Test Prep Test Prep Certifications FINANCIAL-ACCOUNTING-AND-REPORTING Questions & Answers

• Question 141:

  How should the effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate be reported?

  A. As a component of income from continuing operations.

  B. By restating the financial statements of all prior periods presented.

  C. As a correction of an error.

  D. By footnote disclosure only.

  Correct Answer: A

  Choice "a" is correct. When the effect of a change in accounting principle is inseparable from the effect of a change in accounting estimate, the reporting treatment for the overall effect is as a change in estimate. Thus, the effect is reported prospectively as a component of income from continuing operations. Under SFAS No. 154, this type of change is now called a change in accounting estimate affected by a change in accounting principle. Choice "b" is incorrect. Restatement of all prior periods is the retroactive accounting treatment that is applied to the correction of an error and the retrospective accounting treatment given to changes in accounting principle. However, a change in accounting principle that is inseparable from the effect of a change in accounting estimate is now treated as a change in accounting estimate. Choice "c" is incorrect. Correction of an error is given retroactive treatment as a prior period adjustment to retained earnings with restatement of prior periods. This is not the treatment appropriate for the effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate. Choice "d" is incorrect. While footnote disclosure is always appropriate for an accounting change, such disclosure alone is never the appropriate accounting treatment.

• Question 142:

  At December 31, 1998, Off-Line Co. changed its method of accounting for demo costs from writing off the costs over two years to expensing the costs immediately. Off-Line made the change in recognition of an increasing number of demos placed with customers that did not result in sales. Off-Line had deferred demo costs of $500,000 at December 31, 1997, $300,000 of which were to be written off in 1998 and the remainder in 1999. Off-Line's income tax rate is 30%. In its 1998 financial statements, what amount should Off-Line report as cumulative effect of change in accounting principle?

  A. $0

  B. $200,000

  C. $350,000

  D. $500,000

  Correct Answer: A

  Choice "a" is correct. When a change in accounting principle is considered inseparable from a change in

  estimate, the change is handled as a change in estimate - prospectively. No cumulative effect adjustment

  is made.

  Choices "b", "c", and "d" are incorrect since no cumulative effect adjustment is made.

• Question 143:

  Income tax-basis financial statements differ from those prepared under GAAP in that income tax-basis financial statements:

  A. Do not include nontaxable revenues and nondeductible expenses in determining income.

  B. Include detailed information about current and deferred income tax liabilities.

  C. Contain no disclosures about capital and operating lease transactions.

  D. Recognize certain revenues and expenses in different reporting periods.

  Correct Answer: D

  Choice "d" is correct. Income tax-basis financial statements recognize events when taxable income or deductible expenses are recognized on the entity's tax return. Non-taxable income and non-deductible expenses are shown on the financial statement and included in the determination of income (and become M-1 adjustments to arrive at taxable income). Please Note: This question appeared in the releases for 1999 in FARE; however, it may also apply to OCBOA financial statements discussed in the Auditing textbook. The question did not apply well to any FARE CSO line item, so we included it here so that you could read the Explanation: and learn from it.

• Question 144:

  An extraordinary gain should be reported as a direct increase to which of the following?

  A. Net income.

  B. Comprehensive income.

  C. Income from continuing operations, net of tax.

  D. Income from discontinued operations, net of tax.

  Correct Answer: A

  Choice "a" is correct. Extraordinary items are reported as a component of net income, after income from continuing operations and discontinued operations. Choice "b" is incorrect. An extraordinary gain (or loss) only indirectly affects comprehensive income as a component of net income. Choice "c" is incorrect. Extraordinary items are reported net of tax after income from continuing operations and discontinued operations. Choice "d" is incorrect. Extraordinary items are reported net of tax after income from continuing operations and discontinued operations.

• Question 145:

  On December 2, 20X1, Flint Corp.'s board of directors voted to discontinue operations of its frozen food division and to sell the division's assets on the open market as soon as possible. The division reported net operating losses of $20,000 in December and $30,000 in January. On February 26, 20X2, sale of the division's assets resulted in a gain of $90,000. Assuming that the frozen foods division qualifies as a component of the business and ignoring income taxes, what amount of gain/loss from discontinued operations should Flint recognize in its income statement for 20X2?

  A. $0

  B. $40,000

  C. $60,000

  D. $90,000

  Correct Answer: C

  Choice "c" is correct. The $60,000 gain from discontinued operations would be reported in Flint's 20X2

  income statement. The operating loss for January would offset the gain from disposal in February, and the

  net amount would be reported as a gain (in this case) from discontinued operations.

  The operating losses for December would have been reported in Flint's 20X1 income statement.

  Choice "a" is incorrect per the above. It would be correct if all of the gains and losses were included in

  20X1 instead of 20X2. However, gains and losses from discontinued operations are included in the year

  they occur.

  Choice "b" is incorrect. It includes the operating loss for December, 20X1 in with the 20X2 amounts.

  Choice "d" is incorrect. It ignores the January operating loss. Operating losses are included in gain/loss

  from discontinued operations, along with impairment losses and gains/losses on disposal.

• Question 146:

  Which of the following assumptions means that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis?

