Intermediate Accouting Sample Problems

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Intermediate Accouting sample problems
Bachelor of Science in Accountancy (Polytechnic University of the Philippines)
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1. On December 31, 2005, Grey, Inc. owned 90% of consolidated balance sheet on that date, what amount of
Winn Corp., a consolidated subsidiary, and 20% of Carr the advance should be eliminated?
Corp., an investee in which Grey cannot exercise A. $-0-
significant influence. On the same date, Grey had B. $80,000
receivables of $300,000 from Winn and $200,000 from C. $120,000
Carr. D. $200,000
In its December 31, 2005, consolidated balance sheet,
Grey should report accounts receivable from affiliates D. $200,000
of: The amount to be eliminated is $200,000, which is the
full amount of the intercompany receivable-payable
A. $500,000 resulting from the cash advance.
B. $340,000
C. $230,000 5
D. $200,000
Which one of the following will occur on consolidated
D. $200,000 financial statements if an intercompany inventory
transaction is not eliminated?
A 90% owned subsidiary will be consolidated, and any A. An understatement of sales.
intercompany receivables such as these are eliminated B. An overstatement of sales.
from both parties' books in the consolidating process. C. An understatement of purchases.
D. An overstatement of accounts receivable.
Therefore, the $300,000 receivable from Winn will not
appear on the consolidated balance sheet at all. The B. An overstatement of sales.
$200,000 from Carr is a receivable from an affiliate
6
(20% owned) and will need to be reported as such.
Which of the following can be overstated on

2. Which of the following kinds of transactions should
consolidated financial statements if intercompany
be eliminated in the consolidating process?
inventory balances on-hand at the end of a period are not
eliminated?
Parent to Subsidiary Subsidiary to Parent Subsidiary 1
Subsidiary 2
Consolidated Income Consolidated Loss
Yes Yes Yes
Yes Yes
Yes Yes No
Yes No
Yes No No
No Yes
No Yes Yes
No No
Parent to Subsidiary Subsidiary to Parent Subsidiary 1
Consolidated Income Consolidated Loss
Subsidiary 2
Yes Yes
Yes Yes Yes
7
3. Which one of the following is not a characteristic
associated with intercompany transactions?
A. Intercompany transactions must be eliminated in the Assume that on January 2, Company P recognized a
consolidating process. $3,000 gain on the sale of a depreciable fixed asset to its
B. Gains and losses must be eliminated in the subsidiary, Company S. Company S will depreciate the
consolidating process. asset using straight-line depreciation over the remaining
C. Transactions that originate with a subsidiary must be three-year life of the asset. What amount of
eliminated in the consolidating process. intercompany gain will be eliminated from P's retained
D. Transactions between two subsidiaries to be earnings at the end of the year following the year of the
consolidated with the same parent do not need to be intercompany fixed asset transactions?
eliminated. A. $- 0 -
B. $1,000
C. $2,000
D. Transactions between two subsidiaries to be
D. $3,000
consolidated with the same parent do not need to be
eliminated.
C. $2,000
Intercompany transactions (i.e., transactions between The amount of intercompany gain to be eliminated at the
affiliated firms) must be eliminated regardless of end of the year following the year of the intercompany
whether the transactions are between the parent and its fixed asset sale is $2,000. At the end of the year of the
subsidiaries or between two subsidiaries of the same intercompany sale, depreciation taken by the buying
parent. affiliate on the $3,000 inter-company gain will be $1,000
($3,000/3 years). As a consequence, $1,000 of the
4 $3,000 intercompany gain will have been properly
recognized, leaving only $2,000 to eliminate at the end
Bell, Inc. owns 60% of Dart Corporation's common of the second year. Depreciation expense taken on the
stock. On December 31, 20X6, Dart is indebted to Bell intercompany gain for the second year will confirm
for a $200,000 cash advance. In preparing the another $1,000 of the intercompany gain, and

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depreciation expense taken on the intercompany gain for affiliate?

the third year will confirm the last $1,000 of the At a Profit At a Loss
intercompany gain. Overstate Overstate
Overstate Understate
8 Understate Overstate
Understate Understate
Scroll, Inc., a wholly owned subsidiary of Pirn, Inc.,
began operations on January 1, 2005. The following Understate Overstate
information is from the condensed 2005 income An intercompany sale of a fixed asset at a profit will
statements of Pirn and Scroll: result in the buying affiliate overstating, not
Pirn Scroll understating, depreciation expense by the amount of
Sale to Scroll $100,000 $- depreciation taken on the intercompany profit, and an
Sales to others 400,000 300,000 intercompany sale at a loss will result in an
500,000 300,000 understatement of depreciation expense taken by the
Cost of goods sold: buying affiliate, not an overstatement of depreciation
Acquired from Pirn - 80,000 expense. When an intercompany sale of a fixed asset
Acquired from others 350,000 190,000 results in a loss, the carrying value of the asset will be
Gross profit 150,000 30,000 understated by the amount of the loss. As a result,
Depreciation 40,000 10,000 depreciation expense taken by the buying affiliate will
Other expenses 60,000 15,000 be understated by the amount of depreciation that would
Income from operations 50,000 5,000 have been taken on the intercompany loss.
Gain on sale of equipment to Scroll 12,000 -
Income before income taxes $38,000 $5,000 11
Additional information:
Sales by Pirn to Scroll are made on the same terms as Zest Co. owns 100% of Cinn, Inc. On January 2, 1999,
those made to third parties. Zest sold equipment with an original cost of $80,000 and
Equipment purchased by Scroll from Pirn for $36,000 on a carrying amount of $48,000 to Cinn for $72,000. Zest
January 1, 2005, is depreciated using the straight-line had been depreciating the equipment over a five-year
method over four years. period using straight-line depreciation with no residual
What amount should be reported as depreciation expense value. Cinn is using straight-line depreciation over three
in Pirn's 2005 consolidated income statement? years with no residual value. In Zest's December 31,
1999, consolidating worksheet, by what amount should
A. $50,000 depreciation expense be decreased?
B. $47,000 A. $0
C. $44,000 B. $8,000
D. $41,000 C. $16,000
B. $47,000 B. $8,000
The gain on the equipment sold to Scroll must be There are two ways to approach this solution. First, take
eliminated, since it was not sold outside the consolidated the difference in carrying values 72,000-48,000 =
entity. With the elimination of the gain, one must also 24,000. The 24,000 is the incremental amount Cinn
eliminate the depreciation of the gain that Scroll would carries the equipment over the carrying amount of Zest.
have been booking (based on their higher purchase The 24,000/3 = 8,000
price). This excess depreciation is $3,000 a year OR, compute the depreciation for each company:
($12,000 gain/4 years). Cinn is 72,000/3 = 24,000
This would reduce the total consolidated depreciation Zest is 80,000/5 = 16,000
from $50,000 ($40,000+$10,000) to $47,000.
9 Since Cinn is 100% owned by Zest, the equipment
cannot be depreciated by a greater amount through an
intracompany sale. The difference is 24,000 - 16,000 =
Water Co. owns 80% of the outstanding common stock 8,000.
of Fire Co. On December 31, 2005, Fire sold equipment
to Water at a price in excess of Fire's carrying amount 12
but less than its original cost. On a consolidated balance
sheet on December 31, 2005, the carrying amount of the On December 31, 2008, Pico acquired $250,000 par
equipment should be reported at: value of the outstanding $1,000,000 bonds of its
A. Water's original cost. subsidiary, Sico, in the market for $200,000. At that date,
B. Fire's original cost. Sico had a $100,000 premium on its total bond liability.
C. Water's original cost less Fire's recorded gain.
D. Water's original cost less 80% of Fire's recorded gain. Assume each company maintains its premium or
discount in a separate account. Which one of the
C. Water's original cost less Fire's recorded gain. following will be the intercompany bond elimination
entry made on the December 31, 2008 consolidating
10 worksheet?
For consolidated purposes, what effect will the A.

intercompany sale of a fixed asset at a profit or at a loss DR: Bonds Payable
have on depreciation expense recognized by the buying Discount on Bond Investment

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Loss on Constructive Retirement Which one of the following is the net amount of gain or
CR: Investment in Bonds loss that will be recognized by Pico in its December 31,
Premium on Bonds Payable 2008, consolidated financial statements as a result of its
B. intercompany bonds?
DR: Bonds Payable
Premium on Bonds Payable A. $25,000
CR: Investment in Bonds B. $50,000
Discount on Bond Investment C. $75,000
Gain on Constructive Retirement D. $150,000
C.
DR: Bonds Payable C. $75,000
Premium on Bonds Payable In the elimination of intercompany bonds, the
Discount on Bond Investment intercompany bond liability at par will be eliminated
CR: Investment in Bonds against the intercompany bond investment at par.
Gain on Constructive Retirement Therefore, the gain or loss recognized as a result of
D. constructive retirement of intercompany bonds is the net
DR: Investment in Bonds of the premium or discount on the bond liability and the
Gain on Constructive Retirement premium or discount on the bond investment. In this
CR: Bonds Payable case, there is a total $100,000 premium on the bond
Premium on Bonds Payable liability, but because only one-fourth
Discount on Bond Investment ($250,000/$1,000,000 = 1/4) of the bonds are
intercompany, only one fourth of the premium is
eliminated. Thus, $25,000 of premium on the bond
C. liability (a credit) will be eliminated against the $50,000
DR: Bonds Payable discount on the bond investment (also a credit). As a
Premium on Bonds Payable result of eliminating the two credits ($25,000 + $50,000
Discount on Bond Investment = $75,000), a $75,000 gain on constructive retirement
CR: Investment in Bonds will be recognized.
Gain on Constructive Retirement
15
the Premium on Bonds Payable $25,000 (a credit
balance, so it will be debited) will be eliminated In which of the following cases will the elimination of
resulting in a Gain on Constructive Retirement of intercompany bonds always result in a gain on
$75,000, a credit balance. constructive retirement?
Issuing Affiliate Has Buying Affiliate Has
Therefore, the correct entry would be: Premium Premium
DR: Bonds Payable Premium Discount
Premium on Bonds Payable Discount Premium
Discount on Bond Investment Discount Discount
CR: Investment in Bonds
Gain on Constructive Retirement Issuing Affiliate Has Premium
13 Buying Affiliate Has Discount
On December 31, 2008, Pico acquired $250,000 par When the issuing affiliate has a premium on the bond
value of the outstanding $1,000,000 bonds of its liability and the buying affiliate has a discount on the
subsidiary, Sico, in the market for $200,000. On that bond investment, the elimination of the bond liability
date, Sico had a $100,000 premium on its total bond against the bond investment will result in a gain on
liability. constructive retirement. If the bonds are issued at a
premium, the issuing firm received a greater amount for
Which one of the following is the net carrying value of the bonds than face value. In addition, if the buying
Sico's total bond liability? affiliate acquired the bonds at a discount, it paid less
than face value for the bonds. Therefore, the elimination
A. $900,000 of the payable against the investment in the
B. $1,000,000 consolidating process must result in a gain on
C. $1,050,000 constructive retirement.
D. $1,100,000
16
D. $1,100,000
Assume Instco acquires an option to buy (a call option)
14 100 shares of Opco for $50 per share when the market
price of Opco is $45 per share and that Instco paid a
On December 31, 2008, Pico acquired $250,000 par premium of $1.00 per share to acquire the options.
value of the outstanding $1,000,000 bonds of its Which one of the following is the underlying related to
subsidiary, Sico, in the market for $200,000. On that Instco's options?
date, Sico had a $100,000 premium on its total bond
liability. A. 100 shares.
B. $1.00 per option.

