. Cash
Accumulated depreciation machinery
Expense- disposal of machinery
Machinery
b. Cash
Income disposal of machinery
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Machinery
c. Cash
Expensed disposal of machinery
Machinery
d. Cash
Machinery
Expensed disposal of machinery
51
An enterprise installed an assembly line in 1997. Four years

later, 100,000 was invested to automate the line. The
automation increased the market value and productive capacity
of the assemble line but did not affect its useful life. Proper
accounting for the cost of automation should be to
a. Report it as expense in 2001.
b. Establish a separate account for the 100,000.
c. Allocate the cost of automation between the asset and
accumulated depreciation accounts.
d. Debit the cost to the property, plant, and equipment
account.
52
The amortization of the intangible assets over their useful lives

is justified by the
a. Economic entity assumption.
b. Going concern assumption.
c. Monetary unit assumption.
d. Historical cost assumption.
53
Which of the following is not considered to be an intangible

asset?
a. Goods on consignment.
b. Patents.
c. Copyrights.
d. Trademarks.
54
The costs of start-up activities, including fees of attorneys,

should be
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a. Capitalized, but not amortized, because of the indefinite life

of the business.
b. Capitalized and amortized.
c. Capitalized and deferred until liquidation of the business.
d. Expensed when incurred.
55
On December 31, 1997, XYZ issued 5-year bonds with a face

amount of 1 million. The bonds carried a stated interest rate of
10% and were sold at par. Interest is payable annually on
December 31. According to the provision of the bond indenture,
XYZ was to make annual deposits into a bond sinking fund
(beginning December 31, 1998) to accumulate the fund
necessary to retire the bonds at their maturity. On December
31, 2001, all required interest payments and sinking-funds
payments due to date had been made on schedule. If the
sinking-fund assets are properly classified as noncurrent, how
should the balance of bonds payable be classified on the
December 31, 2001 balance sheet?
a. Current liability.
b. Long-term liability.
c. Contra to long-term investments.
d. Deferred credit.
56
A manufacturer produces a quality product for which it charges

a little more than some competing items but gives its
consumers a more liberal warranty policy. The product carries a
5-yaer warranty that covers both labor and material charges.
Which of the followings defines the appropriate method of
accounting for the warranty?
a. Cash basis.
b. Recognition of a provision.
c. Sales warranty.
d. Tax basis.
57
At its balance sheet date, an enterprise reliably estimates that

the expected cost of compensated absences resulting from
short-term disability will be 100,000. This unused entitlement
arose from employees services rendered during the period and
is accumulating. How should it be accounted for?
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a. Only a disclosure should be made because recognition

does not occur until the absences occur.
b. An expense should be recorded for 100,000.
c. An asset of 100,000 should be recognized.
d. A direct reduction to retained earnings of 100,000 should
occur.
58
The publisher of a popular magazine offers a special

discounted price for a 3-year subscription. At the balance sheet
date, the amount that has already been collected but pertains
to future periods is best referred to as
a. Accrued subscription revenue (an asset account).
b. Deferred subscriptions revenue (a liability account).
c. Earned subscriptions revenue (a revenue account).
d. Precollected subscriptions receivable (a deferred asset
account).
59
A cable television enterprise receives deposit from customers

that are refunded when service is terminated. The average
customer stays with the enterprise 8-years. How should these
deposits be shown on the financial statements?
a. Operating revenue.
b. Other revenue.
c. Share capital.
d. Liability.
60
In performing an audit, you encounter an adjusting journal entry

recorded at year-end that contains a debit to rental revenue
and a credit to deferred rental revenue. The purpose of this
journal entry is to record
a. An accrued revenue.
b. An unexpired expense.
c. An expired expense.
d. A liability.
61
Because of defect discovered in its seat belts in December

2001, an automobile manufacturer believes it is probable that it
will be required to recall its products. The final decision on the
recall is expected to be made in March 2002. The cost of the
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recall is reliably estimated to be 2.5 million. How should this

information be reported in the December 31, 2001 financial
statements?
a. As a loss of 2.5 million and a provision of 2.5 million.
b. As an adjustment of the opening balance of retained
earnings equal to 2.5 million.
c. As an appropriation of retained earnings of 2.5 million.
d. It should not be disclosed because it has not yet happened.
62
An enterprise is subject to warranty claims. A reliable estimate

is that between 1 million and 3 million will probably be paid out.
No estimated of loss within this range is most likely than any
other. The enterprise should
a. Make no journal entry at this time.
b. Disclose only a possible loss.
c. Defer a provision of 1 million to 3 million depending on the
applicable national accounting standards.
d. Recognize a provision of 1 million to 3 million depending on
the applicable national accounting standards.
63
Which one of the following will usually be accounted for by

recognizing a provision?
a. Just prior to the balance sheet date, the board decided to
close a division. No implementation steps have been taken.
b. As of the balance sheet date, the board was aware that a
new law would require the enterprise to fit smoke filters to
its factories within the next year. No such filters have been
fitted.
c. A law requires an airline to overhaul its aircraft once every 3
years.
d. Premiums offered to customers
64
Which of the following is not a factor, with respect to pending

litigation, that must be considered in determining whether a
provision should be recognized?
a. The time period in which the underlying cause of action
occurred.
b. The probability of an unfavorable outcome.
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c. The ability to make a reliable estimate of the amount of

loss.
d. The number of parties involved in the litigation.
65
An enterprise is currently being sued by a customer. A reliable

estimate can be made of the costs that would result from a
ruling unfavorable to the enterprise, and the amount involved is
material. The enterprises mangers, lawyers, and auditors
agree that the likelihood of an unfavorable rulings is remote.
The contingent liability
a. Should be disclosed in a note.
b. Should be disclosed as a parenthetical comment in the
balance sheet.
c. Need not be disclosed.
d. Should be disclosed by an appropriation of retained
earnings.
66
If market rates of interest rise after issuance of a bond,

a. The market price of the bond will drop.
b. Interest expense recorded on the bond will rise.
c. Cash interest payments on the bond will rise.
d. The market price of the bond will exceeds its face amount.
67
In November 2001, the vice-president of a local bank reviews

the banks mortgage portfolio prior to the December 31 yearend. The banks largest client has mortgages on buildings in
three cities. The client has incurred net losses for the past 3
years and is now experiencing serious cash flow problems. For
the past 6 months, no payments have been made on any of the
three mortgages. The vice-president reluctantly concludes that
is probable that the full amount of principal and interest will not
be collected. What is the impact of this conclusion on the local
banks 2001 financial statements?
a. No accounting or disclosure of a possible loss in value is
necessary.
b. Contingency note disclosure of a possible impairment is
required.
c. The carrying amount of the mortgages should be reduced,
with a charge directly to retained earnings.
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d. The carrying amount of the mortgages should be reduced,

with a charge to the income statement.
68
An enterprise issues bonds with a 10% coupon rate at a time

when the market interest rate on the bonds of similar risk and
maturity is 15%. The format of the journal entry that the
enterprise would use to record the issuance is
a. Cash
Premiums on bonds payable
Bonds payable
b. Cash
Premium on bonds payable
Bonds payable
c. Cash
Discount on bonds payable
Bonds payable
d. Cash
Discount on bonds payable
Bonds payable
69
If bonds are initially sold at a discount and the effective-interest

method of amortization is used,
a. Interest expense in the earlier periods will be less than
interest expense in the later periods.
b. Interest expense inn the earlier periods will be greater than
interest expense in the later periods.
c. Interest expense will equal the cash interest payment each
period.
d. Interest expense will be less than the cash interest payment
each period.
70
If bonds payable with a carrying amount equal to par value are

refunded by use of a call provision, the call premium of a
refunded issue should be
a. Amortized over the remaining original life of the
extinguished issue.
b. Amortized over the life of the new issue.
c. Recognized currently in net profit or loss as an
extraordinary item.
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d. Recognized currently in net profit or loss.

71
An enterprise most likely may derecognize a financial liability if

it
a. Transfers amounts to a trust to be used to repay the
obligation.
b. Exchanges debt instruments with the lender with
substantially similar terms.
c. Exchanges debt instruments with the lender with
substantially different terms.
d. Transfers amounts in a transaction that meets the
requirements of an in-substance defeasance.
72
How will net profit or loss be affected by the amortization of a

premium on bonds payable?
a. Interest expense is decreased, so net profit or loss is
increased.
b. Interest expense is increased, so net profit or loss is
decreased.
c. Interest income is increased, so net profit or loss is
increased.
d. Interest income is decreased, so net profit or loss is
decreased.
73
What is the preferred method of handling unamortized

discount, unamortized issue costs, and the costs of
implementing a conversion of debt into common shares?
a. Expense them in the periods bonds are converted.
b. Amortize them over the remaining life of the issue retired.
c. Amortize them over a period not to exceed 40 years.
d. Charge them to share premium in excess of the par value
of the shares issued.
74
Enterprise X effects self-insurance against loss from fire by

appropriating an amount of retained earnings each year equal
to the amount that would otherwise be paid out as fire
insurance premiums. The procedure used by Enterprise X is
a. Prohibited for external reporting purposes.
22
Gloria/Moreno
b. Acceptable provided that fire losses are not charged

against the appropriation.
c. Acceptable provided that fire losses are charged against
the appropriation.
d. Acceptable if eh amount is shown outside the equity section
of eh balance sheet.
75
Unlike a share split, a share dividend requires a formal journal

entry in the financial accounting records because share
a. Dividends increase the relative carrying amount of an
individuals share holding.
b. Splits increase the relative carrying amount of an
individuals share holdings.
c. Dividends are payable on the date they are declared.
d. Dividends represent a transfer from retained earnings to
share capital.
76
Changes in accounting estimates are viewed as

a. Extraordinary items.
b. Errors in reported amounts in prior periods.
c. Catch-up adjustments related to amounts reported in prior
periods.
d. Normal recurring revisions.
77
The following statement notes are extracts from the audited

financial statements of public enterprises. Which note
describes a change in accounting estimate?
a. The enterprise changed its amortization of capital assets
based on a reassessment of the useful lives of the assets.
Accordingly, the enterprise changed its rate of amortization
from 5% and 6% to 8% and 10%, for machinery and
equipment.
b. Prior to 2001, plant and equipment (other than customer
service replacement parts) were depreciated using the
diminishing-balance method. Plant and equipment are now
depreciated on a straight-line basis.
c. During the year, the enterprise changed its method of
accounting for noninterest-bearing note, nonrecourse loans
23
Gloria/Moreno
due from employees, pursuant to a change in an

