Test Bank For Financial Accounting Theory and Analysis: Text and Cases Tenth (10th) By Richa

Test Bank For Financial Accounting Theory and

Analysis: Text and Cases Tenth (10th) By Richard G.
Schroeder, Myrtle W. Clark, Jack M. Cathey

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 Example Test Questions
Chapter 9

Multiple Choice

1. When a closely held corporation issues preferred stock for land, the land should be recorded at
the
a. Total par value of the stock issued
b. Total book value of the stock issued
c. Appraised value of the land
d. Total liquidating value of the stock issued

Answer c

2. A principal objection to the straight-line method of depreciation is that it

a. Provides for the declining productivity of an aging asset
b. Ignores variations in the rate of asset use
c. Tends to result in a constant rate of return on a diminishing investment base
d. Gives smaller periodic write-offs than decreasing charge methods

Answer b

3. Property, plant, and equipment are conventionally presented n the balance sheet at
a. Replacement cost less accumulated depreciation
b. Historical cost less salvage value
c. Original cost adjusted for general price level changes
d. Acquisition cost less depreciated portion thereof

Answer d

4. As generally used in accounting, depreciation

a. Is a process of asset valuation for balance sheet purposes
b. Applies only to long-lived intangible assets
c. Is used to indicate a decline in market value of a long-lived asset
d. Is an accounting process that allocates long-lived asset cost to accounting periods

Answer d

5. Lyle, Inc., purchased certain plant assets under a deferred payment contract on December 31,
2011. The agreement was to pay $20,000 at the time of purchase and $20,000 at the end of each
of the next five years. The plant assets should be valued at
a. The present value of a $20,000 ordinary annuity for five years
b. $120,000
 c. $120,000 less imputed interest
d. $120,000 plus imputed interest

Answer c

6. For income statement purposes, depreciation is a variable expense if the depreciation method
used for book purposes is
a. Units of production
b. Straight line
c. Sum-of-the-year’s-digits
d. Declining balance

Answer a

7. A method that excludes salvage value from the base for the depreciation calculation is
a. Straight line
b. Sum-of-the-year’s digits
c. Double-declining balance
d. Productive output

Answer c

8. When a company purchases land with a building on it and immediately tears down the building so
that the land can be used for the construction of a plant, the cost incurred to tear down the
building should be
a. Expensed as incurred
b. Added to the cost of the plant
c. Added to the cost of the land
d. Amortized over the estimated time period between the tearing down of the building and the
completion of the plant

Answer c

9. A machine with a four-year estimated useful life and an estimated 15 percent salvage value was
acquired on January 1, 2010. On December 31, 2012, the accumulated depreciation using the
sum-of-year’s digits method would be
a. (Original cost less salvage value) multiplied by 9/10
b. Original cost multiplied by 9/10
c. Original cost multiplied by 9/10 less total salvage value
d. (Original cost less salvage value) multiplied by 1/10

Answer a

10. The theoretical justification for reporting depreciation expense is

 a. Depreciation expense represents a decrease in the value of the asset that has occurred during
the accounting period.
b. Depreciation expense represents the impairment of the asset that has occurred during the
accounting period.
c. Depreciation expense represents the unrealized loss that has been incurred by using the asset
during the accounting period.
d. Depreciation expense represents the allocation of the historical cost of the asset that has been
applied to the accounting period.

Answer d

11. A company using the group depreciation method for its delivery trucks retired one of its delivery
trucks due to damage before the average service life of the group was reached. An insurance
recovery was received. The net book value of these group asset accounts would be decreased by
the
a. Original cost of the truck
b. Original cost of the truck less the insurance recovery received
c. Original cost of the truck less depreciation on the truck to the date of retirement
d. Insurance recovery received

Answer b

12. When equipment is retired, accumulated depreciation is debited for the original cost less any
residual recovery under which of the following depreciation methods?

