Test Bank For Intermediate Accounting Volume 1, 11th Canadian Edition By Keiso

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Intermediate Accounting Volume 1, 11th Canadian Edition Test Bank

CHAPTER 1

 

THE CANADIAN FINANCIAL REPORTING ENVIRONMENT

CHAPTER STUDY OBJECTIVES

 

 

  1. 1. Explain how accounting makes it possible to use scarce resources more efficiently. Accounting provides reliable, relevant, and timely information to managers, investors, and creditors so that resources are allocated to the most efficient enterprises. Accounting also provides measurements of efficiency (profitability) and financial soundness.

 

 

  1. Explain the meaning of “stakeholder” and identify key stakeholders in financial reporting, explaining what is at stake for each one. Investors, creditors, management, securities commissions, stock exchanges, analysts, credit rating agencies, auditors, and standard setters are some of the major stakeholders. Illustration 1-4 explains what is at stake for each one.

 

 

  1. Identify the objective of financial reporting. The objective of financial reporting is to communicate information that is useful to key decision makers such as investors and creditors in making resource allocation decisions (including assessing management stewardship) about the resources and claims to resources of an entity and how these are changing.

 

 

  1. Explain how information asymmetry and bias interferes with the objective of financial reporting. Ideally, all stakeholders should have access to the same information in order to ensure that good decisions are made in the capital marketplace. (This is known as information symmetry.) However, this is not the case—there is often information asymmetry. Of necessity, management has access to more information so that it can run the company. It must also make sure that it does not give away information that might harm the company, such as in a lawsuit where disclosure might cause the company to lose. Aside from this, information asymmetry exists because of management bias whereby management acts in its own self-interest, such as wanting to maximize management bonuses. This is known as moral hazard in accounting theory. Information asymmetry causes markets to be less efficient. It may cause stock prices to be discounted or costs of capital to increase. In addition, it might detract good companies from raising capital in the particular market where relevant information is not available (referred to as adverse selection in accounting theory). The efficient markets hypothesis is felt to exist only in a semi-strong form, meaning that only publicly available information is assimilated into stock prices.

 

 

  1. Explain the need for accounting standards & identify the major entities that influence standard setting and financial reporting. The accounting profession has tried to develop a set of standards that is generally accepted and universally practised. This is known as GAAP (generally accepted accounting principles). Without this set of standards, each enterprise would have to develop its own standards, and readers of financial statements would have to become familiar with every company’s particular accounting and reporting practices. As a result, it would be almost impossible to prepare statements that could be compared. In addition, accounting standards help deal with the information asymmetry problem.

The Canadian Accounting Standards Board (AcSB) is the main standard-setting body in Canada for private companies, pension plans, and not-for-profit entities. Its mandate comes from the Canada Business Corporations Act and Regulations as well as provincial acts of incorporation. For public companies, GAAP is International Financial Reporting Standards (IFRS) as established by the International Accounting Standards Board (IASB). Public companies are required to follow GAAP in order to access capital markets, which are monitored by provincial securities commissions. The Financial Accounting Standards Board (FASB) is also important as it influences IFRS standard setting. Private companies may choose to follow IFRS. Public companies that list on U.S. stock exchanges may choose to follow U.S. GAAP.

 

 

  1. Explain the meaning of generally accepted accounting principles (GAAP) & the significance of professional judgement in applying GAAP. Generally accepted accounting principles are either principles that have substantial authoritative support, such as the CPA Canada Handbook, or those arrived at through the use of professional judgement and the conceptual framework.

Professional judgement plays an important role in Accounting Standards for Private Enterprises (ASPE) and IFRS since much of GAAP is based on general principles, which need to be interpreted.

 

 

  1. Discuss some of the challenges and opportunities for accounting. Some of the challenges facing accounting are oversight in the capital markets, centrality of ethics, standard setting in a political environment, principles versus rules-based standard setting, the impact of technology, and integrated reporting. All of these require the accounting profession to continue to strive for excellence and to understand how accounting adds value in the capital marketplace.

 

 

Multiple Choice QUESTIONS

 

Answer          No.       Description

d                1.        Accounting characteristics

a                2.        Nature of financial accounting

c                3.        Definition of financial accounting

b                4.        Definition of management accounting

d                5.        Efficient use of resources

c                6.        Capital allocation process

d                7.        Importance of accounting information

d                8.        Primary exchange mechanism(s) for allocating resources

c                9.        Changing financial reporting environment

b               10.       Stakeholders in the financial reporting environment

d               11.       Preparation of audited financial statements

a               12.       Auditor’s responsibility

c               13.       Causes of subprime lending crisis

a               14.       Management’s primary responsibility with respect to financial statements

c               15.       Primary responsibility of security and exchange commissions

b               16.       Objectives of financial reporting

b               17.       Appropriate objectives of general-purpose financial reporting

b               18.       Accrual-basis accounting

c               19.       Preparation of biased information

c               20.       Existence of information asymmetry

b               21.       Efficient markets hypothesis

d               22.       Management bias

a               23.       Moral hazard

d               24.       Conservative accounting

b               25.       Reduction of information asymmetry

b               26.       Development of GAAP

c               27.       Financial reporting before 1900

c               28.       Responsibility of the AcSB

a               29.       Oversight of AcSB

c               30.       Authority over accounting standards in the U.S

d               31.       Development of financial reporting standards in Canada

b               32.       Adoption of IFRS

d               33.       Activities and authority of the Ontario Securities Commission (OSC)

b               34.       Use of ASPE

a               35.       IASB’s standard setting process

c               36.       Primary sources of GAAP under ASPE

c               37.       Sources of GAAP

d               38.       Exercise of professional judgement

c               39.       Rules-based vs. principles-based approach

c               40.       Comparison of Canadian GAAP and U.S. GAAP

b               41.       SOX

a               42.       Advancement of technology on financial reporting

a               43.       IASB principles regarding funding

c               44.       Rules-based GAAP body of knowledge

 

 

Exercises

 

Item                 Description

E1-45              Effective capital allocation

E1-46              Financial statements in practice and theory

E1-47              Stakeholders in the financial reporting environment

E1-48              Sources of capital and stages of company growth

E1-49              Objectives of financial reporting

E1-50              Traditional users vs. others

E1-51              Imperfection of the stakeholder ecosystem

E1-52              Entity vs. proprietary perspective

E1-53              User needs

E1-54              The decision-usefulness approach to financial reporting

E1-55              Merits of accrual- vs. cash-basis accounting

E1-56              Information asymmetry

E1-57              Maintaining competitive advantage

E1-58              Management bias in financial statement presentation

E1-59              Role of securities commissions and stock exchanges

E1-60              Standard setting

E1-61              Purpose of accounting standards

E1-62              ASPE vs. IFRS

E1-63              Source of GAAP

E1-64              Sources of GAAP

E1-65              Professional judgement

E1-66              SOX and standard setting

E1-67              Challenges facing financial reporting

E1-68              Role of executives and management in a post-SOX world

E1-69              Technology and financial information


MULTIPLE CHOICE QUESTIONS

 

 

  1. The essential characteristic(s) of accounting is (are)
  2. a) communication of financial information to interested internal parties only.
  3. b) communication of economic information to external parties.
  4. c) identification and measurement of financial information only.
  5. d) identification, measurement, and communication of financial information.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Financial accounting is concerned with the process that culminates in
  2. a) the preparation of financial reports.
  3. b) specialized reports for inventory management and control.
  4. c) specialized reports for income tax calculation and recognition.
  5. d) reports on changes in stock prices and future estimates of market position.

 

Answer: a

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Financial accounting can be broadly defined as the area of accounting that prepares financial statements to be used
  2. a) by parties internal to the business enterprise only.
  3. b) by investors only.
  4. c) by parties both internal and external to the business enterprise.
  5. d) primarily by external users and Canada Revenue Agency.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Management accounting can be broadly defined as the area of accounting that communicates financial information
  2. a) to investors only.
  3. b) to parties internal to the business enterprise only.
  4. c) to parties both internal and external to the business enterprise.
  5. d) primarily to external users and Canada Revenue Agency.

 

Answer: b

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

CPA: Management Accounting

Bloomcode: Knowledge

 

 

  1. Whether a business is successful and thrives is determined by
  2. a) free enterprise or competition.
  3. b) competition and markets only.
  4. c) markets and competition only.
  5. d) markets, competition and free enterprise.

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. Which of the following is correct?
  2. a) Reported accounting numbers do not affect the transfer of resources.
  3. b) Credit rating agencies use accounting information to assess their assets.
  4. c) Efficient capital markets promote productivity and encourage innovation.
  5. d) Efficient capital markets promote productivity but do not encourage innovation.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. Information provided by accounting is important because it enables investors and creditors to
  2. a) compare income and assets of companies.
  3. b) assess the relative risks and returns of investment opportunities.
  4. c) channel their resources more effectively.
  5. d) all of the above

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. In Canada, the primary exchange mechanism(s) for allocating resources is (are)
  2. a) debt & equity markets.
  3. b) financial Institutions such as banks.
  4. c) government authorities such as the Canada Revenue Agency (CRA).
  5. d) both a & b

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following is/are major factors in the rapidly changing financial reporting environment in Canada?
  2. a) increased demand for accountants and the impact of technology
  3. b) globalization and the unethical actions of accountants
  4. c) the growing number of institutional investors who want more information regarding environmental and social issues
  5. d) increased use of the Internet

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Stakeholders who help in the efficient allocation of resources include
  2. a) investors and creditors.
  3. b) financial analysts and regulators.
  4. c) creditors and auditors.
  5. d) management and auditors.

 

Answer: b

 

Difficulty: Easy

Learning Objective: Explain the meaning of “stakeholder” and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Audited financial statements are prepared by
  2. a) auditors.
  3. b) financial analysts.
  4. c) Canada Revenue Agency.
  5. d) management.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain the meaning of “stakeholder” and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The auditor’s primary responsibility is to
  2. a) review financial statements and discuss them with management.
  3. b) prepare financial statements.
  4. c) report to Canada Revenue Agency.
  5. d) report to standard setters.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Explain the meaning of “stakeholder” and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Audit & Assurance

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The widely publicized subprime lending crisis was NOT caused by
  2. a) capital market participants who acted in their own self-interest.
  3. b) a lack of transparency.
  4. c) the practice of securitizing assets.
  5. d) a lack of investor understanding of the investment’s true risk.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the meaning of “stakeholder” and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Finance

CPA: Professional & Ethical Behaviour

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. Management’s primary responsibility with respect to financial statements is to
  2. a) prepare them, as they have the best insight and know what should be included.
  3. b) audit them, as they are distant enough from daily operations.
  4. c) rely on them to make decisions.
  5. d) None of the above are true.

 

Answer: a

 

Difficulty: Easy

Learning Objective: Explain the meaning of “stakeholder” and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. The primary responsibility of security and exchange commissions with respect to financial statements is to
  2. a) set generally accepted accounting principles (GAAP), which must be followed in their preparation.
  3. b) review accounting choices made by companies in their financial statements to ensure decision-making logic is sound.
  4. c) monitor financial statements to ensure full and plain disclosure of material information thus maintaining compliance with listing requirements.
  5. d) monitor and analyze the information looking for signs of an improved or weakened financial condition.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the meaning of “stakeholder” and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. Objectives of financial reporting do NOT include
  2. a) providing information that is useful to users in making resource allocation decisions.
  3. b) providing information about the liquidation value of an enterprise.
  4. c) providing information about an entity’s economic resources, obligations, and equity/net assets.
  5. d) providing information about changes in an entity’s economic resources, obligations, and equity/net assets.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. As part of the objective of general-purpose financial reporting, which of the following perspectives are considered appropriate?
  2. a) proprietary perspective
  3. b) entity perspective
  4. c) stakeholder perspective
  5. d) None of the above perspectives are considered appropriate.

 

Answer: b

 

Difficulty: Easy

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following is NOT true regarding accrual-basis accounting?
  2. a) A company records events that change its financial statements in the periods in which the events occur.
  3. b) Revenues and expenses are recognized in the periods in which the company receives or pays cash.
  4. c) It has greater potential to depict meaningful trends in revenues and expenses.
  5. d) Revenues and expenses can be more easily related to the economic environment of the period in which they occurred.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The preparation by some companies of biased information is sometimes referred to as
  2. a) conservative financial reporting.
  3. b) full disclosure of all material facts.
  4. c) aggressive financial reporting.
  5. d) stewardship.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Where information asymmetry exists, the capital market may attract the wrong kind of company. This is known as
  2. a) moral hazard.
  3. b) conservative accounting.
  4. c) adverse selection.
  5. d) an inefficient marketplace.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Financial Reporting

CPA: Professional & Ethical Behaviour

Bloomcode: Knowledge

 

 

  1. The “efficient markets hypothesis” proposes that
  2. a) market prices reflect information known only to internal stakeholders.
  3. b) market prices reflect all information about a company.
  4. c) market prices reflect information known only to external stakeholders.
  5. d) information asymmetry is required.

 

Answer: b

 

Difficulty: Easy

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Finance

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following does NOT describe a cause of management bias?
  2. a) the need to comply with contracts, such as debt covenants
  3. b) the desire to meet financial analysts’ expectations
  4. c) the tendency to downplay negative events
  5. d) the desire for all stakeholders to have access to all information

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Audit & Assurance

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Where people think that no one is watching, they will often shirk their responsibilities. This is known as
  2. a) moral hazard.
  3. b) conservative accounting.
  4. c) adverse selection.
  5. d) an inefficient marketplace.

 

Answer: a

 

Difficulty: Easy

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Conservative accounting refers to
  2. a) a manager’s tendency to shirk his stewardship responsibilities.
  3. b) a manager’s engagement in greater risk taking.
  4. c) a decision to downplay the negative and focus on the positive.
  5. d) a decision to downplay the positive and focus on the negative.

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

Feedback: a, b, & c describe aggressive accounting.

 

 

  1. The problem of information asymmetry can be reduced by
  2. a) aggressive accounting.
  3. b) accounting standards.
  4. c) adverse selection.
  5. d) only focusing on positive events.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. Which of the following sources of generally accepted accounting principles (GAAP) are NOT developed by the Canadian Accounting Standards Board (AcSB)?
  2. a) Accounting Standards for Private Enterprises (ASPE)
  3. b) International Financial Reporting Standards (IFRS)
  4. c) GAAP for Pension Plans
  5. d) GAAP for Not-for-Profit entities

 

Answer: b

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Before 1900, which of the following accurately describes financial reports?
  2. a) They emphasized the need for standardized and increased corporate disclosures.
  3. b) They were for widespread use and distribution.
  4. c) They emphasized solvency and liquidity.
  5. d) None of the above accurately describe financial reports pre-1900.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. As of 2011, the responsibilities of the Accounting Standards Board (AcSB) in Canada relate to setting standards for
  2. a) publicly accountable entities only.
  3. b) both publicly accountable entities and private enterprises.
  4. c) private enterprises, not-for-profit entities and pension plans.
  5. d) not-for-profit entities and pension plans only.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Audit & Assurance

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. In Canada, the body that has the responsibility of overseeing the Accounting Standards Board (AcSB) is the
  2. a) Accounting Standards Oversight Council (AcSOC).
  3. b) International Accounting Standards Board (IASB).
  4. c) Canadian Institute of Chartered Accountants (CICA).
  5. d) Financial Accounting Standards Board (FASB).

 

Answer: a

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. In the United States, the body that has the final authority over accounting standards is the
  2. a) Financial Accounting Standards Board (FASB).
  3. b) International Accounting Standards Board (IASB).
  4. c) Securities Exchange Commission (SEC).
  5. d) Accounting Standards Oversight Council (AcSOC).

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. In Canada, the body which is NOT instrumental in the development of financial reporting standards is the
  2. a) Accounting Standards Board (AcSB).
  3. b) Financial Accounting Standards Board (FASB).
  4. c) International Accounting Standards Board (IASB).
  5. d) American Institute of Certified Public Accountants.