International Accounting Standard.
d. Effective January 1, 2001, the enterprise changed to the
LIFO method of inventory valuation. Prior to 2001, the FIFO
method was used.
78
When financial statements are being prepared, which of the

following items requires that accountants estimate the effects of
future conditions and events?
a. The purchase price for an acquired building.
b. The price of a marketable security.
c. The amount of recoverable mineral reserves.
d. The physical quantity of inventory.
79
In the prior accounting period, an enterprise incorrectly

expensed a newly purchased piece of equipment rather than
establishing an asset balance and beginning to depreciate it
over the estimated useful life of the item.
a. Debit equipment
Credit retained earnings
Credit accumulated depreciation-equipment
b. Debit retained earnings
Debit accumulated depreciation-equipment
Credit accumulated depreciation-equipment
c. Debit equipment
Debit accumulated depreciation-equipment
Credit equipment
80
In accordance with the benchmark treatment of a change in

accounting policy, when an enterprise changes to the last-in,
first-out (LIFO) method of inventory valuation, the most likely
reason for not restating prior-year financial statements is that
restatement would
a. Be impracticable.
b. Reduce the usefulness of prior-period statements.
c. Not change the resulted report.
d. Reduce prior years net profit.
24
Gloria/Moreno
81
A retrospective change in an accounting change policy in the

current period should accounted for in comparative reports by
a. An adjustment directly to retained earnings and restatement
to prior years statements.
b. A line item on the current income statement for the
cumulative effect of the change.
c. Presentation of pro forma comparative information.
d. Note disclosure only in the current period.
82
An accounting change requiring retrospective treatment is a

change in
a. The residual value of equipment.
b. Depreciation methods from straight-line to diminishingbalance.
c. An accounting policy inseparable from a change in an
accounting estimate.
d. A provision for warranty costs.
Which of the following describes a fundamental aspects of an
employers accounting for post employment benefits provided
by a defined benefit plan?
a. Changes in assets and obligations are recognized
immediately.
b. The amount of benefits is not precisely determinable.
c. Expense (or income) is recognized in the income statement
within maximum and minimum limits.
d. Immediate recognition in the balance sheet of the present
value of the defined benefit obligation.
83
84
Which of the following statements is true for defined

contribution postemployment benefit plan?
a. The employer is required to contribute a certain amount
each period based on the plans formula.
b. The employer bears the risk of the plans investment
performance.
c. Postemployment benefits received by employees are
defined by the plans formula.
d. The employer and the employees are required to contribute
equal amounts to the fund.
25
Gloria/Moreno
85
The defined postemployment benefit obligation of an enterprise

includes benefit obligations to <List A> employees at <List B>
salary levels.
List A
List B
a.
Vested
Current
b.
Vested
Future
c.
Vested and nonvested
Current
d.
Vested and nonvested
Future
86
An employees right to obtain postemployment benefits

regardless of whether (s)he remains employed is known as
his/her
a. Past service cost.
b. Defined benefit plan.
c. Vested benefits.
d. Additional minimum liability.
87
An employer sponsors a defined postemployment benefit plan.

If the given amount of the present value of the defined benefit
obligation exceeds the given amount of the fair value of plan
assets, the defined benefit liability to be recognized in the
balance sheet is greatest when the employer has
a. Net unrecognized actuarial gains and no past service cost.
b. Net unrecognized actuarial losses and no past service cost.
c. Net unrecognized actuarial losses and unrecognized past
service cost.
d. No unrecognized actuarial gains losses and unrecognized
past service cost.
88
If a lease agreements transfers substantially all of the risks and

rewards of ownership of the asset to the lessee, the asset
value is recognized on the lessees record as a(an) <List A>
asset, and the lease is referred to as a <List B> lease.
List A
List B
a.
Tangible
Finance
b.
Intangible
Finance
c.
Tangible
Operating
d.
Intangible
Operating
26
Gloria/Moreno
89
Finance and operating leases differ in that the lessor

a. Obtains a use of the asset only under a finance lease.
b. Is using the lease as a source of financing only under an
operating lease.
c. Makes rent payments that are actually installment
payments constituting a payment of both principal and
interest only under a finance lease.
d. Finance the transaction through the leased asset only
under a finance lease.
90
Which of the following statements is not true of a finance

lease?
a. The lessor capitalized the net investment in the lease.
b. The lessor records the leased items as an asset.
c. The lessee records depreciation or finance cost allowance
on the leased asset.
d. The lease arrangement represents a form of financing.
91
At the inception of a finance lease, how should the lessee

account for guaranteed residual value?
a. As part of minimum lease payment at the present value.
b. As part of minimum lease payment at future value.
c. As part of minimum lease payment at future value of an
annuity due.
d. As not part of the lease contract.
92
An enterprise has a high a fixed-assets turnover ratio. What

conclusions can a financial analyst draw from this?
a. The enterprise may be overcapitalized.
b. The enterprise may have a problem with employees
converting inventory to personal use.
c. The enterprise may be undercapitalized.
d. The enterprise has favorable profitability.
93
An enterprises receivable collection period is equal to

a. The inventory conversion period.
b. The cash conversion cycle.
c. The days sales outstanding.
d. The inventory divided by average daily sales.
27
Gloria/Moreno
94
The times-interest-earned ratio is primarily an indication of

a. Solvency.
b. Liquidity.
c. Asset management.
d. Profitability.
95
Which of the following is true about the impact of price inflation

on financial ratio analysis?
a. Inflation has no impact on financial ratio analysis.
b. Inflation affects financial ratio analysis for one enterprise
over time but not comparative analysis of enterprises of
differences ages.
c. Inflation affects financial ratio analysis for one enterprise
over time, as well as comparative analysis of enterprises of
different ages.
d. Inflation affects comparative analysis of enterprise of
different ages but not financial ratio analysis for one
enterprise over time.
An investor has been given several financial ratios for an
enterprise but none of the financial reports. Which combination
of ratios can be used to derive return on equity?
a. Market-to-book-value ratio and total-debt-to-total-assets
ratio.
b. Price-to-earnings ratio, earnings per share, and net profit
margin.
c. Price-to-earnings ratio and return-on-assets ratio.
d. Net profit margin, total assets turnover, and equity
multiplier.
96
97
Which one of the following statements best describes the

asset-liability method of accounting for deferred income taxes?
a. The amount of deferred tax is based on tax rates in effect
when temporary differences originate.
b. The amount of deferred tax is based on the tax rates
expected to be in effect during the periods in which the
deferred tax liability is settled or the deferred tax asset is
realized.
28
Gloria/Moreno
c. The tax effects of temporary differences are not reported

separately but are reported as adjustments to the amounts
of specific asset and liabilities and the related revenues and
expenses.
d. The appropriate tax rate to be reported on the income
statement is the tax actually levied in that year, meaning no
deferred taxes would be reported.
98
Which one of the following temporary differences will result in a

deferred tax asset?
a. Use of the straight-line depreciation method for determining
accounting profit and an accelerated for determining
taxable profit (tax loss)
b. Installment sale profits accounted for on the accrual basis
for determining accounting profit and on a cash basis for
determining taxable profit (tax loss).
c. Advance rental receipts accounted for on the accrual basis
for financial statement purpose and on cash basis for tax
purposes.
d. Prepaid expenses accounted for on the accrual basis for
determining accounting profit and on a cash basis for
determining taxable profit (tax loss).
When a change in the tax law or rate occurs, the effect of the
change on a deferred tax liability or asset is
a. Not recognized.
b. Recognized as an adjustment only as of enactment date of
the change.
c. Recognized as an adjustment as of the date the change is
enacted or substantively enacted.
d. Recognized retrospectively.
99
100
When an enterprise reports deferred tax assets and liabilities,

deferred tax expense or income should be disclosed equal to
the
a. Decrease in the deferred tax assets.
b. Sum of the net changes in deferred tax assets and
deferred tax liabilities.
c. Increase in the deferred tax liabilities.
d. Amount of the total tax liability.
29

101
Gloria/Moreno
A service enterprise keeps its accounting records on a cash

basis. During 2001, the enterprise collected 600,000 from
customers. The following information is also available:
Accounts Receivable
Unearned Revenue
Beginning of End of Year

Year
120,000
180,000
0
15,000
What was the amount of service revenue for the year on an

accrual basis?
a. 525,000
b. 555,000
c. 645,000
d. 675,000
102
The required adjusting entry at December 31, 2001, related to

salaries and wages is
a. Salaries & wages expense
Income summary
b. Salaries & wages payable
Salaries & wages expense
c. Salaries & wages expense
Salaries & wages payable
d. Income summary
Salaries & wages payable
103
1,700
1,700
1,700
1,700
1,700
1,700
1,700
1,700
The journal entry required to close the utilities expense account

is
a. Utilities expense
14,000
Income summary
14,000
b. Income summary
14,000
Utilities expense
14,000
c.
Rental revenue
14,000
Utilities expense
14,000
d.
Utilities expense
14,000
30
Gloria/Moreno
Retained earnings
104
14,000
Which adjusting entry should be used at year-end to account

for interest expense on the long-term debt?
a. Interest expense
Interest payable
100,000
100,000
b. Interest expense
Cash
105
50,000
50,000
c.
Interest payable
Interest expense
d.
Interest expense
Interest payable
100,000
100,000
50,000
50,000
Assume that the enterprise reports cost of goods sold of

200,000 and interest expense of 10,000 for the current period.
Also assume a 50% tax rate on corporate earnings. The final
closing entry required to ensure that current earnings are
incorporated into year-end retained earnings is
a. Income summary
Retained earnings
140,000
b. Retained earnings
280,000
31
140,000
Gloria/Moreno
Income summary
106
c. Income summary
Retained earnings
240,000
d. Retained earnings
Income summary
240,000
240,000
145,000
165,000
175,000
185,000
At January 1, 2001, a sole proprietorships assets totaled

210,000, and its liabilities amounted to 120,000. During 2001,
owner investments amounted to 72,000, and owner
withdrawals totaled 75,000. At December 31, 2001, assets
totaled 270,000, and liabilities amounted to 171,000. The
amount of net profit for 2001 was
a.
b.
c.
d.
108
240,000
An enterprise had cash receipts from sales of 175,000 during

2001, of which 30,000 was unearned at the end of 2001. At the
end of 2000, the company had 40,000 of unearned revenue, all
of which was earned in 2001. The companys sales revenue for
2001 would be
a.
b.
c.
d.
107
280,000
0
6,000
9,000
12,000
An enterprise has a 50% gross margin, general and

administrative expenses of 50, interest expense of 20, and net
profit of 10 for the year ended. If the corporate tax rate is 50%,
the level of sales for the year just ended was
a. 90
b. 135
c. 150
32
Gloria/Moreno
d. 180
109
The comparative balance sheet for an enterprise that had net

profit of 150,000 for the year ended December 31, 2001, and
paid 125,000 of dividends during 2001 is as follows:
Cash
Accounts receivable
Total assets
12/31/01
12/31/00
150,000
180,000
200,000
220,000
350,000
400,000
Payables
Share Capital
Retained earnings
Total
80,000
130,000
140,000
350,000
160,000
125,000
115,000
400,000
If dividends paid are treated as a cost of obtaining financial resources,

the amount of net cash from operating activities during 2001 was
a.
b.
c.
d.
110
70,000
90,000
150,000
210,000
A corporation reported salaries expense of 190,000 for

December 2001. The following data are from its records:
Dec. 31. 2001
Nov. 30, 2001
46,000
40,000
170,000
140,000
Prepaid salaries
Salaries payable
a.
b.
c.
d.
154,000
166,000
214,000
226,000
33

