Preview Extract
Chapter 3
The Measurement Fundamentals of Financial Accounting
Multiple Choice Questions
1. When preparing the financial statements, we assume that the life of the entity will continue
beyond the current period. Which assumption are we most likely following?
a. Stable dollar theory.
b. Going concern assumption.
c. Economic entity assumption.
d. Fiscal period assumption.
Answer: B
2. By recognizing the economic effects of inflation on the accounting financial statements,
which accounting assumption is ignored?
a. Economic entity assumption
b. Going concern assumption
c. Stable dollar assumption
d. Fiscal period assumption
Answer: C
3. A company prepares financial statements once every year. What practice does this
assumption illustrate?
a. Going concern assumption
b. Fiscal period assumption
c. The five-year moving theory
d. Stable dollar assumption
Answer: B
4. Which assumption is applied when Laramie recognizes the operations of its wholly owned
subsidiary, Big Sky, separately and distinctly from its own operations?
a. Economic entity assumption
b. Going concern assumption
c. Fiscal period assumption
d. The subsidiary stability assumption
Answer: A
5. Original cost may be defined as the:
a. cash price of the asset when purchased.
b. discounted future cash flows.
c. selling price.
d. price you bought the item for when it was first released for consumer sales.
Answer: A
6. Expensing the cost of a pencil holder that cost $1.25 instead of capitalizing it as a plant
asset and depreciating it over its estimated useful life of 10 years:
a. violates the economic entity assumption.
b. violates GAAP since pencil holders are important assets.
c. is justified because of materiality.
d. is appropriate because of the stable dollar assumption.
Answer: C
7. Today’s fair market value would be the same as:
a. the cash price of the asset when it was originally purchased.
b. the current price paid for an item in the input market.
c. the value of an item in the output market or sales price.
d. the discounted future cash flows from input and output markets.
Answer: C
8. Net realizable value is:
a. the input price of liabilities.
b. a form of market value.
c. a present value concept.
d. the current input cost.
Answer: B
9. Present value, as of today, would be the same as:
a. the cash price of the asset when it was purchased.
b. the present price of any given product or service.
c. the selling price.
d. the discounted value of future cash flows.
Answer: D
10. Recognition of increases in purchasing power of monetary units is inconsistent with the:
a. economic entity assumption.
b. going concern assumption.
c. consistency principle.
d. stable dollar assumption.
Answer: D
11. Which one of the following statements best describes the concept of consistency?
a. When uncertainty exists, understating assets, overstating liabilities, accelerating
recognition of losses, and delaying recognition of gains is preferred.
b. Accounting numbers are consistently market value.
c. Different firms use identical accounting measurement methods for similar events.
d. Similar events are measured using identical accounting procedures from period to period.
Answer: D
12. The valuation basis used to measure long-term liabilities is:
a. present value.
b. replacement cost.
c. fair market value.
d. historical cost.
Answer: A
13. The valuation basis used to measure accounts payable is:
a. fair value.
b. replacement cost.
c. face value.
d. present value.
Answer: C
14. Most companies prepare annual financial statements:
a. with a fiscal ending date of June 30.
b. on the calendar year.
c. at a different date each year.
d. every two weeks.
Answer: B
15. Which one of the following statements best describes objectivity?
a. When uncertainty exists, understating assets, overstating liabilities, accelerating
recognition of losses, and delaying recognition of gains is preferred.
b. The measurement of an event is verifiable and reliable.
c. Different firms use identical accounting measurement methods for similar events.
d. Objectives are laid out that are conservative or too aggressive by management.
Answer: B
16. Which one of the following is violated when a firm has a policy of accelerating the
recognition of depreciation expense during good years and decreasing depreciation expense
during lean years?
a. Relevance
b. Matching
c. Consistency
d. Conservatism
Answer: C
17. Which one of the following is violated when a firm measures property, plant, and
equipment at its estimated selling price?
a. Objectivity
b. Economic entity assumption
c. Materiality
d. Input markets
Answer: A
18. Ten years after a company purchases a plot of land, it is measured on the balance sheet at
its cost from the year it was purchased instead of its current selling price. This accounting
practice is justified by the:
a. financial period assumption.
b. going concern assumption.
c. fiscal period assumption.
d. original cost base.
Answer: D
19. The shareholders’ equity section of the balance sheet is:
a. a residual interest based on the book value of the company.
b. the amount for which the owner could sell the company.
c. valued at the present value of the dividends paid to shareholders.
d. the difference between the fair market value and the original cost of the company’s assets.
