2011 AICPA financial questions

Governmental fund financial statements would record the asset financed by a capital lease as an expenditure and the lease financing as other financing sources under modified accrual acco

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Following are multiple choice questions and simulations recently released by the

AICPA These questions were released by the AICPA with letter answers only Our editorial board has provided the accompanying explanation

Please note that the AICPA generally releases questions that it does NOT intend to use again These questions and content may or may not be representative of questions you may see on any upcoming exams

Of the four expenses listed in the fact pattern, two are clearly support services as follows:

Management and general 200,000

Education and Research expenses are likely program services of the Fen Museum

Choice "a" is incorrect The proposed answer combines the likely program service amounts associated with Education and Research to arrive at $350,000 Program services would not be displayed as support services

Choice "c" is incorrect The proposed answer either combines the likely program service amount

associated with Education and the Support service of Management and General to arrive at $500,000 or combines the program service amount associated with Research and all Support services to arrive at

$500,000 Program services would not be displayed as support services

Choice "d" is incorrect The proposed answer combines all the amounts in the fact pattern, both program and support services, to arrive at $800,000 Program services would not be displayed as support

services

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2

In January, Stitch, Inc adopted the dollar-value LIFO method of inventory valuation At adoption,

inventory was valued at $50,000 During the year, inventory increased $30,000 using base-year prices, and prices increased 10% The designated market value of Stitch's inventory exceeded its cost at year end What amount of inventory should Stitch report in its year-end balance sheet?

Choice "b" is correct Since inventory increased $30,000 using base-year prices, under dollar value LIFO

we must restate this increase by the appropriate price-level index, in this case 10% $30,000 times 10% equals $3,000, so this increase actually becomes $33,000 using current-year prices Therefore, the amount of inventory Stitch should report in its year-end balance sheet is the $50,000 at adoption plus the

$33,000 increase, so $83,000 in total since they are utilizing dollar-value LIFO for inventory valuation Choice "a" is incorrect $80,000 would only be correct if we were not utilizing dollar-value LIFO

Choice "c" is incorrect $85,000 Is incorrect since we do not have to adjust the original $50,000

Choice "d" is incorrect $88,000 is incorrect since we only have to adjust the $30,000 increase

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Jonn City entered into a capital lease for equipment during the year How should the asset obtained through the lease be reported in Jonn City's government-wide statement of net assets?

a General capital asset

b Other financing use

Governmental fund financial statements would record the asset financed by a capital lease as an

expenditure and the lease financing as other financing sources under modified accrual accounting Choice "b" is incorrect Although governmental fund financial statements (GRaSPP funds) would initially record an asset financed by a capital lease as an expenditure and the lease financing as other financing sources under modified accrual accounting, capital lease obligations associated with governmental activities are recorded as an asset and as a liability on the full accrual government-wide financial

statements

Choice "c" is incorrect Although governmental fund financial statements (GRaSPP funds) would initially record an asset financed by a capital lease as an expenditure and the lease financing as other financing sources under modified accrual accounting, capital lease obligations associated with governmental activities are recorded as an asset and as a liability on the full accrual government-wide financial

statements

Choice "d" is incorrect Capital lease obligations associated with general governmental activities are recorded as an asset and as a liability on the full accrual government-wide financial statements Capital outlay would be recorded as an expenditure in the modified accrual governmental fund financial

statements Lease financing would be recorded as other financing sources in the fund financial

statements Governments would report capital lease activity in both fund and government-wide financial statements

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4

Jane Co owns 90% of the common stock of Dun Corp and 100% of the common stock of Beech Corp

On December 30, Dun and Beech each declared a cash dividend of $100,000 for the current year What

is the total amount of dividends that should be reported in the December 31 consolidated financial statements of Jane and its subsidiaries, Dun and Beech?

