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Question #1 (AICPA.

950514FAR-FA)
Roro, Inc. paid $7,200 to renew its only insurance policy for three years on March 1, 2005,
the effective date of the policy. At March 31, 2005, Roro's unadjusted trial balance showed
a balance of $300 for prepaid insurance and $7,200 for insurance expense.

What amounts should be reported for prepaid insurance and insurance expense in Roro's
financial statements for the three months ended March 31, 2005?

Prepaid insurance Insurance expense


$7,000 $300

$7,000 $500

The $300 of prepaid insurance on March 31 before adjustment represents the


remaining unexpired portion of the insurance policy before renewal. This amount must
have expired by March 31 because there is only one insurance policy, and that policy
was renewed March 1. The $300 is included in insurance expense for the three months
ended March 31. In addition, one month of coverage has been used on the renewed
policy as of March 31. Therefore $7,200/36 months or $200 is included in insurance
expense for the three months ended March 31. In total, $500 of insurance expense is
recognized. Prepaid insurance remaining at March 31 is $7,200 - $200 = $7,000.
$7,200 $300

$7,300 $200

Question #2 (AICPA.941147FAR-FA)
Clark Co.'s advertising expense account had a balance of $146,000 at December 31, 2003,
before any necessary year-end adjustment relating to the following:

 Included in the $146,000 is the $15,000 cost of printing catalogs for a sales
promotional campaign in January 2004.
 Radio advertisements broadcast during December 2003 were billed to Clark on
January 2, 2004. Clark paid the $9,000 invoice on January 11, 2004.

What amount should Clark report as advertising expense in its Income Statement for the
year ended December 31, 2003?

A. $122,000

B. $131,000

C. $140,000

The correct advertising expense amount is $146,000 - $15,000 + $9,000 = $140,000.


The catalog printing is subtracted because the cost relates to 2004, not to 2003. The
benefit of this cost will be received in 2004. The radio advertisements are added
because they benefit 2003, but they were not included in the $146,000 because they
were paid in 2004. Clark was apparently unaware of the cost before 12/31/03
because the firm was not billed until 2004.
D. $155,000

Question #3 (AICPA.930550FAR-P1-FA)
On February 12, 2005, VIP Publishing, Inc. purchased the copyright to a book for $15,000
and agreed to pay royalties equal to 10% of book sales, with a guaranteed minimum royalty
of $60,000. VIP had book sales of $800,000 in 2005.

In its 2005 Income Statement, what amount should VIP report as royalty expense?
A. $60,000

B. $75,000

C. $80,000

A royalty is an amount to be paid based on the sales of a commodity or product, in this


case a book. The royalty expense is 10% of $800,000 sales ($80,000) because this
amount exceeds the minimum of $60,000 that would be paid if sales were less than
$600,000.
D. $95,000

Question #4 (AICPA.930549FAR-P1-FA)
Zach Corp. pays commissions to its sales staff at the rate of 3% of net sales.

Sales staff are not paid salaries but are given monthly advances of $15,000. Advances are
charged to commission expense, and reconciliations against commissions are prepared
quarterly. Net sales for the year ended March 31, 2002, were $15,000,000. The unadjusted
balance in the commissions expense account on March 31, 2002, was $400,000. March
advances were paid on April 3, 2002.

In its Income Statement for the year ended March 31, 2002, what amount should Zach
report as commission expense?

A. $465,000

B. $450,000

Commission expense is 3% of sales or $450,000 (.03 x $15,000,000). The information


about advances is irrelevant because it pertains to how commissions are paid, not
recognized.
C. $415,000

D. $400,000

Question #5 (AICPA.930527FAR-P1-FA)

An analysis of Thrift Corp.'s unadjusted prepaid expense account at December 31, 2004,
revealed the following:

Thrift had an opening balance of $1,500 for its comprehensive insurance policy. Thrift had
paid an annual premium of $3,000 on July 1, 2003.

A $3,200 annual insurance premium payment made July 1, 2004 was unadjusted.

A $2,000 advance rental payment for a warehouse Thrift leased for one year beginning
January 1, 2005 was included.

In its December 31, 2004, Balance Sheet, what amount should Thrift report as prepaid
expenses?

A. $5,200

B. $3,600

Opening balance $1,500


less the amortization of remaining balance. The $3,000 payment on July 1, 2003
covers the period July 1, 2003 - June 30, 2004. Thus by the end of 2004, the (1,500)
prepayment has expired.

Plus the annual payment made July 1, 2004 3,200

Less 1/2 year's amortization to December 31, 2004 (1,600)

Plus warehouse prepayment (no amortization is required for this payment because
2,000
the lease term begins Jan. 1, 2005)

Equals ending 2004 prepaid expenses (prepaid asset) 3,600

C. $2,000

D. $1,600

Question #6 (AICPA.921128FAR-TH-FA)
On January 1, 2001, Sip Co. signed a five-year contract enabling it to use a patented
manufacturing process beginning in 2001.

