CMA finance decision making part 2

Answer D is incorrect because A increase in the speed with which accounts payable invoices are paid signifies a fasteroutflow of cash for payment of the liabilities, meaning a decrease i

[1] The Foreign Corrupt Practices Act prohibits

Bribes to all foreigners

Answer (A) is incorrect because Bribes to all foreigners is not covered by the provisions in the FCPA

Answer (B) is incorrect because Small bribes to foreign officials that serve as facilitating or grease payments is notcovered by the provisions in the FCPA

Answer (C) is incorrect because All U.S firms are subject to the anti-bribery provisions

Answer (D) is correct The Foreign Corrupt Practices Act (FCPA) prohibits any U.S firm from making bribes to

foreign officials to influence official acts The businesses subject to the FCPA include corporations, partnerships,limited partnerships, business trusts, and unincorporated organizations Violations of the FCPA are federal

felonies The penalties are up to 5 years in prison or up to a $100,000 fine or both for an officer, director, or

shareholder who helps make the bribe

[2] A major impact of the Foreign Corrupt Practices Act of 1977 is that registrants subject to the Securities Exchange Act of

1934 are now required to

Keep records that reflect the transactions and dispositions of assets and to maintain a system of internal accountingcontrols

Answer (A) is correct The main purpose of the Foreign Corrupt Practices Act of 1977 is to prevent bribery by

firms that do business in foreign countries A major ramification is that it requires all companies that must registerwith the SEC under the Securities Exchange Act of 1934 to maintain adequate accounting records and a system ofinternal accounting control

Answer (B) is incorrect because Authorized agents of the federal government already have access to records ofSEC registrants

Answer (C) is incorrect because Although some international accounting standards have been promulgated, theyare incomplete and have not gained widespread acceptance

Answer (D) is incorrect because There are no requirements for providing periodic reports on foreign commerce orforeign political party affiliations

[3] The reporting of accounting information plays a central role in the regulation of business operations The importance ofsound internal control practices is underscored by the Foreign Corrupt Practices Act of 1977 which requires publicly

owned U.S corporations to maintain systems of internal control that meet certain minimum standards Preventive

controls are an integral part of virtually all accounting processing systems, and much of the information generated by the

accounting system is used for preventive control purposes Which one of the following is not an essential element of a

sound preventive control system?

Separation of responsibilities for the recording, custodial, and authorization functions

Answer (A) is incorrect because Segregation of functions makes it more difficult for one person both to perpetrate andconceal an irregularity.

Answer (B) is incorrect because Hiring honest and capable employees prevents many problems

Answer (C) is incorrect because Documentation provides a guide for conduct

Answer (D) is correct Preventive controls are designed to prevent an error or irregularity from occurring State-of-the-art

hardware and software would presumably incorporate the latest control features, but a less advanced system could verywell contain a sound preventive control structure Hence, state-of-the-art components are not essential for effective

Answer (C) is correct The Foreign Corrupt Practices Act of 1977 prohibits bribes to foreign officials for purposes

of obtaining or retaining business The Act also requires companies to maintain effective systems of internal

control

Answer (D) is incorrect because The North American Free Trade Agreement (NAFTA), passed in 1993, providesfor free trade among the nations of Canada, Mexico, and the U.S

[5] Which of the following is not an aspect of the Foreign Corrupt Practices Act of 1977?

It subjects management to fines and imprisonment

Answer (A) is incorrect because This is a provision of the Act

Answer (B) is incorrect because This is a provision of the Act

Answer (C) is correct The Foreign Corrupt Practices Act of 1977 prohibits bribes to foreign officials and requires

firms to have adequate systems of internal control Violation of the Act subjects individual managers to fines

and/or imprisonment The Act does not specifically require the establishment of audit committees, but many firmshave established audit committees as one means of dealing with the internal control provisions of the Act

Answer (D) is incorrect because This is a provision of the Act

[6] Firms subject to the reporting requirements of the Securities Exchange Act of 1934 are required by the Foreign CorruptPractices Act of 1977 to maintain satisfactory internal control The role of the independent auditor relative to this Act isto

Report clients with unsatisfactory internal control to the SEC

Answer (B) is incorrect because The traditional attest function does not involve compliance auditing

Answer (C) is incorrect because The FCPA contains no requirement that an auditor express an opinion on internalcontrol

Answer (D) is correct Whether a client is in conformity with the Foreign Corrupt Practices Act is a legal

question Auditors cannot be expected to provide clients or users of the financial statements with legal advice Therole of the auditor is to assess control risk in the course of an engagement to attest to the fair presentation of thefinancial statements

[7] The requirement of the Foreign Corrupt Practices Act of 1977 to devise and maintain adequate internal control is

assigned in the Act to the

Chief financial officer

Answer (D) is correct The accounting requirements apply to all public companies that must register under the

Securities Exchange Act of 1934 The responsibility is thus placed on companies, not individuals

[8] Which of the following corporations are subject to the accounting requirements of the Foreign Corrupt Practices Act

Answer (C) is incorrect because The accounting requirements apply only to publicly held companies registered under the

1934 act

Answer (D) is correct The accounting requirements of the FCPA apply to all companies required to register and report under

the Securities Exchange Act of 1934 These companies must maintain books, records, and accounts in reasonable detail thataccurately and fairly reflect transactions The FCPA also requires these companies to maintain a system of internal accountingcontrol that provides certain reasonable assurances, including that corporate assets are not used for bribes

[9] The Foreign Corrupt Practices Act of 1977 prohibits bribery of foreign officials Which of the following statements

correctly describes the act’s application to corporations engaging in such practices?

It applies only to multinational corporations

Answer (B) is correct Although the requirements of the FCPA relating to the maintenance of accounting records

and systems of internal accounting control apply only to companies required to register under the Securities

Exchange Act of 1934, the antibribery provisions apply to all domestic business concerns engaged in interstatecommerce

Answer (C) is incorrect because Although the requirements of the FCPA relating to the maintenance of accountingrecords and systems of internal accounting control apply only to companies required to register under the

Securities Exchange Act of 1934, the antibribery provisions apply to all domestic business concerns engaged ininterstate commerce

Answer (D) is incorrect because The FCPA antibribery provisions apply to all corporations engaged in interstatecommerce (and also to any form of business organization, not just to corporations)

[10] Under the Foreign Corrupt Practices Act (FCPA), an action may be brought that seeks

Treble damages by a private party

Answer (A) is incorrect because Private parties may not bring an action under the FCPA

Answer (B) is incorrect because Private parties may not bring an action under the FCPA

Answer (C) is correct The SEC may investigate violations of the FCPA, bring civil actions for its enforcement,

and recommend that the Justice Department prosecute criminal violations

Answer (D) is incorrect because Although the SEC is empowered to seek injunctions, the Justice Department mustseek penalties Damages are sought by private parties who cannot sue under this statute

[11] The U.S Foreign Corrupt Practices Act is particularly focused on the dealings of financial institutions and the

safeguarding of the global financial system Financial institutions must implement robust controls to ensure knowledge oftheir customers and the nature of their business transactions and be in a position to prove to regulators a high level of due

diligence These safeguards are required to minimize all of the following except

Answer (B) is correct The safeguards of the global financial system relating to the U.S Foreign Corrupt Practices

Act deal with minimizing money laundering, terrorist financing, and extortion and bribery Insider trading is not afocus of the safeguards

Answer (C) is incorrect because Terrorist financing is one focus of the safeguards of the global financial systemrelating to the U.S Foreign Corrupt Practices Act

Answer (D) is incorrect because Extortion and bribery are focuses of the safeguards of the global financial systemrelating to the U.S Foreign Corrupt Practices Act

[12] Corporations have the responsibility to issue financial statements that are timely, accurate, and transparent, reflecting allthe transactions of the company Which of the following documents refer to this responsibility?

