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Chapter 3 Accrual Accounting

Learning Objective 1

1) What is a "cash" cycle?

A) A cycle of transactions that converts cash inflows to cash outflows, or vice versa.

B) A cycle where there is receipt of funding from investors, those funds are used to generate returns from investments and operations, and then the funds are returned to investors.

C) A cycle where a property is purchased that has long-term future benefits for the enterprise, which ultimately results in cash inflows, and then the property is disposed of.

D) A cycle that involves the purchase of items such as inventory; production, sales, delivery of goods or provision of services; and receipts from customers.

Answer: A

Diff: 1

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

2) What is the cash basis of accounting?

A) A method of accounting that records accounting transactions based on economic substance.

B) A method of accounting that requires accruals for amounts due or outstanding at year-end.

C) A method of accounting that records transactions only when cash is received or paid.

D) An entry that reflects events in a period different from their corresponding cash flow.

Answer: C

Diff: 1

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

3) What is a financing cash cycle?

A) A cycle of transactions that converts cash inflows to cash outflows, or vice versa.

B) A cycle where there is receipt of funding from investors, those funds are used to generate returns from investments and operations, and then the funds are returned to investors.

C) A cycle where a property is purchased that has long-term future benefits for the enterprise, which

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Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting

ultimately results in cash inflows, and then the property is disposed of.

D) A cycle that involves the purchase of items such as inventory; production, sales, delivery of goods or provision of services; and receipts from customers.

Answer: B

Diff: 1

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

3-2

4) What is the accrual basis of accounting?

A) A basis of accounting that records economic events when they happen rather than only when cash exchanges occur.

B) A method of accounting that does not require accruals for amounts due or outstanding at year-end.

C) An entry that reflects accounting events and transactions after the related cash flow.

D) An entry that reflects events in a period different from their corresponding cash flow.

Answer: A

Diff: 1

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

5) What is an "operating" cycle?

A) A cycle of transactions that converts cash inflows to cash outflows, or vice versa.

B) A cycle where there is receipt of funding from investors, those funds are used to generate returns from investments and operations, and then the funds are returned to investors.

C) A cycle where a property is purchased that has long-term future benefits for the enterprise, which ultimately results in cash inflows, and then the property is disposed of.

D) A cycle that involves the purchase of items such as inventory; production, sales, delivery of goods or provision of services; and receipts from customers.

Answer: D

Diff: 1

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

6) What is an "accrual"?

A) An entry to record deposits received from a customer for services to be provided next year.

B) An entry that reflects accounting events or transactions after the related cash flow.

C) An entry that reflects transactions in a period different from its corresponding cash flow.

D) An entry to record the payment of a supplier invoice for goods received last month.

Answer: C

Diff: 3

Skill: Conceptual Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

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7) Which of the following is NOT an example of a "cash" cycle?

A) Receipt of funding from investors that is used to generate returns from investments and operations, and then returned to investors.

B) Purchase of property with long-term future benefits which results in cash inflows and then the property is disposed of.

C) Planning for product growth which results in investment opportunities that will create returns for investors.

D) Purchase of inventory, conversion into products that are delivered to customers, and receipts from customers.

Answer: C

Diff: 1

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

8) What is an investing cash cycle?

A) A cycle of transactions that converts cash inflows to cash outflows, or vice versa.

B) A cycle where there is receipt of funding from investors, those funds are used to generate returns from investments and operations, and then the funds are returned to investors.

C) A cycle where a property is purchased that has long-term future benefits for the enterprise, which ultimately results in cash inflows, and then the property is disposed of.

D) A cycle that involves the purchase of items such as inventory; production, sales, delivery of goods or provision of services; and receipts from customers.

Answer: C

Diff: 1

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

9) What is a "deferral"?

A) An entry to record payments received from customers that had been outstanding for 100 days.

B) An entry that reflects accounting events or transactions after the related cash flow.

C) An entry that reflects transactions in a period different from its corresponding cash flow.

D) An entry to record the receipt of inventory that will be paid in 60 days.

Answer: B

Diff: 3

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

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10) Which of the following is an example of the "financing" cash cycle?

A) Receipt of funding from investors that is used to generate returns from investments and operations, and then returned to investors.

B) Purchase of property with long-term future benefits which results in cash inflows and then the property is disposed of.

C) Planning for product growth which results in investment opportunities that will create returns for investors.

D) Purchase of inventory, conversion into products that are delivered to customers, and receipts from customers.

Answer: A

Diff: 1

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

11) Which of the following is an example of an "investing" cash cycle?

A) Receipt of funding from investors that is used to generate returns from investments and operations, and then returned to investors.

B) Purchase of property with long-term future benefits which results in cash inflows and then the property is disposed of.

C) Planning for product growth which results in investment opportunities that will create returns for investors.

D) Purchase of inventory, conversion into products that are delivered to customers, and receipts from customers.

Answer: B

Diff: 1

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

12) Which of the following is an example of an "operating" cash cycle?

A) Receipt of funding from investors that is used to generate returns from investments and operations, and then returned to investors.

B) Purchase of property with long-term future benefits which results in cash inflows and then the property is disposed of.

C) Planning for product growth which results in investment opportunities that will create returns for investors.

D) Purchase of inventory, conversion into products that are delivered to customers, and receipts from customers.

Answer: D

Diff: 1

Skill: Conceptual Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

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13) Explain the meaning of the cash basis of accounting and the accrual basis of accounting. When is the cash basis appropriate? Why is the accrual basis used in financial reporting?

Answer:

• Cash basis of accounting: Record transactions when they have been settled in cash as of the balance sheet date.

• Accrual basis of accounting: Record transactions even if they have not been settled in cash as of the balance sheet date.

• Cash accounting sufficiently meets information demand when enterprises have finite and short lives because all cash cycles close when the entity dissolves.

• Accrual accounting better satisfies the demand for information because it provides additional information on cash cycles that are not yet complete at the reporting date.

Diff: 2

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

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14) Which cycle is being described in the following situations?

Cycle Situation

A cycle that involves the purchase of items such as inventory; production, sales, delivery of goods or provision of services; and receipts from customers.

A cycle where there is receipt of funding from investors, those funds are used to generate returns from investments and operations, and then the funds are returned to investors.

A cycle where a property is purchased that has longterm future benefits for the enterprise, which ultimately results in cash inflows, and then the property is disposed of.

A cycle of transactions that converts cash inflows to cash outflows, or vice versa.

Answer: Cycle Situation

Operating cash cycle

A cycle that involves the purchase of items such as inventory; production, sales, delivery of goods or provision of services; and receipts from customers.