Composite Group
Depreciation Depreciation
a. No No
b. No Yes
c. Yes No
d. Yes Yes

Answer d

13. Recognizing depletion expense is an example of the accounting process of

Allocation Amortization
a. No No
b. No Yes
c. Yes Yes
d. Yes No

Answer c
 14. A donated plant asset for which the fair value has been determined, and for which incidental
costs were incurred in acceptance of the asset, should be recorded at an amount equal to its
a. Incidental costs incurred
b. Fair value and incidental costs incurred
c. Book value on books of donor and incidental costs incurred
d. Book value on books of donor

Answer b

Essay

1. List the objectives of accounting for property, plant and equipment.

The objectives of plant and equipment accounting are:

1. Reporting to investors on stewardship.

2. Accounting for the use and deterioration of plant and equipment.
3. Planning for new acquisitions, through budgeting.
4. Supplying information for taxing authorities.
5. Supplying rate-making information for regulated industries

2. Describe how cost is assigned to individual assets when they are acquired in a lump-sum group
purchase.

When a group of assets is acquired for a lump-sum purchase price, such as the purchase of land,
buildings, and equipment for a single purchase price, the total acquisition cost must be allocated
to the individual assets so that an appropriate amount of cost can be charged to expense as the
service potential of the individual assets expires. The most frequent, though arbitrary, solution to
this allocation problem has been to assign the acquisition cost to the various assets on the basis of
the weighted average of their respective appraisal values. Where appraisal values are not
available, the cost assignment may be based on the relative carrying values on the seller’s books.

3. Discuss the three approaches to allocating fixed overhead to a self-construction project.

The three approaches are:

1. Allocate no fixed overhead to the self-construction project. Some accountants favor the first
approach. They argue that the allocation of fixed overhead is arbitrary and therefore only
direct costs should be considered.
2. Allocate only incremental fixed overhead to the project. When operations are at less than
full capacity, this approach is the most logical. The decision to build the asset was probably
connected with the availability of idle facilities. Increasing the profit margin on existing
products by allocating a portion of the fixed overhead to the self-construction project will
distort reported profits.
 3. Allocate fixed overhead to the project on the same basis as it is allocated to other products.
When the production of other products has been discontinued to produce a self-
constructed asset, allocation of the entire amount of fixed overhead to the remaining
products will cause reported profits on these products to decrease. (The same amount of
overhead is allocated to fewer products.)

4. Discuss the issue of allocating interest to self construction projects. That is, when should interest
be allocated and how much interest should be allocated?

During the construction period, extra financing for materials and supplies will undoubtedly be
required, and these funds will frequently be obtained from external sources. The central
question is the advisability of capitalizing the cost associated with the use of these funds. Some
accountants have argued that interest is a financing rather than an operating charge and should
not be charged against the asset. Others have noted that if the asset were acquired from
outsiders, interest charges would undoubtedly be part of the cost basis to the seller and would
be included in the sales price. In addition, public utilities normally capitalize both actual and
implicit interest (when their own funds are used) on construction projects because future rates
are based on the costs of services. Charging existing products for the expenses associated with a
separate decision results in an improper matching of costs and revenues. Therefore, a more
logical approach is to capitalize incremental interest charges during the construction period.
Once the new asset is placed in service, interest is charged against operations. The FASB ASC
835-20-30 guidance indicates that the amount of interest to be capitalized is the amount that
could have been avoided if the asset had not been constructed. Two interest rates may be used:
the weighted average rate of interest charges during the period and the interest charge on a
specific debt instrument issued to finance the project. The amount of avoidable interest is
determined by applying the appropriate interest rate to the average amount of accumulated
expenditures for the asset during the construction period.

5. Explain the concept of commercial substance originally outlined in SFAS No. 158.

A nonmonetary exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. For these exchanges, the book value
of the asset exchanged is to be used to measure the asset acquired in the exchange. Thus, no gains
are to be recognized; however, a loss should be recognized if the fair value of the asset exchanged
is less than its book value (i.e., an impairment is evident).