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The adoption of International Financial Reporting Standards in Canada is an example of
  2. a) the impact of technology on user’s needs.
  3. b) the impact of globalization on capital markets.
  4. c) ethical behaviour.
  5. d) the desire of most private companies to expand internationally.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following statements does NOT describe the activities and authority of the Ontario Securities Commission (OSC)?
  2. a) The OSC reviews and monitors the financial statements of companies whose shares are listed on the Toronto Stock Exchange.
  3. b) The OSC issues its own disclosure requirements for listed companies.
  4. c) The OSC has the ability to fine or delist companies.
  5. d) The OSC issues financial accounting standards for Canadian companies.

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following does NOT support the use of Accounting Standards for Private Enterprises (ASPE)?
  2. a) Private enterprises usually have less complex business models.
  3. b) Private enterprises that are “going public.”
  4. c) Private enterprises usually have fewer users.
  5. d) Private enterprises’ financial statement users tend to have first-hand information.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following does NOT describe a step in the IASB’s standard setting process?
  2. a) appointing trustees to the IFRS Foundation
  3. b) development of an exposure draft
  4. c) provision of strategic advice by the IFRS Advisory Council
  5. d) public consultation

 

Answer: a

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Under ASPE, the primary sources of GAAP include
  2. a) accounting textbooks and journals.
  3. b) International Financial Reporting Standards.
  4. c) the CICA Handbook and appendices.
  5. d) research studies.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Under ASPE, the other (as opposed to primary) sources of GAAP include
  2. a) the CICA Handbook and appendices.
  3. b) Accounting Guidelines, including appendices.
  4. c) pronouncements by accounting standard-setting bodes in other jurisdictions.
  5. d) All of these are primary sources of GAAP.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying GAAP.

Section Reference: Generally Accepted Accounting Principles

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The exercise of professional judgement does NOT involve
  2. a) the use of knowledge gained through education.
  3. b) the application of knowledge gained through experience.
  4. c) the use of ethical decision making.
  5. d) aggressive accounting.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying GAAP.

Section Reference: Generally Accepted Accounting Principles

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. In a rules-based approach (such as U.S. GAAP), compared to a principles-based approach (such as Canadian GAAP),
  2. a) the body of knowledge is smaller.
  3. b) the importance of communicating the best information to users is emphasized.
  4. c) since it is more prescriptive, it may be easier to defend how to account for a particular item.
  5. d) companies frequently do not interpret the rules literally.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying GAAP.

Section Reference: Generally Accepted Accounting Principles

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. In a principles-based standard-setting system (such as Canadian GAAP), compared to a rules-based approach (such as U.S. GAAP),
  2. a) since it is more prescriptive, it may be easier to defend how to account for a particular item.
  3. b) there is a rule for every situation.
  4. c) accountants either apply specific standards based on the conceptual framework, or, professional judgement consistent with the framework.
  5. d) it is expected that professional accountants might encounter situations where they are unable to apply the principles appropriately.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying GAAP.

Section Reference: Generally Accepted Accounting Principles

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The Sarbanes-Oxley Act (SOX) was NOT enacted to
  2. a) help prevent fraud and poor financial reporting practices.
  3. b) ensure the act was applied internationally.
  4. c) enable the SEC to increase its policing efforts.
  5. d) introduce new independence rules for auditors.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following is likely to be an advantage of the advancement of technology on financial reporting?
  2. a) Users of financial information will have access to more information.
  3. b) The quality and reliability of the information may be compromised.
  4. c) Equal and fair access may be at issue.
  5. d) Internet reporting will increase costs.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. One political factor influencing the standard setting process is how the standard-setting bodies are financed. Which of the following is NOT an IASB principle regarding the nature and amount of funding?
  2. a) Closed-loop: Financial commitments for funding should be contingent upon particular outcomes.
  3. b) Broad-based: It should not rely on one or a few sources.
  4. c) Compelling: Constituents should not be allowed to benefit from the standards without contributing to the process of standard setting.
  5. d) Country-specific: Funding should be shared by the major economies on a proportionate basis.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Financial Reporting

Bloomcode: Knowledge

Feedback: Funding must be open-ended.

 

 

  1. Which of the following is an argument in favour of a GAAP body of knowledge that is more prescriptive, or rules-based?
  2. a) It always emphasizes communicating the best information for users.
  3. b) The body of knowledge becomes significantly smaller and therefore easier to manage.
  4. c) It may be easier to defend how to account for a particular item.
  5. d) There is a tendency for companies to interpret guidelines loosely, and thus account for items inconsistently.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Exercises

 

 

Ex. 1-45 Effective capital allocation

Explain the advantages of an effective capital allocation process.

 

Solution 1-45

An effective capital allocation process encourages innovation, promotes productivity, and            provides a platform for buying and selling securities and obtaining and granting credit.

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Communication

CPA: Management Accounting

Bloomcode: Knowledge

 

 

Ex 1-46 Financial statements in practice and theory

What are the four most frequently provided financial statements? Provide two terminologies used to refer to each statement.

 

Solution 1-46

  1. Statement of financial position/Balance sheet
  2. Statement of income/comprehensive income/Income statement/ Profit & loss statement
  3. Statement of cash flows/ Cash flow statement
  4. Statement of changes in equity/ Statement of retained earnings

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-47 Stakeholders in the financial reporting environment

Briefly describe the much-publicized subprime lending crisis in the United States, and identify the stakeholders and how they were affected.

 

Solution 1-47

At the centre of this issue were securitized mortgage assets that were sold to investors. These assets were based on mortgages that had been extended to high-risk borrowers who could no longer afford their mortgage payments once interest rates rose. This led to a flooding of the housing market as borrowers walked away from their houses (and debt). The primary stakeholders were the lenders, borrowers and investors. Lenders (acting in their own self-interest) sold these investments to investors who may not have fully understood the high-risk nature of their investment. Borrowers lost their homes they could no longer afford, and investors suffered large losses due to the defaulted loans.

 

Difficulty: Medium

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Communication

CPA: Finance

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-48 Sources of capital and stages of company growth

Briefly describe how the sources of capital a company relies upon for funding might vary according to their stage of growth.

 

Solution 1-48

As per Illustration 1-2, in the early project/idea stages a company will acquire its initial capital from founders, family, and friends. As they progress to the research & development or prototype stage, private and public venture capital may be introduced, and includes capital provided by angel investors, venture capitalists, and public exchanges such as the TSX Venture Exchange or TSX. Venture capitalists and these public exchanges become the dominant capital sources as greater amounts of capital are required and as a company progresses through commercialization and into stable production.

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Communication

CPA: Finance

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-49 Objectives of financial reporting

What are the objectives of financial reporting by business enterprises?

 

Solution 1-49

The objectives of financial reporting are to provide information

  1. that is useful to investors, members, contributors, creditors and other users in making their resource allocation decisions and/or assessing management stewardship.
  2. to help users in evaluating an entity’s economic resources, obligations and equity/net assets and the changes to these items.
  3. to help users evaluate the economic performance of an entity.

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex 1-50 Traditional users vs. others

Beyond users relying directly on financial information for resource allocation, such as investors and creditor, identify at least two categories of stakeholders included in the broader definition of users who help in the efficient allocation of resources. For each category, indicate what is at stake.

 

Solution 1-50

Refer to Illustration 1-4.

Stakeholder What is at Stake
Securities commissions and stock exchanges Reputation, effective and efficient capital marketplace
Analysts and credit rating agencies Reputation, profits
Auditors Reputation, profits (companies and their clients)
Standard setters Reputation

 

Difficulty: Medium

Learning Objective: Explain the meaning of “stakeholder” and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Communication

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-51 Imperfection of the stakeholder ecosystem

The stakeholder ecosystem (depicted in Illustration 1-3) provides checks and balances to ensure that the people with capital—investors and creditors—have good information to use when deciding where best to invest and allocate capital. The system does not always work, however. Explain why this is the case.

 

Solution 1-51

The stakeholder ecosystem does not always provide perfect information for people with capital because it involves people, and human behaviour is an unpredictable variable. People often act in their own self-interest rather than in the best interest of the capital marketplace, and by extension, the economy.

 

Difficulty: Medium

Learning Objective: Explain the meaning of “stakeholder” and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Communication

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-52 Entity vs. proprietary perspective

Explain the difference between the entity perspective and the proprietary perspective.

 

Solution 1-52

The entity perspective views companies as separate and distinct from their owners. e.g., corporate assets are viewed as assets of the company and not of a specific creditor or shareholder. Investors and creditors have liability or equity claims. On the other hand, the proprietary perspective holds that financial reporting should focus only on the needs of the shareholders, and is not considered appropriate. The entity perspective is adopted as part of the objective of general-purpose financial reporting.

 

Difficulty: Easy

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-53 User needs

Explain why providing information to users is a challenging task.

 

Solution 1-53

First, users have very different knowledge levels. Some users have accounting designations or have worked in the finance industry for several years. Others have limited knowledge of how the information is gathered and reported. Secondly, users have very different needs. Some users are institutional investors who hold a large percentage of equity shareholdings and generally devote significant resources to managing their investment portfolios. Others are credit managers at banks or credit unions who deal mainly with small business or personal loans. Still others are labour negotiators whose knowledge of financial reporting is limited to periodic reviews of financial information for the purpose of negotiations.

 

Difficulty: Easy

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-54 The decision-usefulness approach to financial reporting

Explain what is meant by the “decision-usefulness” approach to financial reporting. Who will this information be useful to, and why?

 

Solution 1-54

The decision-usefulness approach to financial reporting dictates that financial statements provide information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers. It may also be useful to those who are not providers of capital such as analysts, regulators, and competitors.

 

Difficulty: Easy

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-55 Merits of accrual- vs. cash-basis accounting

Investors are interested in assessing a company’s ability to generate net cash inflows, as well as its ability to protect and enhance capital investments. Briefly explain how each of the accrual- and cash-basis methods, respectively, might enhance these objectives.

 

Solution 1-55

Cash-basis accounting provides better information for assessing timing and amounts of cash flows, which assist with objective 1. Objective 2, concerning long-term performance of the company, may be better served by accrual-based accounting, which generally provides better information about future ability to generate favourable cash flows. It also ties operations to events and the surrounding environment, which are better indicators of performance, and the company’s ability to continue operating as a going concern.

 

Difficulty: Medium

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Communication

CPA: Financial Reporting

CPA: Management Accounting

Bloomcode: Knowledge

 

 

Ex. 1-56 Information asymmetry

In markets where information asymmetry exists, there can be adverse selection and moral hazard. Explain what these terms mean.

 

Solution 1-56

Adverse selection refers to hidden knowledge, where the capital marketplace may attract the wrong type of company, such as companies who have the most to gain from not disclosing information. Given this situation, companies who do fully disclose all information may choose not to enter the marketplace if they are aware of the presence of adverse selection.

Moral hazard refers to hidden actions, and occurs as a result of human nature. People or companies may shirk their responsibilities if they think they can get away with it, e.g., not disclose negative information since they know it may be detrimental to their share price. This is a form of management bias.

 

Difficulty: Medium

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Communication

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-57 Maintaining competitive advantage

In the most efficient and effective marketplace possible, all stakeholders would have equal access to all relevant information. However, a company may feel that complete disclosure may hurt their competitive advantage or position. Offer an example of a circumstance where this may be the case. What do you think the company should do?

 

Solution 1-57

An example where disclosure may hurt the company’s competitive advantage or position would be a legal battle. If the company were in the middle of a lawsuit, the company would want to be careful about how much information was disclosed because it might affect the outcome of the lawsuit. This is an ethical dilemma. The company must weigh the costs and benefits of sharing information. If the financial impact of the lawsuit is expected to be material, they should, at minimum, disclose its existence in the notes to the financial statements. If amount and timing of any financial impact are sufficiently known and certain, an accrual of these amounts may be necessary.

 

Difficulty: Medium

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Communication

CPA: Professional & Ethical Behaviour

CPA: Strategy & Governance

Bloomcode: Knowledge

Bloomcode: Evaluation

 

 

Ex. 1-58 Management bias in financial statement presentation

There are many reasons why management may present biased information in the financial statements. Identify at least three (3) such motivations.

 

Solution 1-58

Refer to Illustration 1-5. Possible motivations include:

  • evaluation of management performance
  • compensation structures
  • access to capital markets and meeting financial analyst expectations
  • contractual obligations

 

Difficulty: Easy

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Communication

CPA: Professional & Ethical Behaviour

CPA: Strategy & Governance

Bloomcode: Knowledge

Bloomcode: Evaluation

 

 

Ex. 1-59 Role of securities commissions and stock exchanges

Explain the role of securities commissions and stock exchanges in financial reporting.

 

Solution 1-59

The securities commissions and stock exchanges monitor the financial statements of companies whose shares are publicly traded to ensure that they provide full and plain disclosure of material information, and to ensure that the companies may continue to list shares on the stock exchanges. Securities commissions oversee and monitor the capital marketplace.

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Communication

CPA: Management Accounting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-60 Standard setting

Explain the relationship between Canadian GAAP and International Financial Reporting Standards (IFRS).

 

Solution 1-60

Since the decision to adopt IFRS was made, Canadian GAAP has been continuously adjusted (converged) to mirror IFRS. Even prior to that convergence, both standards were principles based (rather than rules based).

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Communication

CPA: Management Accounting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-61 Purpose of accounting standards

Accounting professions in various countries have tried to develop a set of standards that are generally accepted and universally practised. Explain the motivation for creating such a set of standards.

 

Solution 1-61

Creating standards facilitates comparability across companies and periods. Without standards, each enterprise would develop its own standards, and readers of financial statement would have to become familiar with every company’s particular accounting and reporting practices. It would be almost impossible to prepare statements that could be compared.

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-62 ASPE vs. IFRS

Accounting standards for Private Enterprises (ASPE) are geared towards fewer users who have access to additional information about the company. The need for common language and comparability as facilitated by IFRS less necessary among private enterprises. Explain why, despite this, a private company might choose to voluntarily adopt IFRS.

 

Solution 1-62

A private company that is looking to go public might find it easier to follow IFRS right from the beginning. Other motivations might include specific requests from users, or ease of adoption if the small enterprise if a subsidiary of a larger company with IFRS reporting already in place.

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-63 Sources of GAAP

International Financial Reporting Standards (IFRS) are the primary source of GAAP for public enterprises in Canada. They are, however, insufficient to address all of the accounting issues facing accountants. Explain why this is so and outline some other sources of GAAP that accountants use.

 

Solution 1-63

Although IFRS outline the specific accounting treatment for a multitude of items, for some items the guidelines are very general. Also, the business environment is complex and constantly changing and, therefore, some items may not be discussed at all. Thus, accountants must use IFRS in conjunction with other sources like professional judgement, pronouncements of other standard-setting bodies, accounting literature, and accepted industry practices.

 

Difficulty: Easy

Learning Objective: Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying GAAP.

Section Reference: Generally Accepted Accounting Principles

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-64 Sources of GAAP

The Canadian Principles-based GAAP does not offer specific standards for every transition. When specific guidance cannot be found in primary sources such as the Handbook and Accounting guidelines, what process should the accountant follow in their consultation of other sources?

 

Solution 1-64

If primary sources do not deal with the specific issue, the entity should use accounting policies that are consistent with primary sources. The policies should be developed through use of professional judgement in accordance with the conceptual framework. The accountant might consider pronouncements of other standard setters, accepted industry practices, and other literature, with the goal of producing information which is as relevant and reliable.

 

Difficulty: Medium

Learning Objective: Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying GAAP.

Section Reference: Generally Accepted Accounting Principles

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-65 Professional judgement

Explain the principle of professional judgement. When or why might it be necessary to employ professional judgement, even in a rules-based system?

