Financial Accounting A Global Perspective Test Bank

Type:

Test Bank

Financial Accounting A Global Resource: Perspective Edition:

1st Edition

Author(s):

Rod Monger

Chapter 1 The Financial Accounting Reporting System Test Bank True/False Questions 1. Financial accounting reports are created primarily for use by internal users.

False Page: p8 2. External users include investors, managers, employees, lenders, suppliers and other creditors, customers, governments and their agencies and the public.

False Page: p9 3. A transaction is an exchange between two entities.

True Page: p9 4. In the past, accounting used the double-entry method created in the 15th century but modern accounting has replaced this with transaction accounting.

False Page: p9 5. The owner or owners of a business are a separate entity from the business.

True Page: p11 6. The entity concept refers to a business organization in which the individual owner and the business are one and the same.

False Page: p13 7. A barter transaction is an exchange that does not involve money.

True Page: p13 8. A limited liability company is sometimes referred to as a corporation, joint stock company or share-based entity.

True Page: p15 9. Limited liability companies cannot own assets, create debt obligations, enter into legal contracts or engage in business transactions. All these things must be owned personally by the shareholders of the company.

False Page: p15 . .

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10. A company named Benedikt Motor Works, AG would be a limited liability company registered in either Austria or Germany.

True Page: p14 11. A share provides evidence of ownership of a partner’s share in a partnership.

False Page: p15 12. Partnerships can be either privately-held or publicly-traded.

False Page: p16 13. Alternative names for bourses are stock exchanges, stock markets or equity securities market.

True Page: p15 14. One primary advantage of a sole proprietorship is that raising capital is easier than in the other two forms of business organization.

False Page: p16 15. An individual who is a sole proprietor has no protection from creditors.

True Page: p16 16. Creditors cannot pursue the individual partners in a partnership to collect debts of the partnership. Only the partnership is responsible to the creditors.

False Page: p16 17. The form of business organization that is the easiest to raise capital for is the limited liability company because it is able to continue operations uninterrupted even though the ownership changes.

True Page: p15 18. A complete set of financial statements includes the statement of comprehensive income, statement of financial position, statement of changes in equity and statement of cash flows.

False Page: p18 19. The statement of comprehensive income answers the question ‘How did the business perform?’

True Page: p19

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20. The statement of changes in equity answers the question ‘How did the business obtain cash and how was it used?’

False Page: p19 21. The statement of cash flows answers the question ‘What resources have the owners invested in the business?’

False Page: p19 22. The reporting date for a business entity is the same as the date on the statement of financial position.

True Page: p20 23. The reporting date for a business entity is the same as the date on the statement of comprehensive income.

False Page: p20 24. The time period assumption requires that businesses prepare financial statements at least once annually.

False Page: p20 25. Only the statement of financial position is reported for a single date. The other financial statements report results for a period of time such as a year, quarter or month.

True Page: p20 26. The term ‘financial position’ refers to the relationship between the statement of financial position and the statement of comprehensive income.

False Page: p22 27. If equity is deducted from assets, the result is liabilities.

True Page: p24 28. In order to be an asset, an item must have some future relevance to the business.

True Page: p23 29. Cash is classified as equity on the statement of financial position.

True Page: p25

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30. If liabilities are $75 000 and equity is $32 000, assets must be $43 000.

False Page: p24 31. A company reports the following amounts: loans payable €230, trade accounts payable €1 170, inventories €500, contributed capital €100, land €2 500. Total liabilities are €4 500.

False Page: p24 32. Total comprehensive income is the total of profit or loss plus other comprehensive income.

True Page: p31 33. A company reports the following amounts on its statement of comprehensive income: Total comprehensive income £2 760, revenue £5 000 and other comprehensive income of £2 300.

Expenses were £4 540.

True Page: p28 34. Revenue is also known as profit or sales.

False Page: p25 35. Expenses are outflows of economic benefits during the period arising from the entity’s business activity.

True Page: p28 36. The difference between revenue and expenses is profit or loss.

True Page: p29 37. Equity has three basic elements: contributed capital, reserves and retained earnings.

True Page: p25 38. A dividend is an expense of the business and therefore appears on the statement of comprehensive income.

False Page: p31 39. Operating activities and financing activities are sources of cash while investing activities are a use of cash.

False Page: p33

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40. Investing activities on the statement of cash flows refers to changes in the size and composition of the amount owners have invested in the business and borrowings.

False Page: p33 41. If a company sells more shares to investors, this would be a source of cash from financing activities.

True Page: p33 42. If a company pays a supplier cash, this would be a use of cash from operating activities.

True Page: p33 43. If a business repays a loan to a creditor, this would be a source of cash from financing activities.

False Page: p33 44. A company reports on its statement of cash flows that operating activities were a source of cash for $500, investing activities were a use of cash for $600 and financing activities were a use of cash for $550. Then cash balance shown on the statement of financial position for the end of the year was $700. The cash balance shown on the statement of financial position at the end of the previous year was $1 350.

True Page: p34 45. The four major steps in the accounting process are to analyze transactions, record transactions, prepare financial statements and then close the account.

False Page: p40 46. The reporting decision deals with the question ‘What additional information should be provided to external users?’

False Page: p41 47. The recognition decision deals with the question ‘Should a transaction be included?’ in the accounting records.

True Page: p41 48. Generally accepted accounting principles include laws and regulations of governments and commonly accepted accounting practices but do not include accounting standards which are separate.

False Page: p43

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49. All nations have now use international accounting standards which are referred to as International Financial Reporting Standards (IFRS).

False Page: p44 50. An audit is a review by management to determine whether the company’s accountants have prepared the financial statements in accordance with applicable accounting standards.

False Page: p45 51. Accounting policies are formal and informal guidelines within a business to determine how the business will account for financial transactions within the context of applicable accounting standards.

False Page: p56

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Multiple Choice Questions 1. Someone who uses accounting information is: a. an internal user b. an external user c. a user d. a manager Page: p7 2. External users include all of the following except: a. lenders b. customers c. managers d. employees Page: p9 3. The following would be a type of external user who needs financial information to help them decide whether to buy, hold or sell equity securities in the company, and whether the company can pay dividends. a. Investors b. Lenders c. Suppliers and other trade creditors d. Customers Page: p9 4. Accounting accounts for which of the following? a. Any information desired by external users b. Only financial information desired by external users c. All financial transactions except those involving barter transactions d. Financial transactions including barter transactions Page: p8

5. Anzhela begins a new business which is registered as a limited liability company. She invests €150 000 of her personal savings in the business. This would be treated as a transaction which must be accounted for because: a. of the form of business organization b. of the entity concept c. the business is profit-making d. Anzhela began the business Page: p13

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6. Which of the following business forms is a legally independent entity established under the laws and regulations of the government in the jurisdiction where the business is registered. a. Partnership b. Sole proprietorship c. Limited liability company d. Both a and c Page: p15 7. Which of the following business forms has the advantage of being able to operating continuously even though ownership changes? a. Partnership b. Sole proprietorship c. Limited liability company d. Both a and c Page: p15 8. Which of the following business forms has the advantage of protecting the owners from business creditors? a. Partnership b. Sole proprietorship c. Limited liability company d. Both a and c Page: p15 9. Which of the following forms of business has the advantage of simplicity? a. Partnership b. Sole proprietorship c. Limited liability company d. Both a and c Page: p16 10. Which of the following forms of business does not protect owners from business creditors? a. Partnership b. Sole proprietorship c. Limited liability company d. Both a and b Page: p16 11. Which of the following forms of business would result in the termination of the business if the ownership changes? a. Partnership b. Sole proprietorship c. Limited liability company d. Both a and b Page: p16

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12. Which of the following forms of business can engage in transactions on its own cognizance? a. Partnership b. Sole proprietorship c. Limited liability company d. Both a and c Page: p15 13. Which of the following forms of business engages in transactions in the name of the owners rather than the business itself? a. Partnership b. Sole proprietorship c. Limited liability company d. Both a and b Page: p16 14. Which of the following forms of business organization can be publicly-traded? a. Partnership b. Sole proprietorship c. Limited liability company d. Both a and c Page: p15 15. Which of the following forms of business organization can be privately owned? a. Partnership b. Sole proprietorship c. Limited liability company d. All can be privately owned Page: p15 16. Which of the following financial statements answers the question ‘How did the business perform”? a. Statement of financial position b. Statement of comprehensive income c. Statement of changes in equity d. Statement of cash flows Page: p19 17. Which of the following financial statements answers the question ‘What resources have the owners invested in the business”? a. Statement of financial position b. Statement of comprehensive income c. Statement of changes in equity d. Statement of cash flows Page: p19

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18. Which of the following is true about the time period assumption? a. It allows reporting periods to be broken into specific time periods b. It requires that business report their financial results at least once annually c. It requires businesses to choose whether to report their financial results once per year, quarter or month d. It requires businesses to report their financial results at least monthly Page: p20 19. Which of the following financial statements reports financial results as of a single date? a. Statement of financial position b. Statement of comprehensive income c. Statement of changes in equity d. Statement of cash flows Page: p20 20. Which of the following items would not appear on the statement of financial position? a. Assets b. Revenues c. Equity d. Liabilities Page: p22 21. Inventories would appear on which financial statement? a. Statement of financial position b. Statement of comprehensive income c. Statement of changes in equity d. Statement of cash flows Page: p20 22. Trade accounts receivable would appear on which financial statement? a. Statement of financial position b. Statement of comprehensive income c. Statement of changes in equity d. Statement of cash flows Page: p20 23. Cash in bank would appear on which financial statement? a. Statement of financial position b. Statement of comprehensive income c. Statement of changes in equity d. Statement of cash flows Page: p20

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24. Equipment would appear on which financial statement? a. Statement of financial position b. Statement of comprehensive income c. Statement of changes in equity d. Statement of cash flows Page: p20 25. Trade accounts payable would appear on which financial statement? a. Statement of financial position b. Statement of comprehensive income c. Statement of changes in equity d. Statement of cash flows 26. Contributed capital would appear on which financial statement? a. Statement of financial position b. Statement of comprehensive income c. Statement of changes in equity d. Statement of cash flows Page: p20 27. Retained earnings would appear on which financial statement? a. Statement of financial position b. Statement of comprehensive income c. Statement of changes in equity d. Statement of cash flows Page: p24 28. A company has equity of $125 000, liabilities of $80 000. Which of the following is true? a. Total assets cannot be determined from this information b. Total assets are equal to $205 000 c. Total assets are equal to $35 000 d. Revenue is equal to $35 000 Page: p24 29. Which of the following is not true? a. Assets – liabilities = equity b. Liabilities + equity = assets c. Liabilities – equity = assets d. Assets – equity = liabilities Page: p24

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30. During a reporting period, a company’s assets increase by ¥80 000 000. Liabilities decrease by ¥20 000 000. Equity must therefore: a. decrease by ¥100 000 000 b. increase by ¥100 000 000 c. decrease by ¥60 000 000 d. increase by ¥60 000 000 Page: p24 31. During a reporting period, a company’s trade accounts payable increase by €1 200; cash in bank decreased by €800; trade accounts receivable increases by €1 300, Inventories decrease by €200, and loans payable decrease by €500. What is the effect on equity? a. Increases by €400 b. Decreases by €400 c. Increases by €600 d. Decreases by €600 Page: p24 32. During a reporting period, a company’s total assets decrease by £650. Liabilities increase by £300. Contributed capital increases by £200. What is the effect on the amount of retained earnings? a. Increases by £150 b. Decreases by £1150 c. Decreases by £150 d. Increases by £1150 Page: p24 33. A company reports the following amounts for the year ended 31 December 2011: Rent expense $120; revenue $1 500; other comprehensive income $42; cost of goods sold $800; and wages expense $215. How much is total comprehensive income? a. $42 b. $365 c. $407 d. $1542 Page: p28 34. A company reports the following amounts for the year ended 31 December 2011: Rent expense $120; revenue $1 500; total comprehensive income $565; cost of goods sold $800; and wages expense $215. How much is other comprehensive income? a. $200 b. $365 c. $930 d. $2 065 Page: p28

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35. Which of the following items would be reported in the statement of changes in equity?

1- A change in other comprehensive income 2- The beginning balance in equity 3- A change in the amount of assets during the reporting period 4- A change in the amount of liabilities during the reporting period 5- Profit for the reporting period 6- Dividends paid during the reporting period 7- Increases and decreases in contributed capital during the reporting period a. 1, 2, 5, 6 and 7 only b. 1, 3, 4, 6 and 7 only c. 2, 5, 6 and 7 only d. All items are reported in the statement of changes in equity Page: p28 36. An investor purchases shares in privately-held limited liability company. For the company, this is a: a. source of cash from an investing activity b. source of cash from a financing activity c. use of cash from an investing activity d. use of cash from a financing activity Page: p33 37. A company collects a trade accounts receivable balance owed by a customer. For the company, this is a: a. Source of cash from a financing activity b. Use of cash from a financing activity c. Source of cash from an operating activity d. Use of cash from an operating activity Page: p33 38. A company borrows €1 000 000 to be repaid over the next two years. The cash will be used to buy more inventory to sell to customers and to purchase some additional display equipment for a retail store. For the company, this is a: a. Source of cash for operating activity b. Use of cash for operating activity c. Source of cash for financing activity d. Source of cash for investing activity Page: p33

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39. A company reported the following amounts on the statement of cash flows for the year ended 31 December 2010. Beginning cash balance $410; use of cash from investing activity 130; use of cash from financing activity $112 and source of cash from operating activity $200. Which of the following statements is correct? a. The ending cash balance for the reporting period was $452 b. The cash balance increased by $42 during the reporting period c. The cash balance decreased by $42 during the reporting period d. The ending cash balance for the reporting period was negative Page: p33 40. The question of whether a transaction should be included in accounting refers to: a. Reporting b. Recognition c. Disclosure d. Measurement Page: p41 41. The question of what monetary amount is associated to a transaction refers to: a. Reporting b. Recognition c. Disclosure d. Measurement Page: p41 42. The question of whether the results of certain transactions should be reported separately in the financial statements refers to: a. reporting b. recognition c. disclosure d. measurement Page: p41 43. The question of what additional information should be provided to external users refers to: a. reporting b. recognition c. disclosure d. measurement Page: p41

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Essay Question 1. Define generally accepted accounting principles and accounting standards. Discuss the difference between the two.

Answer Generally accepted accounting principles (GAAP) govern the decisions about recognition, measurement, reporting and disclosure of accounting information. The term GAAP refers to the laws, regulations and rules that govern accounting including commonly accepted practices.

GAAP are influence by academic research, the opinions of industry group and the companies and others who prepare financial statements. GAAP are usually specific to nations or regions.

Accounting standards are the formal rules and regulations that govern accounting practice. They are usually set at the national level though international standards (IFRS) are now being used in whole or part by many nations. Accounting standards are part of generally accepted accounting principles.

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Chapter 2 Accounting Standards and Ethics True/False Questions 1. Accounting standards were previously set at the national level but now are all established at the international level.

False Page: p67 2. International accounting standards use a principle-based approach.

True Page: p68 3. Principles-based standards are criticized because management has an incentive to apply them by the ‘letter of the law’ rather than the ‘spirit of the law’ as a means of circumventing certain requirements.

False Page: p68 4. A major advantage of principles-based standards is that they are flexible enough to be applied in different jurisdictions, each of which can have its own implementation of the standard in a way that satisfied local laws and culture.

True Page: p68 5. A major criticism of rules-based standards is that management has too much latitude in their application and therefore uncertainty is created about whether a company is in compliance or not.

False Page: p68 6. The IASC Foundation creates international accounting standards.

False Page: p68 7. International Financial Reporting Standards (IFRS) include International Financial Reporting Standards provided by the International Accounting Standards Board (IASB) as well as International Accounting Standards (IAS), interpretations by the International Financial Reporting Interpretations Committee (IFRIC) and the former Standing Interpretations Committee.

True Page: p68

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8. International Financial Reporting Standards (IFRS) interpretations by the International Financial Reporting Interpretations Committee (IFRIC).

True Page: p68 9. International Financial Reporting Standards (IFRS) include International Financial Reporting Standards provided by the International Accounting Standards Board (IASB) but not International Accounting Standards (IAS) that were established by the International Accounting Standards Committee (IASC) that preceded the IASB. False Page: p68 10. International Financial Reporting Standards (IFRS) are set by the International Accounting Standards Board (IASB).

True Page: p68 11. Advice provided by the Standards Advisory Council is considered to be part of International Financial Reporting Standards (IFRS).

False Page: p68 12. Holding public hearings is a mandatory step in the IASB standard-setting process.

False Page: p72 13. Consulting the Standards Advisory Committee on major projects, agenda decisions and work priorities is a mandatory step in the IASB standard-setting process.

True Page: p72 14. Publishing a discussion document is a non-mandatory step in the IASB standard-setting process.

True Page: p72 15. Publishing bases for conclusions with standards and exposure drafts is a non-mandatory step in the IASB standard-setting process.

False Page: p72 16. Undertaking field tests both in developed countries and emerging markets is a mandatory step in the IASB standard-setting process.

False Page: p72

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17. The Framework for the Preparation and Presentation of Financial Statements is an example of one accounting standard established by the International Accounting Standards Board (IASB).

False Page: p73 18. The three levels of authoritative guidance listed in order are IFRS, the Framework for the Preparation and Presentation of Financial Statements and management judgment.

True Page: p74 19. The two underlying assumptions in the Framework for the Preparation and Presentation of Financial Statements are going concern and accrual basis.

True Page: p74 20. On 25 April 2010, employees provide services to a company for €15,000. The company pays for these services on 4 May 2010. Under accrual basis accounting, the effect of these services will be reported in May 2010.

False Page: p74 21. The accrual basis of accounting requires that transactions be recorded in the period when payment is received or made by the company.

False Page: p74 22. Going concern refers to the assumption that a business entity will continue operating without threat of liquidation in the foreseeable future.

True Page: p75 23. The four qualitative characteristics of financial statements defined by the Framework for the Preparation and Presentation of Financial Statements are 1) comparability, 2) relevance, 3) reliability and 4) understandability.

True Page: p75 24. One constraint on relevant and reliable information as defined by the Framework for the Preparation and Presentation of Financial Statements is prudence.

False Page: p76 25. One constraint on relevant and reliable information as defined by the Framework for the Preparation and Presentation of Financial Statements is that financial statements should present a true and fair view.

True Page: p76 . .

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26. One constraint on relevant and reliable information as defined by the Framework for the Preparation and Presentation of Financial Statements is timeliness.

True Page: p76 27. An external user assumes that IFRS have been used to prepare financial statement unless there is an explicit and unreserved statement in the notes to the financial statements than another accounting standard was used.

False Page: p79 28. In accounting, information is material if omission or misstatement of that information could influence the economic decisions of users.

True Page: p80 29. A reporting entity is normally not allowed to offset assets and liabilities.

True Page: p80 30. International Financial Reporting Standards (IFRS) require that a business present a complete set of financial statement at least once annually even though the business may elect to present financial statement more frequently.

True Page: p80 31. International Financial Reporting Standards (IFRS) require that a business present at least three years’ comparable information when the business presents its annual financial statements.

False Page: p81 32. Realizable value means that assets are recorded for an amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them.

False Page: p82 33. Present value means that assets are carried at the discounted value of future net cash inflows that the asset is expected to generate, while liabilities are carried at the discounted value of the net cash outflows expected to settle the obligation in the normal course of business.

True Page: p82 34. Under historical cost, liabilities are measured by the amount of proceeds exchanged for the obligation.

True Page: p82 . .

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35. One issue within professional ethics is whether professionals including accountants are able to make independent judgments about their work.

True Page: p82

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Multiple Choice Questions 1. Which of the following statements is not correct? a. Some nations have converged their national standards with International Financial Reporting Standards b. Some nations have not converged their national standards with International Financial Reporting Standards c. By the year 2012, all nations will be required to use International Financial Reporting Standards d. Accounting standards are still established at the national level Page: p67

2. Which of the following is not a characteristic of rules-based standards? a. Rules-based standards must be clear and understandable in their application and enforcement b. Rules-based standards can be more flexibly applied in different jurisdictions c. Rules-based standards must be comprehensive to avoid gaps that fail to provide guidance in all circumstances d. Critics believe that rules-based standards give management an incentive to apply standards by the ‘letter of the law’ rather than in the ‘spirit of the law’ Page: p68 3. Which of the following is not a characteristic of principles-based standards? a. Principles-based standards provide specific guidelines for those who prepare financial statements b. Critics believe that principles-based standards create some uncertainty about whether a company is in compliance or not c. Critics believe that management has too much latitude in the application of principlesbased standards d. With principles-based standards, it is easier to have implementations that satisfy local laws and culture Page: p68 4. International Financial Reporting Standards (IFRS) are now established by: a. the International Monetary Fund b. the International Accounting Standards Committee c. the IASC Foundation d. the International Accounting Standards Board Page: p68 5. International Financial Reporting Standards (IFRS) include all except which of the following: a. interpretations by the International Financial Reporting Interpretations Committee b. Pronouncements by the Standards Advisory Council c. International Financial Reporting Standards (IFRS) as currently established by the IASB d. International Accounting Standards Page: p68 . .

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6.

Which of the following is not an objective of the International Accounting Standards Board? a. Promote the use and rigorous application of IFRS b. Follow directives issued by national accounting standards organizations c. Develop a single set of high quality, understandable and enforceable global standards d. Work actively with national standard-setters to bring about convergence of national accounting standards with IFRS Page: p69

7. The organization that is responsible for ensuring that IASB board members are selected for the best combination of technical skills and background experience on relevant international business and market conditions is the: a. IASC Foundation b. International Accounting Standards Board c. Standards Advisory Council d. International Financial Reporting Interpretations Committee Page: p69 8. Which of the following are requirements for developing international accounting standards?

