ANSWER KEY

1. $480,000

The requirement is to compute the amount of expenses to be included in

selling expenses for year 1. Advertising ($150,000) and sales salaries and
commissions ($140,000) are clearly selling expenses, as is the rent for the office
space occupied by the sales department ($220,000 × 1/2 = $110,000).
Additionally, freight-out ($80,000) is a selling expense because shipping the
goods from the point of sale to the customer is the final effort in the selling
process. The total selling expense is, therefore, $480,000 ($150,000 + $140,000
+ $110,000 + $80,000). The remaining expenses given are general and
administrative expenses, except for interest and the loss on sale of long-term
investment, which are nonoperating items (other expenses and losses).

2.

The same as it would have been if the original payment had been initially
debited to a prepaid asset account.

This answer is correct because under either method the balance in the
prepaid asset account on December 31, year 2, should be the unexpired portion
of the policy. On 12/31/Y1, an adjusting entry would be made by debiting
“Prepaid insurance” and crediting “Insurance expense” for two-thirds of the
original payment (the unexpired portion of the policy). This would result in one-
third of the payment being expensed. This entry would then be reversed on
1/1/Y2. At the end of year 2, an adjusting entry would again be made by debiting
“Prepaid insurance” and crediting “Insurance expense” for one-third of the
original payment (the unexpired portion of the policy). Since the reversing entry
will not be made until 1/1/Y3, the prepaid asset account balance would be the
same on 12/31/Y2 for this method as it would have been had the payment
originally been debited to “Prepaid insurance” on 1/1/Y1.
 3. Consolidated financial statements should only be prepared by Star and not by
Sun.
Star owns Sun. Therefore, consolidated financial statements should be prepared
for Star but not Sun.

4. Zero. A change in depreciation method is a change in method that is not

distinguishable from a change in estimate, and is accounted for as a change in
estimate. The change is reported on a prospective basis in the current year and
future years. Because a change in depreciation method is no longer given
cumulative effect treatment on the income statement, there are no deferred
income tax liability effects.
5. $33,025

The acquisition cost is equal to the $15,000 down payment plus the present
value of the $25,000 loan. The loan is payable in 5 equal installments of
$5,000 at the end of each year (ordinary annuity).

Down payment on 1/1/Y1 $15,000

Present value of ordinary annuity ($5,000 × 3.605) 18,025
Total acquisition cost $33,025

6. Decrease No effect

Regardless of the size of a stock dividend, RE is decreased and other SE

accounts are increased. Since the dividend described in this question is small (< 20-
25% of the outstanding shares), the journal entry would be

Retained earnings (FV)

Common stock dividend distributable (par value)
Additional paid-in capital (plug)

Accordingly, RE will decrease and, since all affected accounts are elements of SE,
total SE will not change. Note that the entry for a large stock dividend would be
 Retained earnings (par)
Common stock dividend distributable (par)

7. Yes Yes
Among the components which should be included in the net pension cost
recognized for a period by an employer sponsoring a defined benefit pension plan
are both actual return on plan assets, if any, and amortization of unrecognized prior
service cost, if any.

8. Decreasing annual insurance expense.

When a company insures the lives of employees and names itself the
beneficiary, the cash surrender value of the policies is considered an asset. During the
first few years of a policy, no cash surrender value may accrue. If no increase in cash
surrender value (CSV) occurs, the journal entry to record a premium paid would be
Insurance expense xxx
Cash xxx
However, if cash surrender value increases, part of the cash paid is recorded as an
increase in the CSV. The entry is
Insurance expense xx
Cash surrender value xx
Cash xxx
Therefore, the increase in CSV decreases insurance expense because the same amount
of cash paid must be allocated between the two accounts. The increase in CSV
does notaffect investment income or deferred charges.

9.
Investors and creditors and their advisors

External financial reporting provides information for external users of the

financial statements to aid decision making. Those users include investors, creditors,
and their advisors.

