Far 7 Flashcards - Quizlet

6/20/2014 Far 7 flashcards | Quizlet
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Created by maddogdil
On September 30 of the current year, a
U.S. company entered into a futures
contract to hedge the value of its
inventory. The inventory was reported on
the balance sheet at its cost of $250,000
on September 30. On
December 31, the market value of the
inventory had decreased to $175,000.
The entity had a gain of
$74,500 on the futures contract at
December 31. What is the proper
accounting for this hedging transaction
on the December 31 year-end financial
statements, assuming that the hedge is
considered to be highly
effective?
a. Other comprehensive income will
increase by $74,500.
b. Other comprehensive income will
decrease by $500.
c. Net income will increase by $74,500.
d. Net income will decrease by $500.
Choice "d" is correct. This hedge is
classified as a fair value hedge because it
is being used to hedge the
value of the inventory. Therefore, the gain
on the fair value hedge must be recognized
in earnings, along with
the loss on the inventory, for a net
decrease in net income of $500:
Gain on derivative= $74,500
Loss on inventory= $175,000 FV -
$250,000 BV = $(75,000)
Net loss on fair value hedge= $(75,000)
loss+ $74,500 gain= $(500) loss
In order for a financial instrument to be a
derivative for accounting purposes, the
financial instrument must:
I. Have one or more underlyings.
II. Require an initial net investment.
a. I only.
b. II only.
c. Both I and 11.
d. Neither I nor II.
Choice "a" is correct. SFAS No.133
defines derivatives for accounting
purposes as having one or more
underlyings (and one or more notional
amounts), and as not requiring an initial net
investment (or having an
initial net investment that is smaller than
would be required for other types of
similar contracts).
derivative may be designated and qualify
as a fair value hedge if a set
of criteria relating to the derivative and the
hedged item are met. The most significant
criteria are:
1. There is formal documentation of the
hedging relationship between the
derivative and the hedged item.
2. The hedge must be expected to be
highly effective in offsetting changes in the
fair value of the hedged
item and the effectiveness is assessed at
least every 3 months.
3. The hedged item is specifically
identified.
4. The hedged item presents exposure to
changes in fair value that could affect
income.
A change in the fair value of a derivative
qualified as a cash flow hedge is
determined to be either effective in
offsetting a change in the hedged item or
ineffective in offsetting such a change.
How should the effective
and ineffective portions of the change in
value of a derivative which qualifies as a
cash flow hedge be
reported in financial statements?
1. Effective portion in ?
2. Ineffective portion in?
Choice "c" is correct. Changes in (gains
and losses on) the effective portion of a
cash flow hedge are
deferred and reported in "other
comprehensive income;" changes in the
ineffective portion are reported in
current income. Gains and losses which
are deferred and reported in "other
comprehensive income" must be
reclassified and recognized in income in
the period(s) in which the hedged item
affects income.
Selected information from the accounts of
Row Co. at December 31, Year 5,
follows:
Total income since incorporation
$420,000
Total cash dividends paid 130,000
Total value of property dividends
distributed
30,000
Excess of proceeds over cost of treasury
stock sold, accounted for using the cost
method
110,000
In its December 31, Year 5, financial
statements, what amount should Row
report as retained earnings?
Choice "a" is correct. Look at each item
given and decide how it affects retained
earnings: income since
incorporation equals unadjusted ending
retained earnings (RE), that is, current
year income is included; cash
dividends is a direct deduction from RE on
the date of declaration; property dividends
are deducted from RE
at market value on the date of declaration;
the excess proceeds from the sale of
treasury stock is considered
additional paid-in capital. Thus, ending RE
= unadj. RE -cash dividends - property
dividends = $420,000 -
$130,000- $30,000 = $260,000.
Choice "b" is incorrect. This amount does
not include the effect of the property
dividends. Property dividends
are deducted from RE at market value on
the date of declaration.
Choice "c" is incorrect. This amount
incorrectly includes the proceeds from the
sale of the treasury stock.
The cost method of accounting for
treasury stock affects retained earnings
only if the shares are sold below
cost and the difference exceeds any
additional paid-in capital from treasury
stock.
Cyan Corp. issued 20,000 shares of $5
par common stock at $10 per share. On
December 31, Year 1,
Cyan's retained earnings were $300,000.
In March, Year 2, Cyan reacquired 5,000
shares of its common
stock at $20 per share. In June, Year 2,
Cyan sold 1,000 of these shares to its
corporate officers for $25 per
share. Cyan uses the cost method to
record treasury stock. Net income for the
year ended December 31,
Year 2, was $60,000. At December 31,
Year 2, what amount should Cyan report
as retained earnings?
Choice "a" is correct. $360,000 retained
earnings at 12/31 /Year 2 ($300 + $60).
Because all treasury stock
transactions were recorded under the
"cost method," and the resale of treasury
stock was at a price that
exceeded its acquisition price, none of the
treasury stock transactions affected
retained earnings.
Choice "b" is incorrect. The $5,000 gain
[1 000 shares x ($25 sale price - $20
purchase price)] is recorded as
a credit to Additional Paid-in Capital-
Treasury Stock, not as a credit to retained
earnings. Only losses in
excess of APIC-Treasury Stock are
booked to retained earnings.