Answer: A
20. The valuation basis used to measure short-term investments is:
a. fair market value.
b. replacement cost.
c. original cost.
d. present value.
Answer: A
21. Which one of the following statements best describes the concept of conservatism?
a. Profits should be accelerated in all cases.
b. The measurement of an event is verifiable and reliable.
c. The value of goods and services provided is recognized when earned.
d. When uncertainty exists, understating assets, overstating liabilities, accelerating
recognition of losses, and delaying recognition of gains is preferred.
Answer: D
22. The valuation basis used to measure accounts receivable is:
a. the original cost of the goods sold.
b. current input cost
c. net realizable value.
d. replacement cost.
Answer: C
23. The valuation basis used to measure equipment and other plant assets on the balance sheet
is:
a. the dollar amount for which the assets can be sold.
b. the cash expected to be received in the future.
c. the original cost adjusted for depreciation.
d. the assets’ net realizable value.
Answer: C
24. Technically, the valuation basis used to measure shareholders' equity is:
a. original cost adjusted to net book value.
b. replacement value.
c. net realizable value.
d. None of these.
Answer: D
25. Which one of the following is violated when a department store records revenue for gift
certificates sold to customers that are not expected to be redeemed until next year?
a. Matching
b. Revenue recognition criteria
c. Going concern
d. Expense versus revenue concept
Answer: B
26. Which one of the following is violated when a retail store records revenue for a bank
credit card sale prior to receiving the money from the bank?
a. No violation occurred
b. Objectivity
c. Going concern
d. Revenue recognition criteria
Answer: A
27. Which one of the following is violated when a company recognizes revenue upon the
receipt of cash from a customer who has paid in advance for services?
a. Expense policy
b. Objectivity
c. Matching
d. Revenue recognition criteria
Answer: D
28. Which one of the following is violated when a firm measures accounts receivable at its
face amount even though knowing some customers may not pay the amounts due?
a. Consistency
b. Conservatism
c. Materiality
d. Revenue recognition criteria
Answer: B
29. Which of the following are exceptions to financial accounting measurement?
a. Consistency and conservatism
b. Objectivity and materiality
c. Going concern and materiality
d. Conservatism and materiality
Answer: D
30. Which one of the following is most likely violated if firm increases the dollar amount
reported for unsold inventory on the balance sheet to a cost it anticipates it will have to pay
for future inventory items?
a. Consistency
b. Conservatism
c. Going concern
d. Economic entity
Answer: B
31. Which one of the following reflects the proper inventory valuation on a company’s
balance sheet?
a. Lower of original cost or face value
b. Net realizable value
c. Lower of cost or market
d. Expected selling price
Answer: C
32. Which one of the following is violated when a company records cost of goods sold
expense at the time when inventory is purchased?
a. Relevance
b. Historical cost
c. Matching
d. Revenue recognition criteria
Answer: C
33. Which one of the following is violated when a firm reports its long-term debt at the
present value of the cash flows associated with that debt?
a. Matching
b. No violations occurred. This accounting is correct.
c. Revenue recognition
d. Gross value of the debt
34. A business entity operates in two general markets. They are:
a. a producer and a consumer market.
b. an economic and a fiscal market.
c. an input and an output market.
d. a profit and a non-profit market.
Answer: C
35. Which one of the following is violated when a sole proprietor records its magazine stand
at the present value of the cash flows expected to be earned from the sale of magazine over
the expected life of the stand?
a. Original cost
b. Fair market value
c. Going concern
d. Revenue recognition
Answer: A
36. Which one of the following is violated when a company pays for its CEO’s personal
groceries using the company’s bank account?
a. Stable dollar
b. Economic entity
c. Going concern
d. Ethical principle of accounting
Answer: B
37. Why must measures of performance and financial position be available on a timely basis?
a. For the users of the financial information to make decisions
b. For the SEC to determine whether the company should be shut down or not
c. FASB requires this information to be submitted to them for approval
d. For management to have time to manipulate income
Answer: A
38. The fiscal period assumption states that the operating life of an economic entity:
a. is generally for a period of one year.
b. can be any period management decides it to be.
c. must be an entity separately distinct from its owners.
d. can be divided into time periods over which measures can be developed and applied.