$100,000 would be eliminated Therefore, just 10% of Dun's $100,000 dividend, or $10,000, will appear

in Jane and subs' year-end consolidated financial statements

Choice "b" is incorrect $100,000 is incorrect since we do not present half the dividends just because we don't own 100% of one sub

Choice "c" is incorrect $190,000 out of $200,000 in dividends are "eliminated", leaving us with $10,000 reported in the consolidated financial statements

Choice "d" is incorrect $200,000 are the total dividends declared, but the $190,000 paid to Jane gets eliminated when the financial statements are consolidated

Choice "b" is correct Under the par value method, when the shares are (re)acquired by Lem, the

treasury stock is recorded at par value ($6/share) and additional paid-in-capital is reduced by the $100 recorded when the shares were originally issued The difference, in this case between the $10 buy-back price and the $7 initial issuance price, or $3/share, is assigned to retained earnings as a reduction Here are the journal entries for additional clarification:

Choice "c" is incorrect The $300 difference between the $1,000 paid by the company to reacquire the shares and the $700 originally received when the shares were issued to investors is recorded as a

reduction to retained earnings

Choice "d" is incorrect The $400 is the amount of both the debit to APIC and the debit to retained

earnings This question asks only for the reduction in APIC

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6

Abbott Co is preparing its statement of cash flows for the year Abbott's cash disbursements during the year included the following:

Payment of interest on bonds payable $500,000

Payment to acquire 1,000 shares

What should Abbott report as total cash outflows for financing activities in its statement of cash flows under U.S GAAP?

of interest on the bonds payable is an operating cash outflow under U.S GAAP and the payment to acquire the common stock of Marks is an investing cash outflow

Choice "a" is incorrect The $300,000 dividend to stockholders should be classified as a financing cash outflow

Choice "c" is incorrect The $500,000 payment of interest, although related to a financing activity, is not reported in the financing section under U.S.GAAP It is reported as an operating cash outflow

Choice "d" is incorrect The $100,000 payment to acquire someone else's common stock should be classified as an investing activity

7

In preparing Chase City's reconciliation of the statement of revenues, expenditures, and changes in fund balances to the government-wide statement of activities, which of the following items should be

subtracted from changes in fund balances?

a Capital assets purchases

b Payment of long-term debt principal

c Internal service fund increase in net assets

d Book value of capital assets sold during the year

Solution:

Choice "d" is correct The elimination of the book value of a previously acquired asset has no impact on fund financial statements but serves to reduce the changes in net assets of the government-wide financial statements as the asset is written off (net of proceeds and accumulated depreciation) The book value of capital assets is, therefore, essentially subtracted from change in fund balance to reconcile to the change

in government-wide net assets Actual reconciling items might focus more on the computation of a gain

or loss and proceeds from the disposal rather than individual components such as the asset book value Choice "a" is incorrect Capital asset purchases are added back to the changes in fund balance to reconcile to the change in net assets displayed on the government-wide statement of activities Capital asset purchases are displayed as an expenditure in fund financial statements but are capitalized in the government-wide financial statements Capital outlay is the "E" in "GOES" and is added back, not

subtracted

Choice "b" is incorrect Payment of long term debt principal is added back to the changes in fund balance

to reconcile to the change in net assets displayed on the government-wide statement of activities

Payment of long term debt principal is displayed as an expenditure in fund financial statements but is shown as a reduction liabilities in the government-wide financial statements Principal payment on debt is part of the "E" in "GOES" and is added back, not subtracted

Choice "c" is incorrect Increases in internal service fund net assets would be added to the changes in fund balance to reconcile to the change in net assets displayed on the government-wide statement of activities A net loss in the internal service funds would be subtracted Internal Service fund activity is the

"S" in "GOES" and is added back

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8

Neron Co has two derivatives related to two different financial instruments, instrument A and instrument

B, both of which are debt instruments The derivative related to instrument A is a fair value hedge, and the derivative related to instrument B is a cash flow hedge Neron experienced gains in the value of instruments A and B due to a change in interest rates Which of the gains should be reported by Neron in its income statement?

Choice "a" is incorrect Only fair value hedge gains and losses should be reported within the income statement

Choice "c" is incorrect This selection is backwards Fair value gains and losses appear on the income statement while cash flows gains and losses should be presented as a component of other

comprehensive income (PUFER)

Choice "d" is incorrect Fair value hedge gains and losses are to be reported within the income

statement

9

Fern Co has net income, before taxes, of $200,000, including $20,000 interest revenue from municipal bonds and $10,000 paid for officers' life insurance premiums where the company is the beneficiary The tax rate for the current year is 30% What is Fern's effective tax rate?

- Municipal bond income (20,000)

+ Life insurance premiums 10,000

The $20,000 of municipal bond income is subtracted because it is not taxable income The insurance premiums are added back because they are not deductible Because there are no temporary differences and no deferred taxes, income tax expense is equal to taxable income times the current period tax rate: Income tax expense = Taxable income x Tax rate = $190,000 x 30% = $57,000

The effective tax rate can then be calculated as income tax expense divided by pretax income:

Effective tax rate = Income tax expense / Pretax income = $57,000 / $200,000 = 28.5%

Choice "a" is incorrect This answer choice would result if you computed $180,000 times 30% or $54,000 and divided this back by the $200,000 However, this is incorrect since you must remember to add back the $10,000 in insurance premiums

Choice "c" is incorrect The effective tax rate is equal to income tax expense divided by pretax income The effective tax rate is not equal to the current year tax rate of 30% due to the existence of the two permanent differences

Choice "d" is incorrect This answer choice would result if the municipal bond income was added and the life insurance premiums were subtracted when calculating taxable income The $20,000 of municipal bond income should be subtracted because it is not taxable income The insurance premiums should be added back because they are not deductible

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10

Assuming constant inventory quantities, which of the following inventory-costing methods will produce a lower inventory turnover ratio in an inflationary economy?

a FIFO (first in, first out)

b LIFO (last in, first out)

inventory would be higher, causing our average inventory to be higher as well Therefore, FIFO will result

in a lowest inventory turnover in an inflationary environment assuming constant inventory quantities Choice "b" is incorrect LIFO's effects would be the reverse LIFO results in a higher COGS figure and a lower ending inventory valuation amount which in turn causes a lower average inventory valuation

amount as well Therefore, LIFO would yield a higher inventory turnover ratio in an inflationary

environment, not a lower one, assuming constant inventory quantities

Choice "c" is incorrect The moving average inventory costing method would result in an inventory turnover ratio between those calculated using FIFO and LIFO

Choice "d" is incorrect The weighted average inventory costing method would result in an inventory turnover ratio between those calculated using FIFO and LIFO

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Hilltop Co.'s monthly bank statement shows a balance of $54,200 Reconciliation of the statement with company books reveals the following information:

Check deposited by Hilltop and cleared by the bank for $125,

but improperly recorded by Hilltop as $152

What is the net cash balance after the reconciliation?

Any other reconciling items, namely service charges, NSF checks, credit memos (customer collections via wire transfer), interest income, and errors made by the company are only reconciling items to the balance per the books or general ledger balance, and this balance was not provided here

Therefore, starting with the $54,200, the only two things we can do are to add the deposits in transit of

$350 and subtract the outstanding checks of $1,500 This yields us a corrected or adjusted cash balance

of $53,050

Choices "a", "b", and "d" are incorrect The bank service charge, NSF check, and recording error are only reconciling items to the book, or GL, balance, but the examiners did not provide us with this amount

permanently restricted investment

Choice "a" is incorrect Investment earnings and growth are accounted for as temporarily restricted Choice "b" is incorrect Temporarily restricted earnings would include both the investment growth of

$10,000 as well as the $40,000 in earnings

Choice "c" is incorrect Temporarily restricted earnings would include both the $40,000 in earnings as well as investment growth of $10,000

semiannual, using present value of an annuity tables and factors at the same market or effective interest rate (yield) Remember that the face rate of interest only has one job, and this is to compute the regular interest payments It's the market rate of interest that will determine the bond's selling price

Choice "b" is incorrect The par value of the bond is also known as the maturity value since this is the amount that must be paid back at maturity

Choice "c" is incorrect The yield is another term for market or effective interest rate It is this rate that will be used when using the PV table and the PV annuity table to determine the issue price of the bond Choice "d" is incorrect Interest will be paid semiannually (usually) or annually, and this interest must be present valued at the market rate along with the bond principal in order to come up with the bond price

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14

A company calculated the following data for the period:

Cash received from sale of equipment 1,000

What amount should the company report as net cash provided by operating activities in its statement of cash flows?

