Financial Accounting

Easy

1. Which of the following is a fundamental characteristic of useful accounting information?

a. Comparability.
b. Relevance.
c. Neutrality.
d. Materiality.

Answer: B

Relevance and faithful representation are the two primary qualities that make accounting information
useful for decision making.

2. Gross billings for merchandise sold by Smile Company to its customers last year amounted to
P12,720,000; sales returns and allowances were P370,000, sales discounts were P175,000, and
freight-out was P140,000. Net sales last year for Smile Company were
a. P12,720,000.00
b. P12,350,000.00
c. P12,175,000.00
d. P12,035,000.00

Answer: C

P12,720,000 – P370,000 – P175,000 = P12,175,000

3. Happy Corporation reports:

Cash provided by operating activities P220,000

Cash used by investing activities 110,000
Cash provided by financing activities 140,000
Beginning cash balance 70,000
What is Happy’s ending cash balance?
a. P250,000.
b. P320,000.
c. P470,000.
d. P540,000.

Answer: B

P70,000 + P220,000 – P110,000 + P140,000 = P320,000.

4. Joy Company has cash in bank of P15,000, restricted cash in a separate account of P3,000, and
a bank overdraft in an account at another bank of P1,000. Joy should report cash of
a. P14,000.
b. P15,000.
c. P17,000.
d. P18,000.

Answer: B

Restricted cash in a separate account and bank overdraft are normally reported separate from
cash.

5. Jolly Corp. has outstanding accounts receivable totaling P6.5 million as of December 31 and
sales on credit during the year of P24 million. There is also a credit balance of P12,000 in the
 allowance for doubtful accounts. If the company estimates that 8% of its outstanding receivables
will be uncollectible, what will be the amount of bad debt expense recognized for the year?
a. P 532,000.
b. P 520,000.
c. P1,920,000.
d. P 508,000.

Answer: D

(P6,500,000 × .08) – P12,000 = P508,000.

6. Fine Inc. took a physical inventory at the end of the year and determined that P780,000 of goods
were on hand. In addition, Fine, Inc. determined that P60,000 of goods that were in transit that
were shipped f.o.b. shipping point were actually received two days after the inventory count and
that the company had P90,000 of goods out on consignment. What amount should Fine report as
inventory at the end of the year?
a. P780,000.
b. P840,000.
c. P870,000.
d. P930,000.

Answer: D

P780,000 + P60,000 + P90,000 = P930,000.

7. Glad Corporation constructed a building at a cost of P10,000,000. Average accumulated

expenditures were P4,000,000, actual interest was P600,000, and avoidable interest was
P400,000. If the salvage value is P800,000, and the useful life is 40 years, depreciation expense
for the first full year using the straight-line method is
a. P240,000.
b. P245,000.
c. P260,000.
d. P340,000.

Answer: A

[(P10,000,000 + P400,000) – P800,000] ÷ 40 = P240,000.

8. On January 2, 2012, Fine Co. bought a trademark from Good, Inc. for P1,200,000. An
independent research company estimated that the remaining useful life of the trademark was 10
years. Its unamortized cost on Good’s books was P900,000. In Fine’s 2012 income statement,
what amount should be reported as amortization expense?
a. P120,000.
b. P 90,000.
c. P 60,000.
d. P 45,000.

Answer: A

P1,200,000 ÷ 10 = P120,000.

9. Vista newspapers sold 6,000 of annual subscriptions at P125 each on September 1. How much
unearned revenue will exist as of December 31?
a. P0.
b. P500,000.
c. P250,000.
 d. P750,000.

Answer: B

(6,000 × P125) × 8/12 = P500,000.

10. On January 1, 2017, Best Co. sold 12% bonds with a face value of P800,000. The bonds mature
in five years, and interest is paid semiannually on June 30 and December 31. The bonds were
sold for P861,600 to yield 10%. Using the effective-interest method of amortization, interest
expense for 2017 is
a. P80,000.
b. P85,914.
c. P86,160.
d. P96,000.

