1. Unrealized holding gains/losses would be included in earnings for which of the following securities?

Choice 1 is correct. Trading securities are reported at fair value with unrealized gains and losses
included in earnings. Held-to-maturity securities are reported at their amortized costs.

2. According to the FASB conceptual framework, which of the following would cause earnings to differ
from comprehensive income?

3. Which of the following would be considered an element of comprehensive income?

Comprehensive income is the change in equity (net assets) of a business enterprise during a period from
transactions and other events and circumstances from non owner sources. It includes all changes in
equity during a period except those resulting from investments by owners and distributions to owners.

Comprehensive income is the total of all components of comprehensive income including net income and
other comprehensive income.

4. On January 1, Year 2, West Co. adopted the dollar-value LIFO inventory method. Inventory data for
Year 2 and Year 3 are as follows:

Inventory Relevant
Date Current Year Cost Price Index
1/1/Year 2 $250,000 1.00
12/31/Year 2 $278,250 1.05
12/31/Year 3 $364,000 1.12

West's dollar-value LIFO inventory at December 31, Year 3 is:

Cy Index Base Layer Index Result

C ÷ I = B → L x I = R

250,0001.00 250,000 250,0001.00 $250,000

278,2501.05 265,000 250,0001.00 $250,000

15,0001.05 15,750
$265,750

364,0001.12 325,000 250,0001.00 $250,000

15,0001.05 15,750
60,0001.12 67,200
$332,950
Choice 1 is incorrect. $364,000 is the inventory at current year cost and not the dollar-value LIFO
inventory.

Choice 2 is incorrect. $328,750 is the dollar-value inventory of $332,950 with the 3 rd year layer re-
inflated by the year 2 index of 1.05 instead of the year 3 index of 1.12. The 3 rd year layer would have
been $63,000 instead of $67,200 and the total would have been $328,750 instead of $332,950. Each
year's layer must be re-inflated by that year's index.
Choice 4 is incorrect. $325,000 is the dollar-value inventory calculated without re-inflating the layers by
the price indexes ($250,000 + $15,000 + $60,000). Each year's layer must be re-inflated by that year's
index.

5. On July 1, Year 1, Tracy Co. sold a machine to Chester Co. for a non-interest bearing note. The note
requires ten annual payments of $10,000. Chester made the first payment on June 30, Year 2. The
market interest rate for similar notes was determined to be 8%. Information on present value factors is
as follows:

Present value
of ordinary
Present value annuity of
Period of $1 at 8% $1 at 8%
9 0.50 6.25
10 0.46 6.71

Assume that the machine had a carrying value of $45,000 on Tracy's books on July 1, Year 1.

In Tracy's Year 1 income statement, what amount should be reported as gain on sale of machinery?

Choice 1 is correct.
Present value of payments $10,000 x 6.71 = $67,100
Less: Carrying value (45,000)
Gain on sale $22,100
Choice 2 is incorrect. $17,500 is calculated by using the 9-period present value factor of 6.25 instead of
the 10-period present value factor of 6.71. The present value of the payments would have been $62,500
instead of $67,100 and the gain $17,500 instead of $22,100. Since at the date of sale, there were 10
payments remaining, the 10-period present value factor must be used.

6. On July 1, Year 1, Tracy Co. sold a machine to Chester Co. for a non-interest bearing note. The note
requires ten annual payments of $10,000. Chester made the first payment on June 30, Year 2. The
market interest rate for similar notes was determined to be 8%. Information on present value factors is
as follows:
Present value
of ordinary
Present value annuity of
Period of $1 at 8% $1 at 8%
9 0.50 6.25
10 0.46 6.71
Assume that the machine had a carrying value of $45,000 on Tracy’s books on July 1, Year 1.

In Tracy’s December 31, Year 1 income statement, what amount should be reported as interest income?

Present value of payments $10,000 x 6.71 = $67,100

Interest rate (8% x 1/2 year) x 4%
Interest income $ 2,684
Choice 1 is incorrect. $5,000 is calculated by using the $10,000 payment in the first year as interest for
that full year and then by dividing it by 2 to reflect that the sale occurred halfway through the year. Each
payment includes principal and interest.
Choice 2 is incorrect. $5,368 is calculated by using a full year’s interest instead of a half year’s interest.
It would be easy to calculate $5,538 by not reading the question carefully enough. For any question
where dates are important, such as a question where interest is calculated, watch the dates.

Choice 4 is incorrect. $0 is calculated by assuming that, since the note is stated to be non-interest
bearing, there is no interest. There is no such thing as a free lunch. If a note is non-interest bearing or
if the rate is unreasonably low for a note of that type, a reasonable interest rate must be used to impute
interest.

7. Bentley Company leased equipment from Babson Company for a six year term beginning July 1, Year
1. The lease was appropriately accounted for as an operating lease. The rent for the first lease year is
$8,000, and the rental charge for each of the remaining five years is $10,600. However, as an incentive
to lease its equipment, Babson provided the first six months of the lease rent free. In its December 31,
Year 1 income statement, what was Bentley's rental expense?

