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Income tax

1. Taxable income is a tax accounting term and is also referred to as income before taxes.

2. Pretax financial income is the amount used to compute income tax payable.

3. Taxable amounts increase taxable income in future years.

4. A deferred tax liability represents the increase in taxes payable in future years as a result of taxable temporary differences existing at
the end of the current year.

5. Deductible amounts cause taxable income to be greater than pretax financial income in the future as a result of existing temporary
differences.

6. A deferred tax asset represents the increase in taxes refundable in future years as a result of deductible temporary differences
existing at the end of the current year.

7. A company reduces a deferred tax asset by a valuation allowance if it is probable that it will not realize some portion of the deferred
tax asset.

8. Companies should consider both positive and negative evidence to determine whether it needs to record a valuation allowance to
reduce a deferred tax asset.

9. A company should add a decrease in a deferred tax liability to income tax payable in computing income tax expense.

10. Taxable temporary differences will result in taxable amounts in future years when the related assets are recovered.

11. Examples of taxable temporary differences are subscriptions received in advance and advance rental receipts.

12. Permanent differences do not give rise to future taxable or deductible amounts.

13. Companies must consider presently enacted changes in the tax rate that become effective in future years when determining the tax
rate to apply to existing temporary differences.

14. When a change in the tax rate is enacted, the effect is reported as an adjustment to income tax payable in the period of the change.

15. Under the loss carryback approach, companies must apply a current year loss to the most recent year first and then to an earlier
year.
16. The tax effect of a loss carryforward represents future tax savings and results in the recognition of a deferred tax asset.

17. A possible source of taxable income that may be available to realize a tax benefit for loss carryforwards is future reversals of existing
taxable temporary differences.

18. An individual deferred tax asset or liability is classified as current or noncurrent based on the classification of the related
asset/liability for financial reporting purposes.

19. Companies should classify the balances in the deferred tax accounts on the balance sheet as noncurrent assets and noncurrent
liabilities.

20. The FASB believes that the deferred tax method is the most consistent method for accounting for income taxes.

True-False Answers—Conceptual

Item Ans. Item Ans. Item Ans. Item Ans.

1. F 6. T 11. F 16. T

2. F 7. F 12. T 17. T

3. T 8. T 13. T 18. T

4. T 9. F 14. F 19. F

5. F 10. T 15. F 20. F

MULTIPLE CHOICE—Conceptual

21. Taxable income of a corporation

a. differs from accounting income due to differences in intraperiod allocation between the two methods of income
determination.
b. differs from accounting income due to differences in interperiod allocation and permanent differences between the
two methods of income determination.
c. is based on generally accepted accounting principles.
d. is reported on the corporation's income statement.

22 Taxable income of a corporation differs from pretax financial income because of

Permanent Temporary
DifferencesDifferences
a. No No
b. No Yes
c. Yes Yes
d. Yes No

23. Interperiod income tax allocation causes


a. tax expense shown on the income statement to equal the amount of income taxes payable for the current year plus
or minus the change in the deferred tax asset or liability balances for the year.
b. tax expense shown in the income statement to bear a normal relation to the tax liability.
c. tax liability shown in the balance sheet to bear a normal relation to the income before tax reported in the income
statement.
d. tax expense in the income statement to be presented with the specific revenues causing the tax.
24. The deferred tax expense is the

a. increase in balance of deferred tax asset minus the increase in balance of deferred tax liability.

b. increase in balance of deferred tax liability minus the increase in balance of deferred tax asset.

c. increase in balance of deferred tax asset plus the increase in balance of deferred tax liability.

d. decrease in balance of deferred tax asset minus the increase in balance of deferred tax liability.

25. The rationale for interperiod income tax allocation is to

a. recognize a tax asset or liability for the tax consequences of temporary differences that exist at the balance sheet
date.
b. recognize a distribution of earnings to the taxing agency.
c. reconcile the tax consequences of permanent and temporary differences appearing on the current year's financial
statements.
d. adjust income tax expense on the income statement to be in agreement with income taxes payable on the balance
sheet.

26. Interperiod tax allocation results in a deferred tax liability from

a. an income item partially recognized for financial purposes but fully recognized for tax purposes in any one year.
b. the amount of deferred tax consequences attributed to temporary differences that result in net deductible amounts in
future years.
c. an income item fully recognized for tax and financial purposes in any one year.
d. the amount of deferred tax consequences attributed to temporary differences that result in net taxable amounts in
future years.

27. Which of the following situations would require interperiod income tax allocation procedures?

a. An excess of percentage depletion over cost depletion


b. Interest received on municipal bonds
c. A temporary difference exists at the balance sheet date because the tax basis of an asset or liability and its reported
amount in the financial statements differ
d. Proceeds from a life insurance policy on an officer

28. Interperiod income tax allocation procedures are appropriate when

a. an extraordinary loss will cause the amount of income tax expense to be less than the tax on ordinary net income.
b. an extraordinary gain will cause the amount of income tax expense to be greater than the tax on ordinary net
income.
c. differences between net income for tax purposes and financial reporting occur because tax laws and financial
accounting principles do not concur on the items to be recognized as revenue and expense.
d. differences between net income for tax purposes and financial reporting occur because, even though financial
accounting principles and tax laws concur on the item to be recognized as revenues and expenses, they don't concur
on the timing of the recognition.
29. Interperiod tax allocation would not be required when

a. costs are written off in the year of the expenditure for tax purposes but capitalized for accounting purposes.
b. statutory (or percentage) depletion exceeds cost depletion for the period.
c. different methods of revenue recognition arise for tax purposes and accounting purposes.
d. different depreciable lives are used for machinery for tax and accounting purposes.

30. Machinery was acquired at the beginning of the year. Depreciation recorded during the life of the machinery could result in

Future Future
Taxable Amounts Deductible Amounts
a. Yes Yes
b. Yes No
c. No Yes
d. No No

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31. A temporary difference arises when a revenue item is reported for tax purposes in a period

After it is reported Before it is reported

in financial income in financial income

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

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32. At the December 31, 2007 balance sheet date, Garth Brooks Corporation reports an accrued receivable for financial reporting
purposes but not for tax purposes. When this asset is recovered in 2008, a future taxable amount will occur and

a. pretax financial income will exceed taxable income in 2008.


b. Garth will record a decrease in a deferred tax liability in 2008.
c. total income tax expense for 2008 will exceed current tax expense for 2008.
d. Garth will record an increase in a deferred tax asset in 2008.

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33. Assuming a 40% statutory tax rate applies to all years involved, which of the following situations will give rise to reporting a deferred
tax liability on the balance sheet?

I. A revenue is deferred for financial reporting purposes but not for tax purposes.

II. A revenue is deferred for tax purposes but not for financial reporting purposes.

III. An expense is deferred for financial reporting purposes but not for tax purposes.

IV. An expense is deferred for tax purposes but not for financial reporting purposes.

a. item II only
b. items I and II only
c. items II and III only
d. items I and IV only
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34. A major distinction between temporary and permanent differences is

a. permanent differences are not representative of acceptable accounting practice.


b. temporary differences occur frequently, whereas permanent differences occur only once.
c. once an item is determined to be a temporary difference, it maintains that status; however, a permanent difference
can change in status with the passage of time.
d. temporary differences reverse themselves in subsequent accounting periods, whereas permanent
differences do not reverse.