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C. $45.00 per option.

D. $50.00 per option. A. It is evidenced by a contractual obligation.
B. It can be the hedged item in a fair value hedge.
D. $50.00 per option. C. It has been recorded as an asset or liability.
D. It is subject to the risk of change in fair value.
Underlying = strike price, or the price Instco will buy the
stock at. C. It has been recorded as an asset or liability.
17 A firm commitment has not been recorded (yet) as an
asset or liability. A firm commitment occurs when an
Smythe Co. invested $200 in a call option for 100 shares entity has a contractual obligation or contractual right,
of Gin Co. $.50 par common stock, when the market but no transaction has been recorded (and no asset or
price was $10 per share. The option expired in three liability recognized) because GAAP requirements for
months and had an exercise price of $9 per share. What recognition have not yet been met. Nevertheless, the
was the intrinsic value of the call option at the time of subject matter of the firm commitment is at risk of
initial investment? change in fair value and can be hedged.
A. $50
B. $100 21
C. $200
D. $900 A derivative cannot be used as a fair value hedge for:
B. $100 A. A recognized asset.

intrinsic value of a call option = (exercise (strike) price - B. A recognized liability.
market price) * # of shares (or notional amount). C. An unrecognized forecasted transaction.
D. An unrecognized firm commitment.
18
C. An unrecognized forecasted transaction.
Which one of the following is an item for which risk
associated with the item cannot be hedged for For GAAP purposes, a derivative cannot be used to
accounting purposes? hedge the risk associated with an unrecognized
A. Foreign currency risk of a net investment in a foreign forecasted transaction, primarily because, since the
operation. transaction is only "forecasted," there is no established
B. Fair value of an investment accounted for using the fair value to hedge. A derivative can be used to hedge the
equity method of accounting. risk associated with a recognized asset, recognized
C. Credit risk of investments classified as held for liability, or unrecognized firm commitment, but not an
trading. unrecognized forecasted transaction.
D. Overall change in the fair value of a non-financial
asset 22
A. Foreign currency risk of a net investment in a foreign On October 1, 2008, Buyco entered into a legally
operation. enforceable contract to acquire raw material inventory in
180 days for $20,000. In order to mitigate the risk of a
The foreign currency risk associated with a net change in the value of the raw materials, Buyco also
investment in a foreign operation (e.g., an investment in entered into a qualified 180-day forward contract to
a foreign subsidiary) can be hedged for accounting hedge the fair value of the raw materials. At December
purposes. 31, 2008, the value of the raw materials had decreased
by $500, and the fair value of the futures contract had
The fair value of an investment accounted for using the increased by $480. On March 29, 2009, the date the raw
equity method of accounting cannot be hedged for materials were delivered to Buyco, they had a fair value
accounting purposes. of $19,300, and the forward contract had a fair value of
$700. Which one of the following is the net gain or loss
19 that would be recognized on the raw material and related
forward contract by Buyco over the life of the contract?
Hedges of foreign currency risks can be the hedge of:
A. $ -0-
Fair Value Cash Flows B. $20
Yes Yes C. $220
Yes No D. $700
No Yes
No No A. $ -0-
Because Buyco entered into the forward contract
Fair Value Cash Flows (hedging instrument) to hedge the risk of change in the
Yes Yes fair value of the raw materials (hedged item), the change
in the fair value of the forward contract over the life of
20
the contract offsets the change in the fair value of the
raw materials. Specifically, the decrease in the value of
Which one of the following is least likely to be a the raw materials, $700 ($20,000 - $19,300 = $700), was
characteristic of a firm commitment? offset by the increase in the value of the forward contract

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of $700 (given), so the net gain recognized over the life B. I and II only.
of the contract was $700 - $700 = $-0-, which is the Both the net gain or loss recognized in earnings during
correct answer. the period (Statement I) and the amount of gain or loss
deferred in other comprehensive income (Statement II)
Which of the following statements concerning must be disclosed. Statement III is not a required
derivatives used as foreign currency hedges is/are disclosure.
correct? 26
I. Can be used to hedge the risk of exchange rate
changes on planned transactions.
Which one of the following is not a required disclosure
II. Can be used to hedge the risk of exchange rate for derivatives used as fair value hedges?
changes on available-for-sale investments. A. The amount of net gain or loss recognized in earnings
during the period.
III. Can be used to hedge the risk of exchange rate B. The location in the financial statements where any
changes on accounts receivable and accounts payable. gain or loss is reported.
When derivatives are used as fair value hedges, the
A. I only. location in the financial statements where any gain or
B. I and II only. loss is reported must be disclosed.
C. II and III only. C. The net gain or loss in earnings from firm
D. I, II, and III. commitment hedges that no longer qualify for hedge
treatment.
D. The amount of gain or loss arising during the period
D. I, II, and III. that was deferred.
24
D. The amount of gain or loss arising during the period
Which of the following, if any, can be the risk being that was deferred.
hedged in a foreign currency hedge? When derivatives are used for fair value hedges, the
Fair Value Cash Flow amount of gain or loss arising during the period that was
Yes Yes deferred is not a required (or relevant) disclosure. When
Yes No fair value hedges are used, any resulting gain or loss is
No Yes recognized in current income, not deferred. CF hedge
No No G/L is deferred in OCI.
27
Fair Value Cash Flow
Yes Yes Bigco, Inc. transferred long-term receivables with a
Foreign currency hedges may be either fair value or cash carrying value of $500,000 and a fair value of $450,000
flow hedges. to Banco for $425,000 cash. Of the $450,000 fair value,
$45,000 is attributable to collection of future fees and
FV hedges: penalties, which Bigco will retain. The surrender of
unrecognized firm commitments, inv. in AFS securities, control requirements have been met, therefore the
net inv. in foreign ops. transfer qualifies as a sale. What amount of loss should
Bigco recognize at the time of the transfer?
CF hedges: A. $ -0-
foreign currency hedges of forecasted transactions are B. $25,000
cash flow hedges. C. $50,000
D. $75,000
Additionally, foreign currency hedges of recognized
assets or liabilities may be treated either as FV or CF
hedges. B. $25,000
Bigco's loss is the difference between the carrying value
25 of the portion of the asset transferred and the cash
received for the transferred portion. In this case, the total
Which of the following statements concerning disclosure carrying value of $500,000 must be allocated between
requirements for derivatives used as cash flow hedges the portion of the asset surrendered and the portion
is/are correct? retained, based on relative fair values. The relative fair
I. The net gain or loss recognized in earnings during the values are:
period must be disclosed. Amount Percent
Asset retained $ 45,000 10%
II. The amount of gain or loss deferred in other Asset transferred 405,000 __90_
comprehensive income must be disclosed. Total fair value $450,000 100%
Therefore, the carrying value of the asset transferred is .
III. A listing of derivatives used for cash flow hedges 90 x $500,000 = $450,000. The resulting loss is carrying
and the amount of each must be disclosed. value transferred $450,000 - cash received $425,000 =
$25,000 loss.
A. I only. 28
B. I and II only.
C. I and III only.
D. I, II, and III.

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Which one of the following is not associated with Will a transferor have to allocate the carrying value of a
accounting for a transfer of a financial asset treated as a financial asset when the transferor retains an interest in
sale by the transferor? the transferred asset or when the transferor does not
A. Derecognizing the asset(s) sold. retain an interest in the transferred asset?
B. Recognizing asset(s) obtained or liability(ies) Allocate Carrying Value When:
incurred.
C. Measuring assets and liabilities at fair value. Interest Retained No Interest Retained
D. Deferring any gain or loss in other comprehensive Yes Yes
income. Yes No
No Yes
D. Deferring any gain or loss in other comprehensive No No
income.
Any gain or loss resulting from the transfer of financial Interest Retained No Interest Retained
assets would not be deferred in other comprehensive Yes No
income (outside net income) by the transferor, but rather The transferor will have to allocate the carrying value of
would be recognized in current income. a financial asset when it is transferred and the transferor
retains an interest in the asset, but allocation of the
29 carrying value is not necessary when the transferor does
not retain an interest in the asset. When no interest is
Which of the following statements concerning the retained, the full carrying value of the asset will be
transfer of financial assets that qualifies as a sale is/are written off by the transferor.
correct?
I. The transferor may retain an interest in the asset 32
transferred.
A financial asset is transferred with one component of
II. The transferor may recognize a gain or a loss on the the asset appropriately treated as sold and another
transfer. component appropriately treated as retained. How will
the amount to be written off as sold be determined?
III. The transferor's proceeds are decreased by any A. Write off the fair value of the component sold.
liability it incurs in the transfer. B. Write off a portion of the asset carrying value based
on the relative fair values of the components.
A. I only. C. Write off the portion of the asset carrying value left
B. II only. after deducting the fair value of the retained interest.
C. I and II only. D. Write off the present value of the cash flows of the
D. I, II, and III. component sold.
D. I, II, and III. B. Write off a portion of the asset carrying value based
All three statements are correct. The transferor may on the relative fair values of the components.
retain an interest in the asset transferred (Statement I),
the transferor may recognize a gain or loss on the The carrying amount of the asset before the transfer will
transfer (Statement II), and the transferor's proceeds be allocated to the component sold and the component
from the transfer are decreased by any liability incurred retained based on the relative fair values of the
in the transfer (Statement III). components at the date of the transfer. The portion of the
carrying value allocated to the component sold will be
30 written off.
If the transfer of a financial asset does not meet the 33

requirements of surrender of control by the transferor,
how will it be treated by the transferor and by the Which of the following is not a characteristic associated
transferee? with the servicing of financial assets?
Transferor Transferee A. The servicing function is inherent in all financial
Sale Purchase assets.
Sale Secured Lending B. The right to service financial assets can result in
Borrowing with Collateral Secured Lending either a separate asset or a separate liability.
Borrowing with Collateral Purchase C. If a servicing asset is retained as a component in a
sale of a financial asset, the servicing asset is measured
Transferor Transferee as a portion of the carrying value of the transferred asset.
Sale Secured Lending D. If a servicing asset is acquired in the market, the
Borrowing with Collateral Secured Lending servicing asset is measured at fair value.
If the transfer of the financial asset does not meet the
requirements of surrender of control by the transferor, C. If a servicing asset is retained as a component in a
the transfer is a borrowing with collateral by the sale of a financial asset, the servicing asset is measured
transferor and a secured lending by the transferee (not a as a portion of the carrying value of the transferred asset.
sale and purchase, respectively).
When a servicing asset is retained as a component in a
31 sale of a financial asset, the servicing asset is not
measured as a portion of the carrying value of the

