@acct

Chapter 21

T1. Leasing equipment reduces the risk of obsolescence to the lessee, and passes the risk of

residual value to the lessor.

F2. The FASB agrees with the capitalization approach and requires companies to capitalize

all long-term leases.

F3. A lease that contains a purchase option must be capitalized by the lessee.

T4. Executory costs should be excluded by the lessee in computing the present value of the

minimum lease payments.

F5. A capitalized leased asset is always depreciated over the term of the lease by the lessee.

F6. A lessee records interest expense in both a capital lease and an operating lease.

T7. A benefit of leasing to the lessor is the return of the leased property at the end of the lease

term.

F8. The distinction between a direct-financing lease and a sales-type lease is the presence or

absence of a transfer of title.

F9. Lessors classify and account for all leases that don’t qualify as sales-type leases as

operating leases.

T10. Direct-financing leases are in substance the financing of an asset purchase by the lessee.

F11. Under the operating method, the lessor records each rental receipt as part interest

revenue and part rental revenue.

F12. In computing the annual lease payments, the lessor deducts only a guaranteed residual

value from the fair market value of a leased asset.

T13. When the lessee agrees to make up any deficiency below a stated amount that the lessor

realizes in residual value, that stated amount is the guaranteed residual value.

F14. Both a guaranteed and an unguaranteed residual value affect the lessee’s computation of

amounts capitalized as a leased asset.

T15. From the lessee’s viewpoint, an unguaranteed residual value is the same as no residual

value in terms of computing the minimum lease payments.

F16. The lessor will recover a greater net investment if the residual value is guaranteed instead

of unguaranteed.

T17. The primary difference between a direct-financing lease and a sales-type lease is the

manufacturer’s or dealer’s gross profit.

F18. The gross profit amount in a sales-type lease is greater when a guaranteed residual value

exists.

Accounting for Leases

T19. Companies must periodically review the estimated unguaranteed residual value in a

sales-type lease.

T20. The FASB requires lessees and lessors to disclose certain information about leases in

their financial statements or in the notes.

21. Major reasons why a company may become involved in leasing to other companies is

(are)

d. all of these.

22. Which of the following is an advantage of leasing?

d. All of these

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

b. Leases similar to installment purchases are capitalized.

24. While only certain leases are currently accounted for as a sale or purchase, there is

theoretic justification for considering all leases to be sales or purchases. The principal

reason that supports this idea is that

c. a lease reflects the purchase or sale of a quantifiable right to the use of property.

S25. An essential element of a lease conveyance is that the

a. lessor conveys less than his or her total interest in the property.

S26. What impact does a bargain purchase option have on the present value of the minimum

lease payments computed by the lessee?

b. The lessee must increase the present value of the minimum lease payments by the

present value of the option price.

P27. The amount to be recorded as the cost of an asset under capital lease is equal to the

b. present value of the minimum lease payments or the fair value of the asset, whichever

is lower.

28. The methods of accounting for a lease by the lessee are

a. operating and capital lease methods.

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

c. The lease term is equal to or more than 75% of the estimated economic life of the

leased property.

30. Minimum lease payments may include a

d. any of these.

31. Executory costs include

d. all of these.

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

c. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is

lower, assuming that the implicit rate is known to the lessee.

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

a. a guaranteed residual value and depreciate over the term of the lease.

34. In the earlier years of a lease, from the lessee's perspective, the use of the

b. capital method will cause debt to increase, compared to the operating method.

P35. A lessee with a capital lease containing a bargain purchase option should depreciate the

leased asset over the

a. asset's remaining economic life.

36. Based solely upon the following sets of circumstances indicated below, which set gives

rise to a sales-type or direct-financing lease of a lessor?

Transfers Ownership Contains Bargain Collectibility of Lease Any Important

By End Of Lease? Purchase Option? Payments Assured? Uncertainties?

a. No Yes Yes No

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

d. All would be included

38. In a lease that is appropriately recorded as a direct-financing lease by the lessor,

unearned income

a. should be amortized over the period of the lease using the interest method.

S39. In order to properly record a direct-financing lease, the lessor needs to know how to

calculate the lease receivable. The lease receivable in a direct-financing lease is best

defined as

c. the present value of minimum lease payments.

S40. If the residual value of a leased asset is guaranteed by a third party

d. it is treated by the lessee as an additional payment and by the lessor as realized at the

end of the lease term.

S41. The primary difference between a direct-financing lease and a sales-type lease is the

c. recognition of the manufacturer's or dealer's profit at the inception of the lease.

P42. A lessor with a sales-type lease involving an unguaranteed residual value available to the

lessor at the end of the lease term will report sales revenue in the period of inception of

the lease at which of the following amounts?

b. The present value of the minimum lease payments.

43. For a sales-type lease,

c. the gross profit will be the same whether the residual value is guaranteed or

unguaranteed.

44. Which of the following statements is correct?

d. All of these.

45. The Lease Liability account should be disclosed as

c. current portions in current liabilities and the remainder in noncurrent liabilities.

*46. When a company sells property and then leases it back, any gain on the sale should

usually be

d. deferred and recognized as income over the term of the lease.

47. On December 1, 2008, Perez Corporation leased office space for 10 years at a monthly

rental of $90,000. On that date Perez paid the landlord the following amounts:

Rent deposit $ 90,000

First month's rent 90,000

Last month's rent 90,000

Installation of new walls and offices 495,000

$765,000

The entire amount of $765,000 was charged to rent expense in 2008. What amount

should Perez have charged to expense for the year ended December 31, 2008?

b. $94,125

48. On January 1, 2008, Penn Corporation signed a ten-year noncancelable lease for certain

machinery. The terms of the lease called for Penn to make annual payments of $100,000

at the end of each year for ten years with title to pass to Penn at the end of this period.

The machinery has an estimated useful life of 15 years and no salvage value. Penn uses

the straight-line method of depreciation for all of its fixed assets. Penn accordingly

accounted for this lease transaction as a capital lease. The lease payments were

determined to have a present value of $671,008 at an effective interest rate of 8%. With

respect to this capitalized lease, Penn should record for 2008

c. interest expense of $53,681 and depreciation expense of $44,734.

Use the following information for questions 49 through 54. (Annuity tables on page 21-20.)

On January 1, 2008, Dexter, Inc. signs a 10-year noncancelable lease agreement to lease a

storage building from Garr Warehouse Company. Collectibility of lease payments is reasonably

predictable and no important uncertainties surround the amount of costs yet to be incurred by the

lessor. The following information pertains to this lease agreement.

(a) The agreement requires equal rental payments at the end of each year.

(b) The fair value of the building on January 1, 2008 is $3,000,000; however, the book value

to Garr is $2,500,000.

(c) The building has an estimated economic life of 10 years, with no residual value. Dexter

depreciates similar buildings on the straight-line method.

(d) At the termination of the lease, the title to the building will be transferred to the lessee.

(e) Dexter's incremental borrowing rate is 11% per year. Garr Warehouse Co. set the annual

rental to insure a 10% rate of return. The implicit rate of the lessor is known by Dexter,

Inc.

(f) The yearly rental payment includes $10,000 of executory costs related to taxes on the

property.

49. What is the amount of the minimum annual lease payment? (Rounded to the nearest

dollar.)

c. $488,236

50. What is the amount of the total annual lease payment?

d. $498,237

51. From the lessor's viewpoint, what type of lease is involved?

a. Sales-type lease

52. From the lessee's viewpoint, what type of lease exists in this case?

c. Capital lease

53. Dexter, Inc. would record depreciation expense on this storage building in 2008 of

(Rounded to the nearest dollar.)

c. $300,000.

54. If the lease were nonrenewable, there was no purchase option, title to the building does

not pass to the lessee at termination of the lease and the lease were only for eight years,

what type of lease would this be for the lessee?

d. Capital lease

55. Huffman Company leases a machine from Lincoln Corp. under an agreement which

meets the criteria to be a capital lease for Huffman. The six-year lease requires payment

of $102,000 at the beginning of each year, including $15,000 per year for maintenance,

insurance, and taxes. The incremental borrowing rate for the lessee is 10%; the lessor's

implicit rate is 8% and is known by the lessee. The present value of an annuity due of 1

for six years at 10% is 4.79079. The present value of an annuity due of 1 for six years at

8% is 4.99271. Huffman should record the leased asset at

c. $434,366.

56. On December 31, 2007, Pool Corporation leased a ship from Renn Company for an eightyear

period expiring December 30, 2015. Equal annual payments of $200,000 are due on

December 31 of each year, beginning with December 31, 2007. The lease is properly

classified as a capital lease on Pool's books. The present value at December 31, 2007 of

the eight lease payments over the lease term discounted at 10% is $1,173,685. Assuming

all payments are made on time, the amount that should be reported by Pool Corporation

as the total obligation under capital leases on its December 31, 2008 balance sheet is

c. $871,054.

Use the following information for questions 57 and 58.

On January 1, 2008, Dalton Corporation signed a five-year noncancelable lease for equipment.

The terms of the lease called for Dalton to make annual payments of $50,000 at the beginning of

each year for five years with title to pass to Dalton at the end of this period. The equipment has

an estimated useful life of 7 years and no salvage value. Dalton uses the straight-line method of

depreciation for all of its fixed assets. Dalton accordingly accounts for this lease transaction as a

capital lease. The minimum lease payments were determined to have a present value of

$208,493 at an effective interest rate of 10%.

57. In 2008, Dalton should record interest expense of

a. $15,849.

58. In 2009, Dalton should record interest expense of

b. $12,434.

59. On December 31, 2008, Dodd Corporation leased a plane from Aero Company for an

eight-year period expiring December 30, 2016. Equal annual payments of $150,000 are

due on December 31 of each year, beginning with December 31, 2008. The lease is

properly classified as a capital lease on Dodd’s books. The present value at December

31, 2008 of the eight lease payments over the lease term discounted at 10% is $880,264.

Assuming the first payment is made on time, the amount that should be reported by Dodd

Corporation as the lease liability on its December 31, 2008 balance sheet is

d. $730,264.


On January 1, 2008, Carley Corporation signed a five-year noncancelable lease for equipment.

The terms of the lease called for Carley to make annual payments of $60,000 at the end of each

year for five years with title to pass to Carley at the end of this period. The equipment has an

estimated useful life of 7 years and no salvage value. Carley uses the straight-line method of

depreciation for all of its fixed assets. Carley accordingly accounts for this lease transaction as a

capital lease. The minimum lease payments were determined to have a present value of

$227,448 at an effective interest rate of 10%.

60. With respect to this capitalized lease, for 2008 Carley should record


61. With respect to this capitalized lease, for 2009 Carley should record


62. Barkley Corporation is a lessee with a capital lease. The asset is recorded at $450,000

and has an economic life of 8 years. The lease term is 5 years. The asset is expected to

have a market value of $150,000 at the end of 5 years, and a market value of $50,000 at

the end of 8 years. The lease agreement provides for the transfer of title of the asset to

the lessee at the end of the lease term. What amount of depreciation expense would the

lessee record for the first year of the lease?

d. $50,000

Use the following information for questions 63 through 68. (Annuity tables on page 21-20.)

Hay Corporation enters into an agreement with Marly Rentals Co. on January 1, 2008 for the

purpose of leasing a machine to be used in its manufacturing operations. The following data

pertain to the agreement:

(a) The term of the noncancelable lease is 3 years with no renewal option. Payments of

$155,213 are due on December 31 of each year.

(b) The fair value of the machine on January 1, 2008, is $400,000. The machine has a

remaining economic life of 10 years, with no salvage value. The machine reverts to the

lessor upon the termination of the lease.

(c) Hay depreciates all machinery it owns on a straight-line basis.

(d) Hay's incremental borrowing rate is 10% per year. Hay does not have knowledge of the

8% implicit rate used by Marly.

(e) Immediately after signing the lease, Marly finds out that Hay Corp. is the defendant in a

suit which is sufficiently material to make collectibility of future lease payments doubtful.