In September, Year 1, West Corp. made
a dividend distribution of one right for
each of its 120,000 shares of
outstanding common stock. Each right
was exercisable for the purchase of 1/100
of a share of West's $50
variable rate preferred stock at an
exercise price of $80 per share. On
March 20, Year 5, none of the rights
had been exercised, and West redeemed
them by paying each stockholder $0.10
per right. As a result of this
redemption, West's stockholders' equity
was reduced by:
a. $120
b. $2,400
c. $12,000
d. $36,000
Choice "c" is correct. In Year 1, no
dividend was recorded since none of the
rights were exercised and no
value was assigned. In Year 5, redemption
reduced equity by $12,000 [120,000
rights x $.10 per share].
How would the declaration of a 15/o
stock dividend by a corporation affect
each of the following?
1. Retained earnings
2. Total
stockholders' equity
Decrease to retained earnings - No effect
on shareholder's equity.
Rule: A stock dividend (less than 20-
25/o of stock outstanding) is treated by
transferring the FMV of the stock
dividend at declaration date from retained
earnings to capital stock and paid-in
capital. There is no effect on
total shareholder's equity because all
transfers take place within shareholder's
equity.
Shares of its own stock held by a
corporation should
be recorded as treasury stock and shown
as a reduction in the stockholders' equity
section of the B/S.
...
Hoyt Corp.'s current balance sheet
reports the following stockholders' equity:
5/o cumulative preferred stock, par value
$100 per share;
2,500 shares issued and outstanding
$250,000
Common stock, par value $3.50 per
share; 100,000 shares issued and
outstanding 350,000
Additional paid-in capital in excess of par
value of common stock 125,000
Retained earnings 300,000
Dividends in arrears on the preferred
stock amount to $25,000. If Hoyt were to
be liquidated, the preferred
stockholders would receive par value plus
a premium of $50,000. The book value
per share of common stock
IS:
a. $7.75
b. $7.50
c. $7.25
d. $7.00
Choice "d" is correct. $7.00 book value
per common share.
Preferred stock 250,000
Common stock 350,000
Additional paid-in capital 125,000
Retained earnings 300,000
Total stockholders equity 1,025,000
Less: PR stock interest (325,000)*
700,000
Total shares O/S / 100,000
Book value per share $ 7.00
* Par value preferred 250,000
Premium on preferred 50,000
Div. In arrears 25,000
Total preferred stock interest 325,000
Any preferred shareholder interest must
be removed from shareholders' equity
before computing book value
per share.
Ole Corp. declared and paid a liquidating
dividend of $100,000. This distribution
resulted in a decrease in
Ole's:
Paid-in capital
Retained earnings
Yes - No.
By definition, a liquidating dividend is one
in which the company is returning a
portion of capital originally
contributed to the company in excess of
retained earnings. A (pure) "liquidating
dividend" implies there is no
"retained earnings" left to decrease.
Posy Corp. acquired treasury shares at an
amount greater than their par value, but
less than their original
issue price. Compared to the cost method
of accounting for treasury stock, does the
par value method report
a greater amount for additional paid-in
capital and a greater amount for retained
earnings?
Additional
paid-in capital
Retained earnings
No - No.
Compared to the cost method for
reporting treasury stock, the par value
method will report a lower amount for
additional paid-in capital (APIC) and the
same amount for retained earnings.
The easiest way to solve this problem is to
make a set of assumptions consistent with
the facts and record the
proper entries.
Assumptions:
Original issue$100
Acquisition cost$80
Par value$60
Cost method
DR CR
Treasury stock 80
Cash 80
Par value method
DR CR
Treasury stock 60
APIC 20
Cash 80
Note: The only difference is that a portion
of the debit is transferred from treasury
stock to APIC, thereby
reducing the credit balance of APIC.
Grid Corp. acquired some of its own
common shares at a price greater than
both their par value and original
issue price but less than their book value.
Grid uses the cost method of accounting
for treasury stock. What
is the impact of this acquisition on total
stockholders' equity and the book value
per common share?
Total stockholders' equity
Book value per share
Decrease - Increase.
The acquisition of treasury stock at a price
less than their book value will:
1. Decrease stockholders' equity in total.
All treasury stock transactions decrease
total equity.
2. Increase book value per share. Book
value per share is based on the number of
outstanding common
shares, which is reduced by the acquisition
of treasury stock (the denominator is
reduced). The
numerator (book value) is also reduced by
the cost to purchase the shares, but the
overall effect on the
ratio is an increase in book value per
share. For example, if book value were
$1,000 and there were 100
common shares, the book value per
common share would be $10. If 10 shares
were repurchased for $8
(which is less than the original book value
per share), the new book value would be
$920 and the reduced
number of shares would be 90, thus,
resulting in a new book value per common
share of $10.22, which is
larger than the original $10.
How would the 5% stock dividend affect
the additional paid-in capital and retained
earnings amounts reported
in Gee's Year 2 statement of owners'
equity
1. APIC
2. RETAINED EARNINGS
Increase, Decrease.
A 5% stock dividend is a true stock
dividend, as opposed to a stock split
effected in the form of a dividend.
The fair market value of the stock
dividend at declaration date is capitalized
(transferred) from retained
earnings to capital stock and paid-in
capital.