Answer: D
39. As fiscal periods become shorter, the application of certain accounting methods become:
a. more arbitrary and subjective.
b. more objective.
c. more accurate.
d. more conservative.
Answer: A
40. The stable dollar assumption assumes that:
a. the monetary unit is the functional currency of any country in which a company operates.
b. inflationary effects should be recognized in the financial statements
c. economic wealth is not measurable.
d. the monetary unit is stable across time.
Answer: D
41. The monetary unit that a company uses to measure economic transactions is primarily
determined by the:
a. stable dollar concept adjusted for inflationary effects.
b. markets in which a company operates.
c. fiscal period a company has chosen.
d. decision by management to elect to use a given currency.
Answer: B
42. Which one of the following is considered an unrealistic assumption in accounting?
a. Economic entity
b. Stable dollar
c. Going concern
d. Fiscal period concept
Answer: B
43. Objective accounting information:
a. cannot be used in the financial statements.
b. requires that values of transactions and related assets and liabilities created by them be
arbitrarily determined.
c. ensures that revenue matches expenses for every accounting period.
d. states that financial accounting information must be reliable and verifiable.
Answer: D
44. The matching principle states that:
a. expenses should be recognized in the period that the related revenue is recognized.
b. after expenses have been identified in a particular accounting period in which they were
incurred, revenues can be recognized.
c. each company should use the same accounting principles as other companies use.
d. for every dollar of revenue recognized, the company should recognize a corresponding
dollar of expenses.
Answer: A
45. Morgan Shipping held cash of $1 million throughout 2010 when the general price level
decreased by over 30 percent. Morgan Shipping:
a. has more than $1 million of purchasing power at the end of the period.
b. has less than $1 million purchasing power at the end of the period.
c. must recognize the gain due to general price level increases in its income statement.
d. has the same $1 million purchasing power at the end of the period as at the beginning of
the period.
Answer: A
47. The most common point of revenue recognition is:
a. when the cash is collected from the customer.
b. when the customer elects to issue the check to pay for goods shipped.
c. when the goods are delivered to the customer.
d. as the goods are being produced.
Answer: C
48. The principle of consistency states that:
a. companies should choose a set of accounting methods and use them from one period to the
next.
b. once a company selects an accounting method, it must use that method throughout the
company's entire existence.
c. a company may change any accounting method, provided the SEC approves the change.
d. companies should elect to use methods that consistently inflate profits.
Answer: A
49. Everett, Inc.’s reporting period ends on June 30th every year. This is an example of:
a. matching.
b. fiscal period.
c. materiality.
d. relevance.
Answer: B
50. Which of the following represents two of the four criteria that must be met before revenue
can be included in the income statement?
a. The amount of revenue must be objectively measurable and the cash must be collected.
b. The company elects to record the revenue and the cash for payment is relatively certain.
c. The company must intend to transfer the goods or services to the buyer and the collection
of cash must be reasonably assured.
d. The collection of cash must be reasonably assured and the amount of revenue can be
objectively measured.
Answer: D
51. Information is considered material if:
a. it would have a bearing on decisions of those who use the financial statements.
b. there is a substantial likelihood that a reasonable investor would not be concerned about
the information.
c. an item is so insignificant that users would likely ignore it.
d. the FASB explicitly rules the transaction or item to be material.
Answer: A
52. Why would a company recognize the cost of an asset on its balance sheet rather than treat
it as an expense on the date it is acquired?
a. Conservatism requires this recognition.
b. Matching requires costs to be matched against the related revenues of the asset.
c. Strictly to record the amount in the most economically favorable manner possible for the
company.
d. The stable dollar concept will not allow inflation to be added to expenses, but does allow
inflation to be added to assets.
Answer: B
53. When in doubt, financial statements should:
a. understate assets, overstate liabilities, delay the recognition of gains, and accelerate the
recognition of losses.
b. understate assets and liabilities and delay the recognition of gains and losses.
c. understate assets, overstate liabilities, and delay the recognition of gains and losses.
d. overstate assets and understate liabilities.
Answer: A
54. Jeter Company ordered 400 toy wagons from Lamar, Inc. on May 1, 2010. Jeter Company
paid for them on May 20 at a cost of $2 each. Jeter sold 50 of them on June 2, 2010, for $4
each to Gilloz Company. Gilloz Company paid Jeter on June 10.