10.
$18,000

No dividend revenue is recognized when an investor receives a proportional

stock dividend, because the investor continues to own the same proportion of the
investee as before the stock dividend. In addition the investee has not distributed any
assets to the investor. Therefore, Cobb’s dividend income includes only the cash
dividend received [(10,000 + 2,000) × $1.50 = $18,000].

11.
Had lower accrued expenses on December 31, 20X4, than on January 1, 2004.

If the accrued expenses account (a current liability, often called accrued

expenses payable) decreased during 20X4, then a greater amount of cash was paid for
those expenses in 20X4 than were accrued in 20X4. This would cause cash-basis net
income to be less than accrual-basis net income. Cash-basis net income reflects
expenses paid; accrual-basis net income reflects expenses recognized (accrued).

12.
Higher by $36,000

Because accounts receivable decreased by $20,000, the cash received was

$20,000 more than the accrual-basis sales. Since accounts payable increased by
$16,000 during the year, accrual-basis expenses were $16,000 more than cash
payments. Therefore, accrual-basis net income is equal to $114,000 ($150,000 –
20,000 – $16,000), and therefore, cash-basis pretax income is $36,000 ($150,000 –
$114,000) higher than accrual-basis income.

13.
$260,000

Operating expenses are usually divided into two categories, selling

expenses and general and administrative (G&A) expenses. Selling expenses are
related to the sale of a company's products, while G&A expenses are related to the
company's general operations. Therefore, Griff should include the following costs in
G&A expense:
Accounting and legal fees $ 25,000
Officers' salaries 150,000
Insurance 85,000
G&A expense $ 260,000
Freight-in ($175,000) is an inventoriable cost which should be reflected in cost of
goods sold and ending inventory. Freight-out, the cost of delivering goods to
customers ($160,000), is included in selling expenses. Sales representatives' salaries
($215,000) are also a selling expense.
 14. Comparability, verifiability, timeliness, and understandability.

The relevance and faithful representation are fundamental qualitative characteristics

of financial information. Reliability is no longer listed as a fundamental quality.

15. Market value plus the accrued interest paid.

Accrued interest is recorded separately as a receivable.

16.
Discounts on accounts receivable.

Derivatives are financial instruments that derive their value from changes in a
benchmark (an underlying) based on stock prices, interest rates, mortgage rates,
currency rates, commodity prices, or some other agreed-upon financial or physical
variable that has observable or objectively verifiable changes. Discounts on accounts
receivable would not serve as a benchmark for a derivative financial instrument.

17. $9,000

Organizational costs include the attorney’s fees and meetings of incorporators,

state filing fees, and other organizational expenses. Under generally accepted
accounting principles, per ASC Subtopic 720-15, they should be expensed
immediately. Leasehold improvements are amortizable assets but do not qualify as
organization costs.

Attorney’s fees $4,000

Meetings, etc. 5,000
$9,000

18.
Component of income from continuing operations.
Gain should be recognized as income.
19. $650,000
The basic cost of goods sold formula is

Beg. inv. + Net Purchases – End. inv. = CGS

To compute cost of goods sold from the information given, cash paid for purchases
must be adjusted for increases (decreases) in both accounts payable and merchandise
inventory. Cash payments for purchases during year 1 were $580,000. In addition,
accounts payable increased by $50,000, indicating that total purchases exceeded cash
payments for purchases by $50,000. Merchandise inventory decreased by $20,000,
which means beginning inventory exceeded ending inventory by $20,000. This
decrease in inventory must be added to cash payments for purchases to compute the
cost of goods sold of $650,000.

Cash paid for purchases $580,000

+ Increase in AP 50,000
+ Decrease in inv 20,000
Cost of goods sold $650,000

20. The cost model or the revaluation model.

Under IFRS, intangible assets can be measured using either the cost model or
the revaluation model.

21.
Trade accounts receivable.

Derivative financial instruments include

1. Interest rate and foreign currency swaps

2. Currency swaps
3. Interest rate caps/floors/collars
Trade accounts receivable are not financial instruments. Therefore, this answer is
correct.

22. Bank certificates of deposit