Financing cash cycle

A cycle where there is receipt of funding from investors, those funds are used to generate returns from investments and operations, and then the funds are returned to investors.

Investing cash cycle

A cycle where a property is purchased that has longterm future benefits for the enterprise, which ultimately results in cash inflows, and then the property is disposed of.

Cash cycle

Diff: 2

Skill: Conceptual

A cycle of transactions that converts cash inflows to cash outflows, or vice versa.

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

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15) Explain how "accruals" are used in financial reporting. Provide an example to support your discussion.

Answer:

• Accruals are accounting entries that record events in a period different from the corresponding cash flows.

• Accruals encompass both instances where the accounting record reflects (i) events before cash flows and (ii) events after cash flows.

• Sometimes, accountants will refer to the latter more specifically as deferrals

• For example, recognizing sales revenue after the receipt of cash is a deferral of revenue (i.e. a liability/obligation).

• For example, recognizing sales revenue before the receipt of cash is an accrual (i.e. Accounts Receivable).

Diff: 2

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

16) What is the difference between accrual accounting and cash accounting?

Answer: Accrual accounting is a method of accounting that records economic events when they happen rather than only when cash exchanges occur. Cash accounting is a method of accounting that records only cash exchanges.

Diff: 1

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

17) Explain why companies prepare financial statements on an annual basis.

Answer: Both business and regulations respond to market demands. Financial information is needed for decision making. Investors and creditors of publicly accountable enterprises are numerous and have needs for information at different times for their investing and lending decisions. It would be impractical for enterprises to provide financial statements according to when each of these investors/creditors requires the information. Therefore, companies provide the information on fixed schedules annually and/or quarterly. As well, periodic reports are more useful in reflecting the economic condition of the business when the accrual basis is used.

Diff: 2

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

18) Explain how financial information prepared using accrual accounting provides better information to predict future cash flows than financial information prepared using the cash basis of accounting.

Answer: Accrual accounting numbers can be a better predictor of future cash flows because they smooth out and reallocate cash flows to periods that better reflect the long-term average cash flow of the enterprise. For example, an equipment purchase results in a large cash outflow but benefits the company over many years, so allocating the purchase cost over those years makes each year more representative of the cash flow expected in a typical year.

Diff: 2

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

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19) What is meant by the "going concern assumption" in financial accounting? Explain the implications to financial accounting if the going concern assumption is not valid.

Answer: The accrual basis of accounting implicitly assumes that the firm will continue to operate well into the future such that the result of incomplete transactions will be completed or concluded. This assumption is called the going-concern assumption. Because of this assumption we can use the historical cost basis of valuing most of the accounts on the balance sheet.

The opposite of the going-concern assumption is the notion that the firm is or will soon be bankrupt, and therefore no longer continues to operate. If the going-concern assumption is no longer valid (and the firm is going into bankruptcy), then assets should be valued at their exit value. This usually will be their net realizable value, which will likely result in a major reduction in the carrying value of the asset on the balance sheet and a large loss recorded on the income statement.

Diff: 3

Skill: Conceptual

Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

20) Explain the difference between a cash cycle, a financing cash cycle, an investing cash cycle and an operating cash cycle.

Answer:

A cash cycle is a set of transactions that converts a cash inflow to a cash outflow, or vice versa.

A financing cash cycle is the receipt of funding from investors, using those funds to generate returns from investments and operations, and returning the funds to investors.

An investing cash cycle is the purchase of property that has long-term future benefits for the enterprise, using that property to obtain economic benefits which ultimately results in cash inflows, and disposing of the property.

An operating cash cycle involves the purchase of items such as inventory; production, sales, and delivery of goods or provision of services; and receipts from customers.

Diff: 2

Skill: Conceptual Objective: 3.1 Explain the source of demand for periodic reporting and how accrual accounting satisfies that demand.

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Learning Objective 2

1) Which statement is correct about accrual accounting?

A) Accounting estimates or professional judgment are not necessary with accrual accounting.

B) A true measure of economic or accounting income is possible with accrual accounting.

C) An accounting method that records events when they have an economic effect on the company.

D) A method of accounting that does not require accruals for amounts due or outstanding at year-end.

Answer: C

Diff: 2

Skill: Conceptual

Objective: 3.2 Explain why accrual accounting is fundamentally inexact, why estimates are central to accrual accounting, and why there is no "true" income for typical situations; and evaluate the "quality of earnings."

2) What is meant by the phrase "true and fair view" of financial reporting?

A) The financial statements provide a true representation of the company's economic conditions and performance.

B) The financial statements provide an unbiased representation of the company's economic conditions and performance.

C) The financial statements provide a fair representation of the company's economic conditions and performance.

D) The financial statements provide an accurate representation of the company's economic conditions and performance.

Answer: C Diff: 2

Skill: Conceptual

3) What is meant by "earnings quality"?

A) A measure of how closely expense accruals correspond to actual expenses without management bias.

B) A measure to determine management bias by comparing actual reported profits with "true" earnings.

C) A measure to determine management bias by comparing reported income to actual cash flows.

D) A measure of how closely earnings correspond to earnings reported without management bias.

Answer: D

Diff: 2

Skill: Conceptual

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4) A company's reported earnings are $1,000 and cash flows are $600. Based on economic conditions during the year, the company booked allowances of $250. As a result of contractual incentives, the company booked a further $150 in accruals. What is the total of the unbiased accruals and excessive accruals?

A) $150

B) $400

C) $600

D) $1,000

Answer: B

Explanation: B) 1,000 - 600 = $400 (also: 250 + 150 = 400)

Diff: 2

Skill: Computational

5) A company's reported earnings are $1,000 and cash flows are $600. Based on economic conditions during the year, the company booked allowances of $250. As a result of contractual incentives, the company booked a further $150 in accruals. How much are the unbiased accruals?

A) $150

B) $250

C) $400

D) $600

Answer: B

Diff: 2

Skill: Computational

6) A company's reported earnings are $2,000 and cash flows are $1,600. Based on economic conditions during the year, the company booked allowances of $150. As a result of contractual incentives, the company booked a further $250 in accruals. What is the total of the excessive accruals?

A) $150

B) $250

C) $400

D) $1,600

Answer: B

Diff: 2

Skill: Computational

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7) A company's cash flows are $3,600. Based on economic conditions during the year, the company booked allowances of $1,500. As a result of contractual incentives, the company booked a further $700 in accruals. What is the total reported earnings of the company?

A) $1,400

B) $2,200

C) $3,600

D) $5,800

Answer: D

Explanation: D) 3,600 + 1,500 + 700 = 5,800

Diff: 3

Skill: Computational

8) A company's reported earnings are $2,000 and cash flows are $1,600. Based on economic conditions during the year, the company booked allowances of $150. As a result of contractual incentives, the company booked a further $250 in accruals. What is the amount of unbiased earnings?