IMA’s Statement of Ethical Professional Practice

Answer (B) is incorrect because The IMA’s Statement on Management Accounting “Values and Ethics: FromInception to Practice” is a useful document for understanding ethical concepts in an organizational context Thisdoes not refer to the responsibility to issue financial statements that are timely, accurate, and transparent, reflectingall the transactions of the company The IMA’s Statement of Ethical Professional Practice discusses ethical

principles and standards that should be followed by members of the IMA This does not refer to the responsibility

to issue financial statements that are timely, accurate, and transparent, reflecting all the transactions of the

company

Answer (C) is incorrect because The IMA’s Statement on Management Accounting “Values and Ethics: FromInception to Practice” is a useful document for understanding ethical concepts in an organizational context Thisdoes not refer to the responsibility to issue financial statements that are timely, accurate, and transparent, reflectingall the transactions of the company

Answer (D) is correct SOX Section 406: Code of Ethics for Senior Financial Officers and the U.S Foreign

Corrupt Practices Act both refer to the corporate responsibility to issue financial statements that are timely,

[13] IMA’s Statement on Management Accounting, “Values and Ethics: From Inception to Practice,” recommends a definedcode of conduct and ethical behavior for all organizations One advantage of having such a code is that it

Provides employees with guidance for handling unfamiliar situations

Answer (A) is correct “Values and Ethics: From Inception to Practice” states, in part, “ what does an employee

do when unplanned events occur? What reference does an individual look to for help in making decisions? This

is why it is important to have a defined set of organizational values and code of ethics – they create the

“touchstone” against which every unanticipated decision must be judged Failure to have every individual in theorganization know and understand these values and ethical code leads to inconsistency and, in the worst cases,unethical or fraudulent behavior.” (IV Values, Ethics, and Accounting.)

Answer (B) is incorrect because A code of conduct cannot guarantee ethical behavior by employees

Answer (C) is incorrect because A code of conduct cannot guarantee that an organization will be shielded fromliability in cases of fraud

Answer (D) is incorrect because A code of conduct does not ease law enforcement’s investigative process

[14] Which one of the following is a true statement regarding organizational ethics?

As long as officer and employee behavior meet the requirements of the law, the organization can be considered tohave a functioning system of ethical behavior

A

A strong sense of ethics on the part of employees who are in the best position to appropriate cash and other assets

is the most vital part of a functioning system of ethical behavior

individuals did not define their behavior by what most of society would see as ‘reasonable,’ but rather they

followed their own particular code – in some cases, limiting the definition of ethical behavior to require

compliance with the law and nothing more.” (II Introduction.)

Answer (B) is incorrect because “Values and Ethics: From Inception to Practice” states, in part, “Ethical behavior

is not something that applies to someone else – every single individual is responsible for behaving ethically

Nowhere is this more important than the demonstration of ethical behavior that managers and supervisors exhibit

in the way they execute their day-to-day work ” This phenomenon is referred to as the “tone at the top.”

(VI Leadership by Example.)

Answer (C) is incorrect because Employee training is important to maintaining an ethical organizational culture

“Values and Ethics: From Inception to Practice” states, in part, “Every existing member of staff should receiveongoing training, starting at the board level and cascading down throughout the organization Ethics training foremployees should focus on covering ethical concepts, the organization’s code, and compliance To achieve this,training should include: ethical concepts and thinking: What is ‘behind’ the issue of ethical action?; [and] the

organization’s code of ethics and any supporting ‘rules.’” (VIII Practical Application: Converting Intent into

Operational Reality.)

Answer (D) is correct “Values and Ethics: From Inception to Practice” states, in part, “A whistleblowing

framework (e.g., an ethics helpline) is an important component in maintaining an ethical organizational culture

An effective feedback system includes having a confidential framework for employees to report possible violations

of the organization’s code of ethics and to receive advice on the ethical aspects of challenging decisions Statisticsshow that a large number of occupational fraud cases are detected through an employee “hotline” or other

[15] Which one of the following is a true statement regarding organizational ethics?

A comprehensive framework of corporate ethical behavior is a prerequisite for an effective system of internal

control

A

An effective system of internal control is a prerequisite for corporate ethical behavior

B

If a functioning system of ethical behavior is in place, an organization is able to devote fewer resources to

developing human capital

C

“Organizational culture” is determined mostly by the industry(ies) in which the firm operates

D

Answer (A) is correct A comprehensive framework of corporate ethical behavior is a prerequisite for an effective

system of internal control “Values and Ethics: From Inception to Practice” states, in part, “CEOs and CFOs have

to place their own integrity on the line by attesting to compliance with an adequate level of internal controls (aswell as all other certifications) Creating a thorough, integrated system for developing, implementing, sustaining,and monitoring ethical performance within the organization will allow executives to make such declarations withconfidence that a code of ethics is the foundation of the organization’s culture and is fully integrated into the

thinking process of every employee and business partner.” (IX Measuring and Improving Ethical Compliance.)Answer (B) is incorrect because It is more nearly true to state the opposite

Answer (C) is incorrect because The concept of “human capital” is important to an organization in creating a

climate where “doing the right thing” is expected In most organizations today, labor costs constitute the majority

of operating expenses “Values and Ethics: From Inception to Practice” states, in part, “ an organization must, to

a great degree, trust that its employees are acting in its best interests Human ‘capital’ is a critical asset

Unmotivated employees can poison the atmosphere and reduce the teamwork and cooperation required for

knowledge transfer and innovation, and they can have a significant negative impact on relationships with suppliersand customers.” (IV Values, Ethics, and Accounting.)

Answer (D) is incorrect because “Values and Ethics: From Inception to Practice” states, in part, “Every

organization already has a culture Step one in establishing an ethical culture must be an assessment of the

existing organizational values and culture and the development of a set of statements that define the principles theorganization believes in and should act upon These statements and principles can be developed by the

shareholders, the board, or a governing body within the organization.” (V Defining and Developing the

Organization’s Behavioral Values.)

[16] The basic financial statements include a

Balance sheet, income statement, statement of retained earnings, and statement of changes in retained earnings.A

Statement of financial position, income statement, statement of retained earnings, and statement of changes in

Answer (D) is correct Under GAAP, the basic required statements are the statements of financial position,

income, cash flows, and retained earnings Changes in equity must be disclosed in the basic statements, the notes,

or a separate statement A statement of cash flows is now a required part of a full set of financial statements of all

[17] Financial statement users with a direct economic interest in a specific business include

Answer (A) is incorrect because Financial advisers have indirect interests

Answer (B) is incorrect because Regulatory bodies have indirect interests

Answer (C) is incorrect because Stock markets have indirect interests

Answer (D) is correct Users with direct interests include investors or potential investors, suppliers and creditors,

employees, and management

[18] A primary objective of external financial reporting is

Direct measurement of the value of a business enterprise

Answer (A) is incorrect because Financial reporting is not designed to measure directly the value of a business

Answer (B) is correct According to the FASB’s Conceptual Framework, the objectives of external financial

reporting are to provide information that (1) is useful to present and potential investors, creditors, and others inmaking rational financial decisions regarding the enterprise; (2) helps those parties in assessing the amounts,

timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from sale,

redemption, or maturity of securities or loans; and (3) concerns the economic resources of an enterprise, the claimsthereto, and the effects of transactions, events, and circumstances that change its resources and claims thereto

Answer (C) is incorrect because While rules for accruing liabilities are a practical concern, the establishment ofsuch rules is not a primary objective of external reporting

Answer (D) is incorrect because The objectives of financial accounting are unrelated to the measurement of stockprices; stock prices are a product of stock market forces

[19] Notes to financial statements are beneficial in meeting the disclosure requirements of financial reporting The notes

should not be used to

Describe significant accounting policies

Answer (A) is incorrect because It describes an appropriate and required disclosure that should appear in the notes

to the financial statements

Answer (B) is incorrect because It describes an appropriate and required disclosure that should appear in the notes

to the financial statements

Answer (C) is incorrect because It describes an appropriate and required disclosure that should appear in the notes to thefinancial statements.

Answer (D) is correct Financial statement notes should not be used to correct improper presentations The financial

statements should be presented correctly on their own Notes should be used to explain the methods used to prepare the

financial statements and the amounts shown The first footnote typically describes significant accounting policies

[20] Which of the following is not a need of financial statement users?

Financial advisers and analysts need financial statements to help investors evaluate particular investments

Answer (A) is incorrect because Financial advisers use financial statements for evaluating investments

Answer (B) is correct Investors’ purchases and sales set stock prices Stock exchanges need financial statements

to evaluate whether to accept a firm’s stock for listing or whether to suspend trading in the stock

Answer (C) is incorrect because Regulatory agencies use financial statements for rate making

Answer (D) is incorrect because Employees use financial statements for labor negotiations

[21] The management of ABC Corporation is analyzing the financial statements of XYZ Corporation because ABC is stronglyconsidering purchasing a block of XYZ common stock that would give ABC significant influence over XYZ Which

financial statement should ABC primarily use to assess the amounts, timing, and uncertainty of future cash flows of XYZCompany?