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35. Which of the following are temporary differences that are normally classified as expenses or losses that are deductible after they are
recognized in financial income?

a. Advance rental receipts.


b. Product warranty liabilities.
c. Depreciable property.
d. Fines and expenses resulting from a violation of law.

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36. Which of the following is a temporary difference classified as a revenue or gain that is taxable after it is recognized in financial
income?

a. Subscriptions received in advance.


b. Prepaid royalty received in advance.
c. An installment sale accounted for on the accrual basis for financial reporting purposes and on the installment (cash)
basis for tax purposes.
d. Interest received on a municipal obligation.

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37. Which of the following differences would result in future taxable amounts?

a. Expenses or losses that are tax deductible after they are recognized in financial income.
b. Revenues or gains that are taxable before they are recognized in financial income.
c. Revenues or gains that are recognized in financial income but are never included in taxable income.
d. Expenses or losses that are tax deductible before they are recognized in financial income.

38. Renner Corporation's taxable income differed from its accounting income computed for this past year. An item that would create a
permanent difference in accounting and taxable incomes for Renner would be

a. a balance in the Unearned Rent account at year end.

b. using accelerated depreciation for tax purposes and straight-line depreciation for book purposes.

c. a fine resulting from violations of OSHA regulations.

d. making installment sales during the year.

39. An example of a permanent difference is

a. proceeds from life insurance on officers.


b. interest expense on money borrowed to invest in municipal bonds.
c. insurance expense for a life insurance policy on officers.
d. all of these.

40. Which of the following will not result in a temporary difference?

a. Product warranty liabilities


b. Advance rental receipts
c. Installment sales
d. All of these will result in a temporary difference.
41. A company uses the equity method to account for an investment. This would result in what type of difference and in what type of
deferred income tax?

Type of Difference Deferred Tax


a. Permanent Asset
b. Permanent Liability
c. Temporary Asset
d. Temporary Liability

42. A company records an unrealized loss on short-term securities. This would result in what type of difference and in what type of
deferred income tax?

Type of Difference Deferred Tax


a. Temporary Liability
b. Temporary Asset
c. Permanent Liability
d. Permanent Asset
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43. When a change in the tax rate is enacted into law, its effect on existing deferred income tax accounts should be

a. handled retroactively in accordance with the guidance related to changes in accounting principles.
b. considered, but it should only be recorded in the accounts if it reduces a deferred tax liability or increases a deferred
tax asset.
c. reported as an adjustment to tax expense in the period of change.
d. applied to all temporary or permanent differences that arise prior to the date of the enactment of the tax rate change,
but not subsequent to the date of the change.

44. Tax rates other than the current tax rate may be used to calculate the deferred income tax amount on the balance sheet if

a. it is probable that a future tax rate change will occur.


b. it appears likely that a future tax rate will be greater than the current tax rate.
c. the future tax rates have been enacted into law.
d. it appears likely that a future tax rate will be less than the current tax rate.

45. Recognition of tax benefits in the loss year due to a loss carryforward requires

a. the establishment of a deferred tax liability.


b. the establishment of a deferred tax asset.
c. the establishment of an income tax refund receivable.
d. only a note to the financial statements.

46. Major reasons for disclosure of deferred income tax information is (are)

a. better assessment of quality of earnings.


b. better predictions of future cash flows.
c. that it may be helpful in setting government policy.
d. all of these.

47. Accounting for income taxes can result in the reporting of deferred taxes as any of the following except

a. a current or long-term asset.


b. a current or long-term liability.
c. a contra-asset account.
d. All of these are acceptable methods of reporting deferred taxes.
48. Deferred taxes should be presented on the balance sheet

a. as one net debit or credit amount.


b. in two amounts: one for the net current amount and one for the net noncurrent amount.
c. in two amounts: one for the net debit amount and one for the net credit amount.
d. as reductions of the related asset or liability accounts.

49. Deferred tax amounts that are related to specific assets or liabilities should be classified as current or noncurrent based on

a. their expected reversal dates.


b. their debit or credit balance.
c. the length of time the deferred tax amounts will generate future tax deferral benefits.
d. the classification of the related asset or liability.
50. Tanner, Inc. incurred a financial and taxable loss for 2007. Tanner therefore decided to use the carryback provisions as it had been
profitable up to this year. How should the amounts related to the carryback be reported in the 2007 financial statements?

a. The reduction of the loss should be reported as a prior period adjustment.


b. The refund claimed should be reported as a deferred charge and amortized over five years.
c. The refund claimed should be reported as revenue in the current year.
d. The refund claimed should be shown as a reduction of the loss in 2007.

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51. A deferred tax liability is classified on the balance sheet as either a current or a noncurrent liability. The current amount of a
deferred tax liability should generally be

a. the net deferred tax consequences of temporary differences that will result in net taxable amounts during the next
year.
b. totally eliminated from the financial statements if the amount is related to a noncurrent asset.
c. based on the classification of the related asset or liability for financial reporting purposes.
d. the total of all deferred tax consequences that are not expected to reverse in the operating period or one year,
whichever is greater.

52. All of the following are procedures for the computation of deferred income taxes except to

a. identify the types and amounts of existing temporary differences.


b. measure the total deferred tax liability for taxable temporary differences.
c. measure the total deferred tax asset for deductible temporary differences and operating loss carrybacks.
d. All of these are procedures in computing deferred income taxes.

Multiple Choice Answers—Conceptual

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
21. b 26. d 31. a 36. c 41. d 46. d 51. c
22. c 27. c 32. b 37. d 42. b 47. c 52. c
23. a 28. d 33. c 38. c 43. c 48. b
24. b 29. b 34. d 39. d 44. c 49. d
25. a 30. a 35. b 40. d 45. b 50. d

Changes and Errors

1. A change in accounting principle is a change that occurs as the result of new information or additional experience.

2. Errors in financial statements result from mathematical mistakes or oversight or misuse of facts that existed when preparing the
financial statements.

3. Adoption of a new principle in recognition of events that have occurred for the first time or that were previously immaterial is
treated as an accounting change.

4. Retrospective application refers to the application of a different accounting principle to recast previously issued financial statements
—as if the new principle had always been used.
5. When a company changes an accounting principle, it should report the change by reporting the cumulative effect of the change in
the current year’s income statement.

6. One of the disclosure requirements for a change in accounting principle is to show the cumulative effect of the change on retained
earnings as of the beginning of the earliest period presented.

7. An indirect effect of an accounting change is any change to current or future cash flows of a company that result from making a
change in accounting principle that is applied retrospectively.

8. Retrospective application is considered impracticable if a company cannot determine the prior period effects using every reasonable
effort to do so.

9. Companies report changes in accounting estimates retrospectively.

10. When it is impossible to determine whether a change in principle or change in estimate has occurred, the change is considered a
change in estimate.