1- Extensive consultation and responsiveness 2- Transparency and accessibility 3- Accountability 4- Collating responses to discussion papers and exposure drafts a. 1, 2 and 3 only b. 2, 3 and 4 only c. 1, 2 and 4 only d. All four are requirements Page: p71 9. Which of the following is not a mandatory step in the IASB standard-setting process? a. Establishing procedures for reviewing comments made within a reasonable period on documents published for comment. b. Publishing bases for conclusions with standards and exposure drafts. c. Preparing and issuing standards and exposure drafts, each of which is to include any dissenting opinions. d. Publishing a discussion document Page: p72

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10. Which of the following is the correct sequence for obtaining authoritative guidance when preparing financial statements according to the IASB Framework for the Preparation and Presentation of Financial Statements?

1- National standards other than IFRS 2- The Framework for the Preparation and Presentation of Financial Statements 3- Public accountants 4- IFRS 5- Management judgment a. 1, 2, 4 and then 3 b. 1, 2, 4 and then 5 c. 4, 2 and then 5 d. 4, 1 and then 3 Page: p74 11. Which concept relates to the reporting of the effects of transactions when they occur and not necessarily when cash is received or paid? a. Time period assumption b. Accrual basis c. Going concern d. Double-entry assumption Page: p74 12. Which concept relates to the assumption that a business entity will continue to operate without threat of liquidation in the foreseeable future? a. Accrual basis b. Going concern c. Entity assumption d. Reporting assumption Page: p75 13. Qualitative characteristics that make information provided in financial statements useful to users include which of the following: 1- relevance 2- integrity 3- understandability 4- cost effectiveness 5- comparability 6- timeliness 7- reliability a. 2, 4, 6 and 7 b. 1, 2, 5 and 6 c. 2, 3, 4 and 7 d. 1, 3, 5 and 7 Page: p75

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14. The qualitative characteristic of financial statements that assumes that users have a reasonable knowledge of business, economic activities and financial accounting, and will study the information with reasonable diligence to comprehend its meaning is which of the following? a. Reliability b. Relevance c. Understandability d. Comparability Page: p75 15. The qualitative characteristic of financial statements that describes information that is free from material error and faithfully represents what it purports to represent is which of the following? a. Reliability b. Relevance c. Understandability d. Comparability Page: p75 16. Consistency relates to which of the following qualitative characteristic of financial statements? a. Reliability b. Relevance c. Understandability d. Comparability Page: p76 17. Prudence relates to which of the following qualitative characteristic of financial statements? a. Reliability b. Relevance c. Understandability d. Comparability Page: p76 18. Completeness relates to which of the following qualitative characteristic of financial statements? a. Reliability b. Relevance c. Understandability d. Comparability Page: p76 19. Substance over form relates to which of the following qualitative characteristic of financial statements? a. Reliability b. Relevance c. Understandability d. Comparability Page: p76

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20. Neutrality relates to which of the following qualitative characteristic of financial statements? a. Reliability b. Relevance c. Understandability d. Comparability Page: p76 21. Faithful reprentations relates to which of the following qualitative characteristic of financial statements? a. Reliability b. Relevance c. Understandability d. Comparability Page: p76 22. Which of the following is not a constraint on relevant and reliable information as identified in the IASB Framework for the Preparation and Presentation of Financial Statements? a. Fair presentation b. Balance between qualitative characteristics c. Prudence d. Timeliness Page: p76 23. If the omission or misstatement could influence the economic decisions of users on the basis of financial statements, then information is which of the following? a. Timely b. Material c. Relevant d. Reliable Page: p80 24. Lam Corporation owes Ling Ltd. ¥50,000. Ling owes Lam ¥45,000. Which of the following is correct about reporting this information according to the IASB Framework for the Preparation and Presentation of Financial Statements? a. Lam should report a negative trade accounts payable amount of ¥5,000 b. Lam should report assets of ¥50,000 c. Ling should report assets of ¥5,000 d. Ling should report assets of ¥45,000 Page: p80

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25. Which of the following measurement concepts described in the IASB Framework for the Preparation and Presentation of Financial Statements measures liabilities at the amount of cash or cash equivalents that would currently be required to settle the obligation? a. Current cost b. Present value c. Historical cost d. Realizable value Page: p80 26. Which of the following measurement concepts described in the IASB Framework for the Preparation and Presentation of Financial Statements measures liabilities by the amount of proceeds exchanged for the obligation? a. Current cost b. Present value c. Historical cost d. Realizable value Page: p82 27. Which of the following measurement concepts described in the IASB Framework for the Preparation and Presentation of Financial Statements measures liabilities at the discounted value of the net cash outflows expected to settle the obligation in the normal course of business? a. Current cost b. Present value c. Historical cost d. Realizable value Page: p82 28. Which of the following measurement concepts described in the IASB Framework for the Preparation and Presentation of Financial Statements measures liabilities at the amount of cash or cash equivalents that would be needed to settle the obligation in the normal course of business? a. Current cost b. Present value c. Historical cost d. Realizable value Page: p82 29. Which of the following measurement concepts described in the IASB Framework for the Preparation and Presentation of Financial Statements measures assets based on the amount of cash or cash equivalents that would be paid if they were acquired currently? a. Current cost b. Present value c. Historical cost d. Realizable value Page: p82

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30. Which of the following measurement concepts described in the IASB Framework for the Preparation and Presentation of Financial Statements measures assets based on an amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them? a. Current cost b. Present value c. Historical cost d. Realizable value Page: p82 31. Which of the following measurement concepts described in the IASB Framework for the Preparation and Presentation of Financial Statements measures assets at the discounted value of future net cash inflows that the asset is expected to generate? a. Current cost b. Present value c. Historical cost d. Realizable value Page: p82 32. Which of the following measurement concepts described in the IASB Framework for the Preparation and Presentation of Financial Statements measures assets at an amount of cash or cash equivalents that would be paid if they were acquired currently? a. Current cost b. Present value c. Historical cost d. Realizable value

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Essay Questions 1. Explain the difference between rules-based and principles-based standards? What are the criticisms of each approach? Which approach does the International Financial Reporting Standards use?

Answer Rules-based standards provide specific guidelines but these guidelines must be clear and understandable in their application and enforcement. They must also be comprehensive so as to not leave gaps in the guidance provided. Principles-based standards focus on broad objectives and are therefore can be flexibly applied to different jurisdictions. Thus, implementation is easier across different cultures.

Critics believe that rules-based standards cause management to apply rules by the ‘letter of the law’ rather than focusing on a true and fair view of the reporting entity’s financial condition.

Critics of principles-based standards believe that it is difficult to determine whether a reporting entity has complied with the standards or not.

IFRS use a principle-based approach to standards.

2. What are the objectives of the International Accounting Standards Board?

Answer • To develop, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements and other financial reporting to help participants in the various capital markets of the world and other users of the information to make economic decisions; • To promote the use and rigorous application of those standards; and • To work actively with national standard-setters to bring about convergence of national accounting standards and IFRSs to high quality solutions.”

3.

Describe the six stages in the proper sequence that the International Accounting Standards Board uses to set standards.

Answer 1. Setting the agenda – The IASB considers the following criteria when setting its agenda: a. The relevance to users of the information and the reliability of information that could be provided b. Existing guidance available c. The possibility of increasing convergence d. The quality of the standard to be developed e. Resource constraints.

2. Project planning – The IASB can decide whether it wishes to work alone on a specific project or jointly with another standard-setter. In some cases, the IASB may establish a working

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group. The Director of Technical Activities and the Director of Research select a project team and appoint a project manager who draws up a project plan.

3. Development and publication of a discussion paper. A discussion paper typically includes a comprehensive overview of the issue, possible approaches to addressing the issue, preliminary of views of the authors or the IASB, and an invitation to comment. Normally 120 days is allowed for comment.

4. Development and publication of exposure draft. A mandatory exposure draft of the published setting out the proposed standard, or amendment to an existing standard. The IASB invites comments typically for a period of 120 days, though for shorter periods in some cases.

5. Development and publication of a standard. After resolving issues that arise in the exposure draft, the IASB has the option of publishing a second exposure draft or issuing the actual standard.

6. Procedures after a standard is issued. The IASB members and staff hold regular meetings with interested parties after the issuance of a standard to understand any unanticipated issues that may arise related to practical implementation or the standards potential impact.

4. What are the four measurement methods identified in the IASB Framework for the Preparation and Presentation of Financial Statements? Describe how each measures assets and liabilities?

Answer 1. Historical cost – Assets are recorded for an amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them. Liabilities are measured by the amount of proceeds exchanged for the obligation.

2. Current cost – Assets are valued based on the amount of cash or cash equivalents that would be paid if they were acquired currently. Liabilities are measured at the amount of cash or cash equivalents that would currently be required to settle the obligation.

3. Realizable value – Assets are carried at an amount of cash or cash equivalents that would be obtained by selling the asset in an orderly (not liquidation) disposal. Liabilities are carried at the amount of cash or cash equivalents that would be needed to settle the obligation in the normal course of business.

4. Present value – Assets are carried at the discounted value of future net cash inflows that the asset is expected to generate, while liabilities are carried at the discounted value of the net cash outflows expected to settle the obligation in the normal course of business.

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Chapter 3 The Financial Statements Test Bank True/False Questions 1. Annual reports do not always include financial statements.

True Page: p116 2. Under International Financial Reporting Standards, financial statements may include reports by directors, statements by the chairman of the company, discussion and analysis by management and similar items.

False Page: p116 3. Financial statements must include an opinion from a public accountant about whether a true and fair view of financial results is presented.

False Page: p117 4. Under IFRS, notes to the financial statements should contain the following items in the order listed: 1) a statement of compliance with IFRS, 2) a summary of significant accounting policies, 3) supporting information for items presented on the face of the financial statements, and 4) other disclosures.

True Page p119 5. Financial position refers to whether a business reports a profit when revenues exceed expenses, or whether it reports a loss when expenses exceed revenues.

False Page: p120 6. In order to meet the IFRS definition of an asset, a resource must be controlled by the entity as the result of past events.

True Page: p120 7. In order to meet the IFRS definition of an asset, a resource must represent future cash expected to flow to the entity.

False Page: p120

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8. To qualify as a current asset under IFRS, an entity must: 1) expect to realize the asset or intends to sell or consume it in its normal operating cycle, 2) hold the asset primarily for the purpose of trading, 3) expect to realize the asset within twelve months after the reporting period or 4) have cash or a cash equivalent.

True Page: p122 9. Under IFRS, if an asset does not meet the criteria to be classified as a current asset, then it is automatically classified as a non-current asset.

True Page: p122 10. An operating cycle is the time it takes to manufacture a product.

False Page: p122 11. Cash equivalents include cash on hand, demand deposits and short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to insignificant amounts of risk.

False Page: p123 12. A company owns an investment that pays 6% interest per year. This investment can be exchanged for cash on demand but if the investment is exchanged before three months, then a fixed fee penalty applies. This investment qualifies as a cash equivalent.

True Page: p123 13. A retail company sells casual clothing such as jeans, t-shirts and similar times. This company orders t-shirts with the company logo for its employees to wear while on duty. The amount spent for these employee t-shirts would be classified as inventories.

False Page: p123 14. A company sells goods to a customer on credit for €12,000. The customer will pay the amount owed within 60 days. This amount owed by the customer would be classified as a trade accounts receivable on the statement of comprehensive income.

True Page: p123 15. A pre-paid expense represents goods and services that are paid for before they are used.

True Page: p123

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16. Intangible assets are assets with no physical substance.

True Page: p124 17. A company purchases supplies that will be used over the next three years. These would be classified as a current asset.

False Page: p122 18. A liability is a present obligation arising from past events, the settlement of which is expected to result in an outflow of economic benefits from the entity.

True Page: p124 19. A company borrows ¥120,000,000 which it is obligated to pay back to the lender over two years even though management expects to actually pay the debt within the next six months. This would be classified as a non-current liability.

False Page: p126 20. A trade accounts payable can be a current liability or non-current liability depending on when the company is obligated to pay the amount owed.

True Page: p126 21. A company owes €100,000 which it must repay over the next two years. Half of that amount is due within twelve months and the remainder within twenty-four months. €50,000 would be classified as a current liability and the remainder would be classified as a non-current liability.

True Page: p126 22. Working capital is calculated by subtracting current liabilities from current assets.

True Page: p127 23. Working capital is calculated by subtracting liabilities from assets.

False Page: p127 24. Working capital is calculated by adding current liabilities and current assets.

False Page: p127 25. A company has £1,000 in current assets, £2,500 in total assets, £700 in current liabilities and £2,000 in liabilities. Working capital is £300.

True Page: p127 . .

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26. Contributed capital refers to the amount owners have invested in the business plus their interest in retained earnings.

False Page: p127 27. Reserves can be created in one of two ways: 1) Management can appropriate a portion of retained earnings and designate it as a reserve or 2) they can be established through other comprehensive income.

True Page: p129 28. Retained earnings are increased by profit, decreased by losses and increased by dividends.

False Page: p129 29. On 31 December 2010 a company has retained earnings of €14,000. Profit was €6,500 for the year ending 31 December 2011. Dividends of €2,000 were paid during 2011. Management also appropriated €1,000 of retained earnings and designated it as a reserve. The retained earnings balance at 31 December 2011 is €18,500.

False Page: p129 30. On 31 December 2010 a company has contributed capital of £25,000 and retained earnings of £10,000. During 2011 the following changes occur. Shares are sold for £10,000. The company reports a loss for 2011 of £7,700 and pays dividends of £1,200. Management establishes a reserve by appropriating £500 from retained earnings. The equity balance at 31 December 2011 is £51,500.

True Page: p129 31. Consolidated financial statements would include the financial results for the parent and all subsidiaries.

True Page: p136 32. Consolidated financial statements are presented for a group.

True Page: p136 33. If a company has control of one or more other companies it is known as a subsidiary.

False Page: p136

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34. A non-controlling interest represents the equity in a company that is not owned by another company.

False Page: p137 35. A non-controlling interest represents the equity in a company that is not owned by the parent.

True Page: p137 36. Performance refers to the financial results of a business entity as reported in the statement of comprehensive income and the statement of financial position.

False Page: p140 37. Performance refers to the relationship of income and expenses as reported in the statement of comprehensive income.

True Page: p140 38. Total comprehensive income has two components: 1) profit or loss and 2) other comprehensive income.

True Page: p140 39. Profit or loss includes other comprehensive income.

False Page: p140 40. The only items that are classified as other comprehensive income are those that are required or permitted by International Financial Reporting Standards.

True Page: p140 41. A company reports that it has income of €150,000 during the year. From this we can conclude that the company had a gross inflow of economic benefits arising in the course of the ordinary activities of the entity.

False Page: p141 42. A gain may be part of profit or loss, or other comprehensive income depending on the nature of the gain.

True Page: p142 43. Cost of sales is an expense.

True Page: p144 . .

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44. Cost of goods sold can be an expense or an asset depending on whether an item has been sold or not.

False Page: p145 45. Administrative expenses would not be included as part of cost of sales.

True Page: p145 46. Selling expense are part of cost of sales.

False Page: p145 47. Cost of goods sold refers to a manufacturer’s or merchandiser’s product cost once the product is sold.

True Page: p145 48. Operating profit is calculated by subtracting cost of sales from revenue.

False Page: p145 49. Operating profit is calculated by subtracting operating expenses from gross profit.

True Page: p145 50. Operating profit is the profit from the business’s ordinary operations before other income and expense, finance expense and tax expense are deducted.

True Page: p145 51. A company reports revenue for €3,000 for the period. It also reports €550 in tax expense, €100 in finance expense, €1,200 for cost of goods sold and €500 for operating expense. Operating profit would be €650.

False Page: p145 52. A company reports revenue for €3,000 for the period. It also reports €550 in tax expense, €100 in finance expense, €1,200 for cost of goods sold and €500 for operating expense. Profit would be €650.

True Page: p145 53. A company pays €5,000 in dividends during the reporting period. This reduces equity.

True Page: p149 . .

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54. A company incurs expenses of €1,500 during the reporting period. This increases equity.

False Page: p145 55. A company purchases €350 in supplies. This decreases equity.

False Page: p149 56. A company buys back shares from one of its shareholders for £43,000. This decreases retained earnings.

False Page: p149 57. A company buys back shares from one of its shareholders for £43,000. This decreases equity.

True Page: p149 58. A company buys back shares from one of its shareholders for ¥55,000,000. During the period ¥12,000,000 in revenue is reported and ¥3,000,000 dividends are paid. The company also reports ¥15,000,000 in expenses. The equity balance at the beginning of the period is ¥120,000,000. The ending equity balance is therefore ¥59,000,000.

True Page: p149 59. A company purchases supplies for £500 on credit. From this statement we know that expenditure has been made.

True Page: p154 60. A company purchases supplies for £500 on credit. From this statement we know that an expense has been incurred.

False Page: p155 61. A company purchases supplies for £500 on credit. From this statement we know that a cost has been incurred.

True Page: p154 62. A company purchases and uses supplies for £500 on credit during the reporting period. From this statement we know that an expense has been incurred.

True Page: p155

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63. A company purchases and uses supplies for £500 on credit during the reporting period. From this statement we know that a cost has been incurred.

True Page: p154 64. A company purchases and uses supplies for £500 on credit during the reporting period. From this statement we know that expenditure has been made.

True Page: p154 65. An inventories cost on the statement of financial position becomes cost of goods sold on the statement of comprehensive income.

True Page: p156 66. A company pays €35,000 in rent in advance, this would be classified as rent expense.

False Page: p156

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Multiple Choice Questions 1.

Which of the following would be included in a complete set of financial statements?

1. A statement of financial position, a statement of comprehensive income, a statement of changes in financial position, and statement of cash flows 2. Report by the board of directors 3. Notes to the financial statements 4. A statement by the chairman 5. Supplementary schedules with additional financial information 6. Analysis of financial results by management a. 1 and 3 only b. 1, 3 and 4 only c. 1, 2, 3 and 5 only d. All would be included in a complete set of financial statements Page: p117

2.

Which order of the following items in the notes to the financial statements is required by the International Financial Reporting Standards?

1. Supporting information for items presented on the face of the financial statements 2. A summary of significant accounting policies 3. A statement of compliance with IFRS 4. Other disclosures a. 2, 3, 4 and then 1 b. 3, 2, 1 and then 4 c. 2, 3, 1 and then 4 d. 3, 2, 4 and then 1 Page: p119

3.

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Financial position refers to the relationship between which of the following? a. Income and expenses b. Profit or loss and other comprehensive income c. Total comprehensive income, assets, liabilities and equity d. Assets, liabilities and equity Page: p120

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4.

Which criteria are part of the IFRS definition of an asset?

1. Classified as current or non-current 2. Future economic benefits are expected to flow to the entity 3. Controlled by the entity as a result of past events 4. Can be converted to cash or cash equivalents a. All are part of the IFRS definition of an asset b. 1, 2 and 3 only c. 1, 3 and 4 only d. 2 and 3 only Page: p120

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Which of the following is not part of the IFRS definition of a current asset? a. It cannot be classified as non-current b. Is cash or a cash equivalent c. The entity expects to realize the asset or intends to sell or consume the asset in its normal operating cycle d. The entity holds the asset primarily for the purpose of trading Page: p122

6.

A company acquires materials to produce audio components on 1 April 2010. These materials are put into production on 15 April and production is completed on 17 April. On 25 May they are sold on credit and shipped to the customer. On 15 June the customer pays the amount owed for the components. What is the company’s operating cycle? a. 15 days b. 17 days c. 55 days d. 76 days Page: p122

7.

A chain of retail stores has the following assets at 31 May 2010: 1) cash in stores €150,000, 2) investments that can be converted to within three days for €75,000, 3) bank deposits of €420,000, 4) investments in the shares of two other companies totaling €60,000. How amount of cash should the company report on its statement of financial position at 31 May 2010? a. €705,000 b. €225,000 c. €645,000 d. €150,000 Page: p123

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8.

A chain of retail stores has the following assets at 31 May 2010: 1) cash in stores €150,000, 2) investments that can be converted to within three days for €75,000, 3) bank deposits of €420,000, 4) investments in the shares of two other companies totaling €60,000. How amount of cash equivalents should the company report on its statement of financial position at 31 May 2010? a. €75,000 b. €225,000 c. €645,000 d. €540,000 Page: p123

9. On 31 December 2010, a company reports the following amounts: 1) $12,000 borrowed from a bank with repayment due at the end of September; 2) $150,000 borrowed from a bank with repayment due in three equal installments at the end June in 2011, 2012 and 2013; 3) trade accounts receivable of $27,000; 4) wages expense for $4,500. How much should the company report for current liabilities? a. $162,000 b. $39,000 c. $43,500 d. $62,000 Page: p124 10. Which of the following items would not be classified as a non-current asset on 31 December 2010?

1. Property, plant and equipment which will be used for an estimated 10 years 2. A trade account receivable to by paid by the customer during the first quarter of 2011 3. Pre-paid expenses expected to be consumed over the next three months 4. Inventories of perishable food a. 1, 2 and 3 only b. 2, 3 and 4 only c. 3 and 4 only d. 2 and 4 only Page: p124 11. Which of the following statements is not part of the IFRS definition for a current liability? a. The entity holds the liability primarily for the purpose of trading b. The entity expects to settle the liability for cash within the normal operating cycle c. The entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting date d. The liability is due to be settled within twelve months after the reporting period Page: p126

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12. An entity that controls one or more other entities is known as a: a. controlling interest b. parent c. subsidiary d. group Page: p136 13. An entity that is controlled by another entity is known as a: a. controlling interest b. parent c. subsidiary d. group Page: p136 14. An entity that controls one or more entity and the entities that are controlled are known as a: a. controlling interest b. parent c. subsidiary d. group Page: p136 15. Arti-Pharm Ltd., a pharmaceuticals firm, owns 80% of the shares of Mangan Medical Marketing, Inc. and therefore has control. The shareholders that represent the other 20% of Mangan stock are referred to as: a. non-controlling interest b. majority interest c. subsidiary interest d. non-voting interest Page: p137 16. IFRS defines performance as the relationship described in which of the following? a. Income and expenses b. Profit or loss and other comprehensive income c. Total comprehensive income, assets, liabilities and equity d. Assets, liabilities and equity Page: p137 17. A company reports the following amounts for 2011: 1) total comprehensive income $89,000; 2) expenses $35,000 and 3) revenue $70,000. What amount of other comprehensive income did the company report? a. $159,000 b. $35,000 c. $54,000 d. $124,000 Page: p140

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18. A company reports the following amounts for 2011: 1) total comprehensive income $89,000; 2) expenses $35,000 and 3) revenue $70,000. What amount of profit or loss did the company report? a. $159,000 b. $35,000 c. $54,000 d. $124,000 Page: p140 19. Under IFRS, increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants would be defined by which of the following terms? a. Revenue b. Gain c. Income d. Profit Page: p142 20. A clothing company sells £15,000 of t-shirts during the reporting period. This amount can be described by which of the following terms?