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transferred asset, but rather at fair value at the date of Year 20X3 10,000
transfer of the financial asset. Which one of the following is the amount of the $60,000
acquisition fee that Servco should amortize during year
34 1?
A. $ -0-
Recognized servicing assets should be assessed for B. $20,000
impairment and servicing liabilities should be assessed C. $30,000
for understatement. In which of the following cases will D. $40,000
an impairment loss be recognized?
A. Servicing asset with carrying value less than fair C. $30,000
value. Servco would record the $60,000 as a servicing asset and
When an asset has a carrying value less than fair value, would amortize it in proportion to and over the period of
there is no unrealized loss. If GAAP calls for the asset to the estimated income. In this case, during year 20X1,
be adjusted to fair value (e.g., investment held-for- $40,000 of the total $80,000 estimated income would be
trading), a gain would be recognized, not a loss. earned. Therefore, 50% of the servicing asset would be
B. Servicing asset with fair value greater than carrying amortized in year 20X1. Thus, $60,000 x .50 = $30,000
value. amortization in year 20X1.
C. Servicing liability with carrying value less than fair
value. 37
D. Servicing liability with fair value less than carrying
value. Assume a creditor releases a debtor from being primarily
responsible for a liability because an unrelated third-
C. Servicing liability with carrying value less than fair party legally assumes the liability, with the original
value. debtor becoming secondarily liable for the obligation.
Which of the following statements is correct?
When a liability has a carrying value less than fair value, I. The original debtor's liability has been extinguished.
an unrealized loss exists. Adjusting the carrying value of
the liability to the higher fair value will result in a loss; II. The original debtor became a guarantor of the
DR: Impairment Loss (+), CR: Liability (+). liability.
35 III. The original debtor may recognize a gain or loss on
its release from the obligation.
On January 2, 20X8, Fiserveco acquired a five-year right
to service mortgage contracts for which it paid $120,000. A. II only.
Fiserveco estimated that servicing and other fees would B. I and II only.
generate $400,000 over the five-year period. During C. I and III only.
20X8 the contract generated $100,000 in revenues. D. I, II, and III.
Which one of the following is the amount of expense, if
any, that Fiseerveco should recognize in 20X8 as D. I, II, and III.
amortization of its servicing asset? The original debtor's liability has been extinguished, the
A. $ -0- debtor has become a guarantor of the liability now held
B. $ 24,000 by a third-party, and the original debtor may recognize a
C. $ 30,000 gain or loss on its release from the obligation.
D. $ 100,000
38
C. $ 30,000
Since Fiserveco acquired the servicing rights asset in the Sloco has a debt with a carrying value of $500,000 due
market, it should recognize a servicing asset at its fair to Topco. Because Topco is concerned about Sloco's on-
value, which is the cost to Fiserveco in the market. going ability to meet its debt obligation, it has agreed to
Therefore, it should recognize an asset of $120,000 on Sloco's proposal that Trico, an unrelated third-party,
January 2, 20X8. That servicing asset should be assume the debt, with Sloco becoming secondarily
amortized each period over the life of the contract in the liable. Sloco will transfer to Trico equipment with a
same proportion that period revenues have to expected current fair value of $400,000 in exchange for Trico's
total revenues. During 20X8, $100,000 of an expected assumption of its debt to Topco. Based on its objective
$400,000 total revenues was earned. Therefore, assessment as to Trico's likelihood of satisfying the debt
$100,000/$400,000, or ¼ of the servicing asset should be obligation, Sloco estimates the possibility of its
amortized. One-fourth of $120,000 = $30,000, the secondary obligation for the debt has a fair value of
correct answer. $70,000.
36 What amount of gain or loss, if any, should Sloco
recognize as a consequence of carrying out its
Servco, a loan servicing agency, paid $60,000 to acquire arrangement with Topco and Trico?
a three-year right to service $1,000,000 of Banco's loans.
Servco will be entitled to a servicing fee of 1% of the A. $ -0-
interest and fees collected during the three-year period. B. $30,000
Servco expects its servicing fees to be: C. $100,000
Year 20X1 $40,000 D. $170,000
Year 20X2 30,000

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B. $30,000 outflow of benefits, amount is estimable.

Sloco would recognize a gain or loss as the difference B. A provision with a 40% chance of requiring an
between the carrying value of its debt and the fair value outflow of benefits, amount is estimable.
of consideration given to extinguish the debt, less any C. A provision with a 90% chance of requiring an
obligation incurred in the arrangement. Therefore, Sloco outflow of benefits, amount not estimable.
would write off the carrying value of its debt ($500,000) D. A possible obligation.
and the fair value of the equipment conveyed to Trico
($400,000) for a gross gain of $100,000. That gross gain A. A provision with a 60% chance of requiring an
would be reduced by the guarantor obligation it would outflow of benefits, amount is estimable.
recognize of $70,000. Thus, Sloco would recognize a net
gain of $100,000 - $70,000 = $30,000. A probable (
39 42
Choose the correct statement regarding international Which of the following is a recognized liability for both
accounting standards and U.S. standards as they relate to international accounting standards and U.S. standards?
contingent liabilities and similar items. A. Regular warranty liability, 60% probability of
A. All provisions under international accounting occurring.
standards are contingent liabilities under U.S. standards. B. Obligation to provide rebates to customers, 90%
B. Both sets of standards require discounting of probability of occurring.
estimated liabilities. C. Possible loss due to lawsuit, 60% probability of
C. A possible obligation that requires a future event for occurring.
confirmation is treated as a contingent liability under D. Possible loss due to lawsuit, 40% probability of
both sets of standards. occurring.
D. Both sets of standards are essentially the same with
regard to recognition of contingent assets. B. Obligation to provide rebates to customers, 90%
probability of occurring.
C. A possible obligation that requires a future event for
confirmation is treated as a contingent liability under For international accounting standards, this is a
both sets of standards. recognized provision. For U.S. standards, it is a
recognized contingent liability.
This is the one situation where both sets of standards
agree with respect to classifying contingent liabilities. 43
For international accounting standards, there are other
situations calling for the reporting of a contingent A firm considers its regular warranty liability to be an
liability. existing liability of uncertain amount. At year-end, the
firm estimates that the amount required to extinguish its
40 warranty liability in the future is in the range of $20 to
$60 million, with no amount more likely than any other.
Choose the correct statement about international Under the two sets of standards, what amount will be
accounting standards as they relate to contingent recognized?
liabilities and similar items.
A. A provision that has a reasonably possible chance of International U.S.
requiring the outflow of benefits is treated as a 40 40
contingent liability. 40 20
B. Provisions are recognized only when there is greater 20 20
than a 90% probability of an outflow of benefits 0 40
occurring.
C. A recognized provision is a contingent liability. International U.S.
D. A provision for which it is probable that an outflow of 40 20
benefits will be required is recognized, even if it is not of International accounting standards recognize the
estimable amount. midpoint, whereas U.S. standards recognize the low
point.
A. A provision that has a reasonably possible chance of
requiring the outflow of benefits is treated as a 44
contingent liability.
Ian Co. is calculating earnings per share amounts for
A provision is a present obligation. This is one of the inclusion in the Ian's annual report to shareholders. Ian
ways a liability can be treated as a contingent liability has obtained the following information from the
under international standards. If the provision involved a controller's office as well as shareholder services:
probable outflow, then it would be recognized, but
would not be a contingent liability. Net income from January 1 to December 31 $125,000
Number of outstanding shares:
41 January 1 to March 31 15,000
April 1 to May 31 12,500
Which of the following is not a contingent liability under June 1 to December 31 17,000
international accounting standards? In addition, Ian has issued 10,000 incentive stock
A. A provision with a 60% chance of requiring an options with an exercise price of $30 to its employees

lOMoARcPSD|9304052
and a year-end market price of $25 per share. What B. $480,000

amount is Ian's diluted earnings per share for the year C. $120,000
ended December 31? D. $360,000
A. $4.63 A. $600,000
B. $4.85 The $600,000 total loss from discontinued operations is
C. $7.35 the sum of the operating loss ($120,000) and the loss on
D. $7.94 disposal ($480,000). The two amounts, $120,000 and
$480,000, are disclosed separately but together comprise
D. $7.94 the total loss on the discontinued operation.
Weighted average shares outstanding for basic EPS =
15,000(3/12) + 12,500(2/12) + 17,000(7/12) = 15,750. 47
Basic EPS = $125,000/15,750 = $7.94. The stock
options are antidilutive because the exercise price A firm with a net income of $30,000 and weighted
exceeds the average market price of the stock. Such average actual shares outstanding of 15,000 for the year
options would not be assumed exercised. Under the also had the following two securities outstanding the
treasury stock method, assuming exercise would result in entire year: (1) 2,000 options to purchase one share of
more shares being purchased for the treasury than issued stock for $12 per share. The average share price during
upon assumed exercised. The result is a decrease in the the year was $20, (2) cumulative convertible preferred
denominator of diluted EPS causing diluted EPS to stock with an annual dividend commitment of $4,500.
exceed basic EPS. Therefore, in this case, diluted and Total common shares issued on conversion are 2,900.
basic EPS are equal. Compute diluted EPS for this firm.
45 A. $1.70
B. $1.60
A company decided to sell an unprofitable division of its C. $1.55
business. The company can sell the entire operation for D. $1.61
$800,000, and the buyer will assume all assets and
liabilities of the operations. The tax rate is 30%. The B. $1.60
assets and liabilities of the discontinued operation are as The options and convertible preferred stock are potential
follows: common stock (PCS). First compute basic EPS as the
Buildings $5,000,000 basis for diluted EPS, and also as a benchmark for
Accumulated depreciation 3,000,000 determining whether the two potential common stock
Mortgage on buildings 1,100,000 securities are dilutive. Basic EPS = ($30,000 -
Inventory 500,000 $4,500)/15,000 = $1.70. The preferred dividend is
Accounts payable 600,000 subtracted from income because the preferred is
Accounts receivable 200,000 cumulative. Then determine the numerator and
What is the after-tax net loss on the disposal of the denominator effects of the PCS to enter them into diluted
division? EPS in the order of lowest ratio of numerator to
denominator effect (n/d) first. The option?s numerator
A. $140,000 effect is zero; the denominator effect = 2,000 -
B. $200,000 (2,000)$12/$20 = 800. 2,000 shares would be issued
C. $1,540,000 upon exercise but under the treasury stock method the
D. $2,200,000 firm is assumed to apply the proceeds from exercise
(2,000 x $12) and purchase shares of the firm?s stock for
A. $140,000 $20 each. Thus, the n/d for options = 0/800 = 0. The n/d
The after tax net loss on the disposal of the division is for the convertible preferred stock is the ratio of
the net asset value, ($2,700,000 of assets - $1,700,000 of dividends that would not have been declared if the stock
liabilities) $1,000,000, less the selling price of $800,000. converted, to the common shares asson. n/d =
The result is a net loss of $200,000 before tax. After $4,500/2,900 = $1.55. Enter the options into diluted EPS
30% taxes, the net loss is $140,000. first, because the options have the lower n/d. DEPS
tentative = ($30,000 - $4,500)/(15,000 + 800) = $1.61.
46 The convertible preferred is dilutive because its n/d ratio
of $1.55 is less than $1.61, the tentative or first-pass
On April 30, 2005, Carty Corp. approved a plan to amount for diluted EPS. DEPS final = ($30,000 - $4,500
dispose of a segment of its business. The disposal loss is + $4,500)/(15,000 + 800 + 2,900) = $1.60.
$480,000, including severance pay of $55,000 and
employee relocation costs of $25,000, both of which are 48
directly associated with the decision to dispose of the
segment. The firm is a calendar-fiscal year firm, and the On November 1, 2004, Beni Corp. was awarded a
segment's operating loss for the entire year (2005) judgment of $1,500,000 in connection with a lawsuit.
through the date of disposal was $120,000. The decision is being appealed by the defendant, and it
Before income taxes, what amount should be reported in is expected that the appeal process will be completed by
Carty's income statement for the year ended December the end of 2005.
31, 2005, as the total income effect (loss) from Beni's attorney feels that it is highly probable that an
discontinued operations? award will be upheld on appeal, but that the judgment
may be reduced by an estimated 40%.
A. $600,000 In addition to footnote disclosure, what amount should