A) $150

B) $400

C) $1,750

D) $2,000

Answer: C

Explanation: C) 1,600 + 150 = 1,750

Diff: 3

Skill: Computational

9) What are biased accruals?

A) Accruals based on applying GAAP.

B) Accruals based on overly optimistic estimates.

C) Accruals based on ethical considerations.

D) Accruals based on applying professional judgment.

Answer: B

Diff: 2

Skill: Conceptual

10) What are excessive accruals?

A) Accruals that are based on professional judgment.

B) Accruals that are based on ethical considerations.

C) Accruals based on contractual incentives or opportunism.

D) Accruals required by GAAP.

Answer: C

Diff: 2

Skill: Conceptual

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11) Why are excessive accruals a concern for accounting and financial reporting?

A) They improve the quality of earnings of the company.

B) They may represent unethical practices by the company.

C) They require too much professional judgment.

D) They result in standards overload.

Answer: B

Diff: 2

Skill: Conceptual

12) Which statement is correct?

A) Lower amounts of excessive accruals results in higher earnings quality.

B) Excessive accruals are directly observable in financial reporting.

C) It is easy to determine the contractual incentives causing excessive accruals.

D) Excessive accruals improve the comparability of financial reporting.

Answer: A

Diff: 2

Skill: Conceptual

13) Which statement correctly explains the relationship between cash flows, accruals and reported earnings?

A) Cash flows are the best representation of a company's financial position and performance because of excessive accruals.

B) The cash basis of accounting provides the best representation of a company's financial position and performance.

C) The accrual basis of accounting provides the best representation of a company's financial position and performance.

D) Accruals reduce earnings quality but are needed in financial reporting because GAAP is founded on professional judgment.

Answer: C

Diff: 3

Skill: Conceptual

14) Which statement is correct?

A) The amount and types of excessive accruals are directly related to earnings quality.

B) Excessive accruals are transparent and improve the quality of financial reporting.

C) Users can routinely determine the contractual incentives causing excessive accruals.

D) Users like earnings that closely correspond to reported results without management bias.

Answer: D

Diff: 2

Skill: Conceptual

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15) Dexter Corp. received cash for a service that is to be performed in the next accounting period. How should this transaction be accounted for?

A) As accrued revenue.

B) As an expense.

C) As a prepaid expense.

D) As a liability.

Answer: D

Diff: 2

Skill: Conceptual

16) What is the impact of overstating an accrued expense during the 2013 fiscal year?

A) There is no effect on 2013 income.

B) Net income for 2013 will be overstated.

C) Current liabilities for 2013 will be understated.

D) Ending retained earnings for 2013 will be understated.

Answer: D

Diff: 3

Skill: Conceptual

17) Which is NOT an example of a biased accrual?

A) Accruals based on overly optimistic estimates.

B) Accruals based on overly conservative estimates.

C) Accruals based on achieving target level of revenues.

D) Accruals based on applying professional judgment.

Answer: D

Diff: 3

Skill: Conceptual

18) Explain why estimates are necessary in accrual accounting and why a "true" measure of income cannot be provided.

Answer:

• Since accrual accounting includes information about cash cycles that are not yet complete, management/accountants need to estimate the cycles' outcomes, which are inherently uncertain.

• There are better or worse estimates based on available information, but since the future is unknowable, none of the predictions about the future can be considered to be true and therefore "true" income does not exist.

Diff: 1

Skill: Conceptual

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19) Explain what is meant by "quality of earnings."

Answer: Quality of earnings conceptually refers to how close the reported earnings are to an unbiased amount. Since we cannot observe unbiased earnings, quality of earnings is difficult to measure in practice.

Diff: 1

Skill: Conceptual

20) Identify at least one estimate that would be required in measuring the following financial statement items.

Work in process inventories

Intangible assets

Building

Vacation pay

Revenue from a 5-year construction contract

Answer:

Work in process inventories

Intangible assets

Directly attributable overhead

Definite or indefinite expected useful life; residual values at end of useful lives; depreciation method that would be most appropriate

Building Useful lives; pattern of benefits obtained; residual values at end of useful lives; separable components

Vacation pay

Revenue from a 5-year construction contract

Diff: 1

Skill: Conceptual

Expected vacation days that will not be used by people (i.e. expires before they can take)

Profitability of contract; degree of progress fulfilling contract; expected costs to complete

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21) What is meant by "quality of earnings"? Discuss if earnings quality should be assessed by comparing earnings to cash flows.

Answer: Quality of earnings refers to how closely reported earnings correspond to earnings that would be reported in the absence of management bias.

The practice of assessing earnings quality by comparing earnings and cash flows has some merit but is imperfect. The difference between earnings and cash flows generally can be referred to as accruals. These accruals reflect economic circumstances, accounting standards, professional judgment, ethics (the unbiased portion), as well as management bias resulting from contractual incentives and managerial opportunism. To the extent accruals reflect management bias, comparing earnings and cash flows helps to uncover that bias.

Diff: 2

Skill: Conceptual

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22) Computer Consulting Limited was started in early 2010 and continued to operate until early 2013, when it was wound up due to disputes between the two principal shareholders. When it started, the company used the following accounting policies:

1. Use straight-line depreciation for the firm's only asset, a computer which cost $1,100,000 and has an estimated useful life of four years.

2. Estimate warranty expense as 9% of sales.

3. Estimate bad debts expense as 5% of sales.

Derive net income for 2010 to 2012. For the year-end balance for 2013, assume accounts receivable, allowance for doubtful accounts, and the warranty accrual are $0, as the firm wound itself up during the year and all timing differences have been resolved.

Skill: Computational

3-17

2010 2011 2012 2013 Sales (all on account 3,400,000 3,600,000 4,100,000 410,000 Warranties paid 272,000 288,000 420,250 147,600 Proceeds on disposal of computer 0 0 0 410,000 Accounts receivable collected in the year 2,958,000 2,880,000 3,895,000 1,126,000 Accounts receivable written off in the year 102,000 108,000 205,000 236,000 All other expenses (paid in cash in the year incurred) 2,380,000 2,520,000 2,767,500 287,000 Answer: 2010 2011 2012 Sales 3,400,000 3,600,000 4,100,000 Operating expenses 2,380,000 2,520,000 2,767,500 Warranty expense 306,000 324,000 369,000 Bad debt expense 170,000 180,000 205,000 Deprec. expense 4 yr SL 275,000 275,000 275,000 Net income 269,000 301,000 483,500

Diff:

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting

23) Xavier Computer Limited was started in early 2010 and continued to operate until early 2013, when it was wound up due to disputes between the two principal shareholders. When it started, the company used the following accounting policies:

1. Use 50% declining-balance depreciation for the firm's only asset, a computer which cost $1,100,000 and has an estimated useful life of four years.