1. Revenue 2. Income 3. Gain a. 1 only b. 1 and 2 only c. 2 and 3 only d. All three describe this amount Page: p142 21. A clothing company is in the business of selling t-shirts. However, the company also owns some land that it sold for ¥500,000 more than it paid when it acquired the land. The ¥500,000 can be described by which of the following terms?

1. Revenue 2. Income 3. Gain a. 1 only b. 1 and 2 only c. 2 and 3 only d. All three describe this amount Page: p142

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22. A company owns land that it purchased for $4 million. The value has increased to $5 million. The $1 million is correctly classified as other comprehensive income. The $1 million can be described by which of the following terms?

1. Revenue 2. Income 3. Gain a. 1 only b. 1 and 2 only c. 2 and 3 only d. All three describe this amount Page: p142 23. Which of the following are expenses of the business?

1. Operating expenses 2. Cost of goods sold 3. Pre-paid expenses 4. Financing expenses 5. Tax expenses a. All are expenses b. 1, 3, 4 and 5 only c. 1, 2, 4 and 5 only d. 2, 3,4 and 5 only Page: p143 24. On 31 December 2011, Vincentio Mining, Ltd. reported the following amounts on its statement of comprehensive income: 1) revenue €45,000; 2) selling expenses €3,300; 3) cost of goods sold €23,000; 4) tax expenses €6,500; 5) administrative expenses €4,000; 6) and financing expenses.

Operating expenses were totaled €10,500. What amount did Vincentio report for gross profit for the period? a. €22,000 profit b. €14,700 profit c. €4,200 profit d. €6,300 loss Page: p143 25. On 31 December 2011, Vincentio Mining, Ltd. reported the following amounts on its statement of comprehensive income: 1) revenue €45,000; 2) selling expenses €3,300; 3) cost of goods sold €23,000; 4) tax expenses €6,500; 5) administrative expenses €4,000; 6) and financing expenses.

Operating expenses were totaled €10,500. What amount did Vincentio report for profit or loss for the period? a. €22,000 profit b. €14,700 profit c. €4,200 profit d. €6,300 loss Page: p144 . .

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26. On 31 December 2011, Vincentio Mining, Ltd. reported the following amounts on its statement of comprehensive income: 1) revenue €45,000; 2) selling expenses €3,300; 3) cost of goods sold €23,000; 4) tax expenses €6,500; 5) administrative expenses €4,000; 6) and financing expenses.

Operating expenses were totaled €10,500. What amount did Vincentio report for operating profit for the period? a. €22,000 profit b. €14,700 profit c. €4,200 profit d. €6,300 loss Page: p144 27. What is the net effect on equity during a reporting period if revenue increased $5,500: expenses increased $2,000; a dividend of $3,000 were paid; and other comprehensive income increased $1,700? a. Equity decreased by $1,700 b. Equity increased by $500 c. Equity increased by $5,700 d. Equity increased by $2,200 Page: p149 28. What is the net effect on retained earnings during a reporting period if revenue increased $5,500: expenses increased $2,000; a dividend of $3,000 were paid; and other comprehensive income increased $1,700? a. Equity decreased by $1700 b. Equity increased by $500 c. Equity increased by $5,700 d. Equity increased by $2,200 Page: p149 29. What is the net effect on total comprehensive income during a reporting period if revenue increased $5,500: expenses increased $2,000; a dividend of $3,000 were paid; and other comprehensive income increased $1,700? a. Equity decreased by $1,700 b. Equity increased by $500 c. Equity increased by $5,700 d. Equity increased by $2,200 Page: p149

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30. Xian Healthy Juices, Ltd. produces bottle fruit drinks. On 15 September 2010, Xian purchased bottles for ¥450,000 in cash. The bottles were all used in production during September. Which of the following terms can be applied to the ¥450,000?

1. Expenditure 2. Cost 3. Expense 4. Asset a. All can be applied b. 1, 2 and 3 only c. 1, 2 and 4 only d. 2, 3 and 4 only Page: p154 31. Xian Healthy Juices, Ltd. produces bottle fruit drinks. On 15 September 2010, Xian purchased bottles for ¥450,000 in cash. However, none of these bottles were used in production during September. Which of the following terms can be applied to the ¥450,000?

1. Expenditure 2. Cost 3. Expense 4. Asset a. All can be applied b. 1, 2 and 3 only c. 1, 2 and 4 only d. 2, 3 and 4 only Page: p154 32. Which of the following costs have not expired? a. Rent expense b. Wage expense c. Depreciation expense d. Supplies Page: p156 33. Which of the following costs are unexpired? a. Cost of goods sold b. Inventories c. Depreciation expense d. Insurance expense Page: p156

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Essay Questions 1. From an accounting perspective, what is the difference between a corporate annual report and the financial statements?

Answer Corporate annual reports often contain the financial statements, they are otherwise not related.

Annual reports may contain features such as statements by the chairman or other officers of the business, reports by the board of directors and its committees, analysis by management and other supplementary information. Sometimes annual reports will summarize “key results” from the financial statements.

Financial statements a separate presentation even though, as already noted, they may be included with the annual report. To comply with IFRS, a reporting entity must present a complete set of financial statements to include a statement of comprehensive income, statement of financial position, statement of changes in equity and statement of cash flows and accompanying notes. IFRS contains the requirements for how this complete set of financial statements and notes are to be prepared in order to comply.

2. Describe what information must be contained in the notes and in what order in order to comply with IFRS. Answer The notes should contain in the following order: 1. a statement of compliance with IFRS; 2. a summary of significant accounting policies; 3. supporting information for items presented on the face of the financial statements; and 4.

Other disclosures such as contingent liabilities and non-financial disclosures.

If not disclosed elsewhere the entity must include the domicile and legal form of the entity, the country of incorporation and address of its registered office or place of business. The entity must also provide a description of its operations and principal activities, and the name of the parent and the ultimate parent of the group.

3. Explain the difference between profit or loss and other comprehensive income.

Answer Profit or loss is the calculated when expenses are deducted from revenues. These expenses and revenues are the result of the ordinary activities of the business entity. However, profit or loss may also include other income and expenses. A gain or loss is included in other comprehensive income only in specific situations when IFRS requires or permits it to be included.

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4. Define income, gains and revenue based on IFRS. Distinguish between the three concepts.

Answer Income represents “increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.”

Based on the IASB Framework, “gains represent other items that meet the definition of income and may or may not, arise in the course of the ordinary activities of an entity. Gains represent increases in economic benefits and as such are no different in nature from revenue. Hence, they are not regarded as constituting a separate element…”

Revenue is “the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants.”

Income and gains are synonyms. Income and gains include revenue and gains included in profit and loss plus income included in other comprehensive income.

5. Define expenditure, cost and expense based on IFRS. Distinguish between these three concepts.

Answer Expenditure refers to any outlay of cash or other consideration.

A cost refers to the amount given to acquire an asset.

Expenses are “decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.”

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Chapter 4 The Accounting Process Test Bank True/False Questions 1. In the accounting process, three basic reports are available once journal entries are recorded the: 1) journal, 2) ledger and 3) trial balance.

True Page: p187 2. In the accounting process, once accounts are closed then adjusting entries can be recorded.

False Page: p186 3. In the accounting process, the financial statements are prepared from the adjusted trial balance.

True Page: p186 4. A company purchases supplies on credit. This transaction would be an exchange of goods for a promise.

True Page: p188 5. A company lends an employee £10,000. This would be an exchange of services for money.

False Page: p188 6. A company purchases plastics for production of eyewear frames using cash. This transaction would be an exchange of goods for money.

True Page: p188 7. A home security systems manufacturer pays €5,500 which it owes to a supplier for a past purchase of computer chips to be used in the production. This transaction would be an exchange of goods for cash.

False Page: p188 8. A company hires four workers for one month to distribute marketing material in a local shopping mall. The workers will be paid ¥50,000 in total which they will be paid one week after the work is completed. The transaction to record the work provided by the workers would be an exchange of services for money.

False Page: p188

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9. A company hires four workers for one month to distribute marketing material in a local shopping mall. The workers will be paid ¥50,000 in total which they will be paid one week after the work is completed. The transaction to record the payment for the work provided by the workers would be an exchange of a promise for money.

True Page: p188 10. A company purchases supplies on credit which are to be used immediately. This transaction would be recorded as a debit to expense and credit to a liability.

True Page: p190 11. A company lends an employee £10,000. This would be recorded as a debit to an asset and a credit to an asset.

True Page: p190 12. A company purchases plastics for production of eyewear frames using cash. This transaction would be recorded as an asset and a credit to an asset.

True Page: p190 13. A company which manufactures home security systems pays €5,500 which it owes to a supplier for the purchase of computer chips to be used in the production. This transaction would be recorded as a debit to an asset and a credit to an asset.

False Page: p190 14. A company hires four workers for one month to distribute marketing material in a local shopping mall. The workers will be paid ¥50,000 in total which they will be paid one week after the work is completed. The transaction to record the work provided by the workers would be recorded as a debit to expense and a credit to an asset.

False Page: p190 15. A company hires four workers for one month to distribute marketing material in a local shopping mall. The workers will be paid ¥50,000 in total which they will be paid one week after the work is completed. The transaction to record the payment for the work provided by the workers would be recorded as a debit to a liability and a credit to cash.

True Page: p190 16. In a business transaction, debits record what is received by the reporting entity and credits record what has been given.

True Page: p192

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17. A chart of accounts contains a list of all account titles and the net debit or credit balance for each account.

False Page: p197 18. A debit increases a liability.

False Page: p219 19. A debit increases an asset.

True Page: p219 20. A debit increases equity.

False Page: p219 21. A credit increases equity.

True Page: p219 22. A credit increases an asset.

True Page: p219 23. A credit increases a liability.

True Page: p219 24. A debit can increase an asset or decrease an asset depending on the type of transaction that is being recorded.

False Page: p219 25. On 30 June 2010, a retail store pays €12,000 for insurance coverage for the last six months of 2010. The journal entry to record this transaction would be a debit to expense and a credit to an asset.

False Page: p196 26. On 14 September 2011, a publisher purchases paper stock to print books for $85,000 on credit.

On 23 September 2011, the publisher pays the amount owed. The journal entry to record the purchase would be a debit to inventories and a credit to cash.

False Page: p196

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27. On 14 September 2011, a publisher purchases paper stock to print books for $85,000 on credit.

On 23 September 2011, the publisher pays the amount owed. The journal entry to record the payment of the amount owed would be a debit to trade accounts payable and a credit to cash.

True Page: p196 28. A consulting firm rents office space. The landlord requires the firm to pay €36,000 for the first three months’ rent in advance. The journal entry to record this transaction would be a debit to pre-paid rent and a credit to cash.

True Page: p196 29. A manufacturing company borrows $500,000 from a bank on 23 March 2011 for the purpose of purchasing new robotic equipment. This amount will be repaid to the bank within three months.

Since the amount will be repaid within the same reporting period, the journal entry to record this transaction would be a debit to production equipment and a credit to cash.

False Page: p196 30. 28.A creative agency rents office space for the coming six months for £60,000. The landlord requires the firm to pay half this amount when the rental agreement is signed. The journal entry to record this transaction would be a debit to pre-paid rent for £30,000, a debit to rent expense for £30,000 and a credit to cash for £60,000.

False Page: p196 31. An advertising firm is contracted by a oil company to handle its ad campaign for the coming year. The total amount of the contract is $300,000. Half of this amount must be paid when the work contract is signed. The journal entry to record this transaction would include a debit to cash and a credit to unearned service revenue.

True Page: p196 32. A journal is a chronological record of all journal entries.

True Page: p210 33. Journal entries are posted to the journal.

False Page: p212 34. The purpose of the journal is to ensure that the total of all debit balances is equal to the total of all credit balances for all accounts.

False Page: p216

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35. A ledger summarizes information that has been recorded in the journal by account.

True Page: p212 36. The ledger contains all detail that affects each account.

True Page: p212 37. Debits and credits from the journal are posted to the ledger.

True Page: p212 38. A company has the following debits and credits posted to its cash account for the month of April 2010: 2 April 8 April 13 April 14 April 17 April 20 April 23 April 24 April 26 April

Debit $2,000 Credit $15,000 Debit $1,500 Debit $1,000 Credit $20,000 Debit $5,000 Credit $14,000 Credit $10,000 Debit $500

If the beginning balance in the cash account was $45,000, then the ending balance would be a net debit of $4,000.

False Page: p216 39. A trial balance is a listing of all accounts in the ledger with the net debit or credit balance for each account.

True Page: p216 40. A company purchases supplies for £500 for cash. The accountant recording the journal entry mistakenly records the credit as a debit. The trial balance would help discover this error.

True Page: p218 41. A company purchases supplies for £455 for cash. The accountant recording the journal entry mistakenly records the debit as £445. The trial balance would help discover this error.

True Page: p218

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42. A company purchases supplies for $750 for cash. The accountant fails to record the journal entry. The trial balance would help discover this error.

False Page: p218 43. A company purchases supplies for $310 for cash. The accountant mistakenly credits trade accounts payable rather than cash when the journal entry is recorded. The trial balance would help discover this error.

False Page: p218 44. The normal balance in asset account is a debit.

True Page: p219 45. An overdraft in the cash account would mean that the normal balance of cash is a debit.

False Page: p219 46. The normal balance of the capital account is a credit.

False Page: p219 47. Retained earnings is increased by debits and decreased by credits.

False Page: p219 48. Trade accounts receivable are increased by debits and decreased by credits.

True Page: p219 49. Dividends are increased by debits and decreased by credits.

True Page: p219 50. Notes payable would be decreased by credits and increased by debits.

False Page: p219

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Multiple Choice Questions 1. Which is the correct order of the four major steps in the accounting process?

1. Close accounts 2. Adjust accounts 3. Analyze and record transactions 4. Prepare financial statements a. 3, 2, 4 and then 1 b. 2, 3, 4 and then 1 c. 3, 4, 2 and then 1 d. 3, 2, 1 and then 4 Page: 186 2. Which of the following reports are available immediately after transactions recorded in the accounting process?

1. Adjusted trial balance 2. Ledger 3. Journal 4. Financial statements 5. Trial balance 6. Post-closing trial balance a. 2, 3 and 1 only b. 1, 2 and 4 only c. 2, 3, and 5 only d. 1,2 and 3 only Page: 187 3.

Which of the following reports are available immediately after closing entries are recorded in the accounting process?

1. Adjusted trial balance 2. Ledger 3. Journal 4. Financial statements 5. Trial balance 6. Post-closing trial balance a. 2 and 3 only b. 6 only c. 2, 3, and 6 only d. 4 and 6 only Page: 187

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4. Which of the following reports are available immediately after adjusting entries are recorded in the accounting process?

1. Adjusted trial balance 2. Ledger 3. Journal 4. Financial statements 5. Trial balance 6. Post-closing trial balance a. 1 and 4 only b. 1 only c. 2, 3, and 5 only d. 4 and 6 only Page: 187 5.

On 23 June 2010, an electrical utility purchases three large generators on credit to be used in its new hydroelectric dam currently under construction. On 2 July 2010, the electrical utility pays the amount owed on the generators. The transaction for the purchase is described by which of the following exchanges? a. Money received in exchange for a good given b. A good received in exchange for money given c. A good received in exchange for a promise given d. A promise received in exchange for money given Page: 188

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On 23 June 2010, an electrical utility purchases three large generators on credit to be used in its new hydroelectric dam currently under construction. On 2 July 2010, the electrical utility pays the amount owed on the generators. The transaction for the payment is described by which of the following exchanges? a. Money received in exchange for a good given b. A good received in exchange for money given c. A good received in exchange for a promise given d. A promise received in exchange for money given Page: 188

7. On 23 June 2010, an electrical utility purchases three large generators on credit to be used in its new hydroelectric dam currently under construction. On 2 July 2010, the electrical utility pays the amount owed on the generators. In the transaction for the purchase which financial statement categories are affected? a. Expense and liabilities b. Assets and expense c. Assets and liabilities d. Assets only Page: 190

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8. On 23 June 2010, an electrical utility purchases three large generators on credit to be used in its new hydroelectric dam currently under construction. On 2 July 2010, the electrical utility pays the amount owed on the generators. In the transaction for the payment which financial statement categories are affected? a. Expense and liabilities b. Assets and expense c. Assets and liabilities d. Assets only Page: 190 9. A company buys office supplies for $370 for cash which are used immediately. Which financial statement categories would be affected by this transaction? a. Expense and liabilities b. Assets and expense c. Assets and liabilities d. Assets only Page: 190 10. A company buys office supplies for $370 on credit which are used immediately. Which financial statement categories would be affected by this transaction? a. Expense and liabilities b. Assets and expense c. Assets and liabilities d. Assets only Page: 190 11. Which accounting process report lists only account titles? a. Ledger b. Journal c. Chart of accounts d. Trial balance Page: 197 12. Pre-paid rent appears in which of the following financial statement categories? a. Assets b. Liabilities c. Revenues d. Expenses Page: 197 13. Wages payable would appear in which of the following financial statement categories? a. Assets b. Liabilities c. Revenues d. Expenses Page: 197

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14. Unearned revenue would appear in which of the following financial statement categories? a. Assets b. Liabilities c. Revenues d. Expenses Page: 197 15. Which accounting process report lists journal entries in chronological order? a. Ledger b. Journal c. Chart of accounts d. Trial balance Page: 210 16. Which accounting process report lists all debit and credit detail that affect each account? a. Ledger b. Journal c. Chart of accounts d. Trial balance Page: 212 17. Which of the following described posting in the accounting process? a. Entries are posted from the journal entry to the ledger b. Entries are posted from the ledger to the trial balance c. Entries are posted from the trial balance to the ledger d. Entries are posted from the journal to the ledger Page: 212 18. Which accounting process report lists all ledger accounts with the net debit or credit balance for each? a. Ledger b. Journal c. Chart of accounts d. Trial balance Page: 216

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19. Which of the following errors would the trial balance not identify?

1. The credit in a journal entry was recorded as $1,718 instead of the correct amount for $1,781 2. An accountant failed to make a journal entry 3. The debit in a journal entry for €550 was identified as supplies rather than supplies expense 4. An accountant entered an amount for ¥11,100 twice as a debit instead of entering it as a debit and credit 5. A journal entry was recorded in the incorrect reporting period a. 2 and 3 only b. 2, 3 and 5 only c. 1 and 4 only d. 1, 2 and 3 only Page: 218 20. Which accounts have a normal debit balance?

1. Trade account payable 2. Revenue 3. Dividends 4. Wages expense 5. Contributed capital 6. Retained earnings 7. Equipment 8. Borrowings a. 3, 4, 5 and 7 only b. 1, 2, 5, 6 and 8 only c. 1, 2 and 8 only d. 3, 4 and 7 only Page: 219 21. Which accounts have a normal credit balance?

1. Trade account receivable 2. Revenue 3. Dividends 4. Wages expense 5. Contributed capital 6. Retained earnings 7. Equipment 8. Borrowings a. 3, 4, 5 and 7 only b. 1, 2, 5, 6 and 8 only c. 2, 5, 6 and 8 only d. 2 and 8 only Page: 219 . .

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Essay Questions 1. List the four major steps in the accounting process in order and briefly describe what reports are available at each step.

Answer I. ANALYZE AND RECORD TRANSACTIONS -- The first step is an ongoing activity which continues throughout the reporting period. Transactions are analyzed based information contained in source documents. This information is then recorded in the accounting system using a journal entry. Three basic reports are available once all the journal entries are recorded: 1) the journal, 2) the ledger, and 2) the trial balance.

II. ADJUST ACCOUNTS – Once all transactions for the reporting period are completed, adjusting entries are recorded. Once adjustments have been made, the adjusted trial balance is generated.

III. PREPARE FINANCIAL STATEMENTS -- The adjusted trail balance is then used to prepare the financial statements.

IV. CLOSE ACCOUNTS – Once financial statements have been completed, the accounting records are “closed” and made ready for the next reporting period by recording closing entries. A postclosing trial balance is then generated after which the accounting department can begin recording transactions for the next reporting period.

2. Explain what a source document is providing three examples. How is a source document used in the accounting process?

Answer A source document is the original record of a transaction. Examples include: customer invoices, supplier invoices, purchase orders, time cards, deposit slips, notes for loans, cash receipts, credit card receipts, cash register tapes and cancelled checks.

Source documents contain verifiable sources of information from which transactions are recorded.

3. Explain what each of the following reports from the accounting process contains and what it is used for: journal, ledger, trial balance, adjusted trial balance and post-closing trial balance.

Which reports is used to prepare the financial statements?

Answer The journal contains a list of all journal entries listed in chronological order. This is used as a “diary” of all transactions which can be referenced by date.

The ledger contains all debits and credits posted from the journal organized by account title.

This is used to determine what entries affected the account and to determine its balance

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The trial balance is a listing of the net debit or credit balances for each ledger account after journal entries have been recorded. The trial balance may be used to ensure that debits equal credits.

The adjusted trial balance is a listing of the net debit or credit balances for each ledger account after adjusting entries have been recorded. The trial balance may be used to ensure that debits equal credits.

The post-closing trial balance is a listing of the net debit or credit balances for each ledger account after closing entries have been recorded. The trial balance may be used to ensure that debits equal credits.

The adjusted trial balance is used to prepare the financial statements.

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Chapter 5 Accrual and Closing Test Bank True/False Questions 1. A company purchased £30,000 of cotton fabric on credit from Egypt on 2 November 2011 to use in the production of summer shirts. On 17 November 2011, the company paid the amount owed. The fabric is received on 5 November 2011 and used in production on 7 November 2011.