Answer: C

P861,600 × .05 = P43,080

[P861,600 – (P48,000 – P43,080)] × .05 = 42,834
P85,914

11. Hopeful Company issues 6,000 shares of its P5 par value ordinary share capital having a fair
value of P25 per share and 9,000 shares of its P15 par value preference share capital having a
fair value of P20 per share for a lump sum of P312,000. The proceeds allocated to the ordinary
share capital is
a. P32,500
b. P141,818
c. P162,500
d. P170,182

Answer: B

{(6,000 × P25) ÷ [(6,000 × P25) + (9,000 × P20)]} × P312,000 = P141,818.

12. Bright Corporation had 400,000 ordinary shares outstanding at December 31, 2017. In addition, it
had 90,000 stock options outstanding, which had been granted to certain executives, and which
gave them the right to purchase shares of Bright's stock at an option price of P37 per share. The
average market price of Bright's ordinary share capital for 2017 was P50. What is the number of
shares that should be used in computing diluted earnings per share for the year ended December
31, 2017?
a. 400,000
b. 431,622
c. 466,600
d. 423,400

Answer: D

90,000 – (90,000 × P37 ÷ P50) = 23,400

400,000 + 23,400 = 423,400.

13. Winner Corporation accounts for its investment in the ordinary shares of Luck Company under
the equity method. Winner Corporation should ordinarily record a cash dividend received from
Luck as
a. a reduction of the carrying value of the investment.
b. additional paid-in capital.
c. an addition to the carrying value of the investment.
 d. dividend income.

Answer: A

Under equity method, a cash dividend received from an investee is treated as a reduction of the carrying
value of the investment.

14. Hyper Corporation reported P100,000 in revenues in its 2017 financial statements, of which
P55,000 will not be included in the tax return until 2018. The enacted tax rate is 40% for 2017 and
35% for 2018. What amount should Hyper report for deferred income tax liability in its balance
sheet at December 31, 2017?
a. P19,250
b. P22,000
c. P24,500
d. P28,000

Answer: A

P55,000 × .35 = P19,250.

15. On December 1, 2017, Go Corporation leased office space for 10 years at a monthly rental of

Rent deposit P 90,000

First month's rent 90,000
Last month's rent 90,000
Installation of new walls and offices 660,000
P930,000
The entire amount of P930,000 was charged to rent expense in 2017. What amount should Go
have charged to expense for the year ended December 31, 2017?

a. P90,000
b. P95,500
c. P185,500
d. P660,000

Answer: B

P90,000 + [(P660,000/10) x (1/12)] = P95,500.

Average

1. Jian Co.’s beginning inventory at January 1, 20x1, was understated by Php26,000, and its ending
inventory was overstated by Php52,000. As a result, Jian’s cost of goods sold for 20x1 was

a. Understated by Php26,000.
b. Overstated by Php26,000.
c. Understated by Php78,000.
d. Overstated by Php78,000.

Answer: C
The effect of the errors on Jian’s 20x1 cost of goods sold (CGS) is illustrated below.
BI
+P – Php26,000 CGS understated Php26,000
GAFS
– EI (+ Php52,000) CGS understated Php52,000
 CGS CGS understated Php78,000

2. Joi Wholesalers stocks a changing variety of products. Which inventory costing method will be most
likely to give Jones the lowest ending inventory when its product lines are subject to specific price
increases?

a. Specific identification.
b. Weighted-average.
c. LIFO.
d. FIFO periodic.

Answer: C

During periods of rising prices, the inventory costing methods which will give Joi the lowest ending
inventory balance are LIFO methods, because inventory items that were purchased at the earliest
date (when prices were lower) will remain in inventory and the most recently purchased and more
expensive items will be expensed through cost of goods sold.

3. Under IFRS, which of the following inventory items are not valued at the lower of cost or net
realizable value?

a. Manufactured inventory items.

b. Retail inventory items.
c. Biological inventory items.
d. Industrial inventory items.

Answer: C

Biological inventory items are valued at fair value less the cost to sell at the point of harvest.