A royalty is payable for each product produced, subject to a minimum annual fee. Any
royalties in excess of the minimum will be paid annually. On the contract date, Sip prepaid a
sum equal to two years' minimum annual fees. In 2001, only the minimum fees were
incurred.

The royalty prepayment should be reported in Sip's December 31, 2001, financial
statements as:

A. An expense only.

B. A current asset and an expense.

At the end of 2001, 1/2 of the prepayment is recognized as an expense. The minimum
fee was incurred in 2001 equaling 1/2 of the prepayment amount. Sip has received
the benefit of 1/2 of prepayment amount. The other 1/2 is applied to 2002 and allows
Sip to use the patent in that year. This amount had future value as of 12/31/01. That
future value is expected to expire at the end of 2002 and, thus, is classified as a
current asset at the end of 2001. Additional use in 2002 beyond the minimum will be
paid in that year.
C. A current asset and noncurrent asset.

One-half of the prepayment that applies to 2001 has expired and is expensed because
it is the cost of a benefit already received by Sip. One-half of the prepayment that
applies to 2002 is a current asset because it allows Sip to use the patent in 2002. That
portion of the prepayment does not allow Sip to use the patent beyond 2002, and
thus, the future benefits will expire within a year of the 2001 Balance Sheet.
Additional use in 2002 beyond the minimum will be paid in that year.
D. A noncurrent asset.

Question #7 (AICPA.921152FAR-P1-FA)
Kent Co.'s advertising expense account had a balance of $292,500 at December 31, 2003,
before any necessary year-end adjustment relating to the following:

 Included in the $292,500 is the $30,000 cost of printing catalogs for a sales
promotional campaign in January 2004.
 Radio advertising spots broadcast during December 2003 were billed to Kent on
January 2, 2004. Kent paid the $17,500 invoice on January 11, 2004.

What amount should Kent report as advertising expense in its Income Statement for the
year ended December 31, 2003?

A. $310,000

B. $280,000

The correct advertising expense amount is $292,500 - $30,000 + $17,500 = $280,000.


The catalog printing is subtracted because the cost relates to 2004, not to 2003. The
benefit of this cost will be received in 2004. The radio advertisements are added
because they benefit 2003, but they were not included in the $292,500 because they
were paid in 2004. Kent was apparently unaware of the cost before 12/31/03 because
the firm was not billed until 2004.
C. $262,500

This answer fails to add the radio advertising cost. This cost should be added because
it benefits 2003 but is not included because it was paid in 2004.
D. $245,000

Question #8 (AICPA.130726FAR)
Ina Co. had the following beginning and ending balances in its prepaid expense and accrued
liabilities accounts for the current year:
Prepaid expenses Accrued liabilities
Beginning balance $ 5,000 $ 8,000
Ending balance 10,000 20,000

Debits to operating expenses totaled $100,000. What amount did Ina pay for operating
expenses during the current year?

A. $ 83,000

B. $ 93,000

An increase in prepaid expenses indicates that more cash was paid than expensed
(5,000). An increase in accrued liabilities indicates that more expense was accrued
than paid (12,000). The reconciliation of operating expense to cash paid is: 100,000 +
5,000 - 12,000 = 93,000.
C. $107,000

D. $117,000

Question #9 (AICPA.920548FAR-P1-FA)
Pak Co.'s professional fees expense account had a balance of $82,000 on December 31,
2001, before considering year-end adjustments relating to the following:

 Consultants were hired for a special project at a total fee not to exceed $65,000. Pak
has recorded $55,000 of this fee based on billings for work performed in 2001.
 The attorney's letter requested by the auditors dated January 28, 2002, indicated
that legal fees of $6,000 were billed on January 15, 2002, for work performed in
November 2001, and unbilled fees for December 2001 were $7000.

What amount should Pak report for professional fees expense for the year ended December
31, 2001?
A. $105,000

B. $95,000

The two amounts listed in the attorney's letter should be added to the preadjusted
amount of expense, but the appropriate amount of the consultant expense has been
included in the preadjusted amount. The ending expense balance therefore is $95,000
($82,000 + $6,000 + $7,000).
C. $88,000

D. $82,000

Question #10 (AICPA.920523FAR-P1-FA)


On November 1, 2005, Key Co. paid $3,600 to renew its insurance policy for three years. At
December 31, 2005, Key's unadjusted trial balance showed a balance of $90 for prepaid
insurance and $4,410 for insurance expense.

What amounts should be reported for prepaid insurance and insurance expense in Key's
December 31, 2005, financial statements?