11. Companies account for a change in depreciation methods as a change in accounting principle.

12. When companies make changes that result in different reporting entities, the change is reported prospectively.

13. Changing the cost or equity method of accounting for investments is an example of a change in reporting entity.

14. Accounting errors include changes in estimates that occur because a company acquires more experience, or as it obtains additional
information.

15. Companies record corrections of errors from prior periods as an adjustment to the beginning balance of retained earnings in the
current period.

16. If an FASB standard creates a new principle, expresses preference for, or rejects a specific accounting principle, the change is
considered clearly acceptable.

17. Balance sheet errors affect only the presentation of an asset or liability account.

18. Counterbalancing errors are those that will be offset and that take longer than two periods to correct themselves.

19. For counterbalancing errors, restatement of comparative financial statements is necessary even if a correcting entry is not required.

20. Companies must make correcting entries for noncounterbalancing errors, even if they have closed the prior year’s books.
True-False Answers—Conceptual

Item Ans. Item Ans. Item Ans. Item Ans.

1. F 6. T 11. F 16. T

2. T 7. T 12. F 17. F

3. F 8. T 13. T 18. F

4. T 9. F 14. F 19. T

5. F 10. T 15. T 20. T

MULTIPLE CHOICE—Conceptual

21. Accounting changes are often made and the monetary impact is reflected in the financial statements of a company even though, in
theory, this may be a violation of the accounting concept of

a. materiality.
b. consistency.
c. conservatism.
d. objectivity.

22. Which of the following is not treated as a change in accounting principle?

a. A change from LIFO to FIFO for inventory valuation


b. A change to a different method of depreciation for plant assets
c. A change from full-cost to successful efforts in the extractive industry
d. A change from completed-contract to percentage-of-completion

23. Which of the following is not a retrospective-type accounting change?

a. Completed-contract method to the percentage-of-completion method for long-term contracts


b. LIFO method to the FIFO method for inventory valuation
c. Sum-of-the-years'-digits method to the straight-line method
d. "Full cost" method to another method in the extractive industry

24. Which of the following is accounted for as a change in accounting principle?

a. A change in the estimated useful life of plant assets.


b. A change from the cash basis of accounting to the accrual basis of accounting.
c. A change from expensing immaterial expenditures to deferring and amortizing them as they become material.
d. A change in inventory valuation from average cost to FIFO.
25. A company changes from straight-line to an accelerated method of calculating depreciation, which will be similar to the method
used for tax purposes. The entry to record this change should include a

a. credit to Accumulated Depreciation.


b. debit to Retained Earnings in the amount of the difference on prior years.
c. debit to Deferred Tax Asset.
d. credit to Deferred Tax Liability.

26. Which of the following disclosures is required for a change from sum-of-the-years-digits to straight-line?
a. The cumulative effect on prior years, net of tax, in the current retained earnings statement
b. Restatement of prior years’ income statements
c. Recomputation of current and future years’ depreciation
d. All of these are required.

27. A company changes from percentage-of-completion to completed-contract, which is the method used for tax purposes. The entry to
record this change should include a

a. debit to Construction in Process.


b. debit to Loss on Long-term Contracts in the amount of the difference on prior years, net of tax.
c. debit to Retained Earnings in the amount of the difference on prior years, net of tax.
d. credit to Deferred Tax Liability.

28. Which of the following disclosures is required for a change from LIFO to FIFO?

a. The cumulative effect on prior years, net of tax, in the current retained earnings statement
b. The justification for the change
c. Restated prior year income statements
d. All of these are required.

29. Stone Company changed its method of pricing inventories from FIFO to LIFO. What type of accounting change does this represent?

a. A change in accounting estimate for which the financial statements for prior periods included for comparative
purposes should be presented as previously reported.
b. A change in accounting principle for which the financial statements for prior periods included for comparative
purposes should be presented as previously reported.
c. A change in accounting estimate for which the financial statements for prior periods included for comparative
purposes should be restated.
d. A change in accounting principle for which the financial statements for prior periods included for comparative
purposes should be restated.

30. Which type of accounting change should always be accounted for in current and future periods?

a. Change in accounting principle


b. Change in reporting entity
c. Change in accounting estimate
d. Correction of an error
31. Which of the following is (are) the proper time period(s) to record the effects of a change in accounting estimate?

a. Current period and prospectively


b. Current period and retrospectively
c. Retrospectively only
d. Current period only

32. When a company decides to switch from the double-declining balance method to the straight-line method, this change should be
handled as a

a. change in accounting principle.


b. change in accounting estimate.
c. prior period adjustment.
d. correction of an error.

33. The estimated life of a building that has been depreciated 30 years of an originally estimated life of 50 years has been revised to a
remaining life of 10 years. Based on this information, the accountant should

a. continue to depreciate the building over the original 50-year life.


b. depreciate the remaining book value over the remaining life of the asset.
c. adjust accumulated depreciation to its appropriate balance, through net income, based on a 40-year life, and then
depreciate the adjusted book value as though the estimated life had always been 40 years.
d. adjust accumulated depreciation to its appropriate balance through retained earnings, based on a 40-year life, and
then depreciate the adjusted book value as though the estimated life had always been 40 years.

34. Which of the following statements is correct?

a. Changes in accounting principle are always handled in the current or prospective period.
b. Prior statements should be restated for changes in accounting estimates.
c. A change from expensing certain costs to capitalizing these costs due to a change in the period benefited, should be
handled as a change in accounting estimate.
d. Correction of an error related to a prior period should be considered as an adjustment to current year net income.

35. Which of the following describes a change in reporting entity?

a. A company acquires a subsidiary that is to be accounted for as a purchase.


b. A manufacturing company expands its market from regional to nationwide.
c. A company divests itself of a European branch sales office.
d. Changing the companies included in combined financial statements.

36. Presenting consolidated financial statements this year when statements of individual companies were presented last year is

a. a correction of an error.
b. an accounting change that should be reported prospectively.
c. an accounting change that should be reported by restating the financial statements of all prior periods presented.
d. not an accounting change.
37. An example of a correction of an error in previously issued financial statements is a change

a. from the FIFO method of inventory valuation to the LIFO method.


b. in the service life of plant assets, based on changes in the economic environment.
c. from the cash basis of accounting to the accrual basis of accounting.
d. in the tax assessment related to a prior period.

38. Counterbalancing errors do not include

a. errors that correct themselves in two years.


b. errors that correct themselves in three years.
c. an understatement of purchases.
d. an overstatement of unearned revenue.

39. A company using a perpetual inventory system neglected to record a purchase of merchandise on account at year end. This
merchandise was omitted from the year-end physical count. How will these errors affect assets, liabilities, and stockholders' equity
at year end and net income for the year?

Assets Liabilities Stockholders' Equity Net Income

a. No effect Understate Overstate Overstate.

b. No effect Overstate Understate Understate.

c. Understate Understate No effect No effect.

d. Understate No effect Understate Understate.

40. If, at the end of a period, a company erroneously excluded some goods from its ending inventory and also erroneously did not
record the purchase of these goods in its accounting records, these errors would cause

a. the ending inventory and retained earnings to be understated.


b. the ending inventory, cost of goods sold, and retained earnings to be understated.
c. no effect on net income, working capital, and retained earnings.
d. cost of goods sold and net income to be understated.

Multiple Choice Answers—Conceptual

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
21. b 24. d 27. c 30. c 33. b 36. c 39. c
22. b 25. a 28. d 31. a 34. c 37. c 40. c
23. c 26. c 29. b 32. b 35. d 38. b

Cash Flows

1.The primary purpose of the statement of cash flows is to provide cash-basis information about the company’s operating , investing, and
financing activities.

2. The statement of cash flows provides information to help investors and creditors assess the cash and noncash investing and
financing transactions during the period.
3. Companies classify some cash flows relating to investing or financing activities as operating activities.

4. The first step in the preparation of the statement of cash flows is to determine the net cash flow from operating activities.

5. The net increase (decrease) in cash reported on the statement of cash flows should reconcile the beginning and ending cash
balances reported in the comparative balance sheets.

6. Under the accrual basis of accounting, net income is usually the same as net cash flow from operating activities.

7. A company can convert net income to net cash flow from operating activities through either the direct method or the indirect
method.

8. The direct method, also called the reconciliation method, reports cash receipts and cash disbursements from operating activities.

9. The indirect method adjusts net income for items that affected reported net income but did not affect cash.

10. The FASB encourages the use of the indirect method over the direct method.

11. When accounts receivable decrease during a period, cash-basis revenues are higher than revenues reported on an accrual basis.

12. When prepaid expenses decrease during a period, expenses on the accrual-basis are lower than they are on a cash-basis.

13. Income from an investment in common stock using the equity method is added to net income in computing net cash provided from
operating activities.

14. Cash receipts from customers are computed by adding a decrease in accounts receivable to revenue from sales.

15. Cash payments for operating expenses are computed by subtracting an increase in prepaid expenses and a decrease in accrued
expenses payable from operating expenses.

16. A company should add back bond premium amortization to net income to arrive at net cash flow from operating activities.

17. Companies report the cash flows from purchases and sales of trading securities as cash flows from operating activities.

18. Noncash investing and financing activities are disclosed either in a separate schedule or in a separate note to the financial
statements.
19. When numerous adjustments are necessary, companies often use a cash flow worksheet instead of preparing a statement of cash
flows.

20. The issuance of stock dividends is entered on the cash flow worksheet, but is not reported in the statement of cash flows.

True-False Answers—Conceptual

Item Ans. Item Ans. Item Ans. Item Ans.

1. F 6. F 11. T 16. F

2. T 7. T 12. F 17. T

3. T 8. F 13. F 18. T

4. F 9. T 14. T 19. F

5. T 10. F 15. F 20. T

MULTIPLE CHOICE—Conceptual

21. It is an objective of the statement of cash flows to

a. disclose changes during the period in all asset and all equity accounts.
b. disclose the change in working capital during the period.
c. provide information about the operating, investing, and financing activities of an entity during a period.
d. none of these.

22. The primary purpose of the statement of cash flows is to provide information

a. about the operating, investing, and financing activities of an entity during a period.
b. that is useful in assessing cash flow prospects.
c. about the cash receipts and cash payments of an entity during a period.
d. about the entity's ability to meet its obligations, its ability to pay dividends, and its needs for external financing.

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23. Of the following questions, which one would not be answered by the statement of cash flows?

a. Where did the cash come from during the period?


b. What was the cash used for during the period?
c. Were all the cash expenditures of benefit to the company during the period?
d. What was the change in the cash balance during the period?

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24. The first step in the preparation of the statement of cash flows requires the use of information included in which comparative
financial statements?

a. Statements of cash flows


b. Balance sheets
c. Income statements
d. Statements of retained earnings
25. Cash equivalents are
a. treasury bills, commercial paper, and money market funds purchased with excess cash.
b. investments with original maturities of three months or less.
c. readily convertible into known amounts of cash.
d. all of these.

26. A company borrows $10,000 and signs a 90-day nontrade note payable. In preparing a statement of cash flows (indirect method),
this event would be reflected as a(n)

a. addition adjustment to net income in the cash flows from operating activities section.
b. cash outflow from investing activities.
c. cash inflow from investing activities.
d. cash inflow from financing activities.

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27. To arrive at net cash provided by operating activities, it is necessary to report revenues and expenses on a cash basis. This is done by

a. re-recording all income statement transactions that directly affect cash in a separate cash flow journal.
b. estimating the percentage of income statement transactions that were originally reported on a cash basis and
projecting this amount to the entire array of income statement transactions.
c. eliminating the effects of income statement transactions that did not result in a corresponding increase or decrease
in cash.
d. eliminating all transactions that have no current or future effect on cash, such as depreciation, from the net income
computation.

28. An increase in inventory balance would be reported in a statement of cash flows using the indirect method (reconciliation method)
as a(n)

a. addition to net income in arriving at net cash flow from operating activities.
b. deduction from net income in arriving at net cash flow from operating activities.
c. cash outflow from investing activities.
d. cash outflow from financing activities.

29. A statement of cash flows typically would not disclose the effects of

a. capital stock issued at an amount greater than par value.


b. stock dividends declared.
c. cash dividends paid.
d. a purchase and immediate retirement of treasury stock.

30. When preparing a statement of cash flows (indirect method), which of the following is not an adjustment to reconcile net income to
net cash provided by operating activities?

a. A change in interest payable


b. A change in dividends payable
c. A change in income taxes payable
d. All of these are adjustments.
31. Declaration of a cash dividend on common stock affects cash flows from operating activities under the direct and indirect methods
as follows:

Direct Method Indirect Method

a. Outflow Inflow

b. Inflow Inflow

c. Outflow Outflow

d. No effect No effect

32. In a statement of cash flows, the cash flows from investing activities section should report

a. the issuance of common stock in exchange for a factory building.


b. stock dividends received.
c. a major repair to machinery charged to accumulated depreciation.
d. the assignment of accounts receivable.

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33. Xanthe Corporation had the following transactions occur in the current year:

1. Cash sale of merchandise inventory.

2. Sale of delivery truck at book value.

3. Sale of Xanthe common stock for cash.

4. Issuance of a note payable to a bank for cash.

5. Sale of a security held as an available-for-sale investment.

6. Collection of loan receivable.

How many of the above items will appear as a cash inflow from investing activities on a statement of cash flows for the current year?

a. Five items
b. Four items
c. Three items
d. Two items

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34. Which of the following would be classified as a financing activity on a statement of cash flows?

a. Declaration and distribution of a stock dividend


b. Deposit to a bond sinking fund
c. Sale of a loan receivable
d. Payment of interest to a creditor

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35. The amortization of bond premium on long-term debt should be presented in a statement of cash flows (using the indirect method
for operating activities) as a(n)

a. addition to net income.


b. deduction from net income.
c. investing activity.
d. financing activity.

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36. Crabbe Company reported $80,000 of selling and administrative expenses on its income statement for the past year. The company
had depreciation expense and an increase in prepaid expenses associated with the selling and administrative expenses for the year.
Assuming use of the direct method, how would these items be handled in converting the accrual based selling and administrative
expenses to the cash basis?
Increase in

Depreciation Prepaid Expenses

a. Deducted From Deducted From

b. Added To Added To

c. Deducted From Added To

d. Added To Deducted From

37. When preparing a statement of cash flows (indirect method), an increase in ending inventory over beginning inventory will result in
an adjustment to reported net earnings because

a. cash was increased while cost of goods sold was decreased.


b. cost of goods sold on an accrual basis is lower than on a cash basis.
c. acquisition of inventory is an investment activity.
d. inventory purchased during the period was less than inventory sold resulting in a net cash increase.

38. When preparing a statement of cash flows, a decrease in accounts receivable during a period would cause which one of the
following adjustments in determining cash flow from operating activities?

Direct Method Indirect Method

a. Increase Decrease

b. Decrease Increase

c. Increase Increase

d. Decrease Decrease

39. In determining net cash flow from operating activities, a decrease in accounts payable during a period

a. means that income on an accrual basis is less than income on a cash basis.
b. requires an addition adjustment to net income under the indirect method.
c. requires an increase adjustment to cost of goods sold under the direct method.
d. requires a decrease adjustment to cost of goods sold under the direct method.

40. When preparing a statement of cash flows, an increase in accounts payable during a period would require which of the following
adjustments in determining cash flows from operating activities?

Indirect Method Direct Method

a. Increase Decrease

b. Decrease Increase

c. Increase Increase

d. Decrease Decrease

41. When preparing a statement of cash flows, a decrease in prepaid insurance during a period would require which of the following
adjustments in determining cash flows from operating activities?

Indirect Method Direct Method

a. Increase Decrease
b. Decrease Increase

c. Increase Increase

d. Decrease Decrease

42. When preparing a statement of cash flows, the following are used for which method in determining cash flows from operating
activities?

Gross Accounts Receivable Net Accounts Receivable

a. Indirect Direct

b. Direct Indirect

c. Direct Direct

d. Neither Indirect

43. Which of the following statements is correct?

a. The indirect method starts with income before extraordinary items.


b. The direct method is known as the reconciliation method.
c. The direct method is more consistent with the primary purpose of the statement of cash flows.
d. All of these.

44. Riley Company reports its income from investments under the equity method and recognized income of $25,000 from its investment
in Wood Co. during the current year, even though no dividends were declared or paid by Wood during the year. On Riley's statement
of cash flows (indirect method), the $25,000 should

a. not be shown.
b. be shown as cash inflow from investing activities.
c. be shown as cash outflow from financing activities.
d. be shown as a deduction from net income in the cash flows from operating activities section.

45. In reporting extraordinary transactions on a statement of cash flows (indirect method), the

a. gross amount of an extraordinary gain should be deducted from net income.


b. net of tax amount of an extraordinary gain should be added to net income.
c. net of tax amount of an extraordinary gain should be deducted from net income.
d. gross amount of an extraordinary gain should be added to net income.

46. Which of the following is shown on a statement of cash flows?

a. A stock dividend
b. A stock split
c. An appropriation of retained earnings
d. None of these

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47. How should significant noncash transactions be reported in the statement of cash flows according to FASB Statement No. 95?

a. They should be incorporated in the statement of cash flows in a section labeled, "Significant Noncash Transactions."
b. Such transactions should be incorporated in the section (operating, financing, or investing) that is most
representative of the major component of the transaction.
c. These noncash transactions are not to be incorporated in the statement of cash flows. They may be summarized in a
separate schedule at the bottom of the statement or appear in a separate supplementary schedule to the financials.
d. They should be handled in a manner consistent with the transactions that affect cash flows.
Multiple Choice Answers—Conceptual

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
21. c 25. d 29. b 33. c 37. b 41. a 45. a
22. c 26. d 30. b 34. b 38. c 42. b 46. d
23. c 27. c 31. d 35. b 39. c 43. c 47. c
24. b 28. b 32. c 36. c 40. a 44. d

Disclosure

1. FASB standards directly affect financial statements, notes to the financial statements, and management’s discussion and analysis.

2. The SEC requires that companies report to it certain substantive information that is not found in their annual reports.

3. Accounting policies are the specific accounting principles and methods a company uses and considers most appropriate to present
fairly its financial statements.

4. In order to make adequate disclosure of related party transactions, companies should report the legal form, rather than the
economic substance, of these transactions.

5. If the loss on an account receivable results from a customer’s bankruptcy after the balance sheet date, the company only discloses
this information in the notes to the financial statements.

6. FASB Statement 131 requires that general purpose financial statements include selected information on a single basis of
segmentation.

7. The FASB requires allocations of joint, common, or company-wide costs for external reporting purposes.

8. If 10 percent or more of company revenue is derived from a single customer, the company must disclose the total amount of
revenue from each such customer by segment.

9. Companies should report accounting transactions as they occur, and expense recognition should not change with the period of time
covered under the integral approach.

10. Companies should generally use the same accounting principles for interim reports and for annual reports.

11. Companies report extraordinary items in interim reports by prorating them over the four quarters.
12. To compute the year-to-date tax, companies apply the estimated annual effective tax rate to the year-to-date ordinary income at
the end of each interim period.

13. In most situations, an auditor issues a qualified opinion or disclaims an opinion.

14. A qualified opinion is issued when the exception to the standard opinion is not of sufficient magnitude to invalidate the statements
as a whole.

15. Management’s discussion and analysis section covers three financial aspects of an enterprise’s business-liquidity, profitability, and
solvency.

16. The MD&A section must provide information about the effects of inflation and changing prices, if they are material to financial
statement trends.

17. A financial projection is a set of prospective financial statements that present a company’s expected financial position and results of
operations.

18. The difference between a financial forecast and a financial projection is that a forecast provides information on what is expected to
happen, while a projection provides information on what might take place.

19. Fraudulent financial reporting is intentional or reckless conduct, whether act or omission, that results in materially misleading
financial statements.

20. Influences in a company’s internal environment may relate to industry conditions, poor internal control systems, or legal and
regulatory considerations.

True-False Answers—Conceptual

Item Ans. Item Ans. Item Ans. Item Ans.

1. F 6. T 11. F 16. T

2. T 7. F 12. T 17. F

3. T 8. T 13. F 18. T

4. F 9. F 14. T 19. T

5. F 10. T 15. F 20. F


MULTIPLE CHOICE—Conceptual

21. Which of the following should be disclosed in a Summary of Significant Accounting Policies?

a. Types of executory contracts


b. Amount for cumulative effect of change in accounting principle
c. Claims of equity holders
d. Depreciation method followed

22. An example of an inventory accounting policy that should be disclosed in a Summary of Significant Accounting Policies is the

a. amount of income resulting from the involuntary liquidation of LIFO.


b. major backlogs of inventory orders.
c. method used for pricing inventory.
d. composition of inventory into raw materials, work-in-process, and finished goods.