Under cash-basis accounting, the purchase would be recorded on 2 November 2011 and the payment on 17 November 2011.

False Page: p236 2. Moorea Marine Services, LLC services yachts. On 2 May 2010 a customer brings her boat in to have the engine repaired. On 30 May 2010, the work is completed. On 2 June 2010 the customer picks up her sailboat and on 5 June 2010 Moorea Marine Services receives payment which has been wired from the customer’s London bank. Under accrual basis accounting, service revenue would be recognized on 30 May 2010.

True Page: p236 3. Adjusting entries must meet two criteria: 1) they cannot involve cash and 2) both the statement of comprehensive income and the statement of financial position are affected.

True Page: p241 4. Cenek Systems, Inc. has a contract with a customer to provide programming services. The work would was completed on 29 June 2010 however the customer has not been billed for payment nor has the customer paid. Cenek’s fiscal year ends 30 June. No adjusting entry is needed for the programming services contract until the customer is billed for the services.

False Page: p243 5. Akilina Travel, Ltd. has three employees. The amount of the payroll each week is €3,500 for all employees. The workweek is from Monday through Friday. Employees are paid on Friday. The reporting period ends on 30 June 2011 which is Thursday. The Akilina would make an adjusting entry on 30 June 2011 with a debit to salaries expense for €3,500 and a credit to salaries payable for €3,500.

False Page: p243 . .

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6. On 27 February 2010, Udaya Cosmetics, Ltd. receives an advance payment of €17,500 in cash from a customer for one-half of the cost of the merchandise being bought. The merchandise will be shipped on 4 March 2010. On 27 February 2010 Udaya would make an adjusting entry to record cash for €17,500 and credit unearned revenue for €17,500.

False Page: p245 7. A company pays ¥228,000 for six months advance rent on a warehouse. The company reports its financial results on a monthly basis. At the end of each of the six months an adjusting entry would be recorded to debit rent expense for ¥38,000 and credit pre-paid rent for ¥38,000.

True Page: p247 8. A company pays $86,400 in advance for insurance coverage on a small manufacturing facility.

The company reports financial results on a monthly basis. At the end of each of the following twelve months an adjusting entry would be recorded to debit insurance expense for $7,200 and credit cash for $7,200.

False Page: p247 9. Adjusting entries are recorded in the journal and posted to the ledger.

True Page: p249 10. Temporary accounts include revenues, expenses and dividends.

True Page: p258 11. Retained earnings is a temporary account.

False Page: p260 12. Reserves are permanent accounts.

True Page: p260 13. Typical closing entries would be: 1) close revenue to income summary, 2) close expenses to income summary, 3) close dividends to income summary, and 4) close income summary to retained earnings.

False Page: p260 . .

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14. The post-closing trial balance will have net debit or credit balances only for accounts that appear on the statement of financial position. All other accounts have a zero balance.

True Page: p263 15. A closing entry could include a debit or credit to cash.

False Page: p258 16. A closing entry could include a debit or credit to insurance expense.

True Page: p258 17. A closing entry could include a debit or credit to trade accounts payable.

False Page: p258 18. A company has a monthly reporting period. At the end of August 2011, the accounting department fails to record the closing entries. As a result, revenue for September 2011 will be overstated.

True Page: p258 19. A company has a monthly reporting period. At the end of March 2009, the accounting department fails to record the closing entry for expenses. As a result, profit or loss for April 2009 will be overstated.

False Page: p258 20. A company has a monthly reporting period. At the end of February 2010, the accounting department fails to record the closing entry for dividends. As a result, profit or loss for March 2010 will be understated.

False Page: p258 21. When preparing an extend trial balance worksheet, profit or loss shown in the credit column on the statement of comprehensive income would be a profit and would be shown in the debit column of the statement of financial position.

False Page: p284 . .

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Multiple Choice Questions 1. Revenue must be accrued by recording an adjusting entry for which of the following? a. An orchestra receives a cash advance for an engagement the following month b. An office cleaning business was hired for a special two day job which has been completed but for which the customer has not yet been billed c. A retail book store received an order from an overseas customer. The books have been shipped and a bill has been sent to the customer requesting payment. d. An office supplies company sells copier paper to a customer. The paper has been delivered and a bill has been sent to the customer requesting payment within three days before the end of the office supply company’s reporting period.

Page: p240 2. Which of the following is not an adjusting entry? a. Debit unearned revenue; credit revenue b. Debit insurance expense; credit pre-paid insurance c. Debit cash; credit unearned revenue d. Debit wages expense; credit wages payable Page: p240 3. Which of the following is not an adjusting entry? a. Debit unearned revenue; credit revenue b. Debit rent expense; credit rent payable c. Debit rent expense; credit pre-paid rent d. Debit unearned revenue; credit pre-paid expenses Page: p240 4. A company sells a subscription to a financial journal for £288 per year which customers pay in advance. The company has a monthly reporting period and its fiscal year ends on 31 December.

At the end of each month, the company would take which of the following actions? a. No adjusting would be necessary b. An adjusting entry would be recorded to debit pre-paid subscriptions for £24 and credit subscription revenue for £24 c. An adjusting entry would be recorded to debit pre-paid subscriptions for £288 and credit subscription revenue for £288 d. An adjusting entry would be recorded at the end of the company’s fiscal year to debit pre-paid subscriptions for £288 and credit subscription revenue for £288 Page: p245

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5. A real estate development company leases office space in one of its towers. In the year ended 31 December 2010, the company had received payments from tenants totaling $19,503,000.

The following amounts were reported for rent in arrears and in advance: 31 December 2009 31 December 2010

In advance $57,000 70,500

In arrears $36,000 45,000

All amounts in arrears were subsequently received. What amount for rental income should be reported in the statement of comprehensive income at 31 December 2010? a. $1,287,000 b. $1,209,000 c. $1,260,000 d. $1,251,000 Page: p247 6. A company hires four people for five days to work on a telephone advertising campaign. Which of the following independent circumstances would not require an adjusting entry? a. Workers are paid on the last day of the work period. On the third day of the work period, the company’s reporting period ends. b. The company pays each of the four employees in cash at the end of each day’s work. c. The company pays the employees the week before the work begins. d. The company’s reporting period ends on the fifth day. Employees will be paid one week after completion of the work.

Page: p243 7. Which of the following is not a temporary account? a. Dividends b. Insurance expense c. Retained earnings d. Cost of goods sold Page: p258 8. Which of the following is not a permanent account? a. Retained earnings b. Dividends c. Trade accounts payable d. Trade accounts receivable Page: p258

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9. Which of the following statements does not accurately describe the closing process? a. Income summary is closed to retained earnings b. Dividends are closed to income summary c. Expenses are closed to income summary d. Revenue is closed to income summary 10. In which of the following accounting process reports do temporary accounts have a zero balance?

1 trial balance 2 post-closing trial balance at the end of the reporting period 3 adjusted trial balance 4 ledger at the beginning of a reporting period a. All have zero balances b. 2, 3 and 4 only c. 2 only d. 2 and 4 only Page: p264 11. A company’s accountant fails to record the closing entries for the fiscal year ended 31 December 2010. The company reported a profit and paid dividends of £20,000 in both 2010 and 2011.

Which of the following statements is inaccurate with regard to 2011’s financial statements if all temporary accounts were closed at the end of 2011? a. Revenues will be understated b. Net income will be overstated c. Retained earnings will not be affected d. Expenses will be overstated Page: p258 12. On 30 June 2010, a company received $120 in advance for a year’s subscription to its magazine.

However, the company’s account fails to record the adjusting entries related to this transaction during 2010. Which of the following statements is accurate regarding the effect of this error on the financial statements at 31 December 2010? a. Revenue will be understated by $60 b. Revenue will be understated by $120 c. Profit will be understated by $120 d. Retained earnings will be overstated by $60 Page: p258

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Essay Questions 1. Discuss the difference between cash-basis accounting and accrual accounting.

Answer Under cash-basis accounting, revenue is recorded when cash is received and expenses are recorded when cash is paid. Smaller businesses that engage in mostly cash transactions might use cash-basis accounting.

Under the accrual basis of accounting, the effects of transaction and other events are recognized when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods in which they relate. The IASB Framework for the Preparation and Presentation of Financial Statements mandates the accrual basis of accounting.

2. Explain the two criteria that all adjusting entries must meet.

Answer 1. Adjusting entries do not involve cash. Business transactions may include cash; adjusting entries may not.

2. Both the statement of comprehensive income and the statement of financial position must be affected. In the example above, service revenue appears on the statement of comprehensive income, and trade accounts receivable on the statement of financial position.

3.

Explain what an adjusting entry is and why it is recorded.

Answer Adjusting entries are journal entries that convert the accounting records to the accrual basis.

They are typically made at the end of the reporting period after all transactions for that period have been recorded.

4.

Explain the four types of adjusting entries?

Answer Two types of adjusting entries relate to recognition of previously unrecorded items, one related to revenue and the other expenses. In the first case, revenue has been earned but not recorded because the customer has not yet been billed nor has the customer paid the amount owed. In the second case, expenses have been incurred and therefore must be expensed in the current reporting period, but not bill has been received from the supplier nor has payment been made to the supplier.

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The other two types of adjusting entries are related to the reclassification of unearned revenue into revenue and pre-paid expenses or other assets into expenses. In the case of unearned revenue, cash had been received by the business but not yet earned. It was therefore recorded as unearned revenue which is a liability. The adjusting entry is made because the revenue is now earned and therefore must be reclassified to revenue. In the case of pre-paid expenses or other assets, payment was made to acquire an asset before it was used. When the pre-paid expense or other asset cost expires, it must be reclassified to expense.

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Chapter 6 Accounting Information Systems Test Bank True/False Questions 1. An accounting information system is the overall accounting system maintained by a business entity including computerized software modules that handle the accounting process, accounting policies and procedures and the human organizations that handle accounting activities.

True Page: p303 2. Transactions recorded in special journals are summarized and recorded in the general journal.

True Page: p305 3. A subsidiary ledger is a listing of all journal entries related to a given general ledger account.

False Page: p305 4. In the sales subsystem, the sales invoice is the source document used to record the journal entry for the sale in the sales journal.

True Page: p310 5. In the sales subsystem, customers order goods or services using a sales order.

False Page: p310 6. In the sales subsystem, a sales order is an internal document that a customer’s credit has been approved and that other appropriate approvals have been given.

True Page: p310 7. In the sales subsystem, the receivables sub-ledger contains a list of all sales journals that have been recorded in the general ledger to the sales account.

False Page: p310 8. In the sales subsystem, once goods are shipped a shipping document, also known as a bill of lading is prepared.

True Page: p310

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9. In the sales subsystem, the source document used to record the sales in the sales journal is the bill of lading.

False Page: p310 10. In the cash receipts subsystem, the source document used to record the cash receipt journal is the bank deposit slip.

False Page: p312 11. In the cash receipts subsystem, the cash receipts journal is posted to the receivables sub-ledger.

True Page: p312 12. In the sales returns and allowances subsystem, when a customer’s request for a sales return or allowance is approved, a debit memo is issued.

False Page: p313 13. A customer is offered a sales discount of 4/10, net 45. In this case, the customer pays within four days, a 10% discount.

False Page: p314 14. A customer is offered a sales discount of 3/5, net 20. In this case, the customer is expected to pay within 20 days or be classified as delinquent. However, a three percent discount will be given if the customer pays within 5 days.

True Page: p314 15. A customer is offered a sales discount of net 40. In this case, the customer is expected to pay within 40 days or be classified as delinquent. No discount is offered.

True Page: p314 16. Both the sales returns and allowances account and the sales discount account are contraaccounts to sales revenue.

True Page: p315 17. Net sales is calculated by deducting sales returns and allowances from gross sales.

False Page: p316

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18. In the statement mode of payment, customers are expected to pay for each order individually within the terms agreed upon.

False Page: p316 19. A retail store sells $400 in merchandise to a customer who uses a Visa™ to pay. Visa™ charges a 2% fee for processing the transaction. To record the sales entry, the store would debit Trade Accounts Receivable -- Visa™ for $392 and credit Sales Revenue for $392.

False Page: p316 20. In the purchases subsystem, the source document used to enter the purchase journal is the vendor invoice.

True Page: p319 21. In the purchases subsystem, a company orders goods or services by sending a purchase requisition to the supplier.

False Page: p319 22. In the purchase subsystem, if an internal department or function within a company wishes to purchase goods or services, a purchase requisition is prepared.

True Page: p319 23. In the cash disbursements subsystem, the journal entry to record payment is prepared from the check or electronic funds transfer sent to the vendor.

True Page: p320 24. In the cash disbursements subsystem, a remittance advice is a request for payment by the vendor for goods or services that have been shipped to the company.

False Page: p320 25. In the purchase returns and allowances subsystem, a debit memo is issued when the supplier grants the request for a purchase return or allowance.

True Page: p321 26. A journal entry to record a purchase return or allowance is recorded in the receivables subsidiary ledger.

False Page: p322

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27. A company purchases ¥50,000 in electronic components on terms 2/15, net 30. If the company pays within 10 days the appropriate journal entry to record the payment would be to debit Trade Accounts Payable for ¥49,000 and purchase discount for ¥1,000 and credit cash for ¥50,000.

False Page: p322 28. In the fixed assets cycle, the fixed assets register contains a listing of all journal entries that have affected fixed assets.

False Page: p326 29. The conversion subsystem accounts for three levels of inventory: finished goods, work-inprocess and direct materials.

True Page: p326 30. Audit trails are used in both manual and computerized accounting systems.

True Page: p329

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Multiple Choice Questions 1. The accounting information system is a part of which of the following business information systems? a. Customer Relationship Management b. Supply Chain Management c. Business Intelligence Systems d. Enteprise Resource Planning Page: p303 2. Detailed information on the balances owed to specific suppliers would be maintained in which of the following? a. General ledger b. Special journal c. Daybook d. Subsidiary ledger Page: p305 3. In the sales subsystem, the source document to record the journal entry for the sale in the sales journal would be which of the following? a. Bill of lading b. Sales invoice c. Sales order d. Customer purchase order Page: p310 4. In the sales subsystem, detail information on what transactions account for a specific customer’s trade accounts receivable balance would be found in which of the following? a. Receivables sub-ledger b. General ledger c. Sales journal d. Sales order file Page: p310 5. In the sales subsystem, an internal document which verifies that the appropriate approvals have been given on a customer order would be which of the following? a. Sales invoice b. Customer purchase order c. Sales order d. Bill of lading Page: p310

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6. In the cash receipts subsystem, the source document to record the journal entry for the receipt of cash would be which of the following? a. Receivables sub-ledger b. The payment received from the customer c. Bank deposit slip d. Cash receipts list Page: p312 7. In the sales returns and allowances subsystem, when a customer is granted a sales return or allowance which of the following would be issued? a. Credit memo b. Debit memo c. Journal entry recorded in the special returns and allowances journal d. Sales return or allowance request Page: p313 8. A customer is offered a sales discount of 4% if payment is made within 12 days and no discount thereafter. In any event, the customer will be in default if payment is not made within 45 days.

These terms would be expressed by which of the following? a. Net 45, 4/12 b. 4/12, net 45 c. 4/12/45 d. 4/12, 0/45 Page: p314 9. A company has gross sales of €23,000 for the reporting period. During the same period, €450 in sales discounts were taken by customers and the company granted €130 in sales returns and allowances. Cost of goods sold was €12,500. Purchase discounts totaling €200 were taken by the company. What amount of net sales did the company report for the period? a. €22,200 b. €10,120 c. €22,420 d. €9,920 Page: p316 10. A company extends credit to a customer on terms 3/10. Net 30 for a merchandise purchase on 30 June 2011 totaling $45,000. The customer paid the balance owed on 11 July 2011. The journal entry to record the payment would be which of the following? a. Debit Cash $45,000; credit Trade Accounts Receivable $45,000 b. Debit Cash $43,650 and Sales Discounts $1,350; credit Trade Accounts Receivable $45,000 c. Debit Cash $43,650; credit Trade Accounts Receivable $43,650 d. Debit Cash $45,000; credit Trade Account Receivable $43,650 and Sales Discounts $1,350 Page: p314

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11. On 28 February 2010, a company sold equipment to a customer for £450,000 on terms 2/20, net 45.

On 4 March 2010, the customer returned £25,000 of the equipment which was defective. One 17 March 2010, the customer paid the balance owed. The journal entry to record payment from the customer would be which of the following? a. Debit Cash £425,000; credit Trade Accounts Receivable £416,500 and Sales Discounts £8,500 b. Debit Cash £441,000 and Sales Discounts £9,000; credit Trade Accounts Receivable £450,000 c. Debit Cash £450,000; credit Trade Accounts Receivable £441,000 and Sales Discounts £9,000 d. Debit Cash £416,500 and Sales Discounts £8,500; credit Trade Accounts Receivable £425,000 Page: p314 12. In the purchases subsystem, the source document to record the journal entry for a purchase is which of the following? a. Receiving report b. Vendor invoice c. Purchase order d. Purchase requisition Page: p319 13. In the purchases subsystem, the document used to prepare a purchase order is which of the following? a. Receiving report b. Vendor invoice c. Purchase order d. Purchase requisition Page: p319 14. In the purchases subsystem, the document that verifies that goods have been received from the supplier is which of the following? a. Receiving report b. Vendor invoice c. Purchase order d. Purchase requisition Page: p319 15. In the cash disbursements subsystem, the journal entry to record the disbursement of the funds would be recorded from which of the following? a. Receiving report b. Vendor invoice c. Purchase order d. Cheque or electronic funds transfer Page: p320

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16. In the purchase returns and allowances subsystem, the journal entry to record the purchase return or allowance is recorded from which of the following? a. Credit memo b. Vendor invoice c. Debit memo d. Cheque or electronic funds transfer Page: p321 17. In the purchase returns and allowances subsystem, when a supplier grants a purchase return or allowance, which of the following is prepared? a. Credit memo b. Purchase requisition c. Debit memo d. Vendor invoice Page: p321 18. Prszha, Ltd. ordered 124 desk chairs for its new office facilities on 13 June 2010 which were received on 20 August 2010. The total amount of the order was €7812. However, the supplier offered a 2.5% discount if the amount were paid within 15 days. On 22 August 2010, Prszha returned 18 of the chairs because they were defective. On 24 August 2010 Prszha paid the balance due. The journal entry to record the payment would have included which of the following? a. Credit to purchase discount for €1134 b. Credit to cash for €6511 c. Debit to purchase discount for €167 d. Debit to trade accounts payable for €7812 Page: p321 19. In the employee compensation cycle, which of the following would result in a journal entry being recorded in the payroll journal? a. The employee provides services b. The employee is paid c. The business hires the employee d. The personnel record including deductions is completed Page: p325 20. A listing of fixed assets maintained in the fixed assets subsystem is referred to as which of the following? a. Asset sub-ledger b. Asset general ledger c. Asset inventory d. Asset register Page: p326

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21. In the inventories and conversion cycle, which of the following makes up overhead costs? a. Direct materials and labour b. Indirect materials, labor and indirect labour c. Indirect materials and indirect labour d. Direct materials, labour, indirect materials and indirect labour Page: p327 22. A specific amount shown on a financial statement would be traced back to the source document by an audit trail in which of the following sequences? a. Trial balance, ledger account, journal, source document b. Source document, ledger account, trial balance, journal c. Ledger account, source document, trial balance, journal d. Journal, ledger account, trial balance, source document Page: p329

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Essay Questions 1. Explain the difference between the general ledger and subsidiary ledger. Provide an example.

Answer The general ledger is the combined set of ledger accounts. A subsidiary ledger maintains detailed information on a particular general ledger account. One example would be trade accounts receivable where detailed information on customer balances would be maintained in the subsidiary ledger and the total of all customer balances in the general ledger.

2. What is a contra-account? Provide an example.

Answer A contra-account offsets another account and is classified with that account in the financial statements. Examples include sales returns and allowances and sales discounts which are both contra-accounts to the sales revenue account. Another example would be purchase discounts which is a contra-account to the purchases account.

3. What are the two common modes of payment in business?

Answer The first is the invoice basis where a customer is expected to pay each invoice separately. The second is the statement method where a customer receives a statement periodically showing all amounts after prior payments have been deducted.

4. What are the three levels of inventory maintained in the conversion cycle? Briefly describe each.

Answer Finished goods inventories include all items on which the production has been completed and are ready for sale. Work-in-process inventories are goods on which production has begun but not yet been completed by the end of the reporting period. Direct material inventories are materials on hand which have not yet been used in production.

5. Explain what an audit trail is and its purpose.

Answer An audit trail provides links that allow a transaction to be traced through an accounting system from the source document all the way to the final account balance that appear on the financial statements. Audit trails are used to determine what transactions comprise an account balance.

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Chapter 7 Nonfinancial Assets True/False Questions 1. If a capital expenditure is misclassified as a revenue expenditure, then both assets and expenses are overstated.

False Page: p348 2. If revenue expenditure is overstated, then profit will be understated.

True Page: p348 3. If a revenue expenditure is misclassified as a capital expenditure, then assets will be overstated and profit overstated.

True Page: p348 4. Cost of services can be recorded in inventories when a service business has not recognized related revenue.

True Page: p350 5. Carriage-outwards costs are included in inventories.

False Page: p351 6. Carriage-inwards costs are included in inventories.

True Page: p351 7. A merchandise company has the following costs related to merchandise that has been acquired: Cost to purchase from foreign manufacturer €21 000; transportation into warehouse €700; import duties €120; transportation to retail store €55; and transportation from the retail store to the customer €68. The cost of goods sold related to these inventories would be €21 875.

False Page: p351 8. A company pays $75 000 for display equipment to use in its retail outlet. Carriage-inwards was $2 000 and customs duties paid to import the equipment were $4 000. The inventories cost would be $81 000.

False Page: p351 9. At the beginning of the reporting period, a company has £70 000 in inventories. At the end of the reporting period inventories were £65 000. Net purchases during the period were £130 000. Cost of goods sold was therefore £135 000.

True Page: p353 . .

