Which of the following statements best describes the operating procedure for issuing a new Financial Accounting Standards Board (FASB) statement?

Which of the following statements best describes the operating procedure for issuing a new Financial Accounting Standards Board (FASB) statement?
A. The emerging issues task force must approve a discussion memorandum before it is disseminated to the public.
B. The exposure draft is modified per public opinion before issuing the discussion memorandum.
C. A new statement is issued only after a majority vote by the members of the FASB.
D. A new FASB statement can be rescinded by a majority vote of the AICPA membership.
C. A new statement is issued only after a majority vote by the members of the FASB.

At least four of the seven members of the FASB must vote in favor of a proposed Statement of Financial Accounting Standards.

The purpose of financial accounting is to provide information primarily for which of the following groups?
A. Government.
B. Internal Revenue Service.
C. Financial Accounting Standards Board.
D. Investors and creditors.
D. Investors and creditors.

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The purpose of financial reporting is to provide information relevant to the decision making of investors and creditors.

These individuals and firms make decisions about allocating resources across thousands of firms. Investment and credit decisions are the primary focus of financial reporting.

Which of the following will best protect investors against fraudulent financial reporting by corporations?
A. Criminal statutes.
B. The requirement that financial statements be audited.
C. The fact that all firms must report the same way.
D. The integrity of management.
B. The requirement that financial statements be audited.

The audit of the financial statements by independent third parties provides assurance that the financial statements are fairly presented in all material respects. As part of the audit, the auditor should perform risk assessment procedures to identify and assess the risk of material misstatement due to error or fraud, which includes understanding the corporation’s internal control over financial reporting.The auditors do not prepare the information, nor do they have employment ties with either the reporting firm or the intended audience of the financial statements. However, even the audit of financial statements is not a perfect protection as indicated by the frequency of fraud and audit failure.

What group currently writes the Generally Accepted Accounting Principles?
A. Internal Revenue Service.
B. Securities and Exchange Commission.
C. Financial Accounting Foundation.
D. Financial Accounting Standards Board.
D. Financial Accounting Standards Board.

The FASB is currently the rule-making body for GAAP. The Board has codified well over one hundred Statements of Financial Accounting Standards, and Interpretations of those standards. The FASB is a private-sector body, the third such body serving as the entity which creates GAAP for U.S. businesses. The FASB has no authority to enforce GAAP, however.

In reference to proposed accounting standards, the term “negative economic consequences” includes:
A. The cost of complying with GAAP.
B. The inability to raise capital.
C. The cost of government intervention when not in compliance with GAAP.
D. The failure of internal control systems.
B. The inability to raise capital.

A proposed standard may cause firm earnings to fall, for example when they are adopted. Firms will be concerned that lower earnings may make it more difficult to sell stock or to secure loans.

As a result, negative economic consequences become a focal point for arguments against the proposed standard.

The FASB is a(n):
A. Private sector body.
B. Governmental unit.
C. International organization.
D. Group of accounting firms.
A. Private sector body.

The FASB has no official connection with the U.S. Government although the SEC, an agency of the federal government, can modify or rescind an accounting standard adopted by the FASB.

Choose the correct statement about GAAP.
A. GAAP are laws.
B. Only publicly traded companies must comply with GAAP.
C. It is a violation of SEC regulations for publicly traded companies to depart from GAAP.
D. Firms may not restate financial statements previously issued.
C. It is a violation of SEC regulations for publicly traded companies to depart from GAAP.

The SEC requires that all registrants provide financial statements that comply with GAAP and will sanction firms and individuals involved in financial reporting that does not comply with GAAP.

The FASB has maintained that:
A. The interests of the reporting firms will be a primary consideration when developing new GAAP.
B. GAAP should have little or no cost of compliance.
C. New GAAP should be neutral and not favor any particular reporting objective.
DGAAP should result in the most conservative possible financial statements.
C. New GAAP should be neutral and not favor any particular reporting objective.

One of the objectives of the FASB in setting standards is to develop rules that are unbiased. FASB statements generally do not reflect any reporting bias.

For example, the requirement to expense all research and development costs is uniform across all firms and does not favor one firm over another.

Dannon Co. mistakenly reported its expenses of $35,200 on the cash basis. Corporate records revealed the following information:

Beginning prepaid expense $1,300
Beginning accrued expense 1,650
Ending prepaid expense 1,800
Ending accrued expense 1,200

What amount of expense should the Dannon report on its books under the accrual basis?

A. $34,250
B. $35,150
C. $35,300
D. $36,150
A. $34,250

Correct! The best way to approach this question is by thinking through the effect on cash basis expenses for the change in the prepaid and accrued expenses. The expenses reported on a cash basis are 35,200. Prepaid expenses increased by 500; which means that more cash was paid than expense incurred. Therefore, the 500 should be deducted from the cash basis expense to derive accrual basis expense. Accrued expenses decreased by 450; which means more cash was paid than expenses incurred. Therefore, the 450 should be deducted from the cash basis expense to derive the accrual basis expense. The correct answer is 35,200 – 500 – 450 = 34,250.

U Co. had cash purchases and payments on account during the current year totaling $455,000. U’s beginning and ending accounts payable balances for the year were $64,000 and $50,000, respectively. What amount represents U’s accrual-basis purchases for the year?

A. $441,000
B. $469,000
C. $505,000
D. $519,000
A. $441,000

Using an equation, or a T-account, to analyze accounts payable (AP) yields accrual purchases: Beginning AP ($64,000) + Accrual purchases—Cash payments ($455,000) = Ending AP ($50,000). Solving for accrual purchases yields $441,000.

Young & Jamison’s modified cash-basis financial statements indicate cash paid for operating expenses of $150,000, end-of-year prepaid expenses of $15,000, and accrued liabilities of $25,000. At the beginning of the year, Young & Jamison had prepaid expenses of $10,000, while accrued liabilities were $5,000. If cash paid for operating expenses is converted to accrual-basis operating expenses, what would be the amount of operating expenses?
A. $125,000
B. $135,000
C. $165,000
D. $175,000
C. $165,000

The approach on this question is to first calculate the cash-based operating expenses. Cash-based operating expenses are $150,000. The next step is to adjust the cash-based expense for the prepaid and accrued expenses. Beginning of the year prepaid expenses were paid in the prior year, but the expense was incurred (or consumed) in the current year, and end of the year prepaid expenses were paid this year but will be consumed next year. Therefore, you add the beginning of the year prepaid and subtract the end of the year prepaid expenses from the cash-based number.

Cash-based expenses will also be adjusted for the accrued expense. Beginnings of the year accrued expenses were not paid last year, but were last year’s expense item paid this year. End of the year accrued expenses were not paid this year, but are this year’s expense paid next year. Therefore, you subtract beginning of the year accrued and add end of the year accrued expenses to the cash-based number.

Cash-based operating expenses $150,000
Add the beginning of the year prepaid expenses 10,000
Subtract the end of the year prepaid expenses (15,000)
Subtract the beginning of the year accrued expenses ( 5,000)
Add the end of the year accrued expenses 25,000
Accrual-based operating expenses $165,000

A company records items on the cash basis throughout the year and converts to an accrual basis for year-end reporting. Its cash-basis net income for the year is $70,000. The company has gathered the following comparative Balance Sheet information:

Beginning of year End of year
Accounts payable $ 3,000 $ 1,000
Unearned revenue 300 500
Wages payable 300 400
Prepaid rent 1,200 1,500
Accounts receivable 1,400 600
What amount should the company report as its accrual-based net income for the current year?

A. $68,800
B $70,200
C. $71,200
D. $73,200
C. $71,200

The general rule to convert from cash to accrual is to add decreases in liabilities and increases in assets, and subtract increases in liabilities and decreases in assets.