lOMoARcPSD|9304052
be reported as a receivable in Beni's balance sheet at AB Company reported earnings per share of $10.50 on
December 31, 2004? income before discontinued operations, ($2.00) on
income (loss) attributed to discontinued operations, and
A. $1,500,000 $8.50 on net income. Which EPS figure is more relevant
B. $900,000 to a potential investor?
C. $600,000 A. ($2.00)
D. $ -0- B. $7.50
C. $8.50
D. $ -0- D. $10.50
This is a contingent asset or gain. Contingent assets are
not recognized in the accounts. D. $10.50
This is a classic case of conservatism. If all the data were Potential investors and current investors are interested in
the same except that a loss was expected, a loss would the future earnings potential of the entity. Thus, they are
be accrued in the accounts. interested in the earnings per share on continuing
income, which would be the $10.50 per share. The EPS
49 attributed to discontinued operations cannot be used in
predicting future earnings, as they are one-time events.
Chape Co. had the following information related to
common and preferred shares during the year: 52
Common shares outstanding, 1/1 700,000
Common shares repurchased, 3/31 20,000 A company had the following outstanding shares as of
Conversion of preferred shares, 6/30 40,000 January 1, year 2:
Common shares repurchased, 12/1 36,000 Preferred stock, $60 par, 4%, cumulative 10,000 shares
Chape reported net income of $2,000,000 at December Common stock, $3 par 50,000 shares
31. What amount of shares should Chape use as the On April 1, year 2, the company sold 8,000 shares of
denominator in the computation of basic earnings per previously unissued common stock. No dividends were
share? in arrears on January 1, year 2, and no dividends were
declared or paid during year 2. Net income for year 2
A. 684,000 totaled $236,000. What amount is basic earnings per
B. 700,000 share for the year ended December 31, year 2?
C. 702,000
D. 740,000 A. $3.66
B. $3.79
C. 702,000 C. $4.07
Weighted average shares outstanding are weighted by D. $4.21
the number of months the shares were outstanding
during the year. The easiest way to do this is to take each B. $3.79
change in common stock and multiply by the number of Basic EPS = Net Income - Preferred Dividends /
months remaining - add the shares that increased shares Weighted shares outstanding. The numerator is $236,000
outstanding and subtract shares that reduced shares - preferred dividends [($60 x 10,000) x .04 = 24,000] =
outstanding. $212,000. The denominator is 50,000 (12/12) + 8,000
Shares Months Wtd avg (9/12) = 56,000 shares. $212,000 / 56,000 = $3.786 or
700,000 12/12 700,000 $3.79.
- 20,000 9/12 - 15,000
+40,000 6/12 +20,000 53
-36,000 1/12 - 3,000
702,000 Balm Co. had 100,000 shares of common stock
outstanding as of January 1. The following events
50 occurred during the year:
4/1 Issued 30,000 shares of common stock.
Jen Co. had 200,000 shares of common stock and 20,000 6/1 Issued 36,000 shares of common stock.
shares of 10%, $100 par value cumulative preferred 7/1 Declared a 5% stock dividend.
stock. No dividends on common stock were declared 9/1 Purchased as treasury stock 35,000 shares of its
during the year. Net income was $2,000,000. What was common stock. Balm used the cost method to account
Jen's basic earnings per share? for the treasury stock.
A. $9.00 What is Balm's weighted average of common stock
B. $9.09 outstanding at December 31?
C. $10.00
D. $11.11 A. 131,000
B. 139,008
A. $9.00 C. 150,675
Earnings per share is: (net income - preferred D. 162,342
dividends)/common shares outstanding. Preferred stock
dividends are $100 X 10% X 20,000 shares = $200,000. B. 139,008
Earnings per share is (2,000,000-200,000)/200,000=$9 More than one approach is available to compute WA
per share. (each yields the same answer) but perhaps the easiest is
to weight each item separately going forward to the end
51 of the year. This approach yields 139,008 =

lOMoARcPSD|9304052
[100,000(12/12) + 30,000(9/12) + 36,000(7/12)](1.05) - date. Financial statement users view the information as if
35,000(4/12). The beginning shares are outstanding the it were current as of the date of publication.
entire year (12/12). The next two items are weighted for
the fraction of the year they are outstanding. Stock 56
dividends and splits are retroactively applied to all items
before their issuance - hence the multiplication by 1.05. Strauch Co. has one class of common stock outstanding
The treasury shares are removed from the average for and no other securities that are potentially convertible
4/12 of the year - these shares already reflect the stock into common stock. During 2005, 100,000 shares of
dividend. common stock were outstanding. In 2006, two
distributions of additional common shares occurred:
54 On April 1, 20,000 shares of treasury stock were sold,
and on July 1, a 2-for-1 stock split was issued.
The following information pertains to Jet Corp. Net income was $410,000 in 2006 and $350,000 in
outstanding stock for 2004: 2005.
Common stock, $5 par value What amounts should Strauch report as earnings per
Shares outstanding, 1/1/04 share in its 2006 and 2005 comparative income
20,000 statements?
2-for-1 stock split, 4/1/04
20,000 2006 2005
Shares issued, 7/1/04 $1.78 $3.50
10,000 $1.78 $1.75
Preferred stock, $10 par value, 5% cumulative $2.34 $1.75
Shares outstanding, 1/1/04 $2.34 $3.50
4,000
What are the number of shares Jet should use to $1.78 $1.75
calculate 2004 earnings per share? For EPS purposes, stock dividends and splits are
retroactively applied to all periods presented, and to all
A. 40,000 share changes within the year of the split or dividend.
B. 45,000 This procedure ensures comparability.
C. 50,000
D. 54,000 The 2-for-1 split in 2006 does not substantively change
the value of any shares outstanding. Without retroactive
B. 45,000 application, EPS would be cut roughly in half in 2006
The effect of the stock split is applied retroactively to all compared to 2005. Yet there was little substantive
changes in the number of shares of common stock change in the performance of the firm. For reporting in
outstanding before the split. 2006:
The weighted average shares outstanding for this firm
for 2004 is: 45,000 = [20,000(2) + 10,000(1/2)]. The Weighted average shares, 2005 = 100,000(2) = 200,000.
split affects only the shares issued before date of the EPS, 2005 = $350,000/200,000 = $1.75.
split. The July 1 issuance is weighted only by 1/2 a year
because the shares were outstanding only 1/2 a year. EPS Weighted average shares, 2006 = [100,000 +
is computed only on common stock outstanding. The 20,000(9/12)]2 = 230,000
preferred shares have no effect on the computation. EPS, 2006 = $410,000/230,000 = $1.78.
55 Had the 2005 shares not been adjusted for the split, 2005
EPS would be $3.50 = $350,000/100,000, or roughly
On January 31, 2004, Pack, Inc. split its common stock 2 double the EPS of 2006. Without retroactive application,
for 1, and Young, Inc. issued a 5% stock dividend. Both it would appear that the firm had a drastic reduction in
companies issued their December 31, 2003, financial EPS in 2006. The retroactive application of the split
statements on March 1, 2004. ensures that the base on which EPS is computed uses the
Should Pack's 2003 earnings per share (EPS) take into same measuring unit.
consideration the stock split, and should Young's 2003
EPS take into consideration the stock dividend? 57
Pack's 2003 EPS Young's 2003 EPS Balm Co. had 100,000 shares of common stock
Yes No outstanding as of January 1. The following events
No No occurred during the year:
Yes Yes 4/1 Issued 30,000 shares of common stock.
No Yes 6/1 Issued 36,000 shares of common stock.
7/1 Declared a 5% stock dividend.
Yes Yes 9/1 Purchased as treasury stock 35,000 shares of its
EPS is used primarily as an input to predictions of future common stock. Balm used the cost method to account
earnings. The stock split and dividend cause the number for the treasury stock.
of shares outstanding to increase, and thus affect the What is Balm's weighted average of common stock
future earnings prospects on a per share basis. These outstanding at December 31?
events should be included in the computation of EPS
even though they did not occur as of the balance sheet A. 131,000

lOMoARcPSD|9304052
B. 139,008 Yes Yes

C. 150,675 No Yes
D. 162,342
Yes Yes
B. 139,008 EPS is used primarily as an input to predictions of future
More than one approach is available to compute WA earnings. The stock split and dividend cause the number
(each yields the same answer) but perhaps the easiest is of shares outstanding to increase, and thus affect the
to weight each item separately going forward to the end future earnings prospects on a per share basis. These
of the year. This approach yields 139,008 = events should be included in the computation of EPS
[100,000(12/12) + 30,000(9/12) + 36,000(7/12)](1.05) - even though they did not occur as of the balance sheet
35,000(4/12). The beginning shares are outstanding the date. Financial statement users view the information as if
entire year (12/12). The next two items are weighted for it were current as of the date of publication.
the fraction of the year they are outstanding. Stock
dividends and splits are retroactively applied to all items 60
before their issuance - hence the multiplication by 1.05.
The treasury shares are removed from the average for Strauch Co. has one class of common stock outstanding
4/12 of the year - these shares already reflect the stock and no other securities that are potentially convertible
dividend. into common stock. During 2005, 100,000 shares of
common stock were outstanding. In 2006, two
58 distributions of additional common shares occurred:
On April 1, 20,000 shares of treasury stock were sold,
The following information pertains to Jet Corp. and on July 1, a 2-for-1 stock split was issued.
outstanding stock for 2004: Net income was $410,000 in 2006 and $350,000 in
2005.
Common stock, $5 par value
Shares outstanding, 1/1/04 What amounts should Strauch report as earnings per
20,000 share in its 2006 and 2005 comparative income
2-for-1 stock split, 4/1/04 statements?
20,000
Shares issued, 7/1/04 2006 2005
10,000 $1.78 $3.50
Preferred stock, $10 par value, 5% cumulative $1.78 $1.75
Shares outstanding, 1/1/04 $2.34 $1.75
4,000 $2.34 $3.50
What are the number of shares Jet should use to
calculate 2004 earnings per share? $1.78 $1.75
For EPS purposes, stock dividends and splits are
A. 40,000 retroactively applied to all periods presented, and to all
B. 45,000 share changes within the year of the split or dividend.
C. 50,000 This procedure ensures comparability.
D. 54,000
The 2-for-1 split in 2006 does not substantively change
B. 45,000 the value of any shares outstanding. Without retroactive
The effect of the stock split is applied retroactively to all application, EPS would be cut roughly in half in 2006
changes in the number of shares of common stock compared to 2005. Yet there was little substantive
outstanding before the split. change in the performance of the firm. For reporting in
The weighted average shares outstanding for this firm 2006:
for 2004 is: 45,000 = [20,000(2) + 10,000(1/2)]. The
split affects only the shares issued before date of the Weighted average shares, 2005 = 100,000(2) = 200,000.
split. The July 1 issuance is weighted only by 1/2 a year EPS, 2005 = $350,000/200,000 = $1.75.
because the shares were outstanding only 1/2 a year. EPS
is computed only on common stock outstanding. The Weighted average shares, 2006 = [100,000 +
preferred shares have no effect on the computation. 20,000(9/12)]2 = 230,000
EPS, 2006 = $410,000/230,000 = $1.78.
59
Had the 2005 shares not been adjusted for the split, 2005
On January 31, 2004, Pack, Inc. split its common stock 2 EPS would be $3.50 = $350,000/100,000, or roughly
for 1, and Young, Inc. issued a 5% stock dividend. Both double the EPS of 2006. Without retroactive application,
companies issued their December 31, 2003, financial it would appear that the firm had a drastic reduction in
statements on March 1, 2004. EPS in 2006. The retroactive application of the split
Should Pack's 2003 earnings per share (EPS) take into ensures that the base on which EPS is computed uses the
consideration the stock split, and should Young's 2003 same measuring unit.
EPS take into consideration the stock dividend?
61
Pack's 2003 EPS Young's 2003 EPS
Yes No The following information pertains to Ceil Co., a
No No company whose common stock trades in a public
market:

lOMoARcPSD|9304052
Shares outstanding at 1/1 100,000 estimated to be $10 million. In the 20x5 income
Stock dividend at 3/31 24,000 statement, what amount of disposal gain or loss will be
Stock issuance at 6/30 5,000 reported in the discontinued operations section?
What is the weighted average number of shares Ceil A. $ -0-
should use to calculate its basic earnings per share for B. $50 million loss.
the year ended December 31? C. $50 million gain.
D. $40 million gain.
A. 120,500
B. 123,000 A. $ -0-
C. 126,500 The estimated disposal gain is $240 [($250 - $10)
D. 129,000 proceeds] - $200 book value, or $40. Estimated disposal
gains are not recognized, only estimated losses. Next
C. 126,500 year, the actual disposal gain will be recognized.
The stock dividend is considered to be outstanding since Nonfinancial assets are not written up in value.
the beginning of the year. The weighted average is
therefore: 65
100,000+24,000+ (5,000X6/12) = 126,500.
On May 15, 2003, Munn, Inc. approved a plan to dispose
62 of a segment of its business. It is expected that the sale
will occur on February 1, 2004, at a selling price of
The treasury stock method of entering stock options into $500,000. The segment reported $195,000 in operating
the calculation of diluted EPS: losses for 2003. The segment is expected to lose $30,000
from operations in 2004. The carrying amount of the
A. Is used only for dilutive treasury stock. segment at the date of sale was expected to be $850,000.
B. Computes the increase in common shares outstanding Before income taxes, what amount should Munn report
from assumed exercise of options to be the number of as a loss from discontinued operations in its 2003
shares under option. income statement?
C. Is called the treasury stock method because the A. $575,000
proceeds from assumed exercise are assumed to be used B. $225,000
to purchase treasury stock. C. $195,000
D. Assumes the treasury shares are purchased at year- D. $545,000
end.
D. $545,000
C. Is called the treasury stock method because the There are two components for discontinued operations:
proceeds from assumed exercise are assumed to be used (1) the operating income or loss for the period in which
to purchase treasury stock. the decision is made to dispose, and (2) the disposal loss.
Only actual operating income (or loss) is recognized, but
63 estimated as well as actual disposal losses are
recognized. The $350,000 estimated disposal loss is the
A firm has basic earnings per share of $1.29. If the tax difference between the $850,000 carrying value of the
rate is 30%, which of the following securities would be segment, and its $500,000 estimated selling price. The
dilutive? operating loss for the period ($195,000) plus the
A. Cumulative 8%, $50 par preferred stock. estimated disposal loss ($350,000) equals the $545,000
B. Ten percent convertible bonds, issued at par, with total loss to be recognized for discontinued operations
each $1,000 bond convertible into 20 shares of common for 2003.
stock.
C. Seven percent convertible bonds, issued at par, with 66
each $1,000 bond convertible into 40 shares of common
stock. During 20x8, a firm discontinued a component
D. Six percent, $100 par cumulative convertible qualifying for separate disclosure within the income
preferred stock, issued at par, with each preferred share statement. The disposal was completed before the end of
convertible into four shares of common stock. 20x8 and resulted in a $300 disposal gain. The
component earned $400 in 20x7 but lost $100 (negative
C. Seven percent convertible bonds, issued at par, with income) in 20x8. The 20x7 income statement reported
each $1,000 bond convertible into 40 shares of common income from continuing operations (IFCO) of $6,000.
stock. The 20x8 income statement reported $7,000 of net
income. Determine the following two amounts:
This security is dilutive. The numerator effect is $49 IFCO for 20x7 as it is reported comparatively in the
saving in interest ($1,000 x .07 x (1-.3)), and the 20x8 statements IFCO for 20x8
denominator effect is 40 more shares outstanding. 49 / $6,000 $7,000
40 = $1.225, which is less than the BEPS of $1.29, so $6,000 $6,800
the security is dilutive. $5,600 $6,800
$5,600 $7,200
64
$5,600 $6,800
In 20x5, a firm decided to discontinue a segment with a Remove income/gains and add losses.
book value of $200 million and a fair value of $250
million. The cost to dispose of the segment in 20x6 is The discontinued operations section of the income

lOMoARcPSD|9304052
statement for prior periods shown comparatively D. $14,250

separates the operating income of discontinued At Dec. 31, 2005, the total warranty liability accrued for
components from IFCO even though the decision had the two years is 6% of sales (2% + 4%). This total is
not yet been made in those earlier periods. This reporting $24,000 (.06 x $400,000). Subtracting $9,750 of actual
results in improved comparability because each year warranty expenditures to the end of 2005 yields the
reports IFCO on the same basis. (1) IFCO for 20x7, as it $14,250 ending warranty liability.
is reported comparatively in the 20x8 statements, reflects
the removal of the $400 operating income for the 69
segment and thus equals $6,000 - $400, or $5,600. (2)
IFCO for 20x8 is computed by removing the effect of Vadis Co. sells appliances that include a three-year
the disposal gain and operating loss from income. IFCO warranty. Service calls under the warranty are performed
for 20x8 equals $7,000 net income - $300 disposal gain by an independent mechanic under a contract with Vadis.
+ $100 operating loss, or $6,800. Based on experience, warranty costs are estimated at $30
for each machine sold.
67 When should Vadis recognize these warranty costs?
Hudson Corp. operates several factories that A. Evenly over the life of the warranty.
manufacture medical equipment. The factories have a B. When the service calls are performed.
historical cost of $200 million. Near the end of the C. When payments are made to the mechanic.
company's fiscal year, a change in business climate D. When the machines are sold.
related to a competitor's innovative products indicated to
Hudson's management that the $170 million carrying D. When the machines are sold.
amount of the assets of one of Hudson's factories may
not be recoverable. Management identified cash flows 70
from this factory and estimated that the undiscounted
future cash flows over the remaining useful life of the At December 31, 2004, Date Co. awaits judgment on a
factory would be $150 million. The fair value of the lawsuit for a competitor's infringement of Date's patent.
factory's assets is reliably estimated to be $135 million. Legal counsel believes it is probable that Date will win
The change in business climate requires investigation of the suit and indicated the most likely award together
possible impairment. Which of the following amounts is with a range of possible awards.
the impairment loss? How should the lawsuit be reported in Date's 2004
A. $15 million financial statements?
B. $20 million
C. $35 million A. In note disclosure only.
D. $65 million B. By accrual for the most likely award.
C. By accrual for the lowest amount of the range of
C. $35 million possible awards.
Under U.S. GAAP, impairment testing is a two step D. Neither in note disclosure nor by accrual.
process. The first step compares the assets' carry value
(CV) to its undiscounted cash flows (UCF). In this A. In note disclosure only.
problem the CV > UCF; therefore the asset is potentially This is a gain contingency.
impaired and we must go to the second step. The second
step compares the assets CV to its fair value (FV). In this Gain contingencies are footnoted at most, not accrued.
problem the FV To recognize gain contingencies in the accounts would
violate the conservatism constraint.
68
71
During 2004, Gum Co. introduced a new product
carrying a two-year warranty against defects. The During 2003, Manfred Corp. guaranteed a supplier's
estimated warranty costs related to dollar sales are 2% $500,000 loan from a bank.
within 12 months following the sale and 4% in the On October 1, 2004, Manfred was notified that the
second 12 months following the sale. supplier had defaulted on the loan and filed for
Sales and actual warranty expenditures for the years bankruptcy protection. Counsel believes Manfred will
ended December 31, 2004 and 2005 are as follows: probably have to pay between $250,000 and $450,000
under its guarantee.
Sales Actual warranty expenditures As a result of the supplier's bankruptcy, Manfred entered
2004 $150,000 $2,250 into a contract in December 2004 to retool its machines
2005 250,000 7,500 so that Manfred could accept parts from other suppliers.
$400,000 $9,750 Retooling costs are estimated to be $300,000.
========= =========
What amount should Gum report as estimated warranty What amount should Manfred report as a liability in its
liability in its December 31, 2005, balance sheet? December 31, 2004, balance sheet?
A. $2,500 A. $250,000
B. $4,250 B. $450,000
C. $11,250 C. $550,000
D. $14,250 D. $750,000