111
Gloria/Moreno
The following information pertains to a checking account of an

enterprise at July 31, 2001:
Balance per bank statement
Interest earned for July
Outstanding checks
Customers check returned for insufficient funds
Deposit in transit
40,000
100
3,000
1,000
5,000
At July 31, 2001, the correct cash balance is

a.
b.
c.
d.
112
41,100
41,000
42,100
42,000
An internal auditor is deriving cash flow data based on an

incomplete set of facts. Bad debt expense was 2,000.
Additional data for this period follow:
Net profit
Accounts receivable beginning balance
Allowance for bad debts beginning balance
Accounts receivable written off
Increase in net accounts receivable (after
subtraction of allowance for bad debts)
100,000
5,000
(500)
1,000
30,000
How much cash was collected this period?

a.
b.
c.
d.
113
67,000
68,500
68,000
70,000
An analysis of an enterprises 150,000 accounts receivable at

year-end resulted in a 5,000 ending balance for its allowance
for uncollectible accounts and a bad debt expense of 2,000.
34
Gloria/Moreno
During the past year, recoveries on bad debts previously

written off were correctly recorded at 500. If the beginning
balance in the allowance for uncollectible accounts was 4,700,
what was the amount of accounts receivable written off as
uncollectible during the year?
a.
b.
c.
d.
114
1,200
1,800
2,200
2,800
At the end of September, an enterprise has outstanding

accounts receivable of 350 on third-quarter credit sales,
composed as follows:
Month
July
August
September
Still outstanding
at the End of
Credit Sales
September
600
100
900
170
500
80
The percentage of receivable in the 31-to-60-day age group at

the end of September is
a.
b.
c.
d.
115
22.86%
28.57%
48.57%
71.43%
An enterprise sells inventory for 80,000 that had an inventory

cost of 40,000. The terms of the sale involve payments
receivable of 10,000 in the first year, 45,000 in the second year,
and 25,000 in the third year. The buyer of the inventory is a
new firm with no credit history. If the cost-recovery method of
revenue recognition is used, the amount of gross profit to be
recognized in the second year is
35

a.
b.
c.
d.
116
Gloria/Moreno
0
5,000
15,000
45,000
The following amounts relate to an enterprise:

Beginninh inventory
Purchases
Sales
Gross margin
50,000
170,000
180,000
60,000
The amount of ending inventory is

a.
b.
c.
d.
117
60,000
100,000
120,000
160,000
A retail enterprise maintains a markup of 25% based on cost.

The enterprise has the following information for 2001:
Purchase of merchandise
Freight-in on purchases
Sales
Ending inventory
690,000
25,000
900,000
80,000
Beginning inventory was

e. Decrease in the deferred tax assets.
f. Sum of the net changes in deferred tax assets and
deferred tax liabilities.
g. Increase in the deferred tax liabilities.
h. Amount of the total tax liability.
36
ANSWER EXPLANATIONS
37
Gloria/Moreno
.
Letter D is the correct answer.
The objective of the establishment of the IASC is to harmonize accounting
standards used by member countries. As of 1999, its members included
accountancy bodies representing 103 countries around the world. As of June
2000, it had issued 40 standards. An affirmative vote equal to three-fourths of
the IASCs board is required to pass a standard. The IASCs pronouncements,
however, is not binding.
Letter A is incorrect because the IASC has no direct influence on governmental
legislation. Letter B is incorrect because the IASC authority is restricted to the
willingness of participating and other countries to adopt its standards. Letter C
is incorrect because the IASC is composed of members from various national
professional accounting organizations, such as PICPA.
.
Letter C is the correct answer.
Differences in accounting standards among countries result from variations in
institutional arrangements, nationalistic tendencies, and divergent reporting
objectives. Nevertheless, the value of greater uniformity in standards has been
recognized. For example, given more comparable financial measurement and
disclosure practices, international investors will most likely require lower, not
higher, risk premiums. Higher risk premiums result in higher costs of equity
financing. Thus, they are obviously not an advantage of developing and
adopting International Accounting Standards.
Letters A and B are incorrect because both increased comparability and greater
freedom of international capital flows are potential benefits of the development
and adoption of IASs. Letter D is incorrect because the elimination of unfair
competitive advantages created by differences in reporting standards is a
potential benefit of IASs.
.
The measurement basis most commonly used by enterprises in the preparation
of financial statements is historical cost. However, it is usually combined with
other measurement bases (attributes). The attribute used to measure a longterm receivable or payable is the present or discounted value of its future cash
flows.
Letter A is incorrect because historical cost is used to measure property, plant,
and equipment and most inventories. Letter B is incorrect because some
inventories are measured at current (replacement) cost. Letter C is incorrect
because short-term receivables and some inventories are reported at net
realizable value.
.
Letter A is the correct answer.
Matching is the simultaneous or combined recognition of revenues and
expenses resulting directly and jointly from the same transactions or other
events. Expenses should be associated with the revenues that they help to
create. Because the catalogs are still on hand at the balance sheet date, they
will not contribute to an inflow of economic benefits until the next period.
Hence, the cost should be deferred and matched with the revenues of the
following period.
Letter B is incorrect because the revenue recognition principle determines the
period in which revenue is recognized. Letter C is incorrect because reliable
information is free of error and bias and is representationally faithful. Letter D is
incorrect because the transaction is not the correction of a fundamental error in
the financial statements of a prior period.
Income includes revenues and gains. Their essential nature is the same, and
they are not treated as separate financial statement elements. Revenues occur
in the course of ordinary activities. Gains may or may not occur in the course of
ordinary activities. For example, gains may occur from the sale of noncurrent
assets. Thus, the gain on the sale of a plant asset is not an operating item and
should be classified in an income statement with separate operating and
nonoperating sections in the other revenues and gains section.
Letter B is incorrect because the asset sold was not stock in trade. Letter C is
incorrect because the transaction does not meet the criteria of an extraordinary
item. Letter D is incorrect because the transaction is not the correction of a
fundamental error in the financial statements of a prior period.
6
.
Expenses include losses. Their essential nature is the same, and they are not
treated as separate financial statement elements. Losses may or may not occur
in the course of ordinary activities. For example, they may result from
nonreciprocal transactions (e.g., theft), reciprocal transactions (e.g., sale of
plant assets), or from holding assets or liabilities. Losses are typically displayed
separately.
Letter B is incorrect because no restitution will be made. Thus, recording the
item as a receivable, then writing it off, is not consistent with the substance of
the event. Letter C is incorrect because, although some inventory shrinkage is
expected in the normal course of processing, fraud is abnormal. Hence, the
item should be recorded as a loss. Letter D is incorrect because losses are
included in the determination of net profit or loss.
.
When liquidation is imminent, and the going concern assumption is no longer
valid, the most appropriate valuation method for assets is realizable value,
which is the amount of cash currently obtainable by sale in an orderly disposal.
Letter A is incorrect because a going concern should report assets at their
undepreciated historical cost.
When liquidation appears imminent, historical
cost is abandoned for balance sheet purposes. Letter B is incorrect because an
enterprise facing liquidation is expected to dispose of its assets in a forced or
distressed sale and is unlikely to realize the fair value amount. The net
realizable value of the assets is the appropriate amount for reporting purposes.
Letter D is incorrect because current cost is only appropriate when the going
concern assumption is applicable and the effects of changing prices are to be
measured and reported in the financial statements.
.
In principle, wasting assets should be capitalized and depreciated. However,
the effect on the financial statements of expensing rather than capitalizing and
depreciating the staplers is clearly not material given that they cost P1,000 and
the enterprise has total assets of P100,000,000. The choice of treatment is not
large enough to influence the decisions of financial statement users. The
balance between benefit and cost is a pervasive constraint, not a qualitative
characteristic. The benefits should exceed the cost of information. Specifically,
the cost of producing the information about depreciation expense over 10 years
for the staplers probably is higher than the benefits of the information for
decision making. Thus, the expedient procedure of expensing the P1,000
should be followed.
Letter A is incorrect because the going concern principle relates to
circumstances in which there is doubt as to the viability of the enterprise.
Letter B is incorrect because relevance and reliability are two of the principal
qualitative characteristics of information in financial statements. Information is
relevant if it permits users to predict the outcome of future events or confirm or
correct their prior expectations.
Reliability provides assurance that the
information is reasonably free from error and bias and represents what it
purports to represent. Thus, reliable information must be neutral, that is, free
from error and bias. Letter C is incorrect because comparability is a principal
qualitative characteristic. Financial statements must be comparable for the
same enterprise over time and also among different enterprises. Information is
relevant if it permits users to predict the outcome of future events or confirm or
correct their prior expectations.
9
.
The objectives of financial reporting are concerned with the underlying goals
and purposes of accounting and these are to provide information that (a) is
useful to those making investment and credit decisions, assuming that those
individuals have a reasonable understanding of business and economic
activities; (b) is helpful to current and potential investors and creditors and
other users in assessing the amount, timing, and uncertainty of future cash
flows; and (c) discloses economic resources, claims to those resources, and the
changes therein.
Letters B, C, and D are incorrect because assessing the adequacy of internal
control, evaluating management results compared with standards, and
providing information on compliance with established procedures are functions
of internal auditing, not financial reporting.
10
.
Letter B is the correct answer.
The journal entry to accrue revenue requires a debit to a receivable account and
a credit to a revenue account. Thus, the accrual of revenue increases assets
and equity.
Letters A, C, and D are incorrect because the accrual of revenue increases
assets, increases equity, and has no effect on liabilities.
11
.
Recognition of an element of financial statements (e.g., income, which includes
revenue and gains) requires that two criteria be met. It must be probable that
any future economic benefit associated with the item will flow to or from the
enterprise, and the cost or value of the item must be measurable with reliability.
The usual procedures for income recognition, e.g., that income be earned,
reflect these criteria. Thus, income is recognized when an increase in future
economic benefits is associated with an increase in an asset or a decrease in a
liability. However, the enterprise has not substantially completed what it must
do to be entitled to the benefits represented by the advance payment, and the
receipt of future economic benefits is not sufficiently certain to merit income
recognition. Accordingly, a liability should be recognized because the entity has
a current obligation arising from a past event that will require an outflow of
economic benefits, that is, to deliver goods or to refund the customers money.
The delivery of goods is to take place within a year of the balance-sheet date;
therefore, the obligation is expected to be settled in the normal course of the
operating cycle or is due to be settled within 12 months.
Letter B is incorrect because the obligation is current.
Letter C is incorrect because a contra account reduces the valuation of the
related account.
Letter D is incorrect because the payment has not met the income recognition
criteria.
12
.
The collections represent a liability (unearned income). The income recognition
criteria are not met with respect to the season ticket collections until the receipt
of future economic benefits is sufficiently certain. Such certainty exists with
respect to collections related to the games played as of the balance sheet date.
Accordingly, the enterprise should recognize 1 million as income in 2001 [2
months x (3,000,000 6 months)]. The remaining 2 million should be reported
as a liability.
Letter B is incorrect because the liability at the end of 2001 is 2 million.
Letters C and D are incorrect because the enterprise should report income of 1
million in 2001 and 2 million in 2002.
13
.
The prepayment does not meet the income recognition criteria because the
future inflow of economic benefits is not sufficiently certain given that the
enterprise has not done what is required to be entitled to those benefits. Thus,
the amount receive in advance is considered a liability (unearned income)
because it represents an obligation to perform a service in the future arising
from a past transaction.
Letter B is incorrect because the income is not earned. The exterminator has not
performed the related services for the customer.
Letter C is incorrect because accrued income has met the recognition criteria
but has not been received.
Letter D is incorrect because the customer has a prepaid expense (expense paid
but not incurred).
14
.
Letter B is correct answer.
The order of the steps in the accounting cycle is identification and measurement
of transactions and other events required to be recognized, journalization,
posting from the journals to the ledgers, the development of a trial balance,
adjustments to produce an adjusted trial balance, statement presentation,
closing, taking a postclosing trial balance (optional), and making reversing
entries (optional).
Letter A is incorrect because adjusting entries are made prior to closing.
Letter C is incorrect because reversing entries are made after adjustments and
closing entries.
Letter D is incorrect because posting is done prior to adjusting.
15
.
An entry debiting prepaid property taxes and crediting property tax expensed is
needed at the balance sheet date when prepayments are initially recorded in an
expense account. This adjusting entry defers expense recognition to the future
period in which the property taxes apply.
Letters B and C are incorrect because the entry records an asset.
Letter D is incorrect because the entry records an unexpired cost (an asset).
.
Assuming an account entitled dividends or dividends declared is debited
when dividends payable is credited on the declaration date, it must be closed at
the end of the period. The balance in this account is closed directly to retained
earnings. The effect of declaring and paying dividends is to reduce retained
earnings, so the entry is a debit to retained earnings and a credit to dividends.
Letter B is incorrect because the closing entry should credit dividends and debit
retained earnings.
Letter C is incorrect because dividends is closed directly to retained earnings.
Letter D is incorrect because dividends is closed directly to retained earnings by
a credit.
16
17
.
Reversing entry are made at the beginning of a period to reverse the effects of
adjusting entries at the end of the preceding period. They are optional entries
made for the sake of convenience in recording the transactions of the period. In
order for reversing entries to reverse the prior adjustments, they must be the
exact opposite of the adjustments made in the previous period.
Letter A is incorrect because reversing entries are optional.
Letter B is incorrect because reversing entries are made at the beginning of the
next accounting period.
Letter C is incorrect because reversing entries are the exact opposite of the
adjustments made in the previous period.
18
.
Recognition of revenue occurs when the flow of future economic benefits to the
enterprise is probable and such benefits are reliably measurable. Recording
advance payment as a liability reflects a determination that the receipt of future
economic benefits is not sufficiently certain to merit revenue recognition, given
that the enterprise has not yet performed its obligations.
Letter A is incorrect because the going concern assumption is that the business
will have an indefinite life.
Letter B is incorrect because the monetary unit assumption is that money is the
common denominator by which economic activity is conducted and that the
monetary unit provides an appropriate basis for accounting measurement and
analysis.
Letter C is incorrect because the historical cost principle reflects the practice
that many assets and liabilities are accounted for and reported on the basis of
acquisition price.
19
.
Because warranty costs are expected to be incurred evenly over the life of the
warranty contracts, the income should be recognized on the straight-line basis
over the life of the extended warranty contract.
Letter A is incorrect because the recognition of income from the sale of the
extended warranty is deferred until the extended warranty period begins.
Letter C is incorrect because the income should be recognized evenly over the
life of the contract. It is not related to the timing of the claims.
Letter D is incorrect because income is recognized over the life of the warranty,
not at expiration.
20
.
The IASs do not require a particular income statement format, although, at a
minimum, certain line items must be presented, including one for the results of
operating activities. The single-step income statement provides one grouping
for income items and one for expense items. The single step is the one
subtraction necessary to arrive at net profit or loss. The multiple-step income
statement matches operating income and expenses separately from
nonoperating items.
Letters B and C are incorrect because both formats separate these items.
Letter D is incorrect because intraperiod income tax allocation procedures must
be applied to both formats.
21
.
Interest incurred is classified as interest expense on the income statement,
which in turn reduces equity on the balance sheet by reducing retained
earnings. According to IAS 7, cash payments for interest made by an enterprise
that is not a financial institution may be classified on the statement of cash