Answer (A) is incorrect because The statement of income is prepared on an accrual basis and is not meant to

report cash flows

Answer (B) is incorrect because The statement of retained earnings merely shows the reasons for changes in

retained earnings during the reporting period

Answer (C) is correct The primary purpose of a statement of cash flows is to provide information about the cash

receipts and cash payments of a business enterprise during a period This information helps investors, creditors,and other users to assess (1) the enterprise’s ability to generate net cash inflows; (2) its ability to meet its

obligations, and pay dividends; (3) its needs for external financing; (4) the reasons for the differences between netincome and net cash flow; and (5) the effects of cash and noncash financing and investing activities

Answer (D) is incorrect because The balance sheet reports on financial position at a moment in time It does notprovide information about future cash flows

[22] The primary purpose of the statement of financial position is to reflect

The fair value of the firm’s assets at some moment in time

Answer (A) is incorrect because The measurement attributes of assets include but are not limited to fair value

Answer (B) is incorrect because Financial statements reflect the going concern assumption Hence, they usually donot report forced liquidation values

Answer (C) is incorrect because The income statement provides this type of information

Answer (D) is correct The balance sheet presents three major financial accounting elements: assets (items of

value), liabilities (debts), and equity (net worth) According to the FASB’s Conceptual Framework, assets are

probable future economic benefits resulting from past transactions or events Liabilities are probable future

sacrifices of economic benefits arising from present obligations as a result of past transactions or events Equity isthe residual interest in the assets after deduction of liabilities

[23] Prepaid expenses are valued on the statement of financial position at the

Cost to acquire the asset

Answer (A) is incorrect because The cost must be reduced by the expired or used portion of the prepaid asset

Answer (B) is incorrect because Prepaid expenses will not be collected at maturity

Answer (C) is incorrect because Prepaid expenses are not depreciated; they expire

Answer (D) is correct Prepaid expenses, such as supplies, prepaid rent, and prepaid insurance, are reported on

the balance sheet at cost minus the expired or used portion These are typically current assets

[Fact Pattern #1]

A company’s pre-closing trial balance and other pertinent information at December 31 are as follows The opening balance ofinventory was $140,000 The long-term debt pays interest at a rate of 10% per annum, payable every 12 months The debt wasissued on July 1 of the current year and originally had 5 years to maturity The fixed assets have a 10-year estimated useful lifeand were 1 year old at the start of the current year Straight-line depreciation is used by the company

[24] (Refers to Fact Pattern #1)

The company will report year-end total assets of

Answer (A) is incorrect because Using the beginning balance of inventory results in $800,000

Answer (B) is correct The year-end total assets can be determined by summing all of the assets and deducting

accumulated depreciation (including the current year’s depreciation) Total accumulated depreciation at the end ofthe second year is $120,000 [($600,000 ÷ 10 years) × 2 years] Total assets equal $890,000 ($80,000 cash +

$100,000 A/R + $230,000 EI + $600,000 gross fixed assets – $120,000 accumulated depreciation)

Answer (C) is incorrect because Omitting second-year depreciation from the calculation results in $950,000

Answer (D) is incorrect because Omitting total accumulated depreciation from the calculation results in

$1,010,000

[25] A statement of financial position allows investors to assess all of the following except the

Efficiency with which enterprise assets are used

Answer (C) is incorrect because The capital structure of the enterprise is reported in the equity section of the statement of

financial position

Answer (D) is correct Assets are usually measured at original historical cost in a statement of financial position, although

some exceptions exist For example, some short-term receivables are reported at their net realizable value Thus, the statement

of financial position cannot be relied upon to assess NRV

[26] The accounting equation (assets – liabilities = equity) reflects the

Entity point of view

Answer (A) is incorrect because The entity concept limits accounting information to that related to a specific

entity (possibly not the same as the legal entity)

Answer (B) is incorrect because Fund theory stresses that assets equal obligations (equity and liabilities are

sources of assets)

Answer (C) is correct The equation is based on the proprietary theory Equity in an enterprise is what remains

after the economic obligations of the enterprise are deducted from its economic resources

Answer (D) is incorrect because The enterprise concept stresses ownership of the assets; that is, the emphasis is onthe credit side of the balance sheet

[27] Karen’s Crafts, Inc., has the following accounts included in its December 31 trial balance:

(Issued 1/1/Year 1; due 1/1/Year 20) 500,000

What amount of current liabilities will be reported on Karen’s December 31 statement of financial position?

Answer (A) is incorrect because The discount on bonds payable is erroneously deducted from the total

Answer (B) is correct Current liabilities consist of those debts that will have to be paid in the coming year or the

normal operating cycle, whichever period is longer Examples include accounts payable, wages payable, interestpayable, and income taxes payable Bonds payable and its contra account, discount on bonds payable, would both

be shown under the long-term liability classification The total current liabilities would be $319,000 ($250,000 +

$29,000 + $14,000 + $26,000)

Answer (C) is incorrect because The amount of $353,000 includes discount on bonds payable

Answer (D) is incorrect because The amount of $819,000 includes bonds payable

[28] Perry Mansfield Corporation has the following accounts included in its December 31 trial balance:

Answer (A) is incorrect because Deducting accounts payable from the current assets results in the amount of

working capital, rather than the total of current assets

Answer (B) is incorrect because It fails to include prepaid insurance in the total

Answer (C) is correct Current assets consist of cash, certain marketable securities, receivables, inventories, and

prepaid expenses Adding these elements together produces a total of $407,500 ($28,000 cash + $110,000

receivables + $250,000 inventories + $19,500 prepaid insurance)

Answer (D) is incorrect because It erroneously includes accounts payable

[29] Long-term obligations that are or will become callable by the creditor because of the debtor’s violation of a provision ofthe debt agreement at the balance sheet date should be classified as

Long-term liabilities

A

Current liabilities unless the debtor goes bankrupt

B

Current liabilities unless the creditor has waived the right to demand repayment for more than 1 year from the

balance sheet date

C

Contingent liabilities until the violation is corrected

D

Answer (A) is incorrect because Such obligations must be current liabilities

Answer (B) is incorrect because Bankruptcy is not an exception

Answer (C) is correct Long-term obligations that are or will become callable by the creditor because of the

debtor’s violation of a provision of the debt agreement at the balance sheet date normally are classified as currentliabilities However, the debt need not be reclassified if the violation will be cured within a specified grace period

or if the creditor formally waives or subsequently loses the right to demand repayment for a period of more than ayear from the balance sheet date (also, reclassification is not required if the debtor expects and has the ability torefinance the obligation on a long-term basis)

Answer (D) is incorrect because Such obligations are not contingent

[30] Abernathy Corporation uses a calendar year for financial and tax reporting purposes and has $100 million of mortgage

bonds due on January 15, Year 2 By January 10, Year 2, Abernathy intends to refinance this debt with new long-term

mortgage bonds and has entered into a financing agreement that clearly demonstrates its ability to consummate the

refinancing This debt is to be

Classified as a current liability on the statement of financial position at December 31, Year 1

Answer (A) is incorrect because The company intends to refinance the debt on a long-term basis

Answer (B) is correct Short-term obligations expected to be refinanced should be reported as current liabilities

unless the firm both plans to refinance and has the ability to refinance the debt on a long-term basis The ability torefinance on a long-term basis is evidenced by a post-balance-sheet date issuance of long-term debt or a financingarrangement that will clearly permit long-term refinancing

Answer (C) is incorrect because The debt has not been retired

Answer (D) is incorrect because The debt is on the balance sheet

[31] Lister Company intends to refinance a portion of its short-term debt in Year 2 and is negotiating a long-term financing

agreement with a local bank This agreement would be noncancelable and would extend for a period of 2 years The

amount of short-term debt that Lister Company can exclude from its statement of financial position at December 31,

Answer (A) is incorrect because The amount excluded cannot exceed the amount available for refinancing

Answer (B) is correct If an enterprise intends to refinance short-term obligations on a long-term basis and

demonstrates an ability to consummate the refinancing, the obligations should be excluded from current liabilitiesand classified as noncurrent The ability to consummate the refinancing may be demonstrated by a post-balance-sheet-date issuance of a long-term obligation or equity securities, or by entering into a financing agreement thatmeets certain criteria These criteria are that the agreement does not expire within 1 year, it is noncancelable by thelender, no violation of the agreement exists at the balance sheet date, and the lender is financially capable of

honoring the agreement

Answer (C) is incorrect because The correct accounting treatment does not depend on changes in ratios

Answer (D) is incorrect because The refinancing need not have occurred if the firm intends and demonstrates anability to consummate such refinancing

[32] When treasury stock is accounted for at cost, the cost is reported on the balance sheet as a(n)

Answer (B) is incorrect because Treasury stock accounted for at cost is subtracted from the total of the other equity accounts.Answer (C) is incorrect because Treasury stock accounted for at cost is subtracted from the total of the other equity accounts.