lOMoARcPSD|9304052
A. $250,000 74
The retooling costs are not part of the liability, but are
rather a response to changing business conditions. They Dunn Trading Stamp Co. records stamp service revenue
most likely would be capitalized and amortized over and provides for the cost of redemptions in the year
their useful life. The liability is a contingent liability. stamps are sold to licensees. Dunn's past experience
The amount depends on the outcome of the bankruptcy indicates that only 80% of the stamps sold to licensees
proceedings. When a range of values is estimated with will be redeemed. Dunn's liability for stamp redemptions
no one value being more probable than the others, the was $6,000,000 at December 31, 2005. Additional
lowest amount is accrued. Thus, $250,000 is accrued as information for 2006 is as follows:
of the end of 2004. Stamp service revenue from stamps sold to licensees
72 $4,000,000
Cost of redemptions (stamps sold prior to 1/1/06)
2,750,000
Baker Co. sells consumer products that are packaged in If all the stamps sold in 2006 were presented for
boxes. Baker offered an unbreakable glass in exchange redemption in 2007, the redemption cost would be
for two box tops and $1 as a promotion during the $2,250,000. What amount should Dunn report as a
current year. The cost of the glass was $2.00. Baker liability for stamp redemptions at December 31, 2006?
estimated at the end of the year that it would be probable
that 50% of the box tops will be redeemed. Baker sold A. $7,250,000
100,000 boxes of the product during the current year, B. $5,500,000
and 40,000 box tops were redeemed during the year for C. $5,050,000
the glasses. What amount should Baker accrue as an D. $3,250,000
estimated liability at the end of the current year, related
to the redemption of box tops?
A. $ -0- C. $5,050,000
B. $5,000 Beginning liability balance $6,000,000
C. $20,000 Plus estimated redemptions for 2006: .80($2,250,000)
D. $25,000 1,800,000
Less actual redemptions in 2006 (2,750,000)
Equals ending liability balance $5,050,000
B. $5,000 The firm estimates the redemption cost in the year of
This is a contingency that meets the criteria for a sale, much like a warranty liability. For 2006, this
liability. The total estimated number of box tops increases the redemption liability by $1,800,000. When
redeemed is 100,000 x 50% = 50,000. actual redemptions occur, the liability is extinguished at
Of these 50,000, 40,000 have been redeemed, leaving the cost of the redemptions ($2,750,000).
10,000 box tops estimated to be redeemed. It takes two
box tops per glass, or 10,000/2 = 5,000 glasses. 75
At a cost of $1 per glass, the total cost is 5,000 X $1 =
5,000 as a liability. Eagle Co. has cosigned the mortgage note on the home
73 of its president, guaranteeing the indebtedness in the
event that the president should default. Eagle considers
the likelihood of default to be remote.
Case Cereal Co. frequently distributes coupons to How should the guarantee be treated in Eagle's financial
promote new products. On October 1, 2004, Case mailed statements?
1,000,000 coupons for $.45 off each box of cereal
purchased. Case expects 120,000 of these coupons to be A. Disclosed only.
redeemed before the December 31, 2004, expiration B. Accrued only.
date. It takes 30 days from the redemption date for Case C. Accrued and disclosed.
to receive the coupons from the retailers. Case D. Neither accrued nor disclosed.
reimburses the retailers an additional $.05 for each
coupon redeemed. As of December 31, 2004, Case had
paid retailers $25,000 related to these coupons and had A. Disclosed only.
50,000 coupons on hand that had not been processed for In the interest of conservatism and disclosure, the
payment. What amount should Case report as a liability guarantee should be disclosed. It is not required to be
for coupons in its December 31, 2004, balance sheets? accrued because the probability is remote that the firm
A. $35,000 will have to pay the note.
B. $29,000 76
C. $25,000
D. $22,500 What kind of hedge can be used to hedge a foreign
currency firm commitment?
A. $35,000
Cash Flow Fair Value
120,000 coupons expected to be redeemed x ($.45 + Yes Yes
$.05) Yes No
$60,000 No Yes
Less amount already paid No No
(25,000)
Liability at 12/31/91 Cash Flow Fair Value
$35,000 Yes Yes

lOMoARcPSD|9304052
A forward contract used to hedge a foreign currency firm investment in the foreign operation, Pinco has a long-
commitment can be either a cash flow hedge (as term borrowing in the same foreign currency in an
permitted by the FASB's Derivatives Implementation amount approximating its net equity in the subsidiary.
Group) or a fair value hedge (as permitted by FASB For 2008, the translated value of Sinco's balance sheet
#133). decreased by $40,000, and the converted value of Pinco's
long-term debt decreased by $42,000. Which one of the
77 following is the net amount that Pinco should recognize
in other comprehensive income for 2008?
On September 1, 2004, Brady Corp. entered into a
foreign exchange contract for speculative purposes by A. $-0-
purchasing 50,000 Euros for delivery in 60 days. The B. $2,000
rates to exchange $1 for 1 Euro follow: C. $40,000
D. $42,000
9/1/04 9/30/04
Spot rate .75 .70 A. $-0-
30-day forward rate .73 .72
60-day forward rate .74 .73 Translation adjustment decrease decreases OCI.
In its September 30, 2004, income statement, what The converted value decrease offsets trans. adjustment.
amount should Brady report as foreign exchange loss? Remainder is reported in current income.
A. $2,500 Since Pinco designated the long-term borrowing to
B. $1,500 hedge its investment in its foreign operation, the amount
C. $1,000 of the change in the borrowing equal to the amount of
D. $500 the change in the translated value of the investment
should be reported as a translation adjustment (along
C. $1,000 with the change in the translated value of the
The correct answer is the difference between the 60-day investment) in other comprehensive income, and the
forward rate on September 1 of $0.74 and the 30-day balance should be reported in current income. Therefore,
forward rate on September 30 of $0.72, or $0.02 x Pinco would report a $40,000 decrease and a $40,000
50,000 Euros = $1,000, the correct amount of the loss. increase as translation adjustments, offsetting each other.
78 The remaining $2,000 would be reported in current
income.
On October 1, 2008, RWB Co., a U.S. entity, signed a 80
contract to provide equipment to Pronto, a Spanish
entity, for 300,000 Euros. The terms of the sale provided Which one of the following is most likely a foreign
for the equipment to be delivered FOB-Destination on currency import transaction by a U.S. company?
December 1, 2008, with payment by Pronto on January
30, 2009. The following dollar cost per Euro exchange A. Sale of goods to be collected in dollars.
rate information was available: B. Purchase of goods to be paid in dollars.
Spot FR 12/1 FR 12/31 FR 1/30 C. Sale of goods to be collected in a foreign currency.
October 1 $1.30 $1.29 $1.28 $1.27 D. Purchase of goods to be paid in a foreign currency.
December 1 $1.29 - $1.28 $1.27
December 31 $1.28 - - $1.27 D. Purchase of goods to be paid in a foreign currency.
January 30 $1.27 - - -
Which of the following is the amount (rounded) of the 81
exchange gain or loss that RWB Co. should recognize in
2008 as a result of its sale to and receivable from On September 1, 2005, Cano & Co., a U.S. corporation,
Pronto? sold merchandise to a foreign firm for 250,000 francs.
Terms of the sale require payment in francs on February
A. $1,817 1, 2006. On September 1, 2005, the spot exchange rate
B. $3,000 was $.20 per franc. At December 31, 2005, Cano's year
C. $6,000 end, the spot rate was $.19, but the rate increased to $.22
D. $9,00 by February 1, 2006, when payment was received.
How much should Cano report as a foreign exchange
B. $3,000 gain or loss in its 2006 income statement?
The correct exchange gain or loss would be calculated
by multiplying the 300,000 Euros to be received by the A. $0
spot exchange rates on December 1, the date of the sale, B. $2,500 loss
and December 31, the end of 2008, and getting the C. $5,000 gain
difference. That calculation would be (300,000E x $1.29 D. $7,500 gain
= $387,000) - (300,000E x $1.28 = $384,000) = $3,000,
the correct answer. D. $7,500 gain
79 A foreign exchange gain or loss is recognized for any
change in value of a monetary debt denominated in a
foreign currency. This is true at balance sheet time as
Pinco, a U.S. entity, has a 100% owned subsidiary, well as when it is realized.
Sinco, located in a foreign country. In order to hedge its Thus, a $2,500 loss would have been recognized at

lOMoARcPSD|9304052
December 31, 2005 (250,000 francs * [.20 - .19]). Then, 85

in 2006, the full difference between the $.19 and $.22
(250,000 francs * .03) would be realized for a total gain In preparing consolidated financial statements of a U.S.
of $7,500. parent company with a foreign subsidiary, the foreign
82 subsidiary's functional currency is the currency:
A. In which the subsidiary maintains its accounting
records.
Which of the following statements concerning foreign A is not correct. Any of those currencies could be the
currency hedging is/are correct? functional currency of the foreign subsidiary, depending
on the circumstances. Since no specific circumstances
I. The item being hedged is denominated in a foreign were given in this question, there is no basis for
currency. selecting any of these answers. Only D, the definition of
functional currency, can be correct.
II. The item being hedged must be recorded on the B. Of the country in which the subsidiary is located.
entity’s books in order to be hedged. C. Of the country in which the parent is located.
D. Of the environment in which the subsidiary primarily
A. I only. generates and expends cash.
B. II only.
C. Both I and II.
D. Neither I nor II. D. Of the environment in which the subsidiary primarily
generates and expends cash.
A. I only. 86
83
Shore Co. records its transactions in U.S. dollars. A sale
of goods resulted in a receivable denominated in
When used for speculative purposes, which of the Japanese Yen, and a purchase of goods resulted in a
following contracts is likely to result in a foreign payable denominated in Swiss francs.
currency loss to the contract holder who initiated the Shore recorded a foreign exchange gain on collection of
contract? the receivable and an exchange loss on settlement of the
payable. The exchange rates are expressed as so many
Foreign Currency Forward Exchange Contract Foreign units of foreign currency to one dollar.
Currency Option Contract
Yes Yes Did the number of foreign currency units exchangeable
Yes No for a dollar increase or decrease between the contract
No Yes and settlement dates?
No No
Yen exchangeable for $1 Francs exchangeable for $1
Yes No Increase Increase
Forex contract would result in a loss b/c it must be Decrease Decrease
undertaken even w/a loss. The option will not likely be Decrease Increase
exercised if a loss would occur. Increase Decrease
84
Decrease = gain on receivable.
On October 1, 2004, Mild Co., a U.S. company, Decrease = loss on payable.
purchased machinery from Grund, a German company, 87
with payment due on April 1, 2005. If Mild's 2004
operating income included no foreign exchange Which one of the following is a direct quotation for a
transaction gain or loss, then the transaction could have: U.S. entity when buying Japanese Yen (JPY)?
A. Resulted in an extraordinary gain. I. 0.89 JPY per $1.00.
B. Been denominated in U.S. dollars.
C. Caused a foreign currency gain to be reported as a II. $.011 per 1.00 JPY.
contra account against machinery.
D. Caused a foreign currency translation gain to be A. I only.
reported as a separate component of stockholders' equity. B. II only.
C. Both I or II.
B. Been denominated in U.S. dollars. D. Neither I nor II.
B. II only.
All foreign exchange gains and losses on foreign
currency transactions are counted as ordinary income 88
from continuing operations. While foreign sub
translation gains and losses are reported as a separate On December 31, 2008, the end of its fiscal year, Domco
component of stockholders' equity, gains and losses on had a foreign currency account payable with a settlement
foreign currency transactions cannot be so reported. amount greater than its previously recorded carrying
They must be counted as ordinary gains or losses from amount. Which one of the following would Domco
continuing operations. recognize for 2008?
A. No exchange gain or loss.