Prepaid Insurance Insurance expense


$3,300 $1,200

$3,400 $1,200

$3,400 $1,100

Prepaid insurance at year end is $3,400, which is the portion of the prepayment on
November 1 that continues to the next three years. Of the 36 months of coverage
purchased, 34 months remain at December 31: $3,400 = (34/36)($3,600). Insurance
expense includes three items: (1) the $90 of prepaid insurance remaining in the trial
balance that has expired, (2) the $200 of insurance expense related to the November 1
purchase above ($3,600-$3,400 remaining prepaid), and (3) the expense portion of
the $4,410 insurance expense amount in the unadjusted trial balance ($4,410-$3,600)
= $810. This firm must have expensed the entire $3,600 November 1 purchase
because it was not reflected in prepaid insurance. The difference of $810 reflects
actual expense. Therefore, total insurance expense equals $1,100 = $90 + $200 +
$810.
$3,490 $1,010

Incorrect but very close on both counts. The prepaid insurance is overstated by only
$90, which is the prepaid insurance remaining in the trial balance from the beginning
of the year. This firm records all insurance as expense and then adjusts for the
remaining prepaid at the end of the year. Such a small amount would have expired by
the end of 2005. The insurance expense is off by the same $90 and for the same
reason but in the other direction. The correct answer is $1,100.
Question #11 (AICPA.910556FAR-P1-FA)
Based on 2000 sales of compact discs recorded by an artist under a contract with Bain Co.,
the artist earned $100,000 after an adjustment of $8,000 for anticipated returns.
In addition, Bain paid the artist $75,000 in 2000 as a reasonable estimate of the amount
recoverable from future royalties to be earned by the artist.

What amount should Bain report in its 2000 Income Statement for royalty expense?

A. $100,000
The net amount earned by the artist is also the royalty expense to the firm. Royalty
expense is recognized on the basis of the sales of the CD. Adjustments to the final
amount earned for 2000, after all return information is known, will be treated as an
adjustment to royalty expense in 2001. New information in 2001 will require a change
in estimate, not retroactive application. The $100,000 amount is the best estimate of
the royalty cost to Bain in 2000 that will ultimately be paid on 2000 sales.
B. $108,000

C. $175,000

This double counts the expense for 2000 in the amount of the $75,000 payment. The
artist earned $100,000, based on the sales of the CD. That is the total expense for
Bain to recognize. The royalty payment of $75,000 is a partial payment of those
earnings.
D. $183,000

Question #12 (AICPA.910554FAR-P1-FA)

At December 31, 2000, Ashe Co. had a $990,000 balance in its advertising expense account
before any year-end adjustments relating to the following:

 Radio advertising spots broadcast during December 2000 were billed to Ashe on
January 4, 2001. The invoice cost of $50,000 was paid on January 15, 2001.
 Included in the $990,000 is $60,000 for newspaper advertising for a January 2001
sales promotional campaign.

Ashe's advertising expense for the year ended December 31, 2000, should be:

A. $930,000

B. $980,000

Preadjusted balance $990,000


Plus radio advertising (benefit was received in 2000;
the expense should be recognized in 2000) 50,000
Less the newspaper advertising (benefit to be received in 2001; there is no expense
in 2000) (60,000)
Equals advertising expense, 2000 $980,000
C. $1,000,000

D. $1,040,000

Question #13 (AICPA.910530FAR-P1-FA)

Under East Co.'s accounting system, all paid insurance premiums are debited to prepaid
insurance. For interim financial reports, East makes monthly estimated charges to
insurance expense with credits to prepaid insurance.
Additional information for the year ended December 31, 2005, is as follows:

Prepaid insurance at December 31, 2004 $105,000


Charges to insurance expense during 2005 (including a year-end adjustment of 17,500) 437,500
Prepaid insurance at December 31, 2005 122,500

What was the total amount of insurance premiums paid by East during 2005?
A. $322,500

B. $420,000

C. $437,500

D. $455,000

Beginning prepaid balance + Premiums paid - Expense charges = Ending prepaid balance
$105,000 + Premiums paid - $437,500 = $122,500
Premiums paid = $455,000

Question #14 (AICPA.910529FAR-P1-FA)


On July 1, 2003, Roxy Co. obtained fire insurance for a three-year period at an annual
premium of $72,000 payable on July 1 of each year.

The first premium payment was made July 1, 2003. On October 1, 2003, Roxy paid $24,000
for real estate taxes to cover the period ending September 30, 2004. This prepayment was
made to obtain a discount.

In its December 31, 2003, Balance Sheet, Roxy should report prepaid expenses of:

A. $60,000

B. $54,000

Unexpired fire insurance premium: $72,000(1/2) =


$36,000
The premium covers only one year and 1/2 the year is elapsed as of December 31.
Unexpired property tax prepayment: $24,000(9/12) 18,000
Total prepaid expenses (asset) at December 31, 2003 $54,000
C. $48,000

This is the difference between the two amounts paid for fire insurance and property
taxes. These amounts are not offset but rather contribute to the ending prepaid
balance. The correct analysis is:
Unexpired fire insurance premium: $72,000(1/2) =
$36,000
The premium covers only one year and 1/2 the year is elapsed as of December 31.
Unexpired property tax prepayment: $24,000(9/12) 18,000
Total prepaid expenses (asset) at December 31, 2003 $54,000
D. $36,000

Question #15 (AICPA.900518FAR-TH-FA)


Compared to the accrual basis of accounting, the cash basis of accounting overstates
income by the net increase during the accounting period of the
accounts receivable and accrued expenses payable
No No

