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

• Question 51:

  Goddard has used the FIFO method of inventory valuation since it began operations in 1987. Goddard decided to change to the weighted-average method for determining inventory costs at the beginning of 1990. The following schedule shows year-end inventory balances under the FIFO and weighted-average methods:

  

  What amount, before income taxes, should be reported in the 1990 retained earnings statement as the

  cumulative effect of the change in accounting principle?

  A. $5,000 decrease.

  B. $3,000 decrease.

  C. $2,000 increase.

  D. $0.

  Correct Answer: A

  Choice "a" is correct. $5,000 decrease. The cumulative effect of change in accounting principle is determined as of the beginning of the year of change if comparative financial statements are not presented. In this case, the year of change is 1990, so the cumulative effect is the difference in inventory as of the end of 1989. [Note that inventory is a balance sheet item, so the change is based on the balances at the end of the last year the prior method was used. Had this question shown annual income statement amounts of cost of goods sold, we would have had to look at all the past years in the aggregate.] This will allow us to arrive at the adjustment to obtain the amount of retained earnings that would have been reported at the beginning of the period of change if the new accounting principle had been used for all prior periods.

  

• Question 52:

  Ocean Corp.'s comprehensive insurance policy allows its assets to be replaced at current value. The policy has a $50,000 deductible clause. One of Ocean's waterfront warehouses was destroyed in a winter storm. Such storms occur approximately every four years. Ocean incurred $20,000 of costs in dismantling the warehouse and plans to replace it. The tax rate is 30%. The following data relate to the warehouse:

  Current carrying amount $ 300,000 Replacement cost 1,100,000

  What amount of gain should Ocean report as a separate component of income before extraordinary items?

  A. $1,030,000

  B. $780,000

  C. $730,000

  D. $0

  Correct Answer: C

  Choice "c" is correct. $730,000 gain reported as a separate component of income before extraordinary items.

  

• Question 53:

  Which of the following should be reported as a prior period adjustment?

  

  A. Option A

  B. Option B

  C. Option C

  D. Option D

  Correct Answer: B

  Choice "b" is correct. No - Yes Change in estimated lives of depreciable assets is a "change in estimate." They affect only current and future periods (not "prior periods," not retained earnings). Change from unaccepted principle to accepted principle is an example of an error of a prior period that should be reported as a "prior period adjustment."

• Question 54:

  On January 1, 20X1, Pell Corp. purchased a machine having an estimated useful life of 10 years and no salvage. The machine was depreciated by the double declining balance method for both financial statement and income tax reporting. On January 1, 20X6, Pell changed to the straight-line method for financial statement reporting but not for income tax reporting. Accumulated depreciation at December 31, 20X5, was $560,000. If the straight-line method had been used, the accumulated depreciation at December 31, 20X5, would have been $420,000. Pell's enacted income tax rate for 20X6 and thereafter is 30%. The amount shown in the 20X6 income statement for the cumulative effect of changing to the straight-line method should be:

  A. $98,000 debit.

  B. $98,000 credit.

  C. $140,000 credit.

  D. $0.

  Correct Answer: D

  Choice "d" is correct. A change in the method of depreciation is now considered to be both a change in method and a change in estimate. These changes should be accounted for as changes in estimate and handled prospectively. The new depreciation method should be used as of the beginning of the year of change and should start with the current book value of the underlying asset. No retroactive or retrospective calculations should be made, and no adjustment should be made to retained earnings. And, certainly, the cumulative effect should not be reflected on the income statement any more. Choices "a", "b", and "c" are incorrect, per the above Explanation: .

• Question 55:

  In 1990, Teller Co. incurred losses arising from its guilty plea in its first antitrust action, and from a substantial increase in production costs caused when a major supplier's workers went on strike. Which of these losses should be reported as an extraordinary item?

  

  A. Option A

  B. Option B

  C. Option C

  D. Option D

  Correct Answer: C

  Choice "c" is correct. Yes - No. Rule: Losses arising from a company's first (and probably "last") "anti-trust" action are unusual and extraordinary and should be reported as an extraordinary item. Losses resulting from additional costs caused by a strike at a major supplier or even at one's own company are not extraordinary and should be disclosed as a separate component of "income from continuing operations."

• Question 56:

  During 1990, Fuqua Steel Co. had the following unusual financial events occur:

  •

  Bonds payable were retired five years before their scheduled maturity, resulting in a $260,000 gain. Fuqua has frequently retired bonds early when interest rates declined significantly.