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10. On 31 January 2011, Shetty Garments, Ltd. Reports $212 500 in ending inventories. On June 2011, beginning inventories were $240 000. Shetty purchased $760 000 in merchandise during June of which $50 000 was returned for credit because of defects. Shetty paid the invoices within the terms specified by the supplier and received a 2% purchase discount.

Shetty also spent $10 000 in transportation costs to bring the goods to its warehouse. Cost of goods sold reported for January 2011 was $733 300.

True Page: p353 11. Cost of goods available is allocated to ending inventories and cost of goods sold by either specific identification or cost flow assumption.

True Page: p355 12. Inventories that are not normally interchangeable are assigned to ending inventories and cost of goods sold using the first-in, first-out method rather than average cost method.

False Page: p353 13. The FIFO cost flow assumption assigns costs of the oldest inventories to ending inventories.

False Page: p356 14. A business which uses the FIFO method to manage physical inventories such as perishable food items could use the average cost flow assumption for accounting for those inventories.

True Page: p360 15. When the average cost flow assumption is used, total cost of goods sold is divided by the total number of goods available to calculate the average cost per inventory unit.

False Page: p360 16. Under the periodic inventory approach, inventory costs are updated continuously as sales and purchases of inventories are made.

False Page: p362 17. A company began the reporting period with no inventories. During November 2011, the company made two purchases; 50 units at $15 each on 5 November and 20 units at $16 each on 17 November. The company uses the perpetual FIFO cost flow assumption. On 10 November, the company sold 40 units at a sales price of $22 each. On 30 November inventories were assigned a cost of $465.

True Page: p362

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18. A company’s beginning FIFO inventories were €500 for April 2010 On 7 April, the company purchased 100 units for €8 each and on 23 April another 150 for €7 each. On 15 April the company sold 70 units for €10 each. Cost of goods sold for April was €1 860. The company uses the perpetual method when calculating inventories cost.

False Page: p362 19. Net realizable value is the estimated selling price in the ordinary course of business less the estimated selling costs of completion and the estimated costs necessary to make the sale.

True Page: p373 20. Under lower of cost and net realizable value, if inventories cost is above net realizable value then an adjustment is made by debiting cost of goods sold.

False Page: p373 21. If inventories cost have previously been reduced under lower of costs or net realizable value and inventory values subsequently increase, the current period’s cost of goods sold should be credited for the increase.

True Page: p373 22. In October 2010, the ending inventories costs was mistakenly understated by $1500.

November ending inventories was calculated correctly. The effect of this error was to overstate November’s profit or loss.

True Page: p348 23. A company used the FIFO cost flow assumption. Beginning inventories for August had 60 units at $20 each. On 16 August, an additional 100 units were purchased at $21 each and on the 22 August another 70 units were purchased at $19 each. During August, 145 units were sold. The value of the August ending inventories is $1 615.

False Page: p359 24. A Company reports ending inventories of €500 for May 2010. During May, the company purchased €1500 in inventories. May’s cost of goods sold was $1600. The inventories turnover ratio is 3.6 (rounded).

True Page: p376 25. A company reports beginning inventories of £500 and ending inventories of £750 for March 2011. During March, the company purchased £2500 in inventories. The days in inventory for March was 122 rounded.

False Page: p379 26. Property, plant and equipment are expected to be used more than one period.

True Page: p380 . .

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27. Property, plant and equipment include both tangible and intangible items that are held for use in production or supply of goods or services, for rentals to others, or for administrative purposes.

False Page: p380 28. A bakery wants to purchase a van for use in deliveries. The bakery owner finds a used van for sale worth €17 000. However, the seller is willing to sell for only €14 000. The bakery pays the seller €7 000 in cash with the remainder to be paid in six months. The cost of the van would be reported in the bakery’s financial statements as €14 000 when it is acquired.

True Page: p382 29. Residual value is the estimated value that an entity would currently obtain from disposal of an asset.

False Page: p383 30. Depreciable amount is the cost of an asset less its residual value.

True Page: p383 31. Useful life can be measured in terms of the number of production or similar units expected to be obtained from the asset by the entity.

True Page: p384 32. A company owns a large construction crane for which it paid £150 000. Residual value is £25 000 and useful life is five years. After five years, the company would report an asset value equal to zero since at that time the crane would be fully depreciated.

False Page: p384 33. A company purchases extrusion moulding equipment used to manufacture snack foods for €27 000. It cost the company €1500 for delivery and another €1700 for installation and training. The machine has a residual value estimated at €2 000 with a four year useful life.

The carrying amount after two years would be €14 100.

True Page: p382 34. A company purchased equipment for $190 000. It cost the company $13 000 for delivery, installation and training. The equipment is expected to operate for a total of 50 000 hours.

The company uses a units-of-production method for depreciating equipment. The equipment was operated for 6500 hours during the first year. The accumulated depreciation reported by the company at the end of the first year was $26 390.

False Page: p386

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35. An agricultural company buys an harvesting machine for $450 000 with a residual value of $50 000 and an eight year useful life. Depreciation expense for the second year if the company uses a double diminishing balance would be $71 875.

True Page: p388 36. A company that uses double diminishing balance to depreciate equipment. The useful life of the equipment is seven years. Compared to the straight-line method, the carrying value of the asset would higher after two years.

False Page: p389 37. When a change in estimate such as useful life or residual value occurs during the life of a depreciable asset, no change is made to the amount of depreciation expense recognized each period. The original useful life or residual value continues to be used.

False Page: p392 38. An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.

True Page: p394 39. IFRS requires that the property, plant and equipment be accounted for only at cost over their useful life.

False Page: p395 40. Fair value is the amount for which an asset could be sold within the next 30 days in an a transaction between knowledgeable, willing parties in an arm’s length transaction.

False Page: p395 41. Under the revaluation model of accounting for property, plant and equipment any change in fair value is recognized directly in equity as other comprehensive income.

True Page: p396 42. When recording a transaction involving the disposal of property, plant and equipment any amount previously recorded in equity because of revaluation would be removed and included in the calculation to determine any gain or loss on the disposal.

True Page: p397 43. The cost of an intangible asset is never capitalized if externally acquired.

False Page: p401

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44. Research expenditures are always expensed when incurred when an intangible asset is internally developed.

True Page: p402 45. When amortizing an intangible asset, the credit in the journal entry is recorded as a direct reduction to the intangible asset cost.

True Page: p403 46. If the legal life of an intangible asset is shorter than its estimated useful life, the asset is amortized over the useful life.

False Page: p403 47. IFRS permits intangible assets to be accounted for under the cost model or the revaluation model.

True Page: p404 48. Goodwill is created when the amount paid for the acquired business exceeds the fair value of the net assets acquired.

True Page: p405 49. An investment property – like property, plant and equipment – can be accounted for under either the cost model or revaluation model.

False Page: p409 50. A gain or loss arising from a change in the fair value of investment property shall be recognized in profit or loss for the period in which it arises.

True Page: p410

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Multiple Choice Questions 1. If a capital expenditure is understated, then revenue and profit, respectively, on the statement of comprehensive income will be which of the following? a. Overstated, overstated b. Overstated, understated c. Understated, overstated d. Understated, understated Page: p348 2. If a capital expenditure is overstated, then revenue and profit, respectively, on the statement of comprehensive income will be which of the following? a. Overstated, overstated b. Overstated, understated c. Understated, overstated d. Understated, understated Page: p348 3. Which of the following would not be included in inventories? a. Finished goods produced by the business but which remain unsold b. Land held for resale to individuals who want to build homes c. Finished goods purchased by the business which have been sold d. Supplies awaiting use in the production process Page: p350 4. Which of the following costs would not be included in inventories cost? a. Sales tax on goods purchased for resale b. Cost of delivery of goods to customers c. Carriage-inwards d. Customs duty on the importation of merchandise Page: p351 5. Net purchases is calculated by which of the following equations? a. Purchases + carriage-inwards + other costs – purchase discounts and allowances – purchase discounts b. Purchases + carriage-outwards + other costs – purchase discounts and allowances – purchase discounts c. Purchases + carriage-outwards + other costs + purchase discounts and allowances + purchase discounts d. Purchases + carriage inwards + other costs + purchase discounts and allowances purchase discounts Page: p353 6. Which of the following is the correct calculation of ending inventories? a. Beginning inventories + net purchases + cost of goods sold b. Beginning inventories - net purchases + cost of goods sold c. Net purchases – cost of goods sold + beginning inventories d. Beginning inventories + cost of goods sold – net purchases Page: p353

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7. Malaysian Imports, Ltd has the following information about the inventory of electronic components for October 2011.

Date Quantity Cost per item Beginning inventory, 1 October 2011 150 $32 5 October 2011 purchase 200 $32 17 October 2011 purchase 450 $31 28 October 2011 purchase 100 $33 At the end of October, 220 components remained in inventory. If Malaysian Imports uses the FIFO method of allocating inventory costs, what would is the cost of goods sold for October? a. $7020 b. $6954 c. $21 430 d. $21 410 Page: p359 8. Malaysian Imports, Ltd has the following information about the inventory of electronic components for October 2011.

Date Beginning inventory, 1 October 2011 5 October 2011 purchase 17 October 2011 purchase 28 October 2011 purchase

Quantity 150 200 450 100

Cost per item $32 $32 $31 $33

At the end of October, 220 components remained in inventory. If Malaysian Imports uses the FIFO method of allocating inventory costs, what would is the ending inventory for October? a. $7020 b. $6954 c. $21 430 d. $21 410 Page: p359

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9. Malaysian Imports, Ltd has the following information about the inventory of electronic components for October 2011.

Date Beginning inventory, 1 October 2011 5 October 2011 purchase 17 October 2011 purchase 28 October 2011 purchase

Quantity 150 200 450 100

Cost per item $32 $32 $31 $33

At the end of October, 220 components remained in inventory. If Malaysian Imports uses the average cost method of allocating inventory costs, what would is the ending inventory for October? a. $7020 b. $6954 c. $21 430 d. $21 410 Page: p359 10. Malaysian Imports, Ltd has the following information about the inventory of electronic components for October 2011.

Date Beginning inventory, 1 October 2011 5 October 2011 purchase 17 October 2011 purchase 28 October 2011 purchase

Quantity 150 200 450 100

Cost per item $32 $32 $31 $33

At the end of October, 220 components remained in inventory. If Malaysian Imports uses the average cost method of allocating inventory costs, what would is the cost of goods sold for October? a. $7020 b. $6954 c. $21 430 d. $21 495 Page: p359

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11. Moroccan Leatherworks, LLC has the following information about the inventory of brief cases for January 2012.

Date Beginning inventory, 1 January 2011 7 January sale 9 January purchase 18 January purchase 23 January sale

Quantity 3300 1200 1700 500 2000

Cost per item €55 -€56 €57 --

Sales price per item €120

€125

If Moroccan Leatherworks use the perpetual average cost method of allocating inventory costs, what would is the cost of goods sold for January? a. €176 000 b. €129 200 c. €127 949 d. €177 251 Page: p368 12. Moroccan Leatherworks, LLC has the following information about the inventory of brief cases for January 2012.

Date Beginning inventory, 1 January 2011 7 January sale 9 January purchase 18 January purchase 23 January sale

Quantity 3300 1200 1700 500 2000

Cost per item €55 -€56 €57 --

Sales price per item €120

€125

If Moroccan Leatherworks use the perpetual average cost method of allocating inventory costs, what would is the ending inventory for January? a. €176 000 b. €129 200 c. €127 949 d. €177 251 Page: p368

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13. Moroccan Leatherworks, LLC has the following information about the inventory of brief cases for January 2012.

Date Beginning inventory, 1 January 2011 7 January sale 9 January purchase 18 January purchase 23 January sale

Quantity 3300 1200 1700 500 2000

Cost per item €55 -€56 €57 --

Sales price per item €120

€125

If Moroccan Leatherworks use the perpetual FIFO method of allocating inventory costs, what would is the cost of goods sold for January? a. €176 000 b. €129 200 c. €127 949 d. €177 251 Page: p362 14. Moroccan Leatherworks, LLC has the following information about the inventory of brief cases for January 2012.

Date Beginning inventory, 1 January 2011 7 January sale 9 January purchase 18 January purchase 23 January sale

Quantity 3300 1200 1700 500 2000

Cost per item €55 -€56 €57 --

Sales price per item €120

€125

If Moroccan Leatherworks use the perpetual FIFO method of allocating inventory costs, what would is the ending inventory for January? a. €176 000 b. €129 200 c. €127 949 d. €177 251 Page: p362 15. Adonia Cosmetics, Limited reported a gross profit of €250 000 in 2012 with sales of €700 000. Profit was €60 000. Inventories were €55 000 at the beginning of 2012, and €65 000 at year’s end. What is the inventories turnover ratio for Adonia? a. 11.67 b. 4.17 c. 1.0 d. 10.77 Page: p376

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16. Adonia Cosmetics, Limited reported a gross profit of €250 000 in 2012 with sales of €700 000. Profit was €60 000. Inventories were €55 000 at the beginning of 2012, and €65 000 at year’s end. What is the inventories turnover ratio for Adonia? a. 33.89 b. 365 c. 31.28 d. 87.53 Page: p379 17. Property, plant and equipment that qualifies for recognition as an asset is recorded at which of the following? a. Fair value b. Discounted value c. Replacement value d. Cost Page: p382 18. Sinarline Office Products, SA purchased land for €300 000 on which it built an headquarters office building. The building cost €2 000 000 and went into service on 1 October 2011. The building has a useful life of 20 years and a residual value of €500 000. Sinarline reports financial results on a calendar year basis. What is the depreciation for 2011 if the company uses the straight-line method? a. €75 000 b. €90 000 c. €22 500 d. €18 750 Page: p385 19. Sinarline Office Products, SA purchased land for €300 000 on which it built an headquarters office building. The building cost €2 000 000 and went into service on 1 October 2011. The building has a useful life of 20 years and a residual value of €500 000. Sinarline reports financial results on a calendar year basis. What is the depreciation for 2011 if the company uses the double diminishing balance method? a. €150 000 b. €230 000 c. €200 000 d. €180 000 Page: p388 20. A company purchases equipment which has a list price of$22 000 on 1 January 2011. The dealer provides a 5% trade discount. Shipping costs for the equipment are $570, installation is $1300, and training related to the use of the new equipment is $1150. The estimated useful life of the equipment is three years at the end of which $1500 will need to be spent to restore the site where the equipment is located. Residual value is $3000. What amount should be recorded on 1 January 2011 when the equipment is first acquired? a. $23 920 b. $20 900 c. $25 420 d. $22 420 Page: p383 . .

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21. A company purchases equipment which has a list price of$22 000. The dealer provides a 5% trade discount. Shipping costs for the equipment are $570, installation is $1300, and training related to the use of the new equipment is $1150. The estimated useful life of the equipment is three years at the end of which $1500 will need to be spent to restore the site where the equipment is located. Residual value is $3000. What amount (in whole dollars) should be recorded as depreciation expense for the first quarter of 2011 if the company uses the straight-line method? a. $7140 b. $1868 c. $8473 d. $2118 Page: p385 22. A company purchases equipment which has a list price of$22 000. The dealer provides a 5% trade discount. Shipping costs for the equipment are $570, installation is $1300, and training related to the use of the new equipment is $1150. The estimated useful life of the equipment is three years at the end of which $1500 will need to be spent to restore the site where the equipment is located. Residual value is $3000. What amount (in whole dollars) should be recorded as depreciation expense for 2012 if the company uses the double diminishing balance method? a. $14 281 b. $4760 c. $2981 d. $16 948 Page: p388 23. On 23 August 2010 A company purchases equipment which for £175 000 with a residual value of £25 000. The useful life is expected to be 5 years. The equipment is also expected to produce 300 000 units during this time. In May 2011, the equipment actually produces 5722 units. What is the depreciation expense in whole pounds recorded for May 2011? a. £2861 b. £3338 c. £668 d. £572 Page: p386

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24. On 31 December 2010, Deutsche Engineering, AB reported the following amounts on its statement of financial position.

Generators (at cost) Accumulated depreciation Carrying amount

€1 250 000 (500 000) €750 000

Generators were being depreciated using the straight line method over 7 years assuming no residual value. On 1 January 2011, management revised their estimate of the residual value to €100 000. What is the annual depreciation expense in whole euros that would be recognized for 2011? a. €125 000 b. €75 000 c. €65 000 d. €108 333 Page: p392 25. On 23 September 2012, Chenard Metals, SA reported the following amounts on its statement of financial position.

Foundries (at cost) Accumulated depreciation Carrying amount

€17 800 000 (2 500 000) €15 300 000

On 31 December 2012, the foundries were sold to Lampron, SA for €14 000 000 cash. The journal entry to record the sale would not include which of the following debits? a. €17 800 000 b. €2 500 000 c. €14 000 000 d. €1 300 000 Page: p397 26. Which of the following is not accurate about the accounting for intangible assets? a. Research costs for internally generated intangible assets are always expensed as incurred. b. Development costs for internally generated intangible assets are always expensed as incurred. c. Externally acquired intangible assets are recorded at cost. d. Intangible assets can be accounted for using either the cost model or revaluation model after acquisition.

Page: p401

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27. Chaoxiang Ch’in Markets, Limited acquired its competitor, Jason Supermarkets, Corporation on 31 December 2011. On that date, the following schedule showed the net carrying amounts on Jason’s statement of financial position and their fair values

Assets Liabilities

Carrying amount ¥250 000 000 ¥225 000 000

Fair value ¥400 000 000 ¥250 000 000

Assuming that Ch’in payed ¥25 000 000 for Jason, how much goodwill would be recognized? a. None b. ¥25 000 000 c. ¥175 000 000 d. ¥150 000 000 Page: p405 28. Which of the following is true about accounting for investment properties? a. A gain or loss on the fair value of an investment property is recognized in other comprehensive income b. Investment properties can be accounted for either under the cost method or revaluation method. c. An investment property cannot be held by lease d. An investment property is held to earn rentals or for capital appreciation Page: p409

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Essay Questions 1. Explain the difference between a capital expenditure and a revenue expenditure.

Answer When a cost is included as part of a tangible or intangible asset, then we say that the cost is a capital expenditure – or that the cost has been ‘capitalized’. It therefore becomes a capital asset or fixed asset, and is sometimes referred to as a depreciable asset. A cost which is expensed is referred to as revenue expenditure which means that it is an expense and that therefore the cost has expired.

2. Describe the two ways in which inventories are created.

Answer First, a merchandising company buys finished goods from a wholesaler or manufacturer. The merchandising company does not itself manufacture goods. Second, a manufacturer produces goods by converting materials and labour into finished goods.

3. What costs are included in inventories?

Answer The initial amount recorded for inventories is the cost of purchase, cost of conversion (manufacture) and other costs incurred to bring the inventories to their present location and condition. Inventory costs include transport costs such as custom duties, sales taxes, and transportation costs. Carriage-inwards (also transportation-in or freight-in) are costs to bring the goods to the current location.

4. What are the two methods of allocating inventory costs to costs of goods sold?

Answer Accounting uses two major methods to reclassify inventory costs: 1) specific identification and 2) cost flow assumption.

5. What are the two cost flow assumptions allowed under IFRS? Answer Entities are allowed to choose one of two assumptions under IFRS: 1) average cost or 2) firstin-first out.

6. When is it appropriate to use specific identification to allocate inventory costs to cost of goods sold?

Answer Inventory items that are not normally interchangeable and goods or services produced are assigned using specific identification of their individual costs.

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7. Describe the difference between periodic and perpetual methods of allocating inventory costs to cost of goods sold.

Answer The periodic method calculates the amount of inventory costs to be allocated to cost of goods sold at the end of the accounting period while the perpetual method calculates the amount to be allocated when each sale occurs. Both the periodic and perpetual methods can be used with either the FIFO or AVCO cost flow assumptions.

8. What is the appropriate accounting if the value of inventories decline subsequent to their acquisition?

Answer If the net realizable value of the inventories declines below their carrying amount, the difference is recognized as part of cost of goods sold.

9. Compare the impact that the three methods of allocating property, plant and equipment costs (straight-line, units-of-production and diminishing balance) have on profit over the useful life of an asset.

Answer In the earlier part of the asset’s useful life, diminishing balance method will result in higher depreciation expense and lower profit compared to the straight-line method. In the later part of the asset’s useful life, the diminishing balance method will result in lower depreciation expense and higher profit compared to the straight-line method. No comparison can be made with units-of-production because the amount of depreciation expense and profit depends on actual usage which varies.

10. Describe the two methods for accounting for property, plant and equipment permitted by IFRS subsequent to acquisition.

Answer Cost model. After recognition as an asset, an item of property, plant and equipment shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses.

Revaluation model. After recognition as an asset, an item of property, plant and equipment whose fair value can be measured reliably shall be carried at the re-valued amount.

11. What is the difference in accounting for intangible assets acquired externally versus those generated internally?

Answer Externally acquired intangible assets are capitalized. Research costs for internally generated assets are expensed as incurred. Development costs for internally generated assets when they meet certain criteria can be capitalized.

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12. What are the two methods of accounting for intangible assets permitted by the IFRS subsequent to acquisition?

Answer Cost Model. Under the cost model, the intangible asset is carried at cost less any accumulated amortization and any accumulated impairment losses.

Revaluation Model. Under the revaluation model, the intangible asset is carried at fair value less any accumulated amortization and accumulated impairment losses since the date of revaluation.

13. What is goodwill?

Answer Goodwill is an asset which represents the future economic benefits that arise from assets acquired when one business buys another. Goodwill is created when the amount paid for the acquired business exceeds the fair value of the net assets acquired.

14. What is the difference in accounting for property, plant and equipment and investment property?

Answer Property, plant and equipment are assets used in production. The costs of these assets are allocated over their useful life. If the value of the asset increased, IFRS permits the increase to be recognized directly in equity. If the asset value decline, IFRS requires an impairment loss to be recognized in profit or loss.

Investment properties include land and buildings held for rental or capital appreciation. IFRS requires that these assets be re-valued to fair market value and any gain or loss is recognized in profit or loss.

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Chapter 8 Financial Assets and Liabilities Test Bank True/False Questions 1. Financial assets would include the shares an entity owns of another entity.