Instead of the usual cash dividend, Evie
Corp. declared and distributed a property
dividend from its
overstocked merchandise. The excess of
the merchandise's carrying amount over its
market value should
be:
a. Ignored.
b. Reported as a separately disclosed
reduction of retained earnings.
c. Reported as an extraordinary loss, net
of income taxes.
d. Reported as a reduction in income
before extraordinary items.
Choice "d" is correct. A loss is recognized
for the merchandise's carrying amount
over its market value. This
results in a reduction in income before
extraordinary items.
Rule: Dividends declared and paid in the
form of assets other than cash are
recorded by the distributing
corporation at fair market value at date of
declaration.
On March 1, Rya Corp. issued 1,000
shares of its $20 par value common stock
and 2,000 shares of its $20 par value
convertible preferred stock for a total of
$80,000. At this date, Rya's common
stock was selling for $36 per share, and
the convertible preferred stock was selling
for $27 per share. What amount of the
proceeds should be allocated to Rya's
convertible preferred stock?
Choice "c" is correct. $48,000 allocated
to preferred.
Rule: Allocate "issue proceeds" of a
basket purchase or sale of convertible
preferred stock based on relative
fair market values:
Allocated
Shares $ Fair Value Basis
Common stock 1000 x 36 = $36,000
$32,000
Preferred stock 2000 x 27 =54, 000
48,000
Total fair value $90,000 $80,000
Allocate to preferred: 54/90 x $80,000 =
$48,000
When collectibility is reasonably assured,
the excess of the subscription price over
the stated value of the no par common
stock subscribed should be recorded as:
a. No par common stock.
b. Additional paid-in capital when the
subscription is recorded.
c. Additional paid-in capital when the
subscription is collected.
d. Additional paid-in capital when the
common stock is issued.
Choice "b" is correct. When collectibility is
reasonably assured, the excess of the
subscription price over the
stated value of the no par common stock
subscribed should be recorded as
additional paid-in capital (APIC)
when the subscription is received.
Entry to record subscription of 1,000
shares of common stock ($5 stated value
or par value) at a price of $18
with down payment of $3 per share:
Cash (1,000 x $3) 3,000
Subscription received - c/s 15,000
Common stock subscribed (1,000 shs x
$5) 5,000
Additional paid-in capital ($13 x 1,000)
13,000
Note: This is same "APIC" as if the stock
had been fully paid for and issued.
A corporation issuing stock should charge
retained earnings for the market value of
the shares issued in a
(an):
a. Employee stock bonus.
b. Pooling of interests.
c. 10/o stock dividend.
d. 2-for-1 stock split.
Choice "c" is correct. 1 Oo/o stock
dividend.
Rule:
1. Charge retained earnings for the market
value of shares issued for stock dividend
of less than 20-
250/o.
2. Use par value if more than 20-25/o
stock dividend.
3. If between 20-25/o use either par or
FMV.
Stock dividends on common stock should
be recorded at their fair market value by
the investor when the
related investment is accounted for under
which of the following methods?
Cost
Equity
No - No.
Rule: Stock dividends and stock splits are
not considered income to the recipient.
Therefore, investors do not record stock
dividends at fair market value. They simply
reallocate the
investment account balance (under either
method -- cost or equity) over more
shares so that value per share
decreases.
On January 1, Year 1, Ward Corp.
granted stock options to corporate
executives for the purchase of 20,000
shares of the company's $20 par value
common stock at $48 per share. All stock
options were exercised on
December 28, Year 1. Using an
acceptable option pricing model, Ward
calculated total compensation cost of
$240,000. The quoted market prices of
Ward's $20 par value common stock
were as follows:
January 1, Year 1 $45
December 28, Year 1 60
As a result of the grant and exercise of the
stock options and the issuance of the
common stock, Ward's additional paid-in
capital increased by:
$800,000 increase to additional paid-in
capital.
January 1 Journal Entry
Compensation expense $240,000
APIC - Stock options 240,000
December 28 Journal Entry
Cash ($48 x 20,000 shares) $960,000
APIC - Stock options $240,000
Common stock (20,000 x $20) $400,000
APIC 800,000
On January 1, Year 1, Lord Corp.
granted stock options for 10,000 shares at
$38 per share as additional
compensation for services to be rendered
over the next three years. Using an
acceptable option pricing
model, Lord calculated total compensation
cost of $90,000. The options are
exercisable during a 4-year
period beginning January 1, Year 4, by
grantees still employed by Lord. Market
price of Lord's stock was $47
per share at the grant date. No stock
options were terminated during Year 1. In
Lord's Year 1 income
statement, what amount should be
reported as compensation expense
pertaining to the options?
a. $90,000
b. $40,000
c. $30,000
d. $0
The compensation should be allocated
over the period for which the services are
performed.