Annual (years 2 - 6) $10,600

Term (years 2 - 6) x 5 yrs
Expense (years 2 - 6) $53,000
Expense (1st year) 8,000
Free rent (4,000)
Total rent to be paid $57,000
Total years ÷ 6 yrs
Annual rental expense $ 9,500
Period (July - Dec.) x 1/2 yr
Period rental expense $ 4,750
Choice 1 is incorrect. $8,000 is calculated by using the cash paid out during the first lease year as the
rental expense for Year 1. The accrual basis of accounting requires that the total rent to be paid be
expensed evenly over the lease term.

Choice 2 is incorrect. $4,000 is calculated by using ½ of the cash paid out during the first lease year as
the rental expense for Year 1. The accrual basis of accounting requires that the total rent to be paid be
expensed evenly over the lease term.

Choice 3 is incorrect. $9,500 is calculated by using the calculated annual rental expense and ignoring the
fact that the lease was signed on July 1. For any question where dates are important, such as a question
where lease payments are calculated, watch the dates.

8. On December 31, Day Co. leased a new machine from Parr with the following pertinent information:

Lease term 6 years

Annual rental payable at beginning of each year $50,000
Useful life of machine 8 years
Day's incremental borrowing rate 15%
Implicit interest rate in lease (known by Day) 12%
Present value of an annuity of 1 in
advance for 6 periods at:
12% 4.61
15% 4.35

The lease is not renewable, and the machine reverts to Parr at the termination of the lease. The cost of
the machine on Parr's accounting records is $375,000. At the beginning of the lease term, Day should
record a lease liability of:
 Ownership = No
Written Bargain = No
Ninety % FMV = Unknown
Seventy-five % of life = Yes 6 of 8 = 75%

$50,000 x 4.61 = $230,500

Choice 1 is incorrect. $375,000 is the cost of the machine on Parr's books. Day would not even know
this amount, but if it did, it would certainly not use it to record its lease liability.

Choice 3 is incorrect. $217,500 is calculated by using the 15% present value factor rather than the 12%
present value factor. The interest rate implicit in the lease is 12%. Since Day knows that rate, and since
that rate is lower than Day's incremental borrowing rate, Day would use 12% as the rate to calculate its
lease liability.

Choice 4 is incorrect. $0 is calculated as if the lease were an operating lease instead of a capital lease.
Since the lease satisfies one of the four capital lease criteria (the 75% criteria), it is a capital lease. Only
one of the four criteria is needed.

9. At January 1, Jamin Co. had a credit balance of $260,000 in its allowance for uncollectible accounts.
Based on past experience, 2% of Jamin's credit sales have been uncollectible. During the year, Jamin
wrote off $325,000 of uncollectible accounts. Credit sales for the year were $9,000,000. In its December
31, balance sheet, what amount should Jamin report as allowance for uncollectible accounts?

Choice 1 is correct.
Beginning Balance $260,000
Additions: ($9,000,000 x 2%) 180,000
Subtract: write-offs (325,000)
Ending Balance $115,000
Choice 2 is incorrect. $180,000 is the bad debt expense and the question asks for the allowance.

Choice 3 is incorrect. $245,000 is calculated by subtracting both the write-offs of $325,000 and the bad
debt expense of $180,000 from the $260,000 beginning balance of the account. The bad debt expense is
an add, not a subtract.

Choice 4 is incorrect. $440,000 is calculated by adding the $180,000 bad debt expense to the $260,000
beginning balance of the account and by not subtracting the write-offs.

10. Morris Co. determined that the net realizable value of its accounts receivable at December 31, was
$435,000. This estimate was based on an aging schedule. Additional information is as follows:

Allowance for uncollectible accounts - January 1 $229,000

Uncollectible accounts written off $61,000
Accounts written off in prior years recovered $26,000
Accounts receivable at December 31 $700,000

What is Morris's uncollectible accounts expense for the year ended December 31?

Beginning balance $229,000

Additions: recoveries 26,000
expense (squeeze) 71,000
 Subtract: write-offs (61,000)
Ending balance ($700,000 - 435,000) $265,000

Choice 1 is incorrect. $97,000 is calculated by not considering the recoveries of $26,000. If recoveries
are not considered, squeezing out the uncollectible accounts expense produces $97,000.

Choice 2 is incorrect. $123,000 is calculated by subtracting, instead of adding, the recoveries of $26,000.

Choice 3 is incorrect. $61,000 is calculated by using the write-offs as the expense. Using the write-offs
as the expense would be the cash basis of accounting (direct write-off method) and not the accrual basis.

11. The following data pertains to Tyne Co.'s investment in marketable equity securities:

Fair Value Fair Value

Classification Cost 12/31/Year 2 12/31/Year 1
Trading $150,000 $155,000 $100,000
Avail.-for-Sale 150,000 130,000 120,000

What amount should Tyne report as unrealized holding gain in its Year 2 income statement?

Rule: Unrealized gains and losses are reported as follows:

 Trading securities are reported at fair value with unrealized gains and losses included in
earnings (along with realized gains and losses, if any).
 Available-for-sale securities are reported at fair value with unrealized gains and losses reported
as a component of other comprehensive income.
$55,000 unrealized holding gain on trading securities reported in Year 2 income statement:
Trading Portfolio Fair Value
12/31/Year 2 $155,000
12/31/Year 1 (100,000)
Unrealized gain, reflected in income $ 55,000
Choice 2 is incorrect. $50,000 is calculated by comparing the $100,000 12/31/Year 1 fair value of the
trading portfolio to the $150,000 original cost. This is the wrong comparison. The comparison should
have been the 12/31/Year 2 fair value to the 12/31/Year 1 fair value. Besides, it is a loss instead of a
gain.

Choice 3 is incorrect. $80,000 is calculated by comparing the 12/31/Year 1 fair value of the both
portfolios combined of $220,000, not just the trading portfolio, to the original cost of $300,000. The
available-for-sale portfolio should not be included because holding gains for available-for-sale securities
are part of other comprehensive income. Besides, it is a loss instead of a gain.

Choice 4 is incorrect. $65,000 is calculated by comparing the 12/31/Year 2 combined fair value of the
both portfolios of $285,000, to the 12/31/Year 1 combined fair value of $220,000. The available-for-sale
portfolio should not be included because holding gains for available-for-sale securities are part of other
comprehensive income.

12. Lizzy Co. traded an old machine to Chang Co. for a similar new machine. The exchange is assumed
to lack commercial substance. Lizzy also received $10,000 in cash. The following information relates to
the machines on the date of the exchange:
 Carrying Value Fair Value
Old machine $70,000 $100,000
New machine $45,000 $ 90,000
What amount of gain should Lizzy record from this exchange?

indication that the risk, timing, or amount of the expected future cash flows from the assets received will
not differ significantly from the risk, timing, or amount of expected future cash flows from the assets
transferred, especially if the cash received in the same transaction is insignificant. In this question, the
amount of cash that changes hands is insignificant (10% of the fair value of the asset relinquished and
10% of the total fair value of the assets received). Based on these facts, a conclusion that the exchange
lacks commercial substance appears to be warranted.
To determine the gain to be recognized, a gain of $30,000 ($100,000 fair value - $70,000 carrying value)
is realized on the exchange. The total consideration received is $100,000 ($90,000 + $10,000). The
cash received is $10,000, which is less than 25% of the total consideration received. A gain of $3,000
(1/10th) is recognized. The journal entry is as follows:

Dr Cr
Cash 10,000
New machine 63,000
Gain on exchange 3,000
Old machine (net) 70,000

Note that the question did not really ask for the initial carrying value (cost) of the new machine, but it
certainly could have. The initial carrying value of the new machine could also calculated as the fair value
of the new machine less the realized gain not recognized ($90,000 - $27,000 = $63,000). It is not a bad
idea to calculate the initial carrying value using both methods as a quick check. On these transactions, it
is really easy to get the numbers mixed up.

13. In computing the weighted-average number of shares outstanding during the year, which of the
following midyear events must be treated as if it had occurred at the beginning of the year?

Choice 2 is correct. In computing the weighted-average number of shares outstanding for earnings per
share (EPS) determination, a stock dividend (or a stock split) to the same class of shareholders must be
retroactively recognized and treated as if it had occurred at the beginning of the year. In addition, EPS
for all prior periods presented must be adjusted as though the shares had been outstanding for all
periods presented.

Choices 1, 3, and 4 are incorrect. The issuance (sale) of new shares and the repurchase of a firm's
shares (treasury stock) are included in the weighted-average number of shares outstanding from the date
of the sale or purchase of the shares.

14. On January 1, Year 1, David Corp. issued 1000 of its $1,000 bonds at 94. The bonds mature in 10
years but are callable at 102 any time after issuance. On January 1, Year 1, David incurred bond issue
costs of $50,000. On July 1, Year 8, David called all of the bonds and retired them. Assuming that bond
discount and issue costs were amortized using the straight-line method, what amount of pretax loss
would David report from this extinguishment of debt?

Choice 4 is correct.
Bond face $1,000,000
Issued @ 94 940,000
 Issue cost (50,000)
Net carrying value (890,000)
110,000
÷ 10 years
Amortization per year 11,000
Jan Year 1 - July Year 8 x 7.5
Total amortization 82,500
Original net carrying value 890,000
Current net carrying value 972,500
Call price @ 102 (1,020,000)
Loss on call of bonds $ (47,500)
Choice 1 is incorrect. $20,000 is the call premium on the bonds (the 2% in the 102 call price of the
bonds). It is not the amount of the loss. The carrying value of the bonds must be taken into account.

Choice 2 is incorrect. $85,000 is calculated by not taking the bond issue costs into consideration. If the
bond issue costs were not considered, the net carrying value at the date of issuance would have been
$940,000 instead of $890,000. Total amortization would have been $45,000 instead of $82,500, and the
current net carrying value would have been $935,000 instead of $972,500, producing a gain of $85,000.

Choice 3 is incorrect. $58,500 is calculated by using 6 ½ years of amortization instead of 7 ½ years.

Total amortization would have been $71,500 instead of $82,500, and the current net carrying value
would have been $961,500 instead of $972,500, producing a gain of $58,500.

15. Bonds should be reported in the liability section of the balance sheet at what amount?
Choice 4 is correct. Unamortized premium should be shown on the balance sheet as an addition to the
face value of bonds payable. For example:
Long-term liabilities:
Bonds payable, 10%, due 12/31/Yr xx $500,000
Add: unamortized premium 10,000 $510,000
Unamortized discount should be shown on the balance sheet as a direct deduction from the face (par)
value of bonds payable.

Choice 1 is incorrect. Bonds should be reported taking discount or premium into account.

Choice 2 is incorrect. For reporting purposes, unamortized discount would be subtracted from, not added
to, the par/face value of the bond.

Choice 3 is incorrect. For reporting purposes, unamortized premium would be added to, not subtracted
from, the par/face value of the bond.

16. On January 1, Delta Co. issued five-year bonds with a face amount of $500,000. The bonds pay
interest semiannually on June 30 and December 31 at a stated interest rate of 6%. The bonds were sold
to yield 8%. Present value factors are as follows:
6% 8%
Present value of 1 for 5 periods .747 .680
Present value of 1 for 10 periods .558 .463
Present value of annuity of 1 for 5 periods 4.21 3.99
Present value of annuity of 1 for 10 periods 7.36 6.71

3% 4%
Present value of 1 for 5 periods .863 .822
 Present value of 1 for 10 periods .744 .676
Present value of annuity of 1 for 5 periods 4.58 4.45
Present value of annuity of 1 for 10 periods 8.58 8.11
What was the total issue price for these bonds?

Choice 3 is correct.
Bond, $500,000, 3%, semiannually = $ 15,000 / 2 times per year
$500,000 x .676 = $338,000
$15,000 x 8.11 = 121,650
$459,650
Choice 1 is incorrect. $544,500 is calculated by using the 4% present value factors for 5 periods of .822
and 4.45 instead of the 4% present value factors for 10 periods of .676 and 8.11. Since the bonds pay
interest semiannually, the interest rate would be cut in half and the number of periods would be doubled.
In this case, the number of periods was not doubled.

Choice 2 is incorrect. $338,000 is calculated by using only the $500,000 face amount in the present
value calculation and ignoring the interest.

Choice 4 is incorrect. $500,700 is calculated by using the 3% present value factors for 10 periods of .744
and 8.58 instead of the 4% present value factors for 10 periods of .676 and 8.11. The 6% stated
interest rate is not used to discount the principal and interest payments but only to determine the
amount of the semi-annual (in this case) interest payments. The discount rate is the effective or yield
rate of 8%.

17. On January 1, Year 2, Oak Co. issued 400 of its 8%, $1,000 bonds at 97 plus accrued interest. The
bonds are dated October 1, Year 1, and mature on October 1, Year 11. Interest is payable semiannually
on April 1 and October 1. Accrued interest for the period October 1, Year 1, to January 1, Year 2,
amounted to $8,000. On January 1, Year 2, what amount should Oak report as bonds payable, net of
discount?

Choice 2 is correct. January 1, Year 2 is the date of issue of the bonds and on that date, the bonds will
be reported at their issuance price of $388,000 (97% x $400,000).

Choice 1 is incorrect. $380,300 is calculated by subtracting the $8,000 accrued interest from the amount
calculated in choice "c". This answer just takes an already incorrect answer and makes it worse.

Choice 3 is incorrect. $388,300 is calculated by amortizing the discount for the three months from the
date of the bonds (October 1, Year 1) until the date that the bonds were actually issued (January 1, Year
2). The bonds were issued at 97 or $388,000. The discount was thus $12,000, and the bonds had a life
of 10 years or 120 months, for amortization of $100 per month. There were 3 months from October 1,
Year 1 until January 1, Year 2, for a total of $300 of amortization. The discount should not have been
amortized until the date of issuance.

Choice 4 is incorrect. $392,000 is calculated by subtracting the accrued interest of $8,000 from the face
amount of the bonds. The accrued interest would have affected the cash received from the issuance of
the bonds since it was paid along with the actual price of the bonds, but the accrued interest would not
be reported as part of the bonds.

18 A 10-year capital lease requires equal annual lease payments. The portion of the equal annual lease
payment in year 6 applicable to interest is:
Choice 1 is correct. Interest expense is recognized for a capital lease based on the applicable interest
rate times the carrying amount of the lease liability. As time passes, the portion applicable to interest
decreases and the portion applicable to principle increases. The portion of the equal annual lease
payment in year 6 applicable to interest is more than the portion applicable to interest from the year 7
payment.

Choice 2 is incorrect. The portion of the lease payment allocated to interest in year 6 would be less, not
more, than the portion allocated to interest in year 5. A capital lease works just like a home mortgage,
with decreasing amounts allocated to interest and increasing amounts allocated to principal each period.

Choice 3 is incorrect. The portion of the lease payment allocated to interest in year 6 would be more, not
less, than the portion allocated to interest in year 7. A capital lease works just like a home mortgage,
with decreasing amounts allocated to interest and increasing amounts allocated to principal each period.

Choice 4 is incorrect. The portion of the lease payment allocated to interest in year 6 would be less than,
not equal to, the portion allocated to interest in year 5. A capital lease works just like a home mortgage,
with decreasing amounts allocated to interest and increasing amounts allocated to principal each period.

19. At May 31, 1997, Quay owned a $10,000 whole-life insurance policy with a cash surrender value of
$4,500, net of loans of $2,500. In Quay's May 31, 1997, personal statement of financial condition, what
amount should be reported as investment in life insurance?

surrender value" of a life insurance policy should be reported net of any loans against the policy value. In
this question, the $4,500 value is "net of loans of $2,500."

Choice 1 is incorrect. $7,000 is calculated as the cash surrender value of $4,500 plus the loans of
$2,500. However, the amount reported in the personal statement of financial position should be reported
net of the loans.

Choice 3 is incorrect. $7,500 is calculated as the face value of the life insurance policy reduced by the
loans. The cash surrender value should be used instead of the face value.

Choice 4 is incorrect. $10,000 is the face value of the life insurance policy. The cash surrender value,
net of the loans, should be used instead of the face value.

20. The separate condensed balance sheets and income statements of Potter Corp. and its 80% owned
subsidiary, Squire Corp. are as follows:
Balance Sheets
December 31
Assets Potter Squire
Current assets $ 696,000 $445,000
Property, plant and equipment 300,000 405,000
Investment in Squire (equity method) 644,000 ---
Total assets $1,640,000 $850,000

Liabilities and Stockholders' Equity

Liabilities $ 300,000 $150,000
Stockholder equity
Common stock 500,000 200,000
Additional paid-in capital 100,000 100,000
Retained earnings 740,000 400,000
 Total Liabilities and Stockholders' Equity $ 1,640,000
850,000

Income Statements
For the Year Ended December 31
Potter Squire
Sales $750,000 $300,000
Less: Cost of goods sold (350,000) (50,000)
Gross margin 400,000 250,000
Less: Operating expenses (160,000) (150,000)
Operating income 240,000 100,000
Equity in the earnings of Squire 60,000 ---
Income before income taxes 300,000 100,000
Less: Provision for income taxes (60,000) (25,000)
Net income $240,000 $ 75,000
Additional Information:
 On January 1, of the current year, Potter acquired 80% of Squire's outstanding voting
common stock for $600,000 (no control premium). On January 1, the fair values of
Squire's assets and liabilities equaled their carrying values of $850,000 and $205,000
respectively. Potter's policy is to amortize intangible assets over a 10-year period. No
impairment of goodwill occurred during the year.
 During the current year, Potter and Squire paid cash dividends of $90,000 and $20,000,
respectively.
 There were no intercompany transactions except for Potter's receipt of dividends from
Squire and Potter's recording of its share of Squire's earnings.
In the December 31 consolidated financial statements of Potter and Squire, non-controlling interest
should be:

Because no control premium was paid by Potter, the fair value of Squire on the acquisition date can be
determined using the purchase price paid by Potter:
Fair Value of Squire x 80% = Purchase Price
750,000 x 80% = $600,000
The non-controlling interest on the acquisition date can be calculated using the fair value of Squire:
Non-controlling Interest = FV of Squire x Non-controlling Interest Percentage
$150,000 = $750,000 x 20%
The December 31 non-controlling interest is calculated as follows:
Beginning Non-controlling Interest $150,000
+ 20% x Squire's Net Income 15,000 = 20% x 75,000
- 20% x Squire's Dividend (4,000) = 20% x 20,000
Ending Non-controlling Interest $161,000

21. The separate condensed balance sheets and income statements of Potter Corp. and its 80% owned
subsidiary, Squire Corp. are as follows:
Balance Sheets
 December 31
Assets Potter Squire
Current assets $ 696,000 $ 445,000
Property, plant and equipment 300,000 405,000
Investment in Squire (equity method) 644,000 ---
Total assets $ 1,640,000
850,000

Liabilities and Stockholders' Equity

Liabilities $ 300,000 $ 150,000
Stockholder equity
Common stock 500,000 200,000
Additional paid-in capital 100,000 100,000
Retained earnings 740,000 400,000

Total Liabilities and Stockholders' Equity $ 1,640,000

850,000

Total Liabilities and Stockholders' Equity $1,640,000 $850,000

Income Statements
For the Year Ended December 31
Potter Squire
Sales $ 750,000 $ 300,000
Less: Cost of goods sold (350,000) (50,000)
Gross margin 400,000 250,000
Less: Operating expenses (160,000) (150,000)
Operating income 240,000 100,000
Equity in the earnings of Squire 60,000 ---
Income before income taxes 300,000 100,000
Less: Provision for income taxes (60,000) (25,000)
Net income $ 240,000 $ 75,000

Additional Information:
 On January 1, of the current year, Potter acquired 80% of Squire's outstanding voting
common stock for $600,000 (no control premium). On January 1, the fair values of
Squire's assets and liabilities equaled their carrying values of $850,000 and $205,000
respectively. Potter's policy is to amortize intangible assets over a 10-year period. No
impairment of goodwill occurred during the year.
 During the current year, Potter and Squire paid cash dividends of $90,000 and $20,000,
respectively.
 There were no intercompany transactions except for Potter's receipt of dividends from
Squire and Potter's recording of its share of Squire's earnings.
In the December 31 consolidated financial statements of Potter and Squire, goodwill should be:

Because no control premium was paid by Potter, the fair value of Squire on the acquisition date can be
determined using the purchase price paid by Potter:
FV of Squire x 80% = Purchase Price
$750,000 x 80% = $600,000
The subsidiary's fair value must be allocated to subsidiary book value, balance sheet FV adjustments,
identifiable intangible asset FV and goodwill:
Goodwill $105,000
Identifiable intangible asset FV 0
Balance sheet FV adjustment 0
Book value (CAR) $645,000 = 850,000 - 205,000
Fair value of Squire $750,000

22. The separate condensed balance sheets and income statements of Potter Corp. and its 80% owned
subsidiary, Squire Corp. are as follows:
Balance Sheets
December 31
Assets Potter Squire
Current assets $ 696,000 $ 445,000
Property, plant and equipment 300,000 405,000
Investment in Squire (equity method) 644,000 ---
Total assets $ 1,640,000
850,000

Liabilities and Stockholders' Equity

Liabilities $ 300,000 $ 150,000
Stockholder equity
Common stock 500,000 200,000
Additional paid-in capital 100,000 100,000
Retained earnings 740,000 400,000

Total Liabilities and Stockholders' Equity $ 1,640,000

850,000

Income Statements
For the Year Ended December 31
Potter Squire
Sales $ 750,000 $ 300,000
Less: Cost of goods sold (350,000) (50,000)
Gross margin 400,000 250,000
Less: Operating expenses (160,000) (150,000)
Operating income 240,000 100,000
Equity in the earnings of Squire 60,000 ---
Income before income taxes 300,000 100,000
Less: Provision for income taxes (60,000) (25,000)
Net income $ 240,000 $ 75,000
Additional Information:
• On January 1, of the current year, Potter purchased 80% of Squire's outstanding voting
common stock for $600,000 (no control premium). On January 1, the fair values of Squire's
assets and liabilities equaled their carrying values of $850,000 and $205,000 respectively.
Potter's policy is to amortize intangible assets over a 10-year period. No impairment of
goodwill occurred during the year.
 • During the current year, Potter and Squire paid cash dividends of $90,000 and $20,000,
respectively.
• There were no intercompany transactions except for Potter's receipt of dividends from Squire
and Potter's recording of its share of Squire's earnings.
In the December 31 consolidated financial statements of Potter and Squire, total assets should

Choice 4 is correct.
Parent Sub Eje Consolidate
Current $696,000 $445,000
Goodwill +$105,000 $1,951,000
PP&E $300,000 $405,000
Choice 1 is incorrect. $2,490,000 is calculated by adding the $1,640,000 total assets of Potter to the
$850,000 total assets of Squire, without any eliminating entry to add the $105,000 of goodwill. This
amount would include the assets of Squire twice, once as assets and liabilities and a second time in the
investment in Squire account.

Choice 2 is incorrect. $1,846,000 is calculated by adding the $996,000 total assets of Potter, not
including the investment in Squire, to the to $850,000 total assets of Squire, without any eliminating
entry to add the $105,000 of goodwill.

Choice 3 is incorrect. $2,595,000 is calculated by adding the $1,640,000 total assets of Potter to the
$850,000 total assets of Squire, with a consolidation elimination entry to add $105,000 of goodwill. The
investment in Squire must be eliminated.

23. The separate condensed balance sheets and income statements of Potter Corp. and its 80% owned
subsidiary, Squire Corp. are as follows:
Balance Sheets
December 31
Assets Potter Squire
Current assets $ 696,000 $ 445,000
Property, plant and equipment 300,000 405,000
Investment in Squire (equity method) 644,000 ---
Total assets $ 1,640,000
850,000

Liabilities and Stockholders' Equity

Liabilities $ 300,000 $ 150,000
Stockholder equity
Common stock 500,000 200,000
Additional paid-in capital 100,000 100,000
Retained earnings 740,000 400,000

Total Liabilities and Stockholders' Equity $ 1,640,000

850,000

Income Statements
For the Year Ended December 31
Potter Squire
Sales $ 750,000 $ 300,000
Less: Cost of goods sold (350,000) (50,000)
 Gross margin 400,000 250,000
Less: Operating expenses (160,000) (150,000)
Operating income 240,000 100,000
Equity in the earnings of Squire 60,000 ---
Income before income taxes 300,000 100,000
Less: Provision for income taxes (60,000) (25,000)
Net income $ 240,000 $ 75,000
Additional Information:
• On January 1, of the current year, Potter purchased 80% of Squire's outstanding voting
common stock for $600,000 (no control premium). On January 1, the fair values of Squire's
assets and liabilities equaled their carrying values of $850,000 and $205,000 respectively.
Potter's policy is to amortize intangible assets over a 10-year period. No impairment of
goodwill occurred during the year.
• During the current year, Potter and Squire paid cash dividends of $90,000 and $20,000,
respectively.
• There were no intercompany transactions except for Potter's receipt of dividends from Squire
and Potter's recording of its share of Squire's earnings.
In the December 31 consolidated financial statements of Potter and Squire, total retained earnings should
be:

hoice 1 is correct. $740,000, only the Parent's retained earnings will be reported. The Sub's retained
earnings are eliminated in consolidation.

Choice 2 is incorrect. $1,224,000 is calculated by adding the $400,000 retained earnings of Squire to the
$740,000 retained earnings of Potter and then adding $84,000 of goodwill.

Choice 3 is incorrect, per the explanation above.