4. Sloan Corporation is performing its annual test of the impairment of goodwill for its Financing
reporting unit. It has determined that the fair value of the unit exceeds it carrying value. Which of
the following is correct concerning this test of impairment?

a. Goodwill should be written down as impaired.

b. The assets and liabilities should be valued to determine if there has been an impairment
of goodwill.
c. Goodwill should be retested at the entity level.
d. Impairment is not indicated and no additional analysis is necessary.

Answer: D

There are two steps in the test of impairment of goodwill. The first is to compare the carrying value
of the reporting unit to its fair value. If the fair value exceeds the carrying value there is no need to
perform the second step of valuing the unit’s assets and liabilities. Goodwill is never tested at the
entity level.

5. Star Co. leases a building for its product showroom. The ten-year nonrenewable lease will expire
on December 31, year 11. In January year 6, Star redecorated its showroom and made leasehold
improvements of Php48,000. The estimated useful life of the improvements is eight years. Star
uses the straight-line method of amortization. What amount of leasehold improvements, net of
amortization, should Star report in its June 30, year 6 balance sheet?
 a. Php45,600
b. Php45,000
c. Php44,000
d. Php43,200

Answer: C

Leasehold improvements are capitalized and amortized over the shorter of the remaining life of the
lease (six years from 1/1/Y6 to 12/31/Y11) or the useful life of the improvements (eight years).
Therefore, the Php48,000 cost is amortized over six years, resulting in annual amortization of
Php8,000 (Php48,000 ÷ 6). For the period 1/1/Y6 to 6/30/Y6, amortization is Php4,000 (Php8,000
× 6/12), so the 6/30/Y6 net amount for leasehold improvements is Php44,000 (Php48,000 –
Php4,000).

6. On January 1, year 4, Kew Corp. incurred organization costs of Php24,000. What portion of the
organization costs will Kew defer to years subsequent to year 4?

a. Php23,400
b. Php19,200
c. Php4,800
d. Php0

Answer: D

Organization costs are those incurred in the formation of a corporation. These costs should be
expensed as incurred. The rationale is that uncertainty exists concerning the future benefit of these
costs in future years. Thus, they are properly recorded as an expense in year 4.

7. Fenn Stores, Inc. had sales of Php1,000,000 during December, year 2. Experience has shown that
merchandise equaling 7% of sales will be returned within thirty days and an additional 3% will be
returned within ninety days. Returned merchandise is readily resalable. In addition, merchandise
equaling 15% of sales will be exchanged for merchandise of equal or greater value. What amount
should Fenn report for net sales in its income statement for the month of December year 2?

a. Php900,000
b. Php850,000
c. Php780,000
d. Php750,000

Answer: A

When revenue is recognized from sales and a right of return exists, sales revenue must be reduced
to reflect estimated returns. In this case, sales of Php1,000,000 must be reduced by estimated
returns of Php100,000 [(7% + 3%) × Php1,000,000], resulting in net sales of Php900,000. The
estimated exchanges (15%) will not result in a future reduction of sales.

8. The ingredients of faithful representation are

a. Completeness and neutrality

b. Completeness and free from error
c. Completeness, neutrality and free from error
 d. Completeness, neutrality, free from error and conservatism

Answer: C

Under the Conceptual Framework for Financial Reporting, the characteristics of faithful
representation are: (1) completeness, (2) neutrality, and (3) free from error

9. A building suffered uninsured fire damage. The damaged portion of the building was refurbished
with higher quality materials. The cost and related accumulated depreciation of the damaged
portion are identifiable. To account for these events, the owner should

a. Reduce accumulated depreciation equal to the cost of refurbishing.

b. Record a loss in the current period equal to the sum of the cost of refurbishing and the
carrying amount of the damaged portion of the building.
c. Capitalize the cost of refurbishing and record a loss in the current period equal to the
carrying amount of the damaged portion of the building.
d. Capitalize the cost of refurbishing by adding the cost to the carrying amount of the building.