Fair value of options at grant date
$90,000
Services for 3 years 3
Compensation expense - Year 1 $30,000
On March 4, Year 1, Evan Co. purchased
1,000 shares of LVC common stock at
$80 per share. On
September 26, Year 1, Evan received
1,000 stock rights to purchase an
additional 1,000 shares at $90 per
share. The stock rights had an expiration
date of February 1, Year 2. On
September 30, Year 1, LVC's
common stock had a market value, ex-
rights, of $95 per share and the stock
rights had a market value of $5
each. What amount should Evan report on
its September 30, Year 1, balance sheet
for investment in stock
rights?
a. $4,000
b. $5,000
c. $10,000
d. $15,000
5000/(5k+95k) x 80,000=4000
Cash flow statement
--During Year 2, equipment costing
$40,000 was sold for cash.
Depreciation expense $33,000
Increase in Accumulated depreciation
(11,000)
Depreciation on equipment sold $22,000
Gain on sale of equipment 13,000
What are the proceeds of the Sale I.e
what are the cash flows? J/e please....
Cash 31,000 **
Acc depreciation 22,000 ****
Equipment 40,000
Gain 13,000
*****33k
(11k)
22,000 depreciation attributable to the
equipment
Cash flow
Proceeds from the sale of equipment is
under what activity ?
INVESTING
Cash flow Statement under IFRS
Cash dividends paid, under U.S. GAAP.
[F] Financing activity.
[I] Investing activity.
[O] Operating activity.
FINANCING. Under IFRS, cash
dividends paid may be classified as a
financing activity
or an operating activity.
Redemption of bonds payable.
[F] Financing activity.
[I] Investing activity.
[O] Operating activity.
Choice [F] is correct. FINANCING.
At December 31, Year 1, Eagle Corp.
reported $1,750,000 of appropriated
retained earnings for the
construction of a new office building,
which was completed in Year 2 at a total
cost of $1,500,000.
In Year 2, Eagle appropriated
$1,200,000 of retained earnings for the
construction of a new plant.
Also, $2,000,000 of cash was restricted
for the retirement of bonds due in Year 3.
In its Year 2
balance sheet, Eagle should report what
amount of appropriated retained earnings?
a. $1,200,000 b. $1,450,000 c.
$2,950,000 d. $3,200,000
Explanation
Rule: When the purpose of the
appropriation has been achieved, it should
be restored to
unappropriated retained earnings.
Choice "a" is correct. $1,200,000
appropriated retained earnings at Dec. 31,
Year 2 (for the
construction of a
new plant only).
Choices "b" and "c" are incorrect. When
the new ($1,500,000) office building was
completed in Year
2,
$1,750,000 was restored to
unappropriated retained earnings.
Choice "d" is incorrect. "Cash restricted
for the retirement of bonds" (an asset
account called
"sinking fund
cash") typically reduces regular cash and
does not affect retained earnings. (There
may also be an
appropriation, but this would have to be
specifically mentioned in the question.)
On December 1, Line Corp. received a
donation of 2,000 shares of its $5 par
value common stock from
a
stockholder. On that date, the stock's
market value was $35 per share. The
stock was originally
issued for
$25 per share. By what amount would this
donation cause total stockholders' equity
to decrease?
a. $70,000
b. $50,000
c. $20,000
d. $0
Explanation
Choice "d" is correct. $0 decrease in total
stockholders' equity due to donation of its
own stock
from a stockholder because there is no
cost to the corporation. The entry would
be:
DR Donated treasury stock(@ FMV)
CR Additional paid-in capital (@ FMV)
Both accounts enter into total
stockholders' equity; therefore, there is no
change in total
stockholders' equity. When (if) the shares
are reissued, the entry would be:
DR Cash(@ sales price)
DR Additional paid-in capital (for sp <
carrying value)
CR Donated treasury stock(@ carrying
value) additional paid-in capital
(for sp > carrying value)
Quoit, Inc. issued preferred stock with
detachable common stock warrants. The
issue price exceeded the
sum of the warrants' fair value and the
preferred stock's par value. The preferred
stock's fair value was not
determinable. What amount should be
assigned to the warrants outstanding?
a. Total proceeds.
b. Excess of proceeds over the par value
of the preferred stock.
c. The proportion of the proceeds that the
warrants' fair value bears to the preferred
stock's par value.
d. The fair value of the warrants.
hoice "d" is correct. The fair value of the
warrants is credited to paid in capital.
In a compensatory stock option plan for
which the grant and exercise dates are
different, the stock options
outstanding account should be reduced at
the:
a. Date of grant.
b. Beginning of the vesting period.
c. Beginning of the service period.
d. Exercise date.
Choice "d" is correct. Stock options
outstanding are reduced at the exercise
date.
Choice "a" is incorrect. Stock options
outstanding are increased at the date of
grant.
Choice "b" is incorrect. The beginning of
the vesting period is not used.
Choice "c" is incorrect. The beginning of
the service period is the beginning of the
period over which the
compensation expense is amortized.
Universe Co. issued 500,000 shares of
common stock in the current year.
Universe declared a 30o/o
stock
dividend. The market value was $50 per
share, the par value was $10, and the
average issue price
was $30
per share. By what amount will Universe
decrease stockholders' equity for the
dividend?
a. $0
b. $1,500,000 c. $4,500,000 d. $7,500
,000
Explanation
Choice "a" is correct. The net effect on
Universe's stockholders equity is zero, as
the reduction
to retained
earnings is offset by an equal increase in
common stock.