flows as an outflow of cash from operating or financing activities.
Letters A, C and D are incorrect because credit card interest charges reduce
equity, and interest payment are classified as an operating or financing outflow
on the statement of cash flows.
22
.
The statement of cash flows may report cash flows from operating activities in
either an indirect or direct format. The direct format reports the major classes of
operating cash receipts and cash payments as gross amounts the indirect
presentation adjusts net profit or loss to the same amount of net cash from
operating activities that would be determined in accordance with the direct
method. To arrive at this amount, the indirect method adjusts net profit or loss
for the effects of noncash transactions, deferrals or accruals of past or future
operating cash flows, and income or expense related to financing or investing
activities.
Letter A is incorrect because only the direct method supplies information about
major classes of gross cash receipts and payments related to operating
activities.
Letter C is incorrect because the direct method, rather than the indirect method,
supplies information about major classes of gross cash receipts and payments
related to operating activities.
Letter D is incorrect because the direct method reports major classes of gross
cash receipts and payments from operating activities.
23
.
According to IAS 7, dividends paid may be treated as a cash outflow from
financing activities because they are a cost of obtaining resources from owners.
However, they may also be treated as operating items to help determine the
enterprises ability to pay dividends from operating cash flows.
Letters A, C and D are incorrect because payment of cash dividends is a use of
cash for an operating or financing activity.
24
.
To convert from the cash basis (cash payments) to the accrual basis (cost of
goods sold), an increase in accounts payable must be added to cash payments
for goods to determine net purchases. Net purchases is then adjusted for the
change to determine cost of goods sold.
Letter B is incorrect because a decrease in accounts payable must be
subtracted from, not added to, cash payments.
Letter C is incorrect because an increase in inventory must be subtracted from,
not added to, cash payments to calculate cost of goods sold.
Letter D is incorrect because a decrease in inventory must be added to, not
subtracted from, cash payments to calculate cost of goods sold.
25
.
An increase in prepaid expenses indicates that cash outlays for expenses
exceeded the related expense incurred; thus, net profit exceeded net cash from
operating activities, and a deduction is needed in the reconciliation. Also, the
amortization of premium on bonds payable causes a reduction of interest
expense but does not increase cash; therefore, net profit exceeds net cash from
operating activities, and a deduction is needed in the reconciliation.
Letters A, B and C are incorrect because both the increase in prepaid expenses
and amortization of premium on bonds payable require a deduction from net
profit in the reconciliation.
.
A discounting operation (DO) is a separate major line of business or
geographical operating area that is distinct for operational and reporting
purposes. Furthermore, it is a component that the enterprise is disposing of
under a single plan. The initial disclosure event (IDE) is the earlier of entry into a
binding agreement to sell substantially all of the DOs assets or the approval
and announcement by the enterprises governing body of a detailed, formal
plan of discontinuance. Disclosures about a DO should be included in the
financial statements beginning with period of the IDE.
Letter A is incorrect because the component is to be terminated (discontinued).
Letter C is incorrect because discontinuing operations are not extraordinary
items. They are not clearly distinct from ordinary activities.
Letter D is incorrect because disclosures begin with the period of the IDE.
26
27

Net profit or loss includes profit or loss from ordinary activities and
extraordinary items. Both are disclosed on the face of the income statement.
Extraordinary items result from events or transactions that are clearly different
from ordinary activities and are not expected to recur frequently and regularly.
Examples are an expropriation of assets or a natural disaster. Each
extraordinary item is separately disclosed. However, a total may be disclosed
on the income statement if the nature and amount of each item are disclosed in
the notes.
Letters B, C and D are incorrect because an extraordinary item must be clearly
different from ordinary activities.
28
.
Under IAS 8, Net Profit or Loss for the Period, Fundamental Errors, and Changes
in Accounting Policies, the benchmark treatment provides that a change in
accounting policy should be applied retrospectively unless any resulting
adjustments that relates to prior periods is not reasonably determinable. If the
adjustment to the opening balance of retained earnings cannot be reasonably
determined, the change in accounting policy should be applied retrospectively.
Given that the benchmark treatment is not indicated, the allowed alternative
treatment, that is, a cumulative-effect adjustment included in the determination
of current net profit or loss, is permissible unless the amount to be included in
current net profit or loss is not reasonably determinable. In that case, the
allowed alternative treatment provides for the change in accounting policy to be
applied prospectively. In the current period, a change in depreciation methods is
reported by a cumulative-effect adjustment under the allowed alternative
treatment. Pro forma comparative information also should be presented if
practicable.
Letter A is incorrect because changes in accounting policies must be disclosed
in the financial statements for the period.
Letter B is incorrect because the benchmark treatment reports an adjustment to
beginning retained earnings.
Letter C is incorrect because the cumulative-effect on net profit or loss should
be reported.
29
.
Costs and expenses other than product costs should be either changed to
income in interim periods as incurred or allocated among interim periods based
upon the benefits received. Accordingly, costs such as advertising should be
deferred in an interim period if the benefits extend beyond that period;
otherwise, they should be expensed as incurred. But such a determination is
difficult, and deferral raises the additional issue of how the deferred costs
should be allocated among quarters. 0Thus, many companies expense the costs
as incurred even though they may benefit other interim periods in the same
annual period.
Letter B is incorrect because the only product costs appropriate to expense an
interim period are the ones related to the revenue transactions recognized in
the same interim period.
Letter C is incorrect because the annual depreciation amount is an estimate.
The depreciation amount for an interim period is simply a pro rata amount of
the annual estimate.
Letter D is incorrect because an extraordinary item is to be reported in the
interim period in which it occurs rather than allocated to multiple interim
periods. This approach is consistent with the way extraordinary items are
handled on an annual basis.
30
.
Extraordinary items result from events or transactions that are clearly different
from ordinary activities and are not expected to recur frequently and regularly.
Examples are an appropriation of assets or a natural disaster. Extraordinary
items should be disclosed separately and included in the determination of net
profit for the interim period in which they occur. Gains and losses similar to
those that would not be deferred at year-end should not be deferred to later
interim periods of the same year. Hence, the extraordinary gain should not be
prorated.
Letters B, C and D are incorrect because the gain should be recognized in full in
the second quarter.
31
.
A basis feature of financial accounting is that the enterprise is assumed to be a
going concern in the absence of evidence to the contrary. The going concern
concept is based on the empirical observation that many enterprises have an
indefinite life. The reporting entity is assumed to have a life long enough to
fulfill its objectives and commitments and therefore to depreciate wasting
assets over their useful lives.
Letter A is incorrect because the economic entity assumption provides that
economic activity can be identified with a particular unit of accountability.
Letter B is incorrect because the monetary unit assumption provides that all
transactions and events can be measured in terms of a common denominator,
for instance, the dollar.
Letter C is incorrect because the materiality assumption simply implies that
items of significant value may be expensed rather than capitalized and
depreciated or amortized. The difference in treatment is not large enough to
influence users if the item is not material.
32
.
An imprest bank account is used to make a specific amount of cash available for
a limited purpose. The account acts as a clearing account for a large volume of
checks or for a specific type of check.
Letter A is incorrect because an amount is removed from the general checking
account to be used for a specific type of check.
Letter C is incorrect answer lockbox accounts are frequently used by large,
multi-location companies to make collections in cities within areas of heaviest
customer billing. The company rents a local post office box and authorizes a
local bank to pick up the remittances mailed to that box number.
Letter D is incorrect because a compensating balance agreement requires a
borrower to maintain a specified cash amount on deposit with the lender.
33
.
Letter D is incorrect answer.
The duties of the petty cash custodian include obtaining signed receipts for cash
disbursement from the general cashier. Consequently, the petty cash custodian
is responsible for the petty cash fund (both cash and signed receipts) at all
times.
Letters A, B and C are incorrect because the companys president, general office
manager, and general cashier are not directly responsible for the amount of the
petty cash fund.
34
.
It would be appropriated for the petty cash custodian to retain the petty cash
receipts because the receipts could be used for a second reimbursement. The
receipts should be canceled or mutilated after submission for reimbursement.
Letter B is incorrect because surprise counts may defer fraudulent activity.
Letter C is incorrect because requiring signed receipts is an appropriate control
procedure. The signed receipts provide documentation of cash transactions.
Letter D is incorrect because reimbursement by company check is an
appropriate control procedure. It is unwise to have excessive amounts of cash
readily available.
35
.
The check payable to the enterprise is dated after the balance sheet date, so
the amount of the check should be reported as a receivable in the December
31, 2001 balance sheet. The check drawn on the enterprises account was
dated and recorded in the books in 2001 but no mailed until after the financial
statement date. Thus, the amount of the check should be included in both the
amount reported as cash and the amount reported as accounts payable in the
December 31, 2001 balance sheet. Control of cash requires a proper cutoff of
cash receipts and cash disbursements.
Letters A and C are incorrect because the check payable to the enterprise is a
receivable.
Letter D is incorrect because the check drawn on the enterprises account was
dated and recorded in the enterprises books in 2001, so it should be included in
both the amount reported as cash and the amount reported as accounts
payable.
36
.
The gross method accounts for receivables at their face value. If a discount is
taken, a sales discount is recorded and classified as an offset to sales in the
income statement to yield net sales. The net method records receivables net of
the applicable discount. If the payment is not received during the discount
period, an interest revenue account, such as sales discount forfeited, is credited
at the end of discount period or when the payment is received. Accordingly, the
application of the net method requires a sales discount forfeited but not a sales
discount account.
Letters A, B and C are incorrect because the net method requires sales discount
forfeited but not sales discount account.
37
.
One condition for recognition of revenue from the sale of goods is the transfer of
the significant risks and rewards of ownership. Retention of significant risk may
occur when, for example, the buyer may rescind the purchase for a reason
stipulated in the contract, and the buyer is uncertain about the probability of
return. However, if the enterprise can reliably estimate future returns and
recognizes a liability for returns based of experience and other pertinent
information, revenue may be recognized at the time of sale if the other
conditions for revenue recognition are also met.