True Page: 428 2. Examples of financial liabilities include trade accounts payable, unearned revenues, and notes payable.

False Page: 429 3. Restricted cash refers to situations when a minimum balance must be kept on hand at all times as part of a loan agreement with a lender?

False Page: 429 4. Petty cash refers to an amount set aside for specific purpose such as a large payment on debt or a legal settlement that is soon due.

False Page: 430 5. A bank overdraft refers to a situation in which the cash ledger account has a net credit rather than a net debit balance.

False Page: 430 6. Petty cash is debited when the petty cash fund is being established for the first time and when the amount in the petty cash fund is increased.

True Page: 430 7. Petty cash is credited when the amount of the petty cash fund is decreased and when the cash balance is replenished.

False Page: 431

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8. If the total amount of receipts in petty cash exceed the amount of cash that needs to be replenished, the cash over and short account would credited for the difference.

True Page: 431 9. If the total amount of receipts in petty cash are less than the amount of cash that needs to be replenished, the cash over and short account would be credited for the difference.

False Page: 431 10. When reconciling the cash ledger account and the bank statement, any transaction recorded by the bank but unknown to the business must have a journal entry recorded to correct the cash ledger balance.

True Page: 432 11. When reconciling the cash ledger account and bank statement, a bank fee listed on the bank statement would not need to be recorded in the cash ledger account.

False Page: 433 12. Once journal entries are made for a bank reconciliation, the cash ledger account will be equal to the balance shown on the bank statement.

False Page: 434 13. Financial assets with a maturity of three months or less are typically classified as a cash equivalent.

True Page: 438 14. A current financial liability is typically due between 6 and 12 months into the future.

False Page: 438 15. A financial asset or financial liability at fair value through profit or loss is a financial asset or financial liability that either 1) is classified as held for trading or 2) is designated as at fair value through profit and loss upon initial recognition by the entity.

True Page: 439 . .

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16. Held to maturity investments are financial assets with fixed or determinable payments and which management plans to sell in the short-term for profit.

False Page: 440 17. Loans and receivables are financial assets with fixed or determinable payments that are quoted in an active market.

False Page: 441 18. Available-for-sale financial assets are designated as available for sale or are not classified as 1) loans and receivables, 2) held-to-maturity investments, or 3) financial assets at fair value through profit or loss.

True Page: 441 19. The appropriate accounting for held-to-maturity investments and loans and receivables is amortized cost using effective interest method.

True Page: 442 20. Any gains and losses on available-for-sale financial assets are recognized immediately in profit and loss.

False Page: 442 21. The effective interest rate method is not applied to trade accounts.

False Page: 449 22. Net receivables are calculated by subtracting the allowance for uncollectible accounts from trade accounts receivable.

True Page: 454 23. Under the percentage of sales method, the estimate of the uncollectible amount for the current period is credited to the allowance account in full adjusted for any debit or credit balance that remains in the allowance account from the previous period.

False Page: 455 . .

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24. Under the aged receivables method, the estimate of the uncollectible amount for the current period is credited to the allowance account in full adjusted for any debit or credit balance that remains in the allowance account from the previous period.

True Page: 457 25. Under the allowance method, the journal entry to record a customer default has no impact on profit or loss.

True Page: 460 26. Under the direct write off method of accounting for uncollectible accounts, a journal entry is recorded when the estimate is made to debit uncollectible accounts expense.

False Page: 462 27. Under the direct write off method of accounting for uncollectible accounts, a customer default would have an impact on the profit or loss reported for the period.

True Page: 462 28. Under the aged receivables method of estimating uncollectible amounts, if the allowance account has a net credit remaining from the prior period, the prior credit in the allowance account would be subtracted from the estimate from the aged receivables method to calculate the amount of the adjustment to the allowance account.

True Page: 462 29. The journal entry to record a purchase of merchandise when a customer uses a third-party credit card debits trade accounts receivable.

False Page: 465 30. If a note payable does not have stated interest, then the effective interest rate method is not applicable.

False Page: 467

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31. The effective interest rate method is applicable regardless of whether a note payable is interest or noninterest-bearing.

True Page: 466 32. The principal on a serial bond is paid on the final maturity date.

False Page: 472 33. An unsecured bond is sold on the cognizance of the issuer with no claim against specific assets.

True Page: 472 34. If the market rate of interest is greater than the stated interest when a bond is issued, then the bond sells for more than its stated value.

False Page: 473 35. If the market rate of interest is less than the stated interest when a bond is issued, then the bond sells for more than its stated value.

True Page: 473 36. A noninterest-bearing bond is not amortized since no interest is charged on the bond.

False Page: 479 37. Liquidity is the availability of cash in the near future after taking account of financial commitments over the period.

True Page: 484 38. A company reports the following amounts in its 2011 statement of financial position: Cash €35 000, Current assets €110 000, Current liabilities €80 000, total assets €360 000, and total liabilities €285 000. Working capital is €75 000.

False Page: 485

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39. A company reports the following amounts in its 2011 statement of financial position: Cash €35 000, current assets €110 000, current liabilities €80 000, total assets €360 000, and total liabilities €285 000. The current ratio is 1.38.

True Page: 485 40. A business entity reports the following amounts in its 2012 statement of financial position: Cash and cash equivalents €40 000, trade accounts receivable €21 000, noncurrent securities €60 000, current assets €200 000, current liabilities €140 000, total assets €340 000, and total liabilities €300 000. The acid-test ratio is 0.86.

False Page: 486 41. The receivables turnover ratio is calculated by dividing average receivables into gross profit.

False Page: 487 42. Solvency is the availability of cash over the longer term to meet financial commitments as they fall due.

True Page: 488

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Multiple Choice Questions 1. Which of the following terms describes a minimum cash balance that must be kept on hand at all times as part of a loan agreement with a lender? a. Bank overdraft b. Petty cash c. Restricted cash d. Compensating balance Page: 429 2. A journal entry would not be required for which of the following items when reconciling the cash ledger account with the bank statement? a. The bank charged a fee related to the processing of electronic wire transfers b. A salary cheque to an employee was written and recorded but has not cleared the bank c. An electronic payment was made directly to the bank by a customer and this amount appears ont eh bank statement d. A customer’s cheque was returned to the bank due to insufficient funds Page: 432 3. On 30 April 2011, the petty cash fund at Sage Greengrocers, Ltd had £49 in cash and coin. In addition, £17 in vouchers and £3 in IOUs were on hand. The petty cash fund was established at £70. What entry should be made to the over and short account? a. No entry should be made b. £20 credit c. £1 debit d. £20 debit Page: 430

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4. On 30 June 2012, Ramirez Industries, SA had a $135 000 reported on its bank statement. The reconciliation found four differences between the bank balance and the cash ledger account: ▪ A cheque for $7700 refund had been prepared and sent to a customer but had not yet cleared the bank ▪ The bank charged $450 in fees which appeared on the bank statement.

▪ Ramirez received a cheque for $14 100 from a customer which had been recorded but was not deposited with the bank in time to appear on the 30 June 2012 bank statement.

▪ A customer’s cheque for $1200 was returned because of insufficient funds.

How much was the cash ledger account before adjustments were made from the bank reconciliation? a. $139 750 b. $141 400 c. $143 050 d. $130 250 Page: 431 5. On 30 June 2012, Ramirez Industries, SA had a $135 000 reported on its bank statement. The reconciliation found four differences between the bank balance and the cash ledger account: ▪ A cheque for $7700 refund had been prepared and sent to a customer but had not yet cleared the bank ▪ The bank charged $450 in fees which appeared on the bank statement.

▪ Ramirez received a cheque for $14 100 from a customer which had been recorded but was not deposited with the bank in time to appear on the 30 June 2012 bank statement.

▪ A customer’s cheque for $1200 was returned because of insufficient funds.

How much was the reconciled (or true) balance from the bank reconciliation? a. $139 750 b. $141 400 c. $143 050 d. $130 250 Page: 431 6. Which of the following financial assets and liabilities would not be accounted for using amortized cost using effective interest method? a. Financial liabilities other than held-for-trading b. Loans and receivables c. Available-for-sale financial assets d. Held-to-maturity investments Page: 442

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7. On 30 November 2012, Bahashty Productions, LLC had an allowance for uncollectible accounts balance of €12 880. Revenue for November was €1 303 000. Bahashty estimates that 2% of all sales will be uncollectible. In addition, on 30 November Bahashty’s receivables collection department wrote off €6500 in defaulted amounts. How much should Bahashty report for uncollectible accounts expense for November 2012? a. €26 060 b. €32 440 c. €19 560 d. €6500 Page: 453 8. On 30 November 2012, Bahashty Productions, LLC had an allowance for uncollectible accounts balance of €12 880. Revenue for November was €1 303 000. Bahashty estimates that 2% of all sales will be uncollectible. In addition, on 30 November Bahashty’s receivables collection department wrote off €6500 in defaulted amounts. What is the balance in the allowance for uncollectible accounts that Bahashty will report on its statement of financial position at 30 November 2012? a. €26 060 b. €32 440 c. €19 560 d. €6500 Page: 453 9. Heeran Paper Company, Inc. has an allowance for uncollectible accounts with a net debit of $1650 on 31 August 2011. During August sales were $455 000. Heeran uses the aged receivable method of estimating the amount of uncollectible accounts. At the end of August, the aged balances were:

Total amounts owed Estimated uncollectible percentage

Amount Due $112 000 --

1-30 days $84 000 0.8%

31-60 days $15 000 2.0%

61-90 days $2000 6.0%

Over 90 days $11 000 12.0%

During August, Heeran’s accountants wrote off $1400 in uncollectible accounts. What is the balance in the allowance for uncollectible accounts that Heeran will report on its statement of financial position at 31 August 2011? a. $4062 b. $762 c. $2412 d. $1650 Page: 456 . .

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10. Heeran Paper Company, Inc. has an allowance for uncollectible accounts with a net debit of $1650 on 31 August 2011. During August sales were $455 000. Heeran uses the aged receivable method of estimating the amount of uncollectible accounts. At the end of August, the aged balances were:

Total amounts owed Estimated uncollectible percentage

Amount Due $112 000 --

1-30 days $84 000 0.8%

31-60 days $15 000 2.0%

61-90 days $2000 6.0%

Over 90 days $11 000 12.0%

During August, Heeran’s accountants wrote off $1400 in uncollectible accounts. How much should Heeran report for uncollectible accounts expense for August 2011? a. $4062 b. $762 c. $2412 d. $1650 Page: 456 11. Which type of bond allows the issuer has the right to purchase the bond from the investor at a certain price? a. Unsecured bond b. Callable bond c. Term bond d. Serial bond Page: 472 12. On which type of bond is the principal paid on the maturity date? a. Unsecured bond b. Zero-interest bond c. Term bond d. Serial bond Page: 472 13. On which type of bond is the principal paid in installments over the term of the bond? a. Unsecured bond b. Zero-interest bond c. Term bond d. Serial bond Page: 472

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14. On 1 January 2011, a €200 000 000 bond is issued with a 3.5% stated rate of interest when the market rate of interest is 3.9%. As a result the bond sold for €179 487 180. The bond has a 20 year term. The bond is a term bond with interest paid annually. How much interest expense should be recognized for 2011? a. €7 000 000 b. €8 085 0000 c. €7 973 718 d. €6 282 051 Page: 477 15. On 31 August 2010, a company reported the following amounts in its statement of financial position: Cash and cash equivalents Marketable securities Long term financial investments Trade accounts receivable Current assets Current liabilities Total assets Total equity

€40 000 €150 000 €200 000 €120 000 €620 000 €990 000 €1 500 000 €500 000

What is the company’s acid-test ratio? a. 31.3% b. 50.0% c. 20.7% d. 19.2% Page: 486

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16. On 31 August 2010, a company reported the following amounts in its statement of financial position: Cash and cash equivalents Marketable securities Long term financial investments Trade accounts receivable Current assets Current liabilities Total assets Total equity

€40 000 €150 000 €200 000 €120 000 €620 000 €990 000 €1 500 000 €500 000

What is the company’s cash ratio? a. 31.3% b. 50.0% c. 20.7% d. 19.2% Page: 486 17. On 31 August 2010, a company reported the following amounts in its statement of financial position: Cash and cash equivalents Marketable securities Long term financial investments Trade accounts receivable Current assets Current liabilities Total assets Total equity

€40 000 €150 000 €200 000 €120 000 €620 000 €990 000 €1 500 000 €500 000

What is the company’s current ratio? a. 41.3% b. 62.6% c. 50.0% d. 300.0% Page: 486

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18. On 31 August 2010, a company reported the following amounts in its statement of financial position: Cash and cash equivalents Marketable securities Long term financial investments Trade accounts receivable Current assets Current liabilities Total assets Total equity

€40 000 €150 000 €200 000 €120 000 €620 000 €990 000 €1 500 000 €500 000

What is the company’s debt ratio? a. 198.0% b. 40.0% c. 200.0% d. 66.7% Page: 486

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Essay Questions 1. List and briefly describe the major forms cash and cash equivalents can take.

Answer 1. Restricted cash means that an amount has been set aside for a specific purpose.

2. A compensating balance is a minimum balance which must be kept on hand at all times as part of a loan agreement with a commercial lender.

3. A business may for a variety of reasons overdraw the amount of cash it has in its bank account which results in a bank overdraft.

4. Finally, cash is sometimes kept in the form of petty cash. Petty cash refers to cash that is kept on hand in a business to pay small expenses such as postage, delivery charges, entertainment for clients and other miscellaneous expenses.

2. What is the difference in the timing of recognizing the uncollectible accounts between the direct write-off method and the allowance method for uncollectible accounts?

Answer Under the direct write-off method, the uncollectible expense is recognized in profit or loss when the default occurs. An estimate of uncollectible amounts is not made under the direct write-off method. Under the allowance method, an estimate is made and this estimate is recognized in profit or loss. However, when the default occurs under the allowance method, no uncollectible accounts expense is recognized.

3. What is the difference between the percentage of sales method and the aged receivables method in terms of the amount of the current estimate that is adjusted to the allowance for uncollectible accounts?

Answer Under the percentage of sales method, the entire amount of the current estimate is credited allowance for uncollectible accounts without any adjustment for the balance currently in that account. Under the aged receivable method, the amount of the current estimate is adjusted by the amount currently in the allowance account. If a net debit is in the allowance account, this amount is added to the aged receivables estimate. If a net credit is in the allowance account, this amount is subtracted from the aged receivables estimate.

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4. List and briefly describe the six types of bonds discussed in the text.

Answer ▪ Term bond – A bond on which the principal is due on the maturity date.

▪ Serial bond – A bond on which the principal is paid in installments over the term of the bond.

▪ Callable bond – The issuer has the right to purchase the bond from the investor at a certain call price.

▪ Secured bond – Also referred to as a debenture bond. Secured bonds are backed by a pledge of some asset such as real estate. The investor has a priority claim on the pledged asset in the event of liquidation.

▪ Unsecured bond – A bond which is sold on the cognizance of the issuer, with no claim against assets.

▪ Zero-interest bond – A bond which pays not interest but on which the investor earns a return by purchasing the bond at a discounted price.

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Chapter 9 Equity Test Bank True/False Questions 1. Equity typically contains three elements: 1) contributed capital, 2) retained earnings and 3) reserves.

True Page: p503 2. All limited liability companies have both ordinary shares and preference shares.

False Page: p503 3. There must be at least one class of ordinary shares though additional classes can exist.

True Page: p503 4. An ordinary share is an equity instrument that is superior to all other classes of equity instruments.

False Page: p504 5. A pre-emptive right means that shareholders have the first right of refusal when additional shares are issued.

True Page: p504 6. Preference shares, like ordinary shares, always have voting rights since they represent an ownership interest in the business.

False Page: p505 7. Some preference shares have a convertibility feature which allows the shares to be exchanged for ordinary shares at some point in the future.

True Page: p505 8. In a liquidation, preference shareholders have priority over creditors and ordinary shareholders.

False Page: p505 9. A preference shareholder receives a stated dividend and can also benefit from any capital appreciation based on increases in share price.

True Page: p505 . .

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10. As part of the registration process, a certain number of authorized shares is specified for a limited liability company and this number cannot subsequently be changed.

False Page: p506 11. Authorized share capital is the amount of share capital that a share-based business can issue to owners, either by sale or grant.

True Page: p506 12. Nominal value is the total amount authorized shares multiplied by the share’s market price.

False Page: p506 13. Nominal value per share is calculated by dividing authorized share capital by the number of shares authorized.

True Page: p507 14. A charter is a document that determines how a share-based business is to be governed.

True Page: p507 15. Issued shares are the number of authorized shares less treasury shares.

False Page: p507 16. The register of members is the list of shareholders at any point in time.

True Page: p507 17. An allotment is the right a board has to sell shares without further approval from the shareholders between general meeting dates.

False Page: p508 18. Shares can only be sold for cash.

False Page: p508 19. The difference between the nominal value of a share and the amount the investor paid to aquire the share is recorded in the share premium account.

True Page: p508

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20. The capitalization of a firm refers to the value of the share-based entity as determined by market price.

True Page: p509 21. An IPO refers to the first time shares are issued to owners.

False Page: p510 22. When a share-based entity’s shares trade in the secondary market after initial public offering.

True Page: p510 23. Shares can be sold to managers and employees of the entity at less than their real market value when a grant is made as part of the employee’s compensation.

True Page: p511 24. A rights issue allows existing shareholders to purchase shares at a discounted price in proportion to their current shareholdings.

True Page: p513 25. When a company makes an investment in own shares, then the shares are removed from the number of shares issued.

False Page: p513 26. An investment in own shares is recorded in a contra account that is shown as a deduction to equity.

True Page: p513 27. The number of outstanding shares is calculated by deducting the number of treasury shares from issued shares.

True Page: p514 28. A dividend is a distribution of profit to owners.

True Page: p516 29. The dividend declaration date is the date the board of directors declares the dividend however the dividend is not recorded until the payment date.

False Page: p517

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30. The dividend date of record is the date the dividend is declared by the board of directors.

False Page: p518 31. A cumulative preference dividend means that all past dividends for both preference and ordinary shares must be paid before a current preference dividend can be paid.

False Page: p518 32. Noncumulative preference shares do not provide for payments of dividend in arrears.

True Page: p520 33. Participating preference shares receive a share of dividend distributions over and above the preference dividend amount.

True Page: p521 34. A scrip issue is a distribution of cash in proportion to current shareholdings.

False Page: p521 35. With a scrip dividend, an amount equal to the fair value of the shares is transferred from retained earnings account to the share capital account.

True Page: p522 36. With a share split, an amount equal to the fair value of the shares is transferred from retained earnings account to the share capital account.

False Page: p522 37. A journal entry must be made for a share split but not for a scrip dividend.

False Page: p522 38. Dividends are not an expense of the business True Page: p524 39. In 2011, Ahmed Chemicals, LLC paid dividends of €300 000 on a total of 1 000 000 ordinary shares. The equity section showed €1 000 000 in the share capital account and €400 000 in the share premium account. The current market price per share is €2. The dividend yield is 15%.

True Page: p524

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40. Earnings per share is calculated by dividing the average ordinary plus preference shares outstanding into profit less preference dividends.

False Page: p527 41. Dilution refers to the effect that conversion of all convertible instruments has on earnings per share.

True Page: p528 42. Slemani Life Water, Ltd. paid total dividends of $40 000 or $0.40 per share in 2010. During 2010, its reported profit was $200 000. The market price of each share was $22. The share capital account showed a balance of $1 000 000 and the share premium account had a balance of $100 000. The price earnings ratio is 11.0.

True Page: p528 43. Book value per share is calculated by dividing the number of ordinary shares outstanding into equity less preference shares amount.

True Page: p530

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Multiple Choice Questions 1. Which of the following statements is not true about ordinary shareholders? a. Ordinary shareholders receive distributions in liquidation before preference shareholders b. Ordinary shareholders receive distributions in liquidation after creditors c. Ordinary shares represent the residual interest in the assets of the business entity d. Ordinary shareholders receive a distribution of profits from the business only if and when the board declares a dividend Page: p504 2. Which of the following elements is not included in equity? a. Retained earnings b. Reserves c. Preference shares d. Bonds Page: p503 3. A convertibility feature is described by which of the following statements? a. Shareholders have the first right of refusal when new shares are issued b. Shareholders have the right to exchange one class of shares for another c. Shareholders have the right to receive a dividend each year d. Shareholders have the option of exchanging their shares for voting rights Page: p505 4. Which of the following will receive the first priority distribution in liquidation? a. Creditors b. Class B ordinary shareholders c. Class A ordinary shareholders d. Preference shareholders Page: p505 5. Which of the following describes the shares that the jurisdiction in which a limited liability company is registered permit to be sold? a. Treasury shares b. Issued shares c. Authorized shares d. Outstanding shares Page: p506 6. Which of the following describes the shares owned by investors? a. Treasury shares b. Issued shares c. Authorized shares d. Outstanding shares Page: p507

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7. Four individuals register a new limited liability company with the appropriate jurisdiction. The jurisdiction authorizes 10 000 000 shares and total share capital of $25 000 000. Each individual receives 100 000 shares paying $200 000 in cash. Another 500 000 shares are sold to family and friends for a total of $1 500 000. What is the nominal value per share? a. $2.56 b. $2.00 c. $2.50 d. $3.00 Page: p507 8. Which of the following describes the shares owned by investors? a. Treasury shares b. Issued shares c. Authorized shares d. Outstanding shares Page: p507 9. Salim Street Sales, Incorporated sells 10 000 preference shares for £72 000 cash. The shares have a nominal value per share of £4. The company’s ordinary shares have a nominal value of £2 each. 50 000 ordinary shares are issued which sold for £3 each. How much is the preference shares premium account? a. £50 000 b. £82 000 c. £140 000 d. £32 000 Page: p508 10. On 1 April 2011, Bano Corporation is selling for €3.50 per ordinary share. The company has 400 000 authorized shares of which 150 000 have been issued. The nominal value of each share is €1.50. What is the capitalization of Bano? a. €1 400 000 b. €600 000 c. €525 000 d. €225 000 Page: p509 11. On 2 December 2010, Yamada Hanako, KK sells shares in an initial public offering. What can be said about this sale? a. The shares were sold through a private placement in the secondary market b. The shares were sold through a bourse in the primary market c. The shares were sold through a bourse in the secondary market d. The shares were sold through a private placement in the primary market Page: p509

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12. Spinner Ltd. owns a patent which is recorded on its statement of financial position for $40 000.

The fair value of the patent is $50 000. Spinner transfers the patent to Lurssen, Incorporated in exchange for 1000 Lurssen’s ordinary shares. The nominal value of each Lurssen share is $4.

What amount of share premium will Lurssen record as the result of this transaction? a. None b. $10 000 c. $40 000 d. $20 000 Page: p511 13. Which of the following describes the difference between issued shares less treasury shares? a. Treasury shares b. Issued shares c. Authorized shares d. Outstanding shares Page: p507 14. Adalheidis SA purchases 112 000 of its own ordinary shares for €42 each. The nominal value of each share is €30. The shares were originally sold in an initial public offering for €55 each. The journal entry to record the acquisition would credit investment in own shares for what amount? a. €336 000 b. €6 160 000 c. €4 704 000 d. None of the above Page: p513 15. Adalheidis SA purchases 112 000 of its own ordinary shares for €42 each. The nominal value of each share is €30. The shares were originally sold in an initial public offering for €55 each. The journal entry to record the acquisition would debit investment in own shares for what amount? a. €336 000 b. €6 160 000 c. €4 704 000 d. None of the above Page: p513 16. A dividend becomes a legal obligation of the entity on what date? a. The date of record b. The declaration date c. The payment date d. It is automatically an obligation once the shares are issued Page: p517

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17. A preference dividend becomes a legal obligation of the entity on what date? a. The date of record b. The declaration date c. The payment date d. It is automatically an obligation once the shares are issued Page: p519 18. Barham Salih Company has 15 000 preference shares outstanding with a nominal value of €20 each. The stated dividend is 5%. In 2009 and 2010 the board did not declare the preference dividend because business was slow. In 2011, the board made €70 000 available for dividends.

How much in dividends did the ordinary shareholders receive? a. €70 000 b. €40 000 c. €25 000 d. €55 000 Page: p520 19. The board of directors for Geyer Computer Training, Inc. declared a 3-for-1 split on 15 June 2010. At that time, the company had 100 000 shares outstanding. Each share had a nominal value of $7 and was trading for $22 per share. The journal entry to record this transaction would debit retained earnings for how much? a. $0 b. $4 400 000 c. $1 400 000 d. $3 000 000 Page: p522 20. The board of directors for Amina Enterprises Ltd. declared a 15% scrip dividend on 1 May 2010.

At that time, the company had 300 000 shares outstanding. Each share had a nominal value of £3 and was trading for £31 per share. The journal entry to record this transaction would debit retained earnings for how much? a. £0 b. £135 000 c. £9 300 000 d. £1 395 000 Page: p522

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Essay Questions 1. Compare and contrast ordinary and preference shares.

Answer An ordinary share is “an equity instrument that is subordinate to all other classes of equity instruments.” It represents the ownership interest of the last resort, meaning that both creditors and preference shareholders must be satisfied before distributions to ordinary shareholders.

Preference shares have priority over ordinary shares in liquidation. Preference shares also have a stated dividend though this is not a legal obligation of the business entity until the board of directors declares the dividend.

2. What is the difference between a private placement and a public sale of shares? What is the difference between the primary and secondary markets?

Answer A private placement refers to the sale of shares to individuals and institutions without the involvement of a stock market or bourse. A public sale occurs on the stock market or bourse. If the public sale is the first time the shares appear on the bourse, then we say that the sale was into the primary market. Afterwards, the shares trade in the secondary market.

3. What is an allotment?

Answer An allotment is the process by which the board grants a right to receive shares often subject to the vote of the membership.

4. Briefly describe the process a board of directors undertakes to pay a dividend to shareholders.

Answer Usually upon the recommendation of financial professionals, the board will formally declare the dividend which then becomes a legal obligation of the business. This is the declaration date. At that time, the board designates a date of record. On this date, the shareholders of record – those who appear on the shareholder register are eligible for the dividend payment. The board also designates a payment date which is the date the dividend is actually paid.

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Chapter 10 Equity Changes Test Bank True/False Questions 1. Any change to contributed capital appears on the statement of comprehensive income and is included in contributed capital on the statement of financial position.

False Page: p546 2. Payment of dividends appears on the statement of changes in equity or the notes, and is deducted from retained earnings on the statement of financial position.

True Page: p546 3. An investment in own shares is reported on the statement of comprehensive income, the statement of changes in equity and is reported as part of a contra account in equity on the statement of financial position.

False Page: p546 4. Profit or loss are reported in the statement of comprehensive income, statement of changes in equity and is included in retained earnings on the statement of financial position.

True Page: p546 5. Three major types of transactions affect contributed capital: 1) the payment of cash dividends, 2) the repurchase of own shares and 3) the issuance of ordinary or preference shares.

False Page: p546 6. Two types of transactions increase or decrease retained earnings: 1) dividends and 2) profit or loss.

True Page: p547 7. A revaluation of property, plant and equipment or intangible costs would affect reserves in the equity section of the statement of financial position.

True Page: p547 8. The distribution of a scrip dividend would affect reserves in the equity section of the statement of financial position.

False Page: p547

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9. When cash is used to reacquire shares of the business, an expense would result on the statement of comprehensive income.

False Page: p548 10. Reporting entity’s have the option of reporting profit or loss and other comprehensive income on two separate statements.

True Page: p549 11. Expenses on the statement of comprehensive income can be reported either by nature or function.

True Page: p550 12. Examples of expense categories reported by function include depreciation, materials purchases and employee benefits.

False Page: p550 13. Revenue is measured by the fair value of the consideration given in the transaction.

False Page: p554 14. The following is one of the criteria to determine whether revenue for goods should be recognized: The business no longer has control over the goods sold.

True Page: p555 15. The following is one of the criteria to determine whether revenue for goods should be recognized: The cash has been received by the business even if the journal entry has not been made to record the cash receipt.

False Page: p555 16. FOB destination means that the buyer assumes ownership and thus responsibility when the carrier delivers the goods to the buyer.

True Page: p555 17. Revenue for services should be recognized based on how complete the services are.

True Page: p556

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18. To recognize service revenue, the amount of costs, associated costs, stage of completion and exact completion date must be known.

False Page: p556 19. Revenue from interest, royalties and dividends is generally recognized when the cash is received.

False Page: p558 20. A value added tax (VAT) is assessed on the value added to goods and services at each stage of production.

True Page: p559 21. A sales tax is levied on the total value of the goods or services at the point of sale.

True Page: p559 22. A gain or loss is always recognized as part of other comprehensive income.

False Page: p564 23. A gain or loss which does not qualify as revenue or expenses, respectively, in the ordinary course of business can sometimes still be recognized as part of profit or loss.

True Page: p564 24. A gain or loss recognized as other comprehensive income would be included in profit or loss on the statement of comprehensive income.

False Page: p564 25. If equipment is impaired during the current period and in a previous period had been revalued upwards, the revaluation reserve would first be decreased up to its balance, and the remainder of the impairment loss would be recognized in profit or loss.

True Page: p566 26. The gross profit and profit margin ratios are both solvency ratios.

False Page: p570 27. Baxtier Incorporated reported €150 000 in revenue for the year. Gross profit was €70 000 and net profit was €20 000. The profit margin ratio is 13%.

True Page: p570 . .

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28. Marzya Ltd reported $44 000 in revenue for the year with a gross profit of $30 000 and a net profit was $25000. The gross profit ratio is 43%.

False Page: p570 29. Return on investments is calculated by dividing profit + interest expense (1 – tax rate) by average total assets.

False Page: p571

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Multiple Choice Questions 1. Which of the following is true about reporting profit or loss in the financial statements? a. Profit and loss is reported only on the statement of changes in equity b. Profit and loss is included in retained earnings on the statement of financial position c. Profit and loss is reported on the statement of comprehensive income d. All of the above are true Page: p546 2. Which of the following is not true about reporting an investment in own shares? a. The gain or loss on an investment in own shares is reported on the statement of comprehensive income in the period in which the shares are reacquired b. Investment in own shares is reported as a contra account in equity c. Investment in own shares is reported in the statement of changes in equity d. Investment in own shares is reported on the statement of financial position Page: p546 3. Which of the following is not true about reporting a change to contributed capital? a. A change to contributed capital is reported in the statement of changes in equity b. A change to contributed capital is not reported in the statement of comprehensive income c. A change to contributed capital is included in contributed capital in equity d. A change to contributed capital is reported as a contra account in the statement of financial position Page: p546 4. Which of the following major transactions types do not affect contributed capital? a. A scrip dividend b. Issuance of ordinary or preference shares c. A change in share price d. Repurchase of own shares Page: p546 5. Which of the following would not affect retained earnings? a. Profit as reported in the statement of comprehensive income b. Cash dividends c. A change in a revaluation reserve d. Loss as reported in the statement of comprehensive income Page: p547 6. Which of the following is not a transaction identified in IFRS that affects reserves? a. Gains and losses on the sale of plant and equipment and intangible assets b. Gains and losses related to the transaction of foreign currencies c. Gains and losses related to available-for-sale financial assets d. Gains and losses related to certain types of employee benefits Page: p547

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7. Which of the following is not one of the criteria for recognizing revenue for goods? a. When the business no longer has control over the good sold b. When the business hands the goods over to the carrier c. When it is probable that the economic benefits of the sale will flow to the business d. When the amount of revenues and the costs associated with that revenue can be reliably measured Page: p555 8. Which is not true regarding the recognition of revenue related to services? a. Revenue is recognized when the service is substantially complete b. The economic benefits from the service revenue transaction must flow to the business entity c. Associated costs must be able to be reliably measured d. Stage of completion must be able to be reliability measured Page: p556 9. Which of the following is not a reason for recognizing an expense? a. When expenditure produces no future economic benefit that would qualify as recognition of an asset on the statement of financial position b. Asset costs are systematically allocated such as depreciation of property, plant and equipment and amortization of intangible costs c. When a liability is incurred with the recognition of an asset d. Costs are matched to revenue on the basis of a direct association between the cost incurred and the earning of specific revenue Page: p562 10. Lawchak, Inc. reported $414 000 in profit for 2011 with a profit margin ratio of 20%. Cost of goods sold was $600 100. What was the gross margin ratio? a. 71% b. 80% c. 29% d. The answer cannot be determined from information provided Page: p570 11. Van Houton Corporation has a gross profit ratio of 24%. Cost of goods sold was ¥700 000 000.

The tax rate was 32%. What is the profit or loss than Van Houten reported in the same period? a. ¥168 000 000 b. ¥476 000 000 c. ¥323 680 000 d. The answer cannot be determined from the information provided Page: p570

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Essay Questions 1. List the criteria to determine if revenue for the sale of goods has been earned.

Answer 1) When ownership is transferred to the buyer 2) When the business no longer has control over the goods sold 3) When the amount of revenue and the costs associated with that revenue can be reliably measured 4) When it is probable that the economic benefits of the sale will flow to the business 2. List and describe the two basic methods of shipping goods.

Answer 1) FOB Shipping Point means that the buyer assumes responsibility for the goods when the seller turns them over to the carrier (the shipping company).

2) FOB Destination means the buyer assumes ownership and thus responsibility when the carrier delivers the goods.

3. Discuss the criteria for recognizing service revenues.

Answer Service revenue is recognized based on the stage of completion at the reporting date. However, several conditions must be met: 1) The amount of revenue, associated costs and stage of completion can be reliably measured 2) The economic benefits from the service revenue transaction will probably flow to the business entity.

4. When should revenue from interest, royalties and dividends be recognized?

Answer Recognition is generally based on when the business is entitled to the economic benefits and when they can be reliably measured.

5. Discuss the difference between a value added tax and a sales tax.

Answer A value added tax is added to the goods and services at each step of the production and sales process. A sales tax is levied on the total value of the exchange when the goods and services are sold to the final customer.

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6. List and explain the four reasons that expenses are recognized.

Answer Expenses are recognized for one of four reasons: 1) Costs are matched to revenue on the basis of a direct association between the cost incurred and the earning of specific revenue.

2) The systematic allocation of asset costs such as depreciation of property, plant and equipment and amortization of intangible assets.

3) When expenditure produces no future economic benefit that would qualify as recognition of an asset on the statement of financial position. For example, research expenditures are not capitalized but are expensed in the current period.

4) When a liability is incurred without the recognition of an asset. For example, employees have rendered services for which the business has not paid.

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Chapter 11 Cash Flows

True/False Questions 1. The four phases of the business life cycle in order are: 1) start-up, 2) expansion, 3) growth and 4) maturity.

False Pages: p591 2. Operating activities are likely to be a source of cash in maturity phase businesses.

True Pages: p592 3. During the start-up phase, operating activities and financing activities are likely to be a use of cash while investing activities are likely to be a source of cash.

False Pages: p592 4. IFRS defines cash flows as both cash and cash equivalents.

True Pages: p593 5. In order to meet the IFRS definition of cash equivalent, the investment cannot be subject to a significant amount of risk of changes in value.

True Pages: p593 6. IFRS requires that movements between cash and cash equivalents be included in the statement of cash flows.

False Pages: p594 7. Bank overdrafts are typically included as a normal cash management activity and are therefore are not reported in the statement of cash flows.

True Pages: p595 8. Under IFRS, the appropriate treatment when a customer owes money to the business and at the same time the business owes money to the customer is to offset the two amounts.

False Pages: p592

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9. Cash sources and uses for investing activities are the result in the size and composition of the contributed equity and borrowings of the entity.

False Pages: p592 10. Cash payments to acquire property, plant and equipment, intangible and other assets are a use of cash related to investing activities.

True Pages: p597 11. Cash repayments of amounts borrowed are a use of cash related to investing activities.

False Pages: p597 12. Cash inflows from the disposal of subsidiaries and other businesses are a source of cash from financing activities.

False Pages: p597 13. Cash proceeds from the sale of the business’s shares are a source of cash from financing activities.

True Pages: p597 14. Cash payments to acquire the business’s own shares are a use of cash for operating activities.

False Pages: p597 15. The acquisition of assets by assuming a related liability would be reported as a use of cash for investing activities.

False Pages: p597 16. The conversion of debt to equity would not be reported as a source or use of cash in the statement of cash flows.

True Pages: p598 17. The acquisition of another company by issuing shares in the business would not be reported as a source or use of cash in the statement of cash flows.

True Pages: p598 18. The two methods of reporting cash flows from operating activities are the direct method and indirect method.

True Pages: p600 . .

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19. The International Accounting Standards Board encourages the use of the indirect method of reporting cash flows.

False Pages: p600 20. The only difference between the reporting of cash flows under the direct method and the indirect method is in the operating activities section.

True Pages: p600 21. The amount of the net change in cash during the period may be different when cash flows are calculated using the direct method versus the indirect method.

False Pages: p600 22. An increase in inventories during the period would be a use of cash.

True Pages: p603 23. A decrease in trade accounts receivable during the period would be a use of cash.

False Pages: p603 24. A decrease in trade accounts payable during the period would be a use of cash.

True Pages: p603 25. A gain on the sale of equipment reported during the period would be added to profit in order to calculate cash flows related to operating activities under the indirect method.

False Pages: p604 26. A loss on the sale of equipment reported during the period would be added to profit in order to calculate cash flows related to operating activities under the indirect method.

True Pages: p604 27. The current cash debt coverage ratio is calculated by dividing average total liabilities into cash from operating activities.

False Pages: p613 28. The cash debt coverage ratio is calculated by dividing average total liabilities into cash from operating activities.

True Pages: p614 . .

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29. Free cash flow is calculating by subtracting capital expenditures and cash dividends from cash provided by operating activities.

True Pages: p615 30. Operating cash flow per share is calculated by dividing cash from operating activities by ordinary shares plus preference shares outstanding.

False Pages: p615

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Multiple Choice Questions 1. Which of the following is unlikely to be true about cash flow patterns during the business life cycle? a. During the start-up phase, investing activities will be a use of cash b. During the growth phase, financing activities will be a source of cash c. During the start-up phase, operating activities are likely to be a source of cash d. During the maturity phase, operating activities are likely to be a source of cash Pages: p592 2. Which of the following regarding cash flows is not true? a. movements between categories within current assets are excluded from the statement of cash flows b. Cash inflows and cash outflows are not generally offset against one another c. Some financing activities do not require the use of cash or cash equivalents and are therefore excluded from sources and uses reported on the face of the statement of cash flows d. Some investing activities do not require the use of cash or cash equivalents and are therefore excluded from sources and uses reported on the face of the statement of cash flows Pages: p594 3. Which of the following would be a cash flow related to investing activities? a. cash payment require to acquire the business’s own shares b. cash proceeds from short-term and long-term borrowings c. cash outflows for acquisition of subsidiaries and other businesses d. cash proceeds from the sale of the business’s shares Pages: p596 4. Which of the following would be added to profit or loss when calculating cash flows from operating activities under the indirect method? a. an increase in trade accounts receivable b. a decrease in inventories c. a decrease in trade accounts payable d. a decrease in taxes payable Pages: p603 5. Which of the following is incorrect with respect to calculating cash flows under the direct method? a. An increase in trade accounts receivable is deducted from sales b. An increase in trade accounts payable is deducted from cost of sales and selling and administrative expenses c. An increase in inventories would be deducted from cost of sales and selling and administrative expenses d. A decrease in trade accounts receivable is added to cost of sales and selling and administrative expenses Pages: p609 . .

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Use the following information from Teng Companies, Ltd to for items 6-8 below. ¥ 000 Cash from operating activities Cash used by investing activities Average current liabilities Average total liabilities Number of shares outstanding Capital expenditures Cash dividends

150 300 000 75 100 000 85 500 000 340 000 000 200 000 000 90 000 000 25 000 000

6. What is Teng’s current cash debt coverage ratio? a. 1.67 b. 0.44 c. 6.01 d. 1.76 Pages: p613 7. What is Teng’s cash debt coverage ratio? a. 1.67 b. 0.44 c. 6.01 d. 1.76 Pages: p614 8. What is Teng’s operating cash flow per share? a. ¥0.38 b. ¥0.75 c. ¥0.58 d. ¥0.45 Pages: p615

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Essay Questions 1. List and briefly describe the four stages of the business life cycle.

Answer The business life cycle has four phases: 1) start-up, 2) growth, 3) expansion and 4) maturity.

In the start-up phase or entrepreneurial phase, a business is just beginning operations. Costs typically exceed sales revenue.

In the growth phase, the business is beginning to produce and market the product or service.

The expansion phase is the turning point for cash flows. At this phase, businesses have usually established a presence in the market place and sometimes have a positive cash flow from operating activities.

In the maturity phase, the business has reached the point where its infrastructure – property, plant and equipment and other assets – is fully developed.

2. Describe the difference between cash and cash equivalents.

Answer Cash comprises cash on hand and demand deposits. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.

3. List and briefly describe the three sources and uses of cash as reported in the statement of cash flows.

Answer Operating activities are “the principal revenue-producing activities of the entity and other activities that are not investing or financing activities.

Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.

4. What reporting does IFRS require when a transaction does not involve an exchange of cash?

Answer The transaction would not be included in the statement of cash flows. However, IFRS does require that it be disclosed somewhere in the financial statements (for example, the notes) in a way that provides all relevant information about the investing and financing activities to users.

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5. What two methods of calculating cash flows are permitted by IFRS? Briefly describe how each is calculated. Which method does the IASB recommend? Which method is more commonly used in practice?

Answer Entities can report either by the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed, or by the indirect method, whereby profit or loss is adjusted for the effects of transaction of a noncash nature, any deferrals or accruals of past or future operating cash receipts and payments, and items of income or expense associated with investing or financing cash flows.

The IASB recommends the direct method though the indirect method is used more commonly in practice.

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Chapter 12 Comparability and Consistency Test Bank True/False Questions 1. With the base-period approach to horizontal analysis, each period’s amounts are divided by the amounts for the first period.

True Page: p641 2. With a period-to-period approach to horizontal analysis, each period’s amount are divided by the amounts for the first period.

False Page: p642 3. Given the following sequence of numbers, the percentage for 2009 sales revenue under the base-period approach to horizontal analysis would be 119%.

Sales revenue

2009 ¥152 333 000 000

2008 ¥128 495 000 000

2007 ¥110 875 000 000

False Page: p654 4. Given the following sequence of numbers, the percentage for 2009 sales revenue under the period-to-period approach to horizontal analysis would be 119%.

Sales revenue

2009 ¥152 333 000 000

2008 ¥128 495 000 000

2007 ¥110 875 000 000

True Page: p654 5. With vertical analysis, amounts on the statement of income are divided by sales revenue for the same period.

True Page: p651

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6. With vertical analysis, amounts on the statement of financial position are divided by total equity for the same period.

False Page: p663 7. Working capital is calculated by subtracting current liabilities from total assets.

False Page: p666 8. When comparing two or more companies, working capital provides a better measure of liquidity than current ratio because one can easily see which company has the largest amount of working capital.

False Page: p667 9. The current ratio is calculated by dividing current liabilities into current assets.

True Page: p667 10. The acid-test ratio is calculated by dividing current liabilities into cash and cash equivalents plus trade receivables.

False Page: p667 11. The cash ratio is calculated by dividing cash and cash equivalents plus marketable securities by current liabilities.

True Page: p668 12. The receivable turnover ratio is calculated by dividing average receivables by net sales.

False Page: p668 13. The current cash debt coverage ratio is calculated by dividing cash from operating activities by average total liabilities.

False Page: p669

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14. The debt ratio is calculated by dividing total liabilities by total assets.

True Page: p670 15. The debt to equity ratio is calculated by dividing current liabilities by noncurrent liabilities plus equity.

False Page: p679 16. The times interest earned ratio is calculated by dividing interest expense into profit plus interest expense plus tax expense.

True Page: p671 17. The cash debt coverage ratio is calculated by dividing average current liabilities into cash from operating activities.

False Page: p671 18. Free cash flow is calculated by subtracting capital expenditures and cash dividends from cash provided from operating activities.