Answer: C

When an entity suffers a casualty loss to an asset, the accounting loss is recorded at the net
carrying value of the damaged asset, if known. In this case, the cost and related accumulated
depreciation are identifiable. The entity should therefore recognize a loss in the current period equal
to the carrying amount of the damaged portion of the building. The refurbishing of the building,
which is an economic event separate from the fire damage, should be treated similarly to the
purchase of other assets or betterments. The cost of refurbishing the building should therefore be
capitalized and depreciated over the shorter of the refurbishment’s useful life or the useful life of
the building.

For Nos. 10 to 11

On December 31, 2017, Nolte Co. is in financial difficulty and cannot pay a note due that day. It is a
P1,200,000 note with P120,000 accrued interest payable to Piper, Inc. Piper agrees to accept from Nolte
equipment that has a fair value of P580,000, an original cost of P960,000, and accumulated depreciation
of P460,000. Piper also forgives the accrued interest, extends the maturity date to December 31, 2020,
reduces the face amount of the note to P500,000, and reduces the interest rate to 6%, with interest payable
at the end of each year.

10. Nolte should recognize a gain or loss on the transfer of the equipment of

a. P0
b. P80,000
c. P120,000
d. P380,000

Answer: B

P580,000 – (P960,000 – P460,000) = P80,000

11. Nolte should recognize a gain on the partial settlement and restructure of the debt of

a. P0
 b. P30,000
c. P110,000
d. P150,000

Answer: D

(P1,200,000 + P120,000) – [P580,000 + P500,000 + (P500,000 x .06 x 3)] = P150,000

12. Kapayapaan Company purchased equipment for P15,000. Sales tax on the purchase was P900.
Other costs incurred were freight charges of P240, repairs of P420 for damage during installation,
and installation costs of P270. What is the cost of the equipment?

a. P15,000
b. P15,900
c. P16,410
d. P16,830

Answer: C

P15,000 + P900 + P240 + P270 = P16,410

13. What accounting concept justifies the usage of depreciation and amortization policies?

a. Going concern assumption

b. Fair value principle
c. Ful disclosure principle
d. Monetary unit assumption

Answer: A

Going concern assumption justifies the usage of depreciation and amortization policies.

14. Which statement is true about the retail inventory method?

a. It may not be used to estimate inventories for interim statements.

b. It may not be used to estimate inventories for annual statements.
c. It may not be used by auditors.
d. None of these.

Answer: D

Many answers are possible.

15. Mango, Inc. sponsors a defined-benefit pension plan. The following data relates to the operation of
the plan for the year 2017.
Service cost P250,000
Contribution to the plan 220,000
Actual return on plan assets 180,000
Projected benefit obligation (beginning) 2,400,000
Fair value of plan assets (beginning) 1,600,000
 The expected return on plan assets and settlement rate were both 10%. The amount of pension
expense reported for 2017 is

a. P250,000
b. P310,000
c. P330,000
d. P490,000

Answer: C

P250,000 + (P2,400,000 x .10) – (P1,600,000 x .10) = P330,000

Difficult

1. An entity provided the following pension plan information:

Projected benefit obligation – January 1, 2016 3,500,000

Fair value of plan assets – January 1, 2016 2,800,000
Pension benefits paid during the year 250,000
Current service cost for 2016 1,750,000
Past service cost for 2016 (vesting period 5 years) 425,000
Actual return on plan assets 180,000
Contribution to the plan 1,500,000
Actuarial loss due to change in assumptions on PBO 200,000
Discount or settlement rate 10%

What amount should be reported as accrued benefit cost on December 31, 2016?

a. 1,745,000
b. 1,750,000
c. 1,045,000
d. 700,000

Answer: A

PBO – January 1 3,500,000

Current service cost 1,750,000
Past service cost 425,000
Interest expense 350,000
Actuarial loss 200,000
Benefits paid ( 250,000)
PBO – December 31 5,975,000

FVPA – January 1 2,800,000

Actual return 180,000
Contribution to the plan 1,500,000
Benefits paid ( 250,000)
FVPA – December 31 4,230,000

FVPA – December 31 4,230,000

PBO – December 31 (5,975,000)
Prepaid/accrued benefit cost – December 31 (1,745,000)
 2. On January 1, 2016, an entity granted the employees option to buy 200,000 shares with P20 par
for P30 per share. The employees exercised the options on January 1, 2019.