Letter B is incorrect because the risks and rewards of ownership must be
transferred.
Letter C is incorrect because this contingency is an example of retention of
significant risk.
Letter D is incorrect because returns may be material if they can be reliably
estimated.
38
.
When a transfer of receivable with recourse meets the criteria to be accounted
for as a sale, the enterprise decognizes the financial assets it no longer controls.
After derecognition, periodic net profit or loss will include the difference
between the carrying amount transferred and the proceeds, plus or minus any
prior adjustment reflecting the fair value of the asset that had been reported in
equity. If a new financial asset is created or a new financial liability is assumed,
the calculation is adjusted for the fair value of the asset or liability. Thus, the
proceeds of the sale are reduced by the fair value of the recourse obligation (a
new financial liability). When the transfer does not meet these criteria, the
transfer is accounted for as a collateralized borrowing.
Letters A, B, and C are incorrect because the proceeds of the sale are reduced
by the fair value of the recourse obligation.
39
.
An enterprise derecognizes a financial asset if it losses control of the contractual
rights the asset represents. Control is lost when the enterprise realizes the
rights to be specified contractual benefits, the rights expire, or it surrenders the
rights. A transferor has not lost control and does not derecognize the financial
asset if it is entitled and obligated to repurchase or redeem the asset, and the
terms of this transaction in effect allow the transferee to obtain a lenders return
on the assets it receives in exchange for the transferred financial asset.
Letter A and C are incorrect because a financial asset should be derecognized
despite the transferors right to reacquire if the asset is readily obtainable in the
market or the price is fair value at the date of reacquisition.
Letter B is incorrect because control is lost when the transferee has the ability
to obtain the benefits of he asset, for example, when the transferee may sell or
pledge the full fair value of the asset.
40
.
FIFO assigns the most recent purchase prices to ending inventory and the
earliest purchase prices to cost of goods sold. LIFO uses the earliest acquisition
costs to price the ending inventory. Thus, FIFO approximates current cost for
ending inventory, and LIFO approximates current cost of goods sold.
Letters A, B and D are incorrect because FIFO approximated current cost for
ending inventory, and LIFO approximates current cost of goods sold.
41
.
Net profit will be higher when cost of goods sold is lower, other factors held
constant. Cost of goods sold equals beginning inventory, plus purchases, minus
ending inventory. Accordingly, cost of goods sold will be lowest when the ending
inventory is highest. Ending inventory is highest under FIFO because the older,
less expensive items are deemed to have been sold, leaving the more
expensive items in the ending inventory.
Letter A is incorrect because LIFO yields the lowest net profit.
Letter C is incorrect because weighted averages inventory, so it results in a
lower net profit than FIFO.
Letter D is incorrect because, under specific identification, the newest (most

expensive) items are not necessarily in the ending inventory. The result is a
higher cost of goods sold and lower net profit than under FIFO.
42
.
The entry to record the write-down is a debit to inventory and short and a credit
to inventory. This amount is reported as an adjustment of cost of goods sold or
as an other expense on the income statement.
Letters B and C are incorrect because a difference between a physical count and
a perpetual inventory balance is common. Reasons include normal and
expected shrinkage, breakage, shoplifting, and faulty record keeping. Thus, it is
not an extraordinary item.
Letter D is incorrect because, although the debit to cost of goods sold is
acceptable, the credit should be to inventory. Also, any appropriation of retained
earnings would also have tom involve the unappropriated retained earnings
account.
43
.
When the equity method is used, the investment is initially recorded at cost on
the enterprises books. The carrying amount is subsequently adjusted to
recognized the profit or losses of the associate after the date of acquisition.
Dividends received from an associate reduce the carrying amount.
Letter A is incorrect because, when the equity method is used, investment
income (loss) is recognized for the investees share of eh profits or losses of the
associate. Dividends received from the investee are recorded as a reduction of
the investment account.
Letters C and D are incorrect because the investment account is credited.
44
.
Financial assets or liabilities held for trading are intended to result in profits
from short-term changes in prices or dealers margins. Regardless of intent,
however, a financial asset is held for trading if it is included in the portfolio with
a recent pattern of short-term profit taking. Derivatives are also deemed to be
held for trading unless they are designated and effective as hedging
instruments.
Letter B us incorrect because held-to-maturity investment have fixed or
determinable payments and a fixed maturity. Moreover, the enterprise must
have a positive intent and ability to hold such investments to maturity.
However, this classification excludes loans and receivables originated by the
enterprise.
Letter C is incorrect because loans and receivables originated by the enterprise
result from providing money, goods, or services directly to the debtor, excluding
those that are held for trading.
Letter D is incorrect because available-for-sale financial assets are those that do
not fall within one of the other classifications.
45
.
Available-for-sale and held-for-trading financial assets are measured at fair
value unless they do not have quoted market prices in an active market and
their fair values cannot be reliably measured. Remeasurement to fair value of
financial assets and liabilities that are not part of a hedge results in recognition
of a gain or loss in net profit or loss if the items are held for trading. A gain or
loss on an available-for-sale financial asset may be recognized in net profit or
loss when it arises or directly in equity through the statement of changes in
equity, in the latter case, the accumulated remeasurement gain or loss is
included in net profit or loss when the asset is disposed of or is impaired.
Letters A, B and D are incorrect because an enterprise should choose either

immediate recognition of remeasurement gain or loss in net profit or loss or
recognition directly in equity. The chosen accounting policy should then be
applied to all available-for-sale financial assets not part of a hedging
relationship.
46
.
Items of property, plant and equipment (PPE) that meet the recognition criteria
are initially measured at cost. The cost includes the purchase price (minus trade
discounts and rebates, plus purchase taxes) and the directly attributable costs
of bringing the assets to working condition for their intended use. Directly
attributable costs include site preparation, installation, initial delivery and
handling, architects and engineers fees, costs of removing the assets and
restoring the site, etc. accordingly, the cost of land includes the cost of
obtaining the land and readying it for its intended use, but it is inappropriate to
recognized the proceeds related to site preparation immediately as income.
They should be treated as reduction in the price of the land.
Letter A is incorrect because the purchase price, freight costs, and installation
costs of a productive asset are included in the assets cost.
Letter C is incorrect because subsequent expenditures are added to the carrying
amount of an item of PPE if it is probable that, as a result, future economic
benefits will exceed the originally assessed standard of performance, for
example, because of an extended useful life, improve output quality, or reduced
operating costs.
Letter D is incorrect because the costs of construction should be included as
part of the assets cost.
47
.
Accelerated depreciation in methods, such as sum-of-the-years-digits,
diminishing-balance, and 200% diminishing-balance, charge higher depreciation
costs in the early year of the assets life and lower depreciation costs in the
later years. These decreasing charge methods will therefore charge lower
depreciation costs in the later years of the assets life than straight-line method,
which charges the same amount to depreciation expense each year.
Letters A, B and C are incorrect because the SYD, diminishing-balance, and
200% diminishing-balance methods accelerate recognition of depreciation.
48
.
At the end of the estimated useful life of a depreciable asset, the amount of the
accumulated depreciation should equal the depreciable cost (original cost
estimated residual value), regardless of the depreciation method used. Periodic
diminishing-balance depreciation is calculated without regard to residual value,
but the asset is not depreciated below its residual value. The SYD method uses
a depreciable asset base equal to cost minus residual value.
Letters A, B and C are incorrect because, at the end of the estimated useful life
of a depreciable asset, the amount of the accumulated depreciation should
equal to the depreciable cost (original cost estimated residual value),
regardless of the depreciation method used.
49
.
Under the SYD method, the amount of the depreciable cost that is expensed
each year is the remaining useful life at the beginning of that year divided by
the sum of the years of useful life. For the third year, the portion expensed is
20% [2 (1 + 2 +3 +4)].
Letter A is incorrect because 10% is the amount expensed in the last year.
Letter B is incorrect because 25% is the percentage expensed each year under
the straight-line method.
Letter D is incorrect because 70% is the total amount expensed in the first 2
years.
50
.
The cash account is debited for the amount of the sale proceeds. The machinery
account and the related accumulated depreciation account is eliminated by a
credit and a debit, respectively. Because the sale price was less than the
carrying amount of the asset on the date of sale, a loss on disposal should be
recognized as an expense of the income statement.
Letter B is incorrect because a loss on disposal should be recognized as an
expense of the income statement.
Letter C is incorrect because accumulated deprecation should be debited.
Letter D is incorrect because an expense and accumulated depreciation should
be debited.
51
.
Subsequent expenditure are added to the carrying amount of an item of PPE if it
is probable that, as a result, future economic benefits will exceed the originally
assessed standard of performance, for example, because of an extended useful
life, improved output quantity or quality, or reduced operating costs.
Letter A is incorrect because the cost should be capitalized.
Letter B is incorrect because the same account should be used.
Letter C is incorrect because allocation is not an accepted procedure.
52
.
Unless stated otherwise, every business is assumed to be going concern that
will continue operating indefinitely. As a result, liquidation values are not
important because it is assumed that the enterprise is not going to be liquidated
in the near future. If an enterprise is not a going concern, its intangible assets
would be presented in the balance sheet at liquidation values, not at historical
cost reduced by amortization.
Letter A is incorrect because the economic entity assumption is that every
enterprise is a separate entity and that it affairs are separate from those of its
owners.
Letter C is incorrect because the monetary unit assumption provides that all
transactions and events can be measured in terms of money as a common
denominator.
Letter D is incorrect because the historical cost principle is applied because cost
is the most objective and reliable measure.
53
.
IAS 38, Intangible Assets, defines an intangible asset as an identifiable
nonmonetary asset without physical substance held for use in the production or
supply of goods or services, for rental to others, or for administrative purposes.
Inventory is a tangible asset. Thus, goods on consignment are not intangible
assets.
Letters B, C and D are incorrect because patents, copyrights, and trademarks
are intangible assets.
54
.
Expenditures on start-up activities are expensed when incurred unless they are
included in the cost of an item of property, plant and equipment. They include
the cost of establishing a new legal entity, such as legal and secretarial costs;
pre-opening costs of an enterprises new business facility; and the pre-opening
costs of new operations, products, or processes.