2. Estimate warranty expense as 10% of sales.

3. The year-end allowance for doubtful accounts should be 40% of gross accounts receivable.

Computational

3.2 Explain why accrual accounting is fundamentally inexact, why estimates are central to accrual accounting, and why there is no "true" income for typical situations; and evaluate the "quality of earnings."

3-18

2010 2011 2012 2013 Sales (all on account) 3,400,000 3,600,000 4,100,000 410,000 Warranties paid 272,000 288,000 420,250 147,600 Proceeds on disposal of computer 0 0 0 410,000 Accounts receivable collected in the year 2,958,000 2,880,000 3,895,000 1,126,000 Accounts receivable written off in the year 102,000 108,000 205,000 236,000 All other expenses (paid in cash in the year incurred) 2,380,000 2,520,000 2,767,500 287,000 Answer: 2010 2011 2012 Sales 3,400,000 3,600,000 4,100,000 Operating expenses 2,380,000 2,520,000 2,767,500 Warranty expense 340,000 360,000 410,000 Bad debt expense 238,000 352,800 205,000 Deprec expense 50% DB 550,000 275,000 137,500 Net income (loss) (108,000) 92,200 580,000 Diff:

Skill:

Objective:

24) Computer Consulting Limited was started in early 2010 and continued to operate until early 2013, when it was wound up due to disputes between the two principal shareholders. When it started, the company used these accounting policies:

1. Use straight-line depreciation for the firm's only asset, a computer which cost $1,100,000 and has an estimated useful life of four years.

2. Estimate warranty expense as 9% of sales.

3. Estimate bad debts expense as 5% of sales. Derive the ANNUAL NET CASH FLOWS for 2010 to 2012. For the year-end balance for 2013, assume accounts receivable, allowance for doubtful accounts, and the warranty accrual are $0, as the firm wound itself up during the year and all timing differences have been resolved.

Skill: Computational

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting 3-19

2010 2011 2012 2013 Sales (all on account 3,400,000 3,600,000 4,100,000 410,000 Warranties paid 272,000 288,000 420,250 147,600 Proceeds on disposal of computer 0 0 0 410,000 Accounts receivable collected in the year 2,958,000 2,880,000 3,895,000 1,126,000 Accounts receivable written off in the year 102,000 108,000 205,000 236,000 All other expenses (paid in cash in the year incurred) 2,380,000 2,520,000 2,767,500 287,000 Answer: 2010 2011 2012 Collections 2,958,000 2,880,000 3,895,000 Cash operating expenses paid 2,380,000 2,520,000 2,767,500 Warranty exp paid 272,000 288,000 420,250 Purchase of capital asset 1,100,000 0 0 Net cash flows (794,000) 72,000 707,250 Diff:

Learning Objective 3

1) Why is determining the "cut-off" point critical in the accrual basis of accounting?

A) Based on the periodicity concept, financial statements are prepared on a regular basis.

B) It is important to reflect business transactions and events in the subsequent accounting period.

C) The point in time at which one reporting period ends and another begins is important.

D) Transactions must be reported in the cut-off period before the statements are authorized.

Answer: A

Diff: 2

Skill: Conceptual

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

2) Assume that a company has a calendar year of January 1, 2012-December 31, 2012. March 15, 2013 was the end of the period for gathering information pertaining to the financial statements. The financial statements were authorized for issue on March 24, 2013.

What is the cut off point for the "recognition" of transactions and events in a reporting period?

A) January 1, 2012.

B) March 15, 2013.

C) March 24, 2013.

D) December 31, 2012.

Answer: D

Explanation: D) The end of the fiscal period

Diff: 2

Skill: Conceptual

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

3) What is the significance of the subsequent events period for accrual accounting?

A) The subsequent events period can affect the recognition of business transactions and events.

B) The subsequent events period can affect the measurement of business transactions and events.

C) The subsequent events period can affect the recognition and measurement of business transactions and events.

D) Transactions must be reported in the cut-off period before the statements are authorized.

Answer: B

Diff: 2

Skill: Conceptual

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting 3-20

4) The following event occurred after the company's year-end but before the completion of the audit. For this subsequent event, determine whether the event:

• requires an adjustment to the year-end financial statements,

• requires note disclosure, or

• requires neither adjustment to recognized amounts nor disclosure.

There is a fire at the company's only warehouse; the company has insufficient fire insurance to replace the warehouse and contents such that a material loss will result and operations will be curtailed for six months.

(Justify your recommendation)

Answer: No adjustment is required as the fire does not change any estimates or assumptions used in valuing year-end amounts. This event should be disclosed in the notes to the financial statements and the amount of the loss quantified; but not recorded, only described in the notes. Mention should be made of the effect of the fire on the following year's earnings. Disclosure is required as all the relevant information is known and the event is significant to the future operations of the company.

Diff: 1

Skill: Conceptual

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

5) Assume that a company has a fiscal year of July 1, 2012-June 30, 2013. August 15, 2013, was the end of the period for gathering information pertaining to the financial statements. The financial statements were authorized for issue on August 24, 2013.

What is the cut off point for the "measurement" of transactions and events in a reporting period?

A) July 1, 2012.

B) The end of the subsequent events period.

C) August 24, 2013.

D) June 30, 2013.

Answer: C

Explanation: C) Date the financial statements are authorized for issue

Diff: 2

Skill: Conceptual Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

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Intermediate Accounting, Volume 1,

Chapter 3

Accrual Accounting 3-21

6) The Rihanna Company owns 1,000 shares in Abhay Corp, a public company listed on the stock exchange. The share price was as follows:

- At date of purchase, July 2, 2012 = $100/share

- At year end, June 30, 2013 = $100/share

- At start of next fiscal year, July 1, 2013 = $95/share

- At date financial statements authorized for issue, September 1, 2013 = $90/share

Materiality for the Rhianna's financial statements is $500,000. What is the appropriate treatment of the subsequent event in the June 30, 2013 financial statements?

A) Adjustment in the financial statement for the decline in value of $10,000.

B) No adjustment is needed for the subsequent decline in share price to $90/share.

C) Note disclosure in the financial statements for the decline in value of $5,000.

D) Both an adjustment and note disclosure in the financial statements for the decline to $90/share.

Answer: B

Diff: 3

Skill: Computational

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

7) The following event occurred after the company's year-end but before the completion of the audit. For this subsequent event, determine whether the event:

• requires an adjustment to the year-end financial statements,

• requires note disclosure, or

• requires neither adjustment to recognized amounts nor disclosure.