Quoted market prices of shares are as follows.

2016 34
2017 39
2018 42
2019 44

The service period is for two years beginning January 1, 2016. The fair value of the share options cannot
be measured reliably.

What amount should be credited to share premium upon exercise of the share options on January 1, 2019?

a. 3,800,000
b. 4,400,000
c. 4,800,000
d. 0

Answer: B

Option price (200,000 x 30) 6,000,000

Share options outstanding 2,400,000
Total consideration 8,400,000
Par value (200,000 x 20) 4,000,000
Share premium 4,400,000

3. An entity reported the following information on January 1, 2016:

Ordinary share capital, P10 par, 800,000 shares 8,000,000

Preference share capital, P50 par, 50,000 shares 2,500,000
12% Bonds payable 5,000,000

The preference share capital is 10% cumulative and convertible into 100,000 ordinary shares. Dividends
on preference shares are in arrears for two years.

The 12% bonds are convertible into 80 ordinary shares for each P1,000 bond.

Unexercised share options to purchase 90,000 ordinary shares at P20 per share were outstanding at the
beginning and ending of 2016. The average market price of the ordinary share was P30 per share and the
market price on December 31, 2016 was P40 per share.

May 1 Issued 60,000 ordinary shares at P25 per share.

July 1 Purchased 100,000 ordinary shares at P15 to be held as treasury.
Oct. 1 Converted bonds with face amount of P2,000,000.
Dec. 31 The net income for 2016 was P5,000,000. The tax rate is 30%.
What is the amount of basic earnings per share?
 a. 6.02
b. 5.26
c. 5.72
d. 5.42

Answer: C

Net income 5,000,000

Preference dividend (10% x 2,500,000) ( 250,000)
Net income - ordinary 4,750,000

January 1 (800,000 x 12/12) 800,000

May 1 ( 60,000 x 8/12) 40,000
July 1 (100,000 x 6/12) ( 50,000)
October 1 ( 2,000 x 80 x 3/12) 40,000
Average shares outstanding 830,000

Basic EPS (4,750,000 / 830,000) 5.72

4. An entity is a dealer in equipment and uses leases to facilitate the sale of its product. The entity expects a
12% return. At the end of the lease term, the equipment will revert to the lessor.

On January 1, 2016, an equipment is leased to a lessee with the following information:

Cost of equipment to the entity 3,500,000

Fair value of equipment 5,500,000
Residual value – unguaranteed 600,000
Initial direct cost 200,000
Annual rental payable in advance 900,000
Useful life and lease term 8 years
Implicit interest rate 12%
PV of 1 at 12% for 8 periods 0.40
PV of an ordinary annuity of 1 at 12% for 8 periods 4.97
PV of an annuity due of 1 at 12% for 8 periods 5.56
First lease payment January 1, 2016

What is the net investment in the lease?

a. 5,004,000
b. 5,244,000
c. 5,500,000
d. 5,740,000

Answer: B

PV of rentals (900,000 x 5.56) 5,004,000

PV of residual value (600,000 x .40) 240,000
Net investment 5,244,000
5. On January 1, 2016, an entity purchased a building for the cash price of P8,000,000. The seller can choose
how the purchase is to be settled.

The choices are 50,000 shares with par value of P100 in one year’s time, or a cash payment equal to the
market value of 40,000 shares on December 31, 2016.

At grant date on January 1, 2016, the market price of each share is P120 and on the date of settlement on
December 31, 2016, the market price of each share is P150.