No Yes

An increase in accounts receivable reflects recognized but uncollected sales. The


accrual method recognizes these sales as earnings, causing income to exceed cash-
basis income for such sales. Thus cash-basis income is understated relative to accrual-
basis accounting. The opposite is true for an increase in accrued expenses. The
increase in the liability reflects recognized but unpaid expenses. The accrual method
recognizes these expenses in earnings, causing income to decrease relative to cash-
basis income. Thus, cash-basis income is overstated, relative to accrual-basis
accounting.
Yes No

Yes Yes

Question #16 (AICPA.900549FAR-P2-FA)


On January 1, 2005, Layton Co. acquired the copyright to a book owned by Garner for
royalties of 15% of future book sales. Royalties are payable on September 30 for sales in
January through June of the same year, and on March 31 for sales in July through
December of the preceding year.
During 2005 and 2006, Layton remitted royalty checks to Garner as follows:
March 31 September 30
2005 $- $25,000
2006 22,000 40,000

Layton's sales of the Garner book totaled $300,000 for the last half of 2006. In its 2006
Income Statement, Layton should report royalty expense of:
A. $85,000

Royalty expense for 2006 equals 15% of sales for the year 2006, regardless of when
the royalties are paid. The $40,000 paid on September 30, 2006 applies to the sales in
the first half of 2006 (January - June). Sales for the second half of 2006 were
$300,000. The royalty expense associated with these sales is .15($300,000) =
$45,000. Therefore, total royalty expense for the year 2006 is $40,000 + $45,000 =
$85,000.
B. $67,000

C. $62,000

Royalty expense for 2006 equals 15% of sales for the year 2006, regardless of when
the royalties are paid. The $40,000 paid on September 30, 2006 applies to the sales in
the first half of 2006 (January - June). Sales for the second half of 2006 were
$300,000. The royalty expense associated with these sales is .15($300,000) =
$45,000. Therefore, total royalty expense for the year 2006 is $40,000 + $45,000 =
$85,000. The $62,000 answer is the sum of checks paid in 2006. However, the
$22,000 check relates to the second half of 2005, and therefore should not be included
in 2006 royalty expense.
D. $45,000

Question #17 (AICPA.900546FAR-P2-FA)

Doren Co.'s officers' compensation expense account had a balance of $490,000 at


December 31, 2004, before any appropriate year-end adjustment relating to the following:

 No Salary accrual was made for the week of December 25-31, 2004. Officers'
salaries for this period totaled $18,000 and were paid on January 5, 2005.
 Bonuses to officers for 2004 were paid on January 31, 2005 in the total amount of
$175,000.

The adjusted balance for officers' compensation expense for the year ended December 31,
2004 should be:
A. $683,000

Total compensation expense should include the two adjusting items. Therefore, the
total expense is $490,000 + $18,000 + $175,000 = $683,000. The two adjusting items
are not included in the expense account balance because the adjustments have not yet
been made. The accrued, but unpaid, salaries, as well as the bonuses, relate to 2004.
Officer bonuses are another form of employee compensation.
B. $665,000

C. $508,000

D. $490,000

Question #18 (AICPA.900542FAR-P2-FA)


Bird Corp.'s trademark was licensed to Brian Co. for royalties of 15% of the sales of the
trademarked items. Royalties are payable semiannually on March 15 for sales in July
through December of the prior year, and on September 15 for sales in January through June
of the same year.
Bird received the following royalties from Brian:
March 15 September 15
2004 $5,000 $7,500
2005 6,000 8,500

Brian estimated that the sales of the trademarked items would total $30,000 for July
through December 2005.
In Bird's 2005 Income Statement, the royalty revenue should be:
A. $13,000

2005 royalty revenue is the amount earned in 2005, regardless of when it is received.
The September receipt of $8,500 accounts for the royalties earned the first half of
2005. Royalties for the second half are estimated to be .15($30,000) = $4,500.
Although this is an estimate, if reliable, it provides relevant information. Waiting for
the exact amount is not justified in this case. The small increase in reliability does not
justify postponing recognition in 2005. Thus, total royalty revenue for 2005 is
$13,000, which equals $8,500 + $4,500.
B. $14,500

2005 royalty revenue is the amount earned in 2005, regardless of when it is received.
The September receipt of $8,500 accounts for the royalties earned the first half of
2005. Royalties for the second half are estimated to be .15($30,000) = $4,500.
Although this is an estimate, if reliable, it provides relevant information. Waiting for
the exact amount is not justified in this case. The small increase in reliability does not
justify postponing recognition in 2005. Thus, total royalty revenue for 2005 is
$13,000, which equals $8,500 + $4,500. The $14,500 answer is the sum of the two
checks received in 2005. However, this amount includes $6,000, that is related to
sales in the second half of 2004, and does not include the sales for the second half of
2005.
C. $19,000

D. $20,500

Question #19 (AICPA.951156FAR-FA)


In financial statements prepared on the income-tax basis, how should the nondeductible
portion of expenses, such as meals and entertainment, be reported?
A. Included in the expense category in the determination of income.

Despite the fact that these expenses are not deductible for tax purposes, they are still
business expenses and need to be included in the determination of income on the
financial statements. In addition, the income tax return requires information on the
total meals and entertainment expense in order to calculate the deductible amount.
B. Included in a separate category in the determination of income.