63. What type of lease is this from Hay Corporation's viewpoint?

b. Capital lease

64. If Hay accounts for the lease as an operating lease, what expenses will be recorded as a

consequence of the lease during the fiscal year ended December 31, 2008?

b. Rent Expense

65. If the present value of the future lease payments is $400,000 at January 1, 2008, what is

the amount of the reduction in the lease liability for Hay Corp. in the second full year of the

lease if Hay Corp. accounts for the lease as a capital lease? (Rounded to the nearest

dollar.)

c. $126,734

66. From the viewpoint of Marly, what type of lease agreement exists?

a. Operating lease

67. If Marly records this lease as a direct-financing lease, what amount would be recorded as

Lease Receivable at the inception of the lease?

c. $400,000

68. Which of the following lease-related revenue and expense items would be recorded by

Marly if the lease is accounted for as an operating lease?

d. Rental Revenue and Depreciation Expense

69. Sele Company leased equipment to Snead Company on July 1, 2007, for a one-year

period expiring June 30, 2008, for $60,000 a month. On July 1, 2008, Sele leased this

piece of equipment to Quirk Company for a three-year period expiring June 30, 2011, for

$75,000 a month. The original cost of the equipment was $4,800,000. The equipment,

which has been continually on lease since July 1, 2003, is being depreciated on a straightline

basis over an eight-year period with no salvage value. Assuming that both the lease

to Snead and the lease to Quirk are appropriately recorded as operating leases for

accounting purposes, what is the amount of income (expense) before income taxes that

each would record as a result of the above facts for the year ended December 31, 2008?

Sele Snead Quirk

a. $210,000 $(360,000) $(450,000)


Eddy leased equipment to Hoyle Company on May 1, 2008. At that time the collectibility of the

minimum lease payments was not reasonably predictable. The lease expires on May 1, 2009.

Hoyle could have bought the equipment from Eddy for $3,200,000 instead of leasing it. Eddy's

accounting records showed a book value for the equipment on May 1, 2008, of $2,800,000.

Eddy's depreciation on the equipment in 2008 was $360,000. During 2008, Hoyle paid $720,000

in rentals to Eddy for the 8-month period. Eddy incurred maintenance and other related costs

under the terms of the lease of $64,000 in 2008. After the lease with Hoyle expires, Eddy will

lease the equipment to another company for two years.

70. Ignoring income taxes, the amount of expense incurred by Hoyle from this lease for the

year ended December 31, 2008, should be

d. $720,000.

71. The income before income taxes derived by Eddy from this lease for the year ended

December 31, 2008, should be

a. $296,000.

72. Hite Company has a machine with a cost of $400,000 which also is its fair market value

on the date the machine is leased to Rich Company. The lease is for 6 years and the

machine is estimated to have an unguaranteed residual value of $40,000. If the lessor's

interest rate implicit in the lease is 12%, the six beginning-of-the-year lease payments

would be

b. $82,465.

73. Estes Co. leased a machine to Dains Co. Assume the lease payments were made on the

basis that the residual value was guaranteed and Estes gets to recognize all the profits,

and at the end of the lease term, before the lessee transfers the asset to the lessor, the

leased asset and obligation accounts have the following balances:

Leased equipment under capital lease $400,000

Less accumulated depreciation--capital lease 384,000

$ 16,000

Interest payable $ 1,520

Obligations under capital leases 14,480

$16,000

If, at the end of the lease, the fair market value of the residual value is $8,800, what gain

or loss should Estes record?

c. $7,200 loss

74. Durham Company leased machinery to Santi Company on July 1, 2008, for a ten-year

period expiring June 30, 2018. Equal annual payments under the lease are $75,000 and

are due on July 1 of each year. The first payment was made on July 1, 2008. The rate of

interest used by Durham and Santi is 9%. The cash selling price of the machinery is

$525,000 and the cost of the machinery on Durham's accounting records was $465,000.

Assuming that the lease is appropriately recorded as a sale for accounting purposes by

Durham, what amount of interest revenue would Durham record for the year ended

December 31, 2008?

c. $20,250

75. Eby Company leased equipment to the Mills Company on July 1, 2008, for a ten-year

period expiring June 30, 2018. Equal annual payments under the lease are $80,000 and

are due on July 1 of each year. The first payment was made on July 1, 2008. The rate of

interest contemplated by Eby and Mills is 9%. The cash selling price of the equipment is

$560,000 and the cost of the equipment on Eby's accounting records was $496,000.

Assuming that the lease is appropriately recorded as a sale for accounting purposes by

Eby, what is the amount of profit on the sale and the interest revenue that Eby would

record for the year ended December 31, 2008?

c. $64,000 and $21,600


Risen Company, a dealer in machinery and equipment, leased equipment to Foran, Inc., on July

1, 2008. The lease is appropriately accounted for as a sale by Risen and as a purchase by Foran.

The lease is for a 10-year period (the useful life of the asset) expiring June 30, 2018. The first of

10 equal annual payments of $621,000 was made on July 1, 2008. Risen had purchased the

equipment for $3,900,000 on January 1, 2008, and established a list selling price of $5,400,000

on the equipment. Assume that the present value at July 1, 2008, of the rent payments over the

lease term discounted at 8% (the appropriate interest rate) was $4,500,000.

76. Assuming that Foran, Inc. uses straight-line depreciation, what is the amount of depreciation

and interest expense that Foran should record for the year ended December 31,

2008?

a. $225,000 and $155,160

77. What is the amount of profit on the sale and the amount of interest income that Risen

should record for the year ended December 31, 2008?

b. $600,000 and $155,160

78. Mayer Company leased equipment from Lennon Company on July 1, 2008, for an eightyear

period expiring June 30, 2016. Equal annual payments under the lease are $300,000

and are due on July 1 of each year. The first payment was made on July 1, 2008. The rate

of interest contemplated by Mayer and Lennon is 8%. The cash selling price of the

equipment is $1,861,875 and the cost of the equipment on Lennon's accounting records

was $1,650,000. Assuming that the lease is appropriately recorded as a sale for

accounting purposes by Lennon, what is the amount of profit on the sale and the interest

income that Lennon would record for the year ended December 31, 2008?

c. $211,875 and $62,475

Use the following information for questions 79 through 83.

Bohl Co. purchases land and constructs a service station and car wash for a total of $360,000. At

January 2, 2007, when construction is completed, the facility and land on which it was

constructed are sold to a major oil company for $400,000 and immediately leased from the oil

company by Bohl. Fair value of the land at time of the sale was $40,000. The lease is a 10-year,

noncancelable lease. Bohl uses straight-line depreciation for its other various business holdings.

The economic life of the facility is 15 years with zero salvage value. Title to the facility and land

will pass to Bohl at termination of the lease. A partial amortization schedule for this lease is as

follows:

Payments Interes t Amortization Balance

Jan. 2, 2007 $400,000.00

Dec. 31, 2007 $65,098.13 $40,000.00 $25,098.13 374,901.87

Dec. 31, 2008 65,098.13 37,490.19 27,607.94 347,293.93

Dec. 31, 2009 65,098.13 34,729.39 30,368.74 316,925.19

79. From the viewpoint of the lessor, what type of lease is involved above?

c. Direct-financing lease

80. What is the discount rate implicit in the amortization schedule presented above?

b. 10%

81. The total lease-related expenses recognized by the lessee during 2008 is which of the

following? (Rounded to the nearest dollar.)

d. $61,490

82. What is the amount of the lessee's liability to the lessor after the December 31, 2009

payment? (Rounded to the nearest dollar.)

d. $316,925

*83. The total lease-related income recognized by the lessee during 2008 is which of the

following?

b. $2,667

*84. On June 30, 2008, Colt sold equipment to an unaffiliated company for $700,000. The

equipment had a book value of $630,000 and a remaining useful life of 10 years. That

same day, Colt leased back the equipment at $7,000 per month for 5 years with no option

to renew the lease or repurchase the equipment. Colt's rent expense for this equipment

for the year ended December 31, 2008, should be

b. $42,000.

85. Lease A does not contain a bargain purchase option, but the lease term is equal to 90

percent of the estimated economic life of the leased property. Lease B does not transfer

ownership of the property to the lessee by the end of the lease term, but the lease term is

equal to 75 percent of the estimated economic life of the leased property. How should the

lessee classify these leases?

Lease A Lease B

c. Capital lease Capital lease

86. On December 31, 2008, Mendez, Inc. leased machinery with a fair value of $840,000 from

Cey Rentals Co. The agreement is a six-year noncancelable lease requiring annual

payments of $160,000 beginning December 31, 2008. The lease is appropriately

accounted for by Mendez as a capital lease. Mendez's incremental borrowing rate is 11%.

Mendez knows the interest rate implicit in the lease payments is 10%.

The present value of an annuity due of 1 for 6 years at 10% is 4.7908.

The present value of an annuity due of 1 for 6 years at 11% is 4.6959.

In its December 31, 2008 balance sheet, Mendez should report a lease liability of

a. $606,528.

87. On December 31, 2007, Patten Co. leased a machine from Bass, Inc. for a five-year

period. Equal annual payments under the lease are $630,000 (including $30,000 annual

executory costs) and are due on December 31 of each year. The first payment was made

on December 31, 2007, and the second payment was made on December 31, 2008. The

five lease payments are discounted at 10% over the lease term. The present value of

minimum lease payments at the inception of the lease and before the first annual payment

was $2,502,000. The lease is appropriately accounted for as a capital lease by Patten. In

its December 31, 2008 balance sheet, Patten should report a lease liability of

d. $1,492,200.

88. A lessee had a ten-year capital lease requiring equal annual payments. The reduction of

the lease liability in year 2 should equal

a. the current liability shown for the lease at the end of year 1.


On January 2, 2008, Martinez, Inc. signed a ten-year noncancelable lease for a heavy duty drill

press. The lease stipulated annual payments of $150,000 starting at the end of the first year, with

title passing to Martinez at the expiration of the lease. Martinez treated this transaction as a

capital lease. The drill press has an estimated useful life of 15 years, with no salvage value.

Martinez uses straight-line depreciation for all of its plant assets. Aggregate lease payments were

determined to have a present value of $900,000, based on implicit interest of 10%.

89. In its 2008 income statement, what amount of interest expense should Martinez report

from this lease transaction?

d. $90,000

90. In its 2008 income statement, what amount of depreciation expense should Martinez

report from this lease transaction?

d. $60,000

91. In a lease that is recorded as a sales-type lease by the lessor, interest revenue

c. should be recognized over the period of the lease using the effective interest method.

92. Castro Co. manufactures equipment that is sold or leased. On December 31, 2008,

Castro leased equipment to Ermler for a five-year period ending December 31, 2013, at

which date ownership of the leased asset will be transferred to Ermler. Equal payments

under the lease are $220,000 (including $20,000 executory costs) and are due on

December 31 of each year. The first payment was made on December 31, 2008.

Collectibility of the remaining lease payments is reasonably assured, and Castro has no

material cost uncertainties. The normal sales price of the equipment is $770,000, and cost

is $600,000. For the year ended December 31, 2008, what amount of income should

Castro realize from the lease transaction?

a. $170,000

*93. Carey sold its headquarters building at a gain, and simultaneously leased back the

building. The lease was reported as a capital lease. At the time of the sale, the gain

should be reported as

d. a deferred gain.

*94. On December 31, 2008, Devin Corp. sold a machine to Ryan and simultaneously leased it

back for one year. Pertinent information at this date follows:

Sales price $900,000

Carrying amount 825,000

Present value of reasonable lease rentals

($7,500 for 12 months @ 12%) 85,000

Estimated remaining useful life 12 years

In Devin’s December 31, 2008 balance sheet, the deferred profit from the sale of this

machine should be

d. $0.

Chapter 19

F1. Taxable income is a tax accounting term and is also referred to as income before taxes.

F2. Pretax financial income is the amount used to compute income tax payable.

T3. Taxable amounts increase taxable income in future years.

T4. 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.

F5. Deductible amounts cause taxable income to be greater than pretax financial income in

the future as a result of existing temporary differences.

T6. 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.

F7. 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.

T8. Companies should consider both positive and negative evidence to determine whether it

needs to record a valuation allowance to reduce a deferred tax asset.

F9. A company should add a decrease in a deferred tax liability to income tax payable in

computing income tax expense.

T10. Taxable temporary differences will result in taxable amounts in future years when the

related assets are recovered.

F11. Examples of taxable temporary differences are subscriptions received in advance and

advance rental receipts.

T12. Permanent differences do not give rise to future taxable or deductible amounts.

T13. 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.

F14. 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.

F15. Under the loss carryback approach, companies must apply a current year loss to the most

recent year first and then to an earlier year.

T16. The tax effect of a loss carryforward represents future tax savings and results in the

recognition of a deferred tax asset.

T17. 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.

T18. 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.

F19. Companies should classify the balances in the deferred tax accounts on the balance

sheet as noncurrent assets and noncurrent liabilities.

F20. The FASB believes that the deferred tax method is the most consistent method for

accounting for income taxes.

21. Taxable income of a corporation

b. differs from accounting income due to differences in interperiod allocation and

permanent differences between the two methods of income determination.

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

Permanent Temporary

Differences Differences

c. Yes Yes

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.

24. The deferred tax expense is the

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

tax asset.

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.

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

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?

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

28. Interperiod income tax allocation procedures are appropriate when

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

b. statutory (or percentage) depletion exceeds cost depletion for the period.

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

P31. 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

S32. 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

b. Garth will record a decrease in a deferred tax liability in 2008.

P33. 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.

c. items II and III only

S34. A major distinction between temporary and permanent differences is

d. temporary differences reverse themselves in subsequent accounting periods, whereas

permanent differences do not reverse.

S35. 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?

b. Product warranty liabilities.

S36. Which of the following is a temporary difference classified as a revenue or gain that is

taxable after it is recognized in financial income?

c. An installment sale accounted for on the accrual basis for financial reporting purposes

and on the installment (cash) basis for tax purposes.

S37. Which of the following differences would result in future taxable amounts?

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

c. a fine resulting from violations of OSHA regulations.

39. An example of a permanent difference is

d. all of these.

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

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

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

b. Temporary Asset

S43. When a change in the tax rate is enacted into law, its effect on existing deferred income

tax accounts should be

c. reported as an adjustment to tax expense in the period of 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

c. the future tax rates have been enacted into law.

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

b. the establishment of a deferred tax asset.

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

d. all of these.

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

following except

c. a contra-asset account.

48. Deferred taxes should be presented on the balance sheet

b. in two amounts: one for the net current amount and one for the net noncurrent amount.

49. Deferred tax amounts that are related to specific assets or liabilities should be classified

as current or noncurrent based on

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?

d. The refund claimed should be shown as a reduction of the loss in 2007.

S51. 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

c. based on the classification of the related asset or liability for financial reporting

purposes.

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

c. measure the total deferred tax asset for deductible temporary differences and

operating loss carrybacks.

53. Smiley Corporation purchased a machine on January 2, 2006, for $2,000,000. The

machine has an estimated 5-year life with no salvage value. The straight-line method of

depreciation is being used for financial statement purposes and the following MACRS

amounts will be deducted for tax purposes:

2006 $400,000 2009 $230,000

2007 640,000 2010 230,000

2008 384,000 2011 116,000

Assuming an income tax rate of 30% for all years, the net deferred tax liability that should

be reflected on Smiley's balance sheet at December 31, 2007, should be

Deferred Tax Liability

Current Noncurrent

a. $0 $72,000


Hefner Co. at the end of 2007, its first year of operations, prepared a reconciliation between

pretax financial income and taxable income as follows:

Pretax financial income $ 500,000

Estimated litigation expense 1,250,000

Installment sales (1,000,000)

Taxable income $ 750,000

The estimated litigation expense of $1,250,000 will be deductible in 2009 when it is expected to

be paid. The gross profit from the installment sales will be realized in the amount of $500,000 in

each of the next two years. The estimated liability for litigation is classified as noncurrent and the

installment accounts receivable are classified as $500,000 current and $500,000 noncurrent. The

income tax rate is 30% for all years.

54. The income tax expense is

a. $150,000.

55. The deferred tax asset to be recognized is

d. $375,000 noncurrent.

56. The deferred tax liability—current to be recognized is

c. $150,000.


Frizell Co. at the end of 2007, its first year of operations, prepared a reconciliation between pretax

financial income and taxable income as follows:

Pretax financial income $ 750,000

Estimated litigation expense 1,000,000

Extra depreciation for taxes (1,500,000)

Taxable income $ 250,000

The estimated litigation expense of $1,000,000 will be deductible in 2008 when it is expected to

be paid. Use of the depreciable assets will result in taxable amounts of $500,000 in each of the

next three years. The income tax rate is 30% for all years.

57. Income tax payable is

b. $75,000.

58. The deferred tax asset to be recognized is

d. $300,000 current.

59. The deferred tax liability to be recognized is

Current Noncurrent

c. $0 $450,000

60. Markes Corporation's partial income statement after its first year of operations is as

follows:

Income before income taxes $3,750,000

Income tax expense

Current $1,035,000

Deferred 90,000 1,125,000

Net income $2,625,000

Markes uses the straight-line method of depreciation for financial reporting purposes and

accelerated depreciation for tax purposes. The amount charged to depreciation expense

on its books this year was $1,500,000. No other differences existed between book income

and taxable income except for the amount of depreciation. Assuming a 30% tax rate, what

amount was deducted for depreciation on the corporation's tax return for the current year?

d. $1,800,000

61. Dwyer Company reported the following results for the year ended December 31, 2007, its

first year of operations:

2007

Income (per books before income taxes) $ 750,000

Taxable income 1,200,000

The disparity between book income and taxable income is attributable to a temporary

difference which will reverse in 2008. What should Dwyer record as a net deferred tax

asset or liability for the year ended December 31, 2007, assuming that the enacted tax

rates in effect are 40% in 2007 and 35% in 2008?

b. $157,500 deferred tax asset

62. In 2007, Admire Company accrued, for financial statement reporting, estimated losses on

disposal of unused plant facilities of $1,500,000. The facilities were sold in March 2008

and a $1,500,000 loss was recognized for tax purposes. Also in 2007, Admire paid

$100,000 in premiums for a two-year life insurance policy in which the company was the

beneficiary. Assuming that the enacted tax rate is 30% in both 2007 and 2008, and that

Admire paid $780,000 in income taxes in 2007, the amount reported as net deferred

income taxes on Admire's balance sheet at December 31, 2007, should be a

d. $450,000 asset.


O’Malley Corporation prepared the following reconciliation for its first year of operations:

Pretax financial income for 2008 $ 900,000

Tax exempt interest (75,000)

Originating temporary difference (225,000)

Taxable income $600,000

The temporary difference will reverse evenly over the next two years at an enacted tax rate of

40%. The enacted tax rate for 2008 is 35%.

63. What amount should be reported in its 2008 income statement as the deferred portion of

the provision for income taxes?

a. $90,000 debit

64. In O’Malley’s 2008 income statement, what amount should be reported for total income

tax expense?

c. $300,000

65. Jesse Company sells household furniture. Customers who purchase furniture on the

installment basis make payments in equal monthly installments over a two-year period,

with no down payment required. Jesse's gross profit on installment sales equals 40% of

the selling price of the furniture.

For financial accounting purposes, sales revenue is recognized at the time the sale is

made. For income tax purposes, however, the installment method is used. There are no

other book and income tax accounting differences, and Jesse's income tax rate is 30%.

If Jesse's December 31, 2007, balance sheet includes a deferred tax liability of $300,000

arising from the difference between book and tax treatment of the installment sales, it

should also include installment accounts receivable of

a. $2,500,000.

66. Cromwell Company has the following cumulative taxable temporary differences:

12/31/08 12/31/07

$1,350,000 $960,000

The tax rate enacted for 2008 is 40%, while the tax rate enacted for future years is 30%.

Taxable income for 2008 is $2,400,000 and there are no permanent differences.

Cromwell's pretax financial income for 2008 is

b. $2,790,000.


McGee Company deducts insurance expense of $84,000 for tax purposes in 2008, but the

expense is not yet recognized for accounting purposes. In 2009, 2010, and 2011, no insurance

expense will be deducted for tax purposes, but $28,000 of insurance expense will be reported for

accounting purposes in each of these years. McGee Company has a tax rate of 40% and income

taxes payable of $72,000 at the end of 2008. There were no deferred taxes at the beginning of

2008.

67. What is the amount of the deferred tax liability at the end of 2008?

a. $33,600

68. What is the amount of income tax expense for 2008?

a. $105,600

69. Assuming that income tax payable for 2009 is $96,000, the income tax expense for 2009

would be what amount?

d. $84,800

Tyler Company made the following journal entry in late 2008 for rent on property it leases to

Danford Corporation.

Cash 60,000

Unearned Rent 60,000

The payment represents rent for the years 2009 and 2010, the period covered by the lease. Tyler

Company is a cash basis taxpayer. Tyler has income tax payable of $92,000 at the end of 2008,

and its tax rate is 35%.

70. What amount of income tax expense should Tyler Company report at the end of 2008?

b. $71,000

71. Assuming the taxes payable at the end of 2009 is $102,000, what amount of income tax

expense would Tyler Company record for 2009?

c. $112,500

72. The following information is available for Nielsen Company after its first year of

operations:

Income before taxes $250,000

Federal income tax payable $104,000

Deferred income tax (4,000)

Income tax expense 100,000

Net income $150,000

Nielsen estimates its annual warranty expense as a percentage of sales. The amount

charged to warranty expense on its books was $95,000. Assuming a 40% income tax rate,

what amount was actually paid this year for warranty claims?

d. $85,000

Accounting for Income Taxes 19 - 17

73. Meyers Co. had a deferred tax liability balance due to a temporary difference at the

beginning of 2007 related to $600,000 of excess depreciation. In December of 2007, a

new income tax act is signed into law that lowers the corporate rate from 40% to 35%,

effective January 1, 2009. If taxable amounts related to the temporary difference are

scheduled to be reversed by $300,000 for both 2008 and 2009, Meyers should increase or

decrease deferred tax liability by what amount?

b. Decrease by $15,000

74. A reconciliation of Reaker Company's pretax accounting income with its taxable income

for 2008, its first year of operations, is as follows:

Pretax accounting income $3,000,000

Excess tax depreciation (90,000)

Taxable income $2,910,000

The excess tax depreciation will result in equal net taxable amounts in each of the next

three years. Enacted tax rates are 40% in 2008, 35% in 2009 and 2010, and 30% in 2011.

The total deferred tax liability to be reported on Reaker's balance sheet at December 31,

2008, is

b. $30,000.

75. Mast, Inc. reports a taxable and financial loss of $650,000 for 2008. Its pretax financial

income for the last two years was as follows:

2006 $300,000

2007 400,000

The amount that Mast, Inc. reports as a net loss for financial reporting purposes in 2008,

assuming that it uses the carryback provisions, and that the tax rate is 30% for all periods

affected, is

d. $455,000 loss.


Neasha Corporation reported the following results for its first three years of operation:

2006 income (before income taxes) $ 100,000

2007 loss (before income taxes) (900,000)

2008 income (before income taxes) 1,000,000

There were no permanent or temporary differences during these three years. Assume a corporate

tax rate of 30% for 2006 and 2007, and 40% for 2008.

76. Assuming that Neasha elects to use the carryback provision, what income (loss) is

reported in 2007? (Assume that any deferred tax asset recognized is more likely than not

to be realized.)

d. $(550,000)

77. Assuming that Neasha elects to use the carryforward provision and not the carryback

provision, what income (loss) is reported in 2007?

b. $(540,000)

78. Peck Co. reports a taxable and pretax financial loss of $400,000 for 2008. Peck's taxable

and pretax financial income and tax rates for the last two years were:

2006 $400,000 30%

2007 400,000 35%

The amount that Peck should report as an income tax refund receivable in 2008,

assuming that it uses the carryback provisions and that the tax rate is 40% in 2008, is

a. $120,000.

79. Bennington Corporation began operations in 2004. There have been no permanent or

temporary differences to account for since the inception of the business. The following

data are available:

Year

2006

2007

2008

2009

Enacted Tax Rate

45%

40%

35%

30%

Taxable Income

$750,000

900,000

Taxes Paid

$337,500

360,000

In 2008, Bennington had an operating loss of $930,000. What amount of income tax

benefits should be reported on the 2008 income statement due to this loss?

a. $409,500

80. Ramos Corp.'s books showed pretax financial income of $1,500,000 for the year ended

December 31, 2008. In the computation of federal income taxes, the following data were

considered:

Gain on an involuntary conversion $650,000

(Ramos has elected to replace the property within the statutory

period using total proceeds.)

Depreciation deducted for tax purposes in excess of depreciation

deducted for book purposes 100,000

Federal estimated tax payments, 2008 125,000

Enacted federal tax rate, 2008 30%

What amount should Ramos report as its current federal income tax liability on its

December 31, 2008 balance sheet?

a. $100,000

81. Eddy Corp.'s 2008 income statement showed pretax accounting income of $750,000. To

compute the federal income tax liability, the following 2008 data are provided:

Income from exempt municipal bonds $ 30,000

Depreciation deducted for tax purposes in excess of depreciation

deducted for financial statement purposes 60,000

Estimated federal income tax payments made 150,000

Enacted corporate income tax rate 30%

What amount of current federal income tax liability should be included in Eddy's

December 31, 2008 balance sheet?

a. $48,000

82. On January 1, 2007, Lebo, Inc. purchased a machine for $720,000 which will be

depreciated $72,000 per year for financial statement reporting purposes. For income tax

reporting, Lebo elected to expense $80,000 and to use straight-line depreciation which will

allow a cost recovery deduction of $64,000 for 2007. Assume a present and future

enacted income tax rate of 30%. What amount should be added to Lebo's deferred

income tax liability for this temporary difference at December 31, 2007?

c. $21,600

83. On January 1, 2007, Magee Corp. purchased 40% of the voting common stock of Reed,

Inc. and appropriately accounts for its investment by the equity method. During 2007,

Reed reported earnings of $360,000 and paid dividends of $120,000. Magee assumes

that all of Reed's undistributed earnings will be distributed as dividends in future periods

when the enacted tax rate will be 30%. Ignore the dividend-received deduction. Magee's

current enacted income tax rate is 25%. The increase in Magee's deferred income tax

liability for this temporary difference is

d. $28,800.

84. Brock Corp.'s 2007 income statement had pretax financial income of $250,000 in its first

year of operations. Brock uses an accelerated cost recovery method on its tax return and

straight-line depreciation for financial reporting. The differences between the book and tax

deductions for depreciation over the five-year life of the assets acquired in 2007, and the

enacted tax rates for 2007 to 2011 are as follows:

Book Over (Under) Tax Tax Rates

2007 $(50,000) 35%

2008 (65,000) 30%

2009 (15,000) 30%

2010 60,000 30%

2011 70,000 30%

There are no other temporary differences. In Brock's December 31, 2007 balance sheet, the

noncurrent deferred income tax liability and the income taxes currently payable should be

Noncurrent Deferred Income Taxes

Income Tax Liability Currently Payable

d. $15,000 $70,000

85. Foyle Corp. prepared the following reconciliation of income per books with income per tax

return for the year ended December 31, 2008:

Book income before income taxes $1,200,000

Add temporary difference

Construction contract revenue which will reverse in 2009 160,000

Deduct temporary difference

Depreciation expense which will reverse in equal amounts in

each of the next four years (640,000)

Taxable income $720,000

Foyle's effective income tax rate is 34% for 2008. What amount should Foyle report in its

2008 income statement as the current provision for income taxes?

b. $244,800

86. In its 2007 income statement, Hertz Corp. reported depreciation of $1,110,000 and interest

revenue on municipal obligations of $210,000. Hertz reported depreciation of $1,650,000 on

its 2007 income tax return. The difference in depreciation is the only temporary difference,

and it will reverse equally over the next three years. Hertz's enacted income tax rates are

35% for 2007, 30% for 2008, and 25% for 2009 and 2010. What amount should be included

in the deferred income tax liability in Hertz's December 31, 2007 balance sheet?

a. $144,000

87. Karr, Inc. uses the accrual method of accounting for financial reporting purposes and

appropriately uses the installment method of accounting for income tax purposes.

Installment income of $900,000 will be collected in the following years when the enacted

tax rates are:

Collection of Income Enacted Tax Rates

2007 $ 90,000 35%

2008 180,000 30%

2009 270,000 30%

2010 360,000 25%

The installment income is Karr's only temporary difference. What amount should be

included in the deferred income tax liability in Karr's December 31, 2007 balance sheet?

a. $225,000

88. For calendar year 2007, Neer Corp. reported depreciation of $1,200,000 in its income

statement. On its 2007 income tax return, Neer reported depreciation of $1,800,000.

Neer's income statement also included $225,000 accrued warranty expense that will be

deducted for tax purposes when paid. Neer's enacted tax rates are 30% for 2007 and

2008, and 24% for 2009 and 2010. The depreciation difference and warranty expense will

reverse over the next three years as follows:

Depreciation Difference Warranty Expense

2008 $240,000 $ 45,000

2009 210,000 75,000

2010 150,000 105,000

$600,000 $225,000

These were Neer's only temporary differences. In Neer's 2007 income statement, the

deferred portion of its provision for income taxes should be

c. $101,700.

89. Nevitt Co., organized on January 2, 2007, had pretax accounting income of $880,000 and

taxable income of $1,600,000 for the year ended December 31, 2007. The only temporary

difference is accrued product warranty costs which are expected to be paid as follows:

2008 $240,000

2009 120,000

2010 120,000

2011 240,000

The enacted income tax rates are 35% for 2007, 30% for 2008 through 2010, and 25% for

2011. If Nevitt expects taxable income in future years, the deferred tax asset in Nevitt's

December 31, 2007 balance sheet should be

c. $204,000.

Chapter 20

F1. A pension plan is contributory when the employer makes payments to a funding agency.

T2. Qualified pension plans permit deductibility of the employer’s contributions to the pension

fund.

F3. An employer reports no liability on its balance sheet in a defined-contribution plan.

T4. Employers are at risk with defined-benefit plans because they must contribute enough to

meet the cost of benefits that the plan defines.

T5. Companies compute the vested benefit obligation using only vested benefits, at current

salary levels.

F6. The accumulated benefit obligation bases the deferred compensation amount on both

vested and nonvested service using future salary levels.

F7. Service cost is the expense caused by the increase in the accumulated benefit obligation

because of employees’ service during the current year.

T8. The interest component of pension expense is the interest for the period on the projected

benefit obligation outstanding during the period.

F9. Companies recognize the projected benefit obligation in their accounts and in their

financial statements.

T10. The Prepaid/Accrued Pension Cost account balance equals the difference between the

projected benefit obligation and the pension plan assets.

F11. Companies should recognize the entire increase in projected benefit obligation due to a

plan initiation or amendment as pension expense in the year of amendment.

F12. The FASB requires the years-of-service method for amortization of unrecognized prior

service cost.

T13. The difference between the expected return and the actual return is referred to as the

unexpected gain or loss.

F14. The unexpected gains and losses from changes in the projected benefit obligation are

called asset gains and losses.

T15. The Unrecognized Net Gain/Loss account is limited to 10 percent of the larger of the

beginning balances of the projected benefit obligation or the market-related plan assets

value.

F16. If the unrecognized gain or loss is less than the corridor, the net gains and losses are

subject to amortization.

F17. A minimum liability is recognized when the projected benefit obligation exceeds the fair

value of pension plan assets.

T18. Companies can combine the accrued pension cost balance and the additional liability

balance for balance sheet purposes.

F19. When the additional liability exceeds the amount of unrecognized prior service cost, the

excess is credited to Excess of Additional Pension Liability Over Unrecognized Prior

Service Cost.

T20. Companies must disclose a reconciliation of how the projected benefit obligation and the

fair value of plan assets changed during the year either in their financial statements or in

the notes.

21. In determining the present value of the prospective benefits (often referred to as the

projected benefit obligation), the following are considered by the actuary:

d. all of these factors.

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

c. making the periodic contributions to a funding agency to ensure that funds are

available to meet retirees' claims.

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

d. determining the level of individual premiums.

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

c. requires an employer to contribute a certain sum each period based on the formula.

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

b. defines the benefits that the employee will receive at the time of retirement.

S26. Which of the following is not a characteristic of a defined-contribution pension plan?

b. The benefits to be received by employees are defined by the terms of the plan.

S27. In accounting for a defined-benefit pension plan

a. an appropriate funding pattern must be established to ensure that enough monies will

be available at retirement to meet the benefits promised.

S28. Alternative methods exist for the measurement of the pension obligation (liability). Which

measure requires the use of future salaries in its computation?

c. Projected benefit obligation

29. The accumulated benefit obligation measures

a. the pension obligation on the basis of the plan formula applied to years of service to

date and based on existing salary levels.

30. The projected benefit obligation is the measure of pension obligation that

a. is required to be used for reporting the service cost component of pension expense.

31. Differing measures of the pension obligation can be based on

d. all of these.

32. Vested benefits

d. are defined by all of these.

33. The relationship between the amount funded and the amount reported for pension

expense is as follows:

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

34. The computation of pension expense includes all the following except

a. service cost component measured using current salary levels.

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

c. the projected benefit obligation using future compensation levels provides a realistic

measure of present pension obligation and expense.

36. The interest on the projected benefit obligation component of pension expense

b. reflects the rates at which pension benefits could be effectively settled. 37. One component of pension expense is expected return on plan assets. Plan assets

include

a. contributions made by the employer and contributions made by the employee when a

contributory plan of some type is involved.

38. The actual return on plan assets

b. includes interest, dividends, and changes in the market value of the fund assets.

39. In accounting for a pension plan, any difference between the pension cost charged to

expense and the payments into the fund should be reported as

b. accrued or prepaid pension cost.

P40. Which of the following items should be included in the net pension cost calculated by an

employer who sponsors a defined-benefit pension plan for its employees?

Amortization of

Fair value unrecognized prior

of plan assets service cost

c. No Yes

P41. A corporation has a defined-benefit plan. An accrued pension cost will result at the end of

the first year if the

d. amount of net periodic pension cost exceeds the amount of employer contributions.

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

a. operations of current and future periods.

43. When a company amends a pension plan, for accounting purposes, prior service costs

should be

c. amortized under accrual accounting to current and future periods benefited.

44. Prior service cost is amortized on a

b. years-of-service method or on a straight-line basis over the average remaining service

life of active employees.

S45. Whenever a defined-benefit plan is amended and credit is given to employees for years of

service provided before the date of amendment

a. both the accumulated benefit obligation and the projected benefit obligation are

usually greater than before.

S46. The unexpected gains or losses that result from changes in the projected benefit

obligation are called

Asset Liability

Gains & Losses Gains & Losses

d. No Yes

47. Unrecognized gains and losses that relate to the computation of pension expense should

be

b. recorded currently and in the future by applying the corridor method which provides

the amount to be amortized.

48. Market-related asset value is used to determine the corridor and to calculate the expected

return on plan assets.

Expected Return

Corridor on Plan Assets

a. Yes Yes

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

a. recognized immediately as a gain or loss on the plant closing.

50. When a company switches from a defined-benefit to a defined-contribution plan, any gain

arising must generally be reported

c. currently as a gain.

51. A minimum liability for pension expense is reported when

b. the accumulated benefit obligation exceeds the fair value of pension plan assets.

52. An intangible asset (deferred pension cost) is created when

b. the accumulated benefit obligation exceeds the fair value of pension plan assets, but

accrued pension cost is less than this excess, and unrecognized prior service cost

exists.

53. Which of the following statements is correct?

a. There is an account titled Additional Pension Liability.

S54. According to the FASB, immediate recognition of a liability (referred to as the minimum

liability) is required when the accumulated benefit obligation exceeds the fair value of plan

assets. Conversely, when the fair value of plan assets exceeds the accumulated benefit

obligation, the Board

d. does not permit recognition of an asset.

55. Which of the following disclosures of pension plan information would not normally be

required by Statement of Financial Accounting Standards No. 132, "Employers' Disclosure

about Pensions and Other Postretirement Benefits”?

b. The amount paid from the pension fund to retirees during the period

56. The main purpose of the Pension Benefit Guaranty Corporation is to

c. administer terminated plans and to impose liens on the employer's assets for certain

unfunded pension liabilities.

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

c. The beneficiary is the retiree, spouse, and other dependents.

*58. Which of the following disclosures of postretirement benefits would not be required by

professional pronouncements?

c. The amount of the actuarial liability for postretirement benefits

*59. At the beginning of the year of adoption of Statement of Financial Accounting Standards

No. 106, a transition amount is computed as the excess of the

b. accumulated postretirement benefit obligation over the fair value of plan assets or vice

versa.

*60. Postretirement benefits may include all of the following except

a. severance pay to laid-off employees.

*61. Which of the following statements is correct?

d. All of these.

*62. Which of the following statements about the expected postretirement benefit obligation

(EPBO) is not correct?

b. The EPBO is recorded in the accounts.

*63. Which of the following statements about the immediate recognition of a transition amount

is not correct?

c. Restatement of previously issued annual financial statements is permitted.

*64. Which of the following is a significant item not recognized in the accounts and in the

financial statements?

d. All of these.

65. Presented below is pension information related to Tyler, Inc. for the year 2008:

Service cost $72,000

Interest on projected benefit obligation 54,000

Interest on vested benefits 24,000

Amortization of prior service cost due to increase in benefits 12,000

Expected return on plan assets 18,000

The amount of pension expense to be reported for 2008 is

d. $120,000.

66. Koble, Inc. sponsors a defined-benefit pension plan. The following data relates to the

operation of the plan for the year 2008.

Service cost $ 200,000

Contributions to the plan 220,000

Actual return on plan assets 180,000

Projected benefit obligation (beginning of year) 2,400,000

Market-related and fair value of plan assets (beginning of year) 1,600,000

The expected return on plan assets and the settlement rate were both 10%. The amount

of pension expense reported for 2008 is

c. $280,000.

67. Presented below is information related to Marley Inc. pension data for 2008.




Amortization of unrecognized net loss 90,000

Amortization of unrecognized prior service cost 165,000


What amount should be reported for pension expense in 2008?

a. $1,365,000

68. Randel, Inc. received the following information from its pension plan trustee concerning

the operation of the company's defined-benefit pension plan for the year ended December

31, 2007.

January 1, 2008 December 31, 2008

Market-related asset value $4,200,000 $4,500,000

Projected benefit obligation 4,800,000 5,160,000

Accumulated benefit obligation 840,000 1,020,000

Unrecognized net (gains) and losses -0- (90,000)

The service cost component of pension expense for 2008 is $360,000 and the

amortization of unrecognized prior service cost is $60,000. The settlement rate is 10%

and the expected rate of return is 9%. What is the amount of pension expense for 2008?

b. $522,000


The following information for Monroe Enterprises is given below:

December 31, 2008

Assets and obligations

Plan assets (at fair value) $1,200,000

Market-related asset value 1,160,000

Accumulated benefit obligation 1,280,000

Projected benefit obligation 1,840,000

Amounts to be Recognized

Prepaid/(accrued) pension cost at beginning of year (32,000)

Pension expense (240,000)

Contribution 216,000

Prepaid/(accrued) pension cost at end of year $ (56,000)

Unrecognized prior service costs $ 275,000

Unrecognized gains (net) (140,000)

69. What is the pension expense that Monroe Enterprises should report for 2008?

c. $240,000

70. What is the amount that Monroe Enterprises should report as Intangible Asset—Deferred

Pension Cost as of December 31, 2008?

a. $24,000

71. What is the amount that should be reported as the total liability related to pensions as of

December 31, 2008?

b. $80,000

72. The following information is related to the pension plan of King, Inc. for 2008.

Actual return on plan assets $200,000

Amortization of unrecognized net gain 82,500




Service cost 800,000

Pension expense for 2008 is

d. $1,000,000.

73. Presented below is pension information for Welch Company for the year 2008:

Actual return on plan assets $24,000

Interest on vested benefits 15,000

Service cost 30,000


Amortization of prior service cost due to increase in benefits 18,000

The amount of pension expense to be reported for 2008 is

d. $45,000.

74. Downing, Inc. received the following information from its pension plan trustee concerning

the operation of the company's defined-benefit pension plan for the year ended December

31, 2008.

1/1/08 12/31/08

Projected benefit obligation $11,400,000 $11,760,000

Market-related asset value 6,000,000 6,900,000

Accumulated benefit obligation 2,400,000 2,760,000

Unrecognized net (gains) and losses -0- 240,000

The service cost component of pension expense for 2008 is $840,000 and the

amortization of unrecognized prior service cost is $180,000. The settlement rate is 10%

and the expected rate of return is 8%. What is the amount of pension expense for 2008?

b. $1,680,000


The following data are for the pension plan for the employees of Nickels Company.

1/1/07 12/31/07 12/31/08

Accumulated benefit obligation $7,500,000 $7,800,000 $10,200,000

Projected benefit obligation 8,100,000 8,400,000 11,100,000

Market-related asset value 6,600,000 8,700,000 9,300,000

Plan assets (at fair value) 6,900,000 9,000,000 9,900,000

Unrecognized net loss -0- 1,440,000 1,500,000

Settlement rate (for year) 10% 9%

Expected rate of return (for year) 8% 7%

Nickels’ contribution was $1,260,000 in 2008 and benefits paid were $1,125,000. Nickels estimates

that the average remaining service life is 15 years.

75. The actual return on plan assets in 2008 was

b. $765,000.

76. The actual return on plan assets in 2008 was $765,000. The unexpected gain on plan

assets in 2008 was

a. $156,000.

77. The corridor for 2008 was $870,000. The amount of unrecognized net loss amortized in

2008 was

d. $38,000.


On January 1, 2008, Kinder Co. has the following balances:

Projected benefit obligation $2,100,000

Fair value of plan assets 1,800,000

The settlement rate is 10%. Other data related to the pension plan for 2008 are:


Amortization of unrecognized prior service costs 60,000

Contributions 300,000

Benefits paid 105,000



78. The balance of the projected benefit obligation at December 31, 2008 is

b. $2,385,000.

79. The fair value of plan assets at December 31, 2008 is

c. $2,232,000.

80. Gillum, Inc. has a defined-benefit pension plan covering its 50 employees. Gillum agrees

to amend its pension benefits. As a result, the projected benefit obligation increased by

$1,500,000. Gillum determined that all its employees are expected to receive benefits

under the plan over the next 5 years. In addition, 20% are expected to retire or quit each

year. Assuming that Gillum uses the years-of-service method of amortization for prior

service cost, the amount reported as amortization of prior service cost in year one after

the amendment is

b. $500,000.


The following information relates to the pension plan for the employees of Polzin Co.:

1/1/07 12/31/07 12/31/08

Accum. benefit obligation $5,280,000 $5,520,000 $7,200,000

Projected benefit obligation 5,580,000 5,976,000 8,004,000

Fair value of plan assets 5,100,000 6,240,000 6,888,000

Market-related value of assets 4,920,000 6,192,000 6,780,000

Unrecognized net (gain) or loss -0- (864,000) (960,000)

Settlement rate (for year) 11% 11%

Expected rate of return (for year) 8% 7%

Polzin estimates that the average remaining service life is 16 years. Polzin's contribution was

$378,000 in 2008 and benefits paid were $282,000.

Accounting for Pensions and Postretirement Benefits 20 - 19

81. The interest cost for 2008 is

c. $657,360.

82. The actual return on plan assets in 2008 is

b. $456,000.

83. The unexpected gain or loss on plan assets in 2008 is

b. $22,560 gain.

84. The corridor for 2008 is

a. $619,200.

85. The amount of unrecognized net gain amortized in 2008 is

a. $15,300.

86. Presented below is information related to Bitner Manufacturing Company as of December

31, 2008:

Projected benefit obligation in excess of plan assets $900,000

Unrecognized net gain 300,000

Unrecognized prior service cost 405,000

The amount to be reported as accrued pension cost at the end of 2008 is

c. $795,000..


Barkley Corporation received the following report from its actuary at the end of the year:

December 31, 2007 December 31, 2008

Projected benefit obligation $1,600,000 $1,800,000

Market-related asset value 1,400,000 1,420,000


Fair value of pension plan assets 1,380,000 1,440,000

Prepaid pension cost 80,000 100,000

Assume that no prepaid or accrued pension cost exists on January 1, 2007.

87. The amount reported as the total pension liability at December 31, 2007 is

a. $ -0-.

88. The amount reported as the total pension liability at December 31, 2008 is

c. $40,000.


The following information relates to Haywood, Inc.:

For the Year Ended December 31,

2007 2008

Plan assets (at fair value) $1,260,000 $1,824,000

Pension expense 570,000 450,000


Annual contribution to plan 600,000 450,000

Unrecognized prior service cost 480,000 420,000

Prior to 2007, cumulative pension expense recognized equaled cumulative contributions.

89. The amount reported as the total liability for pensions on the December 31, 2007 balance

sheet is

c. $360,000.

90. The amount reported as an intangible asset on the December 31, 2007 balance sheet is

b. $390,000.

Accounting for Pensions and Postretirement Benefits 20 - 21

91. The amount reported as the total liability for pensions on the December 31, 2008 balance

sheet is

b. $60,000.

92. The amount reported as an intangible asset on the December 31, 2008 balance sheet is

c. $90,000.

Questions 93 and 94 relate to the information which follows:

Presented below is information related to Kluth Inc. as of December 31, 2008.

Unrecognized gains and losses $ 90,000



Vested benefits 1,620,000


Plan assets (at fair value) 3,384,000

Unrecognized prior service cost -0-

Assume that cumulative pension expense equaled pension funding through 2008.

93. The amount reported as the total pension liability on Kluth's balance sheet at December

31, 2008 is as follows:

b. $36,000.

94. The amount reported as an intangible asset on Kluth's balance sheet at December 31,

2008 is as follows:

a. $ -0-.

95. Coble Company has a defined-benefit plan. At the end of 2008, it has determined the

following information related to its pension plan:

Projected benefit obligation $700,000

Market-related asset value of pension plan 600,000

Accumulated benefit obligation 660,000

Accrued pension cost 35,000

Fair value of pension plan assets 610,000

The amount of the total pension liability that is reported in Coble's balance sheet at the

end of 2008 is

d. $50,000.

96. Presented below is pension information related to Marten Company as of December 31,

2008:

Accumulated benefit obligation $3,000,000






The amount to be reported as Intangible Asset—Deferred Pension Cost as of December

31, 2008 is

d. $100,000.


On January 1, 2008, Nen Co. has the following balances:


Fair value of plan assets 3,750,000

The settlement rate is 10%. Other data related to the pension plan for 2008 are:


Amortization of unrecognized prior service costs 54,000

Contributions 270,000

Benefits paid 225,000



97. The balance of the projected benefit obligation at December 31, 2008 is

d. $4,635,000.

98. The fair value of plan assets at December 31, 2008 is

c. $4,059,000.

Use the following information for 99 and 100.

Spencer Company has the following information at December 31, 2008 related to its pension

plan:



Plan assets (fair value) 2,000,000


99. The amount of additional pension liability Spencer Company would recognize at

December 31, 2008 is

b. $900,000.

100. What amount of additional pension liability would be recognized if Spencer Company had

prepaid pension cost of $220,000 rather than accrued pension cost of $300,000?

a. $1,420,000

Use the following information for 101 and 102.

101. The following pension plan information is for Ladd Company at December 31, 2008.






Pension expense for 2008 3,000,000

Contribution for 2008 2,400,000

Prior to 2008, cumulative pension expense equaled cumulative contributions. The amount

to be reported as the total liability for pensions on the December 31, 2008 balance sheet

is

c. $1,350,000.

102. The amount to be reported as Intangible Asset—Deferred Pension Cost on the December

31, 2008 balance sheet is

c. $540,000.

*103. The following facts relate to the Lional Co. postretirement benefits plan for 2008:


Discount rate 9%

APBO, January 1, 2008 $1,500,000

EPBO, January 1, 2008 $2,000,000

Benefit payments to employees $115,000

The amount of postretirement expense for 2008 is

b. $305,000.

*104. The following facts relate to the postretirement benefits plan of Ramsey, Inc. for 2008:


Discount rate 8%

APBO, January 1, 2008 (transition amount) $4,000,000

EPBO, January 1, 2008 $4,800,000

Average remaining service to full eligibility 20 years

Average remaining service to expected retirement 25 years


b. $1,160,000.

*105. The following facts relate to the Albers Co. postretirement benefits plan for 2008:


Discount rate 10%

EPBO, January 1, 2008 $1,095,000

APBO, January 1, 2008 $900,000

Actual return on plan assets in 2008 $31,500

Expected return on plan assets in 2008 $24,000


b. $192,000.

106. The following information pertains to Mellon Co.'s pension plan:

Actuarial estimate of projected benefit obligation at 1/1/08 $72,000

Assumed discount rate 10%

Service costs for 2008 $18,000

Pension benefits paid during 2008 $15,000

If no change in actuarial estimates occurred during 2008, Mellon's projected benefit

obligation at December 31, 2008 was

d. $82,200.

107. Interest cost included in the net pension cost recognized for a period by an employer

sponsoring a defined-benefit pension plan represents the

b. increase in the projected benefit obligation due to the passage of time.

108. On January 1, 2008, Pratt Corp. adopted a defined-benefit pension plan. The plan's

service cost of $300,000 was fully funded at the end of 2008. Prior service cost was

funded by a contribution of $120,000 in 2008. Amortization of prior service cost was

$48,000 for 2008. What is the amount of Pratt’s prepaid pension cost at December 31,

2008?

a. $72,000

109. Reser Corp., a company whose stock is publicly traded, provides a noncontributory

defined-benefit pension plan for its employees. The company's actuary has provided the

following information for the year ended December 31, 2008:

Projected benefit obligation $600,000

Accumulated benefit obligation 525,000

Fair value of plan assets 825,000

Service cost 240,000



Expected and actual return on plan assets 82,500

The market-related asset value equals the fair value of plan assets. Prior contributions to

the defined-benefit pension plan equaled the amount of net periodic pension cost accrued

for the previous year end. No contributions have been made for 2008 pension cost. In its

December 31, 2008 balance sheet, Reser should report an accrued pension cost of

c. $241,500.

110. Effective January 1, 2007, Quayle Co. established a defined-benefit plan with no retroactive

benefits. The first of the required equal annual contributions was paid on December

31, 2007. A 10% discount rate was used to calculate service cost and a 10% rate of return

was assumed for plan assets. All information on covered employees for 2007 and 2008 is

the same. How should the service cost for 2008 compare with 2007, and should the 2007

balance sheet report an accrued or a prepaid pension cost?

Service Cost Pension Cost

for 2008 Reported on the

Compared to 2007 2007 Balance Sheet

d. Greater than Prepaid


Tomlin Co. provides retirement benefits to employees through a funded defined-benefit pension

plan. The company administering the plan provided the following information for the year ended

December 31, 2008:

Plan assets at fair value $1,200,000


Pension expense 300,000

Employer's contribution, 12/1/08 360,000


On December 31, 2007, the accrued/prepaid pension cost account had a debit balance of

$45,000. Assume that the fair value of the plan assets is equal to the market-related asset value.

Prior to 2008, the fair value of plan assets exceeded the accumulated benefit obligation.

111. At December 31, 2008, what is the amount of prepaid pension cost?

a. $105,000

112. In Tomlin's December 31, 2008 balance sheet, what is the amount of the minimum

pension liability?

c. $135,000

113. Yeager Co. maintains a defined-benefit pension plan for its employees. At each balance

sheet date, Yeager should report a minimum liability at least equal to the

c. unfunded accumulated benefit obligation.

114. Ohlman, Inc. maintains a defined-benefit pension plan for its employees. As of December

31, 2008, the market value of the plan assets is less than the accumulated benefit

obligation. The projected benefit obligation exceeds the accumulated benefit obligation. In

its balance sheet as of December 31, 2008, Ohlman should report a minimum liability in

the amount of the

b. excess of the accumulated benefit obligation over the value of the plan assets.

115. At December 31, 2008, the following information was provided by the Nilges Corp.

pension plan administrator:

Fair value of plan assets $4,500,000



What is the amount of the pension liability that should be shown on Nilges' December 31,

2008 balance sheet?

d. $1,080,000

Chapter 21 The Statement of Cash Flows

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 369

True/False Questions F1. Amounts held in cash equivalent investments must be reported separately from amounts held

as cash on the statement of cash flows.

T2. Generally speaking, cash flows from operating activities include the elements of net income

reported on a cash basis.

T3. In using a spreadsheet to prepare the statement of cash flows, the spreadsheet entries duplicate

the actual journal entries used to record the transactions during the year.

F4. Interest payments on debt are classified as cash outflows from financing activities.

T5. Transactions that represent noncash investing and financing should be reported in the

statement of cash flows.

T6. If the direct method is used to report cash flows from operating activities in the body of the

statement of cash flows, a reconciliation of net income to net cash flows from operating

activities also is required.

T7. Cash paid for taxes and interest must be disclosed on the face of the statement or in the

disclosure notes under both the direct and indirect methods of reporting cash flows from

operating activities.

F8. The purchase of treasury stock is an investing cash outflow.

T9. A decrease in cash dividends payable means that dividends declared were less than dividends

paid.

T10. When one enters a $50,000 credit entry to the Land account in a spreadsheet for the statement

of cash flows, it represents a negative change in that account and probably is due to selling

such assets.

11-15. Listed below are the reporting classifications for a statement of cash flows using the direct

method for reporting operating cash flows. Indicate the reporting classification that would

apply to each of the five transactions described below by placing the letter of the reporting

classification in the space provided by each transaction.

11. ____ Gain from the sale of a cash equivalent. A. Operating cash inflow

12. ____ Cash purchase of inventory. B. Operating cash outflow

13. ____ Cash dividends received under the equity method. C. Investing cash inflow

14. ____ Principal payment on a note. F. Financing cash outflow

15. ____ Distribution of a stock dividend. H. Not reported on the statement of cash flows

16. ____ Cash collected on accounts receivable. A. Operating cash inflow

17. ____ Cash collection of a nontrade note receivable. C. Investing cash inflow

18. ____ Cash purchase of securities issued by another corporation. D. Investing cash outflow

19. ____ Issuance of a long-term note payable for cash. E. Financing cash inflow

20. ____ Payment of a property dividend. G. Noncash financing and investing activity

21.____ Increase in inventory account. B. Operating activity, negative adjustment to net income

22.____ Payment of cash dividends. G. Financing cash outflow

23.____ Cash sales. A. Operating activity, no adjustment to net income

24.____ Prepayment of an insurance premium for six months. B. Operating activity, negative

adjustment to net income

25.____ Cash proceeds from sale of equipment. D. Investing cash inflow

26. ____ Payment of semi-annual interest on bonds payable. A. Operating activity, no adjustment

to net income

27. ____ Acquisition of a building for cash. E. Investing cash outflow

28. ____ Depreciation expense. C. Operating activity, positive adjustment to net income

29. ____ Issuance of bonds at a discount for cash. F. Financing cash inflow

30. ____ Decrease in account payable. B. Operating activity, negative adjustment to net income

31.____ Acquisition of equipment by issuing bonds payable. G. Noncash financing and investing

activity

32.____ Repayment of long-term debt by issuing preferred stock. G. Noncash financing and investing

activity


370 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition

33.____ Interest received on trading securities. A. Operating cash inflow

34.____ Cash sale of a patent. C. Investing cash inflow

35.____ Loan of cash to a supplier in exchange for a six-month note receivable. D. Investing cash

outflow

36. ____ Payment of cash dividends. F. Financing cash outflow

37. ____ Purchase of treasury stock. F. Financing cash outflow

38. ____ Investment of excess cash in an interest-bearing security classified as a cash

equivalent. H. Not reported on the statement of cash flows

39. ____ Appropriation of retained earnings for expansion of the R&D program. H. Not

reported on the statement of cash flows

40. ____ Acquisition of equipment under a capital lease. G. Noncash financing and

investing activity

41. Which of the following financial statements is prepared as of a particular point in time rather

than for a period of time?

D) Balance sheet.

42. Which one of the following financial statements does not report amounts primarily on an

accrual basis?

C) Statement of cash flows.

43. Which of the following is not required by generally accepted accounting principles?

A) Cash flow per share.

44. Which of the following is always reported as an outflow of cash?

C) The purchase of equipment for cash.

45. Which of the following causes a change in cash?

D) Payment of a cash dividend declared in the previous fiscal year.

46. Cash equivalents generally would not include short-term investments in:

C) Held-to-maturity securities.

47. How is the amortization of patents reported in a statement of cash flows that is prepared using

the indirect method?

D) An addition to net income in arriving at cash flows from operations.

48. How is the amortization of patents reported in a statement of cash flows that is prepared using

the direct method?

A) Not reported.

49. Which of the following is reported as an investing activity on the statement of cash flows?

A) Sale of a subsidiary.

50. Which of the following is reported as an investing activity on the statement of cash flows?

D) The sale of machinery.

51. Which of the following is reported as an operating activity on the statement of cash flows?

C) The payment of interest on long-term notes.

52. Which of the following is reported as an operating activity on the statement of cash flows?

D) The payment of prepaid insurance.

53. Which of the following is reported as a financing activity on the statement of cash flows?

B) The acquisition of stock for the purpose of retiring it.

54. Which of the following is reported as a financing activity on the statement of cash flows?

D) The repayment of bonds issued at par.

55. When preparing the statement of cash flows using the indirect method for determining net

cash flows from operating activities, depreciation is added to net income because:

A) It was deducted as an expense on the income statement, but does not require cash.

56. Which of the following is not classified as an operating activity?

C) Dividends paid on common stock.

57. When a company purchases a security it considers a cash equivalent, the cash outflow is:

D) Not reported on a statement of cash flows.



58. When treasury stock is sold at an amount less than its cost, the sale is classified as:

A) A financing activity.

59. Using the direct method, cash received from customers is calculated as sales:

D) Plus a decrease in accounts receivable.

60. Cash paid to suppliers under the direct method is computed as:

B) Cost of goods sold plus an increase in inventory and minus an increase in accounts payable.

61. Which of the following never requires an outflow of cash?

D) Amortization of patent.

62. Which of the following is not an inflow of cash?

A) Depletion.

63. The amortization of bond discount is included in the statement of cash flows (indirect method)

as:

C) An addition to net income.

64. Which of the following is not reported as an adjustment to net income when using the indirect

method of computing net cash flows from operating activities?

A) Cash dividends paid.

65. Which of the following is reported as a deduction from net income when using the indirect

method to determine net cash flows from operating activities?

C) Amortization of premium on bonds payable.

66. All of the following may qualify as cash equivalents except:

D) Newly issued corporate bonds.

67. Cost of goods sold as reported on the income statement will be less than cash paid to suppliers

if:

B) The decrease in accounts payable is equal to the increase in inventory during the

period.

68. The primary objective of the statement of cash flows is to provide information about a

company's:

A) Cash receipts and disbursements.

69. When a transfer is made between cash and cash equivalents with no gain or loss, how is the

transaction treated on the statement of cash flows?

D) It is not reported.

70. Creditors and investors would generally find the statement of cash flows least useful for

assessing the:

C) Financial position at a point in time.

71. Of the following, which is not an investing activity?

B) Buying treasury stock.

72. A loss on the sale of machinery should be reported on the statement of cash flows as:

A) An adjustment to net income under the indirect method.

73. Which of the following would not be a cash inflow from financing activities?

D) Cash from the sale of stock of a supplier.

74. Which of the following would be reported as a cash outflow from investing activities?

B) Purchase of land.

75. Payments to acquire bonds of other corporations should be classified on a statement of cash

flows as:

D) An investing activity.

76. Which of the following would be added to net income when determining cash flows from

operating activities under the indirect method?

D) A decrease in accounts receivable.

77. Which of the following would be an example of an investing activity on a statement of cash

flows?

A) Sale of equipment.



78. Interest payments to creditors are reported on a statement of cash flows as:

D) An operating activity.

79. Accrual of payroll expense is:

D) None of the above is correct.

80. Purchase of equipment for cash is:

B) Reported as an investing activity in the statement of cash flows.

81. Acquiring land with a long-term note is:

C) Reported as a noncash investing and financing activity in the statement of cash

flows.

82. Proceeds from the sale of a plant site are:

B) Reported as an investing activity in the statement of cash flows.

83. Purchase of treasury stock is:

A) Reported as a financing activity in the statement of cash flows.

Each year, White Mountain Enterprises (WME) prepares a reconciliation schedule that compares its

income statement with its statement of cash flows on both the direct and indirect method bases.

84. In its 2006 income statement, WME reported a $60,000 loss on the sale of equipment. In its

reconciliation schedule, WME should:

B) Show a $40,000 positive adjustment to net income under the indirect method.

85. In its 2006 income statement, WME reported $11,000 of interest expense on its outstanding

bonds. During the year, WME paid its regular installments of $9,000 of interest in cash. In its

reconciliation schedule, WME should:

C) Show a $2,000 positive adjustment to net income under the indirect method for the decrease in bond discount.

86. In its 2006 income statement, WME reported $440,000 for the cost of goods sold. WME paid

inventory suppliers $380,000 in 2006, and its inventory balance decreased by $41,000 during

the year. In its reconciliation schedule, WME should:

A) Show a $19,000 positive adjustment to net income under the indirect method for the

increase in accounts payable.

87. In its 2006 income statement, WME reported $58,000 for insurance expense. WME paid

$72,000 in insurance premiums during 2006. In its reconciliation schedule, WME should:

C) Show a $14,000 negative adjustment to net income under the indirect method for the

increase in prepaid insurance.

88. In its 2006 income statement, WME reported $695,000 for service revenue earned from

membership fees. WME received $681,000 cash in advance from members during 2006. In

its reconciliation schedule, WME should:

B) Show a $14,000 negative adjustment to net income under the indirect method for the

decrease in unearned revenue.

89. Rampart Inc. recorded the following transaction:

Land 15 million

Notes Payable 12 million

Cash 3 million

In the statement of cash flows, this would be reported as:

C) $3 million outflow from investing activities and $12 million noncash investing and

financing activity.

90. On December 31, 2006, Wellstone Company reported net income of $70,000 and sales of

$210,000. The company also reported beginning and ending accounts receivable at $20,000

and $25,000, respectively. Wellstone will report cash collected from customers in its 2006

statement of cash flows (direct method) in the amount of:

D) $205,000.

91. On December 31, 2006, Tiras Company reported net income of $50,000 and sales of

$200,000. The company also reported beginning and ending accounts receivable at $20,000

and $25,000, respectively. Tiras will report cash collected from customers in its 2006

statement of cash flows (indirect method) in the amount of:



A) $0.

92. Hemmer Company reported net income for 2006 in the amount of $40,000. The company's

financial statements also included the following:

Decrease in accounts receivable $6,000

Increase in inventory 1,000

Depreciation expense 3,000

What is net cash provided by operating activities?

D) $48,000.

93. Creble Company reported net income for 2006 in the amount of $40,000. The company's

financial statements also included the following:

Increase in accounts receivable $4,000

Decrease in inventory 2,000


Gain on sale of equipment 5,000

On the statement of cash flows what is net cash provided by operating activities under the

indirect method?

A) $36,000.

94. Lite Travel Company's accounting records include the following information:

Payments to suppliers $50,000

Collections on accounts receivable 79,000

Cash sales 44,000

What is the amount of net cash provided by operating activities indicated by the numbers

provided?

B) $ 73,000.

95. Freeman Company's accounting records include the following information:

Payments to suppliers $50,000

Collections on accounts receivable 90,000

Cash sales 20,000

Income taxes paid 5,000

Equipment purchased 15,000

What is the amount of net cash provided by operating activities indicated by these

transactions?

C) $55,000.

96. Ludwig Company's prepaid rent was $9,000 at December 31, 2005, and $13,000 at December

31, 2006. Ludwig reported rent expense of $19,000 on the 2006 income statement. What

amount would be reported on the statement of cash flows as rent paid using the direct method?

D) None of the above is correct.

97. Pickering Company's prepaid insurance was $8,000 at December 31, 2005, and $10,000 at

December 31, 2006. Pickering reported insurance expense of $15,000 on the 2006 income

statement. What amount would be reported on the statement of cash flows as insurance paid

using the direct method?

B) $17,000.

98. Alpha Company had the following account balances for 2006:

Dec. 31 Jan. 1

Accounts receivable $44,000 $35,000

Accounts payable 58,000 60,000

Alpha reported net income of $210,000 for 2006. Assuming no other changes in current

account balances, what is the amount of net cash provided by operating activities for 2006

reported on the statement of cash flows?

D) $196,000.

99. Hogan Company had the following account balances for 2006:

Dec. 31 Jan. 1

Accounts receivable $44,000 $35,000




Prepaid insurance 15,000 10,000

Hogan reported net income of $300,000 for 2006. Assuming no other changes in current



A) $291,000.

100. Hanson Company had the following account balances for 2006:

Dec. 31 Jan. 1

Inventory $40,000 $35,000


Hanson reported net income of $90,000 for 2006. Assuming no other changes in current



A) $ 70,000.

101. A company reported interest expense of $540,000 for the year. Interest payable was $35,000

and $75,000 at the beginning and the end of the year, respectively. What was the amount of

interest paid?

D) $575,000.

102. A firm reported (in millions of dollars) net cash inflows (outflows) as follows: operating $75,

investing ($200), and financing $350. The beginning cash balance was $250. What was the

ending cash balance?

C) $475.

103. During the year, cash increased by $300 million. Investing and financing activities created

positive cash flow totaling $500 million. What were net cash flows from operating activities

on the statement of cash flows?

B) Outflow of $200 million.

104. Bowers Corporation reported the following (in thousands of dollars) for the year:

Balance

Beginning Ending

Accounts receivable $600 $850

Allowance for bad debts 40 35

Sales on account were $1,900 and bad debt expense was $18 for the year. How much cash was

collected from customers on account?

A) $1,627.

105. Sneed Corporation reported balances in the following accounts for the current year:

Beginning Ending

Income tax payable $50 $30

Deferred tax liability 80 140

Income tax expense was $230 for the year. What was the amount paid for taxes?

D) $190.

106. Dooling Corporation reported balances in the following accounts for the current year:

Beginning Ending

Inventories $600 $300

Accounts payable 300 500

Cost of goods sold was $7,500. What was the amount of cash paid to suppliers?

A) $7,000.

107. A firm reported salary expense of $239,000 for the current year. The beginning and ending

balances in salaries payable were $40,000 and $15,000, respectively. What was the amount of

cash paid for salaries?

C) $264,000.

108. Goodfellow Corporation reported pension expense of $477 for the current year. The beginning

and ending balances in the prepaid pension expense account were $50 and $30, respectively.



What was the amount of cash paid into the pension fund?

B) $457.

109. Melanie Corporation declared cash dividends of $13,500 during the current year. The

beginning and ending balances in dividends payable were $450 and $750, respectively. What

was the amount of cash paid for dividends?

D) $13,200.

Problems 110. Determine the amount of cash received from customers for each of the four independent

situations below.

Sales Accounts Bad debt Allowance for

Situation revenue receivable expense uncollectible

inc (dec) accounts Cash received

inc (dec) from customers

1 $300,000 $ 10,000 $ 0 $ 0 $

2 300,000 (10,000) 0 0 $

3 400,000 (10,000) 2,000 1,000 $

4 400,000 10,000 2,000 (1,000) $

Answer:

1) $300,000 - $10,000 = $290,000

2) $300,000 + $10,000 = $310,000

3) $400,000 + $10,000 + $1,000 - $2,000 = $409,000

4) $400,000 - $10,000 - $1,000 - $2,000 = $387,000

Learning Objective: 3 Level of Learning: 3



111. Determine the amount of cash paid to suppliers for each of the four independent situations

below.

Cost of Inventory Accounts Cash paid to suppliers

Situation goods sold payable

inc (dec) inc (dec)

1 $300,000 $6,000 $ 0 $

2 300,000 0 7,000 $

3 400,000 6,000 7,000 $

4 400,000 (6,000) (7,000) $

Answer:

1) $300,000 + $6,000 = $306,000

2) $300,000 - $7,000 = $293,000

3) $400,000 + $6,000 - $7,000 = $399,000

4) $400,000 + $7,000 - $6,000 = $401,000


112. The accounting records of Eastlake Industries provided the data below.

Net income $300,000



Increase in accounts receivable 1,400

Decrease in interest payable 1,600

Amortization of bond premium 3,000

Increase in accounts payable 7,000

Cash dividends paid 20,000

Required: Prepare a reconciliation of net income to net cash flows from operating activities.

Answer:

Net income $300,000

Adjustments for noncash effects:


Increase in inventory (2,000 )

Decrease in interest payable (1,600 )

Increase in accounts receivable ( 1,400 )

Decrease in bond premium (3,000 )


Net cash flows from operating activities $314,000




113. The accounting records of Westlake Industries provided the data below.

Net income $200,000




Increase in interest payable 1,600

Amortization of bond discount 3,000


Cash dividends paid 20,000


Answer:

Net income $200,000




Increase in interest payable 1,600

Increase in accounts receivable (1,400 )

Decrease in bond discount 3,000




114. Prepare the spreadsheet entries necessary to determine the amount of cash received from

customers for each of the four independent situations below.

Sales Accounts Bad debt Allowance for Cash received

Situation revenue receivable expense uncollectible from customers

inc (dec) inc (dec) accounts

1 200,000 10,000 0 0

2 200,000 (10,000) 0 0

3 200,000 (10,000) 2,000 1,000

4 200,000 10,000 2,000 (1,000)

Answer:

(1.) Cash 190,000

Accounts receivable 10,000

Sales revenue 200,000

(2.) Cash 210,000





(3.) Cash 209,000

Bad debt expense 2,000

Allowance for uncollectible accounts 1,000



(4.) Cash 187,000

Bad debt expense 2,000

Allowance for uncollectible accounts 1,000




115. Prepare the spreadsheet entries necessary to determine the amount of cash paid to suppliers for

each of the four independent situations below.

Cost of Inventory Account Cash paid

Situation goods sold inc (dec) payable to suppliers

inc (dec)

1 400,000 6,000 0

2 400,000 0 7,000

3 100,000 6,000 7,000

4 100,000 (6,000) (7,000)

Answer:

(1.) Cost of goods sold 400,000

Inventory 6,000

Cash 406,000


Accounts payable 7,000

Cash 393,000


Inventory 6,000


Cash 99,000



Inventory 6,000

Cash 101,000




116. Following are the income statement and some additional information for Carolina Consulting

Company.

Carolina Consulting Company

Income Statement

For the Year Ended December 31, 2006

Net sales $10,000

Cost of goods sold (1,500 )

Gross margin 8,500

Operating expenses $2,000

Depreciation expense 900 (2,900 )

Income before taxes 5,600

Income taxes (1,600 )

Net income $4,000

All sales were on credit and accounts receivable decreased by $900 this year compared to last

year. Merchandise purchases were on credit with a decrease in accounts payable of $700

during the year. Ending inventory was $500 larger than beginning inventory. Income taxes

payable increased $300 during the year. All operating expenses were paid for in cash.

Required: Prepare the cash flows from operating activities section of the statement of cash flows using

the direct method.

Answer:

Cash flows from operating activities:

Cash received from customers ($10,000 + $900) $10,900

Cash paid to suppliers ($1,500 + $500 + $700) (2,700 )

Cash paid for operating expenses (2,000 )

Cash paid for taxes ($1,600 - $300) (1,300 )





117. Following are the income statement and some additional information for Parson Corporation

for 2006.

Parson Corporation

Income Statement


Net sales $10,000

Cost of goods sold (1,500 )

Gross margin 8,500

Operating expenses $2,000

Depreciation expense 900 (2,900 )

Income before taxes 5,600

Income taxes (1,600 )

Net income $4,000

All sales were on credit and accounts receivable increased by $600 this year compared to last

year. Merchandise purchases were on credit with a increase in accounts payable of $400

during the year. Ending inventory was $500 larger than beginning inventory. Income taxes

payable increased $300 during the year. All operating expenses were paid for in cash.