lOMoARcPSD|9304052
B. Exchange gain. RWB Co., a U.S. entity, purchased goods for resale from
C. Exchange loss. a Thai manufacturer. The purchase agreement provided
D. Deferred gain. that the U.S. entity would pay the Thai entity 500,000
baht, the Thai currency. The goods were delivered on
C. Exchange loss. July 1, 2008, with payment due August 29, 2008. The
Since the foreign currency account payable had a following exchange rates were determined for the
settlement amount greater than its previously recorded number of baht to the dollar (i.e., B/$):
carrying amount, Domco would have to recognize the Spot Rate 60-day Forward Rate
change in settlement amounts in the period in which the July 1, 2008 35.0B/$ 36.5B/$
settlement amount changed - 2008. Specifically, since August 29, 2008 37.0B/$ 38.0B/$
the amount to settle the account payable increased Which one of the following is the amount (rounded) of
during 2008, Domco would have to recognize an exchange gain or loss, if any, that RWB Co. would
exchange loss - it will take more dollars to acquire the recognize on the purchase of goods from the Thai
foreign currency needed to settle the account. manufacturer?
89 A. $-0-
B. $185
Which of the following is the kind of entry Domestico C. $541
should make on December 31, the end of its fiscal year, D. $772
in connection with the purchase and obligation due?
D. $772
A. Since the exchange rate changed between the date the
DR: Exchange Loss obligation was incurred (July 1) and the date it was
CR: Inventory settled (August 29), the effects of the exchange rate
B. change must be recognized as an exchange gain or loss.
DR: Inventory The correct answer would be the difference between the
CR: Exchange Gain spot rate on July 1 and the spot rate on August 29, or
C. (500,000B/35.0B per $ = $14,286) - (500,000B/37.0B
DR: Exchange Loss per $ = $13,514) = $772.
CR: Accounts Payable
D. 92
DR: Accounts Payable
CR: Exchange Gain On September 22, 2005, Yumi Corp. purchased
merchandise from an unaffiliated foreign company for
D. 10,000 units of the foreign company's local currency. On
DR: Accounts Payable that date, the spot rate was $.55. Yumi paid the bill in
CR: Exchange Gain full on March 20, 2006, when the spot rate was $.65. The
spot rate was $.70 on December 31, 2005.
90 What amount should Yumi report as a foreign currency
transaction loss in its income statement for the year
RWB Co., a U.S. entity, purchased goods for resale from ended December 31, 2005?
a Thai manufacturer. The purchase agreement provided
that the U.S. entity would pay the Thai entity 500,000 A. $0
baht, the Thai currency. The goods were delivered on B. $500
July 1, 2008, with payment due August 29, 2008. The C. $1,000
following exchange rates were determined for the D. $1,500
number of baht to the dollar (i.e., B/$):
Spot Rate 60-day Forward Rate D. $1,500
July 1, 2008 35.0B/$ 36.5B/$ When a monetary obligation in a foreign currency exists,
August 29, 2008 37.0B/$ 38.0B/$ all gains and losses reflective of changes in exchange
At which one of the following amounts (rounded) would rates are recognized in current income.
RWB Co. record the goods purchased from the Thai The loss would be based on the rate at initiation and the
manufacturer? rate at year end. (The recovery in the next period would
be treated as a gain in that period.) The loss is $1,500
A. $13,158 [($.55 - $.70)10,000], making this response correct.
B. $13,514
C. $13,699 93
D. $14,286
Which of the following exchange rates may be used in
D. $14,286 accounting for a forward contract hedging instrument?
The goods should be measured and recorded in dollars
based on the exchange rate in effect (spot rate) at the Spot Rate Forward Rate
date of the purchase, July 1. Thus, the correct amount Yes Yes
would be 500,000B/35.0B per $ = $14,286. Yes No
No Yes
91 No No

lOMoARcPSD|9304052
Spot Rate Forward Rate book value, no impairment is recorded. The firm is
Yes Yes expected to recover its book value.
94 97
Restoration of the carrying value of a long-lived asset is On December 31, 2004, a building owned by Pine Corp.
permitted under IFRS if the asset's fair value increases was totally destroyed by fire. The building had fire
subsequent to recording an impairment loss for which of insurance coverage up to $500,000.
the following? Other pertinent information as of December 31, 2004,
follows:
Held for use Held for disposal Building, carrying amount $520,000
Yes Yes Building, fair market value 550,000
Yes No Removal and cleanup cost 10,000
No Yes During January 2005, before the 2004 financial
No No statements were issued, Pine received insurance
proceeds of $500,000. On what amount should Pine base
Held for use Held for disposal the determination of its loss on involuntary conversion?
Yes Yes
Under IFRS the impairment loss can be recovered if the A. $520,000
asset is held for use or disposal. B. $530,000
C. $550,000
95 D. $560,000
Four years ago on January 2, Randall Co. purchased a B. $530,000

long-lived asset. The purchase price of the asset was The sum of the carrying value ($520,000) and
$250,000, with no salvage value. The estimated useful removal/cleanup cost ($10,000) is the amount to
life of the asset was 10 years. Randall used the straight- compare to the insurance proceeds when computing the
line method to calculate depreciation expense. An loss. The fire caused the latter costs to be incurred;
impairment loss on the asset of $30,000 was recognized therefore, the cleanup costs should be included in the
on December 31 of the current year. The estimated loss.
useful life of the asset at December 31 of the current The fair value of the property would not figure into the
year did not change. What amount should Randall report recorded loss because the building account does not
as depreciation expense in its income statement for the reflect this amount.
next year?
A. $20,000. 98
B. $22,000.
C. $25,000. Which one of the following sets shows the correct
D. $30,000. reporting of an adjustment (gain or loss) that results
from translation and one that results from
A. $20,000. remeasurement of financial statements from a foreign
The net book value of the asset at the time of impairment currency to a reporting currency?
was $150,000: $250,000 cost less $100,000 accumulated
depreciation (4 years of depreciation at $25,000 a year). Translation Adjustment Remeasurement Adjustment
After the impairment of $30,000, the net book value is Net Income Net Income
$120,000 ($150,000 - 30,000). The remaining life is 6 Net Income Other comprehensive income
years and annual depreciation is $20,000. Other comprehensive income Net Income
Other comprehensive income Other comprehensive
96 income
A company has a long-lived asset with a carrying value Translation = OCI

of $120,000, expected future cash flows of $130,000, Remeasurement = NI
present value of expected future cash flows of $100,000,
and a market value of $105,000. What amount of
impairment loss should be reported? 99
A. $0 If the functional currency of a foreign subsidiary is a

B. $5,000 foreign currency other than the subsidiary's recording
C. $15,000 currency, which one of the following will be used to
D. $20,000 convert the subsidiary's financial statements to the final
reporting currency?
A. $0 A. Translation.
The recoverable cost (expected future cash flows) of B. Remeasurement.
$130,000 exceeds the $120,000 book value. Therefore, C. Translation and then remeasurement.
the asset is not impaired, and no loss is recorded. D. Remeasurement and then translation.
Although both the market value and present value of the
future cash flows are less than book value, as long as the D. Remeasurement and then translation.
nominal sum of future cash flows ($130,000) exceeds Remeasurement and then translation would be used to
convert to the reporting currency when a foreign

lOMoARcPSD|9304052
currency other than the foreign subsidiary's recording 300,000E x $1.29 = $387,000. The amount of the sale
currency is the functional currency. Specifically, the would not be adjusted for subsequent changes in
financial statements would be remeasured from the exchange rates.
recording currency to the other foreign functional
currency, and the remeasured financial statements would 102
then be translated to the reporting currency.
Which one of the following sets correctly identifies the
100 relationship between a recorded amount and a related
settlement amount that will result in an exchange gain on
Gordon Ltd., a 100% owned British subsidiary of a U.S. an import transaction and an exchange loss on an export
parent company, reports its financial statement in local transaction?
currency, the British pound. A local newspaper published Gain on Import Transaction Loss on Export Transaction
the following U.S. exchange rates to the British pound at Settlement > Recorded Settlement > Recorded
year end: Settlement > Recorded Recorded > Settlement
Current rate $1.50 Recorded > Settlement Settlement > Recorded
Historical rate (acquisition) 1.70 Recorded > Settlement Recorded > Settlement
Average rate 1.55
Inventory (FIFO) 1.60 Gain on Import Transaction (payable): Recorded >
Which currency rate should Gordon use to convert its Settlement
income statement to U.S. dollars at year end? Loss on Export Transaction (receivable): Recorded >
A. $1.50 Settlement
B. $1.55
C. $1.60 103
D. $1.70
A sale of goods, denominated in a currency other than
B. $1.55 the entity's functional currency, resulted in a receivable
that was fixed in terms of the amount of foreign currency
Since Gordon prepares its financial statements in its that would be received. Exchange rates between the
local currency, the British pound, and since the British functional currency and the currency in which the
economy has not been in hyperinflation, Gordon's transaction was denominated changed. The resulting
functional currency would be the British pound, and its gain should be included as a:
financial statements would be converted to U.S. dollars
using translation, not remeasurement. Under the A. Translation gain reported as a component of
translation method of converting, income statement comprehensive income.
items are converted using the average exchange rate for B. Translation gain reported as a component of income
the period. from continuing operations.
C. Transaction gain reported as a component of
101 comprehensive income.
D. Transaction gain reported as a component of income
On October 1, 2008, RWB Co., a U.S. entity, signed a from continuing operations.
contract to provide equipment to Pronto, a Spanish
entity, for 300,000 Euros. The terms of the sale provided D. Transaction gain reported as a component of income
for the equipment to be delivered FOB-Destination on from continuing operations.
December 1, 2008, with payment by Pronto on January
30, 2009. The following dollar cost per Euro exchange 104
rate information was available:
Spot Rate Forward Rate for December 1 Forward Rate Which of the following is a foreign currency export
for December 31 Forward Rate for January 30 transaction for a U.S. entity?
October 1 $1.30 $1.29 $1.28 $1.27
December 1 $1.29 - $1.28 $1.27 A. Sale of goods to be collected in dollars.
December 31 $1.28 - - $1.27 B. Purchase of goods to be paid in dollars.
January 30 $1.27 - - - C. Sale of goods to be collected in a foreign currency.
Which of the following is the amount (rounded) at which D. Purchase of goods to be paid in a foreign currency.
RWB Co. should recognize sales as a result of its sale to
Pronto? C. Sale of goods to be collected in a foreign currency.
A. $232,558 105
B. $381,000
C. $387,000 On June 19, Don Co., a U.S. company, sold and
D. $390,000 delivered merchandise on a 30-day account to Cologne
GmbH, a German corporation, for 200,000 euros. On
C. $387,000 July 19, Cologne paid Don in full. Relevant currency
exchange rates were:
Use forward rate for value of receivables. June 19 July 19
Spot rate $ .988 $ .995
The correct answer is derived by multiplying the number 30-day forward rate .990 1.000
of Euros to be received (300,000) by the dollar cost What amount should Don record on June 19 as an
(value) per Euro at the date of the sale ($1.29), or account receivable for its sale to Cologne?

lOMoARcPSD|9304052
Balance Sheet (12/31/2008)