Answer (D) is correct Treasury stock is a corporation’s own stock that has been reacquired but not retired In the balance

sheet, treasury stock recorded at cost is subtracted from the total of the capital stock balances, additional paid-in capital,

retained earnings, and accumulated other comprehensive income

[33] When a company was in the process of closing its original store, no accounting notice of the liquidation values of the

discontinued store’s assets were considered in the accounting records The accountant did not make any entries until theassets were disposed of because the company was still a going concern However, when liquidation of a business is

foreseen but not yet accomplished, a different financial statement is prepared This statement is known as the

Answer (A) is incorrect because The statement prepared by the trustee in bankruptcy to reconcile the book

amounts to his/her administration of the estate is the statement of realization and liquidation

Answer (B) is incorrect because A charge and discharge statement is prepared by the personal representative of adecedent’s estate

Answer (C) is incorrect because The statement prepared by the trustee in bankruptcy to reconcile the book

amounts to his/her administration of the estate is the statement of realization and liquidation

Answer (D) is correct A statement of affairs is prepared for a company in the process of liquidation It reflects the

financial condition of the company on a going out of business rather than a going concern basis Liquidation valueinstead of historical cost is used to value assets

[34] Felicity Company has the following accounts included in its December 31 trial balance:

Additional paid-in capital 196,000

Answer (B) is correct Equity consists of contributed capital, retained earnings, and accumulated other comprehensive

income Equity accounts may therefore include retained earnings, preferred stock, common stock, and additional paid-in

capital Treasury stock is a contra account in the equity section of the balance sheet The total is $514,000 ($141,000 +

$175,000 + $50,000 + $196,000 – $48,000)

Answer (C) is incorrect because The amount of $562,000 results from a failure to deduct treasury stock

Answer (D) is incorrect because Treasury stock should be deducted from, not added to, equity

[35] Which of the following assets is normally considered the most liquid?

Answer (C) is incorrect because Inventory takes longer to convert to cash than accounts receivable

Answer (D) is correct Assets presented on the balance sheet are listed in descending order of liquidity, which

allows users of financial statements to identify the assets that will be available first to meet current liabilities Anasset that is readily convertible to cash is considered very liquid Accounts receivable typically has more liquiditythan inventory and therefore is listed above inventory in the current assets section of the balance sheet

[36] A corporation issues a balance sheet and income statement for the current year and comparative income statements for

each of the 2 previous years A statement of cash flows

Should be issued for the current year only

Answer (A) is incorrect because A statement of cash flows must be provided for all 3 years

Answer (B) is incorrect because A statement of cash flows must be provided for all 3 years

Answer (C) is correct When a business enterprise provides a set of financial statements that reports both financial

position and results of operations, it must also present a statement of cash flows for each period for which the

results of operations are provided

Answer (D) is incorrect because The statement of cash flows is not optional in these circumstances

[37] When classifying assets as current and noncurrent for reporting purposes,

The amounts at which current assets are carried and reported must reflect realizable cash values

A

Prepayments for items such as insurance or rent are included in an “other assets” group rather than as current

assets as they will ultimately be expensed

B

The time period by which current assets are distinguished from noncurrent assets is determined by the seasonal

nature of the business

C

Assets are classified as current if they are reasonably expected to be realized in cash or consumed during the

normal operating cycle

D

Answer (A) is incorrect because Current assets are measured using different attributes, for example, lower of cost

or market for inventory and net realizable value for accounts receivable

Answer (B) is incorrect because Prepayments may qualify as current assets They often will be consumed duringthe operating cycle

Answer (C) is incorrect because The classification criterion is based on the normal operating cycle regardless ofthe seasonality of the business

Answer (D) is correct For financial reporting purposes, current assets consist of cash and other assets or

resources expected to be realized in cash, sold, or consumed during the longer of 1 year or the normal operatingcycle of the business

[38] A statement of financial position is intended to help investors and creditors

Assess the amount, timing, and uncertainty of prospective net cash inflows of a firm

Answer (B) is correct The statement of financial position, or balance sheet, provides information about an

entity’s resource structure (assets) and financing structure (liabilities and equity) at a moment in time According

to the FASB’s Conceptual Framework, the statement of financial position does not purport to show the value of abusiness, but it enables investors, creditors, and other users to make their own estimates of value It helps users toassess liquidity, financial flexibility, profitability, and risk

Answer (C) is incorrect because The primary focus of financial reporting is information about an enterprise’s

performance provided by measures of earnings and its components Hence, an income statement is more directlyuseful to investors and creditors for evaluating economic performance

Answer (D) is incorrect because Disclosures of changes in shareholders’ equity, in either the basic statements, thenotes thereto, or a separate statement, help users to evaluate changes in the ownership equity of a firm

[39] All other things being equal, which one of the following factors would result in an increase in cash reported on the

balance sheet from one period to the next?

Reduction of the days’ sales outstanding in accounts receivable

Answer (A) is correct A reduction of the days’ sales outstanding in accounts receivable signifies that the company is

collecting accounts receivables at a faster pace, meaning an increase in the cash reported on the balance sheet on the nextperiod

Answer (B) is incorrect because A decrease in the accrued vacation liability signifies that liabilities are being paid,

meaning a decrease in the cash reported on the balance sheet on the next period

Answer (C) is incorrect because An increase in the level of inventory being held signifies more purchases in the next

period, meaning either a decrease in cash (if the inventory was bought with cash) or an increase in liabilities (if the

inventory was purchased on credit) Either way, this would not increase cash

Answer (D) is incorrect because A increase in the speed with which accounts payable invoices are paid signifies a fasteroutflow of cash for payment of the liabilities, meaning a decrease in the cash reported on the balance sheet

[40] Each of the following statements about the balance sheet is true except

It is a picture of the firm’s financial position at a particular point in time

Answer (B) is incorrect because The balance presents the firm’s assets and claims against those assets

Answer (C) is incorrect because The balance sheet helps users assess the firm’s liquidity

Answer (D) is correct Sources and uses of cash are shown in the statement of cash flows.

[41] An income statement for a business prepared under the current operating performance concept would include only the

recurring earnings from its normal operations and

Answer (A) is correct The current operating performance concept emphasizes the ordinary, normal, recurring

operations of the entity during the current period In this view, the inclusion of extraordinary items or prior-periodadjustments is believed to impair the significance of net income (The current operating performance concept is

not recognized under U.S GAAP.)

Answer (B) is incorrect because Extraordinary items are excluded under the current operating performance

[42] The major distinction between the multiple-step and single-step income statement formats is the separation of

Operating and nonoperating data

Answer (A) is correct Within the income from continuing operations classification, the single-step income

statement provides one grouping for revenue items and one for expense items The single-step is the one

subtraction necessary to arrive at income from continuing operations prior to the effect of income taxes In

contrast, the multiple-step income statement matches operating revenues and expenses separately from

nonoperating items This format emphasizes subtotals such as gross margin, operating income, and nonoperatingincome within presentation of income from continuing operations

Answer (B) is incorrect because The major distinction is the separation of operating and nonoperating data

Answer (C) is incorrect because The major distinction is the separation of operating and nonoperating data

Answer (D) is incorrect because The major distinction is the separation of operating and nonoperating data

[43] In a multiple-step income statement for a retail company, all of the following are included in the operating section except

Answer (A) is incorrect because Sales is part of the normal operations of a retailer

Answer (B) is incorrect because Cost of goods sold is part of the normal operations of a retailer

Answer (C) is correct The operating section of a retailer’s income statement includes all revenues and costs

necessary for the operation of the retail establishment, e.g., sales, cost of goods sold, administrative expenses, andselling expenses Dividend revenue, however, is classified under other revenues In a statement of cash flows, cashdividends received are considered an operating cash flow

Answer (D) is incorrect because Administrative and selling expenses are part of the normal operations of a retailer