On which date should Jeter Company recognize revenue?
a. May 1
b. May 20
c. June 10
d. June 2
Answer: D
55. Jeter Company ordered 400 toy wagons from Lamar, Inc. on May 1, 2010. Jeter Company
paid for them on May 20 at a cost of $2 each. Jeter sold 50 of them on June 2, 2010, for $4
each to Gilloz Company. Gilloz Company paid Jeter on June 10.
How much revenue should Jeter Company recognize at the preferred point of revenue
recognition?
a. $240
b. $100
c. $1,000
d. $200
Answer: D
56. Jeter Company ordered 400 toy wagons from Lamar, Inc. on May 1, 2010. Jeter Company
paid for them on May 20 at a cost of $2 each. Jeter sold 50 of them on June 2, 2010, for $4
each to Gilloz Company. Gilloz Company paid Jeter on June 10.
Which amount represents Jeter Company’s input markets related to this sale?
a. $300
b. $800
c. $1,600
d. $250
Answer: B
57. Equipment with an original cost of $39,000 has a fair market value of $34,000, current
replacement cost of $41,000, and a depreciated value of $36,000 on December 31, 2010. At
what amount would net equipment be measured on the December 31, 2010 balance sheet?
a. $38,000
b. $36,000
c. $41,000
d. $34,000
Answer: B
58. Short-term investments have an original cost of $29,000 and a market price of $31,000 at
December 31, 2010. At what amount would the investments be measured on the December
31, 2010 balance sheet?
a. $29,000
b. $31,000
c. ($2,000)
d. $2,000
Answer: B
59. Sheena Company has accounts receivable of $13,000, with an estimated net realizable
value of $12,000 on December 31, 2010. At what amount would the accounts receivable be
measured on the December 31, 2010 balance sheet?
a. $1,000
b. $13,000
c. $12,000
d. ($1,000)
Answer: C
60. Seinfeld Company has land with an original cost of $68,000 and a fair market value of
$81,000. Seinfeld has considered selling its business next year and listing the land with a
realtor for $100,000. At what amount would land be measured on the December 31, 2010
balance sheet?
a. $100,000
b. $81,000
c. $15,000
d. $68,000
Answer: D
61. On October 1, 2010, $24,000 of annual magazine subscriptions were sold by Cat World
Magazines. The subscribed magazines are delivered on the first day of each month beginning
on October 1, 2010. The total cost of the subscribed magazines is $12,000, equal to $1,000
per month. What is the amount of revenue to be recognized during 2010?
a. $24,000
b. $3,000
c. $6,000
d. $8,400
Answer: C
Revenue for 2010 is the amount earned for the 3 months of subscriptions delivered for a total
of $6,000 ($24,000 x 3/12). Cost of goods sold is $3,000 (3 months x $1,000 per month).
62. On October 1, 2010, $24,000 of annual magazine subscriptions were sold by Cat World
Magazines. The total cost of the subscribed magazines is $12,000, equal to $1,000 per month.
The subscribed magazines are delivered on the first day of each month beginning on October
1, 2010. What is the amount of the cost of the magazines to be recognized during 2010?
a. $12,000
b. $8,400
c. $1,600
d. $3,000
Answer: D
Revenue for 2010 is the amount earned for the 3 months of subscriptions delivered for a total
of $4,500 ($18,000 x 3/12). Cost of goods sold is $3,000 (3 months x $1,000 per month).
63. On March 1, 2010, $72,000 of annual magazine subscriptions were sold by Traveler’s
Monthly Magazines. The subscribed magazines are delivered on the first day of each month
beginning on March 1, 2010. The total cost of the subscribed magazines is $30,000 or $2,500
per month. How much profit will the company recognize during 2010?
a. $60,000
b. $33,000
c. $35,000
d. $24,750
Answer: C
64. On March 1, 2010, $72,000 of annual magazine subscriptions were sold by Traveler’s
Monthly Magazines. The subscribed magazines are delivered on the first day of each month
beginning on March 1, 2010. The total cost of the subscribed magazines is $30,000 or $2,500
per month. How much profit will the company recognize during 2011?
a. $7,000
b. $8,250
c. $10,000
d. $2,750
Answer: A
65. Joseph Corporation purchased an extruding machine on January 1, 2009 for $25,000. The
machine is expected to be used for 5 years, and the company believes an equal portion of the
cost should be allocated to each accounting period. Based on this information, what is the net
book value of the machine on January 1, 2011?