23. Errors and irregularities are defined as intentional distortions of facts.

Errors Irregularities

a. Yes Yes

b. Yes No

c. No Yes

d. No No
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24. The full disclosure principle, as adopted by the accounting profession, is best described by which of the following?

a. All information related to an entity's business and operating objectives is required to be disclosed in the financial
statements.
b. Information about each account balance appearing in the financial statements is to be included in the notes to the
financial statements.
c. Enough information should be disclosed in the financial statements so a person wishing to invest in the stock of the
company can make a profitable decision.
d. Disclosure of any financial facts significant enough to influence the judgment of an informed reader.

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25. The focus of APB Opinion No. 22 is on the disclosure of accounting policies. This information is important to financial statement
readers in determining

a. net income for the year.


b. whether accounting policies are consistently applied from year to year.
c. the value of obsolete items included in ending inventory.
d. whether the working capital position is adequate for future operations.

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26. If a business entity entered into certain related party transactions, it would be required to disclose all of the following information
except the

a. nature of the relationship between the parties to the transactions.


b. nature of any future transactions planned between the parties and the terms involved.
c. dollar amount of the transactions for each of the periods for which an income state-ment is presented.
d. amounts due from or to related parties as of the date of each balance sheet presented.

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27. Events that occur after the December 31, 2008 balance sheet date (but before the balance sheet is issued) and provide additional
evidence about conditions that existed at the balance sheet date and affect the realizability of accounts receivable should be

a. discussed only in the MD&A (Management's Discussion and Analysis) section of the annual report.
b. disclosed only in the Notes to the Financial Statements.
c. used to record an adjustment to Bad Debt Expense for the year ending December 31, 2008.
d. used to record an adjustment directly to the Retained Earnings account

28. Which of the following post-balance-sheet events would generally require disclosure, but no adjustment of the financial statements?

a. Retirement of the company president


b. Settlement of litigation when the event that gave rise to the litigation occurred prior to the balance sheet date.
c. Employee strikes
d. Issue of a large amount of capital stock

29. Which of the following subsequent events (post-balance-sheet events) would require adjustment of the accounts before issuance of
the financial statements?

a. Loss of plant as a result of fire


b. Changes in the quoted market prices of securities held as an investment
c. Loss on an uncollectible account receivable resulting from a customer’s major flood loss
d. Loss on a lawsuit, the outcome of which was deemed uncertain at year end.

30. Revenue of a segment includes

a. only sales to unaffiliated customers.


b. sales to unaffiliated customers and intersegment sales.
c. sales to unaffiliated customers and interest revenue.
d. sales to unaffiliated customers and other revenue and gains.

31. An operating segment is a reportable segment if

a. its operating profit is 10% or more of the combined operating profit of profitable segments.
b. its operating loss is 10% or more of the combined operating losses of segments that incurred an operating loss.
c. the absolute amount of its operating profit or loss is 10% or more of the company's combined operating profit or loss.
d. none of these.
32. A segment of a business enterprise is to be reported separately when the revenues of the segment exceed 10 percent of the

a. total combined revenues of all segments reporting profits.


b. total revenues of all the enterprise's industry segments.
c. total export and foreign sales.
d. combined net income of all segments reporting profits.

33. All of the following information about each operating segment must be reported except

a. unusual items.
b. interest revenue.
c. cost of goods sold.
d. depreciation and amortization expense.

34. The profession requires disaggregated information in the following ways:

a. products or services.
b. geographic areas.
c. major customers.
d. all of these.

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35. In presenting segment information, which of the following items must be reconciled to the entity's consolidated financial
statements?

Operating Identifiable

Revenues Profit (Loss) Assets

a. Yes Yes Yes

b. No Yes Yes

c. Yes No Yes

d. Yes Yes No

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36. APB Opinion No. 28 indicates that

a. all companies that issue an annual report should issue interim financial reports.
b. the discrete view is the most appropriate approach to take in preparing interim financial reports.
c. the three basic financial statements should be presented each time an interim period is reported upon.
d. the same accounting principles used for the annual report should be employed for interim reports.
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37. Donnegan Manufacturing Company employs a standard cost system. A planned volume variance in the first quarter of 2008, which is
expected to be absorbed by the end of the fiscal year, ordinarily should

a. be deferred at the end of the first quarter, regardless of whether it is favorable or unfavorable.
b. never be deferred beyond the quarter in which it occurs.
c. be deferred at the end of the first quarter if it is favorable; unfavorable variances are to be recognized in the period
incurred.
d. be deferred at the end of the first quarter if it is unfavorable; favorable variances are to be recognized in the period
incurred.

38. In considering interim financial reporting, how does the profession conclude that such reporting should be viewed?

a. As a "special" type of reporting that need not follow generally accepted accounting principles.

b. As useful only if activity is evenly spread throughout the year so that estimates are unnecessary.

c. As reporting for a basic accounting period.

d. As reporting for an integral part of an annual period.


39. Accounting principles are modified for the following at interim dates.

Revenue Losses

a. Yes Yes

b. Yes No

c. No Yes

d. No No

40. The following methods of estimating inventory can be used at interim dates for inventory pricing. May they also be used at year
end?

Gross Profit Method Retail Inventory Method

a. No No

b. No Yes

c. Yes No

d. Yes Yes

41. A company that uses the last-in, first-out (LIFO) method of inventory pricing finds at an interim reporting date that there has been a
partial liquidation of the base period inventory level. The decline is considered temporary and the partial liquidation is expected to
be replaced prior to year end. The amount shown as inventory at the interim reporting date should

a. be shown at the actual level, and cost of sales for the interim reporting period should include the expected cost of
replacement of the liquidated LIFO base.
b. be shown at the actual level, and cost of sales for the interim reporting period should reflect the historical cost of the
liquidated LIFO base.
c. not give effect to the LIFO liquidation, and cost of sales for the interim reporting period should reflect the historical
cost of the liquidated LIFO base.
d. be shown at the actual level, and the decrease in inventory level should not be reflected in the cost of sales for the
interim reporting period.
42. Companies should disclose all of the following in interim reports except

a. basic and diluted earnings per share.


b. changes in accounting principles.
c. post-balance-sheet events.
d. seasonal revenue, cost, or expenses.

43. The required approach for handling extraordinary items in interim reports is to

a. prorate them over all four quarters.


b. prorate them over the current and remaining quarters.
c. charge or credit the loss or gain in the quarter that it occurs.
d. disclose them only in the notes.

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44. If the financial statements examined by an auditor lead the auditor to issue an opinion that contains an exception that is not of
sufficient magnitude to invalidate the statement as a whole, the opinion is said to be

a. unqualified.
b. qualified.
c. adverse.
d. exceptional.

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45. The MD&A section of an enterprise's annual report is to cover the following three items:

a. income statement, balance sheet, and statement of owners' equity.


b. income statement, balance sheet, and statement of cash flows.
c. liquidity, capital resources, and results of operations.
d. changes in the stock price, mergers, and acquisitions.

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46. Which of the following best characterizes the difference between a financial forecast and a financial projection?

a. Forecasts include a complete set of financial statements, while projections include only summary financial data.
b. A forecast is normally for a full year or more and a projection presents data for less than a year.
c. A forecast attempts to provide information on what is expected to happen, whereas a projection may provide
information on what is not necessarily expected to happen.
d. A forecast includes data which can be verified about future expectations, while the data in a projection is not
susceptible to verification.