[44] In Hopkins Co.’s Year 3 single-step income statement, the section titled Revenues consisted of the following:

Results from discontinued operations:

Income from operations of component

(including gain on disposal of $21,600) $18,000

Cumulative change in Year 1 and Year 2

income due to change in depreciation

Answer (A) is incorrect because The amount of $217,800 equals $215,400 reported total revenues, plus the

$2,400 loss from operations of the segment

Answer (B) is incorrect because The amount of $215,400 improperly includes the results from discontinued

operations and the cumulative-effect type change

Answer (C) is incorrect because The amount of $203,700 improperly subtracts interest revenue and does not

adjust for the results from discontinued operations

Answer (D) is correct Revenue is a component of income from continuing operations Results of discontinued

operations is a classification in the income statement separate from continuing operations The cumulative effect

of a change in accounting principle is not reported in the income statement Hence, total revenues were $201,900($215,400 – $12,000 results from discontinued operations – $1,500 cumulative-effect type change) Alternatively,total revenues consist of net sales of $187,000, plus interest revenue of $10,200, plus gain on sale of equipment(which is not an extraordinary item) of $4,700

[45] When reporting extraordinary items,

Each item (net of tax) is presented on the face of the income statement separately as a component of net incomefor the period

Answer (A) is correct Extraordinary items are reported net of tax after discontinued operations.

Answer (B) is incorrect because Extraordinary items are to be reported net of the related tax effect

Answer (C) is incorrect because Extraordinary items are not reported in the continuing operations section of theincome statement

Answer (D) is incorrect because Each extraordinary item is to be reported separately

[46] Which one of the following items is included in the determination of income from continuing operations?

Answer (D) is correct Certain items ordinarily are not to be treated as extraordinary gains and losses Rather, they

are included in the determination of income from continuing operations These gains and losses include those

from write-downs of receivables and inventories, translation of foreign currency amounts, disposal of a businesssegment, sale of productive assets, strikes, and accruals on long-term contracts A write-down of inventory is

therefore included in the computation of income from continuing operations

[47] Brett Corporation had retained earnings of $529,000 at January 1 of the current year Net income for the year was

$2,496,000, and cash dividends of $750,000 were declared and paid Another $50,000 of dividends were declared late inDecember, but were unpaid at year end Brett’s ending balance of its statement of retained earnings is

Answer (A) is incorrect because The amount of $1,696,000 does not include the beginning balance

Answer (B) is correct Dividends declared but not paid reduce retained earnings Thus, the year-end balance of

retained earnings is calculated as follows:

Dividends paid during year $750,000

Dividends declared in Dec 50,000 (800,000)

[48] The changes in account balances of the Samson Corporation during the year are presented below:

Increase

Additional paid-in capital 24,000

Assuming there are no charges to retained earnings other than for a dividend payment of $52,000, the net income for theyear should be

Answer (A) is incorrect because The amount of $16,000 is the excess of the sum of the increases in the capital

accounts other than retained earnings over the increase in net assets

Answer (B) is correct To calculate net income, the dividend payment ($52,000) should be added to the increase

in assets ($356,000) The excess of this sum ($408,000) over the increase in liabilities ($108,000) gives the totalincrease in owners’ equity ($300,000) The excess of this amount over the combined increases in the capital

accounts ($264,000) equals the increase in retained earnings ($36,000) arising from net income

Answer (C) is incorrect because The amount of $52,000 is the dividend

Answer (D) is incorrect because The amount of $68,000 equals the sum of the dividend and the excess of the sum

of the increases in the capital accounts other than retained earnings over the increase in net assets

[49] When a business enterprise provides a full set of general-purpose financial statements reporting financial position, results

of operations, and cash flows, comprehensive income and its components should

Appear as a part of discontinued operations, extraordinary items, and cumulative effect of a change in accountingprinciple

is not reported in the income statement

Answer (B) is incorrect because The components of OCI are displayed either (1) net of related tax effects or

(2) before the related tax effects with one amount shown for the aggregate tax effect related to the total of OCI Noamount is displayed for the tax effect related to total comprehensive income

Answer (C) is incorrect because Comprehensive income and its components must be displayed in a financial

statement given the same prominence as other financial statements included in the full set of financial statements

Answer (D) is correct If an enterprise that reports a full set of financial statements has items of other

comprehensive income (OCI), it must display comprehensive income and its components in a financial statementhaving the same prominence as the other statements included in the full set No particular format is required, butnet income must be displayed as a component of comprehensive income in that statement

[Fact Pattern #2]

The Horatio Company’s beginning and ending inventories for the fiscal year ended September 30, Year 2, are

Oct 1, Year 1 Sept 30, Year 2

[50] (Refers to Fact Pattern #2)

Horatio’s cost of goods manufactured (COGM) for the Year ended September 30, Year 2, is

Answer (A) is incorrect because This amount results from reversing the effect of the change in WIP

Answer (B) is incorrect because This amount does not consider the change in WIP

Answer (C) is correct COGM equals all manufacturing costs incurred during the period, plus BWIP, minus

EWIP Materials used equals $144,000 ($30,000 BI + $160,000 purchased – $2,000 discounts – $44,000 EI)

Thus, manufacturing costs incurred during the period equal $494,000 ($144,000 materials used + $200,000 DL +

$150,000 OH), and COGM equals $504,000 ($494,000 + $80,000 BWIP – $70,000 EWIP)

Answer (D) is incorrect because This amount does not consider the change in materials inventory

[51] (Refers to Fact Pattern #2)

Horatio’s cost of goods sold (COGS) for the year ended September 30, Year 2, is

Answer (A) is incorrect because This amount results from reversing the treatment of purchase discounts

Answer (B) is incorrect because This amount is the COGM

Answer (C) is incorrect because This amount results from assuming that no beginning or ending inventories of

materials, WIP, or finished goods existed

Answer (D) is correct COGS equals COGM adjusted for the change in finished goods inventory COGM equals

all manufacturing costs incurred during the period, plus BWIP, minus EWIP Materials used equals $144,000

($30,000 BI + $160,000 purchased – $2,000 discounts – $44,000 EI) Thus, manufacturing costs incurred duringthe period equal $494,000 ($144,000 materials used + $200,000 DL + $150,000 OH), and COGM equals

[52] (Refers to Fact Pattern #2)

The total value of inventory to be reported on Horatio’s balance sheet at September 30, Year 2, is

Answer (A) is incorrect because This amount is the ending materials inventory

Answer (B) is incorrect because This amount is the EWIP

Answer (C) is incorrect because This amount is the finished goods inventory

Answer (D) is correct The ending inventory consists of three elements: materials of $44,000, WIP of $70,000,

and finished goods of $24,000, a total of $138,000

[53] Which of the following items should be reported as a component of other comprehensive income (OCI)?

Unrealized loss on an investment classified as a trading security

Answer (A) is incorrect because Unrealized gains and losses on trading securities are components of net income

Answer (B) is correct Comprehensive income includes all changes in equity (net assets) of a business entity

except those changes resulting from investments by owners and distributions to owners Comprehensive incomeincludes two major categories: net income and OCI Net income includes the results of operations classified as

income from continuing operations, discontinued operations, and extraordinary items Components of

comprehensive income not included in the determination of net income are included in OCI; for example,

unrealized gains and losses on available-for-sale securities (except those that are hedged items in a fair value

[Fact Pattern #3]

A company’s pre-closing trial balance and other pertinent information at December 31 are as follows The opening balance ofinventory was $140,000 The long-term debt pays interest at a rate of 10% per annum, payable every 12 months The debt wasissued on July 1 of the current year and originally had 5 years to maturity The fixed assets have a 10-year estimated useful lifeand were 1 year old at the start of the current year Straight-line depreciation is used by the company

[54] (Refers to Fact Pattern #3)

On the year-end financial statements, the company will report cost of goods sold of

Answer (A) is correct Cost of goods sold equals beginning inventory, plus purchases, minus ending inventory.

Hence, cost of goods old is $440,000 ($140,000 + $530,000 – $230,000)

Answer (B) is incorrect because Purchases equals $530,000

Answer (C) is incorrect because Reversing the opening and closing inventory figures results in $620,000

Answer (D) is incorrect because Omitting closing inventory from the calculation results in $670,000

[55] Which one of the following would be shown on a multiple-step income statement but not on a single-step income

single-Answer (C) is incorrect because Extraordinary gain is shown on both a multiple-step and a single-step income statement.