  •

  A steel forming segment suffered $255,000 in losses due to hurricane damage. This was the fourth similar loss sustained in a 5-year period at that location.

  •

  A component of Fuqua's operations, steel transportation, was sold at a net loss of $350,000.

  This was Fuqua's first divestiture of one of its operating segments.

  Before income taxes, what amount should be disclosed as the gain (loss) from extraordinary items in

  1990?

  A. $0

  B. $5,000

  C. $(90,000)

  D. $(350,000)

  Correct Answer: A

  Choice "a" is correct. $0. Note: The sale of the steel transportation component resulted in a loss from discontinued operations and is reported after "income from continuing operations." The steel forming segment's hurricane damage (4th in 5 years) of $255,000 is only "unusual in nature" and does not occur infrequently, therefore, it is not an "extraordinary item," and should be reported separately as a component of "income from continuing operations." The retirement of debt, although unusual, is not infrequent for the company; therefore, the gain does not qualify for classification as an extraordinary item per APBO No. 30 (and SFAS No. 145).

• Question 57:

  Thorpe Co.'s income statement for the year ended December 31, 1990, reported net income of $74,100. The auditor raised questions about the following amounts that had been included in net income:

  

  The loss from the fire was an infrequent but not unusual occurrence in Thorpe's line of business. Thorpe's December 31, 1990, income statement should report net income of:

  A. $65,000

  B. $66,100

  C. $81,600

  D. $87,000

  Correct Answer: D

  Net income before adjustments

  

  Rule: Unrealized losses (or gains) resulting from changes in market value of available-for-sale investments

  should be reported as a component of other comprehensive income in shareholders' equity.

  Unrealized gains and losses on investments held for trading would be included in net income.

  Correction of errors of prior periods should be reported as an adjustment to beginning retained earnings,

  not as an item of net income.

  Choice "d" is correct. $87,000.

• Question 58:

  A transaction that is unusual, but not infrequent, should be reported separately as a(an):

  A. Extraordinary item, net of applicable income taxes.

  B. Extraordinary item, but not net of applicable income taxes.

  C. Component of income from continuing operations, net of applicable income taxes.

  D. Component of income from continuing operations, but not net of applicable income taxes.

  Correct Answer: D

  Choice "d" is correct. A transaction that is unusual, but not "infrequent" should be reported separately as a

  component of continuing operations, (gross) but not net of applicable income taxes.

  Choices "a" and "b" are incorrect. An extraordinary item has to be both "unusual" and "infrequent."

  Choice "c" is incorrect, per "d" above.

• Question 59:

  During 1990, Fuqua Steel Co. had the following unusual financial events occur:

  •

  Bonds payable were retired five years before their scheduled maturity, resulting in a $260,000 gain. Fuqua has frequently retired bonds early when interest rates declined significantly.

  •

  A steel forming segment suffered $255,000 in losses due to hurricane damage. This was the fourth similar loss sustained in a 5-year period at that location.

  •

  A component of Fuqua's operations, steel transportation, was sold at a net loss of $350,000.

  This was Fuqua's first divestiture of one of its operating segments.

  Before income taxes, what amount of gain (loss) should be reported separately as a component of income

  from continuing operations in 1990?

  A. $260,000

  B. $5,000

  C. $(255,000)

  D. $(350,000)

  Correct Answer: B

  Choice "b" is correct. $5,000.

  The steel forming segment's hurricane damage (4th in 5 years) of $255,000 is only "unusual in nature" and

  does not occur infrequently, therefore, it is not an "extraordinary item," and should be reported separately

  as a component of "income from continuing operations."

  The retirement of debt, although unusual, is not infrequent for the company; therefore, the gain does not

  qualify for classification as an extraordinary item per APBO No. 30 (and SFAS No. 145).

• Question 60:

  Coffey Corp.'s trial balance of Income Statement Accounts for the year ended December 31, 1988 as follows:

  

  Coffey's income tax rate is 30%. The gain on debt extinguishment is considered a usual and recurring part of Coffey's operations. The hurricane is considered an unusual and infrequent event. Coffey prepares a multiple-step income statement for 1988.

  Net income is:

  A. $140,000

  B. $161,000

  C. $168,000

  D. $200,000

  Correct Answer: A

  Choice "a" is correct. $140,000.

  Net income is the "bottom line" amount after all has been considered on the income statement. Without

  showing all the line items as required for the income statement, the "bottom line" amount of $140,000 is

  derived as follows: