2011 AICPA financial questions

2011 AICPA Newly Released Questions – Financial Following are multiple choice questions and simulations recently released by the AICPA These questions were released by the AICPA with letter answers only Our editorial board has provided the accompanying explanation Please note that the AICPA generally releases questions that it does NOT intend to use again These questions and content may or may not be representative of questions you may see on any upcoming exams 2011 AICPA Newly Released Questions – Financial Fenn Museum, a nongovernmental not-for-profit organization, had the following balances in its statement of functional expenses: Education $300,000 Fundraising 250,000 Management and general 200,000 Research 50,000 What amount should Fenn report as expenses for support services? a b c d $350,000 $450,000 $500,000 $800,000 Solution: Choice "b" is correct The expenses of not for profit organizations are typically classified within generic functions as either program or support services Program services relate to the mission or service delivery objectives of the organization, while support services relate to costs that indirectly support the organization's mission such as general and administrative costs, fund raising, membership development, etc Of the four expenses listed in the fact pattern, two are clearly support services as follows: Fundraising Management and general Total $250,000 200,000 $450,000 Education and Research expenses are likely program services of the Fen Museum Choice "a" is incorrect The proposed answer combines the likely program service amounts associated with Education and Research to arrive at $350,000 Program services would not be displayed as support services Choice "c" is incorrect The proposed answer either combines the likely program service amount associated with Education and the Support service of Management and General to arrive at $500,000 or combines the program service amount associated with Research and all Support services to arrive at $500,000 Program services would not be displayed as support services Choice "d" is incorrect The proposed answer combines all the amounts in the fact pattern, both program and support services, to arrive at $800,000 Program services would not be displayed as support services 2011 AICPA Newly Released Questions – Financial In January, Stitch, Inc adopted the dollar-value LIFO method of inventory valuation At adoption, inventory was valued at $50,000 During the year, inventory increased $30,000 using base-year prices, and prices increased 10% The designated market value of Stitch's inventory exceeded its cost at year end What amount of inventory should Stitch report in its year-end balance sheet? a b c d $80,000 $83,000 $85,000 $88,000 Solution: Choice "b" is correct Since inventory increased $30,000 using base-year prices, under dollar value LIFO we must restate this increase by the appropriate price-level index, in this case 10% $30,000 times 10% equals $3,000, so this increase actually becomes $33,000 using current-year prices Therefore, the amount of inventory Stitch should report in its year-end balance sheet is the $50,000 at adoption plus the $33,000 increase, so $83,000 in total since they are utilizing dollar-value LIFO for inventory valuation Choice "a" is incorrect $80,000 would only be correct if we were not utilizing dollar-value LIFO Choice "c" is incorrect $85,000 Is incorrect since we not have to adjust the original $50,000 Choice "d" is incorrect $88,000 is incorrect since we only have to adjust the $30,000 increase 2011 AICPA Newly Released Questions – Financial Jonn City entered into a capital lease for equipment during the year How should the asset obtained through the lease be reported in Jonn City's government-wide statement of net assets? a b c d General capital asset Other financing use Expenditure Not reported Solution: Choice "a" is correct Capital lease obligations associated with general governmental activities are recorded as an asset and as a liability on the full accrual government-wide financial statements Governmental fund financial statements would record the asset financed by a capital lease as an expenditure and the lease financing as other financing sources under modified accrual accounting Choice "b" is incorrect Although governmental fund financial statements (GRaSPP funds) would initially record an asset financed by a capital lease as an expenditure and the lease financing as other financing sources under modified accrual accounting, capital lease obligations associated with governmental activities are recorded as an asset and as a liability on the full accrual government-wide financial statements Choice "c" is incorrect Although governmental fund financial statements (GRaSPP funds) would initially record an asset financed by a capital lease as an expenditure and the lease financing as other financing sources under modified accrual accounting, capital lease obligations associated with governmental activities are recorded