Answer (D) is incorrect because Net income from continuing operations is shown on both a multiple-step and a single-stepincome statement

[56] The major segments of the statement of retained earnings for a period are

Dividends declared, prior period adjustments, and changes due to treasury stock transactions

Answer (B) is incorrect because After-tax income (loss) is included in the statement

Answer (C) is incorrect because After-tax income (loss) is included in the statement

Answer (D) is correct The statement of retained earnings is a basic financial statement Together with the income

statement, the statement of retained earnings is meant to broadly reflect the results of operations The statement ofretained earnings consists of beginning retained earnings adjusted for any prior period adjustment (net of tax),

with further adjustments for income (loss), dividends, and in certain other rare adjustments, e.g.,

quasi-reorganizations The final figure is ending retained earnings

[57] Which one of the following is included in comprehensive income but excluded from net income?

Cumulative effects of a change in accounting principle

Answer (C) is correct The three most common items of comprehensive income are holding gains and losses, such

as changes in the fair values of available-for-sale securities; adjustments arising from translating an entity’s

financial statements from its functional currency into the reporting currency; and the portion of unrecognized priorservice cost that was not recognized in pension expense

Answer (D) is incorrect because Results of discontinued operations are presented in a separate caption of the

income statement

[58] Because of inexact estimates of the service life and the residual value of a plant asset, a fully depreciated asset was sold at

a material gain This gain should be reported

In the other revenues and gains section of the income statement

Answer (A) is correct Gains are increases in equity from peripheral or incidental transactions Thus, the gain on the sale

of an asset is not an operating item and should be classified in a multiple-step income statement in the other revenues andgains section

Answer (B) is incorrect because The asset sold was not stock in trade and the sale of plant assets does not constitute theentity’s major or central operations, so the proceeds should not be classified as sales revenue

Answer (C) is incorrect because The transaction does not meet the criteria of an extraordinary item (unusual in nature andinfrequent in occurrence in the environment in which the entity operates)

Answer (D) is incorrect because The transaction is not a prior-period adjustment It is not the correction of an error in thefinancial statements of a prior period

[59] When preparing the statement of cash flows, companies are required to report separately as operating cash flows all of the

Answer (A) is incorrect because Interest received from investments is an operating cash flow

Answer (B) is incorrect because Interest paid on bonds is an operating cash flow

Answer (C) is incorrect because Customer collections is an operating cash flow

Answer (D) is correct In general, the cash flows from transactions and other events that enter into the

determination of income are to be classified as operating Cash receipts from sales of goods and services, from

interest on loans, and from dividends on equity securities are from operating activities Cash payments to suppliersfor inventory; to employees for wages; to other suppliers and employees for other goods and services; to

governments for taxes, duties, fines, and fees; and to lenders for interest are also from operating activities

However, distributions to owners (cash dividends on a company’s own stock) are cash flows from financing, notoperating, activities

[60] A statement of cash flows is intended to help users of financial statements

Evaluate a firm’s liquidity, solvency, and financial flexibility

Answer (A) is correct The primary purpose of a statement of cash flows is to provide information about the cash

receipts and payments of an entity during a period If used with information in the other financial statements, thestatement of cash flows should help users to assess the entity’s ability to generate positive future net cash flows

(liquidity), its ability to meet obligations (solvency) and pay dividends, the need for external financing, the reasonsfor differences between income and cash receipts and payments, and the cash and noncash aspects of the investingand financing activities

Answer (B) is incorrect because The statement of cash flows deals with only one resource: cash

Answer (C) is incorrect because The income statement shows the components of income from operations

Answer (D) is incorrect because The identity of stock buyers and sellers is not shown

[61] A financial statement includes all of the following items: net income, depreciation, operating activities, and financing

activities What financial statement is this?

Answer (C) is correct A statement of cash flows is a required financial statement Its primary purpose is to

provide information about cash receipts and payments by reporting the cash effects of an enterprise’s operating,investing, and financing activities Related disclosures report the effects of noncash investing and financing

activities Because the statement or a separate schedule reconciles net income and net operating cash flow,

depreciation, a noncash expense, is included in the presentation

Answer (D) is incorrect because Equity does not include captions for operating and investing activities,

depreciation, and net income

[62] Which of the following items is specifically included in the body of a statement of cash flows?

Operating and nonoperating cash flow information

Answer (A) is correct All noncash transactions are excluded from the body of the statement of cash flows to

avoid undue complexity and detraction from the objective of providing information about cash flows Informationabout all noncash financing and investing activities affecting recognized assets and liabilities shall be reported inrelated disclosures

Answer (B) is incorrect because Noncash transactions are excluded from the body of the statement of cash flows.Answer (C) is incorrect because Noncash transactions are excluded from the body of the statement of cash flows.Answer (D) is incorrect because Noncash transactions are excluded from the body of the statement of cash flows

[63] Select the combination below that explains the impact of credit card interest incurred and paid during the period on (1)equity on the balance sheet and (2) the statement of cash flows

(2)

Effect of Equity Statement of

on Balance Sheet Cash Flows as a(n)

Answer (A) is incorrect because The cash flow would be considered as operating, not financing

Answer (B) is correct Credit card interest incurred is classified as interest expense on the income statement, which in turn

reduces equity on the balance sheet by reducing retained earnings Cash payments to lenders and other creditors for interest,e.g., credit card interest payments, are to be classified on the statement of cash flows as an outflow of cash from operating

activities

Answer (C) is incorrect because The cash flow would be considered as operating, not financing

Answer (D) is incorrect because The payment of interest is an expense that will decrease retained earnings on the balance

Answer (A) is incorrect because The payment would be in the financing, not operating, section

Answer (B) is correct Financing activities include, among other things, obtaining resources from owners and

providing them with a return on, and a return of, their investment Consequently, the payment of cash dividends toproviders of common equity financing is a use of cash that appears in the financing section of the statement of

cash flows

Answer (C) is incorrect because Dividends appear in the financing, not investing, section

Answer (D) is incorrect because Dividends appear in the financing, not investing, section

[65] With respect to the content and form of the statement of cash flows, the

Pronouncements covering the cash flow statement encourage the use of the indirect method

Answer (A) is incorrect because The FASB encourages use of the direct method

Answer (B) is incorrect because The indirect method reconciles net income with the net cash flow from

operations

Answer (C) is correct The FASB encourages use of the direct method of reporting major classes of operating

cash receipts and payments, but the indirect method may be used The minimum disclosures of operating cash

flows under the direct method are cash collected from customers, interest and dividends received, other operatingcash receipts, cash paid to employees and other suppliers of goods or services, interest paid, income taxes paid,

and other operating cash payments

Answer (D) is incorrect because The reconciliation is required regardless of the method used

[66] The statement of cash flows may be presented in either a direct or an indirect (reconciliation) format In which of theseformats would cash collected from customers be presented as a gross amount?

Answer (A) is incorrect because Only the direct method format for the statement of cash flows presents cash

collected from customers as a gross amount

Answer (B) is incorrect because Only the direct method format for the statement of cash flows presents cash

collected from customers as a gross amount

Answer (C) is incorrect because Only the direct method format for the statement of cash flows presents cash

collected from customers as a gross amount

Answer (D) is correct The statement of cash flows may report cash flows from operating activities in either an

indirect (reconciliation) or a direct format The direct format reports the major classes of operating cash receiptsand cash payments as gross amounts The indirect presentation reconciles net income to the same amount of netcash flow from operations that would be determined in accordance with the direct method To arrive at net

operating cash flow, the indirect method adjusts net income by removing the effects of (1) all deferrals of past

operating cash receipts and payments, (2) all accruals of expected future operating cash receipts and payments, (3)all financing and investing activities, and (4) all noncash operating transactions

[67] Depreciation expense is added to net income under the indirect method of preparing a statement of cash flows in order to

Report all assets at gross carrying amount

Answer (A) is incorrect because Assets other than cash are not shown on the statement of cash flows

Answer (B) is incorrect because Depreciation is recorded on the income statement On the statement of cash flows,depreciation is added back to net income because it was previously deducted on the income statement

Answer (C) is correct The indirect method begins with net income and then removes the effects of past deferrals

of operating cash receipts and payments, accruals of expected future operating cash receipts and payments, and netincome items not affecting operating cash flows (e.g., depreciation)

Answer (D) is incorrect because Net carrying amount of assets is reported on the balance sheet, not the statement

of cash flows

[68] In reconciling net income on an accrual basis to net cash provided by operating activities, what adjustment is needed tonet income because of (1) an increase during the period in prepaid expenses and (2) the periodic amortization of premium

on bonds payable?