Choice 4 is incorrect. $1,060,000 is calculated by adding 80% of the $400,000 retained earnings of
Squire, or $320,000, to the $740,000 retained earnings of Potter.

24. The separate condensed balance sheets and income statements of Potter Corp. and its 80% owned
subsidiary, Squire Corp. are as follows:
Balance Sheets
December 31
Assets Potter Squire
Current assets $ 696,000 $ 445,000
Property, plant and equipment 300,000 405,000
Investment in Squire (equity method) 644,000 ---
Total assets $ 1,640,000
850,000

Liabilities and Stockholders' Equity

Liabilities $ 300,000 $ 150,000
Stockholder equity
Common stock 500,000 200,000
Additional paid-in capital 100,000 100,000
Retained earnings 740,000 400,000

Total Liabilities and Stockholders' Equity $ 1,640,000

850,000
Income Statements
For the Year Ended December 31
Potter Squire
Sales $ 750,000 $ 300,000
Less: Cost of goods sold (350,000) (50,000)
Gross margin 400,000 250,000
Less: Operating expenses (160,000) (150,000)
Operating income 240,000 100,000
Equity in the earnings of Squire 60,000 ---
Income before income taxes 300,000 100,000
Less: Provision for income taxes (60,000) (25,000)
Net income $ 240,000 $ 75,000
Additional Information:
• On January 1, of the current year, Potter purchased 80% of Squire's outstanding voting
common stock for $600,000 (no control premium). On January 1, the fair values of Squire's
assets and liabilities equaled their carrying values of $850,000 and $205,000 respectively.
Potter's policy is to amortize intangible assets over a 10-year period. No impairment of
goodwill occurred during the year.
• During the current year, Potter and Squire paid cash dividends of $90,000 and $20,000,
respectively.
• There were no intercompany transactions except for Potter's receipt of dividends from Squire
and Potter's recording of its share of Squire's earnings.
In the December 31 consolidated financial statements of Potter and Squire, net income should be:
Choice 1 is correct.
Parent's net income $240,000
Less: equity in sub's income (60,000)
Parent's income only $180,000
Sub's income 75,000
Percentage 80%
Sub's income (parent's share) 60,000
Less: Goodwill impairment 0
Net income $240,000
Choice 2 is incorrect. $229,500 is calculated by subtracting a calculated amortization of goodwill from the
parent's net income of $240,000. If the goodwill had been amortized over the 10-year period of
amortization of intangible assets, the amortization would have been $10,500. Amortization of goodwill is
no longer allowed.

Choice 3 is incorrect. $315,000 is calculated by adding the parent's net income of $240,000 to the
$75,000 net income of the subsidiary.

25. Jessup, Inc., a manufacturing company owns 80% of the common stock of Siegel, Inc., an
investment company. Siegel owns 65% of the common stock of Pell, Inc., a manufacturing company. In
Jessup's consolidated financial statements, should consolidation accounting or equity method accounting
be used for Siegel and Pel

Choice 2 is correct. In a vertical chain of corporations, where the parent company (Jessup in this case)
owns more than 50% of the subsidiary (Siegel), and the subsidiary (Siegel) owns more than 50% of a
third company, consolidate:
 1. Third company (Pell) into the subsidiary (Siegel).
2. Subsidiary (Siegel) (now consolidated with third company (Pell)) into parent company Jessup.
Equity method is used when ownership is between 20-50% or if significant influence can be exercised by
the investor over the investee. If over 50% control is present, consolidated financial statements should
be prepared unless control is temporary or significant doubt exists regarding the parent's ability to control
the subsidiary, neither condition is present in this case.

26. Quentin University is organized as a not-for-profit organization. The university reaches out to its
alumni each year in a mass telephonic fund raising appeal that includes scripted dinner hour calls
appealing for ongoing support. In Year 1, the university used untrained student volunteers to make the
calls. In Year 2, an alumnus who owns a successful telemarketing company offers to perform the task.
The university accepts the offer and provides the alumnus with the script along with appropriate phone
numbers and contribution accounting forms. Based on the usual and customary charges used in his
business, the alumnus anticipates that the value of these services is $10,000. For each year, contributed
revenue associated with this transaction would be

Choice 4 is correct. Donated services are recorded as contribution revenue "SOME" of the time: when a
specialized skill is required, when the donation is otherwise needed and purchased and when measurable
easily. Although the purchase price of the telemarketing appeal can be measured, it does not require a
specialized skill (it can be performed by college students) and would not be purchased if it were not
donated (the college would use its student volunteers).

Choices 1, 2, and 3 are incorrect. Donated services are recorded as contribution revenue SOME of the
time: when a specialized skill is required, when the donation is otherwise needed and purchased and
when measurable easily. Contribution revenue would not be recognized in either year

27. The following information pertains to the defined benefit pension plan of the Cabot Corporation as of
December 31, Year 11 and Year 12:
12/31/Year 11 12/31/Year 12
Projected benefit obligation $250,000 $285,000
Fair value of plan assets 200,000 295,000
The pension plan had unrecognized prior service cost of $50,000 and unrecognized net gain of $30,000
at December 31, Year 11. Service cost for Year 12 was $30,000. The discount rate was 8% and the
expected return on plan assets was 10% for both Year 11 and Year 12. Cabot's employees have an
average remaining service life of 10 years. For the last three years, Cabot has made benefit payments of
$15,000 per year. The company expects to pay the same amount in Year 13. Cabot's effective tax rate
is 30%.