What is the interest expense to be recognized on December 31, 2016 if the seller has chosen the cash
alternative?

a. 1,200,000
b. 2,700,000
c. 1,000,000
d. 0

Answer A

Fair value of liability – 12/31/2016 (40,000 x 150) 6,000,000

Fair value of liability – 1/1/2016 4,800,000
Interest expense 1,200,000

6. An entity reported the following data for the current year:

Net sales 9,500,000

Cost of goods sold 4,000,000
Selling expenses 1,000,000
Administrative expenses 1,200,000
Interest expense 700,000
Gain from expropriation of land 500,000
Income tax 800,000
Income from discontinued operations 600,000
Unrealized gain on equity investment at FVOCI 900,000
Unrealized loss on futures contract designated as a cash flow hedge 400,000
Increase in projected benefit obligation due to actuarial assumptions 300,000
Foreign translation adjustment – debit 100,000
Revaluation surplus 2,500,000

What amount should be reported as income from continuing operations?

a. 3,100,000
b. 2,300,000
c. 1,800,000
d. 2,900,000

Answer B

Net sales 9,500,000

Cost of goods sold (4,000,000)
Gross income 5,500,000
 Gain from expropriation of land 500,000
Total income 6,000,000
Selling expenses 1,000,000
Administrative expenses 1,200,000
Interest expense 700,000 2,900,000
Income before tax 3,100,000
Tax expense ( 800,000)
Income from continuing operations 2,300,000

7. An entity sells a new product. During a move to a new location, the inventory records for the product were
misplaced. The bookkeeper has been able to gather some data for the purchases and sales records. The
July purchases are as follows:

Units Unit cost Total cost

July 5 10,000 65 650,000

10 12,000 70 840,000
15 15,000 60 900,000
25 14,000 55 770,000

On July 31, 17,000 units were on hand. The sales for July amounted to P6,000,000 or 60,000 units at P100
per unit. Roshe Company has always used a perpetual FIFO inventory costing system. Gross profit on
sales for July was P2,400,000.

What was the cost of inventory on July 1?

a. 1,390,000
b. 2,400,000
c. 950,000
d. 760,000

Answer A

July 15 ( 3,000 x 60) 180,000

25 (14,000 x 55) 770,000
Inventory – July 31 950,000

Sales 6,000,000
Gross profit 2,400,000
Cost of goods sold 3,600,000

Inventory – July 1 (SQUEEZE) 1,390,000

Purchases for July 3,160,000
Goods available for sale 4,550,000
Inventory – July 31 ( 950,000)
Cost of goods sold 3,600,000
8. An entity purchased P5,000,000 of 8%, 5-year bonds on January 1, 2016 with interest payable on June 30
and December 31. The bonds were purchased for P5,100,000 plus transaction cost of P108,000 at an
effective interest rate of 7%. The business model for this investment is to collect contractual cash flows and
sell the bonds in the open market. On December 31, 2016, the bonds were quoted at 106.

What amount should be recognized in OCI in the statement of comprehensive income for 2016?

a. 300,000
b. 125,440
c. 128,060
d. 92,000

Carrying amount
Date Interest received Interest income Amortization

1/1/16 5,208,000
6/30/16 200,000 182,280 17,720 5,190,280
12/31/16 200,000 181,660 18,340 5,171,940

Answer C

Market value on December 31, 2016 5,300,000

Carrying amount December 31, 2016 (see table of amortization) 5,171,940
Unrealized gain – OCI 128,060

9. An entity purchased P5,000,000 of 8%, 5-year bonds on January 1, 2016 with interest payable on June 30
and December 31. The bonds were purchased for P5,100,000 plus transaction cost of P108,000 at an
effective interest rate of 7%. The business model for this investment is to collect contractual cash flows and
sell the bonds in the open market. On December 31, 2016, the bonds were quoted at 106.

If the entity elected the fair value option, what total amount of income should be recognized for 2016?

a. 400,000
b. 492,000
c. 600,000
d. 200,000

Answer C

Market value on December 31, 2016 5,300,000

Acquisition cost, excluding transaction cost 5,100,000
Gain from change in fair value 200,000
Interest income (8% x 5,000,000) 400,000
Total income 600,000

10. Which of the following is not an objective of using present value in accounting measurements?
a. To capture the value of an asset or a liability in the context of a particular entity.
b. To estimate fair value.
c. To capture the economic difference between sets of future cash flows.
d. To capture the elements that taken together would comprise a market price if one existed.
 Answer: A

According to SFAC 7, the objective of using present value in an accounting measurement is to capture,
to the extent possible, the economic difference between sets of future cash flows. The objective of
present value, when used in accounting measurements at initial recognition and fresh- start
measurements, is to estimate fair value. Stated differently, present value should attempt to capture the
elements that taken together would comprise a market price, if one existed, that is fair value. Value-in-
use and entity-specific measurements attempt to capture the value of an asset or liability in the context of
a particular entity. An entity-specific measurement substitutes the entity’s assumptions for those that
marketplace participants would make.