Increase in Amortization of Premium

Prepaid Expenses on Bonds Payable

Answer (C) is incorrect because Amortization of bond premium would be deducted from net income

Answer (D) is correct An increase in prepaid expenses indicates that cash outlays for expenses exceeded the

related expense incurred; thus, net income exceeded net cash provided by operations and a deduction is needed inthe reconciliation Also, the amortization of premium on bonds payable causes a reduction of interest expense butdoes not increase cash; therefore, net income exceeds net cash from operating activities, and a deduction is needed

in the reconciliation

[69] In the statement of cash flows, a reconciliation of net cash flows from operating activities to net income

Must be reported in the statement of cash flows

Answer (A) is incorrect because The reconciliation may be presented in a related disclosure

Answer (B) is incorrect because The reconciliation may be reported in the statement of cash flows

Answer (C) is correct The reporting entity must present a reconciliation of net income to net operating cash flow.

This reconciliation removes the effects of (1) all deferrals of past operating cash flows, (2) all accruals of

estimated future operating cash flows, and (3) items whose cash effects are investing or financing cash flows Thisreconciliation may be either (1) reported in the statement of cash flows or (2) provided separately in a related

schedule, with the statement of cash flows presenting only the net cash flows from operating activities

Answer (D) is incorrect because A reconciliation must be reported in an indirect presentation of the statement ofcash flows

[70] All of the following should be classified under the operating section in a statement of cash flows except a

Answer (B) is incorrect because Depreciation expense is an operating item.

Answer (C) is incorrect because A decrease in prepaid insurance is an operating item

Answer (D) is correct Operating activities include all transactions and other events not classified as investing and financing

activities Operating activities include producing and delivering goods and providing services Cash flows from such

activities are usually included in the determination of net income However, the purchase of land and a building in exchangefor a long-term note is an investing activity Because this transaction does not affect cash, it is reported in related disclosures

of noncash investing and financing activities

[71] Which one of the following transactions should be classified as a financing activity in a statement of cash flows?

Answer (A) is incorrect because The purchase of equipment is an investing activity

Answer (B) is correct Financing activities are defined to include the issuance of stock, the payment of dividends,

the receipt of donor-restricted resources to be used for long-term purposes, treasury stock transactions (purchases

or sales), the issuance of debt, the repayment of amounts borrowed, obtaining and paying for other resources

obtained from creditors on long-term credit

Answer (C) is incorrect because The sale of trademarks, like the sale of any long-lived asset, is an investing

activity

Answer (D) is incorrect because The payment of interest on a mortgage note is an operating activity

[72] When using the indirect method to prepare a statement of cash flows, which one of the following should be deducted

from net income when determining net cash flows from operating activities?

An increase in accrued liabilities

Answer (B) is correct The indirect method reconciles the net income of a business with the net operating cash

flow The indirect method removes the effects of all past deferrals of operating cash receipts and payments, all

accruals of expected future operating cash receipts and payments, and all items not affecting operating cash flows

to arrive at the net cash flow from operating activities Hence, the amortization of the premium on bonds payable

is deducted from net income in the reconciliation because it represents a noncash decrease in interest expense (anincrease in net income)

Answer (C) is incorrect because A loss on the sale of plant assets is from an investing activity Thus, it should beadded to net income to determine net operating cash flow

Answer (D) is incorrect because Depreciation is a noncash expense that should be added to net income

[73] Which one of the following transactions should not be classified as a financing activity in the statement of cash flows?

Issuance of common stock

Answer (A) is incorrect because Issuance of common stock is classified as a financing activity

Answer (B) is incorrect because Purchase of treasury stock is classified as a financing activity

Answer (C) is incorrect because Payment of dividends is classified as a financing activity

Answer (D) is correct Financing activities include obtaining resources from owners and providing them with a

return on, and a return of, their investment Cash inflows from financing activities include proceeds from issuingequity instruments Cash outflows include outlays to reacquire the enterprise’s equity instruments, and outlays topay dividends However, an income tax refund is an operating activity

[74] All of the following should be classified as investing activities in the statement of cash flows except

Cash outflows to purchase manufacturing equipment

Answer (A) is incorrect because The purchase of equipment is an investing activity

Answer (B) is incorrect because The sale of bonds issued by another entity is an investing activity

Answer (C) is correct Investing activities include the lending of money and the collecting of those loans; the

acquisition, sale, or other disposal of debt or equity instruments; and the acquisition, sale, or other disposition ofassets (excluding inventory) that are held for or used in the production of goods or services Investing activities donot include acquiring and disposing of certain loans or other debt or equity instruments that are acquired

specifically for resale Cash outflows to lenders for interest are cash from an operating, not an investing, activity.Answer (D) is incorrect because The sale of a plant is an investing activity

[75] A reader of a statement of cash flows wishes to analyze the major classes of cash receipts and cash payments from

operating activities Which methods of reporting cash flows from operating activities will supply that information?

Both the direct and indirect methods

Answer (A) is incorrect because Only the direct method supplies information about individual classes of gross

cash receipts and payments related to operating activities

Answer (B) is correct The statement of cash flows may report cash flows from operating activities in either an indirect

(reconciliation) or a direct format The direct format reports the major classes of operating cash receipts and cash payments asgross amounts The indirect presentation reconciles net income to the same amount of net cash flow from operations that

would be determined in accordance with the direct method To arrive at net operating cash flow, the indirect method adjustsnet income by removing the effects of (1) all deferrals of past operating cash receipts and payments, (2) all accruals of

expected future operating cash receipts and payments, (3) all financing and investing activities, and (4) all noncash operatingtransactions

Answer (C) is incorrect because The direct method, rather than the indirect method, supplies information about individual

classes of gross cash receipts and payments related to operating activities

Answer (D) is incorrect because The direct method reports major classes of gross cash receipts and payments from operatingactivities

[76] In a statement of cash flows (indirect method), depreciation expense should be presented as

Answer (B) is incorrect because Depreciation is a noncash operating expense

Answer (C) is correct Because depreciation is a noncash charge to income, it is added to accrual-basis net income

in the determination of cash flows from operating activities under the indirect method

Answer (D) is incorrect because Depreciation should be added

[77] All of the following should be included in the reconciliation of net income to net operating cash flow in the statement of

cash flows except a(n)

Answer (B) is incorrect because A decrease in prepaid insurance is a reconciling item It implies that insurance

expense was greater than cash paid to insurers

Answer (C) is correct The purchase of land and a building in exchange for a long-term note is a noncash

investing activity that does not affect net income Thus, it is reported in the related disclosures section of the cashflow statement but is not a reconciling item

Answer (D) is incorrect because An increase in income tax payable is a reconciling item It means that income taxexpense exceeded cash paid for income taxes

[78] In preparing a statement of cash flows, an item included in determining net cash flow from operating activities is the

Amortization of a bond premium

Answer (A) is correct The debtor (issuer) on a bond sold at a premium debits or reduces the bond premium for

the excess of cash interest paid over interest expense recognized under the effective interest method The lender(buyer) likewise reduces the bond premium (by a credit) for the excess of cash interest received over interest

income recognized Interest paid (received) is a cash outflow (inflow) from an operating activity In a

reconciliation of net income to net cash flow from operating activities, both the issuer of the bond and the

purchaser must make an adjustment for the difference between the cash flow and the effect on net income

Because the issuer’s cash outflow exceeded interest expense, it must deduct the difference (premium amortization)from net income in performing the reconciliation The purchaser’s cash inflow is greater than interest income, so itmust add the difference (premium amortization) to net income to arrive at net cash flow from operating activities.Answer (B) is incorrect because The sale of equipment is an investing activity, not an operating activity

Answer (C) is incorrect because A cash dividend paid is a cash outflow from a financing activity

Answer (D) is incorrect because The purchase of treasury stock is a financing activity since it involves a change inthe amount of capital stock outstanding