How would the funded status of Cabot's pension plan be reported on December 31, Year 11?
Choice 4 is correct. The funded status of a Cabot's pension plan at December 31, Year 11 is calculated
as:
FV of plan assets - Projected benefit obligation = $200,000 - $250,000 = $(50,000)
On 12/31/Year 11, this pension plan is underfunded because the PBO exceeds the fair value of the plan
assets. This underfunded pension plan will be reported as a noncurrent liability rather than a current
liability because the fair value of the plan assets is sufficient to pay the benefits payable in Year 12.
Choice 1 is incorrect. The funded status of Cabot's pension plan would be reported as a noncurrent asset
of $10,000 ($295,000 - $285,000) at December 31, Year 12. All overfunded (FV plan assets > PBO)
pension plans are reported as noncurrent assets.
Choice 2 is incorrect. The funded status of Cabot's underfunded pension plan at December 31, Year 11
would be reported as a noncurrent liability. An underfunded pension plan is only reported as a current
liability to the extent that benefits payable in the next 12 months exceed the fair value of the pension
plan assets. At December 31, Year 11, Cabot's $200,000 fair value of plan assets is sufficient to pay the
Year 12 benefits of $15,000, so no current liability is necessary.
Choice 3 is incorrect. The funded status of Cabot's underfunded pension plan at December 31, Year 11
would be reported as a noncurrent liability only. An underfunded pension plan is only reported as a
current liability to the extent that benefits payable in the next 12 months exceed the fair value of the
pension plan assets. At December 31, Year 11, Cabot's $200,000 fair value of plan assets is sufficient to
pay the Year 12 benefits of $15,000, so no current liability is necessary.

28. On December 31, Year 1, the Exeter Corporation had property and equipment of $1,450,000 and
accumulated depreciation of $500,000. During Year 2, the company acquired an asset for $250,000 in a
transaction properly classified as a capital lease. The new asset was used to replace a similar piece of
equipment with a historical cost of $200,000 that had been sold for $20,000, resulting in a gain of
$10,000. The net book value of all of Exeter's equipment at December 31, Year 2 was $850,000. What
was the amount of depreciation expense used in Exeter's Statement of Cash Flows, prepared using the
indirect method, to reconcile net income to cash flows from operations?

Choice 4 is correct. Depreciation expense is derived from available information using the analysis format
shown below. The problem provides information regarding beginning and net ending balances as well as
detail concerning additions and deletions of property and equipment. Disposal data pertaining to
proceeds and gains provide information needed to derive accumulated depreciation on disposed assets.
Compare known information (in bold) and posted to the analysis shell to derived information (in plain
text) and squeeze out the depreciation expense, the addition to accumulated depreciation.
Begin Add Subtract End
Property and equipment 1,450,000 250,000 200,000 1,500,000
Accumulated depreciation (500,000) 340,000 190,000 (650,000)
Net book value 950,000 (90,000) 390,000 850,000

Additions
Purchased asset 250,000

Disposals
Historical cost 200,000
Accumulated depreciation 190,000
Net book value 10,000
Proceeds 20,000
Gain 10,000
Choices 1, 2, and 3 are incorrect, per the computation presented above.

29. he Bygone Historical Society, a not-for-profit organization, received a donation of fifteen Daguerre-
type (metal) photos of Bygone's riverfront from a family estate. The photos were not suitable for display
but were accepted by the historical society for their potential value to researchers and historians. The
photos have no alternative use. The Bygone Historical Society adopted a policy of capitalizing its
contributed works of art and historical treasures. Under these circumstances, Bygone Historical Society
would:

Choice 3 is correct. Regardless of Bygone Historical Society's policies, no asset or contribution revenue
will be recognized since the contributed photos are subject to major uncertainties with regard to their
value and have no alternative use.
Choices 1 and 2 are incorrect. The photos have no determinable value and will not be displayed.
Regardless of the organization's policies with regard to capitalization of qualified historical treasures and
works of art, no recognition of assets or contribution will be made.

Choice 4 is incorrect. Bygone Historical Society is not obligated to disclose the contribution of the photos.

30. Davis & Earnest have a partnership with capital accounts of $50,000 and $40,000, respectively, as of
December 31, Year 1. Davis and Earnest split profits 60:40. Frost will be admitted to the partnership
effective January 1, Year 2 with a one-third interest. The partnership elects to use the exact method.
What is the amount of Frost's contribution to the partnership?

Choice 3 is correct. Determination of new partnership contributions is computed algebraically by setting

the amount of the new contribution as one-third of the amount of the partnership capitalization including
the unknown contribution equal to the amount of the contribution and solving for the unknown as
follows:
Frost contribution (F) = 1/3 ($90,000 + F)
(F) = $30,000 + 1/3F
2/3 F = $30,000
F = $45,000
Proof: Existing capitalization $ 90,000
Frost's contribution 45,000
Total capitalization $135,000
Choice 1 is incorrect. One third of the original capitalization will not result in a one-third interest in the
new partnership.

Choice 2 is incorrect, per the calculation above.