a. $5,000
b. $15,000
c. $10,000
d. $25,000
Answer: B
$25,000 / 5 = $5,000 x 2 = $10,000; $25,000 – 10,000 = $15,000
66. Karr Construction built a levee for the state of Mississippi over a three-year period. The
contracted price for the levee was $1,200,000. The costs incurred by Karr and the payments
from the state over the three-year period are as follows:
If revenue is recognized when payments are received, which of the following present the net
income amounts reported in 2009, 2010, and 2011, respectively?
a. $600,000; $400,000; $500,000
b. $300,000; $200,000; $400,000
c. $400,000; $400,000; $400,000
d. $300,000; $200,000; $100,000
Answer: B
67. Karr Construction built a levee for the state of Mississippi over a three-year period. The
contracted price for the levee was $1,200,000. The costs incurred by Karr and the payments
from the state over the three year period are as follows:
If revenue is recognized in proportion to the costs incurred by Karr, how much net income is
reported in 2010?
a. $100,000
b. $200,000
c. $300,000
d. $400,000
Answer: C
68. Karr Construction built a levee for the state of Mississippi over a three-year period. The
contracted price for the levee was $1,200,000. The costs incurred by Karr and the payments
from the state over the three-year period are as follows:
If revenue is recognized in proportion to the costs incurred by Karr, how much net income is
reported in 2011?
a. $600,000
b. $400,000
c. $300,000
d. $150,000
Answer: D
69. Three years ago, Astro Masters, Inc. purchased the three assets listed in the following
table. The chief financial officer, Bill Moss, is presently trying to decide what to do with each
asset. He has three options for each asset: (1) sell it; (2) keep it; and (3) sell it and replace it
with an equivalent asset. The following information is provided to aid his decision.
Based on your calculations of total cash flows, which of the following options is the best for
Bill to pursue with respect to Asset A?
a. Option 1
b. Option 2
c. Option 3
d. Both Options 2 & 3 provide the same total cash flows.
Answer: C
Therefore, Bill should sell and replace with an equivalent asset (Option 3).
70. Three years ago, Astro Masters, Inc. purchased the three assets listed in the following
table. The chief financial officer, Bill Moss, is presently trying to decide what to do with each
asset. He has three options for each asset: (1) sell it; (2) keep it; and (3) sell it and replace it
with an equivalent asset. The following information is provided to aid his decision.
Based on your calculations, what would be the total cash flows associated with selling and
replacing Asset C with an equivalent asset?
a. $2,500
b. $5,500
c. $5,000
d. $4,500
Answer: C
71. Three years ago, Astro Masters, Inc. purchased the three assets listed in the following
table. The chief financial officer, Bill Moss, is presently trying to decide what to do with each
asset. He has three options for each asset: (1) sell it; (2) keep it; and (3) sell it and replace it
with an equivalent asset. The following information is provided to aid his decision.
Based on your calculations of total cash flows, which of the following options is the best for
Bill to pursue with respect to Asset B?
a. Option 1
b. Option 2
c. Option 3
d. Both Options 2 & 3 provide the same total cash flows.
Answer: B
72. Three years ago, Astro Masters, Inc. purchased the three assets listed in the following
table. The chief financial officer, Bill Moss, is presently trying to decide what to do with each
asset. He has three options for each asset: (1) sell it; (2) keep it; and (3) sell it and replace it
with an equivalent asset. The following information is provided to aid his decision.
On December 31, 2009, just before preparing the company’s financial statements, Bill
decides to replace Asset A and keep both Assets B and C. According to generally accepted
accounting principles, at what dollar amount he report each of these respective assets on the
balance sheet?
a. $4,500; $2,000; $2,500
b. $1,500; $2,000; $2,500
c. $2,000; $1,000; $3,500
d. $1,500; $2,500; $4,000
Answer: B
Matching Questions
1. Match the descriptions listed in letters a through e below with the proper assumption
numbered from 1 through 4 below.
____ 1. Economic entity assumption
____ 2. Stable dollar assumption
____ 3. Going concern assumption
____ 4. Fiscal period assumption
Answer:
1. b
2. c
3. e
4. a
2. For each financial statement item listed in 1 through 5 below, identify the financial
statement valuation (listed in a through h) at which it should be reported. You may use each
letter more than once or not at all.
____ 1. Cash
____ 2. Short-term investments
____ 3. Accounts receivable
____ 4. Long-term liabilities
____ 5. Office building
Answer:1. b
2. d
3. e
4. c
5. f
3. Match the descriptions listed in letters a through e below with the proper valuation
numbered from 1 through 4.
