Questions in Financial Acc Answers Part 7

CPA-00244 Type1 M/C 136. CPA-00244 A-D Corr Ans: C PM#55 F 1-99 Nov 92 II #52 Page 38 On March 15, 1992, Krol Co. paid property taxes of $90,000 on its office building for the calendar year 1992. On April 1, 1992, Krol paid $150,000 for unanticipated repairs to its office equipment. The repairs will benefit operations for the remainder of 1992. What is the total amount of these expenses that Krol should include in its quarterly income statement for the three months ended June 30, 1992? a. $172,500 b. $97,500 c. $72,500 d. $37,500 CPA-00244 Explanation Rule: Actual and estimated expenditures benefiting all interim periods equally should be expensed ratably throughout the year. Annual property taxes Repairs which will benefit operations for 3 quarters remaining in year $90,000 ÷ 4 = 150,000 ÷ 3 = Quarterly $22,500 50,000 $72,500 C Choice "c" is correct. $72,500 total expense for the three months ended June 30, 1992. CPA-00245 Type1 M/C 137. CPA-00245 A-D Nov 92 #16 Corr Ans: A PM#56 F 1-99 Page 63 An inventory loss from a market price decline occurred in the first quarter, and the decline was not expected to reverse during the fiscal year. However, in the third quarter the inventory's market price recovery exceeded the market decline that occurred in the first quarter. For interim financial reporting, the dollar amount of net inventory should: a. Decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the decrease in the first quarter. b. Decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the market price recovery. c. Decrease in the first quarter by the amount of the market price decline and not be affected in the third quarter. d. Not be affected in either the first quarter or the third quarter. CPA-00245 Explanation Choice "a" is correct. Market price declines should be recognized in the interim period in which decline is judged permanent and later, if they "turn around," are recognized as gains in subsequent periods only to the extent of previously reported losses. Choice "b" is incorrect. Recovery should not cause an increase in inventory value above original cost. Choice "c" is incorrect. The recovery should be recognized to the extent of the first quarter write down. Choice "d" is incorrect. CPA-00247 Type1 M/C 138. CPA-00247 A-D Corr Ans: B PM#58 May 89 II #20 Page 41 F 1-99 The following information pertains to Aria Corp. and its divisions for the year ended December 31, 1988: Sales to unaffiliated customers Intersegment sales of products similar to those sold to unaffiliated customers Interest earned on loans to other industry segments $2,000,000 600,000 40,000 Aria and all of its divisions are engaged solely in manufacturing operations. Aria has a reportable segment if that segment's revenue exceeds: a. b. c. d. $264,000 $260,000 $204,000 $200,000 CPA-00247 Explanation Choice "b" is correct. $260,000 represents a reportable segment (10% of total sales): Including unaffiliated sales and intersegment sales Total combined sales $2,000,000 600,000 2,600,000 × 10% $ 260,000 Rule: To be significant enough to report on, a segment must be at least 10% of: 1. Combined revenues (whether intersegment or unaffiliated customers), or 2. Operating income, or 3. Identifiable assets. CPA-00248 Type1 M/C 139. CPA-00248 A-D Corr Ans: D PM#59 F 1-99 May 90 II #54 Page 42 Hyde Corp. has three manufacturing divisions, each of which has been determined to be a reportable segment. In 1989, Clay division had sales of $3,000,000, which was 25% of Hyde's total sales, and had operating costs of $1,900,000, as reported to the CFO. In 1989, Hyde incurred operating costs of $500,000 that were not directly traceable to any of the divisions. In addition, Hyde incurred corporate interest expense of $300,000 in 1989. In reporting segment information, what amount should be shown as Clay's operating profit for 1989? a. b. c. d. $875,000 $900,000 $975,000 $1,100,000 CPA-00248 Explanation Choice "d" is correct. $1,100,000 operating profit for clay. Rule: Operating profit by segments is based on the measure of profit reported to the "chief operating decision maker." Allocations for general operating costs and interest, etc., should not be made solely for purposes of segment disclosures. Sales Less operating costs Sub total CPA-00249 $3,000,000 (1,900,000) $1,100,000 Type1 M/C 140. CPA-00249 A-D May 90 #36 Corr Ans: C PM#60 Page 41 F 1-99 YIV, Inc. is a multidivisional corporation, which has both intersegment sales and sales to unaffiliated customers. YIV should report segment financial information for each division meeting which of the following criteria? a. Segment operating profit or loss is 10% or more of consolidated profit or loss. b. Segment operating profit or loss is 10% or more of combined operating profit or loss of all company segments. c. Segment revenue is 10% or more of combined revenue of all the company segments. d. Segment revenue is 10% or more of consolidated revenue. CPA-00249 Explanation Choice "c" is correct. Segment revenue is 10% or more of combined revenue of all the company segments. Rule: To be significant enough to report on, a segment must be at least 10% of: 1. Combined revenues (whether intersegment or affiliated customers) or 2. Operating profit (of all segments not having an operating loss), or 3. Identifiable assets. Choice "a" is incorrect. Rule is 10% of "operating profit," not "consolidated profit." Choice "b" is incorrect. Segments with "operating losses" are not combined with those having "operating profits" in determining a segment. Choice "d" is incorrect. "Consolidated revenue" would not include "intersegment revenue." Rule is "combined revenue," not "consolidated revenue." CPA-00250 Type1 M/C 141. CPA-00250 A-D Corr Ans: D PM#61 F 1-99 Nov 92 II #54 Page 41 Grum Corp., a publicly-owned corporation, is subject to the requirements for segment reporting. In its income statement for the year ended December 31, 1991, Grum reported revenues of $50,000,000, operating expenses of $47,000,000, and net income of $3,000,000. Operating expenses include payroll costs of $ 15,000,000. Grum's combined identifiable assets of all industry segments at December 31, 1991, were $40,000,000. In its 1991 financial statements, Grum should disclose major customer data if sales to any single customer amount to at least: a. b. c. d. $300,000 $1,500,000 $4,000,000 $5,000,000 CPA-00250 Explanation Choice "d" is correct. $5,000,000 (10% x $50,000,000 revenue). If revenue from a single external customer is 10% or more of total revenue, then the company should disclose this fact, the total amount of revenue from the customer, and the segment or segments reporting the revenues. The identity of the customer need not be disclosed. CPA-00251 Type1 M/C 142. CPA-00251 A-D Nov 92 #36 Corr Ans: D PM#62 F 1-99 Page 41 Grum Corp., a publicly-owned corporation, is subject to the requirements for segment reporting. In its income statement for the year ended December 31, 1991, Grum reported revenues of $50,000,000, operating expenses of $47,000,000, and net income of $3,000,000. Operating expenses include payroll costs of $ 15,000,000. Grum's combined identifiable assets of all industry segments at December 31, 1991, were $40,000,000. Cott Co.'s four business segments have revenues and identifiable assets expressed as percentages of Cott's total revenues and total assets as follows: Revenues 64% 14% 14% 8% 100% Ebon Fair Gel Hak Assets 66% 18% 4% 12% 100% Which of these business segments are deemed to be reportable segments? a. b. c. d. Ebon only. Ebon and Fair only. Ebon, Fair, and Gel only. Ebon, Fair, Gel, and Hak. CPA-00251 Explanation Rule: A segment must be at least 10% of: 1. Combined revenues (whether intersegment or unaffiliated customers), or 2. Operating income (of all segments not having an operating loss), or 3. Identifiable assets. Choice "d" is correct. Ebon, Fair, Gel, and Hak, since all four companies meet at least one of the criteria. CPA-00252 Type1 M/C 143. CPA-00252 A-D Nov 89 I #4 Corr Ans: D PM#63 F 1-99 Page 43 Chester Corp. was a development stage enterprise from its inception on September 1, 1987 to December 31, 1988. The following information was taken from Chester's accounting records for the above period: Net sales Cost of sales Selling, general, and administrative expenses Research and development costs Interest expense $1,350,000 1,000,000 400,000 300,000 100,000 For the period September 1, 1987 to December 31, 1988, what amount should Chester report as net loss? a. b. c. d. $ 50,000 $150,000 $350,000 $450,000 CPA-00252 Explanation Choice "d" is correct. $450,000 net loss for the period Sept. 1, 1987 to Dec. 31, 1988. Rule: "Development stage enterprises" present their FS in accordance with GAAP and make additional disclosures such as: cumulative net losses, cumulative deficit, cumulative sales and expenses. Net sales Cost of sales Selling, general and administrative exp. Research & development costs (100% expense) Interest expense Net loss (9/1/87 to 12/31/88) CPA-00253 Type1 M/C A-D Corr Ans: B $1,350,000 (1,000,000) (400,000) (300,000) (100,000) (450,000) PM#64 F 1-99 144. CPA-00253 Nov 90 #8 Page 43 Deficits accumulated during the development stage of a company should be: a. b. c. d. Reported as organization costs. Reported as a part of stockholders' equity. Capitalized and written off in the first year of principal operations. Capitalized and amortized over a five year period beginning when principal operations commence. CPA-00253 Explanation Choice "b" is correct. Deficits accumulated during the development stage of a company should be reported as a part of stockholders' equity. Rule: Development stage enterprises should present FS in accordance with GAAP and make additional disclosures such as: cumulative net losses, cumulative deficit (as part of equity), cumulative sales & expenses (part of I/S), cumulative statement of cash flows and supplementary "shareholders equity." Choices "a", "c", and "d" are incorrect, per the rule above. CPA-00254 Type1 M/C 145. CPA-00254 A-D May 92 #49 Corr Ans: A PM#65 F 1-99 Page 43 Financial reporting by a development stage enterprise differs from financial reporting for an established operating enterprise in regard to footnote disclosures: a. b. c. d. Only. And expense recognition principles only. And revenue recognition principles only. And revenue and expense recognition principles. CPA-00254 Explanation Choice "a" is correct. Financial reporting by a development stage enterprise differs from financial reporting for an established operating enterprise in regard to (more extensive) footnote disclosures only. Choices "b", "c", and "d" are incorrect. Revenue and expense recognition principles are the same. Rule: Development stage enterprises should present financial statements in accordance with GAAP and make additional disclosures such as: cumulative net losses, cumulative deficit (as part of equity), cumulative sales and expenses (as part of the income statement), cumulative statement of cash flows and supplementary "shareholders equity." CPA-00255 Type1 M/C 146. CPA-00255 A-D Nov 92 #44 Corr Ans: A PM#66 F 1-99 Page 43 A statement of cash flows for a development stage enterprise: a. Is the same as that of an established operating enterprise and, in addition, shows cumulative amounts from the enterprise's inception. b. Shows only cumulative amounts from the enterprise's inception. c. Is the same as that of an established operating enterprise, but does not show cumulative amounts from the enterprise's inception. d. Is not presented. CPA-00255 Explanation Rule: Development stage enterprises should present financial statements in accordance with GAAP and make additional disclosures such as cumulative amounts from inception for: net losses, deficits, sales, expenses, and cash flows and supplementary data. Choice "a" is correct, per the rule shown above. Choice "b" is incorrect. Current amounts are shown as well as cumulative amounts. Choice "c" is incorrect. Cumulative amounts from inception are shown. Choice "d" is incorrect. A statement of cash flows is required. CPA-04554 Type1 M/C 147. CPA-04554 A-D Corr Ans: A PM#67 May 94 No. 2 1A F 1-99 Page 3 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List A represents possible clarifications of these transactions as: a change in accounting principle, a change in accounting estimate, a correction of an error in previously presented financial statements, or neither an accounting change nor an accounting error. Item to Be Answered Quo manufactures heavy equipment to customer specifications on a contract basis. On the basis that it is preferable, accounting for these long-term contracts was switched from the completed-contract method to the percentage-of-completion method. a. b. c. d. List A (Select one) Change in accounting principal. Change in accounting estimate. Correction of an error in previously presented financial statements. Neither an accounting change nor an accounting error. CPA-04554 Explanation Choice "a" is correct. Switching from the completed-contract method of accounting to the percentage-ofcompletion method is a "change in accounting principle." CPA-04555 Type1 M/C 148. CPA-04555 X,Y,Z Corr Ans: Y May 94 No. 2 1B PM#68 F 1-99 Page 25 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List B represents the general accounting treatment required for these transactions. These treatments are: • • • Cumulative effect approach - Include the cumulative effect of the adjustment resulting from the accounting change or error correction in the 1993 financial statements, and do not restate the 1992 financial statements. Retroactive or retrospective restatement approach - Restate the 1992 financial statements and adjust 1992 beginning retained earnings if the error or change affects a period prior to 1992. Prospective approach - Report 1993 and future financial statements on the new basis but do not restate 1992 financial statements. Item to Be Answered Quo manufactures heavy equipment to customer specifications on a contract basis. On the basis that it is preferable, accounting for these long-term contracts was switched from the completed-contract method to the percentage-of-completion method. List B (Select one) X. Cumulative effect approach. Y. Retroactive or retrospective restatement approach. Z. Prospective approach. CPA-04555 Explanation Choice "Y" is correct. Changes in accounting principle are handled "retrospectively." Beginning retained earnings of the earliest year presented is adjusted for the cumulative effect of the change and all prior year financial statements are restated. CPA-04556 Type1 M/C 149. CPA-04556 A-D Corr Ans: B PM#69 May 94 No. 2 2A F 1-99 Page 26 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List A represents possible clarifications of these transactions as: a change in accounting principle, a change in accounting estimate, a correction of an error in previously presented financial statements, or neither an accounting change nor an accounting error. Item to Be Answered As a result of a production breakthrough, Quo determined that manufacturing equipment previously depreciated over 15 years should be depreciated over 20 years. a. b. c. d. List A (Select one) Change in accounting principal. Change in accounting estimate. Correction of an error in previously presented financial statements. Neither an accounting change nor an accounting error. CPA-04556 Explanation Choice "b" is correct. Change in lives of fixed assets is a change in accounting estimate. CPA-04557 Type1 M/C X,Y,Z Corr Ans: Z PM#70 F 1-99 150. CPA-04557 May 94 No. 2 2B Page 26 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List B represents the general accounting treatment required for these transactions. These treatments are: • Cumulative effect approach - Include the cumulative effect of the adjustment resulting from the accounting change or error correction in the 1993 financial statements, and do not restate the 1992 financial statements. • Retroactive or retrospective restatement approach - Restate the 1992 financial statements and adjust 1992 beginning retained earnings if the error or change affects a period prior to 1992. • Prospective approach - Report 1993 and future financial statements on the new basis but do not restate 1992 financial statements. Item to Be Answered As a result of a production breakthrough, Quo determined that manufacturing equipment previously depreciated over 15 years should be depreciated over 20 years. List B (Select one) X. Cumulative effect approach. Y. Retroactive or retrospective restatement approach. Z. Prospective approach. CPA-04557 Explanation Choice "Z" is correct. This affects only the prospective (current and subsequent) periods - not prior periods, not retained earnings. CPA-04558 Type1 M/C 151. CPA-04558 A-D Corr Ans: B PM#71 May 94 No. 2 3A F 1-99 Page 24 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List A represents possible clarifications of these transactions as: a change in accounting principle, a change in accounting estimate, a correction of an error in previously presented financial statements, or neither an accounting change nor an accounting error. Item to Be Answered The equipment that Quo manufactures is sold with a five-year warranty. Because of a production breakthrough, Quo reduced its computation of warranty costs from 3% of sales to 1% of sales. List A (Select one) a. Change in accounting principal. b. Change in accounting estimate. c. Correction of an error in previously presented financial statements. d. Neither an accounting change nor an accounting error. CPA-04558 Explanation Choice "b" is correct. Change in the computation of warranty costs from 3% of sales to 1% of sales is a change in accounting estimate. CPA-04559 Type1 M/C 152. CPA-04559 X,Y,Z Corr Ans: Z May 94 No. 2 3B PM#72 F 1-99 Page 24 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List B represents the general accounting treatment required for these transactions. These treatments are: • • • Cumulative effect approach - Include the cumulative effect of the adjustment resulting from the accounting change or error correction in the 1993 financial statements, and do not restate the 1992 financial statements. Retroactive or retrospective restatement approach - Restate the 1992 financial statements and adjust 1992 beginning retained earnings if the error or change affects a period prior to 1992. Prospective approach - Report 1993 and future financial statements on the new basis but do not restate 1992 financial statements. Item to Be Answered The equipment that Quo manufactures is sold with a five-year warranty. Because of a production breakthrough, Quo reduced its computation of warranty costs from 3% of sales to 1% of sales. List B (Select one) X. Cumulative effect approach. Y. Retroactive or retrospective restatement approach. Z. Prospective approach. CPA-04559 Explanation Choice "Z" is correct. This affects only the prospective (current and subsequent) periods - not prior periods, not retained earnings. CPA-04560 Type1 M/C 153. CPA-04560 A-D Corr Ans: A PM#73 May 94 No. 2 4A F 1-99 Page 26 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List A represents possible clarifications of these transactions as: a change in accounting principle, a change in accounting estimate, a correction of an error in previously presented financial statements, or neither an accounting change nor an accounting error. Item to Be Answered Quo changed from LIFO to FIFO to account for its finished goods inventory. List A (Select one) a. Change in accounting principal. b. Change in accounting estimate. c. Correction of an error in previously presented financial statements. d. Neither an accounting change nor an accounting error. CPA-04560 Explanation