There is a significant fall in the market price of a major portion of inventory due to new technology making the existing items obsolete. The market price is lower than the current carrying value. (Justify your recommendation.)

Answer: An adjustment is required as the market price is lower than cost, and inventory should be valued at the lower of cost and market. The drop in market price is relevant to the measurement of inventories at year-end because it reflects conditions at that point in time. No additional disclosure is required; this is just an unfortunate (albeit unusual) operating occurrence.

Diff: 1

Skill: Conceptual

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

8) Why is it important to properly define the reporting period when using the accrual basis of accounting?

Answer: The cut-off date is the end of the period for the recognition of events. Subsequent events, while not recognized in the reporting period, may provide relevant information for the measurement of items recognized before the cut-off date.

Diff: 2

Skill: Conceptual

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting

Intermediate

3-22

9) The following event occurred after the company's year-end but before the completion of the audit. For this subsequent event, determine whether the event:

• requires an adjustment to the year-end financial statements,

• requires note disclosure, or

• requires neither adjustment to recognized amounts nor disclosure.

A new competitor enters the marketplace, which will result in serious price competition and, likely, reduced income next year. (Justify your recommendation.)

Answer: New competition requires neither recognition nor disclosure. The event does not relate to conditions at or prior to the year-end for recognition. The event is neither specific nor unusual in nature to warrant disclosure.

Diff: 1

Skill: Conceptual

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

10) The following event occurred after the company's year-end but before the completion of the audit. For this subsequent event, determine whether the event:

• requires an adjustment to the year-end financial statements,

• requires note disclosure, or

• requires neither adjustment to recognized amounts nor disclosure.

New technology makes a major capital asset redundant or causes it to lose significant fair market and salvage value. (Justify your recommendation).

Answer: Due to the new technology, the assumptions for useful life, salvage value, and depreciation method should be reviewed and assumptions that are no longer appropriate based on this new information should be changed. The depreciation expense for the current year should reflect these new estimates. This requires a note disclosure as this information clarifies estimates used at the year-end for calculating depreciation expense.

Diff: 1

Skill: Conceptual Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

11) The following event occurred after the company's year-end but before the completion of the audit. For this subsequent event, determine whether the event:

• requires an adjustment to the year-end financial statements,

• requires note disclosure, or

• requires neither adjustment to recognized amounts nor disclosure.

A major client unexpectedly goes bankrupt and it is determined that you will get only 30% of the value of their account receivable as full and final settlement. (Justify your recommendation.)

Answer: For the bankruptcy of a client, recognize the reduction in the carrying value of the accounts receivable by 70% and make the necessary adjustment. This is required as this new information relates to the measurement of receivables recognized at the year-end.

Diff: 1

Skill: Conceptual

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting

3-23

12) The following event occurred after the company's year-end but before the completion of the audit. For this subsequent event, determine whether the event:

• requires an adjustment to the year-end financial statements,

• requires note disclosure, or

• requires neither adjustment to recognized amounts nor disclosure.

The company experiences a major labour strike. Workers are still on strike when the audit is finished. Does your answer change if this strike might force the company into bankruptcy? (Justify your recommendation).

Answer: No adjustment and no disclosure; labour strikes are just an unfortunate aspect of normal business operations. However, if the strike threatens the survival of the company it should be disclosed, as this would put into question the validity of the going-concern assumption.

Diff: 1

Skill: Conceptual

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting 3-24

13) Sing Songs Ltd. started operations on January 1, 2010. During its first year of operations, the company had a choice of accounting policies:

Accounting Option 1

Inventory valuation FIFO Average cost

Bad debt expense 7% of sales

Warranty expense 5% of sales

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting 3-25

Accounting Option 2

Allowance: 20% of closing (gross) accounts receivable

Allowance: an analysis of sales and repairs

Using the following information about activities for 2010-2012, derive the net income for each year under BOTH accounting options:

2011 2011 2012 Sales (all on account) 10,500,000 13,500,000 14,100,000 Inventory purchases (paid immediately) 4,500,000 3,000,000 2,900,000 Ending inventory value: FIFO 1,800,000 2,000,000 2,150,000 Ending inventory value: Average cost 1,710,000 1,750,000 2,150,000 Collections 9,500,000 12,500,000 7,165,000 Amounts actually written off 100,000 250,000 750,000 Warranties actually paid 180,000 500,000 525,000 Estimated warranty payable ending balance based on ageing analysis of sales 385,000 525,000 700,000 Depreciation expense 1,100,000 1,100,000 1,100,000 All other operating expenses (paid immediately) 2,500,000 2,800,000 3,000,000

Intermediate Accounting, Volume 1, 2e

Chapter 3 – Accrual Accounting

Answer: Accounting Option 1

Option 2

Skill: Computational

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

3-26

2010 2011 2012 Sales 10,500,000 13,500,000 14,100,000 Cost of goods sold 2,700,000 2,800,000 2,750,000 Bad debt expense 735,000 945,000 987,000 Warranty expense 525,000 675,000 705,000 Depreciation expense 1,100,000 1,100,000 1,100,000 Other operating expenses 2,500,000 2,800,000 3,000,000 Net income 2,940,000 5,180,000 5,558,000 Accounting

2010 2011 2012 Sales 10,500,000 13,500,000 14,100,000 Cost of goods sold 2,790,000 2,960,000 2,500,000 Bad debt expense 280,000 400,000 1,987,000 Warranty expense 565,000 640,000 700,000 Depreciation expense 1,100,000 1,100,000 1,100,000 Other operating expenses 2,500,000 2,800,000 3,000,000 Net Income 3,265,000 5,600,000 4,813,000 Diff: 3

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting

14) Sing Songs Ltd. started operations on January 1, 2010. During its first year of operations, the company had a choice of accounting policies:

Accounting Option 1

Accounting Option 2

Inventory valuation FIFO Average cost

Bad debt expense 7% of sales

Warranty expense 5% of sales

Allowance: 20% of closing (gross) accounts receivable

Allowance: an analysis of sales and repairs

Assume that the company selected Accounting Option 1. Using the following information about activities for 2010-2012, derive the net income for each year:

Option 1

Skill: Computational

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

3-27

2010 2011 2012 Sales (all on account) 10,500,000 13,500,000 14,100,000 Inventory purchases (paid immediately) 4,500,000 3,000,000 2,900,000 Ending inventory value: FIFO 1,800,000 2,000,000 2,150,000 Ending inventory value: Average cost 1,710,000 1,750,000 2,150,000 Collections 9,500,000 12,500,000 7,165,000 Amounts actually written off 100,000 250,000 750,000 Warranties actually paid 180,000 500,000 525,000 Estimated warranty payable ending balance based on ageing analysis of sales 385,000 525,000 700,000 Depreciation expense 1,100,000 1,100,000 1,100,000 All other operating expenses (paid immediately) 2,500,000 2,800,000 3,000,000 Answer: Accounting