____ 1. Present value
____ 2. Fair market value
____ 3. Replacement cost
____ 4. Residual interest
Answer: 1. C
2. e
3. b
4. d
4. For each financial statement item listed in 1 through 5 below, identify at which financial
statement valuation (listed in a through g) the item should be reported. You may use each
letter more than once or not at all.
____ 1. Inventory
____ 2. Plant and equipment (book value)
____ 3. Land used for plant site
____ 4. Current liabilities
____ 5. Long-term notes receivable
Answer: 1. g
2. f
3. c
4. d
5. a
5. For each financial concept listed in 1 through 5 below, identify in which category (listed in
a through f) it should be matched. You may use each letter more than once or not at all.
Categories
____ 1. Comparability
____ 2. Objectivity
____ 3. Revenue recognition criteria
____ 4. Matching concept
____ 5. Consistency
Answer: 1. c
2. f
3. e
4. b
5. a
Short Problems
1. On May 1, 2009, $9,000 of annual magazine subscriptions were sold by Glolar, Inc. The
subscribed magazines are delivered on the first day of each month beginning on May 1, 2009.
The total cost of the subscribed magazines is $3,600 or $300 per month.
A. Determine the amount of revenue during 2009.
B. Explain how the matching concept is applied relative to the magazines.
Answer: A. The amount of revenue to be recognized for 2009 is $6,000, the amount earned (8
months at $750 per month.)
B. Matching is achieved by reporting the cost of goods sold expense ($300 x 8 = $2,400) in
the same accounting period as the revenue of $6,000 that relates to the same accounting
period (May 1 through December 31).
2. During 2010, Hamot Company sold $30,000 of computer chips to a distributor on account.
The distributor planned to sell those chips to a German company. The sold chips were
shipped to a warehouse owned by Hamot and were still there on December 31, 2010.
Hamot’s CFO left two messages for the distributor but received no return calls. The
distributor has had no prior dealings with Hamot or any other manufacturer of computer
chips. None of the past due balance of $30,000 has been paid. How much sales revenue
associated with this transaction would be reported on the income statement for the year
ending December 31, 2010? Explain your selection.
Answer: $0 would be reported because all four of the revenue recognition criteria were not
met. While Hamot Company had completed a significant portion of the production, the goods
had not been delivered to the company that placed the order, i.e., the sales effort was not
complete. In addition, the eventual collection of the amount due from the company was not
assured.
3. During January of 2010, Barry Corporation purchased five acres of land for cash of
$110,000 from Foley Company. On December 31, 2010, after Barry built its plant, it was
estimated that the land's fair market value was $140,000. At what amount would land be
measured on Barry’s December 31, 2010 balance sheet?
Answer: $110,000
4. On December 31, 2010, total assets and liabilities are measured at $16,000 and $12,000,
respectively. The total market value of the company's common stock is $7,000. At what
amount would shareholders' equity be measured on the December 31, 2010 balance sheet?
Answer: $16,000 – $12,000 = $4,000
5. Equipment with an original cost of $23,000 has a fair market value of $19,000, current
replacement cost of $26,000, and a depreciated value of $20,000 on December 31, 2010. At
what amount would net equipment be measured on the December 31, 2010 balance sheet?
Answer: $20,000
6. Short-term investments have an original cost of $2,500 and a market price of $3,000 at
December 31, 2010. At what amount would the investments be measured on the December
31, 2010 balance sheet?
Answer: $3,000
7. Accounts receivable have a face value of $10,000 and estimated net realizable value of
$8,000 on December 31, 2010. At what amount would the accounts receivable be measured
on the December 31, 2010 balance sheet?
Answer: $8,000
8. Equipment with an original cost of $50,000 has a fair market value of $65,000 and
accumulated depreciation of $15,000 on December 31, 2010. What amount would the
December 31, 2010 balance sheet show as the equipment’s net book value?
Answer: $50,000 - $15,000 = $35,000
9. On December 1, 2010, Karr Company purchased inventory for $55,000. On December 31,
2010, the replacement cost of that inventory is $57,000. At what amount would inventory be
measured on the December 31, 2010 balance sheet?