C. Excluded from the determination of income but included in the determination of retained
earnings.
D. Excluded from the financial statements.

Question #20 (AICPA.950538FAR-FA)


Under a royalty agreement with another company, Wand Co. will pay royalties for the
assignment of a patent for three years. The royalties paid should be reported as an
expense:
A. In the period paid.

B. In the period incurred.

Under accrual accounting, expenses are recognized when incurred. This is the point in
time when obligations come into existence. The period to which specific royalty
amounts relate is the period for expense recognition. Often, royalty payments occur at
specified intervals that do not correspond to the period in which the royalties were
earned.
C. At the date the royalty agreement began.

D. At the date the royalty agreement expired.

Question #21 (AICPA.08211248FAR-I.A.II)

U Co. had cash purchases and payments on account during the current year totaling
$455,000. U's beginning and ending accounts payable balances for the year were $64,000
and $50,000, respectively. What amount represents U's accrual-basis purchases for the
year?

A. $441,000

Using an equation, or a T-account, to analyze accounts payable (AP) yields accrual


purchases: Beginning AP ($64,000) + Accrual purchases - Cash payments ($455,000)
= Ending AP ($50,000). Solving for accrual purchases yields $441,000.
B. $469,000

This response incorrectly analyzes the change in accounts payable (AP). AP has
decreased for the year. If AP had increased $14,000, this answer would be correct.
C. $505,000

D. $519,000

Question #22 (AICPA.941158FAR-FA)


The following information pertains to Eagle Co.'s 2005 sales:
Cash Sales

Gross $ 80,000

Returns and allowances 4,000

Credit sales

Gross 120,000

Discounts 6,000
On January 1, 2005, customers owed Eagle $40,000. On December 31, 2005, customers
owed Eagle $30,000. Eagle uses the direct write-off method for bad debts. No bad debts
were recorded in 2005. Under the cash basis of accounting, what amount of net revenue
should Eagle report for 2005?

A. $76,000

Revenue under the cash basis of accounting is the amount of cash collected during the
year from customers, regardless of when the sale took place. This answer is only a
portion of the cash collected during the year-the cash sales. Cash was also collected
from credit sales during the year.
B. $170,000

C. $190,000

D. $200,000

Net cash sales collected $80,000 - $4,000 $76,000

Plus cash collections from credit sales:

Beginning accounts receivable $40,000

Plus net credit sales $120,000 - $6,000 114,000

Less ending accounts receivable (30,000)

Equals cash collections from credit sales 124,000

Equals revenue recognized under the cash basis of accounting $200,000


Question #23 (AICPA.940554FAR-FA)
Which of the following accounting bases may be used to prepare financial statements in
conformity with a comprehensive basis of accounting other than Generally Accepted
Accounting Principles?

I. Basis of accounting used by an entity to file its income tax return;

II. Cash receipts and disbursements basis of accounting.

A. I only.

B. II only.

C. Both I and II.

This question is not asking whether other comprehensive bases of accounting are
acceptable under GAAP. Rather, it is simply asking which statements describe a
comprehensive basis other than GAAP. Both I and II are found in various situations of
accounting practice.
D. Neither I nor II.

Question #24 (AICPA.931140FAR-TH-FA)


Compared to its 2004 cash-basis net income, Potoma Co.'s 2004 accrual-basis net income
increased when it:
A. Declared a cash dividend in 2003 that it paid in 2004.

B. Wrote off more accounts receivable balances than it reported as uncollectible accounts
expense in 2004.
C. Had lower accrued expenses on December 31, 2004, than on January 1, 2004.

If the accrued expenses account (a current liability, often called accrued expenses
payable) decreased during 2004, then a greater amount of cash was paid for those
expenses in 2004 than were accrued in 2004. 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).
D. Sold used equipment for cash at a gain in 2004.

Question #25 (AICPA.08211240FAR-I.A.II)

Sanni Co. had $150,000 in cash-basis pretax income for the year. At the current year end,
accounts receivable decreased by $20,000 and accounts payable increased by $16,000 from
their previous year-end balances. Compared to the accrual-basis method of accounting,
Sanni's cash-basis pretax income is:

A. Higher by $4,000.

B. Lower by $4,000.

C. Higher by $36,000.

The $20,000 AR decrease implies that cash received on account was $20,000 greater
than accrual sales. Cash-basis income is, therefore, $20,000 greater than accrual
income for this difference. The $16,000 accounts payable increase implies that more
inventory was purchased and included in accrual cost of goods sold than was paid.
Cash-basis income is, therefore, $16,000 more than accrual income for this difference.
In total, cash-basis income is $36,000 greater than accrual income.
D. Lower by $36,000.

Question #26 (AICPA.020505FAR-FA)


Hahn Co. prepared financial statements on the cash basis of accounting. The cash basis was
modified so that an accrual of income taxes was reported.

Are these financial statements in accordance with the modified cash basis of accounting?

A. Yes.

Under a strict cash basis of accounting, revenues and expenses are recorded only
when cash is received or paid. Under a modified cash basis of accounting, certain
accruals and/or deferrals are recorded for financial-statement purposes.
The most common modifications are the capitalization and amortization of long-lived
assets and the accrual for income taxes (recognition of income tax expense and
related liability).
B. No, because the modifications are illogical.

C. No, because there is no substantial support for recording income taxes.

D. No, because the modifications result in financial statements equivalent to those prepared
under the accrual basis of accounting.
Question #27 (AICPA.930540FAR-P1-FA)
Class Corp. maintains its accounting records on the cash basis, but it restates its financial
statements to the accrual method of accounting. Class had $60,000 in cash-basis pretax
income for 2002. The following information pertains to Class operations for the years ended
December 31, 2002 and 2001:
2002 2001
Accounts receivable $40,000 $20,000

Accounts payable 15,000 30,000

Under the accrual method, what amount of income before taxes should Class report in its
December 31, 2002, Income Statement?

A. $25,000

B. $55,000

C. $65,000

D. $95,000

Cash basis net income, pretax $60,000

Plus increase in accounts receivable (this represents sales that were not collected
20,000.
and thus are included in accrual income but not in cash-basis income),

Plus decrease in accounts payable (this represents payments in excess of expenses


15,000.
and thus causes accrual income to exceed cash-basis income),

Equals accrual basis net income, pretax, $95,000.

Question #28 (AICPA.920506FAR-TH-FA)


Before 2001, Droit Co. used the cash basis of accounting. As of December 31, 2001, Droit
changed to the accrual basis. Droit cannot determine the beginning balance of supplies
inventory.

What is the effect of Droit's inability to determine beginning supplies inventory on its 2001
accrual basis net income and December 31, 2001, accrual basis owners' equity?

2001 net income 12/31/01 owner's equity


No effect No effect

No effect Overstated

Overstated No effect

Supplies expense for 2001 under the accrual method is: supplies expense = beginning
supplies + purchases - ending supplies. If beginning supplies cannot be determined,
then it is assumed to be zero and supplies expense is understated, causing 2001
income to be overstated. However, total supplies expense for the entire life of the
business is unaffected by the inability to determine beginning supplies for 2001. Total
supplies expense for the life of the business is total purchases less ending inventory in
2001. These two amounts are determinable, and thus, owners' equity at the end of
2001 can be determined.
Overstated Overstated

Incorrect for owners' equity. Total supplies expense for the entire life of the business
is unaffected by the inability to determine beginning supplies for 2001. Total supplies
expense for the life of the business is total purchases less ending inventory in 2001.
These two amounts are determinable and thus owners' equity at the end of 2001 can
be determined.
Question #29 (AICPA.110583FAR)
A company records items on the cash basis throughout the year and converts to an accrual
basis for year-end reporting. Its cash-basis net income for the year is $70,000. The
company has gathered the following comparative Balance Sheet information:
Beginning of year End of year
Accounts payable $ 3,000 $ 1,000
Unearned revenue 300 500
Wages payable 300 400
Prepaid rent 1,200 1,500
Accounts receivable 1,400 600

What amount should the company report as its accrual-based net income for the current
year?

A. $68,800

B. $70,200

C. $71,200

The general rule to convert from cash to accrual is to add the beginning liability
balances and subtract the ending liability balances; also, subtract beginning asset
balances and add ending asset balances.
D. $73,200

Question #30 (AICPA.921141FAR-P1-FA)


Reid Partners, Ltd., which began operations on January 1, 2003, has elected to use cash-
basis accounting for tax purposes and accrual-basis accounting for its financial statements.

Reid reported sales of $175,000 and $80,000 in its tax returns for the years ended
December 31, 2004 and 2003, respectively. Reid reported accounts receivable of $30,000
and $50,000 in its Balance Sheets as of December 31, 2004 and 2003, respectively.

What amount should Reid report as sales in its Income Statement for the year ended
December 31, 2004?

A. $145,000

B. $155,000

When converting from cash-basis sales to accrual-basis sales, sales must be adjusted
for the net change in accounts receivable. There has been a net decrease in
receivables of $20,000 over the course of the year from $50,000 to $30,000. Thus,
accrual sales would decline by $20,000 as compared to cash sales (which included the
additional receivables collected). Therefore, this response of $155,000 ($175,000-
$20,000) is correct.
C. $195,000

D. $205,000

Question #31 (AICPA.920539FAR-P1-FA)

Zeta Co. reported sales revenue of $4,600,000 in its Income Statement for the year ended
December 31, 2001. Additional information is as follows:

12/31/00 12/31/01
Accounts receivable $1,000,000 $1,300,000
Allowance for uncollectible accounts (60,000) (110,000)

Zeta wrote off uncollectible accounts totaling $20,000 during 2001. Under the cash basis of
accounting, Zeta would have reported 2001 sales of:

A. $4,900,000

B. $4,350,000

This amount fails to deduct write-offs from the change in the accounts receivable
balance used to compute cash collections. This overstates cash collections by $20,000.
Remember bad debt expense does not impact accounts receivable. It also includes the
change in the allowance account. The changes in the allowance account do not affect
cash collections.
C. $4,300,000

D. $4,280,000

The question requires a solution for cash collected on accounts receivable. Using the
information for accounts receivable, the collections amount can be found:
Beginning balance + sales - collections - write offs = ending balance

$1,000,000 + $4,600,000 - collections - $20,000 = $1,300,000

collections = $4,280,000
Under the cash basis of accounting, sales equals cash collections.
Question #32 (AICPA.920538FAR-P1-FA)

The following information pertains to Spee Co.'s 2004 sales:

Cash sales

Gross $40,000

Returns and allowances 2,000

Credit sales

Gross 60,000

Discounts 3,000

On January 1, 2004, customers owed Spee $20,000. On December 31, 2004, customers
owed Spee $15,000. Spee uses the direct write-off method for bad debts. No bad debts
were recorded in 2004. Under the cash basis of accounting, what amount of revenue should
Spee report for 2004?

A. $100,000

Revenue under the cash basis equals the amount of cash collected. The decrease in
accounts receivable is $5,000 ($20,000 - $15,000).
Gross cash sales $40,000

Less returns and allowances (2,000)


Plus gross credit sales 60,000

Less discounts (3,000)

Plus decrease in accounts receivable (More cash was


collected than was recorded as sales when accounts 5,000
receivable decreases)

$
Equals cash collected
100,000

B. $95,000

C. $85,000

D. $38,000

This is the net amount collected on cash sales only. There were significant collections
on credit sales as well.
Question #33 (AICPA.070793FAR)
Savor Co. had $100,000 in cash-basis pretax income for 1999. At December 31, 1999,
accounts receivable had increased by $10,000 and accounts payable had decreased by
$6,000 from their December 31, 1998, balances. Compared to the accrual-basis method of
accounting, Savor's cash pretax income is:
A. Higher by $4,000.

B. Lower by $4,000.

C. Higher by $16,000.

This number is correct, but the direction of the answer is incorrect.


D. Lower by $16,000.

cash-basis income is $100,000. The journal entries for an increase and a decrease in
accounts payable respectively are:
DR: Accounts receivable 10,000
CR: Sales 10,000

DR: Accounts payable 6,000


CR: Cash 6,000
The increase in accounts receivable should be added to the cash income as it was not
considered and is recognized as earned for accrual income. The decrease in accounts
payable was subtracted for cash-basis income. This is not a reduction in accrual
income, and as a result, should be added back to the cash income. The computation is:
100,000+10,000+6,000 = 116,000, or a $16,000 increase from cash to accrual. In
other words, the cash-basis income is $16,000 LOWER than accrual income.
Question #34 (AICPA.900506FAR-TH-FA)
The premium on a three-year insurance policy expiring on December 31, 2004 was paid in
total on January 2, 2002. If the company has a six-month operating cycle, then on
December 31, 2002, the prepaid insurance reported as a current asset would be for:
A. six months.

B. 12 months.

At the end of 2002, two years of coverage remains. The cost of coverage for 2003 is a
current asset because it will be consumed within a year of the 2002 Balance Sheet.
The definition of a current asset uses the period "operating cycle or one year,
whichever is longer." An operating cycle of any length, not exceeding one year, would
yield the same answer to this question. The fact that the operating cycle is only six-
months versus, for example eight-months, has no effect on the classification of the
prepaid insurance into a current component (to expire within a year of the 2002
Balance Sheet) and a long-term component (the portion to expire after 2003).
C. 18 months.

D. 24 months.

The correct answer is 12 months. At the end of 2002, two years of coverage remains.
The cost of coverage for 2003 is a current asset because it will be consumed within a
year of the 2002 Balance Sheet. The definition of a current asset uses the period
"operating cycle or one year, whichever is longer." An operating cycle of any length,
not exceeding one year, would yield the same answer to this question. The fact that
the operating cycle is only six-months versus, for example eight-months, has no effect
on the classification of the prepaid insurance into a current component (to expire
within a year of the 2002 Balance Sheet) and a long-term component (the portion to
expire after 2003).
Question #35 (AICPA.941108FAR-FA)
The following trial balance of Trey Co. at December 31, 2005 has been adjusted except for
income tax expense.
Dr. Cr.
Cash $550,000
Accounts Receivable, net 1,650,000
Prepaid taxes 300,000
Accounts payable $ 120,000
Common stock 500,000
Additional paid-in capital 680,000
Retained earnings 630,000
Foreign currency translation adjustment 430,000
Revenues 3,600,000
Expenses 2,600,000 __________
$5,530,000 $5,530,000

Additional information:

 During 2005, estimated tax payments of $300,000 were charged to prepaid taxes.
Trey has not yet recorded income tax expense. There were no differences between
the financial statement and the income tax income, and Trey's tax rate is 30%.
 Included in accounts receivable is $500,000 due from a customer. Special terms
granted to this customer require payments in equal, semiannual installments of
$125,000 every April 1 and October 1.

In Trey's December 31, 2005 Balance Sheet, what amount should be reported as total
current assets?