Cash basis net income $70,000
Add: Increase in accounts payable $2,000
Subtract: Increase in unearned revenue $200
Subtract: Increase in wages payable $100
Add: Increase in prepaid rent $300
Subtract: Decrease in accounts receivable $800
Accrual basis net income $71,200

Ina Co. had the following beginning and ending balances in its prepaid expense and accrued liabilities accounts for the current year:

Prepaid expenses Accrued liabilities
Beginning balance $ 5,000 $ 8,000
Ending balance 10,000 20,000
Debits to operating expenses totaled $100,000. What amount did Ina pay for operating expenses during the current year?

A. $ 83,000
B. $ 93,000
C. $107,000
D. $117,000
B. $ 93,000

An increase in prepaid expenses indicates that more cash was paid than expensed (5,000). An increase in accrued liabilities indicates that more expense was accrued than paid (12,000). The reconciliation of operating expense to cash paid is: 100,000 + 5,000 − 12,000 = 93,000.

The premium on a three-year insurance policy expiring on December 31, 20X4 was paid in total on January 2, 20X2. If the company has a six-month operating cycle, then on December 31, 20X2, the prepaid insurance reported as a current asset would be for:
A. six months.
B. 12 months.
C. 18 months.
D. 24 months.
B. 12 months.

At the end of 20X2, two years of coverage remains. The cost of coverage for 20X3 is a current asset because it will be consumed within a year of the 20X2 Balance Sheet. The definition of a current asset uses the period “operating cycle or one year, whichever is longer.” An operating cycle of any length, not exceeding one year, would yield the same answer to this question. The fact that the operating cycle is only six months versus, for example eight months, has no effect on the classification of the prepaid insurance into a current component (to expire within a year of the 20X2 Balance Sheet) and a long-term component (the portion to expire after 20X3).

Bird Corp.’s trademark was licensed to Brian Co. for royalties of 15% of the sales of the trademarked items. Royalties are payable semiannually on March 15 for sales in July through December of the prior year, and on September 15 for sales in January through June of the same year.

Bird received the following royalties from Brian:

March 15 September 15
20X4 $5,000 $7,500
20X5 6,000 8,500

Brian estimated that the sales of the trademarked items would total $30,000 for July through December 20X5.

In Bird’s 20X5 Income Statement, the royalty revenue should be:

A. $13,000.
B. $14,500.
C. $19,000.
D. $20,500.
A. $13,000.

20X5 royalty revenue is the amount earned in 20X5, regardless of when it is received. The September receipt of $8,500 accounts for the royalties earned the first half of 20X5. Royalties for the second half are estimated to be .15($30,000) = $4,500. Although this is an estimate, if reliable, it provides relevant information. Waiting for the exact amount is not justified in this case. The small increase in reliability does not justify postponing recognition in 20X5. Thus, total royalty revenue for 20X5 is $13,000, which equals $8,500 + $4,500.

Doren Co.’s officers’ compensation expense account had a balance of $490,000 at December 31, 20X4, before any appropriate year-end adjustment relating to the following:

No Salary accrual was made for the week of December 25-31, 20X4. Officers’ salaries for this period totaled $18,000 and were paid on January 5, 20X5.
Bonuses to officers for 20X4 were paid on January 31, 20X5 in the total amount of $175,000.
The adjusted balance for officers’ compensation expense for the year ended December 31, 20X4, should be:

A. $683,000.
B. $665,000.
C. $508,000.
D. $490,000.
A. $683,000.

Total compensation expense should include the two adjusting items. Therefore, the total expense is $490,000 + $18,000 + $175,000 = $683,000. The two adjusting items are not included in the expense account balance because the adjustments have not yet been made. The accrued, but unpaid, salaries, as well as the bonuses, relate to 20X4. Officer bonuses are another form of employee compensation.

On January 1, 20X5, Layton Co. acquired the copyright to a book owned by Garner for royalties of 15% of future book sales. Royalties are payable on September 30 for sales in January through June of the same year, and on March 31 for sales in July through December of the preceding year.