Journal Entry:
DR Retained earnings (.30 x 500,000 x
$10) $1,500,000
CR Common stock ($10 per value)
$1,500,000
Choices "b", "c", and "d" are incorrect, per
the above.
Porter Co. began its business last year and
issued 10,000 shares of common stock at
$3 per share.
The par
value of the stock is $1 per share. During
January of the current year, Porter bought
back 500
shares at $6 per share, which were
reported by Porter as treasury stock. The
treasury stock shares
were reissued later in the current year at
$10 per share . Porter used the cost
method to account
for its equity transactions. What amount
should Porter report as paid-in capital
related to its
treasury stock transactions on its balance
sheet for the current year?
a. $1,500 b. $2,000 c. $4,500 d.
$20,000
Explanation
Choice "b" is correct. Using the cost
method , the treasury stock transactions
include the
reissuance of the treasury shares at $10
per share ($4 per share to APIC x 500
shares) , or $2,000.
The additional paid-in capital from the
original issuance of the stock is not paid-in
capital
related to the treasury stock and is not
included.
Question CPA-0544
Baker Co. issued 100,000 shares of
common stock in the current year. On
October 1, Baker
repurchased 20,000 shares of its common
stock on the open market for $50.00 per
share. At that
date, the stock's par value was $1.00 and
the average issue price was $40.00 per
share. Baker uses
the cost method for treasury stock
transactions. On December 1, Baker
reissued the stock for
$60.00 per share. What amount should
Baker report as treasury stock gain at
December 31?
a. $0
b . $200,000 c. $400,000 d. $980,000
Explanation
Choice "a" is correct. Corporations are
not permitted to report income statement
gains and losses
from treasury stock transactions. Instead,
treasury stock "gains and losses" are
reported as
direct adjustments to stockholders' equity.
Gains are recorded by crediting APIC -
Treasury Stock,
while losses are recorded by first reducing
any existing APIC - Treasury Stock to $0,
and then
debiting any additional loss to Retained
Earnings.
Baker's treasury stock transactions would
be recorded as follows: 10/1 -
Repurchase of Treasury
Stock
DR Treasury stock CR Cash
12/1 - Resell Treasury Stock
DR Treasury stock $1,000 ,000 CR Cash
$1,000,000
DR Cash $1,200 ,000
CR Cash $1,000,000
DR Cash $1,200 ,000
CR Treasury stock $1,000 ,000
CR APIC - Treasury stock 200,000
Deck Co. had 120,000 shares of common
stock outstanding at January 1, Year 2.
On July 1, Year 2,
it issued
40,000 additional shares of common
stock. Outstanding all year were 10,000
shares of
nonconvertible cumulative preferred stock.
What is the number of shares that Deck
should use to
calculate Year 2 earnings per share?
a. 140,000
b. 150,000
c. 160,000
d. 170,000
Explanation
Choice "a" is correct. 140,000 shares of
common stock is the weighted average for
earnings per
share. The
calculation is as follows:
1-1-Year 2: Outstanding all year120,000
7-1-Year 2: 40,000 issued x 6/12
Weighted average20,000
140,000
Which of the following items, if dilutive
and if other conditions are met, would
enter into the
determination of
the weighted average shares outstanding
to be used in the basic earnings per share
(basic EPS)
calculation?
I. Stock options.
II. Contingent shares.
a. I only.
b. II only.
c. Both I and II.
d. Neither I nor II
Explanation
Choice "b" is correct. Contingent shares
(that are dilutive) are included in the
calculation of
basic earnings per share (EPS) if (and as
of the date) all conditions for issuance are
met. Stock
options do not enter into the calculation of
basic EPS.
Choices "a" and "c" are incorrect ,
because stock options do not enter into
the calculation of the
basic EPS,
but will enter into the calculation of dilutive
EPS if dilutive (i.e., the average market
price of
the common stock
during the period exceeds the exercise
price of the option).
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?
a. Declaration and distribution of stock
dividend.
b. Purchase of treasury stock.
c. Sale of additional common stock.
d. Sale of preferred convertible stock.
Explanation
Choice "a" 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 the entire period
presented.
Which one of the following is not
considered contingent shares for purposes
of computing EPS?
a. Shares issuable upon achieving a
specific net income target.
b. Shares issuable upon exercise of a
stock option.
c. Shares issuable upon the passage of a
specific period of time.
d. Shares issuable upon the issuance of a
patent.
Choice "b" is correct. Shares issuable
upon the exercise of a stock option are
not considered contingent
shares as the option holder is required to
pay the strike price to exercise the
options.
Ute Co. had the following capital structure
during Year 1 and Year 2:
Preferred stock , $10 par, 4/o
cumulative, 25,000 shares issued and
outstanding Common stock , $5 par, 200
,000 shares issued and outstanding
$250,000
1,000,000
Ute reported net income of $500,000 for
the year ended December 31, Year 2. Ute
paid no preferred dividends during Year 1
and paid $16,000 in preferred dividends
during Year 2. In its December 31, Year
2, income statement , what amount should
Ute report as basic earnings per share?
a. $2.42
b. $2.45
c. $2.48
d. $2.50
Choice "b" is correct. $2.45 earnings per
share.
Net income$ 500,000
Less: Cumulative preferred(10,000)
Stock dividend "requirement" ($10 par x
25,000 shs x 4/o ) (10,000)
Income available to common shares490
,000
Divide by average common shares O/S.