6. How did SFAS No. 116, now FASB ASC 605-10-15-3, change the accounting for donated assets?

Previous practice required donated assets to be recorded at their fair market values, with a
corresponding increase in an equity account termed donated capital. Recording donated assets
at fair market values is defended on the grounds that if the donation had been in cash, the
amount received would have been recorded as donated capital, and the cash could have been
used to purchase the asset at its fair market value. SFAS No. 116 (See 605-10-15-3), requires that
the inflow of assets from a donation be considered revenue (not donated capital).
7. Discuss the factors comprising the depreciation process.

The depreciation process for long-term assets comprises three separate factors:

1. Establishing the depreciation base.

2. Estimating the useful service life.
3. Choosing a cost apportionment method.

8. Discuss the distinction between capital and revenue expenditures for long-term assets.

In most cases, the decision to expense or capitalize plant and equipment expenditures subsequent
to acquisition is fairly simple and is based on whether the cost incurred is “ordinary and
necessary” or “prolongs future life.” Expenditures in the first category are expensed while those
in the second category are capitalized.

9. Discuss accounting for asset impairments originally outlined in SFAS No’s 121 and 144.

The FASB, noting divergent practices in the recognition of impairment of long-lived assets,
originally issued SFAS No. 121, now superseded, which addressed the matter of when to
recognize the impairment of long-lived assets and how to measure the loss. This release ignored
current value as a determinant of impairment. Rather, it stated that impairment occurs when
the carrying amount of the asset is not recoverable. The recoverable amount is defined as the
sum of the future cash flows expected to result from use of the asset and its eventual disposal.
Under this standard, companies were required to review long-lived assets (including intangibles)
for impairment whenever events or changes in circumstances indicate that book value may not
be recoverable. The FASB, noting divergent practices in the recognition of impairment of long-
lived assets, originally issued SFAS No. 121, now superseded, which addressed the matter of
when to recognize the impairment of long-lived assets and how to measure the loss. This
release ignored current value as a determinant of impairment. Rather, it stated that impairment
occurs when the carrying amount of the asset is not recoverable. The recoverable amount is
defined as the sum of the future cash flows expected to result from use of the asset and its
eventual disposal. Under this standard, companies were required to review long-lived assets
(including intangibles) for impairment whenever events or changes in circumstances indicate
that book value may not be recoverable. The guidance from SFAS No. 144now contained at at
FASB ASC 360-10-40 applies to all dispositions of long-term assets; however, it excludes current
assets, intangibles, and financial instruments because they are covered in other releases.
According to its provisions, assets are to be classified as:

1. Long-term assets held and used.

2. Long-lived assets to be disposed of other than by sale.
3. Long-lived assets to be disposed of by sale.
 Long-term assets held and used are to be tested for impairment using the original SFAS No. 121
criteria if events suggest there may have been impairment. The impairment is to be measured at
fair value by using the present value procedures outlined in SFAC No. 7 (see Chapter 2).

Long-lived assets to be disposed of other than by sale, such as those to be abandoned,

exchanged for a similar productive asset, or distributed to owners in a spin-off, are to be
considered held and used until disposed of. Additionally, in order to resolve implementation
issues, the depreciable life of a long-lived asset to be abandoned was to be revised in
accordance with the criteria originally established in APB Opinion No. 20, “Accounting Changes”
(Since rescinded).

The accounting treatment for long-lived assets to be disposed of by sale is used for all long-lived
assets, whether previously held and used or newly acquired (FASB ASC 360-10-35). That
treatment retains the requirement originally outlined in SFAS No. 121 to measure a long-lived
asset classified as held for sale at the lower of its carrying amount or fair value less cost to sell
and to cease depreciation (amortization). As a result, discontinued operations are no longer
measured on a net realizable value basis, and future operating losses are no longer recognized
before they occur.

In summary, SFAS No. 144 retained the requirements of SFAS No. 121 to recognize an
impairment loss only if the carrying amount of a long-lived asset is not recoverable from its
undiscounted cash flows. This loss is measured as the difference between the carrying amount
and fair value of the asset (FASB ASC 360-10-35-17).