A. $197,600 Cash and Account Receivable 2,000
B. $198,000 Inventory at cost, acquired evenly in 2008 6,000
C. $199,000 Fixed Assets 10,000
D. $200,000 Total Assets 18,000
Liabilities 2,000
A. $197,600 Common Stock 7,000
At the date Don Co. entered into the transaction, June Retained Earnings 9,000
19, and agreed to accept euros in satisfaction of its Subtotal 18,000
account receivable, it should record the transaction (sale Accumulated Other Comprehensive Income 0
and account receivable) at the (then exiting or current) Total Liabilities + Equity 18,000
spot exchange rate of .988. Thus, the dollar amount of The following exchange rates were available:
the account receivable (and sale) would be computed as
200,000 E x .988 = $197,600, which also is the dollar Historic exchange rate when Sanco was established by
value that would be received if the transaction were Panco: 1 FCU = $1.200
settled at that date. Historic exchange rate when Sanco's fixed assets were
acquired: 1 FCU = $1.250
106 Weighted average exchange rate for 2008: 1 FCU =
$1.300
On November 15, 2005, Celt Inc., a U.S. company, Spot exchange rate at date dividend declared: 1 FCU =
ordered merchandise FOB shipping point from an East $1.290
German company for 200,000 marks. The merchandise Spot exchange rate at December 31, 2008: 1 FCU =
was shipped and invoiced to Celt on December 10, 2005. $1.310
Celt paid the invoice on January 10, 2006. Which one of the following is the amount (in 000) of
The spot rates for marks on the respective dates are as Sapco's inventory in U.S. dollars?
follows:
November 15, 2005 $.4955 A. $6,000
December 10, 2005 .4875 B. $7,200
December 31, 2005 .4675 C. $7,800
January 10, 2006 .4475 D. $7,860
In Celt's December 31, 2005, income statement, the
foreign exchange gain is: C. $7,800
A. $9,600 Use weighted avg exchange rate for inventory and sales.
B. $8,000
C. $4,000 Since remeasurement should be used to convert Sapco's
D. $1,600 financial statements expressed in FCUs to U.S. dollars,
inventory should be converted using the historic
C. $4,000 exchange rate in effect when the inventory was acquired.
SFAS #52: Recognition is based on the change in the In this case, the inventory was acquired evenly during
spot rate between the recording of the transaction (when 2008 and the weighted average exchange rate for the
goods arrive and, more importantly, debt is officially year was $1.300. Therefore, the correct dollar amount of
incurred due to /FOB destination) and the F/S date. Sapco's inventory would be 6,000 FCUs x $1.300 =
$7,800.
108
107
Certain balance sheet accounts of a foreign subsidiary of
Papco, a U.S. entity, has a subsidiary, Sapco, located in a Post Inc., at December 31, 2008, have been translated
foreign country. Sapco is essentially a sales unit for into U.S. dollars as follows:
Papco. Sapco prepared the following shortened financial
statements in its local currency, the FCU, for the fiscal Translated at
year ended December 31, 2008: Current Rate Historical Rate
Accounts Receivable, long-term $120,000 $100,000
Statement of Net Income and FCUs Prepaid Insurance 55,000 50,000
Comprehensive Income (2008) (in 000) Copyright 75,000 85,000
Sales 12,000 $250,000 $235,000
COGS (4,000) The subsidiary's functional currency is the currency of
Depreciation Expense (1,000) the country in which it is located. What total amount
Other Expenses (3,000) should be included in Post's December 31, 2008,
Net Income 4,000 consolidated balance sheet for the above accounts?
Other Comprehensive Income 0
Comprehensive Income 4,000 A. $225,000
Retained Earnings (2008) B. $235,000
Beginning Retained Earnings (end 2007) 6,000 C. $240,000
Add: Net Income (2008) 4,000 D. $250,000
Deduct: Dividends (2008) (1,000)
Ending Retained Earnings 9,000

lOMoARcPSD|9304052
D. $250,000 Which of the following general types of transactions

could be a foreign currency transaction?
Translate at current rate. Remeasure at weighted average Operating Transactions Forward Exchange Contract
rate. Transactions
Yes Yes
109 Yes No
No Yes
Which of the following statements concerning the No No
objectives of foreign currency translation is/are correct?
Operating Transactions Forward Exchange Contract
I. To reflect financial statements in conformity with U.S. Transactions
GAAP. Yes Yes
II. To provide information that generally is compatible 113
with expected effects of exchange rate changes on an
entity's cash flows and equity. Forward exchange contracts may be used to:
A. I only. Hedge Risk Speculate

B. II only. No No
C. Both I and II. No Yes
D. Neither I nor II. Yes No
Yes Yes
C. Both I and II.
110 Hedge Risk Speculate
Yes Yes
A foreign subsidiary's functional currency is its local 114
currency, which has not experienced significant
inflation. The weighted average exchange rate for the Which of the following statements concerning foreign
current year would be the appropriate exchange rate for exchange forward contracts is/are correct?
translating: I. A foreign currency forward exchange contract will
result in the exchange of currencies.
Salaries expense Sales to external customers
Yes Yes II. All forward contracts require the exchange of
Yes No currencies.
No Yes
No No A. I only.
B. II only.
Salaries expense Sales to external customers C. Both I and II.
Yes Yes D. Neither I nor II.
When the local currency is the functional currency, and
it is not experiencing hyperinflation, financial statements A. I only.
prepared in the foreign currency will be converted to the
reporting currency using translation, not remeasurement. 115
Under the translation method of converting from a
foreign currency to a reporting currency, revenues, Which one of the following is not associated with
expenses, gains, and losses are converted using the forward contracts?
exchange rate in effect when an item was earned or
incurred; however, a weighted average exchange rate for A. The contract may require a future purchase or sale.
the period can be used. Therefore, both salaries expense B. The contract provides for using the market price at the
and sales to external customers can be translated using date the contract is fulfilled.
the weighted average exchange rate for the period. C. The contract may permit a future purchase or sale.
D. The contract specifies the subject matter of the
111 exchange.
Which one of the following sets correctly identifies the B. The contract provides for using the market price at the
characteristics of foreign currency transactions for a U.S. date the contract is fulfilled.
entity?
Transaction Denominated In Transaction Measured In Forward contracts establish the price at the time the
Dollars Dollars contract is executed, not at the time the contract is
Dollars Non-Dollars fulfilled.
Non-Dollars Dollars
Non-Dollars Non-Dollars 116
Transaction Denominated In Non-Dollars In which of the following hedges using a forward

Transaction Measured In Dollars contract will at least a portion of any currency exchange
gain or loss on the hedging instrument be reported as a
112 translation adjustment in other comprehensive income?

lOMoARcPSD|9304052
losses are measured based on the purchase price of the

A. Forecasted transaction hedge. contract and its current settlement value using forward
B. Firm commitment hedge. rates.
C. Investment in available-for-sale securities hedge. In this case, those rates are the $.90 purchase price
D. Net investment in foreign operations hedge. (forward rate December 12) and the $.93 settlement
price (forward rate December 31). Thus, this $3,000
D. Net investment in foreign operations hedge. amount is correct [($.93-$.90)100,000].
117 119
On November 2, 2005, Platt Co. entered into a 90 day On December 1 of the current year, Bann Co. entered
futures contract to purchase 50,000 Swiss francs when into an option contract to purchase 2,000 shares of Norta
the contract quote was $.70. The purchase was for Co. stock for $40 per share (the same as the current
speculation in price movement. The following exchange market price) by the end of the next two months. The
rates existed during the contract period: time value of the option contract is $600. At the end of
30 day futures Spot rate December, Norta's stock was selling for $43, and the
November 2, 2005 $.62 $.63 time value of the option was now $400. If Bann does not
December 31, 2005 .65 .64 exercise its option until January of the subsequent year,
January 30, 2006 .65 .68 which of the following changes would reflect the proper
What amount should Platt report as foreign currency accounting treatment for this transaction on Bann's
exchange loss in its income statement for the year ended December 31, year-end financial statements?
December 31, 2005?
A. $2,500 A. The option value will be disclosed in footnotes only.
B. $3,000 B. Other comprehensive income will increase by $6,000.
C. $3,500 C. Net income will increase by $5,800.
D. $4,000 D. Current assets will decrease by $200.
A. $2,500 C. Net income will increase by $5,800.

A futures contract entered into for speculative purposes An option is a financial derivative and must be reported
(not to hedge) is valued using futures rates, and any gain as either an asset or liability at fair value, with any
or loss as a result of changes in futures rates is change in fair value recognized in income of the period
recognized in net income in the period during which the that the fair value changes (unless the option is used as a
rate changed. At initiation of Platt's contract, the 90-day hedge). At the date the option contract was initiated, it
futures rate was $.70, as quoted in the contract. On had no intrinsic value (the strike price was the same as
December 31, 2005, 30 days before Platt's contract was the current price), but had a time value of $600 (given).
to be settled, the 30-day futures rate was $.65. Platt's loss At December 31, the time value had decreased to $400, a
would be computed as follows: decline of $200, but the intrinsic value had increased by
November 2, 2005, 50,000 Swiss francs x $.70 = $6,000, computed as the change in the market price from
$35,000 $40 per share to $43 per share, an increase of $3 x 2,000
shares (the option quantity) = $6,000. Thus, the net
December 31, 2005, 50,000 Swiss francs x $.65 = change in fair value, and the amount of gain that would
$32,500 be recognized in December 31 financial statements, is +
Loss in dollar value of futures contract = $2,500 $6,000 - $200 = $5,800, the correct answer.
118 120
On December 12, 2004, Imp Co. entered into three Which one of the following hedges using a forward
forward exchange contracts, each to purchase 100,000 contract will require the recognition of a new asset or
francs in 90 days. The relevant exchange rates are as liability if a gain or loss occurs on the hedging
follows: instrument?
Spot rate Forward rate (for March 12, 2005) A. Forecasted transaction hedge.
December 12, 2004 $.88 $.90 B. Firm commitment hedge.
December 31, 2004 .98 .93 C. Recognized asset or liability hedge.
Imp entered into the third forward contract for D. Net investment in foreign operations hedge.
speculation. At December 31, 2004, what amount of
foreign currency gain should Imp include in income B. Firm commitment hedge.
from this forward contract?
A. $0
B. $3,000
C. $5,000
D. $10,000
B. $3,000
All gains and losses in a speculative forward foreign
exchange contract are included in income of the period
in which the forward exchange rate changes. Gains and

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lOMoARcPSD|9304052

Intermediate Accouting sample problems

Bachelor of Science in Accountancy (Polytechnic University of the Philippines)

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Which of the following can be overstated on

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depreciation expense taken on the intercompany gain for affiliate?

For consolidated purposes, what effect will the A.

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C. $45.00 per option.

B. $100 A. A recognized asset.

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If the transfer of a financial asset does not meet the 33

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B. $30,000 outflow of benefits, amount is estimable.

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and a year-end market price of $25 per share. What B. $480,000

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B. 139,008 Yes Yes

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statement for prior periods shown comparatively D. $14,250

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December 31, 2005 (250,000 francs * [.20 - .19]). Then, 85

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Four years ago on January 2, Randall Co. purchased a B. $530,000

A company has a long-lived asset with a carrying value Translation = OCI

A. $0 If the functional currency of a foreign subsidiary is a

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Balance Sheet (12/31/2008)

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D. $250,000 Which of the following general types of transactions

A. I only. Hedge Risk Speculate

Transaction Denominated In Non-Dollars In which of the following hedges using a forward

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losses are measured based on the purchase price of the

A. $2,500 C. Net income will increase by $5,800.

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