47. A financial forecast per professional pronouncements presents to the best of the responsible party's knowledge and belief,

a. an entity's expected financial position, results of operations, and cash flows.


b. an assessment of the company's ability to be successful in the future.
c. given one or more hypothetical assumptions, an entity's expected financial position, results of operations, and cash
flows.
d. an assessment of the company's ability to be successful in the future under a number of different assumptions.

*48. Cash, short-term investments, and net receivables are the numerator for

Acid-Test Ratio Current Ratio

a. Yes No

b. Yes Yes

c. No No

d No Yes

*49. Theoretically, in computing the receivables turnover, the numerator should include

a. net sales.
b. net credit sales.
c. sales.
d. credit sales.

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

a. net income by average common stockholders’ equity.


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

*51. The payout ratio is calculated by dividing

a. dividends per share by earnings per share.


b. cash dividends by net income plus preferred dividends.
c. cash dividends by market price per share.
d. cash dividends by net income less preferred dividends.

*52. Which of the following ratios measures long-term solvency?

a. Acid-test ratio
b. Receivables turnover
c. Debt to total assets
d. Current ratio

*53. The calculation of the number of times interest is earned involves dividing

a. net income by annual interest expense.


b. net income plus income taxes by annual interest expense.
c. net income plus income taxes and interest expense by annual interest expense.
d. none of these.

*54. When should an average amount be used for the numerator or denominator?

a. When the numerator is a balance sheet item or items


b. When the denominator is a balance sheet item or items
c. When a ratio consists of an income statement item and a balance sheet item
d. When the numerator is an income statement item or items

*55. The basic limitations associated with ratio analysis include

a. the lack of comparability among firms in a given industry.


b. the use of estimated items in accounting.
c. the use of historical costs in accounting.
d. all of these.
Multiple Choice Answers—Conceptual

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
21. d 26. b 31. d 36. d 41. a 46. c *51. d
22. c 27. c 32. b 37. a 42. c 47. a *52. c
23. c 28. d 33. c 38. d 43. c *48. a *53. c
24. d 29. d 34. d 39. d 44. b *49. b *54 c
25. b 30. b 35. a 40. b 45. c *50. b *55. d

Stockholder’s Equity

1.A corporation is incorporated in only one state regardless of the number of states in which it operates.

2, The preemptive right allows stockholders the right to vote for directors of the company.

3. Common stock is the residual corporate interest that bears the ultimate risks of loss.

4. Earned capital consists of additional paid-in capital and retained earnings.

5. True no-par stock should be carried in the accounts at issue price without any additional paid-in capital reported.

6. Companies allocate the proceeds received from a lump-sum sale of securities based on the securities’ par values.

7. Companies should record stock issued for services or noncash property at either the fair value of the stock issued or the fair value of
the consideration received.

8. Treasury stock is a company’s own stock that has been reacquired and retired.

9. The cost method records all transactions in treasury shares at their cost and reports the treasury stock as a deduction from capital
stock.

10. When a corporation sells treasury stock below its cost, it usually debits the difference between cost and selling price to Paid-in
Capital from Treasury Stock.

11. Participating preferred stock requires that if a company fails to pay a dividend in any year, it must make it up in a later year before
paying any common dividends.

12. Callable preferred stock permits the corporation at its option to redeem the outstanding preferred shares at stipulated prices.

13. The laws of some states require that corporations restrict their legal capital from distribution to stockholders.
14. The SEC requires companies to disclose their dividend policy in their annual report.

15. All dividends, except for liquidating dividends, reduce the total stockholders’ equity of a corporation.

16. Dividends payable in assets of the corporation other than cash are called property dividends or dividends in kind.

17. When a stock dividend is less than 20-25 percent of the common stock outstanding, a company is required to transfer the fair
market value of the stock issued from retained earnings.

18. Stock splits and large stock dividends have the same effect on a company’s retained earnings and total stockholders’ equity.

19. The rate of return on common stock equity is computed by dividing net income by the average common stockholders’ equity.

20. The payout ratio is determined by dividing cash dividends paid to common stockholders by net income available to common
stockholders.

True-False Answers—Conceptual

Item Ans. Item Ans. Item Ans. Item Ans.

1. T 6. F 11. F 16. T

2. F 7. T 12. T 17. T

3. T 8. F 13. T 18. F

4. F 9. F 14. F 19. F

5. T 10. T 15. F 20. T

MULTIPLE CHOICE—Conceptual

21. The residual interest in a corporation belongs to the

a. management.
b. creditors.
c. common stockholders.
d. preferred stockholders.

22. The pre-emptive right of a common stockholder is the right to

a. share proportionately in corporate assets upon liquidation.


b. share proportionately in any new issues of stock of the same class.
c. receive cash dividends before they are distributed to preferred stockholders.
d. exclude preferred stockholders from voting rights.

23. The pre-emptive right enables a stockholder to

a. share proportionately in any new issues of stock of the same class.


b. receive cash dividends before other classes of stock without the pre-emptive right.
c. sell capital stock back to the corporation at the option of the stockholder.
d. receive the same amount of dividends on a percentage basis as the preferred stockholders.

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24. In a corporate form of business organization, legal capital is best defined as

a. the amount of capital the state of incorporation allows the company to accumulate over its existence.
b. the par value of all capital stock issued.
c. the amount of capital the federal government allows a corporation to generate.
d. the total capital raised by a corporation within the limits set by the Securities and Exchange Commission.
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25. Stockholders of a business enterprise are said to be the residual owners. The term residual owner means that shareholders

a. are entitled to a dividend every year in which the business earns a profit.
b. have the rights to specific assets of the business.
c. bear the ultimate risks and uncertainties and receive the benefits of enterprise ownership.
d. can negotiate individual contracts on behalf of the enterprise.

26. Total stockholders' equity represents

a. a claim to specific assets contributed by the owners.


b. the maximum amount that can be borrowed by the enterprise.
c. a claim against a portion of the total assets of an enterprise.
d. only the amount of earnings that have been retained in the business.

27. A primary source of stockholders' equity is

a. income retained by the corporation.


b. appropriated retained earnings.
c. contributions by stockholders.
d. both income retained by the corporation and contributions by stockholders.

28. Stockholders' equity is generally classified into two major categories:

a. contributed capital and appropriated capital.


b. appropriated capital and retained earnings.
c. retained earnings and unappropriated capital.
d. earned capital and contributed capital.

29. The accounting problem in a lump sum issuance is the allocation of proceeds between the classes of securities. An acceptable
method of allocation is the

a. pro forma method.


b. proportional method.
c. incremental method.
d. either the proportional method or the incremental method.

30. When a corporation issues its capital stock in payment for services, the least appropriate basis for recording the transaction is the

a. market value of the services received.


b. par value of the shares issued.
c. market value of the shares issued.
d. Any of these provides an appropriate basis for recording the transaction.

31. Direct costs incurred to sell stock such as underwriting costs should be accounted for as

1. a reduction of additional paid-in capital.

2. an expense of the period in which the stock is issued.