  A. Going concern.

  B. Periodicity.

  C. Monetary unit.

  D. Economic entity.

  Correct Answer: C

  Choice "c" is correct. The monetary unit assumption means that money is the common denominator for economic activity and provides an appropriate basis for accounting measurements and analysis. Choice "a" is incorrect. The going concern assumption has nothing to do with money per se. The going concern assumption presumes that an entity will continue to operate in the foreseeable future. Choice "b" is incorrect. The periodicity has nothing to do with money per se. The periodicity assumption is that economic activity can be divided into meaningful time periods. Choice "d" is incorrect. The economic entity assumption has nothing to do with money per se. The economic entity assumption is that economic activity can be accounted for when considering an identifiable set of activities.

• Question 147:

  Which of the following statements best describes an operating procedure for issuing a new Financial Accounting Standards Board (FASB) statement?

  A. The emerging issues task force must approve a discussion memorandum before it is disseminated to the public.

  B. The exposure draft is modified per public opinion before issuing the discussion memorandum.

  C. A new statement is issued only after a majority vote by the members of the FASB.

  D. A new FASB statement can be rescinded by a majority vote of the AICPA membership.

  Correct Answer: C

  Choice "c" is correct. A new statement from the FASB is issued only after a majority vote of the members of the FASB.

  Choice "a" is incorrect. There is no necessity for the EITF to approve a discussion memorandum (presumably the question means a discussion memorandum of the FASB statement itself and not an EITF statement) before it is disseminated to the public.

  Choice "b" is incorrect. There is no necessity for an exposure draft to be modified per public opinion before issuing the discussion memorandum (a question can be raised here as to "what" discussion memorandum"). Exposure drafts are quite/most often modified before they are issued as FASB statements, but they do not have to be. Whether they are or are not modified is a function of whether the FASB thinks they should be modified, partly due to the public comments that have been received.

  Choice "d" is incorrect. There is no way to rescind a new FASB statement, although, in reality, a FASB

  statement can be rescinded by the issuance of a new statement on the same subject. However, even if there was a way to rescind a new FASB statement, it would not be by a majority vote of the AICPA membership, but by a majority vote of the members of the FASB. Reporting Net Income

• Question 148:

  According to the FASB conceptual framework, the quality of information that helps users increase the likelihood of correctly forecasting the outcome of past or present events is called:

  A. Feedback value.

  B. Predictive value.

  C. Representational faithfulness.

  D. Reliability.

  Correct Answer: B

  Choice "b" is correct. The quality of information that helps users increase the likelihood of correctly forecasting the outcome of past or present events is called predictive value. Forecasting is predicting. Choice "a" is incorrect. The quality of information that helps users increase the likelihood of correctly forecasting the outcome of past or present events is called predictive value, not feedback value. Feedback value enables decision makers to confirm prior expectations or to adjust or correct the decisions made previously. Choice "c" is incorrect. The quality of information that helps users increase the likelihood of correctly forecasting the outcome of past or present events is called predictive value, not representational faithfulness. Representational faithfulness is the agreement between financial reporting and the resources or events represented. Choice "d" is incorrect. The quality of information that helps users increase the likelihood of correctly forecasting the outcome of past or present events is called predictive value, not reliability. Reliability is the combination of neutrality, representational faithfulness, and verifiability.

• Question 149:

  Arpco, Inc., a for-profit provider of healthcare services, recently purchased two smaller companies and is researching accounting issues arising from the two business combinations. Which of the following accounting pronouncements are the most authoritative?

  A. AICA Statements of Position.

  B. AICPA Industry and Audit Guides.

  C. FASB Statements of Financial Accounting Concepts.

  D. FASB Statements of Financial Accounting Standards.

  Correct Answer: D

  Choice "d" is correct. Since Arpco is a for-profit provider of healthcare services, it is covered under normal GAAP. Thus, the most authoritative pronouncements are the FASB Statements of Financial Accounting Standards (SFAS). Choice "a" is incorrect. AICPA Statements of Position are not the most authoritative pronouncement for almost anything (other than for some issues that only they cover). They are normally "merely" the opinion of the AICPA. Choice "b" is incorrect. AICPA Industry and Audit Guides are not the most authoritative pronouncement for almost anything (other than for some issues that only they cover). Choice "c" is incorrect. FASB Statements of Financial Accounting Concepts are not authoritative pronouncements except where they have been incorporated by reference into an SFAS. They are the basis on which SFAS can be constructed.

• Question 150:

  Which of the following is a generally accepted accounting principle that illustrates the practice of conservatism during a particular reporting period?

  A. Capitalization of research and development costs.

  B. Accrual of a contingency deemed to be reasonably possible.

  C. Reporting investments with appreciated market values at market value.

  D. Reporting inventory at the lower of cost or market value.

  Correct Answer: D

  Choice "d" is correct. The rule of conservatism states that revenues and gains should be recognized when the earnings process is complete, but that expenses and losses should be expensed immediately. Reporting inventory at the lower of cost or market requires the recording of a loss on inventory when market is lower than cost in the period the loss is sustained, rather than when the inventory is sold, consistent with the rule of conservatism. Choice "a" is incorrect. Because the future benefits of RandD costs are questionable, these cost should be expensed immediately, consistent with the rule of conservatism and the matching principle. Choice "b" is incorrect. The rule of conservatism only requires the accrual of "probable" losses. The accrual of a reasonably possible loss is not required and the accrual of any contingent gain, whether probable, reasonably possible, or remote, is prohibited. Choice "c" is incorrect. The reporting of marketable securities with appreciated values at market value requires the recording of a gain on the asset before the gain is realized. This contradicts the rule of conservatism, but is allowed because fair value is a more relevant measure of the value of marketable securities.