 

Solution 1-65

Professional judgement is the process by which professional accountants with significant education and experience apply general principles appropriately as they see fit. This is important in Canada because IFRS and ASPE are based primarily on general principles rather than on specific rules. It may also be useful in a rules-based system, as novel circumstances and transactions are bound to arise for which a rule does not yet exist. In these scenarios, the professional accountant must make use of professional judgement to decide which treatment/record-keeping approach to a transaction will provide the most relevant, reliable, and timely information to financial statement stakeholders.

 

Difficulty: Medium

Learning Objective: Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying GAAP.

Section Reference: Generally Accepted Accounting Principles

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-66 SOX and standard setting

After several highly-publicized accounting scandals in the U.S. such as Enron, Sunbeam, and WorldCom, all of whom, coincidentally, were clients of the now basically defunct public accounting firm of Arthur Andersen, the U.S. regulators enacted the Sarbanes-Oxley Act (SOX). Pressure was put on Canada to follow a similar course. Explain what Canada has done to make public companies more accountable.

 

Solution 1-66

First, the Canadian Public Accountability Board (CPAB) was created to supervise accounting issues similar to those addressed by SOX. These included establishing auditing, quality control and independence standards and rules.

The Canadian Securities Administrators (CSA) has issued guidelines/rules that require (among other things)

  1. company management to take responsibility for the appropriateness and fairness of the financial statements
  2. public enterprises to have independent audit committees
  3. management to report on the effectiveness of their internal controls
  4. public accounting firms to be subject to CPAB
  5. greater disclosures, such as ratings from rating agencies, legal proceedings, payments to stock promoters, details about corporate directors.

 

Difficulty: Easy

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-67 Challenges facing financial reporting

In North America, the financial reporting environment is changing at a very rapid pace. Briefly describe four challenges facing the accounting profession today.

 

Solution 1-67
  1. Oversight in the capital marketplace. The Sarbanes-Oxley Act (SOX) instituted the Public Company Accounting Oversight Board (PCAOB), stronger independence rules for auditors, reporting on the effectiveness of the financial reporting internal control system, and disclosure of a code of ethics for senior financial officers.

Canada has followed suit and developed the Canadian Public Accountability Board (CPAB). As well, the Canadian Securities Administrators (CSA) requires company management to take responsibility for the appropriateness and fairness of the financial statements, public companies to have independent audit committees, and public accounting firms to be subject to the CPAB. The CSA also requires much greater disclosures. The overall impact of these financial reforms has been to put more emphasis on government regulation and less on self-regulation.

  1. Centrality of ethics. Accountants are central in making the capital marketplace efficient and effective. However, ethical dilemmas are common, often precipitated by management bias. It is not always easy to “do the right thing.” Pressure to bend the rules, play the game or “just ignore it” are often there. There is no consensus (yet) among accounting professionals as to what a comprehensive ethical system is, and so it is up to the individual accountant to maintain a high standard of ethics at all times.
  2. Standard setting in a political environment. Since standard setting is part of the real world, accounting standards often arise from political action. The stakeholders who lobby the hardest may unduly influence new or revised accounting standards. This is not surprising since many accounting standards have economic consequences. Thus standard setters such as the IASB must consider the needs of all stakeholders when creating or changing standards. The challenge is to find a balance between letting stakeholders have a say while not bowing to undue political pressure.
  3. Principles vs. rules. Rules-based, prescriptive systems (such as U.S. GAAP or the Canadian income tax system) have a significantly larger body of knowledge than a principles-based approach such as IFRS and ASPE. However, there is a tendency to interpret the rules literally with a rules-based approach, possibly because it may be easier to defend the accounting for a particular item. A disadvantage of the rules-based approach is that it may not always communicate the best information to the user. The principles-based approaches are based on professional judgement, resulting in carefully reasoned application of the principle to the business facts. Since the body of knowledge is smaller with principles-based approaches, the standard setters must ensure it rests on a cohesive set of principles and conceptual framework, which is sufficiently flexible, and sufficiently detailed to provide good guidance.

Other challenges are the impact of technology and integrated reporting.

 

Difficulty: Medium

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Communication

CPA: Financial Accounting

CPA: Management Accounting

CPA: Professional & Ethical Behaviour

Bloomcode: Knowledge

 

 

Ex. 1-68 Role of executives and management in a post-SOX world

SOX introduced sweeping changes to the institutional structure of the accounting profession. What key provision was introduced relating to the role of management and executive officers, and their relationship to financial reporting? Why?

 

Solution 1-68

Chief executive officers (CEOs) and chief financial officers (CFOs) are required to certify that the financial statements and company disclosures are appropriate and fairly presented. In many cases, they must forfeit bonuses and profits if there is a restatement of their companies’ accounting disclosures. Management must report on the effectiveness of financial reporting internal control systems. Requiring management and executives to make these attestations holds them accountable, and creates a greater sense of ownership over the financial statements. When this is done, management and executives are unable to claim ignorance if intentional misrepresentations or frauds present in the financial reports are uncovered, as many were in the pre-SOX era.

 

Difficulty: Easy

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Audit & Assurance

CPA: Communication

CPA: Financial Reporting

CPA: Professional & Ethical Behaviour

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-69 Technology and financial information

Explain how technology impacts the accountants’ role as providers of information.

 

Solution 1-69

Technology impacts the process of identifying, measuring, and communicating useful information to users in profound ways. Information is increasingly abundant and available through technology. Companies are required to file disclosures electronically through securities commissions. Investors have access to a greater abundance of information as well. This includes earnings calls, analyst briefings, interviews with management and regulators and much, much more. The Internet allows disclosure of and access to a much larger group of users while reducing the cost of said communication. As technology advances as a rapid pace, information may even be available in real time. This raises the concern of equal access to information, as exposes companies to additional risks as they pertain to information security.

 

Difficulty: Medium

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Audit & Assurance

CPA: Communication

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Evaluation

Bloomcode: Knowledge

 

 

 

Legal Notice

 

 

 

Copyright © 2016 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

 

 

The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence.

 

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

CHAPTER 3

 

THE ACCOUNTING INFORMATION SYSTEM & MEASUREMENT ISSUES

 

CHAPTER LEARNING OBJECTIVES

 

 

  1. Understand basic accounting terminology and explain double-entry rules. It is important to understand the following terms: (1) event, (2) transaction, (3) account, (4) permanent and temporary accounts, (5) ledger, (6) journal, (7) posting, (8) trial balance, (9) adjusting entries, (10) financial statements, (11) closing entries, and (12) reversing entries.

The left side of any account is the debit side; the right side is the credit side. All asset and expense accounts are increased on the left or debit side and decreased on the right or credit side. Conversely, all liability and revenue accounts are increased on the right or credit side and decreased on the left or debit side. Shareholders’ equity accounts, Common Stock, and Retained Earnings are increased on the credit side, whereas Dividends is increased on the debit side.

 

 

  1. Explain how transactions affect the accounting equation. In a double-entry accounting system, for every debit there must be a credit, and vice versa. This leads us to the basic accounting equation for corporations: Assets = Liabilities + Shareholders’ Equity. The effect of individual transactions on the statement of financial position can be explained using the basic accounting equation. The shareholders’ equity portion of the equation can also be expanded to illustrate the effect of transactions on components of equity such as common shares and retained earnings. Whenever a transaction occurs, the elements of the equation change, but the equality of the two sides of the equation remains unaffected.

 

 

  1. 3. Identify the steps in the accounting cycle and the steps in the recording process. The basic steps in the accounting cycle are (1) identification and measurement of transactions and other events, (2) journalizing, (3) posting, (4) the unadjusted trial balance, (5) adjustments, (6) the adjusted trial balance, (7) statement preparation, and (8) closing. The first three steps in the accounting cycle form the basis of the recording process used by most medium-sized companies on a daily basis. The simplest journal form is a chronological listing of transactions and events that are expressed as debits and credits to particular accounts. The items entered in a general journal must then be transferred (posted) to the general ledger.

To help prepare financial statements, an unadjusted trial balance should be prepared at the end of a specific period (usually a month, quarter, or year) after the entries have been recorded in the journals and posted to the general ledger.

 

 

  1. Explain the reasons for and prepare adjusting entries. Adjustments achieve a proper matching of revenues and expenses, which is needed to determine the correct net income for the current period and to achieve an accurate statement of the end-of-the-period balances in assets, liabilities, and owners’ equity accounts. When preparing adjusting journal entries, you must first determine how the original transaction was recorded. For example, was an asset created earlier in the fiscal year (such as prepaid rent) when the initial payment was made? If so, an adjustment for the related expense is required. Alternatively, if a statement of comprehensive income account was used initially, an adjustment may be required to set up the proper statement of financial position account at the end of the period.

 

 

  1. 5. Explain how the type of ownership structure affects the financial statements. The type of ownership structure that a business enterprise uses determines the types of accounts that are part of the equity section. In a corporation, ordinary or common shares, contributed surplus, retained earnings, and accumulated other comprehensive income are commonly shown separately on the statement of financial position. In a proprietorship or partnership, a capital account is used to indicate the investment in the company by the owner(s). A drawings or withdrawal account may be used to indicate withdrawals by the owner(s). These two accounts are grouped or netted under owners’ equity.

 

 

  1. Prepare closing entries and consider other matters relating to the closing process. In the closing process, all of the revenue and expense account balances (income statement items) are transferred to a clearing account called Income Summary, which is used only at the end of the fiscal year. Revenues and expenses are matched in the Income Summary account. The net result of this matching, which represents the net income or net loss for the period, is then transferred to a shareholders’ equity account (Retained Earnings for a corporation and capital accounts for proprietorships and partnerships). Reversing entries may be used for reversing accrued revenues and accrued expenses. Prepayments may also be reversed if the initial entry to record the transaction is made to an expense or revenue account.

 

 

  1. Use valuation techniques to measure financial statement elements. IFRS and ASPE incorporate a mixed-attribute measurement model including measurements that are cost-based (such as historical cost), those that are based on current value (such as fair value), and many hybrid measures that have attributes of both cost-based and current value measurements. Valuation techniques are used to help with measurement of financial statement elements. Common examples include market models and income models. Income models are widely used and include discounted cash flow methods and present value concepts. When using models, you must determine what inputs should be used. Common inputs include discount rates and cash flow estimates. The quality of these inputs affects the quality of the final measurement. Accountants often use probabilities to help deal with risk and uncertainty.

 

 

  1. Use IFRS 13 to measure fair value. IFRS 13 establishes a fairly detailed body of knowledge relating to measurement of fair value. Fair value measurement under IFRS 13 is a market-based approach that incorporates the specific attributes of the asset/liability being measured, the valuation premise (how the asset/liability is to be used), the principal market, and the valuation technique. Since market prices are not always available, valuation models are used to measure the value. Inputs to these models are either observable in the market or not. Observable inputs are most useful since they are more objective. The fair value hierarchy establishes three levels of inputs, with level 1 being the highest and best type of input (based on observable market prices). Because level 3 inputs are more subjective, additional disclosures are required.

 

 

  1. Identify differences in accounting between ASPE and IFRS, and what changes are expected in the near future. The main difference is that IFRS contains specific guidance

in IFRS 13 regarding fair value measurements. Under ASPE, guidance is spread throughout the body of knowledge and is less detailed.

 

 

  1. Prepare a 10-column work sheet and financial statements (Appendix 3A). The 10-column work sheet provides columns for the first trial balance, adjustments, adjusted trial balance, statement of comprehensive income, and statement of financial position. The work sheet does not replace the financial statements. Instead, it is the accountant’s informal device for accumulating and sorting the information that is needed for the financial statements.

 

 

  1. Understand and apply present value concepts (Appendix 3B). Present value concepts are used to acknowledge the time value of money. There are various techniques and tools to calculate present value, including formulas, tables, financial calculators, and spreadsheets. Inputs to the calculation include interest, payments, number of periods, and if the calculation involves an annuity, information about whether it is an ordinary annuity or an annuity due. Present value concepts are frequently used in measuring financial statement elements.

 

Multiple Choice QUESTIONS—Conceptual

 

Answer           No.      Description

d                 1.       Purpose of an accounting system

b                 2.       Definition of transaction

d                 3.       Purpose of an accounting system

b                 4.       Identification of a temporary account

d                 5.       Accounting equation

a                 6.       Accounting equation

a                 7.       Criteria for recording transactions

c                 8.       Internal event

b                 9.       Definition of journal

c               10.       Impact of transaction on the accounting equation

d               11.       Transaction analysis

c               12.       Transaction analysis

c               13.       Event recording

c               14.       Double-Entry Accounting System

c               15.       Event recording

b               16.       Trial balance

d               17.       Trial balance

c               18.       Trial balance

d               19.       Uses of adjusting entries

c               20.       Adjusting for accrued expenses

d               21.       Adjusting for accrued revenues

d               22.       Adjusting entries

c               23.       Factors to consider in estimating depreciation

b               24.       Contra-asset account

a               25.       Effect of not recording depreciation

c               26.       Adjusting for bad debts

c               27.       Definition of accrued revenue

b               28.       Closing process

c               29.       Closing process

c               30.       Balance Sheet

c               31.       Closing process

b               32.       Definition of unearned revenue

c               33.       Closing process

a               34.       Fair value adjustments for investments

d               35.       Closing process

c               36.       Closing net income or loss

b               37.       Post-closing trial balance

a               38.       Trial balance – correct statement

a               39.       Effect of understating ending inventory

a               40.       Discounted Cash Flow approach

a               41.       Fair value measurement under IFRS 13

d               42.       Fair value measurement under IFRS 13

c               43.       Differences in accounting between ASPE and IFRS

a               44.       Differences in accounting between ASPE and IFRS

Multiple Choice QUESTIONS—Computational

 

Answer            No.     Description

c               45.       Adjusting entry for prepaid lease

a               46.       Adjusting entry for interest receivable

c               47.       Adjusting entry for interest expense

d               48.       Adjusting entry for bad debts

b               49.       Adjusting entry for bad debts

b               50.       Adjusting entry for unearned rent

c               51.       Adjusting entry for interest receivable

d               52.       Calculate property tax adjustment

c               53.       Calculate balance in unearned revenue

c               54.       Adjusting entry for investments

d               55.       Adjusting entry for investments

c               56.       Calculate cash received for interest

a               57.       Calculate cash paid for salaries

c               58.       Calculate cash paid for insurance

c               59.       Calculate insurance expense

a               60.       Calculate interest revenue

b               61.       Calculate salary expense

c               62.       Valuation of entity-specific asset

c               63.       Calculate accrued interest payable

c               64.       Calculate balance of unearned revenues

b               65.       Calculate prepaid insurance

c               66.       Calculate interest receivable

c               67.       Calculate accrued salaries

c               68.       Calculate royalty revenue

c               69.       Closing entry

b              *70.       Calculate present value

a              *71.       Calculate present value

 

*This topic is dealt with in an Appendix to the chapter.

 

Exercises

 

   Item              Description

E3-72            Definitions

E3-73            The accounting cycle

E3-74            Adjusting entries

E3-75            Recordable events

E3-76            Adjusting entries

E3-77            Calculation of expense

E3-78            Adjusting and Closing Entries

E3-79            Valuation of Equipment under IFRS 13

E3-80            Calculation of expense

E3-81            Calculation of revenue

E3-82            Type of ownership structure

E3-83            Valuation of Entity-Specific assets

E3-84            Measurement of financial statement elements

E3-85            Transaction journal entries

E3-86            Adjusting entries

*E3-87            Calculate market price of a bond

*E3-88            Present value of an annuity due

 

 

PROBLEMS

 

   Item              Description

P3-89            Adjusting entries and calculation of pre-tax income

P3-90            Adjusting entries

P3-91            Adjusting and closing entries

P3-92            Closing entries

P3-93            Accrual accounting

P3-94            Accrual accounting

*P3-95            Adjusting entries

P3-96            Trial balance correction

P3-97            Accrual accounting

P3-98            Ten-column work sheet

*P3-99            Preparation of financial statements

 

*This topic is dealt with in an Appendix to the chapter.