as an asset and as a liability on the full accrual government-wide financial statements Choice "d" is incorrect Capital lease obligations associated with general governmental activities are recorded as an asset and as a liability on the full accrual government-wide financial statements Capital outlay would be recorded as an expenditure in the modified accrual governmental fund financial statements Lease financing would be recorded as other financing sources in the fund financial statements Governments would report capital lease activity in both fund and government-wide financial statements 2011 AICPA Newly Released Questions – Financial Jane Co owns 90% of the common stock of Dun Corp and 100% of the common stock of Beech Corp On December 30, Dun and Beech each declared a cash dividend of $100,000 for the current year What is the total amount of dividends that should be reported in the December 31 consolidated financial statements of Jane and its subsidiaries, Dun and Beech? a b c d $10,000 $100,000 $190,000 $200,000 Solution: Choice "a" is correct Since Jane owns 90% of Dun and 100% of Beech, when they declare and pay dividends, the only amounts that should appear in their year-end consolidated financial statements are the dividends paid to outsiders or external parties Intercompany dividends should be eliminated upon consolidation In this case, the only non-controlling interest that exists is the 10% of Dun that Jane does not own So all 100% of Beech's $100,000 dividend would be eliminated, but only 90% of Dun's $100,000 would be eliminated Therefore, just 10% of Dun's $100,000 dividend, or $10,000, will appear in Jane and subs' year-end consolidated financial statements Choice "b" is incorrect $100,000 is incorrect since we not present half the dividends just because we don't own 100% of one sub Choice "c" is incorrect $190,000 out of $200,000 in dividends are "eliminated", leaving us with $10,000 reported in the consolidated financial statements Choice "d" is incorrect $200,000 are the total dividends declared, but the $190,000 paid to Jane gets eliminated when the financial statements are consolidated 2011 AICPA Newly Released Questions – Financial Lem Co., which accounts for treasury stock under the par value method, acquired 100 shares of its $6 par value common stock for $10 per share The shares had originally been issued by Lem for $7 per share By what amount would Lem's additional paid-in capital from common stock decrease as a result of the acquisition? a b c d $0 $100 $300 $400 Solution: Choice "b" is correct Under the par value method, when the shares are (re)acquired by Lem, the treasury stock is recorded at par value ($6/share) and additional paid-in-capital is reduced by the $100 recorded when the shares were originally issued The difference, in this case between the $10 buy-back price and the $7 initial issuance price, or $3/share, is assigned to retained earnings as a reduction Here are the journal entries for additional clarification: At issuance: Cash 700 Common Stock 600 Add'l Paid-In-Capital 100 At (re)acquisition: Treasury Stock 600 Add'l Paid-In-Capital 100 Retained Earnings-plug 300 Cash 1,000 Choice "a" is incorrect Under the par value method, the acquisition of treasury stock is recorded by reducing additional paid in capital by the amount recorded when the shares were originally issued to investors Choice "c" is incorrect The $300 difference between the $1,000 paid by the company to reacquire the shares and the $700 originally received when the shares were issued to investors is recorded as a reduction to retained earnings Choice "d" is incorrect The $400 is the amount of both the debit to APIC and the debit to retained earnings This question asks only for the reduction in APIC 2011 AICPA Newly Released Questions – Financial Abbott Co is preparing its statement of cash flows for the year Abbott's cash disbursements during the year included the following: Payment of interest on bonds payable $500,000 Payment of dividends to stockholders 300,000 Payment to acquire 1,000 shares of Marks Co common stock 100,000 What should Abbott report as total cash outflows for financing activities in its statement of cash flows under U.S GAAP? a b c d $0 $300,000 $800,000 $900,000 Solution: Choice "b" is correct The $300,000 dividend to stockholders should be classified as a financing cash outflow Other financing activities would include the issuance of stock, the purchase of treasury stock, the issuance of bonds, borrowing funds, and paying back principal related to bonds and loans The payment of interest on the bonds payable is an operating cash outflow under U.S GAAP and the payment to acquire the common stock of Marks is an investing cash outflow Choice "a" is incorrect The $300,000 dividend to stockholders should be classified as a financing cash outflow Choice "c" is incorrect The $500,000 payment of interest, although related to a financing activity, is not reported in the financing section under U.S.GAAP It is reported as an operating cash