Letters A, B and C are incorrect because start-up costs are expensed when
incurred.
55
.
A current liability is an obligation that expected to be settled within the normal
operating cycle or is due to be settled within 12 months of the balance sheet
date. Any other liability is noncurrent. Some current liabilities are included in the
working capital employed in the normal operating cycle, e.g., trade payables
and accrued employee operating costs. Current liabilities not settled within the
normal operating cycle include the current part of interest-bearing debt,
dividends, income taxes, and bank overdrafts. Thus, the bonds payable should
be classified as current because they are due to be settled within 12 months.
Under the IASs, the classification of the sinking-fund assets is irrelevant to the
classification of the bond payable.
Letter B is incorrect because the bonds should be classified as a current liability.
Letter C is incorrect because offsetting assets and liabilities is rarely acceptable.
Letter D is incorrect because the bonds are a liability and should not be put in
an ambiguous category such as deferred credits.
56
.
A provision is a liability of uncertain timing and amount. A liability is a present
obligation arising from past events, the settlement of which is expected to
result in an outflow of resources embodying economic benefits. Whether a past
event result in a present obligation is usually clear. Thus, it is clear from the
circumstances that the enterprises sale of goods without warranty is an
obligating event that resulted in a present obligation for the issuance of
warranty costs. Recognition of provisions is appropriate when the enterprise has
a legal or constructive present obligation resulting from a past event (called an
obligating event), it is probable that an outflow of economic benefits will be
necessary to settle the obligation, and its amount can be reliably estimated.
Assuming that the amount of warranty costs can be reliably estimated (although
they are uncertain in timing and amount compared with a trade payable, for
example) and that the outflow is probable (in these circumstances, more likely
than not), the enterprises contractual present obligation should result in
recognition of a provision.
Letter A is incorrect because the cash basis calls for recognizing warranty
expense as labor and materials are expended to satisfy the warranty.
Letter C is incorrect because the sales warranty method is appropriate for
situations when a warranty is sold separately from the product.
Letter D is incorrect because the method of accounting for warranties for tax
purposes is the cash basis. The cash basis is unacceptable for accounting
purposes because it violates the matching principle.
57
.
Short-term employee benefits expected to be paid as a result of service
rendered during the period ordinarily should be recognized as an expense and a
liability (accrued expense). For short-term compensated absences, the timing of
recognition depends on whether the benefits accumulate. If the benefits for
compensated absences accumulate, the expected cost of short-term absences
is recognized when services are rendered that increase the employees,
entitlement to future compensated absences. The obligation is recognized
whether it is vesting (the employee is entitled to a cash payment for an unused
entitlement upon leaving the enterprise) or not vesting. The amount should not
be discounted. It equal s the additional amount expected to be paid as a result
of the unused accumulated entitlement at the balance sheet date. Hence, the
enterprise should debit expense and credit liability for 100,000 because the
entitlement accumulates and the employees have rendered services during the
period that increase their future entitlement.
Letter A is incorrect because recognition occurs at the time of the absences if
the benefits are not accumulating.
Letter C is incorrect because a liability rather than an asset is recognized.
Letter D is incorrect because the expense is recognized in the income
statement.
58
.
Income, which includes revenue and gains, is recognized in the income
statement when an increase in future economic benefits related to an increase
in an asset or a decrease in a liability can be reliably measured. Revenue is
recognized (reported as revenue) in the period in which recognition criteria are
met; therefore, when it is received in advance, the amount applicable to future
periods is deferred. This deferral reflects the uncertainty of the reliable
measurement of the future economic benefits. The uncertainty arises because
the enterprise still must satisfy an obligation to perform in the future before it is
entitled to the future economic benefits. The amount received in advance is
considered a liability because it represents a present obligation arising from a
past event. Accordingly, deferred or unearned revenue is an amount that has
been received but that has not met the recognition criteria for revenue.
Letter A is incorrect because an accrued revenue is revenue that has met the
recognition criteria but has not been received.
Letter C is incorrect because the revenue will be recognized in future periods
when forthcoming issues of the magazine are published and distributed to the
subscribers.
Letter D is incorrect because there is no such thing as a precollected receivable.
Precollected revenue is deferred revenue, which is an amount received that has
not met the recognition criteria (classified as a liability). A subscription
receivable (an asset) would arise from accrued revenue, which is revenue not
yet received.
59
.
Liabilities are present obligations arising from past events, the settlement of
which is expected to result in an outflow or resources embodying economic
benefits. Customers deposits must be returned or credited to their accounts.
The deposits should therefore be recorded as liabilities.
Letter A and B are incorrect because deposits meet the definition of liabilities,
not revenue. Revenue is income that arises in the ordinary activities of the
enterprise. Income is an increase in economic benefits in the form of inflows or
enhancement of assets or decreases of liabilities that result in an increase in
equity (excluding transactions with owners).
Letter C is incorrect because deposits are liabilities, not equity items. The equity
of an enterprise is the residual interest in the assets of the enterprise that
remains after deducting its liabilities.
60
.
A deferred revenue is a revenue item that has been received but has not met
the recognition criteria. The journal entry described in the question is an
adjusting entry to transfer an amount from the revenue account to a liability
(deferred revenue) account. The initial collection of cash in advance from the
tenant was apparently recorded by a credit to revenue. An adjusting entry is
therefore required at year-end to transfer any remaining amount that does not
qualify for revenue recognition.
Letter A is incorrect because an accrued revenue has met the recognition

criteria but has not yet been received. The journal entry described indicates that
collection has been made.
Letters B and C are incorrect because the entry concerns a revenue rather than
an expense transaction.
61
.
A provision is a liability of uncertain timing or amount. Recognition of provisions
is appropriate when the enterprise has a legal or constructive present obligation
resulting from a past event (called an obligating event), it is probable that an
outflow of economic benefits will be necessary to settle the obligation, and its
amount can be reliably estimated. Consequently, the company must recognize
a loss and a liability for 2.5 million.
Letter B is incorrect because such an adjustment is appropriate for fundamental
errors and changes in accounting policies (under the benchmark treatments).
Letter C is incorrect because an appropriation of a retained earnings is
permissible although not required, but the enterprise must still recognize a loss
and a provision. Moreover, no part of the appropriation of retained earnings.
Letter D is incorrect because, if the loss is probable and can be reliably
estimated, it should be recognize by a charge to income.
62
.
A provision is a liability of uncertain timing or amount. Recognition of provisions
is appropriate when the enterprise has a legal or constructive present obligation
resulting from a past event (called an obligating event), it is probable that an
outflow of economic benefits will be necessary to settle the obligation, and its
amount can be reliably estimated. Thus, a provision should be recognized.
Moreover, the amount recognized should be the best estimate of the
expenditures required to settle the obligation. However, the amount within the
reliable estimate of the range of the obligation that will be recognize will vary
from country to country.
Letter A is incorrect because the criteria for recognition of a provision have been
met, including a reliable estimate of the range of eh obligation.
Letter B is incorrect because the loss is probable.
Letter C is incorrect because the loss is not deferred; it is accrued.
63
.
When premiums are offered to customers, for example, upon redemption of
coupons, , the enterprise can usually establish that it has a legal present
obligation resulting from a past event and that an outflow of economic benefits
is probable. Furthermore, if the enterprise has prior experience with such offers
or information about the experience of eh similar enterprises, a reliable
estimate of the obligation should be feasible.
Letters A, B and C are incorrect because no obligating event has occurred. The
enterprise could avoid the future expenditure by its future actions.
64
.
The number of parties involved in the litigation is irrelevant. For example, the
same accounting treatment is applied whether a claim is brought by an
individual or in a class action suit.
Letter A is incorrect because the time period in which the obligatory event
occurred is relevant. If it arose after the after the date of the financial
statements, a provision may not be recognized in those statements.
Letters B and C are incorrect because a provision is not recognizes unless it is
probable that an outflow of a resources embodying economic benefits will be
required to settle a present obligation arising from a past event. Moreover, the
amount of eh obligation should be capable of reliable estimation.