Choice "a" is correct. Change from LIFO to FIFO is a change in accounting principle. CPA-04561 Type1 M/C X,Y,Z Corr Ans: Y PM#74 F 1-99 154. CPA-04561 May 94 No. 2 4B Page 26 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List B represents the general accounting treatment required for these transactions. These treatments are: • Cumulative effect approach - Include the cumulative effect of the adjustment resulting from the accounting change or error correction in the 1993 financial statements, and do not restate the 1992 financial statements. • Retroactive or retrospective restatement approach - Restate the 1992 financial statements and adjust 1992 beginning retained earnings if the error or change affects a period prior to 1992. • Prospective approach - Report 1993 and future financial statements on the new basis but do not restate 1992 financial statements. Item to Be Answered Quo changed from LIFO to FIFO to account for its finished goods inventory. List B (Select one) X. Cumulative effect approach. Y. Retroactive or retrospective restatement approach. Z. Prospective approach. CPA-04561 Explanation Choice "Y" is correct. A change in accounting principle should be shown in the retained earnings statement of the earliest year presented as an adjustment of the beginning balance. All prior year financial statements are recast. CPA-04562 Type1 M/C 155. CPA-04562 A-D Corr Ans: A PM#75 May 94 No. 2 5A F 1-99 Page 26 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List A represents possible clarifications of these transactions as: a change in accounting principle, a change in accounting estimate, a correction of an error in previously presented financial statements, or neither an accounting change nor an accounting error. Item to Be Answered Quo changed from FIFO to average cost to account for its raw materials and work in process inventories. List A (Select one) a. Change in accounting principal. b. Change in accounting estimate. c. Correction of an error in previously presented financial statements. d. Neither an accounting change nor an accounting error. CPA-04562 Explanation Choice "a" is correct. Change in inventory pricing method from FIFO to average cost is a change in accounting principle. CPA-04563 Type1 M/C 156. CPA-04563 X,Y,Z Corr Ans: Y May 94 No. 2 5B PM#76 F 1-99 Page 26 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List B represents the general accounting treatment required for these transactions. These treatments are: • • • Cumulative effect approach - Include the cumulative effect of the adjustment resulting from the accounting change or error correction in the 1993 financial statements, and do not restate the 1992 financial statements. Retroactive or retrospective restatement approach - Restate the 1992 financial statements and adjust 1992 beginning retained earnings if the error or change affects a period prior to 1992. Prospective approach - Report 1993 and future financial statements on the new basis but do not restate 1992 financial statements. Item to Be Answered Quo changed from FIFO to average cost to account for its raw materials and work in process inventories. List B (Select one) X. Cumulative effect approach. Y. Retroactive or retrospective restatement approach. Z. Prospective approach. CPA-04563 Explanation Choice "Y" is correct. A change in accounting principle should be shown in the retained earnings statement of the earliest year presented as an adjustment of the beginning balance. All prior year financial statements are recast. CPA-04564 Type1 M/C 157. CPA-04564 A-D Corr Ans: C PM#77 May 94 No. 2 6A F 1-99 Page 29 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List A represents possible clarifications of these transactions as: a change in accounting principle, a change in accounting estimate, a correction of an error in previously presented financial statements, or neither an accounting change nor an accounting error. Item to Be Answered Quo sells extended service contracts on its products. Because related services are performed over several years, in 1993 Quo changed from the cash method to the accrual method of recognizing income from these service contracts. a. b. c. d. List A (Select one) Change in accounting principal. Change in accounting estimate. Correction of an error in previously presented financial statements. Neither an accounting change nor an accounting error. CPA-04564 Explanation Choice "c" is correct. Change from the cash method to the accrual method is a correction of an error in previously presented financial statements. CPA-04565 Type1 M/C 158. CPA-04565 X,Y,Z Corr Ans: Y May 94 No. 2 6B PM#78 F 1-99 Page 29 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List B represents the general accounting treatment required for these transactions. These treatments are: • Cumulative effect approach - Include the cumulative effect of the adjustment resulting from the accounting change or error correction in the 