[79] The information reported in the statement of cash flows should help investors, creditors, and others to assess all of the

following except the

Amount, timing, and uncertainty of prospective net cash inflows of a firm

reasons for differences between income and associated cash receipts and payments, and the cash and noncash

aspects of the entity’s investing and financing activities

Answer (B) is incorrect because The primary purpose of a statement of cash flows is to provide information aboutthe cash receipts and payments of an entity during a period A secondary purpose is to provide information aboutinvesting and financing activities The statement should help users to assess the entity’s ability to generate positivefuture net cash flows, the ability to meet its obligations and pay dividends, the need for external financing, the

reasons for differences between income and associated cash receipts and payments, and the cash and noncash

aspects of the entity’s investing and financing activities

Answer (C) is incorrect because The primary purpose of a statement of cash flows is to provide information aboutthe cash receipts and payments of an entity during a period A secondary purpose is to provide information aboutinvesting and financing activities The statement should help users to assess the entity’s ability to generate positivefuture net cash flows, the ability to meet its obligations and pay dividends, the need for external financing, the

reasons for differences between income and associated cash receipts and payments, and the cash and noncash

aspects of the entity’s investing and financing activities

Answer (D) is correct The statement of cash flows is not designed to provide information with respect to the efficient and

profitable use of the firm’s resources Financial reporting provides information about an enterprise’s performance during aperiod when it was under the direction of a particular management but does not directly provide information about that

management’s performance Financial reporting does not try to separate the impact of a particular management’s performancefrom the effects of prior management actions, general economic conditions, the supply and demand for an enterprise’s inputsand outputs, price changes, and other events

[80] To calculate cash flows using the indirect method, which one of the following items must be added back to net income?

Answer (A) is incorrect because Revenues are not added back to net income when using the indirect method of

cash flows Revenues affect cash flows

Answer (B) is incorrect because Marketing expenses are not added back to net income when using the indirect

method of cash flows Marketing expenses affect cash flows

Answer (C) is correct The indirect method begins with accrual-basis net income or the change in net assets and

removes items that did not affect operating cash flow Depreciation is a non-cash item and thus does not affect thecash flows This amount must be added back to net income because it decreased net income even though it had nocash effect

Answer (D) is incorrect because Interest income is not added back to net income when using the indirect method

of cash flows Interest income affects cash flows

[81] The net income for Cypress, Inc., was $3,000,000 for the year ended December 31 Additional information is as follows:Depreciation on fixed assets $1,500,000

Increase in accounts payable 300,000

Dividends paid on preferred stock 400,000

The net cash provided by operating activities in the statement of cash flows for the year ended December 31 should be

Answer (B) is incorrect because This amount equals net income, plus depreciation

Answer (C) is correct Net operating cash flow may be determined by adjusting net income Depreciation is an

expense not directly affecting cash flows that should be added back to net income The increase in accounts

payable is added to net income because it indicates that an expense has been recorded but not paid The gain onthe sale of land is an accrual-basis item affecting net income and thus should be subtracted The dividends paid onpreferred stock are cash outflows from financing, not operating, activities and do not require an adjustment Thus,net cash flow from operations is $4,600,000 ($3,000,000 + $1,500,000 – $200,000 + $300,000)

Answer (D) is incorrect because This amount equals net income, plus depreciation, plus the increase in accountspayable

[82] Frazier Company reported current net income of $161,000 During the year, accounts receivable increased by $14,000

and accounts payable increased by $10,500 Inventories declined by $8,000 Depreciation expense was $40,000 Net cashprovided by operating activities is

Answer (C) is correct The net income of $161,000 must be adjusted by noncash expenses (such as depreciation)

and the amount of changes in current assets as follows:

Answer (D) is incorrect because The amount of $212,500 results from reversing the treatment of receivables andpayables

[Fact Pattern #4]

Royce Company had the following transactions during the fiscal year ended December 31, Year 2:

Accounts receivable decreased from $115,000 on

December 31, Year 1, to $100,000 on December 31,

Year 2

Royce’s board of directors declared dividends on

December 31, Year 2, of $.05 per share on the

2.8 million shares outstanding, payable to shareholders

of record on January 31, Year 3 The company did not

declare or pay dividends for fiscal Year 1

Sold a truck with a net carrying amount of $7,000 for

$5,000 cash, reporting a loss of $2,000

Paid interest to bondholders of $780,000

The cash balance was $106,000 on December 31,Year 1, and $284,000 on December 31, Year 2

[83] (Refers to Fact Pattern #4)

Royce Company uses the direct method to prepare its statement of cash flows at December 31, Year 2 The interest paid

to bondholders is reported in the

Financing section, as a use or outflow of cash

A

Operating section, as a use or outflow of cash

B

Answer (A) is incorrect because Interest paid on bonds is an operating cash flow.

Answer (B) is correct Payment of interest on debt is considered a cash outflow from an operating activity, although

repayment of debt principal is a financing activity

Answer (C) is incorrect because Investing activities include the lending of money and the acquisition, sale, or other

disposal of securities that are not cash equivalents and the acquisition, sale, or other disposal of long-lived productive

assets

Answer (D) is incorrect because The statement of cash flows does not contain a debt section

[84] (Refers to Fact Pattern #4)

Royce Company uses the indirect method to prepare its Year 2 statement of cash flows It reports a(n)

Source or inflow of funds of $5,000 from the sale of the truck in the financing section

Answer (A) is incorrect because The $5,000 inflow should be shown in the investing section

Answer (B) is incorrect because No outflow of cash dividends occurred in Year 2

Answer (C) is incorrect because The decrease in receivables should be added to net income

Answer (D) is correct The indirect method determines net operating cash flow by adjusting net income Under

the indirect method, the $5,000 cash inflow from the sale of the truck is shown in the investing section A $2,000loss was recognized and properly deducted to determine net income This loss, however, did not require the use ofcash and should be added to net income in the operating section

[85] (Refers to Fact Pattern #4)

The total of cash provided (used) by operating activities plus cash provided (used) by investing activities plus cash

provided (used) by financing activities is

Answer (A) is incorrect because This amount is the ending cash balance, not the change in the cash balance; it

ignores the beginning balance

Answer (B) is correct The total of cash provided (used) by the three activities (operating, investing, and

financing) should equal the increase or decrease in cash for the year During Year 2, the cash balance increased

from $106,000 to $284,000 Thus, the sources of cash must have exceeded the uses by $178,000

Answer (C) is incorrect because The cash balance increased during the year

Answer (D) is incorrect because Net income must be adjusted for noncash expenses and other accruals and

deferrals

[86] The following information was taken from the accounting records of Oak Corporation for the year ended December 31:Proceeds from issuance of preferred stock F $4,000,000

Dividends paid on preferred stock F 400,000

Bonds payable converted to common stock 2,000,000

Proceeds from sale of plant building 1,200,000

The net cash flows from investing and financing activities that should be presented on Oak’s statement of cash flows forthe year ended December 31 are, respectively,

Answer (A) is correct The relevant calculations are as follows:

Proceeds from sale of plant building $1,200,000

Net cash provided by investing activities $ 700,000

Proceeds from issuance of preferred stock $4,000,000

Net cash provided by financing activities $3,600,000

Answer (B) is incorrect because The stock dividend has no effect on cash flows from financing activities

Answer (C) is incorrect because The gain on the sale of the building is double counted in determining the net cashflow from investing activities

Answer (D) is incorrect because The gain on the sale of the building is double counted in determining the net cashflow from investing activities

[Fact Pattern #5]

Heniser Corporation engaged in the following cash transactions during the current year:

Sale of land and building $280,000

Purchase of treasury stock 140,000

[87] (Refers to Fact Pattern #5)

Heniser’s net cash provided (used) by investing activities is

Answer (A) is incorrect because Failing to deduct the uses of cash results in $280,000

Answer (B) is correct Investing activities include making and collecting loans and acquiring and disposing of

debt or equity instruments; property, plant, and equipment; and other productive assets The calculation is

Answer (C) is incorrect because Deducting the retirement of bonds results in $(210,000)

Answer (D) is incorrect because The amount of $(350,000) results from deducting the purchase of treasury stock,which would be a financing activity, not an investing activity

[88] (Refers to Fact Pattern #5)

Heniser’s net cash provided (used) by financing activities is

Answer (A) is incorrect because Failing to deduct the uses of cash results in $247,000

Answer (B) is incorrect because Failing to deduct the retirement of bonds results in $(78,000)

Answer (C) is incorrect because Failing to deduct for the purchase of treasury stock results in $(138,000)

Answer (D) is correct Financing activities include the issuance of stock, the payment of dividends, treasury stock

transactions, and the issuance and repayment of debt They also include receiving restricted resources that are

donor-stipulated for long-term purposes The calculation is