11. Jersey, Inc. is a retailer of home appliances and offers a service contract on each appliance sold. Jersey
sells appliances on installment contracts, but all service contracts must be paid in full at the time of sale.
Collections received for service contracts should be recorded as an increase in a
a. Deferred revenue account.
b. Sales contracts receivable valuation account.
c. Stockholders’ valuation account.
d. Service revenue account.

Answer : A

The revenues from service contracts should be recognized on a pro rata basis over the term of the
contract. This treatment allocates the contract revenues to the period(s) in which they are earned. Since
the sale of a service contract does not culminate in the completion of the earnings process (i.e., does
not represent the seller’s performance of the contract), payments received for such a contract should be
recorded initially in a deferred revenue account.

12. Which of the following errors could result in an overstatement of both current assets and stockholders’
equity?
a. An understatement of accrued sales expenses.
b. Noncurrent note receivable principal is misclassified as a current asset.
c. Annual depreciation on manufacturing machinery is understated.
d. Holiday pay expense for administrative employees

Answer: D

The classification of holiday pay expense for administrative employees as manufacturing overhead would
result in the capitalization of some or all of these costs as a component of ending inventory, while these
costs should be expensed as incurred. This error could overstate ending inventory, a current asset. The
overstate- ment of ending inventory also understates the cost of goods sold (Beginning inventories + Net
purchases – Ending inventories = Cost of goods sold), and overstates net income and stockholders’
equity. The understatement of accrued sales expenses would not affect current assets. The
misclassification of the noncurrent note receivable principal as a current asset would have no impact on
stockholders’ equity. The understatement of depreciation on manufacturing machinery would understate
the overhead added to inventories, a current asset.

13. A transaction that is unusual in nature and infrequent in occurrence should be reported separately as a
component of income
a. After cumulative effect of accounting changes and before discontinued operations.
 b. After cumulative effect of accounting changes and after discontinued operations.
c. Before cumulative effect of accounting changes and before discontinued operations.
d. Before cumulative effect of accounting changes and after discontinued operations.

Answer: D

Per APB 30, a transaction that is unusual in nature and infrequent in occurrence is considered an
extraordinary item. An extraordinary item is reported after discontinued operations but before cumulative
effect of accounting changes.

14. For which type of material related-party transactions does Statement of Financial Accounting Standard
57, Related-Party Disclosures, require disclosure?
a. Only those not reported in the body of the financial statements.
b. Only those that receive accounting recognition.
c. Those that contain possible illegal acts.
d. All those other than compensation arrangements, expense allowances, and other similar items in
the ordinary course of business.

Answer: D

SFAS 57 requires disclosure of material transac- tions between related parties except: (1) compensation
agreements, expense allowances, and other similar items in the ordinary course of business and (2)
transactions eliminated in the preparation of consolidated or combined finan- cial statements.

15. Which of the following is not a required disclosure for defined benefit pension plans?
a. An explanation of a significant change in plan assets if not apparent from other disclosures.
b. The amount of any unamortized prior service cost not recognized in the statement of financial
position (balance sheet).
c. The effect of a two-percentage-point increase in the assumed health care cost trend rate(s).
d. Reconciliation of beginning and ending balance of the benefit obligation.

Answer: C

The effect of a one-percentage-point increase in the assumed health care cost trend rate(s) is required,
not a two-percentage-point increase. An explanation of a signifi- cant change in plan assets, if not
apparent from other disclo- sures, is required according to SFAS 132. The amount of any unamortized
prior service cost not recognized in the statement of financial position (balance sheet) is a required
disclosure. Another required disclosure per SFAS 132 is a reconciliation of beginning and ending
balances of the bene- fit obligation.