200,000
Year 1
?
Year2
Basic earnings per common share $ 2.45
Note: Since the preferred stock dividends
are cumulative, when they are declared or
paid is not relevant
West Co. had earnings per share of
$15.00 for the current year before
considering the effects of
any
convertible securities. No conversion or
exercise of convertible securities occurred
during the
year. However, possible conversion of
convertible bonds would have reduced
earnings per share by
$0.75. The effect of possible exercise of
common stock options would have
increased earnings per
share by $0.10. What amount should
West report as diluted earnings per share
for the current year?
a. $15.00
b. $14.35
c. $14.25
d. $15.10
Explanation
Choice "c" is correct. $14.25 diluted
earnings per share.
EPS before the effect of any convertibles
Possible conversion of bonds Diluted
earnings per share
Basic
EPS
$15.00
$15.00
Diluted
EPS
$15.00
(.75)
$14.25
Note: The possible exercise of common
stock options would increase EPS by
$0.10, so they are not
used due
to the anti-dilution rule. Each potentially
dilutive security is considered separately
for its
dilutive effect.
On December 1 of the current year, Clay
Co. declared and issued a 6o/o stock
dividend on its 100,000 shares
of outstanding common stock. There was
no other common stock activity during the
year. What number of
shares should Clay use in determining
basic earnings per share for the current
year?
a. 100,000
b. 100,500
c. 103,000
d. 106,000
Choice "d" is correct. A 6/o stock
dividend equals 6,000 shares with a total
of 106,000 shares outstanding
after the distribution of the dividend. Stock
dividends and stock splits require
restatement of the shares
outstanding before the stock dividend or
stock split. Thus, the stock dividend
would be treated as if it had
occurred at the beginning of the fiscal year
When computing the weighted average of
common shares outstanding for basic
earnings per share,
convertible securities are:
a. Ignored.
b. Recognized whether they are dilutive or
anti-dilutive.
c. Recognized only if they are anti-dilutive.
d. Recognized only if they are dilutive.
Explanation
Choice "a" is correct. When computing
basic earnings per share, convertible
securities are ignored for
purposes of computing the weighted
average of common shares outstanding.
On January 31, Year 2, Pack, Inc. split its
common stock 2 for 1, and Young, Inc.
issued a 5% stock dividend.
Both companies issued their December
31, Year 1, financial statements on March
1, Year 2. Should
Pack's Year 1 earnings per share (EPS)
take into consideration the stock split, and
should Young's Year 1 EPS take into
consideration the stock dividend?
Rule: If stock dividend or a stock split (or
reverse split) changes common stock
outstanding , the
computation
of EPS shall give retroactive recognition
for all periods presented using the new
number of shares
because
the reader's primary interest is presumed
to be related to current capitalization.
The following information is relevant to the
computation of Chan Co.'s earnings per
share to be disclosed on
Chan's income statement for the year
ending December 31:
Net income for 2002 is $600,000.
$5,000,000 face value 10-year
convertible bonds outstanding on January
1. The bonds were issued four
years ago at a discount which is being
amortized in the amount of $20,000 per
year. The stated rate of
interest on the bonds is 9o/o, and the
bonds were issued to yield10/o. Each
$1,000 bond is convertible
into 20 shares of Chan's common stock.
Chan's corporate income tax rate is 25/o.
Chan has no preferred stock outstanding,
and no other convertible securities. What
amount should be used
as the numerator in the fraction used to
compute Chan's diluted earnings per share
assuming that the bonds
are dilutive securities?
a. $130,000
b. $247,500
c. $952,500
d. $1,070,000
Choice "c" is correct. The numerator in the
diluted EPS computation is equal to
income available to common
shareholders plus the after-tax interest
expense that would not have been
incurred if the bonds had been
converted. Note that the company is using
straight-line amortization rather than
effective interest
amortization. Under straight-line
amortization, interest expense of
$470,000 is reported each period. The
interest expense is equal to the interest
payment of $450,000 ($5,000,000 face x
9/o stated rate) plus the
discount amortization of $20,000.
Therefore, the numerator is calculated as:
Income available to common shareholders
+ Interest of dilutive securities
= $600,000 + [$470,000 X (1 - 25/o)]
= $600,000 + $352,500 = $952,500
Mend Co. purchased a three-month U.S.
Treasury bill. Mend's policy is to treat as
cash equivalents all highly
liquid investments with an original maturity
of three months or less when purchased.
How should this
purchase be reported in Mend's statement
of cash flows?
a. As an outflow from operating activities.
b. As an outflow from investing activities.
c. As an outflow from financing activities.
d. Not reported.
Choice "d" is correct. The U.S. Treasury
bill is considered to be a cash equivalent
item so purchasing the Tbill
merely changes the form of cash held, it
does not change the cash position of the
entity. Thus, the
purchase is not reported on the statement
of cash flows.
The following are required disclosures of a
statement of cash flows
under the direct method under U.S.
GAAP.
a. The major classes of gross cash
receipts and gross cash payments.
b. The amount of income taxes paid.
c. A reconciliation of net income to net
cash flow from operations.