MULTIPLE CHOICE – Conceptual

 

 

  1. Which of the following statements is true regarding accounting information systems?
  2. a) Both large and small firms should use the same type of accounting system.
  3. b) All firms should have the same types of transactions.
  4. c) The volume of data to be handled should not vary between firms.
  5. d) The kind of information that management requires of an accounting system will vary, depending on the type of firm.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Understand basic accounting terminology and explain double-entry rules.

Section Reference: Basic Terminology and Double-Entry Rules

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. An external event involving a transfer or exchange between two or more entities or parties is called a(n)
  2. a) account.
  3. b) transaction.
  4. c) ledger.
  5. d) accounting system.

 

Answer: b

 

Difficulty: Easy

Learning Objective: Understand basic accounting terminology and explain double-entry rules.

Section Reference: Basic Terminology and Double-Entry Rules

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. Factors that shape an accounting system include the
  2. a) nature of the business.
  3. b) size of the firm.
  4. c) volume of data to be handled.
  5. d) All of these answer choices are correct.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Understand basic accounting terminology and explain double-entry rules.

Section Reference: Basic Terminology and Double-Entry Rules

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. An example of a temporary account is
  2. a) Unearned Revenue.
  3. b) Salary Expense.
  4. c) Inventory.
  5. d) Retained Earnings.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Understand basic accounting terminology and explain double-entry rules.

Section Reference: Basic Terminology and Double-Entry Rules

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. Which of the following equations is correct?
  2. a) Assets plus Liabilities = Equity.
  3. b) Assets = Liabilities minus Equity.
  4. c) Liabilities = Assets plus Equity.
  5. d) Equity = Assets minus Liabilities.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain how transactions affect the accounting equation.

Section Reference: Accounting Equation

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. The accounting equation must remain in balance
  2. a) throughout each step in the accounting cycle.
  3. b) only when journal entries are recorded.
  4. c) only at the time the trial balance is prepared.
  5. d) only when formal financial statements are prepared.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Explain how transactions affect the accounting equation.

Section Reference: Accounting Equation

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. Which of the following criteria does NOT have to be met before an event or transaction should be recorded for accounting purposes?
  2. a) The event or transaction must be an external event.
  3. b) The event or transaction can be measured objectively in financial terms.
  4. c) The event or transaction is relevant and reliable.
  5. d) The event or transaction must meet the definition of an element.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Explain how transactions affect the accounting equation.

Section Reference: Accounting Equation

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. Which of the following is an internal event?
  2. a) sale of goods or services
  3. b) payment of dividends
  4. c) using raw materials in production
  5. d) purchase of materials

 

Answer: c

 

Difficulty: Medium

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The book of original entry where transactions and other selected events are first recorded is called the
  2. a) ledger.
  3. b) journal.
  4. c) account.
  5. d) statement of financial position.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The debit and credit analysis of a transaction normally takes place
  2. a) before an entry is recorded in a journal.
  3. b) when the entry is posted to the ledger.
  4. c) when the trial balance is prepared.
  5. d) when the financial statements are prepared.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Performing a service for a client on account will
  2. a) increase one asset and decrease another asset.
  3. b) decrease an asset and decrease a liability.
  4. c) increase an asset and decrease equity.
  5. d) increase an asset and increase equity.

 

Answer: d

 

Difficulty: Medium

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The account credited for a receipt of cash on account is
  2. a) Cash.
  3. b) Service Revenue.
  4. c) Accounts Receivable.
  5. d) Accounts Payable.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Some events are NOT recorded in the accounting information system because
  2. a) the service has been provided but the cash has not yet been received.
  3. b) the service has not been provided but the cash has already been received.
  4. c) their measurement is too complex.
  5. d) the amounts are not material.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The double-entry accounting system means
  2. a) each transaction is recorded with two journal entries.
  3. b) each item is recorded in a journal entry, then in a general ledger account.
  4. c) the dual effect of each transaction is recorded with debits and credits of equal amount.
  5. d) None of these answer choices is correct.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following criteria must be met before an event or item should be recorded for accounting purposes?
  2. a) The event or item can be measured objectively in financial terms.
  3. b) The event or item is relevant and reliable.
  4. c) The event or item is an element.
  5. d) All of these must be met.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. A trial balance
  2. a) is a list of all the accounts in the ledger.
  3. b) is a list of all the accounts and their balances at a specific date.
  4. c) cannot be used in the preparation of financial statements.
  5. d) cannot be used as a basis for preparation of adjusting entries.

 

Answer: b

 

Difficulty: Easy

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. A trial balance will NOT balance if
  2. a) an amount is posted to the wrong account.
  3. b) a transaction has been entered twice.
  4. c) a transaction has been omitted.
  5. d) only the debit side of a journal entry has been posted.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The main purpose of a trial balance is
  2. a) to serve as a basic internal control.
  3. b) to assist in preparation of the financial statements.
  4. c) to prove the mathematical equity of debits and credits after posting.
  5. d) to uncover errors in journalizing and posting.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Adjusting entries are necessary to
  2. obtain a proper matching of revenue and expense.
  3. achieve an accurate statement of assets and equities.
  4. adjust assets and liabilities to their fair market value.
  5. a) 1
  6. b) 2
  7. c) 3
  8. d) 1 and 2

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. If, during an accounting period, an expense item has been incurred and consumed but not yet paid for or recorded, then the end-of-period adjusting entry would involve
  2. a) a liability account and an asset account.
  3. b) an asset or contra-asset and an expense account.
  4. c) a liability account and an expense account.
  5. d) a receivable account and a revenue account.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. For adjusting entries relating to accrued revenues,
  2. a) a liability-revenue account relationship exists.
  3. b) the adjusting entry involves a credit to an asset account and a debit to a revenue account.
  4. c) if an adjustment is not made, assets will be overstated.
  5. d) before adjustment, both assets and revenues are understated.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. Which of the following would NOT be a correct form for an adjusting entry?
  2. a) a debit to a revenue and a credit to a liability
  3. b) a debit to an expense and a credit to a liability
  4. c) a debit to a liability and a credit to a revenue
  5. d) a debit to an asset and a credit to a liability

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. Which of the following must be considered in estimating depreciation on an asset for an accounting period?
  2. a) only the original cost of the asset
  3. b) only the asset’s useful life
  4. c) both the original cost of the asset and its useful life
  5. d) the decline in its fair market value

 

Answer: c

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. The type of account and normal balance of “Accumulated Depreciation, Equipment” is
  2. a) Asset, Credit.
  3. b) Contra-asset, Credit.
  4. c) Contra-asset, Debit.
  5. d) Liability, Credit.

 

Answer: b

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. If the accountant forgets to record an adjustment for Accumulated Depreciation, Building at the end of the accounting period, this will cause
  2. a) an overstatement of assets.
  3. b) an understatement of assets.
  4. c) an overstatement of expenses.
  5. d) an overstatement of liabilities.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. An adjusting entry for bad debts will generally
  2. a) increase an expense account and decrease an asset account.
  3. b) increase an expense account and increase an asset account.
  4. c) increase an expense account and increase a contra-asset account.
  5. d) increase an expense account and increase a liability account.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. An accrued revenue can best be described as an amount
  2. a) collected and currently matched with expenses.
  3. b) collected and not currently matched with expenses.
  4. c) not collected and currently matched with expenses.

 

Answer: c

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. What account are revenues and expenses transferred to at the end of the accounting cycle?
  2. a) Comprehensive Income
  3. b) Retained Earnings
  4. c) Accumulated Other Comprehensive Income
  5. d) Income Summary

 

Answer: b

 

Difficulty: Medium

Learning Objective: Explain how the type of ownership structure affects the financial statements.

Section Reference: Financial Statements and Ownership Structure

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. Which of the following is NOT an account appearing in the equity section of a corporation’s statement of financial position?
  2. a) Contributed Surplus
  3. b) Common Shares
  4. c) Owner’s Equity
  5. d) Accumulated Other Comprehensive Income

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain how the type of ownership structure affects the financial statements.

Section Reference: Financial Statements and Ownership Structure

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. Zack Jones operates a sole proprietorship, selling sporting equipment. He has recently prepared financial statements for the fiscal year end of the business. Which equity accounts would you expect to see on the balance sheet?
  2. a) Common Shares, Dividends, and Owner’s Equity
  3. b) Common Shares, Capital, and Withdrawals
  4. c) Capital and Withdrawals, grouped or added under Owner’s Equity
  5. d) Owner’s Equity and Dividends, netted together as Retained Earnings

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain how the type of ownership structure affects the financial statements.

Section Reference: Financial Statements and Ownership Structure

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. Marvin holds 10% of the common shares of Pink Limited. For the 2017 fiscal year end, all shareholders received a cash payment to represent their share in the net income of Pink Limited. How would this cash payment be reported in the equity section of Pink Limited’s financial statements?
  2. a) as a reduction in the Owner’s Equity account
  3. b) as an owner withdrawal, reducing Shareholder’s Equity of Pink Limited
  4. c) as a dividend, reducing Shareholder’s Equity of Pink Limited
  5. d) This payment would not impact the equity section of the financial statements.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain how the type of ownership structure affects the financial statements.

Section Reference: Financial Statements and Ownership Structure

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. An unearned revenue can best be described as an amount
  2. a) collected and currently matched with expenses.
  3. b) collected and not currently matched with expenses.
  4. c) not collected and currently matched with expenses.
  5. d) not collected and not currently matched with expenses.

 

Answer: b

 

Difficulty: Easy

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: The Closing Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which type of account is always debited during the closing process?
  2. a) dividends
  3. b) expense
  4. c) revenue
  5. d) retained earnings

 

Answer: c

 

Difficulty: Easy

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: The Closing Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following statements is INCORRECT regarding fair value adjustments for investments?
  2. a) Both FV–NI investments and FV–OCI investments could include equity investments or investments in debt securities.
  3. b) FV–OCI investments exclude debt securities.
  4. c) At each period end, an estimate is made of the fair value of both FV–NI and FV–OCI investments.
  5. d) An adjusting entry is required to record a holding gain or loss on FV–NI investments.

 

Answer: a

 

Difficulty: Easy

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: The Closing Process

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. In the closing process, all the revenue and expense accounts are transferred to a clearing or suspense account called
  2. a) Other Comprehensive Income.
  3. b) Common Shares.
  4. c) Retained Earnings.
  5. d) Income Summary.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: The Closing Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. A corporation’s net income or loss is closed at year end to
  2. a) Accumulated Other Comprehensive Income.
  3. b) Common Shares.
  4. c) Retained Earnings.
  5. d) Other Comprehensive Income.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: The Closing Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. A post-closing trial balance
  2. a) includes temporary accounts only.
  3. b) includes permanent accounts only.
  4. c) includes both temporary and permanent accounts.
  5. d) may include expense accounts.

 

Answer: b

 

Difficulty: Easy

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: The Closing Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following statements about the trial balance is correct?
  2. a) The debits and credits must balance.
  3. b) The equality of credits and debits ensures that no errors were made.
  4. c) The post-closing trial balance includes temporary accounts only.
  5. d) The post-closing trial balance is used to prepare the financial statements.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: The Closing Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. If the inventory account at the end of the year is understated, the effect will be to
  2. a) overstate the cost of goods sold.
  3. b) understate the net purchases.
  4. c) overstate the gross profit on sales.
  5. d) overstate the goods available for sale.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: The Closing Process

CPA: Financial Reporting

Bloomcode: Comprehension

 

 

  1. Which of the following is true regarding the traditional discounted cash flow approach?
  2. a) The discount rate is adjusted to accommodate the riskiness of the cash flows.
  3. b) The cash flows have been adjustment to accommodate their riskiness.
  4. c) This model is best used where cash flows are fairly uncertain.
  5. d) Both a) and c) are correct.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. A fair value measure under IFRS 13 is based on which view of fair value?
  2. a) market participant view
  3. b) shareholder view
  4. c) fair value view
  5. d) unbiased view

 

Answer: a

 

Difficulty: Hard

Learning Objective: Use IFRS 13 to measure fair value.

Section Reference: Measuring Fair Value Using IFRS 13

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. In order to measure fair value under IFRS13, an entity must determine
  2. a) the item being measured, and how the item could or would be used.
  3. b) the market the item would be (or is) bought and sold in.
  4. c) which fair value model is being used to value the item.
  5. d) all of the above

 

Answer: d

 

Difficulty: Medium

Learning Objective: Use IFRS 13 to measure fair value.

Section Reference: Measuring Fair Value Using IFRS 13

CPA: Financial Reporting

CPA: Finance

CPA: Management Accounting

Bloomcode: Knowledge

 

 

  1. Under ASPE, Other Comprehensive Income (OCI) and Accumulated Other Comprehensive Income (AOCI) accounts
  2. a) appear as separate line items, the same as under IFRS.
  3. b) are part of accounts such as Fair Value–OCI Investments.
  4. c) are not included in financial statements.
  5. d) are measured differently than under IFRS.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Identify differences in accounting between ASPE and IFRS, and what changes are expected in the near future.

Section Reference: IFRS/ASPE Comparison

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The main difference in the accounting for measurement issues between IFRS and ASPE is that
  2. a) IFRS has a well-developed framework for measuring fair values (IFRS13), whereas ASPE does not.
  3. b) there is no difference between accounting for measurement issues between these standards.
  4. c) guidance under ASPE is concentrated in a single area of the ASPE body of knowledge.
  5. d) IFRS requires explicit disclosure of fair value amounts, whereas these disclosures under ASPE are optional.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Identify differences in accounting between ASPE and IFRS, and what changes are expected in the near future.

Section Reference: IFRS/ASPE Comparison

CPA: Financial Reporting

Bloomcode: Knowledge

 

MULTIPLE CHOICE QUESTIONS – Computational

 

 

  1. On September 1, 2017, Brown Corp. made the annual lease payment of $12,000 for its fleet of delivery trucks. The payment covered the period September 1, 2017 to August 31, 2018. Assuming the entire amount had originally been debited to Lease Expense, the required adjustment at December 31, 2017 is
  2. a) debit Lease Expense and credit Prepaid Lease $4,000.
  3. b) debit Prepaid Lease and credit Lease Expense $4,000.
  4. c) debit Prepaid Lease and credit Lease Expense $8,000.
  5. d) debit Lease Expense and credit Prepaid Lease $8,000.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $12,000 – ($12,000 x 4 ÷ 12) = $8,000

 

 

  1. White Resources determines that it has NOT yet recorded the 2017 accrual for Interest Revenue to be received in 2018. Assuming the amount to be recorded for 2017 is $2,000, the required adjustment at December 31, 2017 is
  2. a) debit Interest Receivable and credit Interest Revenue $2,000.
  3. b) debit Interest Revenue and credit Interest Receivable $2,000.
  4. c) debit Interest Payable and credit Interest Revenue $2,000.
  5. d) Silly question: no adjusting entry is required.

 

Answer: a

 

Difficulty: Easy

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: No calculation necessary ($2,000 is figure given in the question.)

 

 

  1. On November 1, 2017, Green Corp. purchased equipment by signing a 5-month, 7% note for $120,000. The December 31, 2017 adjusting entry required in connection with this note is
  2. a) debit Interest Expense and credit Interest Payable, $8,400.
  3. b) debit Interest Expense and credit Interest Payable, $3,500.
  4. c) debit Interest Expense and credit Interest Payable, $1,400.
  5. d) debit Interest Expense and credit Cash, $1,400.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $120,000 x 7% × 2 ÷ 12 = $1,400

 

 

  1. Blue Corp.’s account balances at December 31, 2017 included Accounts Receivable, $385,000 debit; Allowance for Doubtful Accounts, $2,500 credit. From a review of the receivables, Blue estimates that $14,000 of the December 31 receivables will be uncollectible. The required adjusting entry would include a credit to the allowance account for
  2. a) $ 2,500.
  3. b) $16,500.
  4. c) $14,000.
  5. d) $11,500.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $14,000 – $2,500= $11,500

 

 

  1. Yellow Corp.’s account balances at December 31, 2017 included Accounts Receivable, $720,000 debit; Allowance for Doubtful Accounts, $800 debit. Sales during 2017 were $1,840,000. It is estimated that 2% of sales will be uncollectible. The required adjusting entry would include a credit to the allowance account for
  2. a) $28,800.
  3. b) $36,800.
  4. c) $14,400.
  5. d) $30,600.