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting

15) Sing Songs Ltd. started operations on January 1, 2010. During its first year of operations, the company had a choice of accounting policies:

Accounting Option 1 Accounting Option 2

Inventory valuation FIFO Average cost

Bad debt expense 7% of sales

Allowance: 20% of closing (gross) accounts receivable

Warranty expense 5% of sales Allowance: an analysis of sales and repairs

Assume that the company selected Accounting Option 2. Using the following information about activities for 2010-2012, derive the net income for each year:

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

3-28

201 2011 2012 Sales 10,500,000 13,500,000 14,100,000 Cost of goods sold 2,790,000 2,960,000 2,500,000 Bad debt expense 280,000 400,000 1,987,000 Warranty expense 565,000 640,000 700,000 Depreciation expense 1,100,000 1,100,000 1,100,000 Other operating expenses 2,500,000 2,800,000 3,000,000 Net Income 3,265,000 5,600,000 4,813,000 Diff: 3 Skill:

Accounting Option 2

Computational

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting

16) Sing Songs Ltd. started operations on January 1, 2010. During its first year of operations, the company had a choice of accounting policies:

Accounting Option 1

Accounting Option 2

Inventory valuation FIFO Average cost

Bad debt expense 7% of sales

Warranty expense 5% of sales

Allowance: 20% of closing (gross) accounts receivable

Allowance: an analysis of sales and repairs

Using the following information about activities for 2010-2012, derive the 2010 net income (only) under BOTH accounting options and explain why the net incomes are NOT the same.

3-29

Net incomes are different between the two methods due to the different inventory methods and the timing of when certain amounts were expensed. As the cumulative net incomes for all three years happen to be the same, it is just a matter of when the warranty and bad debt expenses were accrued. As accruals try to estimate actual expenditures or events that occur later, the aggregate effects over multiple periods eventually net or wash out.

Accrual or allocation methods are ways of estimating amounts that will only be clarified later when confirming events occur (warranty actually paid) or fail to occur (account receivable actually written off due to non-payment). Accruals are essential as accounting seeks to implement the matching principle, whereby expenses are matched with revenues recognized to determine net income for a period.

Diff: 3

Skill: Computational

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting 3-30

Answer: Accounting Option 1 2010 Sales 10,500,000 Cost of goods sold 2,700,000 Bad debt expense 735,000 Warranty expense 525,000 Depreciation expense 1,100,000 Other operating expenses 2,500,000 Net income 2,940,000 Accounting Option 2 2010 Sales 10,500,000 Cost of goods sold 2,790,000 Bad debt expense 280,000 Warranty expense 565,000 Depreciation expense 1,100,000 Other operating expenses 2,500,000 Net Income 3,265,000

Intermediate Accounting, Volume 1, 2e

17) Sing Songs Ltd. started operations on January 1, 2010. During its first year of operations, the company had a choice of accounting policies:

Accounting Option 1

Inventory valuation FIFO

Bad debt expense

7% of sales

Warranty expense

5% of sales

Accounting Option 2

Average cost

Allowance: 20% of closing (gross) accounts receivable

Allowance: an analysis of sales and repairs

Explain why the net incomes would NOT be the same under both accounting options.

Answer: Net incomes would be different between methods due to the different inventory methods and the timing of when certain amounts were expensed. As the cumulative net incomes for the three years happen to be the same, it is just a matter of when the warranty and bad debt expenses were accrued. As accruals try to estimate actual expenditures or events that occur later, the aggregate effects over multiple periods eventually net or wash out.

Diff: 2

Skill: Computational

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

Chapter 3 – Accrual Accounting 3-31

Intermediate Accounting, Volume 1, 2e

Chapter 3 – Accrual Accounting

18) Sing Songs Ltd. started operations on January 1, 2010. During its first year of operations, the company had a choice of accounting policies:

Accounting Option 1

Accounting Option 2

Inventory valuation FIFO Average cost

Bad debt expense 7% of sales

Warranty expense 5% of sales

Allowance: 20% of closing (gross) accounts receivable

Allowance: an analysis of sales and repairs

Using the information provided below, discuss whether the cumulative cash flows will be the same or different each accounting option.

Answer: Cumulative operating cash flows for all three years are the same ($9,260,000) for both sets of policies because the balance sheet accounts for the affected accounts are the same by the end of 2011. If the relevant balance sheet accounts are the same, all timing differences between different accrual/allocation methods have cancelled out. (This problem was designed to show identical total net income for the three years.)

Cash flows are unaffected by the choice of accounting policies used.

Diff: 3

Skill: Computational

Objective: 3.3 Apply accrual accounting in relation to issues of timing: periodicity, cut-off, and subsequent events.

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Learning Objective 4

1) Which statement is NOT correct?

A) Accruals involve uncertainty about future transactions and events.

B) Companies must use the same accounting estimates year-over-year in preparing statements.

C) A company can change its accounting policies if it provides more relevant information.

D) Higher earnings quality provides users with more decision useful financial statements.

Answer: B

Diff: 1

Skill: Conceptual

Objective: 3.4 Evaluate whether an accounting change is an error, a change in accounting policy, or a change in estimate, and apply the retrospective or prospective treatments appropriate to that type of accounting change.

2) Which statement is correct?

A) Accounting policy changes should reflect changes in economic circumstances.

B) Accounting errors are corrected prospectively in the financial statements.

C) Changes in accounting estimates are corrected retrospectively in the statements.

D) Correction of accounting errors proves that management bias exists in reporting.

Answer: A

Diff: 1

Skill: Conceptual

3) A correction of an accounting error does NOT involve

A) note disclosure.

B) retrospective adjustment.

C) retrospective restatement.

D) management bias.

Answer: D

Diff: 1

Skill: Conceptual

4) A correction of an accounting error involves

A) the use of hindsight.

B) retrospective restatement.

C) professional judgment.

D) prospective adjustment.

Answer: B

Diff: 2

Skill: Conceptual

2e Chapter

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Intermediate Accounting, Volume 1,

Accrual Accounting 3-33

5) Which of the following is an example of an error that should be corrected?

A) Switching from straight-line to the declining balance method of depreciation.

B) Changing from weighted average to the first-in, first out method of inventory valuation.

C) Using 5% for bad debts provision, but 1% is required in the company's procedures manual.