Answer: $55,000
10. On October 1, 2010, $24,000 of annual magazine subscriptions were sold by Kitchen
Design Magazines. The subscribed magazines are delivered on the first day of each month
beginning on October 1, 2010. The total cost of the subscribed magazines is $6,000, equal to
$500 per month. Determine the amount of revenue and the cost of the magazines to be
recognized during 2010.
Answer: Revenue for 2010 is the amount earned for the 3 months of subscriptions delivered
for a total of $6,000 ($24,000 x 3/12). Cost of goods sold is $1,500 (3 months x $500 per
month).
11. On October 1, 2010, $36,000 of annual magazine subscriptions were sold by Motocross
Monthly Magazines. The subscribed magazines are delivered on the first day of each month
beginning on October 1, 2010. The total cost of the subscribed magazines is $15,000 or
$1,250 per month. Determine the amount of revenue and the cost of the magazines to be
recognized during 2010 and 2011, respectively. How much profit will the company recognize
during 2010 and 2011?
Answer:
12. Zurich Corporation sells cases of champagne to customers for $200 a case. Each customer
pays $40 when the case is picked up and then $40 a month for the next four months. The cost
of a case of champagne is $60. Although the payment plan has significantly increased sales,
Zurich has decided to delay the recognition of revenue until cash is received because of the
questionable credit history of the new customers. During January, 2010, 10 cases of
champagne were sold and the initial payment of $40 per case was collected. The normal first
payment of $40 a case was collected on February 1, 2010. List the four revenue recognition
criteria and state how each criterion is either met or not met based on the information
provided.
Answer: 1. The company must have completed a significant portion of the production and
sales effort. The customers have received the champagne, so the sales effort is complete. This
condition is met.
2. The amount of revenue can be objectively measured. The revenue amount is given at $200
per case. This condition is met.
3. The major portion of the costs has been incurred, and the remaining costs can be
reasonably estimated. The cost is provided at $60 per case. This condition is met.
4. The eventual collection of the cash is reasonably assured. Zurich questions the credit
history of the customers, so this condition is not met.
13. During 2009 and 2010, Orange Company recognized $100,000 and $120,000 of sales,
respectively. The inflation rate between 2009 and 2010 was 10 percent. Did sales increase 20
percent from 2009 to 2010? Explain.
Answer: No. A 10% increase because of inflation is $10,000 ($100,000 x 10%). Of the
$20,000 increase, $10,000 represents inflation and $10,000 represents a real sales increase.
14. Victor Corporation purchased a packaging machine on January 1, 2010 for $10,000. The
machine is expected to be used for 3 years, and the company believes an equal portion of the
cost should be allocated to each accounting period. How much expense should Victor
recognize during 2010? What concept is illustrated?
Answer: $10,000 / 3 = $3,333 for 2010
The matching concept is illustrated.
15. On January 27, 2010, Lock Company entered into a three-year agreement with Strong
Enterprises to supply 2,000 ounces of platinum for $200 an ounce. During 2010, Lock mined
and purified the 2,000 ounces of platinum at a cost of $200,000. The platinum was shipped
on January 14, 2011 and arrived on January 15, 2011, at Strong’s warehouse. What is Lock’s
revenue and gross profit recognized during 2010, consistent with the criteria for revenue
recognition and the matching concept? Explain.
Answer: Revenue and gross profit are $0 for 2010 because the sales effort was not complete
by the end of 2010, i.e., the product was not delivered.
16. During 1995, Jeter Company purchased property for its plant for $100,000. During
December of 2010, a similar neighboring plot of land was sold for $120,000. At what amount
would land be measured on Jeter Company’s December 31, 2010 balance sheet?
Answer: $100,000
Short Essay Questions
1. Large public accounting firms employ graduates from state-supported universities, many
of who are graduates with accounting degrees. These firms' reliance on and use of the product
of subsidized educational institutions seem to imply that these colleges and universities are
important assets. However, they are not recognized as assets on the balance sheets of these
public accounting firms. Which one of the four basic assumptions might be used to justify the
exclusion of educational assets from the balance sheets of the public accounting firms?
Answer: Although the lack of ownership or other forms of direct and unchallengeable control
might justify the exclusion of educational institutions from the balance sheets of public
accounting firms, the basic assumption used is the economic entity assumption. The public
accounting firms and educational institutions are considered to be separate economic entities
in one economic society.