Net cash provided by operating activities $14,000

Choice "b" is incorrect The $1,000 of cash received from sale of equipment would fall under the

investing activities section along with any other capital expenditures or other investments

Choice "c" is incorrect The $3,000 of interest paid to bank on note, while related to a financing activity, is actually classified as an operating activity within the statement of cash flows

Choice "d" is incorrect The $8,000 of cash paid to employees is considered an operating activity and therefore must be deducted from this section This section looks very much like a cash-basis income statement

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A company records items on the cash basis throughout the year and converts to an accrual basis for year-end reporting Its cash-basis net income for the year is $70,000 The company has gathered the following comparative balance sheet information:

Choice "c" is correct One approach for converting from cash-basis to accrual-basis is as follows:

1) Add increases in current assets For example, when AR increases, the increase is not

considered to be income under the cash basis because the cash has not been collected, but the increase is income under the accrual basis

2) Subtract decreases in current assets Conversely, when AR decreases, then cash-basis counted

it as revenue when the cash was collected, but under the accrual basis, the income was

recognized in a prior period and should not be recognized again in the current period

3) Add decreases in current liabilities For example, when AP decreases, this represents a cash outflow that is recorded as an expense under the cash basis However, under the accrual basis the paid expenses were recorded in a prior period and should not be recorded again in the current period

4) Subtract increases in current liabilities Conversely, when AP increases, this represents

expenses incurred under the accrual basis method that have not been recorded under the cash basis method because they have not been paid

Therefore, starting with the $70,000, we add the $2,000 decrease in AP, subtract the $200 and $100 increases in unearned revenue and wages payable, add the $300 increase in prepaid rent, and finally subtract the $800 decrease in accounts receivable:

$70,000 + $2,000 - $300 + $300 - $800 = $71,200

Choices "a", "b", and "d" are incorrect as per the rules above

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What are the components of the lease receivable for a lessor involved in a direct-financing lease?

a The minimum lease payments plus any executory costs

b The minimum lease payments plus residual value

c The minimum lease payments less residual value

d The minimum lease payments less initial direct costs

Solution:

Choice "b" is correct Lessors recording a lease receivable for a direct-financing lease should include the minimum lease payments PLUS any residual value The reason for this is because the lessor can also expect to collect this residual value from the lessee at the culmination of the lease

Choice "a" is incorrect Executory costs, like insurance, taxes, and maintenance, are always recorded separately and do not affect the computation of the minimum lease payments nor the lease receivable Choice "c" is incorrect The residual value needs to be added, not subtracted, since the lessee is

obligated to pay this to the lessor at the culmination of the lease

Choice "d" is incorrect Initial direct costs, like executory costs, do not affect the computation of the lease receivable

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18

When the effective interest method of amortization is used for bonds issued at a premium, the amount of interest payable for an interest period is calculated by multiplying the:

a Face value of the bonds at the beginning of the period by the contractual interest rate

b Face value of the bonds at the beginning of the period by the effective interest rates

c Carrying value of the bonds at the beginning of the period by the contractual interest rate

d Carrying value of the bonds at the beginning of the period by the effective interest rates

Solution:

Choice "a" is correct The interest payable on a bond is calculated by taking the face value of the bond at the beginning of the period and multiply this amount by the contractual interest rate

Choice "b" is incorrect This calculation is not used in bond accounting

Choice "c" is incorrect This calculation is not used in bond accounting

Choice "d" is incorrect This is the formula used to calculate the interest expense on a bond

19

In year 1, a company reported in other comprehensive income an unrealized holding loss on an

investment in available-for-sale securities During year 2, these securities were sold at a loss equal to the unrealized loss previously recognized The reclassification adjustment should include which of the following?