 

Answer: b

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $1,840,000 × 2% = $36,800. (ADA balance is irrelevant)

 

 

  1. On September 1, 2017, Black Corporation received $36,000 cash from a tenant for one year’s rent in advance, and recorded the transaction with a credit to Rent Revenue. The December 31, 2017 required adjusting entry in connection with this would be
  2. a) debit Rent Revenue and credit Unearned Rent, $12,000.
  3. b) debit Rent Revenue and credit Unearned Rent, $24,000.
  4. c) debit Unearned Rent and credit Rent Revenue, $12,000.
  5. d) debit Cash and credit Unearned Rent, $6,000.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: 8 ÷ 12 × $36,000 = $24,000

 

 

  1. On October 31, 2017, Pink Inc. lent $42,000 to Zinc Inc. in return for a three-month, 3.5% interest-bearing note. What adjusting entry should Pink Inc. make on December 31, 2017, in connection with this note?
  2. a) Debit Interest Receivable and credit Interest Revenue, $367.50.
  3. b) Debit Cash and credit Interest Revenue, $245.
  4. c) Debit Interest Receivable and credit Interest Revenue, $245.
  5. d) Debit Interest Revenue and credit Interest Receivable, $122.50.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $42,000 x 3.5% x 2 ÷ 12 = $245

 

 

  1. Lime Limited has received its invoice for $75,000 for property taxes for the calendar year 2017. The invoice was received and paid in June 2014 and the entire amount was debited to Property Tax Expense. Assuming Lime does NOT prepare interim financial statements, the required adjustment on December 31, 2017 related to the property taxes is
  2. a) debit Property Tax Expense and credit Prepaid Property Tax $31,250.
  3. b) debit Prepaid Property Tax and credit Property Tax Expense $37,500.
  4. c) debit Property Tax Expense and credit Prepaid Property Tax $37,500.
  5. d) Silly question: no adjusting entry is required.

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: No calculation necessary (No adjusting entry is required as FS are not prepared.)

 

 

  1. On December 10, 2017 Peach Inc. received a cheque for $54,500 from a customer for services that Peach will be performing in December 2017 and January 2018. By December 31, 2017, Peach had earned 40% of that amount. Assuming the appropriate year-end adjustments were made, the 2017 balance in Peach’s Unearned Revenue account will be
  2. a) $21,800.
  3. b) $27,250.
  4. c) $32,700.
  5. d) zero.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $54,500 x 60% = $32,700

 

 

  1. On May 15, 2017, Grey Corp. purchased 1,000 common shares of Regal Bank for $32,000, as a Fair Value through Other Comprehensive Income (FV–OCI) equity investment. At December 31, 2017, the fair value of these shares was $35,400. The required adjusting entry to reflect this fact is
  2. a) debit Fair value–OCI Investment, credit Holding Gain on Investment (OCI) $35,400.
  3. b) debit Holding Gain on Investment (OCI), credit Fair value–OCI Investment $35,400.
  4. c) debit Fair value–OCI Investment, credit Holding Gain on Investment (OCI) $3,400.
  5. d) debit Holding Loss on Investment (OCI), credit Fair value–OCI Investment $3,400.

 

Answer: c

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $35,400 – $32,000 = $3,400 gain

 

 

  1. On May 15, 2017, Cream Corp. purchased 1,000 common shares of Regal Bank for $32,000, as a Fair Value through Net Income (FV–NI) equity investment. At December 31, 2017, the fair value of these shares was $30,800. The required adjusting entry to reflect this fact is
  2. a) debit Fair value–Net Income Investment, credit Holding Gain on Investment (OCI) $30,800.
  3. b) debit Holding Gain on Investment (OCI), credit Fair value–Net Income Investment $30,800.
  4. c) debit Fair value–Net Income Investment, credit Investment Income $21,200.
  5. d) debit Investment Loss, credit Fair value–Net Income Investment $1,200.

 

Answer: d

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $30,800 – $32,000 = $1,200 loss

 

 

Use the following information for questions 56–58.

 

Orange Corp reported the following items on its calendar 2017 statement of comprehensive income:

Interest revenue……………………………………………………       $84,200

Salaries expense…………………………………………………..         72,000

Insurance expense………………………………………………..         10,600

 

As well, their statements of financial position showed the following balances:

December 31, 2016        December 31, 2017

Accrued interest receivable………………….. ….. $10,100                                $8,800

Accrued salaries payable……………………… ……… 9,800                                  5,400

Prepaid insurance……………………………….. ……… 1,500                                  1,600

 

 

  1. The cash received for interest during 2017 was
  2. a) $78,800.
  3. b) $84,200.
  4. c) $82,900.
  5. d) $74,100.

 

Answer: c

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $8,800 + $84,200 – $10,100 = $82,900

 

 

  1. The cash paid for salaries during 2017 was
  2. a) $67,600.
  3. b) $72,000.
  4. c) $77,400.
  5. d) $81,800.

 

Answer: a

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $5,400 + $72,000 – $9,800 = $67,600

 

 

  1. The cash paid for insurance premiums during 2017 was
  2. a) $ 9,100.
  3. b) $ 9,000.
  4. c) $10,700.
  5. d) $10,600.

 

Answer: c

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $10,600 + $1,600 – $1,500 = $10,700

 

 

Use the following information for questions 59–61.

 

During calendar 2017, Purple Corp. paid or collected the following items:

Insurance premiums paid……………………………………….      $ 14,200

Interest collected (revenue)……………………………………         21,700

Salaries paid…………………………………………………………       131,300

 

As well, their statements of financial position showed the following balances:

December 31, 2017          December 31, 2018

Prepaid Insurance……………………………….. …… $ 1,400                              $  1,500

Interest Receivable……………………………… ……… 2,800                                  2,100

Salaries Payable…………………………………. ……. 14,700                                12,900

 

 

  1. The insurance expense on the 2017 statement of comprehensive income was
  2. a) $12,700.
  3. b) $12,800.
  4. c) $14,100.
  5. d) $14,200.

 

Answer: c

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $14,200 – $1,500 + $1,400 = $14,100

 

 

  1. The interest revenue on the 2017 statement of comprehensive income was
  2. a) $22,400.
  3. b) $21,700.
  4. c) $19,600.
  5. d) $21,000.

 

Answer: a

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $21,700 – $2,100 + $2,800 = $22,400

 

 

  1. The salary expense on the 2017 statement of comprehensive income was
  2. a) $118,400.
  3. b) $133,100.
  4. c) $131,300.
  5. d) $116,600.

 

Answer: b

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $131,300 – $12,900 + $14,700 = $133,100

 

 

  1. Amazing Company acquires a trade name from Fantastic Ltd. Amazing estimates it will receive $7,200 per year from the name over the next 9 years. Using a discount rate of 4%, what is the value in use to Amazing of this trade name?
  2. a) $45,528
  3. b) $58,398
  4. c) $53,534
  5. d) $55,676

 

Answer: c

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $7,200 x 7.43533 = $53,534

 

 

  1. On September 1, 2017 Culver Corp. issued a 9% note payable to National Bank for $750,000, payable in three equal annual principal payments of $250,000, plus interest. On this date, the bank’s prime rate was 8%. The first payment for interest and principal was made on September 1, 2018. At December 31, 2018, Culver should record accrued interest payable of
  2. a) $13,333.
  3. b) $22,500.
  4. c) $15,000.
  5. d) $10,000.

 

Answer: c

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

CPA: Problem Solving and Decision Making

Bloomcode: Application

Feedback: ($750,000 – $250,000) × 9% × 4 ÷ 12 = $15,000

 

 

  1. Rathbone Corp. sells major household appliance service contracts for cash. The service contracts are for a one-year, two-year, or three-year period. Cash receipts from contracts are credited to Unearned Service Revenues. This account had a balance of $1,100,000 at December 31, 2017 before year-end adjustment. Service contract costs are charged as incurred to the Service Contract Expense account, which had a balance of $325,000 at December 31, 2017.

Service contracts still outstanding at December 31, 2017 expire as follows:

During 2018               $140,000

During 2019                 210,000

During 2020                   99,000

What amount should be reported as Unearned Service Revenues on Rathbone’s December 31, 2017 statement of financial position?

  1. a) $774,000
  2. b) $325,000
  3. c) $449,000
  4. d) $124,000

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $140,000 + $210,000 + $99,000 = $449,000

 

 

  1. On December 1, 2017, Flynn Consulting paid $27,000 for a three-year insurance policy (December 1, 2017 to November 30, 2020) and debited the entire amount to Prepaid Insurance. The December 31, 2017 required adjusting entry in connection with this policy would be
  2. a) debit Prepaid Insurance and credit Insurance Expense $750.
  3. b) debit Insurance Expense and credit Prepaid Insurance $750.
  4. c) debit Insurance Expense and credit Prepaid Insurance $26,250.
  5. d) debit Prepaid Insurance and credit Insurance Expense $26,250.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $27,000 x 1 ÷ 36 = $750

 

 

  1. On June 1, 2017, Carr Corp. loaned Farr Corp. $600,000 on a 5% note, payable in five annual instalments of $120,000 (plus interest), beginning January 2, 2018. Interest on the note is payable on the first day of each month beginning July 1, 2017. Farr made timely payments through November 1, 2017. On January 2, 2018, Carr received payment of the first principal instalment plus all interest due. At December 31, 2017, Carr’s interest receivable on this loan is
  2. a) $0.
  3. b) $2,500.
  4. c) $5,000.
  5. d) $7,500.

 

Answer: c

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $600,000 × 5% × 2 ÷ 12 = $5,000

 

 

  1. Grant Limited pays all salaried employees on a biweekly basis. Overtime pay, however, is paid in the next biweekly period. Grant accrues salaries expense only at its December 31 year end. Data relating to salaries earned in December 2017 are as follows:

Last payroll was paid on Dec 27, 2017, for the two-week period ended Dec 27, 2017.

Overtime pay earned in the two-week period ended Dec 27, 2017 was $7,000.

Remaining work days in 2017 were December 28, 29, 30, on which days there was no overtime.

The regular biweekly salaries total $100,000. Assuming a five-day work week, Grant should         record a liability at December 31, 2017 for accrued salaries of

  1. a) $24,000.
  2. b) $29,000.
  3. c) $37,000.
  4. d) $53,000.

 

Answer: c

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $7,000 + ($100,000 ÷ 10 × 3) = $37,000

 

 

  1. Mark-Wall Corp.’s trademark was licensed to Rodgers Inc. for royalties of 12% of sales of the trademarked items. Royalties are payable semi-annually on March 15 for sales in July through December of the previous year, and on September 15 for sales in January through June of the same year. Mark-Wall received the following royalties from Rodgers:

March 15         September 15

During 2017                   $5,000                 $9,000

During 2018                     8,000                   6,000

Rodgers estimates that sales of the trademarked items would total $67,000 for July through December 2018. On their statement of comprehensive income for calendar 2018, Mark-Wall’s royalty revenue should be

  1. a) $8,040.
  2. b) $14,000.
  3. c) $14,040.
  4. d) $21,000.

 

Answer: c

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

Feedback: $6,000 + ($67,000 × 12%) = $14,040

 

 

  1. Frog Corporation had revenues of $300,000, expenses of $200,000, and dividends of $45,000. When Income Summary is closed to Retained Earnings, the amount of the debit or credit to Retained Earnings is a
  2. a) debit of $55,000.
  3. b) debit of $100,000.
  4. c) credit of $55,000.
  5. d) credit of $100,000.

 

Answer: c

 

Difficulty: Hard

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: The Closing Process

CPA: Financial Reporting

Bloomcode: Application

Feedback: $300,000 – $200,000 – $45,000 = $55,000

 

 

*70. Barkley Company will receive $400,000 in a future year. If the future receipt is discounted at an interest rate of 8%, its present value is $252,068. In how many years is the $400,000 received?

  1. a) 5 years
  2. b) 6 years
  3. c) 7 years
  4. d) 8 years

 

Answer: b

 

Difficulty: Hard

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

Feedback: $252,068 ÷ $400,000 = 0.63017; 0.63017 is PV factor for 6 years

 

 

*71. Pearson Corporation makes an investment today (January 1, 2014). They will receive $9,000 every December 31 for the next six years (2014–2019). If Pearson wants to earn 12% on the investment, what is the most they should invest on January 1, 2014?

  1. a) $37,003
  2. b) $41,443
  3. c) $73,036
  4. d) $81,801

 

Answer: a

 

Difficulty: Hard

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

Feedback: $9,000 × 4.11141 = $37,003

 

EXERCISES

 

 

Ex. 3-72 Definitions

Define the following terms:

  1. Event
  2. Work sheet
  3. Permanent accounts
  4. Temporary accounts
  5. Income summary
  6. General ledger

 

Solution 3-72

  1. An event is something of consequence that happens. For a business, an event is generally the source or cause of changes in assets, liabilities and equity.

 

  1. Work sheets are used as informal tools to help accountants prepare financial statements.

 

  1. Permanent accounts (also called real accounts) are assets, liability and equity accounts. Unlike temporary accounts, permanent accounts are NOT closed.

 

  1. Temporary accounts are revenue and expense accounts. Unlike permanent accounts, they are periodically closed.

 

  1. The Income Summary is an account that is used as part of the closing process. It facilitates the closing of the temporary accounts at year end.

 

  1. A general ledger is a collection of all the business’ accounts and may include subsidiary ledgers for specific accounts.

 

Difficulty: Easy

Learning Objective: Understand basic accounting terminology and explain double-entry rules.

Section Reference: Basic Terminology and Double-Entry Rules

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 3-73 Definitions

Provide clear, concise answers for the following:

  1. What is the accrual basis of accounting?
  2. What is an accrued expense?
  3. What is accrued revenue?
  4. What is a prepaid expense?
  5. What is unearned revenue?

*6.   State the rule that indicates which adjusting entries for prepaid and unearned items should be reversed.

 

Solution 3-73
  1. The accrual basis of accounting recognizes revenue when the performance obligation is satisfied and recognizes expenses in the period incurred.

 

  1. An accrued expense is an expense which is incurred but not paid in cash or recorded.

 

  1. An accrued revenue is a revenue which is recognized but not yet received in cash or recorded.

 

  1. A prepaid expense is an expense paid in cash and recorded as an asset before it is used.

 

  1. Unearned revenues are the revenues received in cash and recorded as liabilities before they are recognized.

 

*6.   Adjusting entries that create an asset or a liability account should be reversed. This would include prepaid and unearned items originally recorded in a revenue or expense account.

 

Difficulty: Easy

Learning Objective: Understand basic accounting terminology and explain double-entry rules.

Section Reference: Basic Terminology and Double-Entry Rules

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 3-74 Recordable events

Before transactions are entered into a corporation’s accounting system, the underlying event must be analyzed, to determine how (and if) it should be recorded. The situations below relate to Maxwell Corporation:

 

Instructions

Indicate whether the items below are recordable events.

  1. A new mortgage contract for its new factory building is signed.
  2. The first mortgage payment is made.
  3. Wages for the current month are paid.
  4. A new secretary is hired.
  5. Property taxes are paid.
  6. HST collections for the current month are forwarded to the CRA.

 

Solution 3-74

  1. Not recordable

 

  1. Recordable

 

  1. Recordable

 

  1. Not recordable

 

  1. Recordable

 

  1. Recordable

 

Difficulty: Medium

Learning Objective: Explain how transactions affect the accounting equation.

Section Reference: Accounting Equation

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 3-75 The accounting cycle

Summarize the steps in the accounting cycle.