2. What is the fiscal period assumption and why is it used?
Answer: The fiscal period assumption states that the operating life of an economic entity
must be divided into time periods over which performance measures can be developed and
applied. If a company ignores the fiscal period assumption, and recognizes all revenue and all
expenses only over the life of the business, the numbers would be enormous and the true
meaning would be lost. With no fiscal period breakdown of time, a company would not be
able to provide information to users to make decisions.
3. Explain the ‘markets’ in which a business entity operates.
Answer: A business entity operates in an input market, where it purchases inputs (materials,
labor, overhead) for its operations, and an output market, where it sells its outputs (services or
inventories). Input market values (purchase prices) are normally less than output market
values (sales prices). The input and output markets are defined in terms of specific entities. A
sale for one company may be a purchase for another company.
4. Why is materiality a major problem in accounting?
Answer Materiality requires judgments that can differ considerably among investors,
creditors, managers, auditors, and others. GAAP does not provide guidelines for determining
the amount, so assumptions used in determining the dollar amount may be arbitrary.
5. On October 1, 2010, $20,000 of annual magazine subscriptions were sold by Boating
Monthly. The subscribed magazines are delivered on the first day of each month beginning on
October 1, 2010. The total cost of the subscribed magazines is $6,000 or $500 per monthly
delivery. Using the four criteria necessary for revenue recognition, present an argument for
not recognizing $10,000 of revenue during 2010.
Answer: Although during 2010, revenue is objectively measured ($20,000), a significant
portion of the earnings effort has not been made and a major portion of the costs have not
been incurred. The earnings requirement will not be met until the magazines are produced,
printed, and delivered. Only one-fourth of the $20,000 received in 2010 should be reported as
revenue in 2010.
6. When is present value be used on the financial statements? Give an example in your
explanation.
Answer: Present value is used on the financial statements only in those cases where future
cash flows can be objectively determined. Contractual agreements like notes receivable
represent a case that meets this criteria.
7. Explain the concept of face value.
Answer: A specific form of fair market value is called face value. It is a valuation to measure
amounts reported on the financial statements used primarily for cash and all current
liabilities. It reflects the cash expected to be received or paid in the near future.
8. Why are market values not used for property, plant, and equipment on the balance sheet?
Answer: Property, plant, and equipment is sometimes objectively determinable, but most
often not. For plant assets in various stages of useful life, determining the market value would
require finding an identical plant asset in the same state of "used." If this is not possible, an
estimate would be necessary. Estimates of this nature would likely fail to meet the principle
of objectivity.
9. Why is inflation ignored in accounting?
Answer: If companies were to include inflationary effects on their financial statements, the
amounts would have to be estimated since the rate of inflation will not be the same for all
commodities and categories of assets. Management would need to estimate the dollar amount
assignable to the financial statement amounts, and would likely use various assumptions that
would make the information subjective, instead of objective. Information that is not reliable
and verifiable is not objective, and will likely cause the financial statements to be misleading
for users. Original cost is used instead of inflation-adjusted costs in an effort to make the
financial information reliable. It is also very costly to spend the time to make the conversion
to inflationary amounts.
10. Name the four basic assumptions of financial accounting. Indicate why these
assumptions, as a group, are important.
Answer: The basic assumptions of financial accounting are: (1) economic entity, (2) fiscal
period, (3) going concern, and (4) stable dollar. They are important because they form the
building blocks upon which financial accounting measurement is based.
11. What is the most critical question in the matching process? Why is it critical?
Answer: The most critical question is: ‘In what time period will the revenue be realized?’
Matching requires first identifying in which time period the revenue is recognized. Then it is
possible to determine which costs are associated with that particular revenue. The costs
should then be recognized in the same time period to be properly matched against the
revenue.
12. If a company changes its accounting method, does this mean that consistency is violated?
Answer: Management must be able to convince the independent auditors that the
environment facing the company has changed and an alternative accounting method is
appropriate. The effects of the change must be clearly disclosed in the financial statements
and the related notes.
IFRS Questions
1. Compared to U.S. GAAP, IFRS tends to:
a. require fewer disclosures.
b. allow management to choose between fewer accounting method alternatives.
c. be the same as U.S. GAAP in all respects.
d. provide a stricter interpretation of objectivity than in the U.S.
Answer: A
2. IFRS differs from GAAP in that IFRS tends to be:
a. more rules-based
b. more principles-based
c. focused on historical cost
d. focused more on hypothetical future values
Answer: B
Test Bank for Financial Accounting: In an Economic Context
Jamie Pratt
9780470635292, 9781119537571, 9781119444367