outflow Choice "d" is incorrect The $100,000 payment to acquire someone else's common stock should be classified as an investing activity 2011 AICPA Newly Released Questions – Financial In preparing Chase City's reconciliation of the statement of revenues, expenditures, and changes in fund balances to the government-wide statement of activities, which of the following items should be subtracted from changes in fund balances? a b c d Capital assets purchases Payment of long-term debt principal Internal service fund increase in net assets Book value of capital assets sold during the year Solution: Choice "d" is correct The elimination of the book value of a previously acquired asset has no impact on fund financial statements but serves to reduce the changes in net assets of the government-wide financial statements as the asset is written off (net of proceeds and accumulated depreciation) The book value of capital assets is, therefore, essentially subtracted from change in fund balance to reconcile to the change in government-wide net assets Actual reconciling items might focus more on the computation of a gain or loss and proceeds from the disposal rather than individual components such as the asset book value Choice "a" is incorrect Capital asset purchases are added back to the changes in fund balance to reconcile to the change in net assets displayed on the government-wide statement of activities Capital asset purchases are displayed as an expenditure in fund financial statements but are capitalized in the government-wide financial statements Capital outlay is the "E" in "GOES" and is added back, not subtracted Choice "b" is incorrect Payment of long term debt principal is added back to the changes in fund balance to reconcile to the change in net assets displayed on the government-wide statement of activities Payment of long term debt principal is displayed as an expenditure in fund financial statements but is shown as a reduction liabilities in the government-wide financial statements Principal payment on debt is part of the "E" in "GOES" and is added back, not subtracted Choice "c" is incorrect Increases in internal service fund net assets would be added to the changes in fund balance to reconcile to the change in net assets displayed on the government-wide statement of activities A net loss in the internal service funds would be subtracted Internal Service fund activity is the "S" in "GOES" and is added back 2011 AICPA Newly Released Questions – Financial Neron Co has two derivatives related to two different financial instruments, instrument A and instrument B, both of which are debt instruments The derivative related to instrument A is a fair value hedge, and the derivative related to instrument B is a cash flow hedge Neron experienced gains in the value of instruments A and B due to a change in interest rates Which of the gains should be reported by Neron in its income statement? a b c d Gain in value of debt instrument A Yes Yes No No Gain in value of debt instrument B Yes No Yes No Solution: Choice "b" is correct Fair value hedge gains and losses are recorded on the income statement, while cash flow hedge gains and losses, to the extent they are effective (which is assumed in this fact pattern), are recorded as a component of other comprehensive income (the E in our PUFER mnemonic.) Choice "a" is incorrect Only fair value hedge gains and losses should be reported within the income statement Choice "c" is incorrect This selection is backwards Fair value gains and losses appear on the income statement while cash flows gains and losses should be presented as a component of other comprehensive income (PUFER) Choice "d" is incorrect Fair value hedge gains and losses are to be reported within the income statement 2011 AICPA Newly Released Questions – Financial Fern Co has net income, before taxes, of $200,000, including $20,000 interest revenue from municipal bonds and $10,000 paid for officers' life insurance premiums where the company is the beneficiary The tax rate for the current year is 30% What is Fern's effective tax rate? a b c d 27.0% 28.5% 30.0% 31.5% Solution: Choice "b" is correct The municipal bond income and keyperson life insurance premiums are both permanent differences Therefore, pretax income must be adjusted for both items to compute taxable income: Pretax income - Municipal bond income + Life insurance premiums Taxable income $200,000 (20,000) 10,000 $190,000 The $20,000 of municipal bond income is subtracted because it is not taxable income The insurance premiums are added back because they are not deductible Because there are no temporary differences and no deferred taxes, income tax expense is equal to taxable income times the current period tax rate: Income tax expense = Taxable income x Tax rate = $190,000 x 30% = $57,000 The effective tax rate can then be calculated as income tax expense divided by pretax income: Effective tax rate = Income tax expense / Pretax income = $57,000 / $200,000 = 28.5% Choice "a" is incorrect This answer