a The unrealized loss should be credited to the investment account

b The unrealized loss should be credited to the other comprehensive income account

c The unrealized loss should be debited to the other comprehensive income account

d The unrealized loss should be credited to beginning retained earnings

Solution:

Choice "b" is correct In year 1, the company would have debited an unrealized holding loss within other comprehensive income (the U in PUFER) and they would have credited either the investment account itself or more likely a valuation allowance associated with this asset account In Year 2 when these securities were sold for the exact same loss, the company would need to eliminate this unrealized loss from OCI by crediting it and record a realized loss on the income statement by debiting it

Choice "a" is incorrect The investment account would need to be credited at the time of the sale for the carrying value of the investment

Choice "c" is incorrect The unrealized loss was debited in Year 1 when the unrealized loss was initially recorded, so a credit is needed to eliminate it

Choice "d" is incorrect The unrealized loss would not affect retained earnings, although the realized loss certainly would

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20

Toigo Co purchased merchandise from a vendor in England on November 20 for 500,000 British pounds Payment was due in British pounds on January 20 The spot rates to purchase one pound were as follows:

a A gain of $40,000 as a separate component of stockholders' equity

b A gain of $40,000 in the income statement

c A gain of $25,000 as a separate component of stockholders' equity

d A gain of $25,000 in the income statement

Choices "a", "b", and "c" are incorrect Since it's only December 31st, we will not recognize all $40,000 in the first year, and foreign currency transaction gains like these are reported on the income statement Foreign currency translation gains and losses are reported in other comprehensive income and

recognized as a separate component of stockholders' equity

21

A company enters into a three-year operating lease agreement effective January 1, year 1 The amounts due on the first day of each year are $25,000 in year 1, $30,000 in year 2, and $35,000 in year 3 What amount, if any, is the related liability on the first day of year 2?

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22

Damon Co purchased 100% of the outstanding common stock of Smith Co in an acquisition by issuing 20,000 shares of its $1 par common stock that had a fair value of $10 per share and providing contingent consideration that had a fair value of $10,000 on the acquisition date Damon also incurred $15,000 in direct acquisition costs On the acquisition date, Smith had assets with a book value of $200,000, a fair value of $350,000, and related liabilities with a book and fair value of $70,000 What amount of gain should Damon report related to this transaction?

Choice "b" is correct Please see following journal entry with additional details and explanation:

Investment in Smith 280,000 ($350,000 asset fair value less $70,000 liabilities fair value)

Common Stock 20,000 (20,000 shares times $1 par value)

Add'l-paid-in-capital 165,000 (20,000 shares times $9 excess, less $15,000 in dir acq costs) Contingent consideration 10,000 (given)

Cash 15,000 (direct acquisition costs)

Choice "a" is incorrect Component units may be presented using either the discrete or blended method within the financial statements of the primary reporting entity Consolidation is not an acceptable method

to present component units

Choice "b" is incorrect Component units may be presented using either the discrete or blended method within the financial statements of the primary reporting entity The "cost method" is not an acceptable or recognized method to present component units

Choice "d" is incorrect Component units may be presented using either the discrete or blended method within the financial statements of the primary reporting entity Government-wide presentation is a

component of basic financial statement presentation and is not an acceptable or recognized method to present component units

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24

Which of the following statements correctly describes the proper accounting for nonmonetary exchanges that are deemed to have commercial substance?

a It defers any gains and losses

b It defers losses to the extent of any gains

c It recognizes gains and losses immediately

d It defers gains and recognizes losses immediately

Solution:

Choice "c" is correct For nonmonetary exchanges that contain commercial substance, meaning that the amount and timing of future cash flows changes as a result of this exchange, gains and losses are recognized immediately

Choice "a" is incorrect Losses are never deferred, no matter whether the exchange contains commercial substance or not A portion of a gain can only be deferred for nonmonetary exchanges that do NOT contain commercial substance, meaning the amount and timing of future cash flows did not change as a result of this exchange, and only if boot (cash) is RECEIVED as a minor component (less than 25%) of this transaction

Choice "b" is incorrect Losses are never deferred, no matter whether the exchange contains commercial substance or not