 

Solution 3-75

The accounting cycle may be summarized in 10 steps as follows:

  1. identification and measurement of transactions and other events

 

  1. journalization of current period’s entries into journals

 

  1. posting of journals to the general ledger

 

  1. preparation of trial balance (unadjusted)

 

  1. preparation and posting of adjusting entries

 

  1. preparation of adjusted trial balance

 

  1. preparation of financial statements

 

  1. preparation and posting of closing entries

 

  1. preparation of post-closing trial balance

 

  1. preparation and posting of reversing entries (optional)

 

Difficulty: Easy

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 3-76 Adjusting entries

Present, in journal form, the adjustments that would be made on July 31, 2016, the end of the fiscal year, for each of the following:

  1. The supplies inventory on August 1, 2015 was $8,350. Supplies costing $16,650 were purchased during the fiscal year and debited to Supplies Inventory. A count on July 31, 2016 indicated supplies on hand of $6,810.
  2. On April 30, a ten-month, 4% note for $40,000 was received from a customer.
  3. On March 1, $8,400 was collected as rent for one year and a nominal (temporary) account was credited.

 

Solution 3-76

  1. Supplies Expense (8,350 + 16,650 – 6,810)……………………………… 18,190

Supplies Inventory…………………………………………………………..                            18,190

 

  1. Interest Receivable (40,000 x 4% x 3 ÷ 12)………………………………. 400

Interest Revenue……………………………………………………………..                                 400

 

  1. Rent Revenue (8,400 x 7 ÷ 12 unearned)………………………………… 4,900

Unearned Revenue………………………………………………………….                              4,900

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

 

 

Ex. 3-77 Adjusting entries

Reed Co. wishes to record receipts and payments in such a manner that adjustments at the end of the period will NOT require reversing entries at the beginning of the next period.

 

Instructions

Record the following transactions in the desired manner; as well, record the adjusting entry on December 31, 2017. (Two entries for each part.)

  1. An insurance policy for two years was purchased on April 1, 2017 for $18,000.
  2. Rent of $12,000 for six months for a portion of the building was received on November 1, 2017.

 

Solution 3-77
  1. Prepaid Insurance…………………………………………………………………. 18,000

Cash………………………………………………………………………………                            18,000

Insurance Expense (4,800 x 9 ÷ 24)…………………………………………           1,800

Prepaid Insurance……………………………………………………………                              1,800

 

  1. Cash……………………………………………………………………………………. 12,000

Unearned Rent………………………………………………………………..                             12000

Unearned Rent (4,200 x 2 ÷ 6)………………………………………………..           4,000

Rent Revenue…………………………………………………………………                              4,000

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

 

 

Ex. 3-78 Calculation of expense

The records for Jay Inc. showed the following for 2016:

Jan 1                  Dec 31

Accrued expenses………………………………. ……. $2,000                 $3,600

Prepaid expenses………………………………… ………… 900                      800

Cash paid during the year for expenses…………………..                $55,000

 

Instructions

Calculate the total amount of expenses that should be reported on the 2016 statement of comprehensive income.

 

Solution 3-78

$55,000 – $2,000 + $3,600 + $900 – $800 = $56,700.

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

Bloomcode: Application

 

 

Ex. 3-79 Calculation of revenue

The records for Oriole Corp. showed the following for 2016:

Jan 1                  Dec 31

Unearned revenue………………………………. ……. $3,000                 $3,400

Accrued revenue…………………………………. ……… 1,400                   1,100

Cash collected during the year from revenue                               $85,000

 

Instructions

Show the calculation of the amount of revenue that should be reported on the 2016 statement of comprehensive income.

 

Solution 3-79

$85,000 + $3,000 – $3,400 – $1,400 + $1,100 = $84,300.

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

CPA: Communication

Bloomcode: Application

 

 

Ex. 3-80 Adjusting the Closing Entries

The adjusted trial balance of Ryan Financial Planners appears below.

 

Instructions

Using the information from the adjusted trial balance, you are to prepare for the month ending December 31:

  1. a) an income statement.
  2. b) a retained earnings statement.
  3. c) a balance sheet.

 

Ryan Financial Planners

Adjusted Trial Balance

December 31, 2017

 

Debit         Credit

Cash…………………………………………………………………………………………..       $  2,900

Accounts Receivable……………………………………………………………………           2,200

Supplies………………………………………………………………………………………           1,800

Equipment …………………………………………………………………………………..         16,000

Accumulated Depreciation—Equipment…………………………………………                          $  4,000

Accounts Payable………………………………………………………………………..                              3,300

Unearned Service Revenue………………………………………………………….                              5,000

Common Stock……………………………………………………………………………                            10,000

Retained Earnings………………………………………………………………………..                              4,400

Dividends…………………………………………………………………………………….           2,000

Service Revenue…………………………………………………………………………                              4,200

Supplies Expense…………………………………………………………………………              600

Depreciation Expense…………………………………………………………………..           2,500

Rent Expense………………………………………………………………………………           2,900       ______

$30,900      $30,900

 

Solution 3-80 (20 min.)

a)

Ryan Financial Planners

Income Statement

For the Month Ended December 31, 2017

Revenues

Service revenue…………………………………………………………………….                          $  4,200

Expenses

Rent expense………………………………………………………………………..         $2,900

Depreciation expense…………………………………………………………….           2,500

Supplies expense…………………………………………………………………..              600

Total expenses………………………………………………………………..                             6,000

Net loss……………………………………………………………………………………….                         $(1,800)

 

 

b)

Ryan Financial Planners

Retained Earnings Statement

For the Month Ended December 31, 2017

 

Retained earnings, December 1…………………………………………………….                           $ 4,400

Less: Net loss………………………………………………………………………………         $1,800

Dividends……………………………………………………………………………           2,000          3,800

Retained earnings, December 31…………………………………………………..                            $   600

 

 

c)

Ryan Financial Planners

Balance Sheet

December 31, 2017

 

Assets

Cash…………………………………………………………………………………………..                          $  2,900

Accounts receivable……………………………………………………………………..                              2,200

Supplies………………………………………………………………………………………                              1,800

Equipment…………………………………………………………………………………..       $16,000

Less: Accumulated depreciation—equipment………………………………….           4,000        12,000

Total assets……………………………………………………………………………                          $18,900

 

Liabilities and Stockholders’ Equity

Liabilities

Accounts payable……………………………………………………………………       $  3,300

Unearned service revenue……………………………………………………….           5,000

Total liabilities………………………………………………………………….                          $  8,300

Stockholders’ Equity

Common stock……………………………………………………………………….        10,000

Retained earnings…………………………………………………………………..              600        10,600

Total liabilities and stockholders’ equity………………………………                          $18,900

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: Adjusting Entries

Section Reference: The Closing Process

CPA: Financial Reporting

CPA: Communication

Bloomcode: Application

 

 

Ex. 3-81 Calculation of expense

Sales salaries paid during 2017 were $90,000. Advances to salesmen were $1,300 on January 1, 2017, and $800 on December 31, 2017. Sales salaries payable were $1,300 on January 1, 2017, and $1,400 on December 31, 2017.

 

Instructions

Calculate the Sales Salaries Expense for calendar 2017.

 

Solution 3-81

$90,000 + $1,300 – $800 – $1,300 + $1,400 = $90,600.

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: Adjusting Entries

Section Reference: The Closing Process

CPA: Financial Reporting

Bloomcode: Application

 

 

Ex. 3-82 Explain whether the financial statement excerpt below is from the financial statements of a corporation, a sole proprietorship or a partnership:

Abhrams, Capital…………………       $20,000

Johnston, Capital…………………       $25,000

Zinck, Capital………………………       $20,000

Total…………………………………..       $65,000

 

Solution 3-82

This is an excerpt from partnership financial statements. A Corporation would have share capital accounts (common shares and, possibly, preferred shares) and would report Retained Earnings of the firm. Therefore, we know that this excerpt is not a corporation. Since there are capital accounts for more than one individual, it cannot be a sole propietorship. Therefore, based on the multiple owner’s capital accounts, it can be concluded that this is an excerpt from a partnership’s financial statements.

 

Difficulty: Easy

Learning Objective: Explain how the type of ownership structure affects the financial statements.

Section Reference: Financial Statements and Ownership Structure

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 3-83 Expected Cash Flow Approach

Assume that Picnic Paper Co. has several minor lawsuits outstanding. To determine the amount of liability to recognize on the statement of financial position, Picnic decides to use expected cash flow techniques. Based on discussions with their lawyers, Picnic has developed the following cash flow estimates, and related probabilities:

 

Year           Cash Flow Estimate        Probability Assessment

2017                     $2,300                               30%

$4,500                               45%

$8,200                               25%

 

2018                     $3,200                               20%

$5,400                               50%

$7,100                               30%

 

Instructions

Based on these estimates, and assuming a risk-free rate of 5%, what is the present value of expected cash flows which Picnic should record on their statement of financial position for 2017?

 

Solution 3-83

Year           Cash Flow Estimate        Probability Assessment       Expected Cash Flow

2017                     $2,300                               30%                                   $690

$4,500                               45%                                $2,025

$8,200                               25%                                $2,050

$4,765

 

2018                     $3,200                               20%                                   $640

$5,400                               50%                                $2,700

$7,100                               30%                                $2,130

$5,470

 

Year          Expected Cash Flow         PV Factor i-5%                 Present Value

2017                     $4,765                         0.95238                           $4,538.09

2018                     $5,470                         0.90703                           $4,961.45

Total                           $9,499.54

 

Difficulty: Hard

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

CPA: Problem Solving and Decision Making

Bloomcode: Application

 

 

Ex. 3-84 Your client, Bench Company, has a few minor lawsuits outstanding. Your main contact, Michael Wood, has heard that, though their amount is unknown, these lawsuits must be recorded on the financial statements. Explain briefly for Mr. Wood, the cash flow approach you would take to determining the amount to record on Bench Company’s financial statements.

 

Solution 3-84

The stream of expected cash flows related to Bench Company’s expected lawsuits will be paid out at a future time. To account for the time value of money, these cash flows are discounted to the present, using the discount rate reflecting the value of those dollars at present day. Two main cash flow approaches should be considered:

 

Traditional Approach

The stream of cash flows is discounts, and the discount rate used to accommodate the riskiness of the cash flows.

 

Expected Cash Flow Approach

Use the risk-free interest rate and adjust for cash flow uncertainty with probability weighting.

 

Since the traditional approach is best used when cash flows are fairly certain, the expected cash flow approach is recommended to Mr. Wood in this situation, since the amount and timing of Bench Company’s lawsuit payouts is relatively uncertain.

 

Difficulty: Medium

Learning Objective: Use valuation techniques to measure financial statement elements.

Section Reference: Measuring Financial Statement Elements

CPA: Financial Reporting

Bloomcode: Application

 

 

Ex. 3-85 Valuation under IFRS 13

Hood Company owns specialized equipment that was purchased in an acquisition of Riding Company. The equipment has a book value of $1,800,000, but according to IFRS, it is assessed for impairment on an annual basis. To perform this impairment test, Hood must estimate the fair value of the equipment. It has developed the following cash flow estimates related to the equipment based on internal information. Each cash flow estimate reflects Hood’s estimate of annual cash flows over the next 7 years. The equipment is assumed to have no residual value after the 7 years. (Assume the cash flows occur at the end of each year.)

 

Year               Cash Flow Estimate

1–3                      $240,000

4–6                        365,000

7                          425,000

 

Hood determines, using their own assumptions, that the appropriate discount rate for this estimation is 6%. To the nearest dollar, what is the estimated fair value of the equipment?

 

Solution 3-85

($240,000 x 2.67301) + ($365,000 x 2.67301 x .83962) + $425,000 x .66506

= $641,522.40 + $819,174.12 + $282,650.50

= $1,743,347

 

Difficulty: Hard

Learning Objective: Use IFRS 13 to measure fair value.

Section Reference: Measuring Fair Value Using IFRS 13

CPA: Financial Reporting

CPA: Communication

CPA: Finance

Bloomcode: Application

 

 

Ex. 3-86 Inputs under IFRS 13

There are three levels of inputs under IFRS 13. What type of inputs are used by Hood company in exercise 3-85? As a result, what classification would be assigned to the specialized equipment?

 

Solution 3-86

Hood used unobservable internal company data in the valuation of their IFRS 13 valuation of specialized equipment acquired upon acquisition of Riding Company. Unobservable inputs such as a company’s own data or assumptions are considered Level 3 inputs, which are the most subjective of all three in the hierarchy, and, hence require greater disclosures to give financial statement users greater information about the related uncertainty. Because Level 3 inputs are in use, the asset would be classified as a Level 3 asset.

 

Difficulty: Medium

Learning Objective: Use IFRS 13 to measure fair value.

Section Reference: Measuring Fair Value Using IFRS 13

CPA: Financial Reporting

CPA: Communication

Bloomcode: Evaluation

 

 

Ex. 3-87 Calculate market price of a bond

On January 1, 2017 Lance Co. issued five-year bonds with a face value of $700,000 and a stated interest rate of 12% payable semi-annually on July 1 and January 1. The bonds were sold to yield 10%.

Calculate the issue price of the bonds.

 

Solution 3-87

Present value of $700,000 discounted for 10 periods at 5% ($700,000 × .61391) =       $429,737

Present value of $42,000 for 10 periods at 5% ($42,000 × 7.72173) =                             324,313

Issue price of the bonds                                                                                                    $754,050

 

Difficulty: Hard

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

 

 

Ex. 3-88 Present value of an annuity due

How much must be invested now to receive $30,000 for ten years if the first $30,000 is received today and the rate is 8%?

 

Solution 3-88

Present value of an annuity due of $30,000 for ten periods at 8% ($30,000 × 7.24689) = $217,407.

 

Difficulty: Medium

Learning Objective: Understand and apply present value concepts.

Section Reference: Present Value Concepts

CPA: Finance

CPA: Management Accounting

Bloomcode: Application

PROBLEMS

 

 

Pr. 3-89 Journal Entries

Jonathan Green owns Gopher Greenhouses, a gardening centre (as a sole proprietorship). His first year of operations included the following selected events and transactions:

January:

  1. He invested $300,000 in his business.
  2. He buys a greenhouse for $100,000 cash.

May:

  1. He hires a greenhouse supervisor at an annual salary of $34,000.

June:

  1. He orders and pays for a shipment of flowers costing $80,000.
  2. He sells flowers for $40,000. Half of these sales are made on account.

August:

  1. He receives a deposit of $5,000 from a customer to put merchandise “on hold”.
  2. He pays current month’s salaries of $3,000.

 

Instructions

Prepare all required journal entries.

 

Solution 3-89

  1. Cash……………………………………………………………………………………. 300,000

Jonathan Green, Capital…………………………………………………..                          300,000

 

  1. Building………………………………………………………………………………… 100,000

Cash………………………………………………………………………….                          100,000

 

  1. No entry required.

 

  1. Inventories……………………………………………………………………………. 80,000

Cash………………………………………………………………………………                            80,000

 

  1. Cash……………………………………………………………………………………. 20,000

Accounts Receivable……………………………………………………………..         20,000

Sales……………………………………………………………………………..                            40,000

 

  1. Cash……………………………………………………………………………………. 5,000

Unearned Revenue………………………………………………………….                              5,000

 

  1. Salaries Expense………………………………………………………………….. 3,000

Cash………………………………………………………………………………                              3,000

 

Difficulty: Easy

Learning Objective: Identify the steps in the accounting cycle and the steps in the recording process.

Section Reference: The Accounting Cycle and the Recording Process

CPA: Financial Reporting

CPA: Communication

Bloomcode: Application

 

 

Pr. 3-90 Adjusting entries

The information shown below relates to Flower Corporation. At December 31, 2017 Flower’s general ledger shows the following balances:

Prepaid lease………………………         $7,000     Debit

Prepaid insurance………………..          $1200     Debit

Unearned revenue……………….       $84,000     Credit

 

In addition, the following information is available:

  1. The entire amount shown as prepaid lease has expired.
  2. One-third of the amount shown as prepaid insurance has expired.
  3. Half of the amount shown as unearned revenue has now been earned.

