During Year 1, Tidal Co. began construction on a project scheduled for completion in Year 3. At December 31, Year 1, an overall loss was anticipated at contract completion. What would be the effect of the project on Year 1 operating income under the percentage-of-completion method and the completed-contract method?
Answer (D) is correct. When the current estimate of total contract costs indicates a loss, an immediate provision for the entire loss should be made regardless of method. Thus, under either method, Year 1 operating income is decreased by the projected loss.
The measurement basis most often used to report a long-term payable representing a
commitment to pay money at a determinable future date is
Answer (D) is correct.
The measurement basis most commonly adopted by entities in preparing
their financial statements is historical cost. However, it is usually
combined with other measurement bases (attributes). The attribute used
to measure a long-term receivable or payable is the present or discounted
value of its future cash flows.
Johnson Company uses the allowance method to account for uncollectible accounts
receivable. After recording the estimate of uncollectible accounts expense for the current
year, Johnson decided to write off in the current year the $10,000 account of a customer
who had filed for bankruptcy. What effect does this write-off have on the company’s current
net income and total current assets, respectively?
..Net Income...Total Current Assets
Answer (D) is correct.
Johnson uses the allowance method. Thus, when a specific amount is
written off, the journal entry is
Allowance for doubtful accounts $10,000
Accounts receivable $10,000
The write-off of a bad debt has no effect on expenses, net income, and
total current assets.
A shoe retailer allows customers to return shoes within 90 days of purchase. The company
estimates that 5% of sales will be returned within the 90-day period. During the month, the
company has sales of $200,000 and returns of sales made in prior months of $5,000. What
amount should the company record as net sales revenue for new sales made during the
Answer (B) is correct.
The company has $200,000 of sales and estimates that 5% of sales will
be returned. Thus, the company will recognize $10,000 ($200,000 × 5%)
for sales returns (contra revenue) and for a corresponding allowance for
sales returns (contra asset). This amount is subtracted from total sales to
find net sales revenue of $190,000 ($200,000 – $10,000).
Unrealized gains and losses on trading securities should be presented in the
Answer (B) is correct.
Unrealized holding gains and losses on trading securities are included in
earnings and are therefore reported in the income statement.
A corporation entered into a purchase commitment to buy inventory. At the end of the accounting period, the current market value of the inventory was less than the fixed purchase price by a material amount. Which of the following accounting treatments is most appropriate?
Answer (A) is correct. A commitment to acquire goods in the future is not recorded at the time of the agreement, e.g., by debiting an asset and crediting a liability. But recognition in earnings of a loss on goods subject to a firm purchase commitment is required if the market price of these goods declines below the commitment price. The reason for current loss recognition is the same as that for inventory on hand. A decrease (not an increase) in the future benefits of the commitment should be recognized when it occurs. Thus, the lower of cost or market rule is followed. If material losses are expected to arise from firm, noncancelable, and unhedged commitments for the future purchase of inventory, they should be measured in the same way as inventory losses, and, if material, recognized and separately disclosed in the income statement. The entry is to debit unrealized holding loss-earnings and to credit liability-purchase commitment. Furthermore, certain disclosures are required for unconditional purchase obligations that are unrecorded. They include the nature and term of the obligation.
Which one of the following statements is correct about the reconciliation of U.S. GAAP and International Financial Reporting Standards (IFRS)?
Answer (A) is correct. Under IFRS, (1) costs incurred during the research phase of an internal project are expensed as incurred since the company cannot demonstrate that an intangible asset exists that will generate probable future economic benefits; and (2) costs incurred during the development phase of an internal project can be capitalized and recognized as an intangible asset if, and only if, the company can demonstrate all of the following: 1. The technical feasibility to complete the intangible asset 2.Its intention to complete and use or sell the intangible asset 4. Its ability to sell or use the intangible asset 5. Availability of resources to complete and use or sell the intangible asset 6. The way in which the asset will generate probable future economic benefits 7. Its ability to reliably measure expenditures attributable to the asset
Income-tax-basis financial statements differ from those prepared under GAAP because they
Answer (D) is correct. Financial statements prepared under the income tax basis of accounting and financial statements prepared under GAAP differ when the tax basis of an asset or a liability and its reported amount in the GAAP-based financial statements are not the same. The result will be taxable or deductible amounts in future years when the reported amount of the asset is recovered or the liability is settled. Thus, certain revenues and expenses are recognized in different periods. An example is subscriptions revenue received in advance, which is recognized in taxable income when received and recognized in financial income when earned in a later period. Another example is a warranty liability, which is recognized as an expense in financial income when a product is sold and recognized in taxable income when the expenditures are made in a later period.
Selected financial information for Windham, Inc., for the year just ended is shown below.
Interest received on municipal bonds
Gain on the sale of land reported this year but not taxable until next year
Tax rate for all years
Income taxes payable
Deferred tax liability
"The total income tax expense reported on Windham’s income statement for the year just
ended should be"
Answer (C) is correct.
Taxable income consists of pretax income adjusted for those items that
give rise to tax differences. Taxable income is therefore $3,400,000
($5,000,000 – $600,000 – $1,000,000), and current tax expense is
$1,360,000 ($3,400,000 × 40%). The interest on municipal bonds is a
permanent difference because it is tax-exempt, i.e., it is recognized in
GAAP income but never in taxable income. Permanent differences have
no deferred tax effects. However, the gain on the sale of land is a
temporary difference because it is included in GAAP income this year
and is included in taxable income in the future. This temporary
difference gives rise to a future taxable amount, specifically, a $400,000
deferred tax liability ($1,000,000 × 40%). This credit to the deferred tax
liability account is balanced by a debit to income tax expense. Total
income tax expense for the year is therefore $1,760,000 ($1,360,000
current portion + $400,000 deferred portion).
Cali, Inc. had a $4,000,000 note payable due on March 15,
year 3. On January 28, year 3, before the issuance of its year 2
financial statements, Cali issued long-term bonds in the amount
of $4,500,000. Proceeds from the bonds were used to repay the
note when it came due. How should Cali classify the note in its
December 31, year 2 financial statements?
(c) The $4,000,000 note payable is due March 15, year
3 and normally would be classified as a current liability in the
December 31, year 2 financial statements. However, a short-term
obligation can be reclassified as long-term if the enterprise intends
to refinance the obligation on a long-term basis and the
intent is supported by the ability to refinance. Cali demonstrated
its ability to refinance by actually issuing bonds and refinancing
the note prior to the issuance of the December 31, year 2 financial
statements. Since the proceeds from the bonds exceeded the
amount needed to retire the note, the entire $4,000,000 notes
payable would be classified as a noncurrent liability, with separate
disclosure of the note refinancing.