A. $1,950,000

Current assets are assets that are collectible within one year. The sum of the stated
current assets is $2,500,000 ($550,000+$1,650,000+$300,000). However, once the
current tax bill is calculated, the prepaid taxes of $300,000 are transferred into a tax
expense account to cover the $300,000 in current year tax expense. In addition,
$250,000 of the special accounts receivable is not due for over one year and is,
therefore, non-current. Therefore, current assets should be $1,950,000 ($2,500,000-
$300,000-$250,000).
B. $2,200,000

C. $2,250,000

Current assets are assets that are collectible within one year. The sum of the stated
current assets is $2,500,000 ($550,000+$1,650,000+$300,000). However, once the
current tax bill is calculated, the prepaid taxes of $300,000 are transferred into a tax
expense account to cover the $300,000 in current year tax expense. In addition,
$250,000 of the special account receivable is not due for over one year and is,
therefore, non-current. Therefore, current assets should be $1,950,000 ($2,500,000-
$300,000-$250,000). This response correctly adjusted for the accounts receivable but
failed to adjust for the tax situation.
D. $2,500,000

Question #36 (AICPA.941105FAR-FA)


In analyzing a company's financial statements, which financial statement would a potential
investor use primarily to assess the company's liquidity and financial flexibility?
A. Balance Sheet.

The Balance Sheet discloses the assets and liabilities, usually classified by proximity
to realization (assets) or payment (liabilities). The balance shows the relative
magnitude of assets and liabilities and, therefore, the ability to pay obligations in the
near and longer term. It also shows the degree of leverage and ability to adapt to
changing financial conditions as well as the ability to manage future cash flows when
conditions change. Much of the potential of the firm is disclosed in the Balance Sheet.
It is a statement of the wealth position of the firm and allows an assessment of the
relative risk of the enterprise.
B. Income Statement.

C. Statement of retained earnings.

D. Statement of Cash Flows.

Question #37 (AICPA.090639FAR-I-A)

A company has the following accrual-basis balances at the end of its first year of operation:

Unearned consulting fees $2,000


Consulting fees receivable 3,500
Consulting fee revenue 25,000

The company's cash-basis consulting revenue is what amount?

A. $19,500

B. $23,500

Cash-basis revenue is the amount of cash collected for the period. $25,000 of accrual-
basis revenue was recognized for the period. Start with the $25,000 amount, and add
the $2,000 unearned fees. This amount is not included in the $25,000 because it is not
earned but was collected during the period. Subtract the $3,500 receivable, which is
included in the $25,000 but was not collected. The result is that $23,500 in cash was
collected ($25,000 + $2,000 - $3,500).
C. $26,500
D. $30,500

Question #38 (AICPA.101045FAR)


A company provides the following information:
Year 1 Year 2 Year 3
Cash receipts from customers:
From year one sales $95,000 $120,000
From year two sales 200,000 $ 75,000
From year three sales 50,000 225,000

What is the accrual-based revenue for year 2?

A. $200,000

The correct calculation is the cash collected in year two ($200,000) plus the cash
collected in year three related to sales in year two ($75,000) or a total of $275,000.
B. $275,000

Only the cash receipts related to the year two sales would be included in year two
accrual-based revenue. So, no matter when the cash is collected, the total revenue for
year two is the cash collected in year two ($200,000) and the cash collected in year
three related to sales in year two ($75,000) or a total of $275,000.
C. $320,000

D. $370,000

Question #39 (AICPA.101044FAR)


Young & Jamison's modified cash-basis financial statements indicate cash paid for
operating expenses of $150,000, end-of-year prepaid expenses of $15,000, and accrued
liabilities of $25,000. At the beginning of the year, Young & Jamison had prepaid expenses
of $10,000, while accrued liabilities were $5,000. If cash paid for operating expenses is
converted to accrual-basis operating expenses, what would be the amount of operating
expenses?
A. $125,000

B. $135,000

C. $165,000

The approach on this question is to first calculate the cash-based operating expenses.
Cash-based operating expenses are $150,000. The next step is to adjust the cash-
based expense for the prepaid and accrued expenses. Beginning of the year prepaid
expenses were paid in the prior year, but the expense was incurred (or consumed) in
the current year, and end of the year prepaid expenses were paid this year but will be
consumed next year. Therefore, you add the beginning of the year prepaid and
subtract the end of the year prepaid expenses from the cash-based number.

Cash-based expenses will also be adjusted for the accrued expense. Beginnings of the
year accrued expenses were not paid last year, but were last year's expense item paid
this year. End of the year accrued expenses were not paid this year, but are this year's
expense paid next year. Therefore, you subtract beginning of the year accrued and
add end of the year accrued expenses to the cash-based number.

Cash-based operating expenses $150,000


Add the beginning of the year prepaid expenses, 10,000.
Subtract the end of the year prepaid expenses, (15,000).
Subtract the beginning of the year accrued expenses, ( 5,000).
Add the end of the year accrued expenses, 25,000.
Accrual-based operating expenses, $165,000
D. $175,000

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