 

Instructions

Prepare all adjusting entries that are required at December 31, 2017.

 

Solution 3-90

  1. Lease Expense……………………………………………………………………… 7,000

Prepaid Lease…………………………………………………………………                              7,000

 

  1. Insurance Expense (1,200 x 1 ÷ 3) …………………………………………. 400

Prepaid Insurance……………………………………………………………                                 400

 

  1. Unearned Revenue (84,000 x ½) …………………………………………… 42,000

Revenue…………………………………………………………………………                            42,000

 

Difficulty: Easy

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

CPA: Communication

Bloomcode: Application

 

 

Pr. 3-91 Adjusting entries

Part I – Maison Corp. has reported pre-tax income of $250,000 for calendar 2017, before considering the five items below. Prepare the adjusting entries needed at December 31, 2017 in order to correctly state the 2017 pre-tax income. If no entry is needed, write NONE.

  1. Interest on a $42,000, 7%, six-year note payable was last paid on September 1, 2016.
  2. On May 31, 2017, Maison entered into a contract to provide services to a customer for eighteen months beginning June 1. The customer paid the $18,000 fee in full on June 1 and Maison credited it to Service Revenue.
  3. On August 1, 2017, Maison paid a year’s rent in advance on a warehouse, and debited the $48,000 payment to Prepaid Rent.
  4. Depreciation on office equipment for 2017 is $17,000.
  5. On December 18, 2017, Maison paid the local newspaper $1,000 for an advertisement to be run in January of 2018, debiting it to Prepaid Advertising.

 

Part II – Show the effect of each adjusting entry in Part I on previously reported pre-tax income, and indicate the correct amount of pre-tax income.

 

Reported 2017 pre-tax income ……………     $250,000

Add (deduct) Item        (1)

(2)

(3)

(4)

(5)

Correct 2017 pre-tax income……………….    $_______

 

Solution 3-91

Part I

  1. Interest Expense (42,000 x 7% x 4 ÷ 12)………………………………….. 980

Interest Payable………………………………………………………………                                 980

 

  1. Service Revenue (18,000 x 11 ÷ 18 unearned)…………………………. 11,000

Unearned Service Fees……………………………………………………                            11,000

 

  1. Rent Expense (48,000 x 5 ÷ 12)……………………………………………… 20,000

Prepaid Rent…………………………………………………………………..                            20,000

 

  1. Depreciation Expense……………………………………………………………. 17,000

Accumulated Depreciation……………………………………………….                            17,000

 

  1. NONE

 

Part II

Reported 2017 pre-tax income…………….     $250,000

Add (deduct) Item (1) (980)

(2) (11,000)

(3) (20,000)

(4) (17,000)

(5)

Correct 2017 pre-tax income……………….     $201,020

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Section Reference: Adjusting Entries

CPA: Financial Reporting

CPA: Communication

Bloomcode: Application

 

 

Pr. 3-92 Adjusting and closing entries

The following trial balance was taken from the books of Kaslo Corporation at December 31, 2017:

Account                                                                                                           Debit             Credit

Cash…………………………………………………………………………………………..     $  40,000

Accounts Receivable……………………………………………………………………       108,000

Note Receivable…………………………………………………………………………..           8,000

Allowance for Doubtful Accounts…………………………………………………..                         $   1,800

Merchandise Inventory…………………………………………………………………         54,000

Unexpired Insurance…………………………………………………………………….           4,800

Furniture and Equipment……………………………………………………………….       138,000

Accumulated Depreciation…………………………………………………………….                            15,000

Accounts Payable………………………………………………………………………..                            10,800

Common Stock……………………………………………………………………………                            44,000

Retained Earnings………………………………………………………………………..                            65,000

Sales…………………………………………………………………………………………..                          410,000

Cost of Goods Sold………………………………………………………………………       128,000

Salaries Expense…………………………………………………………………………         53,000

Rent Expense………………………………………………………………………………         12,800   ________

Totals……………………………………………………………………………………     $546,600    $546,600

 

At year end, the following items have not yet been recorded.

  1. Insurance expired during the year, $3,000.
  2. Estimated bad debts, 1 percent of gross sales.
  3. Depreciation on furniture and equipment, 10% per year.
  4. Interest at 9% is receivable on the note for one full year.
  5. Rent paid in advance at December 31, $6,800 (originally debited to expense).
  6. Accrued salaries at December 31, $6,200.

 

Instructions

  1. a) Prepare the necessary adjusting entries.
  2. b) Prepare the necessary closing entries.

 

Solution 3-92
  1. a) Adjusting Entries
  2. Insurance Expense……………………………………………………………….. 3,000

Unexpired Insurance………………………………………………………..                              3,000

 

  1. Bad Debt Expense (410,000 x 1%)…………………………………………. 4,100

Allowance for Doubtful Accounts………………………………………                              4,100

 

  1. Depreciation Expense (138,000 x 10%)…………………………………… 13,800

Accumulated Depreciation……………………………………………….                            13,800

 

  1. Interest Receivable (8,000 x 9%)…………………………………………….. 720

Interest Revenue……………………………………………………………..                                 720

 

  1. Prepaid Rent………………………………………………………………………… 6,800

Rent Expense…………………………………………………………………                              6,800

 

  1. Salaries Expense………………………………………………………………….. 6,200

Salaries Payable………………………………………………………………                               6,200

 

  1. b) Closing Entries

Sales…………………………………………………………………………………………..       410,000

Interest Revenue………………………………………………………………………….              720

Income Summary………………………………………………………………….                          410,720

Income Summary………………………………………………………………………..       214,100

Salaries Expense…………………………………………………………………..                            59,200

Rent Expense………………………………………………………………………..                              6,000

Depreciation Expense…………………………………………………………….                            13,800

Bad Debt Expense…………………………………………………………………                              4,100

Insurance Expense………………………………………………………………..                              3,000

Cost of Goods Sold………………………………………………………………..                          128,000

Income Summary………………………………………………………………………..       196,620

Retained Earnings………………………………………………………………….                           196,620

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: Adjusting Entries

Section Reference: The Closing Process

CPA: Financial Reporting

CPA: Communication

Bloomcode: Application

 

 

Pr. 3-93 Adjusting and Closing Entries

  1. Using the Adjusted Trial Balance of Charles Corporation from Pr. 3-99, journalize the adjustments that were made.
  2. Using the adjusted Trial Balance of Charles Corporation from Pr. 3-99, journalize the closing entries that are required.

 

Solution 3-93

  1. Store Supplies Expense…………………………………………………………. 4,000

Store Supplies…………………………………………………………………                              4,000

 

Depr. Expense—Store Equipment…………………………………………..         18,000

Accumulated Depreciation—Store Equipment……………………                            18,000

 

Depr. Expense—Delivery Equipment……………………………………….         14,000

Accumulated Depreciation—Delivery Equipment………………..                            14,000

 

Interest Expense……………………………………………………………………         22,000

Interest Payable………………………………………………………………                            22,000

 

  1. Sales……………………………………………………………………………………. 1,494,400

Income Summary……………………………………………………………                       1,494,400

 

Income Summary………………………………………………………………….    1,527,600

Sales Returns and Allowances………………………………………….                              8,400

Cost of Goods Sold………………………………………………………….                          994,800

Salaries Expense…………………………………………………………….                          280,000

Advertising Expense………………………………………………………..                            52,800

Utilities Expense………………………………………………………………                            28,000

Repair Expense………………………………………………………………                            24,200

Delivery Expense…………………………………………………………….                            33,400

              Rent Expense…………………………………………………………………                            48,000

              Store Supplies Expense……………………………………………………                              4,000

              Depreciation Expense—Store Equipment…………………………..                            18,000

              Depreciation Expense—Delivery Equipment………………………                            14,000

              Interest Expense……………………………………………………………..                            22,000

 

       Retained Earnings………………………………………………………………….         33,200

              Income Summary……………………………………………………………                            33,200

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: Adjusting Entries

Section Reference: The Closing Process

CPA: Financial Reporting

CPA: Communication

Bloomcode: Analysis

 

 

Pr. 3-94 Closing Entries

Below is a selection of account balances for Howard Ltd. at December 31, 2017:

Sales………………………………………….     $856,000

Sales returns……………………………….       $40,000

Cost of goods sold……………………….     $456,000

Advertising expense……………………..       $38,000

Salaries expense………………………….     $113,000

Depreciation expense…………………..       $31,000

Insurance expense……………………….         $9,000

Administrative expense…………………       $10,000

 

All accounts have their normal balances.

 

Instructions

Prepare all necessary closing entries at December 31, 2017.

 

Solution 3-94

Sales…………………………………………………………………………………………..       856,000

Sales returns…………………………………………………………………………                            40,000

Income summary…………………………………………………………………..                          816,000

 

Income summary…………………………………………………………………………       657,000

Administrative expense…………………………………………………………..                           10,000

Advertising expense……………………………………………………………….                           38,000

Depreciation expense…………………………………………………………….                            31,000

Cost of goods sold………………………………………………………………….                          456,000

Insurance expense…………………………………………………………………                              9,000

Salaries expense……………………………………………………………………                          113,000

 

Income summary…………………………………………………………………………       159,000

Retained earnings…………………………………………………………………..                           159,000

 

Difficulty: Medium

Learning Objective: Explain the reasons for and prepare adjusting entries.

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: Adjusting Entries

Section Reference: The Closing Process

CPA: Financial Reporting

CPA: Communication

Bloomcode: Analysis

 

 

Pr. 3-95 Adjusting entries

Data relating to the balances of various accounts affected by adjusting or closing entries appear below. (The entries, which caused the changes in the balances, are not given.) You are asked to supply the missing journal entries, which would logically account for the changes in the account balances.

  1. Interest receivable at January 1, 2017 was $2,000. During 2017, cash received from debtors for interest on outstanding notes receivable was $4,700. The 2017 statement of comprehensive income showed Interest Revenue of $4,900. You are to prepare the missing adjusting entry that must have been made, assuming reversing entries are not made.
  2. Unearned rent at January 1, 2017 was $5,300, and at December 31, 2017 was $6,000. The records indicate cash receipts from rental sources during 2017 were $45,000, all of which were credited to the Unearned Rent Account. You are to prepare the missing adjusting entry.
  3. Accumulated Depreciation—Equipment at January 1, 2017 was $120,000, and at December 31, 2017 was $150,000. During 2017, one piece of equipment was sold. The equipment had an original cost of $10,000 and was three-quarters depreciated when sold. You are to prepare the missing adjusting entry.
  4. Allowance for doubtful accounts on January 1, 2017 was $50,000. The balance in the allowance account on December 31, 2017 after making the annual adjusting entry was $65,000. During 2017 bad debts of $30,000 were written off. You are to provide the missing adjusting entry.
  5. Prepaid rent at January 1, 2017 was $24,000. During 2017 rent payments of $160,000 were made and debited to Rent Expense. The 2017 statement of comprehensive income shows Rent Expense of $180,000. You are to prepare the missing adjusting entry that must have been made, assuming reversing entries are not made.
  6. Retained earnings at January 1, 2017 was $150,000 and at December 31, 2017 it was $210,000. During 2017, cash dividends of $50,000 were paid, which were correctly debited to Retained Earnings. You are to prepare the missing closing entry to close the Income Summary account.

 

Solution 3-95

  1. Interest Receivable……………………………………………………………….. 200

Interest Revenue……………………………………………………………..                                 200

Interest revenue per books                                      $2,900

Interest revenue received related to 2016

($4,700 – $2,000)                                                       2,700

Interest accrued                                                       $   200

 

  1. Unearned Rent Revenue……………………………………………………….. 44,300

Rent Revenue…………………………………………………………………                            44,300

Cash receipts                                                         $45,000

Beginning balance                                                      5,300

Ending balance                                                        (6,000)

Rent revenue                                                         $44,300

 

  1. Depreciation Expense……………………………………………………………. 22,500

Accumulated Depreciation—Equipment…………………………….                            22,500

Ending balance                                                    $150,000

Beginning balance                                                  120,000

Difference                                                                30,000

Write-off at time of sale 3 ÷ 4 × $10,000                   7,500

$  22,500

 

  1. Bad Debt Expense………………………………………………………………… 45,000

Allowance for Doubtful Accounts………………………………………                            45,000

Ending balance                                                      $65,000

Beginning balance                                                    50,000

Difference                                                                15,000

Written off                                                                30,000

$45,000

 

  1. Rent Expense……………………………………………………………………….. 20,000

Prepaid Rent…………………………………………………………………..                            20,000

Rent expense                                                       $180,000

Less cash paid                                                       160,000

Reduction in prepaid rent account                       $  20,000

 

  1. Income Summary…………………………………………………………………. 110,000

Retained Earnings……………………………………………………………                          110,000

Ending balance                                                    $210,000

Beginning balance                                                  150,000

Difference                                                                60,000

Cash dividends                                                         50,000

Net income must be                                             $110,000

 

Difficulty: Hard

Learning Objective: Explain the reasons for and prepare adjusting entries.

Learning Objective: Prepare a 10-column work sheet and financial statements.

Section Reference: Adjusting Entries

Section Reference: Using a Work Sheet

CPA: Financial Reporting

CPA: Communication

Bloomcode: Analysis

 

 

Pr. 3-96 Trial balance correction

The Controller of SHD Corporation asks his assistant to correct the company’s December 31, 2017 trial balance.

 

The preliminary trial balance, which does not balance, is reproduced below:

 

SHD Corporation

Trial Balance

December 31, 2017

 

Debit         Credit

Cash…………………………………………………………………………………………..     $  10,000

Accounts Receivable……………………………………………………………………         15,000

Prepaid Insurance………………………………………………………………………..              600

Equipment…………………………………………………………………………………..         40,000

Inventories…………………………………………………………………………………..           9,000

Accounts Payable………………………………………………………………………..                        $  11,590

Common Shares………………………………………………………………………….                          110,000

Sales…………………………………………………………………………………………..                            17,100

Salaries……………………………………………………………………………………….         64,000

Office Supplies…………………………………………………………………………….           2,150

Depreciation Expense…………………………………………………………………..           2,550     _______

$143,300    $138,690

 

The assistant’s review uncovered the following errors:

1…. The accounts payable for the purchase of inventories in the amount of $6,560 was recorded as $5,650 in error.

2…. Depreciation expense was understated by $450.

3…. Office supplies were overstated by $150.

4…. A collection from a customer in the amount of $4,000 was not posted to the receivable ledger.

 

Instructions

Prepare a corrected trial balance.

 

Solution 3-96

SHD Corporation

Adjusted Trial Balance

December 31, 2017

 

Debit         Credit

Cash…………………………………………………………………………………………..         10,000

Accounts Receivable ($15,000 – $4,000)………………………………………..         11,000

Prepaid Insurance………………………………………………………………………..              600

Equipment…………………………………………………………………………………..         40,000

Inventories…………………………………………………………………………………..           9,000

Accounts Payable ($11,590 + $6,560 – $5,650)………………………………                            12,500

Common Shares………………………………………………………………………….                         110,000

Sales…………………………………………………………………………………………..                            17,100

Salaries……………………………………………………………………………………….         64,000

Office Supplies ($2,150 – $150)…………………………………………………….           2,000

Depreciation Expense ($2,550 + $450)…………………………………………..           3,000     _______

$139,600    $139,600

 

Difficulty: Hard

Learning Objective: Explain how the type of ownership structure affects the financial statements.

Section Reference: Financial Statements and Ownership Structure

CPA: Financial Reporting

CPA: Communication

Bloomcode: Analysis

 

 

Pr. 3-97 Accrual accounting

Prudence Corp.’s records provide the following information concerning certain account balances and changes in these account balances during the current year. Transaction information is missing from each item below.

 

Instructions

Prepare the entry to record the missing information for each account. (Consider each independently.)