During 20X5 and 20X6, Layton remitted royalty checks to Garner as follows:

March 31 September 30
2005 $ – $25,000
2006 22,000 40,000

Layton’s sales of the Garner book totaled $300,000 for the last half of 20X6. In its 20X6 Income Statement, Layton should report royalty expense of:

A. $85,000.
B. $67,000.
C. $62,000.
D. $45,000.
A. $85,000.

Royalty expense for 20X6 equals 15% of sales for the year 2006, regardless of when the royalties are paid. The $40,000 paid on September 30, 20X6 applies to the sales in the first half of 2006 (January—June). Sales for the second half of 20X6 were $300,000. The royalty expense associated with these sales is .15($300,000) = $45,000. Therefore, total royalty expense for the year 2006 is $40,000 + $45,000 = $85,000.

On July 1, 20X3, Roxy Co. obtained fire insurance for a three-year period at an annual premium of $72,000 payable on July 1 of each year.

The first premium payment was made July 1, 20X3. On October 1, 20X3, Roxy paid $24,000 for real estate taxes to cover the period ending September 30, 20X4. This prepayment was made to obtain a discount.

In its December 31, 20X3, Balance Sheet, Roxy should report prepaid expenses of:

A. $60,000.
B. $54,000.
C. $48,000.
D. $36,000.
B. $54,000.

Unexpired fire insurance premium: $72,000(1/2) = $36,000
The premium covers only one year, and half the year is elapsed as of December 31.
Unexpired property tax prepayment: $24,000(9/12) 18,000
Total prepaid expenses (asset) at December 31, 2003 $54,000

Under East Co.’s accounting system, all paid insurance premiums are debited to prepaid insurance. For interim financial reports, East makes monthly estimated charges to insurance expense with credits to prepaid insurance.

Additional information for the year ended December 31, 20X5, is as follows:

Prepaid insurance at December 31, 20X4 $105,000
Charges to insurance expense during 20X5 (including a year-end adjustment of 17,500) 437,500
Prepaid insurance at December 31, 20X5 122,500
What was the total amount of insurance premiums paid by East during 20X5?

A. $322,500
B. $420,000
C. $437,500
D. $455,000
D. $455,000

Beginning prepaid balance + Premiums paid − Expense charges = Ending prepaid balance
$105,000 + Premiums paid − $437,500 = $122,500
Premiums paid = $455,000

At December 31, 20X0, Ashe Co. had a $990,000 balance in its advertising expense account before any year-end adjustments relating to the following:

Radio advertising spots broadcast during December 20X0 were billed to Ashe on January 4, 20X1. The invoice cost of $50,000 was paid on January 15, 20X1.
Included in the $990,000 is $60,000 for newspaper advertising for a January 20X1 sales promotional campaign.
Ashe’s advertising expense for the year ended December 31, 20X0, should be:

A. $930,000.
B. $980,000.
C. $1,000,000.
D. $1,040,000.
B. $980,000.

Preadjusted balance $990,000
Plus radio advertising (benefit was received in 2000; the expense should be recognized in 2000) 50,000
Less the newspaper advertising (benefit to be received in 20X1; there is no expense in 20X0) (60,000)
Equals advertising expense, 2000 $980,000

Zeta Co. reported sales revenue of $4,600,000 in its Income Statement for the year ended December 31, 20X1. Additional information is as follows:

12/31/X0 12/31/X1
Accounts receivable $1,000,000 $1,300,000
Allowance for uncollectible accounts (60,000) (110,000)
Zeta wrote off uncollectible accounts totaling $20,000 during 20X1. Under the cash basis of accounting, Zeta would have reported 20X1 sales of:

A. $4,900,000.
B. $4,350,000.
C. $4,300,000.
D. $4,280,000.
D. $4,280,000.

The question requires a solution for cash collected on accounts receivable. Using the information for accounts receivable, the collections amount can be found:
Beginning balance + sales − collections − write-offs = ending balance
$1,000,000 + $4,600,000 − collections − $20,000 = $1,300,000
collections = $4,280,000
Under the cash basis of accounting, sales equals cash collections.