choice would result if you computed $180,000 times 30% or $54,000 and divided this back by the $200,000 However, this is incorrect since you must remember to add back the $10,000 in insurance premiums Choice "c" is incorrect The effective tax rate is equal to income tax expense divided by pretax income The effective tax rate is not equal to the current year tax rate of 30% due to the existence of the two permanent differences Choice "d" is incorrect This answer choice would result if the municipal bond income was added and the life insurance premiums were subtracted when calculating taxable income The $20,000 of municipal bond income should be subtracted because it is not taxable income The insurance premiums should be added back because they are not deductible 10 2011 AICPA Newly Released Questions – Financial 44 Which of the following items would best enable Driver Co to determine whether the fair value of its investment in Favre Corp is properly stated in the balance sheet? a b c d Discounted cash flow of Favre's operations Quoted market prices available from a business broker for a similar asset Quoted market prices on a stock exchange for an identical asset Historical performance and return on Driver's investment in Favre Solution: Choice "c" is correct Quoted market prices on a stock exchange for an identical asset are considered to be a Level One input, the most reliable of all Choice "a" is incorrect The discounted cash flow of Favre's operations are considered to be a Level Two input, not as reliable as those coming from a stock exchange for an identical asset Choice "b" is incorrect Quoted market prices available from a business broker for a similar asset are considered to be a Level Two input, not as reliable as those coming from a stock exchange for an identical asset Choice "d" is incorrect The historical performance and return on Driver's investment in Favre are considered to be Level Three unobservable inputs, the least reliable of all 45 2011 AICPA Newly Released Questions – Financial 45 A company has a defined benefit pension plan for its employees On December 31, year 1, the accumulated benefit obligation is $45,900, the projected benefit obligation is $68,100, and the fair value of the plan assets is $62,000 What amount, if any, related to the defined benefit plan should be recognized in the balance sheet at December 31, year 1? a b c d An asset of $16,100 A liability of $6,100 Nothing, as the fair value of the plan assets exceeds the accumulated benefit obligation An unrealized loss of $6,100 Solution: Choice "b" is correct Since the projected benefit obligation (PBO) of $68,100 exceeds the fair value of the plan assets of $62,000, the pension is underfunded and a $6,100 liability should be recognized in the year-end balance sheet Choices "a" is incorrect The ABO is not used to compute the funded status of the pension plan Choice "c" is incorrect The ABO is not used to compute the funded status of the pension plan Choice "d" is incorrect This pension plan is underfunded by $6,100 ($68,100 PBO - $62,000 fair value of plan assets) An underfunded pension plan is reported as a liability on the balance sheet, not as an unrealized loss 46 2011 AICPA Newly Released Questions – Financial 46 A company's activities for year included the following: Gross sales Cost of goods sold Selling and administrative expense Adjustment for a prior-year understatement of amortization expense Sales returns Gain on sale of available-for-sale securities Gain on disposal of a discontinued business segment Unrealized gain on available-for-sale securities $3,600,000 1,200,000 500,000 59,000 34,000 8,000 4,000 2,000 The company has a 30% effective income tax rate What is the company's net income for year 2? a b c d $1,267,700 $1,273,300 $1,314,600 $1,316,000 Solution: Choice "c" is correct Net sales 3,566,000 = $3,600,000 gross sales - $34,000 sales returns Cost of goods sold (1,200,000) Gross profit 2,366,000 Selling and administrative Operating income (500,000) 1,866,000 Other income (gain on sale) Income from continuing operations 8,000 1,874,000 Income tax expense Income before discontinued operations (562,200) = $1,874,000 x 30% 1,311,800 Gain from discontinued segment (after tax) Net income 2,800 = $4,000 x (1 – 30%) 1,314,600 The adjustment for the prior year understatement of amortization expense is a prior period adjustment that will be reflected in beginning retained earnings, not on the income statement The unrealized gain on the available for sale security will be reported in other comprehensive income 47 2011 AICPA Newly Released Questions – Financial 47 How should plan investments be reported in a defined benefit plan's financial statements? a b c d At actuarial present value At cost At net realizable value At fair value Solution: Choice "d" is correct Pension plan investment assets must be reported at fair value in a defined benefit plan's financial statements Choices "a", "b", and "c" are incorrect Actuarial present value, cost, and net realizable value are