  1. Accounts Receivable: Jan 1, balance $30,000, Dec 31, balance $37,000, uncollectible accounts written off during the year, $4,000; accounts receivable collected during the year, $134,000. Prepare the entry to record sales for the year.
  2. Allowance for Doubtful Accounts: Jan 1, balance $3,800, Dec 31 balance $7,700, uncollectible accounts written off during the year, $28,000. Prepare the entry to record bad debt expense.
  3. Accounts Payable: Jan 1, balance $20,000, Dec 31, balance $33,000, purchases on account for the year, $110,000. Prepare the entry to record payments on account.
  4. Interest Receivable: Jan 1 accrued, $3,000, Dec 31 accrued, $3,500, earned for the year, $14,000. Prepare the entry to record cash interest received.

 

Solution 3-97

  1. Ending balance $  37,000                  Ending balance                           $  37,000

Beginning balance                  30,000                  Plus:    Rec. collected                   134,000

Difference                                 7,000                  Write-offs                                          4,000

Uncollectible accounts              4,000      OR                                                            175,000

Receivables collected           134,000                  Less:    Beginning balance               30,000

Sales for period                   $145,000                  Sales for period                           $145,000

 

Accounts Receivable………………………………………………………………      145,000

Sales…………………………………………………………………………..                         145,000

 

  1. Ending balance $  7,700                  Ending balance                             $  7,700

Beginning balance                    3,800                  Write-off                                          28,000

Difference                                 3,900      OR                                                               35,700

Write-off                                  28,000                  Beginning balance                             3,800

Adjusting entry                      $31,900                  Adjusting entry                              $31,900

 

Bad Debts Expense………………………………………………………………..        31,900

Allowance for Doubtful Accounts……………………………………                           31,900

 

  1. Ending balance $  33,000                  Beginning balance                       $  20,000

Beginning balance                  20,000                  Plus purchases                              110,000

Difference                               13,000      OR                                                             130,000

Purchases                             110,000                  Less ending balance                       33,000

Payments                            $  97,000                  Payments                                    $  97,000

 

Accounts Payable…………………………………………………………………..        97,000

Cash……………………………………………………………………………                           97,000

 

  1. Revenue Earned $14,000                  Beginning balance                         $  3,000

Less: Dec. 31 accrual             (3,500)                 Plus revenue earned                       14,000

Plus: Jan. 1 accrual                  3,000      OR                                                               17,000

Cash received                       $14,500                  Less ending balance                         3,500

Cash received                               $14,500

 

Cash……………………………………………………………………………………..                           14,500

Interest Receivable……………………………………………………….                         114,500

(This entry assumes that the $14,000 interest earned   was first recorded as a receivable.)

 

Difficulty: Easy

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: The Closing Process

CPA: Financial Reporting

CPA: Communication

Bloomcode: Analysis

 

 

Pr. 3-98 Ten-column work sheet

The work sheet and trial balance of Santos Corporation is reproduced below. The information given below is relevant to the preparation of adjusting entries needed to both properly match revenues and expenses for the period and reflect the proper balances in the real and nominal accounts.

 

Instructions

As the accountant for Santos, you are to prepare adjusting entries based on the following data, entering the adjustments on the work sheet and completing the additional columns with respect to the income statement and statement of financial position. Carefully key your adjustments and label all items. (Due to time constraints, an adjusted trial balance is not required.) Round all calculations to the nearest dollar.

(a)   After an aging of accounts receivable, it was determined that three percent of the accounts will become uncollectible.

(b)   Depreciation is calculated using the straight-line method, with an eight-year life and $1,000 residual (salvage) value.

(c)   Salesmen are paid commissions of 11% of sales. Commissions on sales for the last week of December have not been paid.

(d)   The note was issued on October 1, 2017, with interest at 8%, due Feb. 1, 2018.

(e)   A physical inventory of supplies indicated $280 of supplies currently on hand.

(f)   Provisions of the company’s lease contract specify rent payments must be made one month in advance, with monthly payments of $900/mo. This provision has been complied with as of Dec. 31, 2017.

 

 

Santos Corporation

Work Sheet

Year ended December 31, 2017

 

Trial Balance          Adjustments         Adjusted Trial         Statement of         Statement of

Balance            Comp. Income     Financial position

Accounts                        Dr.          Cr.          Dr.          Cr.            Dr.          Cr.          Dr.          Cr.       Dr.          Cr.

Cash                           5,400

Marketable Securities   4,050

Accounts Receivable  40,000

Allow. for D. A.                             420

Inventory                   16,800

Supplies                      1,040

Equipment                 49,000

Accum. Depr.–Equip.                 9,500

Accounts Payable                      4,400

Notes Payable                           4,250

Common Shares                       40,000

Retained Earnings                     25,340

Cost of Goods Sold 238,520

Office Salaries           20,800

Sales Commissions   29,000

Rent Expense              7,200

Misc. Expense             2,200

Sales                      _______   330,100

Totals               414,010   414,010

 

Solution 3-98

Santos Corporation

Work Sheet

December 31, 2017

 

Trial Balance          Adjustments         Adjusted Trial         Statement of         Statement of

Balance            Comp. Income     Financial position

Accounts                        Dr.          Cr.          Dr.          Cr.            Dr.          Cr.          Dr.          Cr.       Dr.          Cr.

Cash                           5,400                                                   5,400                                                 5,400

Marketable Securities   4,050                                                   4,050                                                4,050

Accounts Receivable  40,000                                                 40,000                                               40,000

Allow. for D. A.                               420                   (a) 780                    1,200                                                 1,200

Mdse. Inventory         16,800                                                 16,800                                               16,800

Supplies                      1,040                                   (e) 760         280                                                   280

Equipment                 49,000                                                 49,000                                               49,000

Accum. Depr.–Equip.                   9,500                (b) 6,000                   15,500                                               15,500

Accounts Payable                        4,400                                                 4,400                                                 4,400

Notes Payable                             4,250                                                 4,250                                                 4,250

Common Stock                         40,000                                               40,000                                               40,000

Retained Earnings                      25,340                                               25,340                                               25,340

Cost of Goods Sold 238,520                                                238,520                 238,520

Office Salaries           20,800                                                 20,800                   20,800

Sales Commissions   29,000                 (c) 7,311                    36,311                   36,311

Rent Expense              7,200                                    (f) 900      6,300                    6,300

Misc. Expense             2,200                                                   2,200                    2,200

Sales                        ______     330,100                                              330,100                 330,100

Totals               414,010     414,010

 

Bad Debt Expense                                 (a) 780                          780                       780

Depr. Expense                                     (b) 6,000                      6,000                    6,000

Sales Com. Payable                                             (c) 7,311                    7,311                                                 7,311

Interest Expense                                      (d) 85                            85                         85

Interest Payable                                                       (d) 85                         85                                                     85

Supplies Expense                                  (e) 760                          760                       760

Prepaid Rent                                          (f) 900      ______         900                _______    ______         900    ______

Totals                                             15,836       15,836                               311,756   330,100   116,430     98,086

Net Income                                                                           ______    ______     18,344    ______    ______     18,344

Totals                                                                          428,186   428,186   330,100   330,100   116,430   116,430

 

 

 

Santos Corporation

Work Sheet

Adjusted Trial Balance

Accounts                                                                                                             Debit         Credit

Cash…………………………………………………………………………………………..           5,400

Marketable Securities…………………………………………………………………..           4,050

Accounts Receivable……………………………………………………………………         40,000

Allow. for D. A……………………………………………………………………………..                              1,200

Mdse. Inventory…………………………………………………………………………..         16,800

Supplies………………………………………………………………………………………              280

Equipment…………………………………………………………………………………..         49,000

Accum. Depr.–Equipment…………………………………………………………….                            15,500

Accounts Payable………………………………………………………………………..                              4,400

Notes Payable……………………………………………………………………………..                              4,250

Common Stock……………………………………………………………………………                            40,000

Retained Earnings………………………………………………………………………..                            25,340

Cost of Goods Sold………………………………………………………………………       238,520

Office Salaries…………………………………………………………………………….         20,800

Sales Commissions………………………………………………………………………         36,311

Rent Expense………………………………………………………………………………           6,300

Misc. Expense……………………………………………………………………………..           2,200

Sales…………………………………………………………………………………………..      _______      330,100

Totals……………………………………………………………………………………       419,661      420,790

 

Bad Debt Expense……………………………………………………………………….              780

Depr. Expense…………………………………………………………………………….           6,000

Sales Com. Payable…………………………………………………………………….                              7,311

Interest Expense………………………………………………………………………….                85

Interest Payable…………………………………………………………………………..                                   85

Supplies Expense…………………………………………………………………………              760

Prepaid Rent……………………………………………………………………………….              900

Totals……………………………………………………………………………………       428,186      428,186

 

Adjusting entries and explanations

  1. Bad Debt Expense…………………………………………………………………. 780

Allowance for Doubtful Accounts……………………………………….                                780

(3% of accounts receivable is 3% × $40,000, which is $1,200. Since the allowance account has a credit balance       of $420 before adjustment, $780 must be added to the allowance account.)

 

  1. Depreciation Expense……………………………………………………………. 6,000

Accumulated Depreciation—Equipment……………………………..                             6,000

($49,000 – $1,000 is $48,000. One-eighth of $48,000 is $6,000.)

 

  1. Sales Commissions………………………………………………………………….. 7,311

Sales Commissions Payable………………………………………………..                          7,311

(11% of sales is 11% × $330,100, which is $36,311. The balance in the Sales Commissions account is $29,000        before adjustment, indicating that $7,311 of commissions are accrued but unpaid.)

 

  1. Interest Expense………………………………………………………………………. 85

Interest Payable………………………………………………………………….                               85

($4,250 × .08 × 3 ÷ 12 = $85)

 

  1. Supplies Expense…………………………………………………………………….. 760

Supplies…………………………………………………………………………….                             760

(The balance of $1,040 in the Supplies account before adjustment less the correct ending balance of $280 is $760.)

 

  1. Prepaid Rent……………………………………………………………………………. 900

Rent Expense…………………………………………………………………….                             900

(Since the trial balance contains no account for prepaid rent, the $900 lease payment has apparently been debited to Rent Expense. An account must be set up for the Prepaid Rent.)

 

Difficulty: Medium

Learning Objective: Prepare closing entries and consider other matters relating to the closing process.

Section Reference: The Closing Process

CPA: Financial Reporting

CPA: Communication

Bloomcode: Analysis

 

 

Pr. 3-99 Preparation of Financial Statements

Use the following information to prepare a multi-step Statement of Comprehensive Income, a Statement of Changes in Shareholders Equity, and a classified Statement of Financial Position.

 

Charles Corporation

Adjusted Trial Balance

December 31, 2017

                                                                                                                            Debit         Credit

Cash…………………………………………………………………………………………..      $ 33,400

Accounts Receivable……………………………………………………………………         87,400

Merchandise Inventory…………………………………………………………………         90,000

Store Supplies……………………………………………………………………………..           7,000

Store Equipment………………………………………………………………………….      170,000

Accumulated Depreciation—Store Equipment…………………………………                            54,000

Delivery Equipment………………………………………………………………………         96,000

Accumulated Depreciation—Delivery Equipment…………………………….                            26,000

Notes Payable……………………………………………………………………………..                            82,000

Accounts Payable………………………………………………………………………..                          117,000

Common Shares………………………………………………………………………….                          200,000

Retained Earnings………………………………………………………………………..                            16,000

Sales…………………………………………………………………………………………..                       1,494,400

Sales Return and Allowances………………………………………………………..           8,400

Cost of Goods Sold………………………………………………………………………      994,800

Salaries Expense…………………………………………………………………………       280,000

Advertising Expense…………………………………………………………………….        52,800

Utilities Expense…………………………………………………………………………..        28,000

Repair Expense……………………………………………………………………………        24,200

Delivery Expense…………………………………………………………………………        33,400

Rent Expense………………………………………………………………………………        48,000

Store Supplies Expense………………………………………………………………..           4,000

Depreciation Expense Store Equipment………………………………………….        18,000

Depreciation Expense Delivery Equipment……………………………………..        14,000

Interest Expense………………………………………………………………………….        22,000

Interest Payable…………………………………………………………………………..    ________        22,000

Totals…………………………………………………………………………………….    2,011,400   2,011,400

 

Other Data:

  1. Salaries expense is 70% selling and 30% administrative.
  2. Rent expense and utilities expense are 80% selling and 20% administrative.
  3. $60,000 of notes payable are due for payment within 12 months.
  4. Repair expense is 100% administrative.

 

Solution 3-99

Charles Corporation

Statement of Comprehensive Income

Year Ended December 31, 2017

Sales revenue

Sales……………………………………………………………………                                        $1,494,400

Less: Sales returns and allowances…………………………                                                 8,400

Net sales…………………………………………………………………….                                          1,486,000

Cost of goods sold……………………………………………………….                                             994,800

Gross profit…………………………………………………………………                                             491,200

Operating expenses

Selling expenses

Salaries expense…………………………………………….     $196,000

($280,000 x 70%)

Advertising expense………………………………………..         52,800

Rent expense…………………………………………………         38,400

($48,000 x 80%)

Delivery expense……………………………………………         33,400

Utilities expense……………………………………………..         22,400

($28,000 x 80%)

Depr. exp.—store equipment……………………………         18,000

Depr. exp.—delivery equipment……………………….         14,000

Stores supplies expense………………………………….           4,000

Total selling expenses……………………………….                        $379,000

Administrative expenses

Salaries expense…………………………………………….         84,000

($280,000 x 30%)

Repair expense………………………………………………         24,200

Rent expense…………………………………………………           9,600

($48,000 x 20%)

Utilities expense……………………………………………..           5,600

($28,000 x 20%)

Total admin. expenses………………………………                         123,400

Total operating expenses…………………….                                            502,400

Loss from operations……………………………………………………                                               11,200

Other expenses and losses

Interest expense……………………………………………………                                               22,000

Net loss………………………………………………………………………                                             $33,200

 

 

  Charles Corporation
  Statement of Changes in Shareholders’ Equity
  for Year Ended December 31, 2017
  Total Common Shares Comprehensive Income Retained Earnings  
Beginning, Jan 1, 2017  $ 216,000 $ 200,000    $  16,000  
Net loss for 2017          (33,200)     (33,200)  (33,200)  
Other comprehensive income          
Comprehensive income       (33,200)    
Ending, Dec 31, 2017  182,800 200,000   (17,200)  

 

 

Charles Corporation

Statement of Financial Position

December 31, 2017

 

Assets

Current assets

Cash……………………………………………………………………                                           $  33,400

Accounts receivable………………………………………………                                               87,400

Merchandise inventory…………………………………………..                                               90,000

Store supplies……………………………………………………….                                                 7,000

Total current assets…………………………………………                                             217,800

Non-current assets

Store equipment……………………………………………………     $170,000

Accumulated depreciation—store equipment……………         54,000    $116,000

Delivery equipment……………………………………………….         96,000

Accumulated depreciation—delivery equipment……….         26,000       70,000      186,000

Total assets……………………………………………………                                           $403,800

 

Liabilities and Shareholders’ Equity

Current liabilities

Current portion of notes payable……………………………..                                           $  60,000

Accounts payable………………………………………………….                                             117,000

Interest payable…………………………………………………….                                               22,000

Total current liabilities………………………………………                                             199,000

Non-current liabilities

Notes payable………………………………………………………                                               22,000

Total liabilities…………………………………………………                                             221,000

Shareholders’ equity

Common Shares…………………………………………………..                        $200,000

Deficit………………………………………………………………….                        (17,200)     182,800

Total liabilities and shareholders’ equity……………………                                           $403,800

 

Difficulty: Medium

Learning Objective: Prepare a 10-column work sheet and financial statements.

Section Reference: Using a Work Sheet

CPA: Financial Reporting

CPA: Communication

CPA: Management Accounting

Bloomcode: Analysis

 

 

 

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