65
.
A contingent liability includes a present obligation for which an outflow of
resources embodying economic benefits is not probable. A contingent liability is
not recognized but is disclosed unless the possibility of the outflow is remote.
Letters A, B and D are incorrect because the contingent liability is required to be
neither recognized nor disclosed.
66
.
The market price of the bonds at any moment in its terms equal the present
value of the future cash payments discounted at the market rate of interest at
that time. As the market rate increases, the present value decreases. Hence,
the market price of eh bond will decrease.
Letter B is incorrect because the interest expense equals the carrying amount of
the liability times the market rate of interest at the time of issuance. The
interest expense is therefore unaffected by changes in the market rate
subsequent to bond issuance.
Letter C is incorrect because the cash interest payment is determined by the
contractual terms of the bond, which are unaffected by market interest rate
changes.
Letter D is incorrect because, when the market rate exceeds the contract rate,
the bond will sell at a discount so that the effective yield will equal the market
rate.
67
.
A financial asset, such as lenders mortgage receivable, is impaired if its
carrying amount at the balance sheet date exceeds its estimated revocable
amount. If it is probable that all amounts due on such a held-to-maturity
investment (a financial asset carried at amortize cost) cannot be collected, the
loss should be included in net profit or loss. The loss equals the difference
between then carrying amount and the present value of the expected future
cash flows discounted at the original effective interest rate. The carrying
amount of the asset should be reduced to its estimated recoverable amount
directly or by crediting an allowance account.
Letters A, B and C are incorrect because the carrying amount should be
reduced, and the charge should be included in net profit or loss.
68
.
Bonds sold with coupon rates below the market rate on comparable bonds are
sold at a discount from the face amount. Thus, the effective yield on the bonds
will equal the market rate. Cash will be debited for the amount received, which
will be below the face amount reflected in bonds payable. The difference
between the face amount of the issued bonds and the cash received is debited
to the discount on bonds payable. Bonds payable is credited for the face
amount.
Letter A is incorrect because the entry for the issuance of bonds at a premium
requires a credit to a premium account.
Letter B is incorrect because bonds sold with coupon rates below the market
rate on comparable bonds are sold at a discount.
Letter D is incorrect because the discount on bonds payable should be debited.
69
.
Interest expense equals the carrying amount of he liability at the beginning of
eh period times the effective interest rate. The carrying amount of the liability
equals the face amount of the bond minus the discount. As the discount is
amortize over the life of eh bond, the carrying mount increases. Consequently,
the interest expense increases over the term of the bond.
Letter B is incorrect because interest expense will increase over the term of the
bonds.
Letters C and D are incorrect because interest expense exceeds the cash
interest payment when bonds are issued at a discount. The reason is that the
effective rate is higher than the nominal rate. The excess of the interest
expense over the cash payment is the amount of discount amortize each period.
70
.
An enterprise should remove a financial liability from its balance sheet only
when it is extinguished, for example, when the creditor is paid. The difference
between the carrying amount and the amount paid should be included in net
profit or loss for the period.
Letters A and B are incorrect because the excess of the reacquisition price over
the net carrying amounts of the old bonds is recognized in full in net profit or
loss for the period.
Letter C is incorrect because an extraordinary item is income or an expense
arising from events or transactions that are clearly distinct from the ordinary
activities of the enterprise and are not expected to recur frequently or regularly.
71
.
Derecognition of a financial liability (or a part thereof) occurs only by means of
extinguishment. This condition is satisfied only when the debtors pay the
creditors or legally released from primary responsibility either by the creditor or
through the legal process. An extinguishment or derecognition of the old debt
and the recognition of new debt occurs when the borrower and lender exchange
debt instruments with substantially different terms, that is, when the respected
discounted cash flows differ by at least 10%.
Letters A and D are incorrect because payment to a third party such as a trust
(also known as an in-substance defeasance) does not by itself extinguish the
obligation absent a legal release.
Letter B is incorrect because the terms should be substantially different.
72
.
The entry is to debit interest expense, debit bond premium, and credit cash
paid. Thus, the amortization of a premium on bonds payable reduces the
interest expense, thereby increasing net profit or loss.
Letter B is incorrect because the amortization of a premium on bonds payable
reduces interest expense.
Letters C and D are incorrect because interest income is not affected by the
amortization of a premium on bonds payable.
73
.
The conversion of debt into common shares is ordinarily based upon the
carrying amount of the debt at the time of issuance. Because the carrying
amount is based on all related accounts, the debit balances of unamortized
bond discount, unamortized issue costs, and conversion costs should be
considered reductions in the net carryings amount at the time of conversion.
Consequently, this item should be reflected as reductions in the share premiums
in excess of par account.
Letters A, B and C are incorrect because these amounts are not expensed. In
effect, each reduces the amount at which the shares are issued.
74
Accrual of an expense prior to the occurrence of the event for which an

enterprise is self-insured should not be permitted. This rules hold because the
fair value of the property diminishes only if the event actually occurs. But an
appropriation of retained earnings is acceptable to disclose the self-insurance
policy if, when a fire loss occurs, the entry appropriating retained earnings is
revised, and the loss is charge against income of the period of loss and not
against retained earnings.
Letter A is incorrect because an appropriation of retained earnings for selfinsurance is permissible.
Letter C is incorrect because fire losses may never be charged against the
appropriation of retained earnings.
Letter D is incorrect because the procedure is acceptable only if the
appropriation is shown within the equity section of the balance sheet.
75
.
The purpose of a share dividend is to provide evidence to the shareholders of
their interest in accumulated earnings without distribution of cash or other
property. Share dividends are typically accounted for by a transfer from retained
earnings at fair value.
Letters A and B are incorrect because share dividends and share splits have no
effect on total equity or on the carrying amount of an individual shareholders
investment.
Letter C is incorrect because dividends, whether of shares, cash, or property,
are usually payable on a date different from declaration date.
76
.
A change in accounting estimate is a normal, recurring revision resulting from
changes in circumstances, additional experience, new information, or
subsequent events. Is neither a fundamental error nor an extraordinary item.
The effect of a change in estimate is included in the determination of net profit
or loss in the period of change and in future periods, if the change affects both
the current and future periods. In other words, a change in accounting estimate
should be reflected in the financial statements prospectively.
Letter A is incorrect because extraordinary items are clearly distinct from
ordinary activities and not expected to recur frequently or regularly. Changes in
accounting estimates are normal and recurring.
Letter B is incorrect because changes in accounting estimates are not errors.
They are responses to new information, subsequent events, additional
experience, or changes in circumstances.
Letter C is incorrect because catch-up adjustments to prior reported amounts
are retroactive. Changes in accounting estimates are accounted for
prospectively.
77
.
Accounting estimates, e.g., services lives, residual values, warranty costs,
uncollectible accounts, and inventory obsolescence, are a necessary part of
preparing financial statements. However, they inevitable change as new events
occur and as additional experience and information are obtained. When altered
conditions require a change in estimate, it is accounted for prospectively. Thus,
a change in the estimate of a service lives of depreciable assets is a change in
accounting estimate.
Letter B is incorrect because a change from diminishing-balance depreciation to
straight-line depreciation is a change in acconting policy.
Letter C is incorrect because changing an accounting an accounting method due
to a change in an IAS is a change in a accounting policy.
Letter D is incorrect because a change from FIFO to LIFO inventory valuation is a

change in accounting policy.
78
.
Changes in estimates used in accounting are necessary consequences of
periodic presentations of financial statements. Preparing financial statements
requires estimating the effects of future events. Examples of items for which
estimates are necessary are uncollectible receivables, inventory obsolescence,
service lives and residual values of depreciable assets, warranty costs, periods
benefited by a deferred cost, and recoverable mineral reserves.
Letter A is incorrect because the purchase price for an acquired building can be
calculated with certainty. No estimate is required.
Letter B is incorrect because the price of a marketable security can be
ascertained with certainty. No estimate is required.
Letter D is incorrect because the physical quantity of inventory as of the
balance sheet date can be measured. Although some estimation of the correct
amount may be required, the estimates will not depend on future conditions and
events but on current conditions and measurement methods.
79
.
The benchmark treatment of fundamental errors requires retrospective
treatment. To correct the fundamental error, the enterprise must debit the
equipment for its cost and credit accumulated depreciation for the depreciation
expense appropriate for the first year of the estimated useful life. Retained
earnings must be credited because the error understated net profit or
overstated net loss in the prior period.
Letter B is incorrect because this entry is the reverse of the correct entry.
Letter C is incorrect because retained earnings should be credited.
Letter D is incorrect because accumulated depreciation and retained earnings
should be credited.
80
.
According to the benchmark treatment, a change in accounting policy is applied
retrospectively unless any adjustment relating to prior periods is not reasonably
determinable. The resulting adjustment is to the opening balance of retained
earnings for the earliest period presented. If practicable, comparative
information is restated. Restatement may be impracticable for a change to LIFO
because determining the LIFO inventory valuation retroactively may not be
feasible. Information concerning the composition of inventory throughout the
history of the entity, as well as all individual unit prices, usually cannot be
reconstructed. Accordingly, a change to LIFO may result in no recognition of the
effect of the change on prior periods, statements.
Letter B is incorrect because prior-period and current statements would be more
comparable if the latter were restated.
Letter C is incorrect because restatement is likely to change reported results.
Letter D is incorrect because restatement could reduce, increase, or not change
prior years net profit.
81
.
According to the benchmark treatment, a change in accounting policy is applied
retrospectively unless any adjustment relating to prior periods is not reasonably
determinable. The resulting adjustment is to the opening balance of retained
earnings for the earliest period presented. If practicable, comparative
information is restated.
Letter B is incorrect because reporting the cumulative effect is allowed
alternative treatment for a change in an accounting policy.
Letter C is incorrect because this answer describes one of the requirements

