Based solely upon the following sets of circumstances indicated below, which set gives rise to a sales-type or direct-financing lease of a lessor?

Based solely upon the following sets of circumstances indicated below, which set gives rise to a sales-type or direct-financing lease of a lessor?

Transfers Ownership Contains Bargain Collectibility of Lease Any Important
By End Of Lease? Purchase Option? Payments Assured? Uncertainties?


a. No Yes Yes No
b. Yes No No No
c. Yes No No Yes
d. No Yes Yes Yes


Answer: No Yes Yes No

A lessee with a capital lease containing a bargain purchase option should depreciate the leased asset over the

a. asset's remaining economic life.
b. term of the lease.
c. life of the asset or the term of the lease, whichever is shorter.
d. life of the asset or the term of the lease, whichever is longer.


Answer: asset's remaining economic life.

From the lessee's perspective, in the earlier years of a lease, the use of the

a. capital method will enable the lessee to report higher income, compared to the operating method.
b. capital method will cause debt to increase, compared to the operating method.
c. operating method will cause income to decrease, compared to the capital method.
d. operating method will cause debt to increase, compared to the capital method.


Answer: capital method will cause debt to increase, compared to the operating method

Which of the following is a correct statement of one of the capitalization criteria?

Which of the following is a correct statement of one of the capitalization criteria?

a. The lease transfers ownership of the property to the lessor.
b. The lease contains a purchase option.
c. The lease term is equal to or more than 75% of the estimated economic life of the leased property.
d. The minimum lease payments (excluding executory costs) equal or exceed 90% of the fair value of the leased property.


Answer: The lease contains a purchase option

Which of the following would not be included in the Lease Receivable account?

a. Guaranteed residual value
b. Unguaranteed residual value
c. A bargain purchase option
d. All would be included


Answer: All would be included

Minimum lease payments may include a

a. penalty for failure to renew.
b. bargain purchase option.
c. guaranteed residual value.
d. any of these.


Answer: any of these

In computing the present value of the minimum lease payments, the lessee should

In computing the present value of the minimum lease payments, the lessee should

a. use its incremental borrowing rate in all cases.
b. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is higher, assuming that the implicit rate is known to the lessee.
c. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee.
d. None of these answers are correct.


Answer: use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee

In computing depreciation of a leased asset, the lessee should subtract

a. a guaranteed residual value and depreciate over the term of the lease.
b. an unguaranteed residual value and depreciate over the term of the lease.
c. a guaranteed residual value and depreciate over the life of the asset.
d. an unguaranteed residual value and depreciate over the life of the asset.


Answer: a guaranteed residual value and depreciate over the term of the lease

Lessees prefer to account for their leases as operating lease because:

a. it increases their debt to total equity ratio.
b. it decreases the income tax expense.
c. it increases the amount of total assets.
d. it decreases the amount of liability reported.


Answer: it decreases the amount of liability reported

What impact does a bargain purchase option have on the present value of the minimum lease payments computed by the lessee?

What impact does a bargain purchase option have on the present value of the minimum lease payments computed by the lessee?

a. There is no impact as the option does not enter into the transaction until the end of the lease term.
b. The lessee must increase the present value of the minimum lease payments by the present value of the option price.
c. The lessee must decrease the present value of the minimum lease payments by the present value of the option price.
d. The minimum lease payments would be increased by the present value of the option price if, at the time of the lease agreement, it appeared certain that the lessee would exercise the option at the end of the lease and purchase the asset at the option price.


Answer: The lessee must increase the present value of the minimum lease payments by the present value of the option price

The methods of accounting for a lease by the lessee are

a. operating and capital lease methods.
b. operating, sales, and capital lease methods.
c. operating and leveraged lease methods.
d. None of these answers are correct.


Answer: operating and capital lease methods

An essential element of a lease is that the

a. lessor conveys less than his or her total interest in the property.
b. lessee provides a sinking fund equal to one year's lease payments.
c. property that is the subject of the lease agreement must be held for sale by the lessor prior to the drafting of the lease agreement.
d. term of the lease is substantially equal to the economic life of the leased property.


Answer: lessor conveys less than his or her total interest in the property

Which of the following is an advantage of captive leasing companies over the other players in the leasing market?

Which of the following is an advantage of captive leasing companies over the other players in the leasing market?

a. They have access to low-cost funds allowing them to purchase assets at lower cost.
b. They are good at developing innovative contracts that help avoid accounting problems.
c. They provide leasing arrangements for a wider range of products than the parent company's product line.
d. They have the paint-of-sale advantage in finding leasing customers.


Answer: They have the paint-of-sale advantage in finding leasing customers

Which of the following best describes current practice in accounting for leases?

a. Leases are not capitalized.
b. Leases similar to installment purchases are capitalized.
c. All long-term leases are capitalized.
d. All leases are capitalized.


Answer: Leases similar to installment purchases are capitalized

The amount to be recorded as the cost of an asset under capital lease is equal to the

a. present value of the minimum lease payments.
b. present value of the minimum lease payments or the fair value of the asset, whichever is lower.
c. present value of the minimum lease payments plus the present value of any unguaranteed residual value.
d. carrying value of the asset on the lessor's books.


Answer: present value of the minimum lease payments or the fair value of the asset, whichever is lower

While only certain leases are currently accounted for as a sale or purchase, there is theoretic justification for considering all leases

While only certain leases are currently accounted for as a sale or purchase, there is theoretic justification for considering all leases to be sales or purchases. The principal reason that supports this idea is that

a. all leases are generally for the economic life of the property and the residual value of the property at the end of the lease is minimal.
b. at the end of the lease the property usually can be purchased by the lessee.
c. a lease reflects the purchase or sale of a quantifiable right to the use of property.
d. during the life of the lease the lessee can effectively treat the property as if it were owned.


Answer: a lease reflects the purchase or sale of a quantifiable right to the use of property

Major reasons why a company may become involved in leasing to other companies is (are)

a. interest revenue.
b. high residual values.
c. tax incentives.
d. All of these answers are correct.


Answer: All of these answers are correct

The main purpose of the Pension Benefit Guaranty Corporation is to

a. require minimum funding of pensions.
b. require plan administrators to publish a comprehensive description and summary of their plans.
c. administer terminated plans and to impose liens on the employer's assets for certain unfunded pension liabilities.
d. All of these answers are correct.