10. Define and discuss accounting for asset retirement obligations under SFAS No. 14FASB ASC
410-20.

According to the provisions of SFAS No. 144 Long-lived assets to be disposed of other than by
sale, such as those to be abandoned, exchanged for a similar productive asset, or distributed to
owners in a spin-off, are to be considered held and used until disposed of. Additionally, in order
to resolve implementation issues, the depreciable life of a long-lived asset to be abandoned was
to be revised in accordance with the criteria originally established in APB Opinion No. 20,
“Accounting Changes” (Since rescinded).

The accounting treatment for long-lived assets to be disposed of by sale is used for all long-lived
assets, whether previously held and used or newly acquired (FASB ASC 360-10-35). That
treatment retains the requirement originally outlined in SFAS No. 121 to measure a long-lived
asset classified as held for sale at the lower of its carrying amount or fair value less cost to sell
and to cease depreciation (amortization). As a result, discontinued operations are no longer
measured on a net realizable value basis, and future operating losses are no longer recognized
before they occur.

In summary, SFAS No. 144 retained the requirements of SFAS No. 121 to recognize an
impairment loss only if the carrying amount of a long-lived asset is not recoverable from its
Test Bank For Financial Accounting Theory and Analysis: Text and Cases Tenth (10th) By Richa

undiscounted cash flows. This loss is measured as the difference between the carrying amount
and fair value of the asset (FASB ASC 360-10-35-17).

11. Discuss the guidelines for accounting for property, plant and equipment outlined in IAS No. 16.

IAS No. 16 indicates that items of property, plant, and equipment should be recognized as assets
when it is probable that the future economic benefit associated with these assets will flow to
the enterprise and that their cost can be reliably measured. Under these circumstances, the
initial measurement of the value of the asset is defined as its cost. Subsequently, the stated
preferred treatment is to depreciate the asset’s historical cost; however, an allowed alternative
treatment is to periodically revalue the asset to its fair market value. When such revaluations
occur, increases in value are to be recorded in stockholders’ equity, unless a previously existing
reevaluation surplus exists, whereas decreases are recorded as current-period expenses. In the
event a revaluation is undertaken, the statement requires that the entire group of assets to
which the revalued asset belongs also be revalued. Examples of groups of property, plant, and
equipment assets are land, buildings, and machinery. Finally, the required disclosures for items
of property, plant, and equipment include the measurement bases used for the assets, as well
as a reconciliation of the beginning and ending balances to include disposals and acquisitions
and any revaluation adjustments.

IAS No. 16 also requires companies to periodically review the carrying amounts of items of
property, plant, and equipment to determine whether the recoverable amount of the asset has
declined below its carrying amount. When such a decline has occurred, the carrying amount of
the asset must be reduced to the recoverable amount, and this reduction is recognized as an
expense in the current period. IAS No. 16 also requires write-ups when the circumstances or
events that led to write-downs cease to exist. This treatment contrasts to the requirements of
SFAS No. 144 (See FASB ASC 360-10), which prohibits recognition of subsequent recoveries.

12. How does IAS no. 23 define borrowing costs?

IAS No. 23 defines borrowing costs as interest on bank overdrafts and borrowings, amortization
of discounts or premiums on borrowings, amortization of ancillary costs incurred in the
arrangement of borrowings, finance charges on finance leases and exchange differences on
foreign currency borrowings where they are regarded as an adjustment to interest costs.

13. Discuss accounting for the impairment of assets as outlined in IAS No. 36.

The purpose of IAS No. 36 is to make sure that assets are carried at no more than their recoverable
amount, and to define how the recoverable amount is calculated. IAS No. 36 requires an
impairment loss to be recognized whenever the recoverable amount of an asset is less than its
carrying amount (its book value). The recoverable amount of an asset is the higher of its net
selling price and its value in use. Both are based on present-value calculations.

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