True Page: p672 19. Return on assets is calculated by dividing average total assets by profit.

False Page: p673 20. Return on investment is calculated by dividing profit plus after tax interest by average noncurrent liabilities plus equity.

True Page: p673 21. The profit margin ratio is calculated by dividing profit by net sales.

True Page: p673

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Multiple Choice Questions 1. Horizontal analysis of the statement of comprehensive income using the base period approach is described by which of the following? Assume that 2009 is the base year. a. 2011 cost of goods sold is divided by 2009 cost of goods sold b. 2011 cost of goods sold is divided by 2010 cost of goods sold c. 2011 cost of goods sold is divided by 2011 revenue d. 2011 cost of goods sold is divided by 2009 revenue Page: p641 2. Horizontal analysis of the statement of comprehensive income using the period-to-period approach is described by which of the following? Assume that 2009 is the base year. a. 2011 cost of goods sold is divided by 2009 cost of goods sold b. 2011 cost of goods sold is divided by 2010 cost of goods sold c. 2011 cost of goods sold is divided by 2011 revenue d. 2011 cost of goods sold is divided by 2009 revenue Page: p642 3. Horizontal analysis of the statement of financial position using the base period approach is described by which of the following? Assume that 2010 is the base year. a. 2012 cash and cash equivalents are divided by 2010 total assets b. 2012 cash and cash equivalents are divided by 2012 total assets c. 2012 cash and cash equivalents are divided by 2010 cash and cash equivalents d. 2012 cash and cash equivalents are divided by 2011 cash and cash equivalents Page: p654 4. Horizontal analysis of the statement of financial position using the period-to-period approach is described by which of the following? Assume that 2010 is the base year. a. 2012 cash and cash equivalents are divided by 2010 total assets b. 2012 cash and cash equivalents are divided by 2012 total assets c. 2012 cash and cash equivalents are divided by 2010 cash and cash equivalents d. 2012 cash and cash equivalents are divided by 2011 cash and cash equivalents Page: p654 5. Vertical analysis of the statement of financial position is described by which of the following?

Assume that 2010 is the base year. a. 2012 cash and cash equivalents are divided by 2010 total assets b. 2012 cash and cash equivalents are divided by 2012 total assets c. 2012 cash and cash equivalents are divided by 2010 cash and cash equivalents d. 2012 cash and cash equivalents are divided by 2011 cash and cash equivalents Page: p663 . .

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6. The availability of cash in the near future short-term financial commitments is which of the following? a. Solvency b. Profitability c. Equitability d. Liquidity Page: p666 7. Company A reports working capital of £3 400 000 for fiscal 2011. Company B reports working capital of £239 900 000 for the same period. Company A’s current ratio is 1.57. Company B’s current ratio is .89. Which company has greater liquidity? a. Company A because it has a higher current ratio b. Company B because it has a higher amount of working capital c. Company B because the amount of working capital is higher even though its current ratio is lower d. Not enough information is available to answer this question Page: p666 8. Company X has a current ratio of 1.4 for fiscal 2010 and an acid-test ratio of .94. Company Y has a current ratio of 1.3 with an acid-test ratio of .98. In the strictest sense, which company has greater liquidity? a. Company X because it has a higher current ratio b. Company Y because it has a higher acid-test ratio c. Company X because the difference between the two current ratios (0.1) is larger than the difference between the two acid-test ratios (0.04). d. Not enough information is available to answer this question Page: p667 9. Which of the following ratios is the most stringent measure of liquidity? a. Acid-test ratio b. Current cash debt coverage ratio c. Cash ratio d. Current ratio Page: p668 10. Which of the following is not a measure of solvency? a. Cash debt coverage ratio b. Receivable turnover ratio c. Times interest earned ratio d. Debt-to-equity ratio Page: p670 . .

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11. Which of the following is not a measure of liquidity? a. Free cash flow b. Acid-test ratio c. Working capital d. Average collection period Page: p666 12. Which of the following measures the excess amount of cash over the amount reinvested in the business and compensation to owners for the use of their capital? a. Return on assets b. Return on investments c. Current ratio d. Free cash flow Page: p672 13. Which of the following is not a measure of profitability? a. Return on assets b. Times interest earned c. Profit margin ratio d. Return on investments Page: p672 14. Which of the following are all measures of profitability? a. Profit margin ratio, free cash flow and working capital b. Profit margin ratio, return on assets and return on investment c. Times interest earned, return on assets and return on investments d. Return on assets, return on investments and free cash flow Page: p672 15. Which of the following are all measures of liquidity? a. Profit margin ratio, free cash flow and working capital b. Current ratio, return on assets and working capital c. Cash ratio, receivables turnover ratio and cash debt coverage ratio d. Cash ratio, receivables turnover ratio and current cash debt coverage ratio Page: p672

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16. Which of the following are all measures of solvency? a. Profit margin ratio, free cash flow and working capital b. Current ratio, return on assets and working capital c. Debt-to-equity ratio, free cash flow and times interest earned ratio d. Cash ratio, receivables turnover ratio and current cash debt coverage ratio Page: p672

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Essay Questions 1. Briefly describe what is meant by the term “investment professionals”.

Answer Investment professionals – financial analysts and advisors -- exists to follow the financial results of major companies, evaluate their performance and offer opinions and advice about whether to invest in the companies’ debt and equity securities. Or for those investors who already hold securities of the company, whether to dispose of their investments. In many cases, investment professionals specialize in a particular industry, type of security (equity, bonds or corporate notes) or region.

2. Briefly describe what is mean by the term “institutional investor.”

Answer Institutional investors are organizations that pool significant sums of money and then invest in securities. Organizations responsible for investing retirement funds are institutional investors.

Many of these funds, sometimes referred to as mutual funds, are also publicly-traded. Insurance companies also qualify as institutional investors since they manage large amounts of money accumulated by the payment of insurance premiums.

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Chapter 13 Assurance Systems True/False Questions 1. Management decision-making is one of the five assurance systems.

False Page: p703 2. Boards of directors generally have three responsibilities: 1) shaping the business’s strategy, 2) monitoring management and 3) ensuring accountability.

True Page: p704 3. A fiduciary represents the principals or owners of the business.

True Page: p704 4. All boards are two-tier with one board representing shareholders and employees and the second focusing on management concerns.

False Page: p706 5. Boards typically have four committees: 1) stockholder rights committee, 2) audit committee, 3) remuneration committee, and 4) risk management committee.

False Page: p711 6. Key duties of the audit committee include monitoring the company’s financial statements and auditing the amount of compensation received by executives.

False Page: p712 7. The nominations committee identifies candidates to serve on the board and advises the board about directors who may need to be removed.

True Page: p713 8. The remunerations committee concerns itself with compensation for the board and top management.

True Page: p713 9. If the board of directors has no autonomous risk committee, risk management duties are often assigned to the remuneration committee.

False Page: p713 . .

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10. The audit committee usually focuses on financial risk while the risk management committee is broader to include nonfinancial considerations.

True Page: p714 11. Risks can be financial, operational or political.

True Page: p716 12. Risk refers to the level of tolerance for mistakes within an entity.

False Page: p718 13. Risk means that there is reasonable assurance that the business’s risk is being managed effectively, and that the business’s goals and objectives are achieved efficiently and effectively.

True Page: p718 14. Internal control refers to the actions that have been taken to reduce the likelihood of adverse risk.

False Page: p720 15. The principles of internal control include assignment of responsibility, effective risk management, segregation of duties, documentation, and physical controls.

False Page: p720 16. If an employee were responsible for both ordering supplies and paying invoices, then duties have not been segregated appropriately.

True Page: p721 17. Documentation serves two major purposes: 1) to document the business’s policies and procedures and 2) to provide evidence of transactions’ validity.

True Page: p721 18. An example of independent verification is when an employee in one department prepares a document that is then reviewed and approved by an employee in another department.

True Page: p722 19. The Enterprise Risk Management – Integrated Framework was created in the Turnbull Guidance.

False Page: p722 . .

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20. Embedded risk management is one of the eight interrelated components for describing and analyzing internal control system which are part of the Enterprise Risk Management Integrated Framework.

False Page: p723 21. Monitoring, risk response, objective setting and event identification are all included in the eight interrelated components for describing and analyzing internal control system which are part of the Enterprise Risk Management Integrated Framework.

True Page: p723 22. A sound system of internal control therefore provides absolute, not just reasonable, assurance that a company will not be hindered in achieving its business objectives.

False Page: p724 23. Limitations of internal control include: cost versus benefit, errors in judgment, management interference, employee collusion and malfunctions.

True Page: p728 24. Management interference refers to situations when managers work together to circumvent the system in order to commit fraud or other irregularities.

False Page: p728 25. Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations.

True Page: p729 26. Internal audit activities are organized as engagements which may include an internal audit, fraud examination or consultancy.

True Page: p729 27. Independent audits are conducted by qualified individuals in the business’s internal audit function.

False Page: p731

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28. An independent auditor’s qualifications typically include having attained a certain level of education, passing a qualifying paper or examination and being employed for a specified period by the company being audited.

False Page: p732 29. An independent audit engagement consists of four phases: 1) planning the audit, 2) evaluating the system of internal control, 3) performing substantive tests, and 4) preparing the audit report and presenting it to the client.

True Page: p735 30. An independent audit that results in an unqualified opinion provides reasonable assurance that no material misstatement of financial results has occurred.

True Page: p736 31. A qualified opinion is given when the independent auditor concludes that the financial statements do not present a true and fair view.

False Page: p736 32. An unqualified opinion is given when the independent auditor concludes that the financial statements provide a true and fair view of financial results in all material respects.

True Page: p736 33. Fraud is a false representation intentionally made in order to gain a material advantage.

True Page: p740 34. A perpetrator is the party injured in a fraud.

False Page: p740 35. Three conditions are usually present when a fraud is committed: 1) the perpetrator is under some pressure or has some incentive to commit fraud, 2) the opportunity must be present and 3) the individual is able to rationalize the fraud.

True Page: p740 36. Auditors are concerned with two types of misstatements in the financial statements: 1) fraudulent financial reporting and 2) misappropriation of assets.

True Page: p741

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37. In recent years, efforts to prevent fraud have been in three areas: 1) creating and maintaining a culture of honesty and high ethics, 2) prosecuting perpetrators in judicial courts, and 3) developing an appropriate oversight process.

False Page: p741

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Multiple Choice Questions 1. Which of the following is not one of the five assurance systems? a. Effective management decision-making b. Internal control c. Independent audit d. Internal audit Page: p703 2. Corporate governance does not include which of the following items? a. Policies and procedures to determine how the entity is directed, administered and controlled b. Organizational culture c. Oversight by the board of directors d. A systematic and disciplined approach to evaluating and reviewing the effectiveness of risk management Page: p703 3. Internal control does not include which of the systems of policies and procedures? a. To facilitate efficient and effective operations b. To monitor compliance with the law c. To express an opinion on the financial statements d. To safeguard assets Page: p703 4. Which of the following is not generally a responsibility of the board of directors? a. Making operational decisions b. Monitoring management c. Shaping the strategy of the business d. Ensuring accountability Page: p704 5. Advantages of nonexecutive directors include all except which of the following items? a. Their independence from management b. Their willingness to vice dissenting opinions c. Their extensive experience in the business’s management d. They often bring skills that otherwise would be absent from the board Page: p705

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6. Which of the following is not a main principle of the Combined Code on Corporate Governance? a. Appointments to the board should be in secret so as to avoid selection bias b. Boards should include a balance of executive and nonexecutive directors c. There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business d. The board should be supplied in a timely manner with information in a form and of a quality appropriate to enable it to discharge its duties Page: p706 7. A board typically has all except which of the following committees? a. Investor relations committee b. Nominations committee c. Remuneration committee d. Risk management committee Page: p711 8. The committee responsible for identifying candidates to serve on the board and advising the board about directors who may need to be removed is which of the following? a. Audit committee b. Nominations committee c. Remuneration committee d. Risk management committee Page: p713 9. The committee that concerns itself with compensation for the board and top management is which of the following? a. Audit committee b. Nominations committee c. Remuneration committee d. Risk management committee Page: p713 10. The committee which oversees financial reporting and the external and internal auditors is which of the following? a. Audit committee b. Nominations committee c. Remuneration committee d. Risk management committee Page: p711 11. The risk management committee’s responsibilities could include which of the following? a. Identifying emerging risks and providing early warning on significant new risks to the full board b. Recommending to the full board any changes in risk management strategy and policy c. Reviewing internal control and internal audit function effectiveness in relation to the entity’s risk profile . .

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d. Providing leadership in risk management and monitoring Page: p714 12. Which of the following terms describes the possibility of an event that will have an impact on the achievement of objectives? a. Adequate control over risks b. Residual risk c. Risk d. Risk tolerance Page: p716 13. Which of the following terms means that there is reasonable assurance that the business’s risk is managed effectively? a. Adequate control over risk b. Residual risk c. Risk tolerance d. Risk appetite Page: p718 14. Which of the following terms refers to any risk that remains once actions have been taken to reduce the likelihood of an adverse event? a. Adequate control over risk b. Residual risk c. Risk tolerance d. Risk appetite Page: p718 15. Which of the following terms refers to a broader statement about the level of tolerance for risk within an entity? a. Adequate control over risk b. Residual risk c. Risk tolerance d. Risk appetite Page: p718 16. Which of the following is not a principle of internal control? a. Physical controls b. Assignment of responsibility c. Risk management d. Documentation Page: p720

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17. Which internal control principle requires that the responsibility for executing a transaction be assigned to an individual other than the person who will have physical custody of the asset? a. Documentation b. Independent verification c. Assignment of responsibility d. Segregation of duties Page: p721 18. Which internal control principle requires that accountability for responsibilities be assigned to specific individuals? a. Documentation b. Independent verification c. Assignment of responsibility d. Segregation of duties Page: p720 19. Which internal control principle requires that information processed by one employee be reviewed by an employee to ensure its accuracy? a. Documentation b. Independent verification c. Assignment of responsibility d. Segregation of duties Page: p720 20. Which of the following is not one of the eight components in the COSO Enterprise Risk Management – Integrated Framework for describing and analyzing internal control systems? a. Risk assessment b. Risk management c. Risk response d. Event identification Page: p723 21. Which of the following is not a limitation of internal control? a. Errors in judgment b. Employee collusion c. Management interference d. Management cooperation Page: p728 22. Which of the following is not an example of an internal audit engagement? a. Consulting with business units on adding value and improving governance, risk management and control processes b. Management of the business during crises created by periods of high management turnover c. Internal audit d. Fraud examination Page: p729 . .

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23. Independent auditors are typically required to have all of the following except which qualification or credential? a. Papers or examinations b. Experience in internal auditing c. Education d. Evidence of social and ethical responsibility Page: p732 24. Audit engagements include all of the following except which major phase? a. Evaluating the system of internal controls b. Planning the audit c. Performing substantive tests d. Surveying employee opinion Page: p735 25. Which of the following audit opinions is given when the client’s financial statements provide a true and fair view in all material respects? a. Adverse opinion b. Disclaimer of opinion c. Unqualified opinion d. Qualified opinion Page: p736 26. Which of the following audit opinions is given when the financial statements provide a true and fair view of the financial results of the business ‘except for’ one or more qualifications? a. Adverse opinion b. Disclaimer of opinion c. Unqualified opinion d. Qualified opinion Page: p736 27. Which of the following audit opinions is given when the auditor concludes that the financial statements do not present a true and fair view? a. Adverse opinion b. Disclaimer of opinion c. Unqualified opinion d. Qualified opinion Page: p736 28. Which of the following is appropriate when the auditor is unable to provide an opinion because the audit engagement could not be completed? a. Adverse opinion b. Disclaimer of opinion c. Unqualified opinion d. Qualified opinion Page: p736

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29. Which of the following is not true of fraud? a. Fraud includes errors that cause one party to have a material advantage at the expense of another b. Frauds include a false representation c. Frauds are intentional d. Frauds involve a perpetrator Page: p740 30. Which of the following items is not a category of fraud prevention measures? a. Developing an appropriate oversight process b. Creating and maintaining a culture of honesty and high ethics c. Evaluating the risk of fraud and evaluating the processes, procedures and controls needed to mitigate risk and reduce the opportunities for fraud d. Increasing public awareness of the need for improvements in law enforcement against perpetrators of fraud Page: p741

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Essay Questions 1. List and describe the five assurance systems.

Answer 1. Corporate governance includes the organization culture, policies and procedures that determine how the entity is directed, administered and controlled, as overseen by the business’s board of directors.

2. Risk management refers to processes that identify, assess, manage, and control potential events or situations, to provide reasonable assurance regarding the achievement of the organization’s objectives. In other words, risk management focuses on events and situations which threaten the ability of the business to achieve its objectives.

3. Internal control is the system of policies and procedures within the business that 1) facilitates efficient and effective operations that allow a company to respond to significant risks, 2) safeguards assets, 3) ensures the quality of internal and external reporting, and 4) monitors compliance with laws, regulations and internal business policies.

4. An Internal audit uses a systematic and disciplined approach to evaluate and review the effectiveness of risk management, the internal control system and corporate governance processes.

5. An independent audit is performed by external accounting and auditing specialists who perform tests and other procedures on the business to enable them to express an opinion about whether the financial statements of the business have been prepared, in all material respects, in accordance with applicable accounting standards.

2. What are the three primary responsibilities of boards of directors?

Answer Boards generally have three responsibilities: 1. Shaping the strategy of the business 2. Monitoring management 3. Ensuring accountability.

3. What is the difference between inside and nonexecutive directors? Why are nonexecutive directors thought to add strength to boards of directors?

Answer An inside director also holds a position as an executive or manager within the business. A nonexecutive director serving on the board is not part of the executive or management team. Nonexecutive directors add strength to the business’s corporate governance because of their independence from management and their willingness to voice dissenting opinions about . .

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management actions. They also have skills that may otherwise be absent from the board which they can bring to bear on the oversight of the company.

4. Describe the differences between unitary and multi-level boards.

Answer A unitary board has both non-executive directors and executive directors serving on a single board that discharges all board obligations. A multi-level board has more than one board. One board may represent the interests of shareholders and employees. The second may be composed only of executive directors and focus on management concerns.

5. List the typical committees that boards have and briefly describe the responsibilities of each.

Answer 1. The audit committee which is usually comprised of non-executive directors oversees financial reporting, and the external and internal auditors. This usually includes recommending the appointment or removal of an independent auditor. The audit committee may also review non-audit work performed by the independent auditors.

2. The nominations committee identifies candidates to serve on the board and advises the board about directors who may need to be removed. The nominations committee may also conduct performance evaluations of board members.

3. The remuneration committee concerns itself with compensation for the board and top management.

4. The risk management committee which is responsible for identifying, assessing and controlling risk.

6. Describe the policies and procedures that comprise a system of internal control.

Answer A system of internal control is comprised of the policies and procedures within the business that: 1. facilitate efficient and effective operations that allow a company to respond to significant risks 2. safeguard assets 3. ensure the quality of internal and external reporting 4. monitor compliance with laws, regulations and internal business policies.

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7. List the five principles of internal control.

Answer The five principles of internal control include: 1. assignment of responsibility 2. segregation of duties 3. documentation 4. physical controls 5. independent verification.

8. List and the eight interrelated components for describing and analyzing internal control systems in the COSO Enterprise Risk Management – Integrated Framework.

Answer 1. Internal environment 2. Objective setting 3. Event identification 4. Risk assessment 5. Risk response 6. Monitoring 7. Information and communication 8. Control activities

9. List and briefly describe the limitations of internal control.

Answer 1. Cost versus benefit – Internal control systems cannot cost effectively be constructed to guard against all risks. The benefit of having internal controls in place for a particular risk should exceed the cost of having a particular control which addresses that risk.

. .

2.

Errors in judgment – Internal control systems cannot overcome errors in judgment especially in areas where risks to the business entity are rapidly evolving.

3.

Management interference – Since management is responsible for the development and maintenance of internal control systems, and supervises employees responsible for its operation, then management overrides are a danger, and in fact have figured prominently into some major internal control system failures.

4.

Employee collusion – A major threat to the internal control effectiveness is when employees work together to circumvent the system in order to commit fraud or conceal irregularities.

5.

Malfunctions – Internal control systems have limitations in their design capabilities and therefore do not adequately address a specific risk.

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10. List and briefly describe the four major phases of an audit engagement.

Answer 1. Planning the audit which establishes the objectives of the audit and what resources will be needed to achieve those objectives.

2. Evaluating the system of internal control to determine its strengths and weaknesses. This evaluation results in a decision about the nature, extent and timing of substantive testing.

3. Performing substantive tests which involve collecting evidence about the validity of transactions and other events to verify financial information. For example, inventories are physically counted to ensure that accounting records accurately reflect the amount of inventories on hand.

4. Preparing and presenting an audit report to the client who includes the auditor’s opinion about whether the company’s financial statements present a true and fair view of the company’s financial position in all material respects.

11. List and briefly describe the four audit opinions that could be given by an independent auditor.

Answer 1. Unqualified opinion – An unqualified opinion is given when the audit reports states that the client’s financial statements provide a true and fair view in all material respects.

2. Qualified opinion – This opinion is given when the financial statements provide a true and fair view of the financial results of the business ‘except for’ one or more qualifications.

3. Adverse opinion – When the auditor concludes that the financial statements do not present a true and fair view, than an adverse opinion is appropriate.

4. Disclaimer of opinion – The auditor is unable to provide an opinion because the audit engagement could not be completed or another factor made providing any opinion impossible.

12. What are the two types of material misstatements that would be considered fraud in the financial statements?

Answer 1. Fraudulent financial reporting – Misstatement or omission of amounts or disclosures that cause financial statements to not conform to applicable accounting standards.

2.

Misappropriation of assets – The effect of a theft of a business’s assets that causes the financial statements not to conform to applicable accounting standards.

13. Fraud prevention measures can be grouped into what three categories?

Answer 1. Creating and maintaining a culture of honesty and high ethics; 2. Evaluating the risk of fraud and implement the processes, procedures, and controls needed to mitigate risks and reduce the opportunities for fraud; and . .

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3. Developing an appropriate oversight process.

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