Answer: administer terminated plans and to impose liens on the employer's assets for certain unfunded pension liabilities

According to the FASB, recognition of a liability is required when the projected benefit obligation exceeds the fair value of plan assets

According to the FASB, recognition of a liability is required when the projected benefit obligation exceeds the fair value of plan assets. Conversely, when the fair value of plan assets exceeds the projected benefit obligation, the Board

a. requires recognition of an asset.
b. requires recognition of an asset if the excess fair value of plan assets exceeds the corridor amount.
c. recommends recognition of an asset but does not require such recognition.
d. does not permit recognition of an asset.


Answer: requires recognition of an asset

Which of the following statements is true about postretirement health care benefits?

a. They are generally funded.
b. The benefits are well-defined and level in dollar amount.
c. The beneficiary is the retiree, spouse, and other dependents.
d. The benefit is payable monthly.


Answer: The beneficiary is the retiree, spouse, and other dependents

Which of the following disclosures of pension plan information would not normally be required?

a. The major components of pension expense
b. The amount of prior service cost changed or credited in previous years.
c. The funded status of the plan and the amounts recognized in the financial statements
d. The rates used in measuring the benefit amounts


Answer: The amount of prior service cost changed or credited in previous years

The fair value of pension plan assets is used to determine the corridor and to calculate the expected return on plan assets.

The fair value of pension plan assets is used to determine the corridor and to calculate the expected return on plan assets.

Expected Return
Corridor on Plan Assets


a. Yes Yes
b. Yes No
c. No Yes
d. No No


Answer: Yes Yes

Which of the following is true of pension termination?

a. Companies can terminate a pension plan whenever they wish to do so.
b. Terminating a pension plan is illegal in U.S.
c. A company must start a new defined benefit plan after it eliminates the old one.
d. FASB requires recognition in earnings of a gain or loss when a pension obligation is settled.


Answer: FASB requires recognition in earnings of a gain or loss when a pension obligation is settled

A pension fund gain or loss that is caused by a plant closing should be

a. recognized immediately as a gain or loss on the plant closing.
b. spread over the current year and future years.
c. charged or credited to the current pension expense.
d. recognized as a prior period adjustment.


Answer: recognized immediately as a gain or loss on the plant closing

The actuarial gains or losses that result from changes in the projected benefit obligation are called

The actuarial gains or losses that result from changes in the projected benefit obligation are called

Asset Liability

Gains & Losses Gains & Losses


a. Yes Yes
b. No No
c. Yes No
d. No Yes


Answer: No Yes

A pension liability is reported when

a. the projected benefit obligation exceeds the fair value of pension plan assets.
b. the accumulated benefit obligation is less than the fair value of pension plan assets.
c. the pension expense reported for the period is greater than the funding amount for the same period.
d. accumulated other comprehensive income exceeds the fair value of pension plan assets.


Answer: the projected benefit obligation exceeds the fair value of pension plan assets

A pension asset is reported when

a. the accumulated benefit obligation exceeds the fair value of pension plan assets.
b. the accumulated benefit obligation exceeds the fair value of pension plan assets, but a prior service cost exists.
c. pension plan assets at fair value exceed the accumulated benefit obligation.
d. pension plan assets at fair value exceed the projected benefit obligation.


Answer: pension plan assets at fair value exceed the projected benefit obligation

Whenever a defined-benefit plan is amended and credit is given to employees for years of service provided before the date of amendment

Whenever a defined-benefit plan is amended and credit is given to employees for years of service provided before the date of amendment

a. both the accumulated benefit obligation and the projected benefit obligation are usually greater than before.
b. both the accumulated benefit obligation and the projected benefit obligation are usually less than before.
c. the expense and the liability should be recognized at the time of the plan change.
d. the expense should be recognized immediately, but the liability may be deferred until a reasonable basis for its determination has been identified.


Answer: both the accumulated benefit obligation and the projected benefit obligation are usually less than before

Gains and losses that relate to the computation of pension expense should be

a. recorded currently as an adjustment to pension expense in the period incurred.
b. recorded currently and in the future by applying the corridor method which provides the amount to be amortized.
c. amortized over a 15-year period.
d. recorded only if a loss is determined.


Answer: recorded currently and in the future by applying the corridor method which provides the amount to be amortized

A corporation has a defined-benefit plan. A pension liability will result at the end of the year if the

a. projected benefit obligation exceeds the fair value of the plan assets.
b. fair value of the plan assets exceeds the projected benefit obligation.
c. amount of employer contributions exceeds the pension expense.
d. amount of pension expense exceeds the amount of employer contributions.


Answer: projected benefit obligation exceeds the fair value of the plan assets

When a company amends a pension plan, for accounting purposes, prior service costs should be

When a company amends a pension plan, for accounting purposes, prior service costs should be

a. treated as a prior period adjustment because no future periods are benefited.
b. amortized in accordance with procedures used for income tax purposes.
c. recorded in other comprehensive income (PSC).
d. reported as an expense in the period the plan is amended.


Answer: recorded in other comprehensive income (PSC)

When a company adopts a pension plan, prior service costs should be charged to

a. accumulated other comprehensive income (PSC).
b. operations of prior periods.
c. Other comprehensive income (PSC).
d. retained earnings.


Answer: Other comprehensive income (PSC)

Prior service cost is amortized on a

a. straight-line basis over the expected future years of service.
b. years-of-service method or on a straight-line basis over the average remaining service life of active employees.
c. straight-line basis over 15 years.
d. straight-line basis over the average remaining service life of active employees or 15 years, whichever is longer.


Answer: years-of-service method or on a straight-line basis over the average remaining service life of active employees

In accounting for a pension plan, any difference between the pension cost charged to expense and the payments into the fund should be reported as

In accounting for a pension plan, any difference between the pension cost charged to expense and the payments into the fund should be reported as

a. an offset to the liability for prior service cost.
b. pension asset/liability.
c. as other comprehensive income (G/L)
d. as accumulated other comprehensive income (PSC).


Answer: pension asset/liability

One component of pension expense is actual return on plan assets. Plan assets include

a. assets that a company holds to earn a reasonable return, generally at minimum risk.
b. plan assets still under the control of the company.
c. only assets reported on the balance sheet of the employer as prepaid pension cost.
d. None of these answers are correct.