not appropriate bases for measuring pension plan asset investments 48 2011 AICPA Newly Released Questions – Financial 48 What is the purpose of reporting comprehensive income? a b c d To summarize all changes in equity from nonowner sources To reconcile the difference between net income and cash flows provided from operating activities To provide a consolidation of the income of the firm's segments To provide information for each segment of the business Solution: Choice "a" is correct Comprehensive income represents all changes in stockholders' equity that come from nonowner sources Therefore, comprehensive income includes all net income plus any and all components of other comprehensive income, the PUFER items However, comprehensive income would not include investments by stockholders (owners) nor would it include distributions or dividends to stockholders (owners) Choices "b", "c", and "d" are incorrect per the explanation above 49 2011 AICPA Newly Released Questions – Financial 49 Which of the following is a component of other comprehensive income? a b c d Minimum accrual of vacation pay Cumulative currency-translation adjustments Changes in market value of inventory Unrealized gain or loss on trading securities Solution: Choice "b" is correct Cumulative currency translation adjustments are reported in other comprehensive income Choice "a" is incorrect Vacation pay is a standard operating item that properly affects net income, not OCI Choice "c" is incorrect Changes in market value of inventory, in accordance with lower of cost or market (GAAP) or lower of cost or realizable value (IFRS) would also properly affect net income, not OCI Choice "d" is incorrect Unrealized gains and loss on trading securities go directly to the income statement Its unrealized gains and losses on available-for-sale securities that would affect OCI 50 2011 AICPA Newly Released Questions – Financial 50 Nongovernmental not-for-profit organizations are required to provide which of the following external financial statements? a b c d Statement of financial position, statement of activities, statement of cash flows Statement of financial position, statement of comprehensive income, statement of cash flows Statement of comprehensive income, statement of cash flows, statement of gains and losses Statement of cash flows, statement of comprehensive income, statement of unrelated business income Solution: Choice "a" is correct A not for profit organization is required to produce a statement of financial position, statement of activities and statement of cash flows Voluntary health and welfare organizations must produce a statement of functional expenses as well, however, that statement is not mandatory for other not for profit organizations Choice "b" is incorrect A not for profit organization is required to produce a statement of financial position, statement of activities and statement of cash flows Not for profit organizations not contemplate the concept of comprehensive income Choice "c" is incorrect A not for profit organization is required to produce a statement of financial position, statement of activities and statement of cash flows Not for profit organizations not contemplate the concept of comprehensive income There is no statement of gains and losses Choice "d" is incorrect A not for profit organization is required to produce a statement of financial position, statement of activities and statement of cash flows Not for profit organizations not contemplate the concept of comprehensive income Unrelated business income, while highly significant to tax reporting, is not a required component of external GAAP reporting 51 2011 AICPA Newly Released Questions – Financial AICPA Newly Released FAR Simulations Task 543_01 52 2011 AICPA Newly Released Questions – Financial 53 2011 AICPA Newly Released Questions – Financial 54 2011 AICPA Newly Released Questions – Financial Explanation: SITUATION The gain or loss on the intercompany sale of a depreciable asset is unrealized from a consolidated financial statement perspective until the asset is sold to an outsider An elimination entry in the period of the sale eliminates the intercompany gain/loss and adjusts the asset and accumulated depreciation to their original balance on the date of sale: DR CR CR CR Gain on sale Accumulated depreciation Depreciation expense Equipment 40,000 15,000 5,000 20,000 Gain on Sale, $40,000 Debit Since Peterson sold the equipment to Silver, a 100% subsidiary, the gain of $40,000 is eliminated It was originally entered in the books of Peterson as a credit and is calculated as the sales price of the asset of $120,000, less the net book value of $80,00 ($100,000 cost less accumulated depreciation on 1/1/Y3 of $20,000) Accumulated Depreciation, $15,000 Credit The accumulated depreciation for the consolidated group at December 31, Yr is based on the original cost of $100,000 Three years of accumulated straight line depreciation is $30,000 The accumulated depreciation shown by the separate companies is as follows: $0 for Peterson since the accumulated depreciation was removed as part of the journal entry recorded at the time of the sale $15,000 for Silver Corp., based on one year of straight-line depreciation ($120,000/8 years) The eliminating journal entry raises the accumulated depreciation from $15,000 to the correct amount of $30,000 Depreciation Expense, $5,000 Credit The correct amount of depreciation expense for Year is $10,000 based on the original purchase of the asset by Peterson ($100,000 cost to Peterson / 10 years = $10,000) Silver Corp recorded depreciation of $15,000 based on their purchase of the asset at the beginning of Year3 ($120,000 cost to Silva / years = $15,000) The eliminating journal entry reduces the depreciation from $15,000 to the correct amount of $10,000 Equipment, $20,000 Credit The original cost of the equipment to Peterson is $100,000 The $120,000 cost of the asset to Silva must be reduced to the original amount paid by Peterson 55 2011 AICPA Newly Released Questions – Financial SITUATION When affiliated companies sell inventory to one another, the total amount of the intercompany sale and cost of goods sold is eliminated when preparing consolidated financial statements In addition, the intercompany profit must be eliminated from the ending inventory and cost of goods sold of the group DR CR CR Sales 50,000 Inventory Cost of goods sold 8,000 42,000 Sales, $50,000 Debit The gross sale amount of Peterson’s sale to Silver is eliminated Inventory, $8,000 Credit 40% of the goods sold by Peterson are still in the ending inventory of Silver The original cost of this inventory on Peterson's books was $12,000 ($30,000 x 40%) The inventory is on Silver’s books at the cost to Silva of $20,000 ($50,000 x 40%) The reduction of inventory adjusts the $20,000 inventory on the books of Silver to the correct amount of $12,000, the original cost to Peterson Cost of Goods Sold, $42,000 Credit The entire amount of Peterson’s cost of goods sold is eliminated This amount is $30,000 In addition, Silver’s cost of sales is based on the price paid to Peterson for the inventory The additional cost Silver paid is $20,000 ($50,000 intercompany sales price - $30,000 cost of goods sold) The amount that was sold represents 60% of $20,000, so that another $12,000 needs to be eliminated to show the cost of goods sold based on the original cost to Peterson 56 2011 AICPA Newly Released Questions – Financial Task 618_01 57 2011 AICPA Newly Released Questions – Financial Explanation: Construction period interest should be capitalized (based on the weighted average of accumulated expenditures) as part of the cost of producing fixed assets Weighted average of accumulated expenditures for year 2: $360,000 The weighted average amount of accumulated expenditures (WAAE) for year is calculated as follows: $130,000 $370,000 $570,000 1/1-3/31/Y2 months 4/1-9/30/Y2 10/1-12/31/Y2 $ 390,000 2,220,000 1,710,000 $4,320,000/12 months Weighted average of accumulated expenditures $360,000 Interest incurred for all borrowings for year 2: $67,000 The interest expense is calculated as follows: $300,000 Loan $100,000 $300,000 12% 10% 7% Total interest for the year $36,000 10,000 21,000 $67,000 All loans were payable throughout Year Avoidable interest for year 2, $40,650 The amount of avoidable interest is the interest that would not have been incurred if the construction project had not taken place: Interest on construction note borrowings: $300,000 construction note x 12% = $36,000 Interest on other borrowings used for construction: Total WAAE $360,000 Less: Construction note funds (300,000) Other borrowings used for construction 60,000 Weighted-average interest rate on other borrowings: ($10,000 + $21,000)/($100,000 + $300,000) = 8% Interest on other borrowings used for construction = $60,000 x 8% = $4,650 Avoidable interest = $36,000 + $4,650 = $40,650 Interest capitalized for Year 2, $40,650 Capitalized interest cannot exceed the actual interest incurred for the period The capitalized interest for year is $40,650 because the avoidable interest of $40,650 is less than the interest incurred of $67,000 Interest expense for Year 2, $26,350 The interest expense is the amount to be shown on the income statement and is the difference between the total interest of $67,000 and the capitalized interest of $40,650 58 2011 AICPA Newly Released Questions – Financial Task 4466_01 Keywords: Cash flow per share 59 ... sources in the fund financial statements Governments would report capital lease activity in both fund and government-wide financial statements 2011 AICPA Newly Released Questions – Financial Jane... lease 37 2011 AICPA Newly Released Questions – Financial 37 Which of the following activities should be excluded when governmental fund financial statements are converted to government-wide financial. .. activity is the "S" in "GOES" and is added back 2011 AICPA Newly Released Questions – Financial Neron Co has two derivatives related to two different financial instruments, instrument A and instrument