Choice "d" is incorrect Losses are recognized immediately, but a portion of a gain can only be deferred for nonmonetary exchanges that do NOT contain commercial substance, meaning the amount and timing

of future cash flows did not change as a result of this exchange, and only if boot (cash) is RECEIVED as

a minor component (less than 25%) of this transaction

However, since this exchange lacks commercial substance, Campbell can only recognize a gain if it received boot/cash If boot/cash is given, or there is no boot or cash in the transaction, then no gain is recognized Because Campbell pays cash of $700, not gain is recognized Therefore, the journal entry

to record the transaction and "plug" for the book value of the Truck received by Campbell is:

Accumulated depreciation 20,000

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26

The replacement cost of an inventory item is below the net realizable value and above the net realizable value less a normal profit margin The inventory item's original cost is above the net realizable value Under the lower of cost or market method, the inventory item should be valued at:

a Original cost

b Replacement cost

c Net realizable value

d Net realizable value less normal profit margin

Solution:

Choice "b" is correct The market value of the inventory is the middle value of the replacement cost, the market ceiling (net realizable value) and the market floor (net realizable value – normal profit margin) Because replacement cost falls between the market ceiling and the market floor, it is considered to be the market value of the inventory

Under U.S GAAP, the inventory is reported at the lower of cost or market Because the cost is above the replacement cost (market value), the inventory is reported at replacement cost

Choice "a" is incorrect The inventory is not reported at original cost because the original cost exceeds the market value (replacement cost) Under U.S GAAP, inventory is reported at the lower of cost or market

Choice "c" is incorrect The inventory is not reported at net realizable value because the net realizable value exceeds the replacement cost and the replacement cost exceeds net realizable value less normal profit margin Therefore, the replacement cost is the market value of the inventory and is the amount used to determine lower of cost or market

Choice "d" is incorrect The inventory is not reported at net realizable value less normal profit margin because this amount is less than the replacement cost and the replacement cost is less than net

realizable value Therefore, the replacement cost is the market value of the inventory and is the amount used to determine lower of cost or market

Choice "d" is correct An enterprise fund would not use encumbrance accounting Encumbrance

accounting is used in the governmental (GRaSPP) funds but is not used in the proprietary (SE) or

fiduciary (PAPI) funds Enterprise is the "E" in "SE"

Choice "a" is incorrect A capital projects fund would use encumbrance accounting Encumbrance accounting is used in the governmental (GRaSPP) funds but is not used in the proprietary (SE) or

fiduciary (PAPI) funds Capital projects is the first "P" in "GRaSPP"

Choice "b" is incorrect A special revenue fund would use encumbrance accounting Encumbrance accounting is used in the governmental (GRaSPP) funds but is not used in the proprietary (SE) or

fiduciary (PAPI) funds Special Revenue is the "R" in "GRaSPP"

Choice "c" is incorrect The general fund would use encumbrance accounting Encumbrance accounting

is used in the governmental (GRaSPP) funds but is not used in the proprietary (SE) or fiduciary (PAPI) funds The General fund is the "G" in "GRaSPP"

b Investment trusts fund

c Private-purpose trusts fund

d Special revenue fund

Solution:

Choice "a" is correct The gift will be accounted for in a permanent fund Permanent funds are used to report resources that are legally restricted to the extent income, and not principal, may be used for purposes supporting the reporting government's programs for the benefit of the public The library is to

be supported by a gift endowment and the library is intended to support the needs of the general

community, not a specifically identified individual

Choice "b" is incorrect Investment trust funds are used to account for external investment pools An endowment contributed in support of a library to benefit the public is not an external investment pool Choice "c" is incorrect Private purpose trust funds are fiduciary relationships that do not meet the

definition of a pension, agency or investment trust fund and are intended for the benefit of specific

individuals, private organizations or other governments The library to be benefitted by the endowment is for the general public, not specific private individuals

Choice "d" is incorrect Special revenue funds account for revenues from specific taxes or other

earmarked sources that (by law) are restricted or committed to finance particular activities of a

government Roy City is accounting for income from a gift that is not appropriate for accounting within a special revenue fund