D) Starting to capitalize fixed assets under $1,000 which were previously considered immaterial.

Answer: C

Diff: 2

Skill: Conceptual

6) A change in accounting policy should

A) be based on changes in the underlying economics of business transactions.

B) not be based on management's best discretion.

C) be based on improving the comparability of financial reporting.

D) not be based on changes to accounting standards.

Answer: A

Diff: 2

Skill: Conceptual

7) A change in accounting policy

A) is accounted for on a retrospective basis, without restatement.

B) allows management to bias financial reporting.

C) is accounted for on a prospective basis, with restatement.

D) is accounted for in the same manner as an error correction.

Answer: D

Diff: 2

Skill: Conceptual

8) Changes in accounting estimates are based on

A) information available from the use of hindsight.

B) information available at the time financial statements are prepared.

C) providing comparable information in the financial statements.

D) low quality of professional judgment being exercised.

Answer: B

Diff: 2

Skill: Conceptual

2e Chapter

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Intermediate Accounting, Volume 1,

Accrual Accounting 3-34

9) Changes in accounting estimates

A) are accounted for in the same manner as changes in accounting policies.

B) reduce the relevance and reliability of financial reporting.

C) are applied to current and past reporting periods.

D) are applied to current and future reporting periods.

Answer: D

Diff: 3

Skill: Conceptual

10) Which of the following is an example of a change in accounting estimate?

A) Switching from straight-line to the declining balance method of depreciation.

B) Using 3% for the allowance for bad debts, instead of 1% as stated in the company's procedures manual.

C) Using 5% for the allowance for bad debts because of the increased possibility of bankruptcy by customers.

D) Changing from weighted average to the first-in, first-out method of inventory valuation.

Answer: C

Diff: 2

Skill: Conceptual Objective: 3.4 Evaluate whether an accounting change is an error, a change in accounting policy, or a change in estimate, and apply the retrospective or prospective treatments appropriate to that type of accounting change.

11) Which of the following is an example of a change in accounting policy?

A) Changing from weighted average to the first-in, first-out method of inventory valuation.

B) Capitalizing a delivery truck that had previously been expensed.

C) Using 5% for the allowance for bad debts because of the increased possibility of bankruptcy by customers.

D) Using 4% for the allowance for bad debts, instead of 2% as stated in the company's procedures manual.

Answer: A

Diff: 2

Skill: Conceptual

12) Changes in accounting estimates are

A) accounted for in the same manner as accounting policy changes.

B) accounted for on a prospective basis.

C) applied to current and past reporting periods.

D) accounted for in the same manner as error corrections.

Answer: B

Diff: 2

Skill: Conceptual

2e Chapter

– Accrual

Intermediate Accounting, Volume 1,

Accounting 3-35

13) Changes in accounting estimates are based on

A) new information that has now become available.

B) management bias.

C) information available from the use of hindsight.

D) comparable industry practice.

Answer: A

Diff: 2

Skill: Conceptual

14) Correction of an error is based on

A) new information that has now become available.

B) information available at the time of preparing the financial statements.

C) the use of hindsight.

D) comparable industry practice.

Answer: B

Diff: 2

Skill: Conceptual

15) Which one of the following errors would cause a company's unadjusted trial balance to be out of balance?

A) Overstating an asset balance by $100 and a revenue balance by the same amount.

B) Failure to post the debit portion of a journal entry to the proper account (recorded, for example, in a revenue rather than an expense account).

C) Recording a $5,000 revenue transaction by crediting the accounts receivable account and debiting the revenue account.

D) Recording $1,000 cash collected from a customer as a debit to the cash account and a debit to the accounts receivable account.

Answer: D

Diff: 2

Skill: Computational

16) Which of the following would result in an overstatement in reported net income?

A) Failure to record $45,000 collection of accounts receivable.

B) Expensing rather than capitalizing the $12,500 cost of a capital asset.

C) Failure to record an accrued revenue of $24,000.

D) Failure to record an accrued expense of $18,000.

Answer: D

Diff: 2

Skill: Computational

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting 3-36

17) If the gross profit percentage used in the gross profit inventory method were understated, which of the following is correct?

A) Cost of goods sold would be understated.

B) Ending inventory would be understated.

C) Ending inventory would be correctly stated, but beginning inventory would be incorrect.

D) Ending inventory would be overstated.

Answer: B

Diff: 2

Skill: Conceptual

18) The method of depreciation was changed from the double-declining-balance method to the straightline method in fiscal 2013. A machine was purchased on January 1, 2011, at a cost of $150,000. The machine has an estimated useful life of 10 years and a residual value of $9,000. What is the appropriate accounting?

A) Retrospective adjustment for fiscal 2013.

B) Retrospective adjustment for fiscal 2011 and 2012.

C) Prospective adjustment from fiscal 2012 going forward.

D) Error correction for fiscal 2013.

Answer: B

Diff: 2

Skill: Computational

19) The method of depreciation was changed from the double-declining-balance method to the straightline method in fiscal 2013. A machine was purchased on January 1, 2011, at a cost of $150,000. The machine has an estimated useful life of 10 years and a residual value of $9,000. Assume that net income before tax (NIBT) was $80,000 for fiscal 2011. What is the appropriate accounting for fiscal 2011?

A) Retrospective adjustment and revised NIBT of $110,000.

B) Retrospective adjustment and revised NIBT of $95,900.

C) Retrospective adjustment and revised NIBT of $65,900.

D) No accounting is necessary in fiscal 2011.

Answer: B

Diff: 3

Skill: Computational

1, 2e Chapter 3 – Accrual

3-37

Intermediate Accounting, Volume

Accounting

20) The method of depreciation was changed from the double-declining-balance method to the straightline method in fiscal 2013. A machine was purchased on January 1, 2011, at a cost of $150,000. The machine has an estimated useful life of 10 years and a residual value of $9,000. Assume that net income before tax NIBT) was $102,000 for fiscal 2012. What is the appropriate accounting for fiscal 2012?

A) Retrospective adjustment and revised NIBT of $87,900.

B) Retrospective adjustment and revised NIBT of $126,000.

C) Retrospective adjustment and revised NIBT of $111,900.

D) No accounting is necessary in fiscal 2012.

Answer: C

Diff: 3

Skill: Computational

21) The method of depreciation was changed from the double-declining-balance method to the straightline method in fiscal 2013. A machine was purchased on January 1, 2011 at a cost of $150,000. The machine has an estimated useful life of 10 years and a residual value of $9,000. What should have been booked as depreciation expense in fiscal 2012?