1993 financial statements, and do not restate the 1992 financial statements. • Retroactive or retrospective restatement approach - Restate the 1992 financial statements and adjust 1992 beginning retained earnings if the error or change affects a period prior to 1992. • Prospective approach - Report 1993 and future financial statements on the new basis but do not restate 1992 financial statements. Item to Be Answered Quo sells extended service contracts on its products. Because related services are performed over several years, in 1993 Quo changed from the cash method to the accrual method of recognizing income from these service contracts. List B (Select one) X. Cumulative effect approach. Y. Retroactive or retrospective restatement approach. Z. Prospective approach. CPA-04565 Explanation Choice "Y" is correct. If comparative FS are issued, restate prior year's FS. If comparative FS are not issued, restate prior year-end's retained earnings account by "adjusting" (net of tax) the opening balance of the current retained earnings statement. Note that when an error is corrected, retroactive restatement is used, and when there is a change in accounting principle, retrospective restatement is done. However, this is only a difference in terminology. CPA-04566 Type1 M/C 159. CPA-04566 A-D Corr Ans: C PM#79 May 94 No. 2 7A F 1-99 Page 29 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List A represents possible clarifications of these transactions as: a change in accounting principle, a change in accounting estimate, a correction of an error in previously presented financial statements, or neither an accounting change nor an accounting error. Item to Be Answered During 1993, Quo determined that an insurance premium paid and entirely expensed in 1992 was for the period January 1, 1992, through January 1, 1994. List A (Select one) a. Change in accounting principal. b. Change in accounting estimate. c. Correction of an error in previously presented financial statements. d. Neither an accounting change nor an accounting error. CPA-04566 Explanation Choice "c" is correct. Expensing insurance premiums when paid (rather than allocating them to the periods benefited) is a correction of an error in previously presented financial statements. CPA-04567 Type1 M/C 160. CPA-04567 X,Y,Z Corr Ans: Y May 94 No. 2 7B PM#80 F 1-99 Page 29 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List B represents the general accounting treatment required for these transactions. These treatments are: • Cumulative effect approach - Include the cumulative effect of the adjustment resulting from the accounting change or error correction in the 1993 financial statements, and do not restate the 1992 financial statements. • • Retroactive or retrospective restatement approach - Restate the 1992 financial statements and adjust 1992 beginning retained earnings if the error or change affects a period prior to 1992. Prospective approach - Report 1993 and future financial statements on the new basis but do not restate 1992 financial statements. Item to Be Answered During 1993, Quo determined that an insurance premium paid and entirely expensed in 1992 was for the period January 1, 1992, through January 1, 1994. List B (Select one) X. Cumulative effect approach. Y. Retroactive or retrospective restatement approach. Z. Prospective approach. CPA-04567 Explanation Choice "Y" is correct. If comparative FS are issued, restate prior year's FS. If comparative FS are not issued, restate prior year-end's retained earnings account by "adjusting" (net of tax) the opening balance of the current retained earnings statement. CPA-04572 Type1 M/C 161. CPA-04572 A-D Corr Ans: D PM#81 May 94 No. 2 10A F 1-99 Page 25 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List A represents possible clarifications of these transactions as: a change in accounting principle, a change in accounting estimate, a correction of an error in previously presented financial statements, or neither an accounting change nor an accounting error. During 1993, Quo increased its investment in Worth, Inc. from a 10% interest, purchased in 1992, to 30%, and acquired a seat on Worth's board of directors. As a result of its increased investment, Quo changed its method of accounting for investment in Worth, Inc. from the cost method to the equity method. a. b. c. d. List A Change in accounting principle. Change in accounting estimate. Correction of an error in previously presented financial statements. Neither an accounting change nor an accounting error. CPA-04572 Explanation Choice "d" is correct. A change from the cost method (less than 20% ownership) to the equity method (20% or more ownership or a Board seat or other significant influence) of accounting for investment in an investee is neither an accounting change nor an accounting error. If it is not an accounting change, it cannot be a change in accounting principle or a change in accounting estimate since