under the allowed alternative treatment for a change in an accounting policy.
Letter D is incorrect because a change in an accounting policy qualifying for
retrospective application requires an adjustment to retained earnings.
82
.
A change in depreciation method is reported as a change in accounting policy.
According to the benchmark treatment, a change in an accounting policy is
applied retrospectively unless any adjustment relating to prior periods is not
reasonably determinable. The resulting adjustment is to the opening balance of
retained earnings for the earliest period presented. If practicable, comparative
information is restated.
Letters A and D are incorrect because each is a change in estimate that is
accounted for on a prospective basis (in the future).
Letter C is incorrect because if distinguishing between a change in estimate and
a change in accounting policy is difficult, the change is accounted for as a
change in estimate and properly disclosed.
83
.
The total benefit to be provided in the form of deferred payments is not
precisely determinable and can only be estimated based on the plans benefit
formula and relevant future events, many of which are not controllable by the
employer. Such events include how long the employee and survivors live, years
of service rendered, and levels of compensation.
Letter A is incorrect because certain changes in the defined benefit obligation
and in the value of plan assets are recognized as they occur. They are
recognized on a systematic and gradual basis over subsequent accounting
periods. All changes ultimately will be recognized except to the extent they may
be offset by subsequent changes.
Letter C is incorrect because a standard method (not a range) is used to
measure the expense (income) recognized in the income statement.
Letter D is incorrect because the defined benefit liability is recognized. It equals
the DBO adjusted for unrecognized actuarial gains and losses and past service
cost, minus the fair value of plan assets at the balance sheet date.
84
.
A defined contribution plan provides benefits in exchange for services, provides
an account for each participant, and specifies how contributions are to be
determined. Postemployment benefits depend only on contributions, returns on
investment, and allocated forfeitures of the other participants benefits. Thus,
employees have the benefit of gain and risk of loss.
Letter B is incorrect because the employees bear the risk of the plans
investment performance.
Letter C is incorrect because under a defined a benefit plan, the post
employment benefits received by employees are defined by the plans formula.
Letter D is incorrect because equal contributions are not required for a defined
contribution plan.
85
.
The measurement of a postemployment benefit obligation includes estimates of
future salary increases, the benefits defined in the plan, the benefits arising
from any constructive obligation beyond the terms of the plan, and estimates of
future changes in state benefits that affect the level of plan benefits. The
possibility that nonvested projected benefits will not vest is a factor in the
measurement of the DBO, but it does not affect the existence of the obligation.
Letters A, B and D are incorrect because the defined postemployment benefits
includes both vested and nonvested benefits and is calculated at future levels.
86
.
Vested benefits are those earned postemployment benefits owed to an
employee that are not contingent upon the employees continued service.
Whether benefits have vested affects the measurement of the employers
defined benefit obligation but not its existence. Moreover, vesting affects the
accounting for past service cost. Past service cost is amortized as an expense
over the average period until the benefits are vested.
Letter A is incorrect because past service cost relates to benefits for employee
service provided prior to the adoption or amendment of a defined benefit plan.
Letter B is incorrect because a defined benefit plan provides a defined benefit
based on one or more factors, such as level of compensation, years of service,
or age.
Letter D is incorrect because under IAS 19, the employer does not recognize an
additional minimum liability.
87
.
The amount of the defined benefit liability recognized equal the present value of
the defined benefit obligation at the balance sheet date, plus (minus)
unrecognized actuarial gains (losses), minus unrecognized past service cost,
minus the fair value of plan assets at the balance sheet date. If this amount is
negative, it represents such an asset is the sum of unrecognized actuarial
losses, unrecognized past service cost, and the present value of future refunds
from the plan or reductions in future contributions. Thus, if the excess of the
DBO over the fair value of the plan assets is constant, net unrecognized
actuarial gains will increase the liability. Net unrecognized actuarial losses and
unrecognized past service cost decrease the liability.
Letter B is incorrect because net unrecognized actuarial losses decrease the
liability.
Letter C is incorrect because net unrecognized actuarial losses and
unrecognized past service cost decrease the liability.
Letter D is incorrect because net unrecognized actuarial gains increase the
liability.
88
.
When a lease agreement transfers the risks and rewards of ownership of the
asset to the lessee, the lease is treated as a finance lease because the
transaction is in essence an installment purchase. Accordingly, the lessee
records a depreciable asset and liability. Moreover, IAS 38, Intangible Assets,
specifically does not apply to leases that are within the scope of IAS 17, Leases.
A finance lease is therefore regarded as a tangible asset.
Letter B is incorrect because the recorded asset is a tangible asset.
Letters C and D are incorrect because if it transfer substantially all of the risks
and rewards of ownership, the lease is a finance lease.
89
.
A lease is a rental or sub-purchase arrangement between a lessor (the owner or
seller of the property) and a lessee ( the renter or purchaser). The issues in all
leases is whether the risks and rewards of ownership have been transferred
from the lessor to the lessee; if so, the lease should be accounted for as a salepurchase, i.e., a finance lease. If the risks and rewards of ownership have not
transferred, the lease is a rental arrangement and is called an operating lease.
In effect, the lessor provides financing for an installment peurchase, and
lessees payments include both principal and interest components.
Letter A is incorrect because the lessee obtains use of the asset.
Letter B is incorrect because the lessee uses the lease as a source of financing
under a finance lease, not an operating lease.
Letter C is incorrect because the lessee makes payments to the lessor.
90
.
When a transaction meets the criteria of a finance lease, the lessor removes the
leased item from the books and records lease payments receivable regardless
of whether the lessor is a manufacturer or a dealer. The lessee records and
depreciates the leased item under a finance lease.
Letter A is incorrect because under a finance lease, the lessor recognizes a net
receivable equal to the net investment in the lease: gross investment (minimum
lease payments from the lessors perspective plus unguaranteed residual value)
minus unearned finance income.
Letter C is incorrect because the lessee records depreciation on the leased asset
under a finance lease. This process is separate from the accounting for the
lease obligation.
Letter D is incorrect because in essence, the leased asset is being purchased
when a lease meets the criteria for capitalization. Hence, the lease agreement
represents a form of financing.
91
.
The lessee records a finance lease as an asset and liability at the inception of
the lease at the fair value of the leased property (not to exceed the present
value of the minimum lease payments). The lessees minimum lease payments
include required payments (excluding contingent rent and costs for services and
taxes to be paid by and reimbursed to the lessor) during the lease term and the
amount of a bargain purchase option. If no bargain purchase option exists, the
minimum lease payments equal the sum of the minimum payments payable
over the lease term and any amounts guaranteed by the lessee or by a party
related to the lessee.
Letters B and C are incorrect because the guaranteed residual must be
discounted to present value.
Letter D is incorrect because guaranteed residuals are part of the lease
contract.
92
.
The fixed-assets turnover ratio equals net sales divided by net fixed assets. A
higher ratio indicates either that the enterprise is undercapitalized, that is, it
cannot afford to buy enough fixed assets, or that it uses fixed assets efficiently.
Letter A is incorrect because the ratio may indicate undercapitalization.
Letter B is incorrect because fluctuations in inventory do not affect fixed-assets
turnover.
Letter D is incorrect because the fixed-assets turnover ratio is not a profitability
indicator. It measures the efficiency of asset management.
93
.
The days sales outstanding (days or receivables) may be stated as the
accounts receivable balance divided by average credit sales per day or as days
in the year divided by the receivables turnover. It is the average time required
to convert the enterprises receivables into cash. Thus, it is also called the
receivables collection period.
Letter A is incorrect because the inventory conversion period (days of inventory)
is the average time required to covert materials into finished goods and then to
sell them. This process typically occurs before the receivables collection period,
and the amount of time in one period does not necessarily bear any relationship
to the other.
Letter B is incorrect because the cash conversion cycle equals the inventory
conversion period, plus the receivables collection period, minus the payable
deferred period (average time between resource purchases and payment of
cash for them). It estimates the time between when the enterprise makes
payments and when it receives cash inflows.
Letter D is incorrect because the inventory divided by the sales per day is the
inventory conversion period (days of inventory).
94
.
The times-interest-earned ratio equals net profit before taxes and interest
divided by the interest. It measures the extent to which operating profit can
decline before the enterprise is unable to meet its annual interest cost. Thus, it
is a measure of debt-paying capacity (solvency).
Letter B is incorrect because liquidity ratios, e.g., the current ratio, indicate the
relationship of current asset to current liabilities.
Letter C is incorrect because asset management ratios indicate how effectively
the enterprise is using its assets.
Letter D is incorrect because profitability ratios measure operating results.
95
.
Inflation is the diminution over time of the purchasing power of money. Because
balance sheet amounts are expressed in terms of money, historical cost
amounts for different periods measured in units representing different levels of
purchasing power. Net profit is also distorted because of inflations impact on
depreciation expense and inventory costs. Inflation therefore impairs the
comparability of financial statement items, whether for the same enterprise
overtime or for enterprise of differing ages.
Letter A is incorrect because inflation badly distorts balance sheets,
depreciation charges, inventory costs, and profits.
Letters B and D are incorrect because inflation affects any financial ratio
analysis involving comparisons of prior-period with current-period monetary
amounts.
96
.
The net profit margin equals the net profit available to common shareholders
divided by sales, the total assets turnover equals sales divided by total assets,
and the product of these two ratios is the return on assets. This result is the
basic DU Pont equation. In the extended DU Pont equation, the return on assets
is multiplied by the leverage factor, also called the equity multiplier (total assets
common equity at carrying amount). The extended Du Pont equation gives
the return on common equity. This result is obtained because the total assets
and sales factors cancel in the multiplication of the three ratios.
Letter A is incorrect because the market-to-carrying-amount ratio and the totaldebt-to-total-assets ratio do not provide any information about net profit
available to shareholders.
Letter B is incorrect because the price-to-earnings ratio, EPS, and the net profit
margin do not provide information about the carrying amount of common
equity.
Letter C is incorrect because the price-to-earnings ratio and the return-on-assets
ratio do not provide information about carrying amount of common equity.
97
.
A DTA or DTL is measured at the rates expected to apply when it is realized or
settled, based on tax laws and rate enacted or substantively enacted as of
balance sheet date. If different rates apply to different taxable profit levels, a
DTA or DTL is measured based on the average rates expected to apply in the
periods when the TDs are expected to reverse. The tax rate or tax base may
vary with the manner of recovery or settlement. For example, one tax rate may
apply if an asset is sold immediately and another may apply if it is to be
recovered through continued use.
Letter A is incorrect because this statement describes the deferred method of
accounting for deferred income taxes.
Letter C is incorrect because this statement describes the net-of-tax method,
which recognizes that future taxability and deductibility are important factors in
the valuation of individual assets and liabilities.
Letter D is incorrect because this statement describes the nonallocation or flowthrough approach, which does not support the calculation and reporting of
deferred income tax.
98
.
A deferred tax asset records deferred tax consequences attributable to
deductible temporary differences and carryforwards. Advance rental receipts
accounted for on the accrual basis for determining accounting profit and on
cash basis for determining taxable profit (tax loss) would give rise to a deferred
tax asset. The financial statement would show no income and no related tax
expense because the rental payments apply to future periods. The tax return,
however, would show the rent as income when the cash was received, and a tax
would be due in the year of receipt. Because the tax is paid prior to recording
accounting profits, it represents an asset that will be recognized as an expense
when income is finally recorded.
Letter A is incorrect because using an accelerated depreciation method for
determining taxable profit (tax loss) results in a deferred tax liability.
Letter B is incorrect because recognizing installment income on the financial
statements but not the tax return results in a taxable temporary difference.
Letter D is incorrect because recognizing prepaid expenses earlier on the tax
return than on the financial statements (a situation akin to the accelerated
deprecation of fixed assets) gives rise to a deferred tax liability.
99
.
A current tax liability or asset for the current and prior periods is the amount to
be paid to, recovered from, the taxation authorities, based on tax laws and rates
enacted or substantively enacted as of the balance sheet date. A DTA or DTL is
measured at the rates expected to apply when it is realized or settled, based on
tax laws and rates enacted or substantively enacted as of the balance sheet
date. In some countries, governmental announcements of laws and rates have
the substantive effect of actual enactment.
Letters A, B and D are incorrect because a change in tax law or rates should be
recognized as an adjustment as of the date the change is enacted or
substantively enacted.
100
.
The deferred tax expense or income disclosed is the sum of the net changes in
the deferred tax assets and deferred tax liabilities. This amount is the deferred
tax expense or income relating to the origination or reversal of temporary
differences. For example, the reduction in a deferred tax asset or an increase in
a deferred tax liability increases deferred tax expense.
Letters A and C are incorrect because the deferred tax expense or income is
equal to the sum of the net changes in the deferred tax assets and deferred tax
liabilities.
101
102
103
104
105
106
107
108
Letter D is incorrect because the total tax liability includes both the correct and
deferred tax expense or income for the year.
.
The amount of service revenue for the year on an accrual basis is equals
645,000 (600,000 cash collected 15,000 unearned revenue + 60,000 increase
in accounts receivable).
.
liabilities.
.
All income statement account balances are closed either to a summary account
(such as income summary or revenue and expense summary) or to retained
earnings. The normal balance of an expense account is a debit; therefore, an
expense account is credited in a closing entry.
.
The debt was issued on July 1 and has been outstanding for only 6 months. Interest
expense equals the face amount of the debt multiplied by the interest rate and the fraction
of the year the debt was outstanding [ 1,000,000 x 10% x (612) = 50,000]. Because
interest is payable on July 1, 6 months interest is accrued and expensed in the current
period. The payable is also recognized in the current period. Thus, the adjusting entry
should be
Interest expense
50,000
Interest payable
50,000
.
Current period pretax net income equals 280,000 (750,000 sales 200,000 CGS
60,000 depreciation 10,000 interest 200,000 administrative expenses).
Thus, after-tax net income credited to retained earnings equals 140,000 [(1.0 - .
5) x 280,000].
.
The sales revenue earned in 2001 equals 2001 cash receipts minus any receipt
in 2001 for which the revenue has not yet been earned, plus the revenue
earned from cash receipts in 2000, 0r 185,000 (175,000 30,000 + 40,000).
.
liabilities.
.
109
110
111
112
113

liabilities.
.
liabilities.
.
liabilities.
.
liabilities.
.
liabilities.
.
114
115
116
117
liabilities.
.
liabilities.
.
liabilities.
.
liabilities.
.
liabilities.

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Theory of Accounts Quizzer

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