A) $9,900

B) $14,100

C) $24,000

D) $30,000

Answer: B

Explanation: B) (150,000 - 9,000) / 10 = 14,100

Diff: 2

Skill: Computational

22) The method of depreciation was changed from the double-declining-balance method to the straightline method in fiscal 2013. A machine was purchased on January 1, 2011, at a cost of $150,000. The machine has an estimated useful life of 10 years and a residual value of $9,000. What was booked as depreciation expense in fiscal 2011?

A) $14,100

B) $15,900

C) $24,000

D) $30,000

Answer: D

Explanation: D) 2011: 150,000 × 2/10 = 30,000

Diff: 2

Skill: Computational

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting 3-38

23) The method of depreciation was changed from the double-declining-balance method to the straightline method in fiscal 2013. A machine was purchased on January 1, 2011, at a cost of $150,000. The machine has an estimated useful life of 10 years and a residual value of $9,000. What adjustment is needed for fiscal 2011?

A) $14,100

B) $15,900

C) $24,000

D) $30,000

Answer: B

Explanation: B) Depreciation required under straight line: (150,000 – 9,000) / 10 = 14,100

2011 depreciation booked: 150,000 × 2/10 = 30,000

Adjustment = 15,900

Diff: 2

Skill: Computational

24) The method of depreciation was changed from the double-declining-balance method to the straightline method in fiscal 2013. A machine was purchased on January 1, 2011, at a cost of $150,000. The machine has an estimated useful life of 10 years and a residual value of $9,000. What adjustment is needed for fiscal 2012?

A) $9,900

B) $10,000

C) $20,000

D) $30,000

Answer: A

Explanation: A) Depreciation required under straight line: (150,000 - 9,000) / 10 = 14,100

2012 depreciation booked: (150,000 - 30,000) × 2/10 = 24,000

Adjustment = 9,900

Diff: 2

Skill: Computational

25) JP Corporation had net income of $1,000,000 for 2011. After issuing its financial statements, it realized that it had failed to include inventory from one of its small warehouses for several years. Specifically, it forgot to include $20,000 on December 31, 2010, and $30,000 on December 31, 2011. Which of the following is true regarding JPs 2011 net income?

A) Net income was understated by $10,000.

B) Net income was overstated by $10,000.

C) Net income was understated by $30,000.

D) Net income was overstated by $30,000.

Answer: A

Diff: 2

Skill: Computational

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Intermediate Accounting, Volume 1, 2e Chapter 3

Accrual Accounting 3-39

26) Lee Limited began operations on January 1, 2010. The following data relate to the company's first 2 years in business:

What is the correct cost of goods sold amount for 2011?

A) $400,000

B) $405,000

C) $450,000

D) $460,000

Answer: C

Explanation: C) 450,000 - (25,000 - 20,000) + (35,000 - 30,000) = $450,000

Diff: 3

Skill: Computational

27) What is the effect of overstating 2012 depreciation expense?

A) Accumulated depreciation will be understated for 2012.

B) Net income for 2012 will be overstated.

C) Ending retained earnings for 2012 will be understated.

D) Ending retained earnings for 2012 will be overstated.

Answer: C

Diff: 3

Skill: Computational

28) Explain how changes in accounting policies, changes in accounting estimates and errors are accounted for under the accrual basis of accounting.

Answer: Correction of errors and changes in accounting policies require retrospective adjustment of financial statements. Changes in estimates due to new information require prospective treatment.

Diff: 1

Skill: Conceptual

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting 3-40

Reported Amount Correct Amount Inventory December 31, 2010 25,000 20,000 December 31, 2011 35,000 30,000 Cost of goods sold For 2010 400,000 ?????? For 2011 450,000 ??????

29) For the following types of accounting changes, identify the relevant criteria for each accounting change by selecting "yes," "no," or "N/A" (not applicable)

Accounting change due to management choice (Yes, No, N/A)

Error correction

Change in estimate

Change in accounting policy

Answer:

Accounting change due to management choice (Yes, No, N/A)

Information known (or should have been known) in the prior period

(Yes, No, N/A)

Information known (or should have been known) in the prior period (Yes, No, N/A)

Error correction No Yes

Change in estimate No No

Change in accounting policy Yes N/A

Diff: 1

Skill: Conceptual

Intermediate Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting 3-41

30) Which of the following would be accounted for as correction of an error?

A. A furniture maker decreases bad debts expense from 3% to 2% of credit sales.

B. A manufacturer determines that credit losses are becoming material due to deteriorating economic conditions. As a result, it decides to set up an allowance for doubtful accounts at 5% of amounts over 90 days.

C. A parking service estimates bad debts to be 10% of the value of parking violations issued. In the current year, it changes to estimating the allowance for bad debts to be equal to 20% of accounts 30 to 90 days and 50% of accounts over 90 days.

D. A shipbuilder changes its revenue recognition policy from the point of receipt by the customer to when the ship leaves the factory shipyard. This change results from a change in shipping policy from f.o.b. destination to f.o.b. shipping point. (Recall from introductory accounting that f.o.b. means "free on board," and it refers to the point at which ownership transfers from seller to buyer.)

E. An electronics retailer has never accrued for warranties or product guarantees. A new consumer protection law comes into effect, giving buyers of electronic products a guarantee against defects for 180 days after purchase and the ability to return defective products to the retailer.

F. A clothing company that has been operating for 20 years decides to obtain an external audit for the first time in order to meet the bank's demands. The audit firm recommends that management report inventories at the lower of cost and net realizable value, whereas the company has previously only tracked and reported inventory figures at cost.

Answer: F

Diff: 2

Skill: Conceptual

2e Chapter 3 – Accrual

Intermediate Accounting, Volume 1,

Accounting 3-42

31) Which of the following would be accounted for as a change in accounting policy? (More than one answer may be correct.)

A. A furniture maker decreases bad debts expense from 3% to 2% of credit sales.

Answer: C, F

Diff: 2

Skill: Conceptual

Accounting, Volume 1, 2e Chapter 3 – Accrual Accounting

Intermediate

3-43

32) Which of the following would be accounted for as a change in accounting estimate? (More than one answer may be correct.)

A. A furniture maker decreases bad debts expense from 3% to 2% of credit sales.

Answer: A, B, D, E

Diff: 2

Skill: Conceptual

Volume 1, 2e Chapter 3 – Accrual Accounting

Intermediate Accounting,

3-44

33) Which of the following would be accounted for on a prospective basis? (More than one answer may be correct.)

A. A furniture maker decreases bad debts expense from 3% to 2% of credit sales.

Answer: A, B, D, E

Diff: 2

Skill: Conceptual

2e Chapter 3 – Accrual Accounting

Intermediate Accounting, Volume 1,

3-45