3. an intangible asset.

a. 1
b. 2
c. 3
d. 1 or 3
32. A "secret reserve" will be created if

a. inadequate depreciation is charged to income.


b. a capital expenditure is charged to expense.
c. liabilities are understated.
d. stockholders' equity is overstated.

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33. Which of the following represents the total number of shares that a corporation may issue under the terms of its charter?

a. authorized shares
b. issued shares
c. unissued shares
d. outstanding shares

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34. Stock that has a fixed per-share amount printed on each stock certificate is called

a. stated value stock.


b. fixed value stock.
c. uniform value stock.
d. par value stock.

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35. Which of the following is not a legal restriction related to profit distributions by a corporation?

a. The amount distributed to owners must be in compliance with the state laws governing corporations.
b. The amount distributed in any one year can never exceed the net income reported for that year.
c. Profit distributions must be formally approved by the board of directors.
d. Dividends must be in full agreement with the capital stock contracts as to preferences and participation.

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36. In January 2007, Castro Corporation, a newly formed company, issued 10,000 shares of its $10 par common stock for $15 per share.
On July 1, 2007, Castro Corporation reacquired 1,000 shares of its outstanding stock for $12 per share. The acquisition of these
treasury shares

a. decreased total stockholders' equity.


b. increased total stockholders' equity.
c. did not change total stockholders' equity.
d. decreased the number of issued shares.

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37. Treasury shares are

a. shares held as an investment by the treasurer of the corporation.


b. shares held as an investment of the corporation.
c. issued and outstanding shares.
d. issued but not outstanding shares.

38. When treasury stock is purchased for more than the par value of the stock and the cost method is used to account for treasury
stock, what account(s) should be debited?

a. Treasury stock for the par value and paid-in capital in excess of par for the excess of the purchase price over the par
value.
b. Paid-in capital in excess of par for the purchase price.
c. Treasury stock for the purchase price.
d. Treasury stock for the par value and retained earnings for the excess of the purchase price over the par value.
39. “Gains" on sales of treasury stock (using the cost method) should be credited to

a. paid-in capital from treasury stock.


b. capital stock.
c. retained earnings.
d. other income.

40. Wilson Corp. purchased its own par value stock on January 1, 2007 for $20,000 and debited the treasury stock account for the
purchase price. The stock was subsequently sold for $12,000. The $8,000 difference between the cost and sales price should be
recorded as a deduction from
a. additional paid-in capital to the extent that previous net "gains" from sales of the same class of stock are included
therein; otherwise, from retained earnings.
b. additional paid-in capital without regard as to whether or not there have been previous net "gains" from sales of the
same class of stock included therein.
c. retained earnings.
d. net income.

41. How should a "gain" from the sale of treasury stock be reflected when using the cost method of recording treasury stock
transactions?

a. As ordinary earnings shown on the income statement.


b. As paid-in capital from treasury stock transactions.
c. As an increase in the amount shown for common stock.
d. As an extraordinary item shown on the income statement.

42. Which of the following best describes a possible result of treasury stock transactions by a corporation?

a. May increase but not decrease retained earnings.


b. May increase net income if the cost method is used.
c. May decrease but not increase retained earnings.
d. May decrease but not increase net income.

43. Which of the following features of preferred stock makes the security more like debt than an equity instrument?

a. Participating
b. Voting
c. Redeemable
d. Noncumulative

44. The cumulative feature of preferred stock

a. limits the amount of cumulative dividends to the par value of the preferred stock.
b. requires that dividends not paid in any year must be made up in a later year before dividends are distributed to
common shareholders.
c. means that the shareholder can accumulate preferred stock until it is equal to the par value of common stock at
which time it can be converted into common stock.
d. enables a preferred stockholder to accumulate dividends until they equal the par value of the stock and receive the
stock in place of the cash dividends.

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45. According to the FASB, redeemable preferred stock should be

a. included with common stock.


b. included as a liability.
c. excluded from the stockholders’ equity heading.
d. included as a contra item in stockholders' equity.
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46. Cumulative preferred dividends in arrears should be shown in a corporation's balance sheet as

a. an increase in current liabilities.


b. an increase in stockholders' equity.
c. a footnote.
d. an increase in current liabilities for the current portion and long-term liabilities for the long-term portion.

47. At the date of the financial statements, common stock shares issued would exceed common stock shares outstanding as a result of
the

a. declaration of a stock split.


b. declaration of a stock dividend.
c. purchase of treasury stock.
d. payment in full of subscribed stock.

48. An entry is not made on the


a. date of declaration.
b. date of record.
c. date of payment.
d. An entry is made on all of these dates.

49. Cash dividends are paid on the basis of the number of shares

a. authorized.
b. issued.
c. outstanding.
d. outstanding less the number of treasury shares.

50. Which of the following statements about property dividends is not true?

a. A property dividend is usually in the form of securities of other companies.


b. A property dividend is also called a dividend in kind.
c. The accounting for a property dividend should be based on the carrying value (book value) of the nonmonetary
assets transferred.
d. All of these statements are true.

51. Farmer Corporation owns 4,000,000 shares of stock in Baha Corporation. On December 31, 2007, Farmer distributed these shares of
stock as a dividend to its stockholders. This is an example of a

a. property dividend.
b. stock dividend.
c. liquidating dividend.
d. cash dividend.

52. A dividend which is a return to stockholders of a portion of their original investments is a

a. liquidating dividend.
b. property dividend.
c. liability dividend.
d. participating dividend.
53. A mining company declared a liquidating dividend. The journal entry to record the declaration must include a debit to

a. Retained Earnings.
b. a paid-in capital account.
c. Accumulated Depletion.
d. Accumulated Depreciation.

54. If management wishes to "capitalize" part of the earnings, it may issue a

a. cash dividend.
b. stock dividend.
c. property dividend.
d. liquidating dividend.

55. Which dividends do not reduce stockholders' equity?

a. Cash dividends
b. Stock dividends
c. Property dividends
d. Liquidating dividends

56. The declaration and issuance of a stock dividend larger than 25% of the shares previously outstanding

a. increases common stock outstanding and increases total stockholders' equity.


b. decreases retained earnings but does not change total stockholders' equity.
c. may increase or decrease paid-in capital in excess of par but does not change total stockholders' equity.
d. increases retained earnings and increases total stockholders' equity.

57. Pryor 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

58. 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.

59. 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.
60. 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.

61. 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.

62. 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

63. 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

64. 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.

65. 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.

66. Windsor 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.

P
67. Assume common stock is the only class of stock outstanding in the B-Bar-B 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.

*68. 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.

*69. 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.

*70. 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

Multiple Choice Answers—Conceptual

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
21. c 29. d 37. d 45. b 53. b 61. b *69. a
22. b 30. b 38. c 46. c 54. b 62. c *70. a
23. a 31. a 39. a 47. c 55. b 63. b
24. b 32. b 40. a 48. b 56. b 64. a
25. c 33. a 41. b 49. c 57. b 65. b
26. c 34. d 42. c 50. c 58. a 66. c
27. d 35. b 43. c 51. a 59. a 67. a
28. d 36. a 44. b 52. a 60. b *68. c