Answer: assets that a company holds to earn a reasonable return, generally at minimum risk

The actual return on plan assets

a. is equal to the change in the fair value of the plan assets during the year.
b. includes interest, dividends, and changes in the fair value of the fund assets.
c. is equal to the expected rate of return times the fair value of the plan assets at the beginning of the period.
d. All of these answers are correct.


Answer: includes interest, dividends, and changes in the fair value of the fund assets

Which of the following items should be included in pension expense calculated by an employer who sponsors a defined-benefit pension plan

Which of the following items should be included in pension expense calculated by an employer who sponsors a defined-benefit pension plan for its employees?

Amortization of
Fair value prior
of plan assets service cost


a. Yes Yes
b. Yes No
c. No Yes
d. No No


Answer: No Yes

The computation of pension expense includes all the following except

a. service cost component measured using current salary levels.
b. interest on projected benefit obligation.
c. expected return on plan assets.
d. All of these are included in the computation.


Answer: service cost component measured using current salary levels

The relationship between the amount funded and the amount reported for pension expense is as follows:

a. pension expense must equal the amount funded.
b. pension expense will be less than the amount funded.
c. pension expense will be more than the amount funded.
d. pension expense may be greater than, equal to, or less than the amount funded.


Answer: pension expense may be greater than, equal to, or less than the amount funded.

In computing the service cost component of pension expense, the FASB concluded that

In computing the service cost component of pension expense, the FASB concluded that

a. the accumulated benefit obligation provides a more realistic measure of the pension obligation on a going concern basis.
b. a company should employ an actuarial funding method to report pension expense that best reflects the cost of benefits to employees.
c. the projected benefit obligation using future compensation levels provides a realistic measure of present pension obligation and expense.
d. All of these answers are correct.


Answer: the projected benefit obligation using future compensation levels provides a realistic measure of present pension obligation and expense

Differing measures of the pension obligation can be based on

a. all years of service—both vested and nonvested—using current salary levels.
b. only the vested benefits using current salary levels.
c. both vested and nonvested service using future salaries.
d. All of these answers are correct.



Answer: All of these answers are correct

The interest on the projected benefit obligation component of pension expense

a. reflects the incremental borrowing rate of the employer.
b. reflects the rates at which pension benefits could be effectively settled.
c. is the same as the expected return on plan assets.
d. may be stated implicitly or explicitly when reported.


Answer: reflects the rates at which pension benefits could be effectively settled

Which of the following is not a characteristic of a defined-contribution pension plan?

Which of the following is not a characteristic of a defined-contribution pension plan?

a. The employer's contribution each period is based on a formula.
b. The benefits to be received by employees are determined by an employee's highest compensation level defined by the terms of the plan.
c. The accounting for a defined-contribution plan is straightforward and uncomplicated.
d. The benefit of gain or the risk of loss from the assets contributed to the pension fund is borne by the employee.


Answer: The benefits to be received by employees are determined by an employee's highest compensation level defined by the terms of the plan

Vested benefits

a. usually require a certain minimum number of years of service.
b. are those that the employee is entitled to receive even if fired.
c. are not contingent upon additional service under the plan.
d. are defined by all of these answers.


Answer: are defined by all of these answers

In accounting for a defined-benefit pension plan

a. an appropriate funding pattern must be established to ensure that enough monies will be available at retirement to meet the benefits promised.
b. the employer's responsibility is simply to make a contribution each year based on the formula established in the plan.
c. the expense recognized each period is equal to the cash contribution.
d. the liability is determined based upon known variables that reflect future salary levels promised to employees.


Answer: an appropriate funding pattern must be established to ensure that enough monies will be available at retirement to meet the benefits promised

Alternative methods exist for the measurement of the pension obligation (liability). Which measure requires the use of future salaries

Alternative methods exist for the measurement of the pension obligation (liability). Which measure requires the use of future salaries in its computation?

a. Vested benefit obligation
b. Accumulated benefit obligation
c. Projected benefit obligation
d. Restructured benefit obligation


Answer: Projected benefit obligation

The accumulated benefit obligation measures

a. the pension obligation on the basis of the plan formula applied to years of service to date and based on existing salary levels.
b. the pension obligation on the basis of the plan formula applied to years of service to date and based on future salary levels.
c. the level cost that will be sufficient, together with interest to provide the total benefits at retirement.
d. the shortest possible period for funding to maximize the tax deduction.


Answer: the pension obligation on the basis of the plan formula applied to years of service to date and based on existing salary levels

The projected benefit obligation is the measure of pension obligation that

a. is required to be used for reporting the service cost component of pension expense.
b. requires pension expense to be determined solely on the basis of the plan formula applied to years of service to date and based on existing salary levels.
c. requires the longest possible period for funding to maximize the tax deduction.
d. is not sanctioned under generally accepted accounting principles for reporting the service cost component of pension expense.


Answer: is required to be used for reporting the service cost component of pension expense

In all pension plans, the accounting problems include all the following except

In all pension plans, the accounting problems include all the following except

a. measuring the amount of pension obligation.
b. disclosing the status and effects of the plan in the financial statements.
c. allocating the cost of the plan to the proper periods.
d. determining the level of individual premiums.


Answer: determining the level of individual premiums

In a defined-benefit plan, the process of funding refers to

a. determining the projected benefit obligation.
b. determining the accumulated benefit obligation.
c. making the periodic contributions to a funding agency to ensure that funds are available to meet retirees' claims.
d. determining the amount that might be reported for pension expense.


Answer: making the periodic contributions to a funding agency to ensure that funds are available to meet retirees' claims

In a defined-contribution plan, a formula is used that

a. defines the benefits that the employee will receive at the time of retirement.
b. ensures that pension expense and the cash funding amount will be different.
c. requires an employer to contribute a certain sum each period based on the formula.
d. ensures that employers are at risk to make sure funds are available at retirement.


Answer: requires an employer to contribute a certain sum each period based on the formula

In determining the present value of the prospective benefits (often referred to as the projected benefit obligation),

In determining the present value of the prospective benefits (often referred to as the projected benefit obligation), which of the following are considered by the actuary?

a. Retirement and mortality rate.
b. Interest rates.
c. Benefit provisions of the plan.
d. All of these are considered.


Answer: All of these are considered

In a defined-benefit plan, a formula is used that

a. requires that the benefit of gain or the risk of loss from the assets contributed to the pension plan be borne by the employee.
b. defines the benefits that the employee will receive at the time of retirement.
c. requires that pension expense and the cash funding amount be the same.
d. defines the contribution the employer is to make; no promise is made concerning the ultimate benefits to be paid out to the employees.


Answer: defines the benefits that the employee will receive at the time of retirement

True or False: Purchase returns and purchase discounts are ignored when computing cost-to-retail ratios for the retail method.

Answer: FALSE

True or False: Losses on reduction to LCM may be charged to either cost of goods sold or to a current loss account without distorting

True or False: Losses on reduction to LCM may be charged to either cost of goods sold or to a current loss account without distorting financial statement ratios.

Answer: FALSE

True or False: The purpose of ceilings and floors in LCM is to prevent profit distortion.

Answer: TRUE

True or False: The primary motivation behind LCM is consistency.

Answer: FALSE

True or False: In using the LIFO retail method, the current period cost-to-retail percentage includes both net markdowns and net markups.

True or False: In using the LIFO retail method, the current period cost-to-retail percentage includes both net markdowns and net markups.

Answer: TRUE

True or False: Inventory written down due to LCM may be written back up if market values go back up.

Answer: FALSE

Transfers between categories

a. result in companies omitting recognition of fair value in the year of the transfer.
b. are accounted for at fair value for all transfers.
c. are considered unrealized and unrecognized if transferred out of held-to-maturity into trading.
d. will always result in an impact on net income.


Answer: are accounted for at fair value for all transfers

A reclassification adjustment is reported in the

A reclassification adjustment is reported in the

a. income statement as an Other revenue or expense.
b. stockholders' equity section of the balance sheet.
c. statement of comprehensive income as other comprehensive income.
d. statement of stockholders' equity.


Answer: statement of comprehensive income as other comprehensive income

True or False: In determining lower-of-cost-or-market, market is the expected selling price under normal operations.

Answer: FALSE

True or False: Net Realizable Value is selling price less costs of completion and disposal.

Answer: TRUE

A debt security is transferred from one category to another. Generally acceptable accounting principles require that for this particular reclassification

A debt security is transferred from one category to another. Generally acceptable accounting principles require that for this particular reclassification (1) the security be transferred at fair value at the date of transfer, and (2) the unrealized gain or loss at the date of transfer currently carried as a separate component of stockholders' equity be amortized over the remaining life of the security. What type of transfer is being described?

a. Transfer from trading to available-for-sale
b. Transfer from available-for-sale to trading
c. Transfer from held-to-maturity to available-for-sale
d. Transfer from available-for-sale to held-to-maturity


Answer: Transfer from available-for-sale to held-to-maturity

When an investment in a held-to-maturity security is transferred to an available-for-sale security, the carrying value assigned to the available-for-sale security should be

a. its original cost.
b. its fair value at the date of the transfer.
c. the lower of its original cost or its fair value at the date of the transfer.
d. the higher of its original cost or its fair value at the date of the transfer.


Answer: its fair value at the date of the transfer

When an investment in an available-for-sale security is transferred to trading because the company anticipates selling the stock in the near future, the carrying value assigned to the investment upon entering it in the trading portfolio should be

a. its original cost.
b. its fair value at the date of the transfer.
c. the higher of its original cost or its fair value at the date of the transfer.
d. the lower of its original cost or its fair value at the date of the transfer.


Answer: its fair value at the date of the transfer

Judd, Inc., owns 35% of Cosby Corporation. During the calendar year 2014, Cosby had net earnings of $300,000 and paid dividends of $30,000

Judd, Inc., owns 35% of Cosby Corporation. During the calendar year 2014, Cosby had net earnings of $300,000 and paid dividends of $30,000. Judd mistakenly recorded these transactions using the fair value method rather than the equity method of accounting. What effect would this have on the investment account, net income, and retained earnings, respectively?

a. Understate, overstate, overstate
b. Overstate, understate, understate
c. Overstate, overstate, overstate
d. Understate, understate, understate


Answer: Understate, understate, understate

Under the equity method of accounting for investments, an investor recognizes its share of the earnings in the period in which the

a. investor sells the investment.
b. investee declares a dividend.
c. investee pays a dividend.
d. earnings are reported by the investee in its financial statements.


Answer: earnings are reported by the investee in its financial statements

"Gains trading" or "cherry picking" involves

a. moving securities whose value has decreased since acquisition from available-for-sale to held-to-maturity in order to avoid reporting losses.
b. reporting investment securities at fair value but liabilities at amortized cost.
c. selling securities whose value has increased since acquisition while holding those whose value has decreased since acquisition.
d. All of the above are considered methods of "gains trading" or "cherry picking."


Answer: selling securities whose value has increased since acquisition while holding those whose value has decreased since acquisition

Dublin Company holds a 30% stake in Club Company which was purchased in 2015 at a cost of $3,000,000

Dublin Company holds a 30% stake in Club Company which was purchased in 2015 at a cost of $3,000,000. After applying the equity method, the Investment in Club Company account has a balance of $3,040,000. At December 31, 2015 the fair value of the investment is $3,120,000. Which of the following values is acceptable for Dublin to use in its balance sheet at December 31, 2015?

I. $3,000,000
II. $3,040,000
III. $3,120,000


a. I, II, or III.
b. I or II only.
c. II only.
d. II or III only.


Answer: II or III only

The fair value option allows a company to

a. value its own liabilities at fair value.
b. record income when the fair value of its bonds increases.
c. report most financial instruments at fair value at any point of time.
d. All of the above are true of the fair value option.


Answer: value its own liabilities at fair value

If the parent company owns 90% of the subsidiary company's outstanding common stock, the company should generally account for the income of the subsidiary under the

a. cost method.
b. fair value method.
c. divesture method.
d. equity method.


Answer: equity method

Koehn Corporation accounts for its investment in the common stock of Sells Company under the equity method

Koehn Corporation accounts for its investment in the common stock of Sells Company under the equity method. Koehn Corporation should ordinarily record a cash dividend received from Sells as

a. a reduction of the carrying value of the investment.
b. additional paid-in capital.
c. an addition to the carrying value of the investment.
d. dividend income.