those two types of changes are both accounting changes. There is a considerable amount of controversy on this particular answer. Some people think that this change is a change in accounting principle (something certainly changed, but was it the accounting principle?), and others think it is a change in accounting entity (which is not one of the available answers; anyway, did the accounting entity actually change or is it the same entity accounted for differently?). Under SFAS No. 154, a change in accounting principle is treated retrospectively and a change in accounting entity is treated retrospectively. This kind of change (cost to equity) has never been specifically identified in any accounting literature as either a change in accounting principle or a change in accounting entity. The words "cost method" were never mentioned in APB 20 (other than the full cost method for oil & gas companies, which is an entirely different subject), nor was it mentioned in SFAS No. 154. It was, however, discussed in APB 18 (the pronouncement for the equity method) in Paragraph 19m (bold added): "An investment in common stock of an investee that was previously accounted for on other than the equity method may become qualified for use of the equity method by an increase in the level of ownership described in paragraph 17 (i.e., acquisition of additional voting stock by the investor, acquisition or retirement of voting stock by the investee, or other transactions). When an investment qualifies for use of the equity method, the investor should adopt the equity method of accounting. The investment, results of operations (current and prior periods presented), and retained earnings of the investor should be adjusted retroactively in a manner consistent with the accounting for a step-by-step acquisition of a subsidiary." What does all this mean? It means that, when there is a change in the percentage of ownership that changes accounting from the cost method to the equity method, the change is treated retroactively (just like changes in accounting entity used to be treated, although they are now treated retrospectively). It does not say that the change is a change in accounting principle or anything else. Nothing in SFAS No. 154 changed this treatment. So all this still makes Choice "d" correct. This whole issue might easily be considered to be splitting hairs, at the very least. Some questions on the CPA exam are just that way. Most are not. CPA-04573 Type1 M/C 162. CPA-04573 X,Y,Z Corr Ans: Y May 94 No. 2 10B PM#82 F 1-99 Page 3 On January 2, 1993, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 1992 and before, and instituted new accounting policies. Quo's 1993 financial statements will be presented in comparative form with its 1992 financial statements. This question represents one of Quo's transactions. List B represents the general accounting treatment required for these transactions. These treatments are: • Cumulative effect approach - Include the cumulative effect of the adjustment resulting from the accounting change or error correction in the 1993 financial statements, and do not restate the 1992 financial statements. • Retroactive or retrospective restatement approach - Restate the 1992 financial statements and adjust 1992 beginning retained earnings if the error or change affects a period prior to 1992. • Prospective approach - Report 1993 and future financial statements on the new basis but do not restate 1992 financial statements. During 1993, Quo increased its investment in Worth, Inc. from a 10% interest, purchased in 1992, to 30%, and acquired a seat on Worth's board of directors. As a result of its increased investment, Quo changed its method of accounting for investment in Worth, Inc. from the cost method to the equity method. List B X. Cumulative effect approach. Y. Retroactive or retrospective restatement approach. Z. Prospective approach. CPA-04573 Explanation Choice "Y" is correct. The equity method of accounting is applied retroactively when the investor has acquired 20% ownership. Prior to acquiring the ability to influence the investee, the cost method is proper. The retroactive restatement approach does not mean that this change is the correction of an error (which is now treated retroactively), a change in accounting principle (which is now treated retrospectively), or a change in accounting entity (which is now treated retrospectively). It just means that retroactive restatement is the proper treatment. CPA-04770 Type1 M/C 163. CPA-04770 A-D Corr Ans: D PM#83 F 1-99 Released 2005 Page 8 According to the FASB conceptual framework, what does the concept of reliability in financial reporting include? a. b. c. d. Effectiveness. Certainty. Precision. Neutrality. CPA-04770 Explanation Choice "d" is correct. The concept of reliability in financial reporting includes; neutrality, representational faithfulness and verifiability. Choices "a", "b", and "c" are incorrect, per the above.