In preparing its cash flow statement for the
year ended December 31, Reve Co.
collected the
following data:
Gain on sale of equipment$ (6,000)
Proceeds from sale of equipment 10,000
Purchase of A.S., Inc. bonds (par value
$200,000) (180,000)
Amortization of bond discount 2,000
Dividends declared (45,000)
Dividends paid 38,000)
Proceeds from sale of Treasury stock
(carrying amount $65,000) 75,000
In its December 31, statement of cash
flows , what amount should Reve report
as net cash used in investing activities?
a. $170,000
b. $176,000
c. $188,000
d. $194,000
Choice "a" is correct. Investing activities
include acquisitions and sales of long-term
assets or
investment
assets. Cash used equals $170,000
($180,000 paid less $10,000 received
from the sale of the
equipment).
Fara Co. reported bonds payable of
$47,000 at December 31, Year 1, and
$50,000 at December 31, Year 2.
During Year 2, Fara issued $20,000 of
bonds payable in exchange for equipment.
There was no amortization
of bond premium or discount during the
year. What amount should Fara report in
its Year 2 statement of cash
flows for redemption of bonds payable?
a. $3,000
b. $17,000
c. $20,000
d. $23,000
Beginning balance 12/31 /Year 147,000
Add: issuance of bonds for
equipment20,000
Subtotal67,000
Less: redemption of bonds payable (17
,000)
Ending balance 12/31/Year 50,000
Karr, Inc. reported net income of
$300,000 during the current year.
Changes occurred in several balance sheet
accounts as follows:
Equipment $25,000 increase
Accumulated depreciation 40,000
increase
Note payable 30,000 increase
During the year , Karr sold equipment
costing $25,000, with accumulated
depreciation of $12,000, for a gain of
$5,000.
In December, Karr purchased
equipment costing $50,000 with $20,000
cash and a 12o/o note payable of
$30,000.
Depreciation expense for the year was
$52,000.
In Karr's statement of cash flows , net
cash used in investing activities should be
a. $2,000
b. $12,000
c. $22,000
d. $35,000
Choice "a" is correct. Cash used for
investing activities is computed as follows:
Sale of equipment
Purchase of equipment Cash used for
investing
$18,000
(20,000)
$ 2.000
Payment for the early retirement of long-
term
bonds payable (carrying amount
$370,000) $375,000
Distribution in Year 2 of cash dividend
declared in Year 1 to preferred
shareholders 31,000
Carrying amount of convertible preferred
stock \in
Xan, converted into common shares
60,000
Proceeds from sale of treasury stock
(carrying
amount at cost, $43,000) 50,000
During Year 2, Xan, Inc. had the following
activities related to its financial operations:
Xan uses U.S. GAAP. In Xan's Year 2
statement of cash flows, net cash used in
financing operations should
be:
356,000 net cash used in financing
operations
Payment to retire bonds $(375,000)
Payment of dividend (31,000)
Proceeds from Treasury stock 50,000
$(356,000)
On July 1 of the current year, Dewey Co.
signed a 20-year building lease that it
reported as a
capital lease.
Dewey paid the monthly lease payments
when due. How should Dewey report the
effect of the lease
payments in the financing activities section
of its statement of cash flows?
a. An inflow equal to the present value of
future lease payments at July 1, less
current year
principal and
interest payments.
b. An outflow equal to the current year
principal and interest payments on the
lease.
c. An outflow equal to the current year
principal payments only.
d. The lease payments should not be
reported in the financing activities section.
Choice "c" is correct. Cash payments
made to reduce debt principal are
properly reported as a
financing
activity. Cash interest payments would be
reported as a component of cash from
operating
activities.
How should a gain from the sale of used
equipment for cash be reported in a
statement of cash flows using
the indirect method?
a. In investment activities as a reduction of
the cash inflow from the sale.
b. In investment activities as a cash
outflow.
c. In operating activities as a deduction
from income.
d. In operating activities as an addition to
income.
Choice "c" is correct. In a statement of
cash flows using the indirect method, gain
from the sale of used
equipment for cash should be reported in
operating activities as a deduction from
income.
Choice "a" is incorrect. In the investment
activities section, cash inflow from the sale
should be reported for
the entire proceeds from the sale.
Choice "b" is incorrect. In the investment
activities section, cash outflows should be
reported for purchases of fixed assets,
stocks/bonds of other entities.
Choice "d" is incorrect. In the operating
activities section, "loss" from the sale of
used equipment should be reported as an
addition to income.
Payne Co. prepares its statement of cash
flows using the indirect method. Payne's
unamortized bond discount account
decreased by $25,000 during the year.
How should Payne report the change in
unamortized bond discount in its statement
of cash flows?
a. As a financing cash inflow.
b. As a financing cash outflow.
c. As an addition to net income in the
operating activities section.
d. As a subtraction from net income in the
operating activities section
Choice "c" is correct. Amortization of
bond discount is an income-related item;
thus, it is almost automatically
an operating activity, not a financing
activity. That knocks out two of the
answers. Because the amortization
of the discount was originally subtracted to
get to net income in the first place, it is
added back to net income
for an indirect method statement of cash
flows.