Answer: a reduction of the carrying value of the investment

An investor has a long-term investment in stocks. Regular cash dividends received by the investor are recorded as

Fair Value Method Equity Method


a. Income Income
b. A reduction of the investment A reduction of the investment
c. Income A reduction of the investment
d. A reduction of the investment Income


Answer: Income A reduction of the investment

When a company holds between 20% and 50% of the outstanding stock of an investee, which of the following statements applies?

a. The investor should always use the equity method to account for its investment.
b. The investor should use the equity method to account for its investment unless circum-stances indicate that it is unable to exercise "significant influence" over the investee.
c. The investor must use the fair value method unless it can clearly demonstrate the ability to exercise "significant influence" over the investee.
d. The investor should always use the fair value method to account for its investment.


Answer: The investor should use the equity method to account for its investment unless circum-stances indicate that it is unable to exercise "significant influence" over the investee

Santo Corporation declares and distributes a cash dividend that is a result of current earnings. How will the receipt of those dividends

Santo Corporation declares and distributes a cash dividend that is a result of current earnings. How will the receipt of those dividends affect the investment account of the investor under each of the following accounting methods?

Fair Value Method Equity Method


a. No Effect Decrease
b. Increase Decrease
c. No Effect No Effect
d. Decrease No Effect


Answer: No Effect Decrease

Which of the following is not generally correct about recording a sale of a debt security before maturity date?

a. Accrued interest will be received by the seller even though it is not an interest payment date.
b. An entry must be made to amortize a discount to the date of sale.
c. The entry to amortize a premium to the date of sale includes a credit to the Premium on Investments in Debt Securities.
d. A gain or loss on the sale is not extraordinary.


Answer: The entry to amortize a premium to the date of sale includes a credit to the Premium on Investments in Debt Securities

When a company has acquired a "passive interest" in another corporation, the acquiring company should account for the investment

a. by using the equity method.
b. by using the fair value method.
c. by using the effective interest method.
d. by consolidation.


Answer: by using the fair value method

APB Opinion No. 21 specifies that, regarding the amortization of a premium or discount on a debt security, the

APB Opinion No. 21 specifies that, regarding the amortization of a premium or discount on a debt security, the

a. effective-interest method of allocation must be used.
b. straight-line method of allocation must be used.
c. effective-interest method of allocation should be used but other methods can be applied if there is no material difference in the results obtained.
d. par value method must be used and therefore no allocation is necessary.


Answer: effective-interest method of allocation should be used but other methods can be applied if there is no material difference in the results obtained

An available-for-sale debt security is purchased at a discount. The entry to record the amortization of the discount includes a

a. debit to Available-for-Sale Securities.
b. debit to the discount account.
c. debit to Interest Revenue.
d. None of these answers are correct.


Answer: debit to Available-for-Sale Securities

Which of the following is correct about the effective-interest method of amortization?

a. The effective-interest method applied to investments in debt securities is different from that applied to bonds payable.
b. Amortization of a discount decreases from period to period.
c. Amortization of a premium decreases from period to period.
d. The effective-interest method produces a constant rate of return on the book value of the investment from period to period.


Answer: The effective-interest method produces a constant rate of return on the book value of the investment from period to period

Jordan Company purchased ten-year, 10% bonds that pay interest semiannually. The bonds are sold to yield 8%

Jordan Company purchased ten-year, 10% bonds that pay interest semiannually. The bonds are sold to yield 8%. One step in calculating the issue price of the bonds is to multiply the principal by the table value for

a. 10 periods and 10% from the present value of 1 table.
b. 10 periods and 8% from the present value of 1 table.
c. 20 periods and 5% from the present value of 1 table.
d. 20 periods and 4% from the present value of 1 table.


Answer: 20 periods and 4% from the present value of 1 table

When investments in debt securities are purchased between interest payment dates, preferably the

a. securities account should include accrued interest.
b. accrued interest is debited to Interest Expense.
c. accrued interest is debited to Interest Revenue.
d. accrued interest is debited to Interest Receivable.


Answer: accrued interest is debited to Interest Revenue

Investments in debt securities are generally recorded at

a. cost including accrued interest.
b. maturity value.
c. cost including brokerage and other fees.
d. maturity value with a separate discount or premium account.


Answer: cost including brokerage and other fees

Watt Company purchased $300,000 of bonds for $315,000. If Watt intends to hold the securities to maturity, the entry to record the investment

Watt Company purchased $300,000 of bonds for $315,000. If Watt intends to hold the securities to maturity, the entry to record the investment includes

a. a debit to Held-to-Maturity Securities at $300,000.
b. a credit to Premium on Investments of $15,000.
c. a debit to Held-to-Maturity Securities at $315,000.
d. None of these answers are correct.


Answer: a debit to Held-to-Maturity Securities at $315,000

Investments in debt securities should be recorded on the date of acquisition at

a. lower of cost or market.
b. market value.
c. market value plus brokerage fees and other costs incident to the purchase.
d. face value plus brokerage fees and other costs incident to the purchase.


Answer: market value plus brokerage fees and other costs incident to the purchase

Held-to-maturity securities are reported at

a. acquisition cost.
b. acquisition cost plus amortization of a discount.
c. acquisition cost plus interest.
d. fair value.


Answer: acquisition cost plus amortization of a discount

In accounting for investments in debt securities that are classified as trading securities,

In accounting for investments in debt securities that are classified as trading securities,

a. a discount is reported separately.
b. a premium is reported separately.
c. any discount or premium is not amortized.
d. None of these answers are correct.


Answer: any discount or premium is not amortized

Which of the following is not correct in regard to trading securities?

a. They are held with the intention of selling them in a short period of time.
b. Unrealized holding gains and losses are reported as part of net income.
c. Any discount or premium is not amortized.
d. All of these are correct.


Answer: All of these are correct.

Debt securities that are accounted for at amortized cost, not fair value, are

a. held-to-maturity debt securities.
b. trading debt securities.
c. available-for-sale debt securities.
d. never-sell debt securities.


Answer: held-to-maturity debt securities

Debt securities acquired by a corporation which are accounted for by recognizing unrealized holding gains or losses

Debt securities acquired by a corporation which are accounted for by recognizing unrealized holding gains or losses and are included as other comprehensive income and as a separate component of stockholders' equity are

a. held-to-maturity debt securities.
b. trading debt securities.
c. available-for-sale debt securities.
d. never-sell debt securities.


Answer: available-for-sale debt securities

Use of the effective-interest method in amortizing bond premiums and discounts results in

a. a greater amount of interest income over the life of the bond issue than would result from use of the straight-line method.
b. a varying amount being recorded as interest income from period to period.
c. a variable rate of return on the book value of the investment.
d. a smaller amount of interest income over the life of the bond issue than would result from use of the straight-line method.


Answer: a varying amount being recorded as interest income from period to period.

Equity securities acquired by a corporation which are accounted for by recognizing unrealized holding gains or losses as other comprehensive income and as a separate component of stockholders' equity are

a. available-for-sale securities where a company has holdings of less than 20%.
b. trading securities where a company has holdings of less than 20%.
c securities where a company has holdings of between 20% and 50%.
d. securities where a company has holdings of more than 50%.


Answer: available-for-sale securities where a company has holdings of less than 20%

Securities which could be classified as held-to-maturity are

Securities which could be classified as held-to-maturity are

a. redeemable preferred stock.
b. warrants.
c. municipal bonds.
d. treasury stock.


Answer: municipal bonds.

A requirement for a security to be classified as held-to-maturity is

a. ability to hold the security to maturity.
b. positive intent.
c. the security must be a debt security.
d. All of these are required.


Answer: All of these are required

A correct valuation is

a. available-for-sale at amortized cost.
b. held-to-maturity at amortized cost.
c. held-to-maturity at fair value.
d. None of these answers are correct.


Answer: held-to-maturity at amortized cost.

When an investor's accounting period ends on a date that does not coincide with an interest receipt date for bonds

When an investor's accounting period ends on a date that does not coincide with an interest receipt date for bonds held as an investment, the investor must

a. make an adjusting entry to debit Interest Receivable and to credit Interest Revenue for the amount of interest accrued since the last interest receipt date.
b. notify the issuer and request that a special payment be made for the appropriate portion of the interest period.
c. make an adjusting entry to debit Interest Receivable and to credit Interest Revenue for the total amount of interest to be received at the next interest receipt date.
d. do nothing special and ignore the fact that the accounting period does not coincide with the bond's interest period.


Answer: make an adjusting entry to debit Interest Receivable and to credit Interest Revenue for the amount of interest accrued since the last interest receipt date

Which of the following is not a debt security?

a. Convertible bonds
b. Commercial paper
c. Loans receivable
d. All of these are debt securities.


Answer: Loans receivable

Unrealized holding gains or losses which are recognized in income are from securities classified as

a. held-to-maturity.
b. available-for-sale.
c. trading.
d. None of these answers are correct.


Answer: trading

In applying the treasury stock method to determine the dilutive effect of stock options and warrants, the proceeds assumed to be received

In applying the treasury stock method to determine the dilutive effect of stock options and warrants, the proceeds assumed to be received upon exercise of the options and warrants

a. are used to calculate the number of common shares repurchased at the average market price, when computing diluted earnings per share.
b. are added, net of tax, to the numerator of the calculation for diluted earnings per share.
c. are disregarded in the computation of earnings per share if the exercise price of the options and warrants is less than the ending market price of common stock.
d. none of these.


Answer: are used to calculate the number of common shares repurchased at the average market price, when computing diluted earnings per share

Assume there are two dilutive convertible securities. The one that should be used first to recalculate earnings per share is the security with the

a. greater earnings adjustment.
b. greater earnings per share adjustment.
c. smaller earnings adjustment.
d. smaller earnings per share adjustment.


Answer: smaller earnings per share adjustment

In the diluted earnings per share computation, the treasury stock method is used for options and warrants to reflect assumed reacquisition of common stock at the average market price during the period. If the exercise price of the options or warrants exceeds the average market price, the computation would

a. fairly present diluted earnings per share on a prospective basis.
b. fairly present the maximum potential dilution of diluted earnings per share on a prospective basis.
c. reflect the excess of the number of shares assumed issued over the number of shares assumed reacquired as the potential dilution of earnings per share.
d. be antidilutive.


Answer: be antidilutive

Due to the importance of earnings per share information, it is required to be reported by all

Due to the importance of earnings per share information, it is required to be reported by all

Public Companies Nonpublic Companies


a. Yes Yes
b. Yes No
c. No No
d. No Yes


Answer: yes no

When applying the treasury stock method for diluted earnings per share, the market price of the common stock used for the repurchase is the

a. price at the end of the year.
b. average market price.
c. price at the beginning of the year.
d. none of these.


Answer: average market price

Antidilutive securities

a. should be included in the computation of diluted earnings per share but not basic earnings per share.
b. are those whose inclusion in earnings per share computations would cause basic earnings per share to exceed diluted earnings per share.
c. include stock options and warrants whose exercise price is less than the average market price of common stock.
d. should be ignored in all earnings per share calculations.


Answer: should be ignored in all earnings per share calculations

A convertible bond issue should be included in the diluted earnings per share computation as if the bonds had been converted into common stock

A convertible bond issue should be included in the diluted earnings per share computation as if the bonds had been converted into common stock, if the effect of its inclusion is

Dilutive Antidilutive


a. Yes Yes
b. Yes No
c. No Yes
d. No No


Answer: yes no

When computing diluted earnings per share, convertible bonds are

a. ignored.
b. assumed converted whether they are dilutive or antidilutive.
c. assumed converted only if they are antidilutive.
d. assumed converted only if they are dilutive.


Answer: assumed converted only if they are dilutive

Dilutive convertible securities must be used in the computation of

a. basic earnings per share only.
b. diluted earnings per share only.
c. diluted and basic earnings per share.
d. none of these.


Answer: diluted earnings per share only

In computing earnings per share, the equivalent number of shares of convertible preferred stock are added as an adjustment to the denominator

In computing earnings per share, the equivalent number of shares of convertible preferred stock are added as an adjustment to the denominator (number of shares outstanding). If the preferred stock is cumulative, which amount should then be added as an adjustment to the numerator (net earnings)?

a. Annual preferred dividend
b. Annual preferred dividend times (one minus the income tax rate)
c. Annual preferred dividend times the income tax rate
d. Annual preferred dividend divided by the income tax rate


Answer: Annual preferred dividend

In computations of weighted average of shares outstanding, when a stock dividend or stock split occurs, the additional shares are

a. weighted by the number of days outstanding.
b. weighted by the number of months outstanding.
c. considered outstanding at the beginning of the year.
d. considered outstanding at the beginning of the earliest year reported.


Answer: considered outstanding at the beginning of the earliest year reported

In computing earnings per share for a simple capital structure, if the preferred stock is cumulative, the amount that should be deducted as an adjustment to the numerator (earnings) is the

a. preferred dividends in arrears.
b. preferred dividends in arrears times (one minus the income tax rate).
c. annual preferred dividend times (one minus the income tax rate).
d. none of these.


Answer: none of these

With respect to the computation of earnings per share, which of the following would be most indicative of a simple capital structure?

With respect to the computation of earnings per share, which of the following would be most indicative of a simple capital structure?

a. Common stock, preferred stock, and convertible securities outstanding in lots of even thousands
b. Earnings derived from one primary line of business
c. Ownership interest consisting solely of common stock
d. None of these


Answer: Ownership interest consisting solely of common stock

Which of the following is not a characteristic of a noncompensatory stock purchase plan?

a. It is open to almost all full-time employees.
b. The discount from market price is small.
c. The plan offers no substantive option feature.
d. All of these are characteristics.


Answer: All of these are characteristics

What effect will the acquisition of treasury stock have on stockholders' equity and earnings per share, respectively?

a. Decrease and no effect
b. Increase and no effect
c. Decrease and increase
d. Increase and decrease


Answer: Decrease and increase

For stock appreciation rights, the measurement date for computing compensation is the date

For stock appreciation rights, the measurement date for computing compensation is the date

a. the rights mature.
b. the stock's price reaches a predetermined amount.
c. of grant.
d. of exercise.


Answer: of exercise

An executive pays no taxes at time of exercise in a(an)

a. stock appreciation rights plan.
b. incentive stock option plan.
c. nonqualified stock option plan.
d. Taxes would be paid in all of these.


Answer: incentive stock option plan

Under the intrinsic value method, compensation expense resulting from an incentive stock option is generally

a. not recognized because no excess of market price over the option price exists at the date of grant.
b. recognized in the period of the grant.
c. allocated to the periods benefited by the employee's required service.
d. recognized in the period of exercise.


Answer: not recognized because no excess of market price over the option price exists at the date of grant

Compensation expense resulting from a compensatory stock option plan is generally

Compensation expense resulting from a compensatory stock option plan is generally

a. recognized in the period of exercise.
b. recognized in the period of the grant.
c. allocated to the periods benefited by the employee's required service.
d. allocated over the periods of the employee's service life to retirement.


Answer: allocated to the periods benefited by the employee's required service

The date on which total compensation expense is computed in a stock option plan is the date

a. of grant.
b. of exercise.
c. that the market price coincides with the option price.
c. that the market price exceeds the option price.


Answer: of grant

A company estimates the fair value of SARs, using an option-pricing model, for

a. share-based equity awards.
b. share-based liability awards.
c. both equity awards and liability awards.
d. neither equity awards or liability awards.


Answer: share-based liability awards

The date on which to measure the compensation element in a stock option granted to a corporate employee ordinarily is the date

The date on which to measure the compensation element in a stock option granted to a corporate employee ordinarily is the date on which the employee

a. is granted the option.
b. has performed all conditions precedent to exercising the option.
c. may first exercise the option.
d. exercises the option.


Answer: is granted the option

Which of the following is not a characteristic of a noncompensatory stock option plan?

a. Substantially all full-time employees may participate on an equitable basis.
b. The plan offers no substantive option feature.
c. Unlimited time period permitted for exercise of an option as long as the holder is still employed by the company.
d. Discount from the market price of the stock no greater than would be reasonable in an offer of stock to stockholders or others.


Answer: Unlimited time period permitted for exercise of an option as long as the holder is still employed by the company.

Stock warrants outstanding should be classified as

a. liabilities.
b. reductions of capital contributed in excess of par value.
c. assets.
d. none of these.


Answer: none of these

The distribution of stock rights to existing common stockholders will increase paid-in capital at the

The distribution of stock rights to existing common stockholders will increase paid-in capital at the

Date of Issuance Date of Exercise

of the Rights of the Rights


a. Yes Yes
b. Yes No
c. No Yes
d. No No


Answer: No Yes

A corporation issues bonds with detachable warrants. The amount to be recorded as paid-in capital is preferably

a. zero.
b. calculated by the excess of the proceeds over the face amount of the bonds.
c. equal to the market value of the warrants.
d. based on the relative market values of the two securities involved.


Answer: based on the relative market values of the two securities involved

The major difference between convertible debt and stock warrants is that upon exercise of the warrants

a. the stock is held by the company for a defined period of time before they are issued to the warrant holder.
b. the holder has to pay a certain amount of cash to obtain the shares.
c. the stock involved is restricted and can only be sold by the recipient after a set period of time.
d. no paid-in capital in excess of par can be a part of the transaction.

Answer: the holder has to pay a certain amount of cash to obtain the shares

The conversion of preferred stock into common requires that any excess of the par value of the common shares issued over the carrying amount

The conversion of preferred stock into common requires that any excess of the par value of the common shares issued over the carrying amount of the preferred being converted should be

a. reflected currently in income, but not as an extraordinary item.
b. reflected currently in income as an extraordinary item.
c. treated as a prior period adjustment.
d. treated as a direct reduction of retained earnings.


Answer: treated as a direct reduction of retained earnings.

The conversion of preferred stock may be recorded by the

a. incremental method.
b. book value method.
c. market value method.
d. par value method.


Answer: book value method.

When the cash proceeds from a bond issued with detachable stock warrants exceed the sum of the par value of the bonds and the fair market value of the warrants, the excess should be credited to

a. additional paid-in capital from stock warrants.
b. retained earnings.
c. a liability account.
d. premium on bonds payable.


Answer: premium on bonds payable

When convertible debt is retired by the issuer, any material difference between the cash acquisition price and the carrying amount of the debt

When convertible debt is retired by the issuer, any material difference between the cash acquisition price and the carrying amount of the debt should be

a. reflected currently in income, but not as an extraordinary item.
b. reflected currently in income as an extraordinary item.
c. treated as a prior period adjustment.
d. treated as an adjustment of additional paid-in capital.


Answer: reflected currently in income, but not as an extraordinary item.

Proceeds from an issue of debt securities having stock warrants should not be allocated between debt and equity features when

a. the market value of the warrants is not readily available.
b. exercise of the warrants within the next few fiscal periods seems remote.
c. the allocation would result in a discount on the debt security.
d. the warrants issued with the debt securities are nondetachable.


Answer: the warrants issued with the debt securities are nondetachable

When a bond issuer offers some form of additional consideration (a "sweetener") to induce conversion, the sweetener is accounted for as a(n)

a. extraordinary item.
b. expense.
c. loss.
d. none of these.


Answer: expense

Corporations issue convertible debt for two main reasons. One is the desire to raise equity capital that, assuming conversion, will arise

Corporations issue convertible debt for two main reasons. One is the desire to raise equity capital that, assuming conversion, will arise when the original debt is converted. The other is

a. the ease with which convertible debt is sold even if the company has a poor credit rating.
b. the fact that equity capital has issue costs that convertible debt does not.
c. that many corporations can obtain financing at lower rates.
d. that convertible bonds will always sell at a premium.


Answer: that many corporations can obtain financing at lower rates.

Convertible bonds

a. have priority over other indebtedness.
b. are usually secured by a first or second mortgage.
c. pay interest only in the event earnings are sufficient to cover the interest.
d. may be exchanged for equity securities.


Answer: may be exchanged for equity securities.

The conversion of bonds is most commonly recorded by the

a. incremental method.
b. proportional method.
c. market value method.
d. book value method.


Answer: book value method.

Younger Company has outstanding both common stock and nonparticipating, non-cumulative preferred stock

Younger Company has outstanding both common stock and nonparticipating, non-cumulative preferred stock. The liquidation value of the preferred is equal to its par value. The book value per share of the common stock is unaffected by

a. the declaration of a stock dividend on preferred payable in preferred stock when the market price of the preferred is equal to its par value.
b. the declaration of a stock dividend on common stock payable in common stock when the market price of the common is equal to its par value.
c. the payment of a previously declared cash dividend on the common stock.
d. a 2-for-1 split of the common stock.


Answer: the payment of a previously declared cash dividend on the common stock

How should cumulative preferred dividends in arrears be shown in a corporation's statement of financial position?

a. Note disclosure
b. Increase in stockholders' equity
c. Increase in current liabilities
d. Increase in current liabilities for the amount expected to be declared within the year or operating cycle, and increase in long-term liabilities for the balance


Answer: Note disclosure

Assume common stock is the only class of stock outstanding in the Manley Corporation. Total stockholders' equity divided by the number of common stock shares outstanding is called

a. book value per share.
b. par value per share.
c. stated value per share.
d. market value per share.


Answer: book value per share

A feature common to both stock splits and stock dividends is

A feature common to both stock splits and stock dividends is

a. a transfer to earned capital of a corporation.
b. that there is no effect on total stockholders' equity.
c. an increase in total liabilities of a corporation.
d. a reduction in the contributed capital of a corporation.


Answer: that there is no effect on total stockholders' equity

Dividends are not paid on

a. noncumulative preferred stock.
b. nonparticipating preferred stock.
c. treasury common stock.
d. Dividends are paid on all of these.


Answer: treasury common stock

Noncumulative preferred dividends in arrears

a. are not paid or disclosed.
b. must be paid before any other cash dividends can be distributed.
c. are disclosed as a liability until paid.
d. are paid to preferred stockholders if sufficient funds remain after payment of the current preferred dividend.


Answer: are not paid or disclosed

Which one of the following disclosures should be made in the equity section of the balance sheet, rather than in the notes to the financial statements

Which one of the following disclosures should be made in the equity section of the balance sheet, rather than in the notes to the financial statements?

a. Dividend preferences
b. Liquidation preferences
c. Call prices
d. Conversion or exercise prices


Answer: Liquidation preferences

The rate of return on common stock equity is calculated by dividing 

a. net income less preferred dividends by average common stockholders' equity.
b. net income by average common stockholders' equity.
c. net income less preferred dividends by ending common stockholders' equity.
d. net income by ending common stockholders' equity.


Answer: net income less preferred dividends by average common stockholders' equity

What effect does the issuance of a 2-for-1 stock split have on each of the following?

Par Value per Share Retained Earnings


a. No effect No effect
b. Increase No effect
c. Decrease No effect
d. Decrease Decrease


Answer: Decrease No effect

Quirk Corporation issued a 100% stock dividend of its common stock which had a par value of $10 before and after the dividend

Quirk Corporation issued a 100% stock dividend of its common stock which had a par value of $10 before and after the dividend. At what amount should retained earnings be capitalized for the additional shares issued?

a. There should be no capitalization of retained earnings.
b. Par value
c. Market value on the declaration date
d. Market value on the payment date


Answer: Par value

The payout ratio can be calculated by dividing

a. dividends per share by earnings per share.
b. cash dividends by net income less preferred dividends.
c. cash dividends by market price per share.
d. dividends per share by earnings per share and dividing cash dividends by net income less preferred dividends.


Answer: cash dividends by net income less preferred dividends

The issuer of a 5% common stock dividend to common stockholders preferably should transfer from retained earnings to contributed capital an amount equal to the

The issuer of a 5% common stock dividend to common stockholders preferably should transfer from retained earnings to contributed capital an amount equal to the

a. market value of the shares issued.
b. book value of the shares issued.
c. minimum legal requirements.
d. par or stated value of the shares issued.


Answer: market value of the shares issued

At the date of declaration of a small common stock dividend, the entry should not include

a. a credit to Common Stock Dividend Payable.
b. a credit to Paid-in Capital in Excess of Par.
c. a debit to Retained Earnings.
d. All of these are acceptable.


Answer: a credit to Common Stock Dividend Payable

The balance in Common Stock Dividend Distributable should be reported as a(n)

a. deduction from common stock issued.
b. addition to capital stock.
c. current liability.
d. contra current asset.


Answer: addition to capital stock.