New England Co. had net cash provided
by operating activities of $351 ,000; net
cash used by investing
activities of $420,000; and cash provided
by financing activities of $250,000. New
England's cash balance
was $27 ,000 on January 1. During the
year, there was a sale of land that resulted
in a gain of $25,000 and
proceeds of $40,000 were received from
the sale. What was New England's cash
balance at the end of the
year?
a. $27,000
b. $40,000
c. $208,000
d. $248,000
Choice "c" is correct. New England's cash
balance at the end of the year includes the
cash balance at the
beginning of the year, the net cash
provided by operating activities, the net
cash used by investing activities,
and the net cash provided by financing
activities ($27,000 + $351,000 -
$420,000 + $250,000 = $208,000).
The sale of the land was included in the
cash from the investing activities and does
not have to be considered
separately. When working this type of
question, be sure to distinguish between
the net cash used and the net
cash provided
Paper Co. had net income of $70,000
during the year. Dividend payment was
$10,000. The following
information is available:
Mortgage repayment $20,000
Available-for-sale securities purchased
10,000 increase
Bonds payable - issued 50,000 increase
Inventory 40,000 increase
Accounts payable 30,000 decrease
What amount should Paper report as net
cash provided by operating activities in its
statement of cash flows
for the year under U.S. GAAP?
0 dollars is correct. The operating
activities section includes cash flows from
working capital (current assets
and current liabilities) and other income
statement items. Under the indirect
method, net income is adjusted
for non-cash items and increases/decrease
in working capital items to arrive at net
cash from operating
activities. Increases in current assets and
decreases in current liabilities are uses of
cash, while decreases in
current assets and increases in current
liabilities increase cash.
Net income $70,000
Less: Increase in inventory (40,000)
Less: Decrease in AP (30,000)
Net cash provided by operating activities
$ 0
For the year ended December 31, Ion
Corp. had cash inflows of $25,000 from
the purchases, sales, and
maturities of held-to-maturity securities
and $40,000 from the purchases, sales,
and maturities of availablefor-
sale securities. What amount of net cash
from investing activities should Ion report
in its cash flow
statement?
a. $0
b. $25,000
c. $40,000
d. $65,000
Choice "d" is correct. Net cash from
investing activities is $65,000 ($25,000 +
$40,000) because investing
activities include cash flows from both
available-for-sale and held-to-maturity
security transactions.
Green Co. had the following equity
transactions at December 31:
Cash proceeds from sale of investment in
Blue Co.
(carrying value - $60,000) $75,000
Dividends received on Grey Co. stock
10,500
Common stock purchased from Brown
Co. 38,000
What amount should Green recognize as
net cash from investing activities in its
statement of cash flows at December 31
under U.S. GAAP?
a. $37,000
b. $47,500
c. $75,000
d. $85,500
Choice "a" is correct. Net cash from
investing activities should include the cash
received from the sale of the investment in
Blue Co. offset by the cash paid to
purchase the common stock from Brown
Co.:$75,000
Cash proceeds from sale of Blue Co.
(38,000)
Cash paid to purchase Brown Co.
common stock Net cash received from
investing activities $37,000
Tam Co. reported the following items in its
year-end financial statements:
Capital expenditures $1,000,000
Capital lease payments 125,000
Income taxes paid 325,000
Dividends paid 200,000
Net interest payments 220,000
What amount should Tam report as
supplemental disclosures in its statement of
cash flows prepared
Using the indirect method?
a. $545,000
b. $745,000
c. $1,125 ,000
d. $1,870 ,000
Choice "a" is correct. When the indirect
method is used, a supplemental disclosure
of cash paid
for interest and income taxes is required.
Tam will report total cash paid for interest
and income
taxes of $545,000
($325,000 income taxes paid + $220,000
net interest payments).
Under IFRS, interest received during a
period is reported on the statement of
cash flows in:
a. Operating cash flow only.
b. Investing cash flow only.
c. Operating or investing cash flow.
d. Operating or financing cash flow
Choice "c" is correct. Under IFRS,
interest (and dividends) received may be
reported in either operating cash
flow or in investing cash flow. Under U.S.
GAAP, interest (and dividends) received
must be reported
Under IFRS, interest paid during a period
is reported on the statement of cash flows
in:
b. Financing cash flow only.
d. Operating or financing cash flow.
Choice "d" is correct. Under IFRS,
interest paid may be reported in either
operating cash flow or in financing
cash flow. Under U.S. GAAP, interest
paid must be reported only in operating
cash flow because interest
expense is reported on the income
statement.
Under IFRS, dividends paid during a
period are reported on the statement of
cash flows in:
b. Financing cash flow only.
d. Operating or financing cash flow
Choice "d" is correct. Under IFRS,
dividends paid may be reported in either
operating cash flow or in
financing cash flow. Under U.S. GAAP,
dividends paid must be reported in
financing cash flow because
dividends are paid on equity and are not
reported on the income statement.
Which of the following would be reported
as an investing activity in a company's
statement of cash flows?
a. Collection of proceeds from a note
payable.
b. Collection of a note receivable from a
related party.
c. Collection of an overdue account
receivable from a customer.
d. Collection of a tax refund from the
government.
Choice "b" is correct. Loans to other
entities and the consequent collection of
the loans are reflected in the
investing activity section of the cash flow
statement.

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