Required: Prepare the cash flows from operating activities section of the statement of cash flows using

the indirect method.

Answer:


Net income $4,000

Adjustment for noncash effects:

Depreciation expense 900

Increase in accounts receivable (600 )

Increase in inventory (500 )

Increase in accounts payable 400

Increase in taxes payable 300





118. Partial balance sheets and additional information are listed below for Sowell Company.

Sowell Company

Partial Balance Sheets

as of December 31

Assets 2006 2005

Cash $40,000 $20,000

Accounts receivable 70,000 85,000

Inventory 40,000 35,000

Liabilities

Accounts payable $54,000 $62,000

Additional information for 2006:

Net income was $88,000.

Depreciation expense was $19,000.

Required: Prepare the operating activities section of the statement of cash flows for 2006 using the

indirect method.

Answer:


Net income $88,000



Decrease in accounts receivable 15,000


Decrease in accounts payable (8,000 )



119. Partial balance sheets and additional information are listed below for Rickey Company.

Rickey Company


as of December 31

Assets 2006 2005

Cash $20,000 $40,000


Inventory 35,000 40,000

Liabilities





Required: Prepare the operating activities section of the statement of cash flows for 2006 using the

indirect method.



Answer:


Net income $160,000








120. Partial balance sheets and additional information are listed below for Monaco Company.

Monaco Company


as of December 31

Assets 2006 2005

Cash $40,000 $20,000


Inventory 25,000 40,000

Liabilities





Sales totaled $800,000.

Cost of goods sold totaled $305,000.

Required: Calculate the amount of cash paid to merchandise suppliers during 2006.

Answer:

Cost of goods sold 305,000


Inventory 15,000

Cash (paid to suppliers) 302,000




121. Partial balance sheets and additional information are listed below for Ensign Company.

Ensign Company


as of December 31

Assets 2006 2005

Cash $20,000 $40,000


Inventory 20,000 25,000

Liabilities







Required: Calculate the amount of cash paid to merchandise suppliers during 2006.

Answer:


Inventory 5,000


Cash (paid to suppliers) 126,000


122. Partial balance sheets and additional information are listed below for Funk Company.

Funk Company


as of December 31

Assets 2006 2005

Cash $40,000 $20,000


Inventory 25,000 40,000

Liabilities







Required: Calculate the amount of cash received from customers during 2006.



Answer:

Cash (received from customers) 796,000




123. Partial balance sheets and additional information are listed below for Julius Company.

Julius Company


as of December 31

Assets 2006 2005

Cash $20,000 $40,000


Inventory 40,000 25,000

Liabilities







Required: Calculate the amount of cash received from customers during 2006.

Answer:

Cash (received from customers) 570,000






124. Partial balance sheets for Yarborough Company and additional information are found below.

Yarborough Company


as of December 31

Assets 2006 2005

Equipment $100,000 $75,000

Accumulated depreciation (25,000 ) (20,000 )

Shareholders' equity

Common stock, $5 par $150,000 $100,000

Paid-in capital - excess of par 20,000 0

Retained earnings 40,000 30,000


July 1: Issued 10,000 shares of common stock for cash.

July 1: Purchased new equipment for cash.

Dec. 31 Paid cash dividends of $30,000.

Required: Prepare the investing activities section of the statement of cash flows for 2006.

Answer:

Cash flows from investing activities:

Purchase of equipment $(25,000)

Net cash flows from investing activities $(25,000)


125. Partial balance sheets for ABC Company and additional information are provided below.

ABC Company


as of December 31

Assets 2006 2005

Equipment $100,000 $75,000


Shareholders' equity

Common stock, $10 par 180,000 $100,000

Paid-in capital – excess of par 20,000 0



July 1: Issued 8,000 shares of common stock for cash.

July 1: Purchased new equipment for cash.

December 31: Paid cash dividends of $20,000.

Required: Prepare the financing activities section of the statement of cash flows for 2006.



Answer:

Cash flows from financing activities:

Issuance of common stock $100,000

Payment of cash dividends (20,000 )

Net cash flows from financing activities $80,000


126. The accounting records of Harrison Company provided the data below.

Net loss $10,000


Increase in salaries payable 1,000



Amortization of patent 700

Decrease in discount on bonds 500


Answer:

Net loss $(10,000 )







Reduction in discount on bonds 500

Net cash flows from operating activities $ 3,400


127. The accounting records of Unlucky Company provided the data below

Net loss $40,000






Decrease in premium on bonds 500




Answer:

Net loss $(40,000 )






Amortization expense 700

Reduction in premium on bonds (500 )

Net cash flows from operating activities $ (16,000 )


128. The Murdock Corporation reported the following balance sheet data for 2006 and 2005.

2006 2005

Cash $ 77,375 $ (22,955 )

Available-for-sale securities

(not cash equivalents) 15,500 85,000


Inventory 165,000 145,000

Prepaid insurance 1,500 2,000

Land, buildings, and equipment 1,250,000 1,125,000


Total assets $ 979,375 $ 830,295

Accounts payable $ 76,340 $ 102,760

Salaries payable 20,000 24,500

Notes payable (current) 25,000 75,000

Bonds payable 200,000 0

Common stock 300,000 300,000


Total liabilities and shareholders' equity $ 979,375 $ 830,295


(1.) Sold available-for-sale securities costing $69,500 for $74,000.

(2.) Equipment costing $20,000 with a book value of $5,000 was sold for $6,000.

(3.) Issued 6% bonds payable at par, $200,000.

(4.) Purchased new equipment for cash $145,000.

(5.) Paid cash dividends of $20,000.

(6.) Net income was $50,000.

(7.) Proceeds of the notes payable were used for operating purposes.

Required: Prepare a statement of cash flows for 2006 in good form using the indirect method for cash

flows from operating activities.



Answer:

Note: This can be solved in spreadsheet form if the instructor wishes.

Murdock Company

Statement of Cash Flows



Net income $ 50,000



Gain on sale of available for sale securities (4,500 )

Gain on sale of equipment (1,000 )



Decrease in prepaid insurance 500


Decrease in salaries payable (4,500 )

Decrease in notes payable (50,000 )

Net cash flows from operating activities $(14,670 )


Sale of available-for-sale securities 74,000

Sale of equipment 6,000

Purchase of equipment (145,000 )

Net cash flows from investing activities (65,000 )


Sale of bonds payable 200,000


Net cash flows from financing activities 180,000

Net increase in cash 100,330

Cash balance, January 1 (22,955 )

Cash balance, December 31 $ 77,375




129. The following are comparative balance sheets and on income statement for Wentworth

Company.

Wentworth Company

Balance Sheets

as of December 31

Assets 2006 2005

Cash $ 21,500 $120,000


Inventory 180,000 225,000

Long-term investments 0 60,000

Totals $396,500 $510,000

Liabilities and shareholders' equity

Accounts payable $ 75,000 $120,000

Operating expenses payable 24,000 15,000

Bonds payable 70,000 100,000

Common stock 125,000 125,000


Totals $396,500 $510,000

Wentworth Company

Income Statement


Sales $560,000

Cost of goods sold:

Beginning inventory $225,000

Purchases 330,000

Goods available for sale 555,000

Less: ending inventory 180,000


Gross profit 185,000

Operating expenses 180,000

Income from operations 5,000

Other expenses:

Loss on sale of long-term investment (7,500 )

Net loss $ (2,500 )

Cash dividends of $45,000 were paid in 2006.

Required: Prepare a statement of cash flows for 2006 using the direct method.



Answer:

Note: This can be solved in spreadsheet form if the instructor wishes.

Wentworth Company

Statement of Cash Flows



Cash inflows:

From customers $470,000

Cash outflows:

To suppliers of goods (375,000 )

For operating expenses (171,000 )

Net cash flows from operating activities $(76,000 )


Sale of long-term investments 52,500

Net cash flows from investing activities 52,500


Payment of bonds (30,000 )


Net cash flows from financing activities (75,000 )

Net decrease in cash (98,500 )

Cash balance, January 1 120,000

Cash balance, December 31 $ 21,500


Use the following to answer questions 130-135:

In its 2005 Annual Report to Shareholders, Henchman & Co. provided the following Statement of

Cash Flows:

Years ended December 31, $ in millions 2005 2004

Operating Activities

Sources of Cash

Cash received from customers

Progress payments $3,102 $ 1,438

Other collections 11,148 7,003

Proceeds from litigation settlement 220

Interest received 17 17

Income tax refunds received 23 15

Other cash receipts 24 10

Cash provided by operating activities 14,534 8,483

Uses of Cash

Cash paid to suppliers and employees 13,251 7,250

Interest paid 333 165

Income taxes paid 126 57

Other cash payments 7 1

Cash used in operating activities 13,717 7,473

Net cash provided by operating activities 817 1,010



Investing Activities

Payment for businesses purchased, net of (3,061 ) (510 )

cash acquired

Additions to property, plant and equipment (393 ) (274 )

Collection of note receivable 148

Proceeds from sale of property, plant and 86 44

equipment

Proceeds from sale of businesses 18 668

Other investing activities (2 ) (6 )

Net cash used in investing activities (3,204 ) (78 )

Financing Activities

Proceeds from issuance of long-term debt 1,491

Proceeds from equity security units 690

Borrowings under lines of credit 1,173

Repayment of borrowings under lines of (1,306 ) (175 )

credit

Principal payments of long-term debt/ (119 ) (485 )

capital leases

Proceeds from issuance of stock 825 19

Dividends paid (158 ) (114 )

Other financing activities (64 ) _____

Net cash provided by (used in) financing 2,532 (755 )

activities

Increase in cash and cash equivalents 145 177

Cash and cash equivalents at beginning of year 319 142

Cash and cash equivalents at end of year $ 464 $ 319

130. What method (direct or indirect) does Henchman & Co. use to present its Statement of Cash

Flows? Explain how you can tell.

Answer: Henchman & Co. uses the direct method, one of very few companies that do. One

can tell this by the fact that they simply list sources and uses of cash in the operating activities

section, rather than starting with net income and making the series of adjustments necessary to

work back to operating cash flows.


131. What was the net change in cash and cash equivalents experienced by Henchman & Co.

during 2005? Was it positive or negative?

Answer: $145 million positive change (increase).




132. Which type of activity (operating, investing, financing) was most responsible for the net

change in cash and cash equivalents experienced by Henchman & Co. during 2005?

Answer: Financing activities were most responsible.


133. (a.) What is the most significant change in operating cash outflow activity in 2005 relative to

2004?

(b.) What balance sheet accounts would likely have changed during 2005 in relation to the

cash flow change that you identify in (a)?

Answer:

(a.) Cash payments to suppliers and employees increased from $7,250 million to $13,251

million.

(b.) Accounts Payable and Wages/Salaries Payable probably are the accounts that would have

changed.


134. What was most responsible for the negative cash flow from financing activities during 2004?

What amount was paid?

Answer: Principal payments on long-term debt and capital leases were $485 million.


135. What was most responsible for the positive cash flow from financing activities during 2005?

What amount was received?

Answer: Proceeds from issuance of long-term debt were $1,491 million.





In its 2005 Annual Report to Shareholders, Kinney Inc. reported the following Consolidated Statement

of Cash Flows:

For the years ended December 31,

2005 2004

Cash flow from operations:

Cash received from customers $197,942,040 $211,773,952

Cash paid to suppliers and employees -191,276,791 -200,474,336

Interest paid, net -1,563,990 -2,098,523

Income taxes paid -406,650 -542,250

Cash provided by operations 4,694,609 8,658,843

Cash flow from investing activities:

Capital expenditures and acquisitions -3,003,579 -1,667,382

Expenditures for other assets -43,560 137,420

Cash used in investing activities -3,047,139 -1,804,802

Cash flow from financing activities:

Principal payments of long-term debt and capitalized

leases

-2,062,485 -6,370,175

Addition to long-term debt and capitalized leases 5,817,348 1,434,847

Changes in restricted unexpended IRB cash -2,748,970 -

Purchase of common stock and other capital

transactions

-1,605,906 -908,231

Payment of dividends -855,558 -1,021,968

Cash provided by (used in) financing activities -1,455,571 -6,865,527

Net increase (decrease) in cash 191,899 -11,486

Cash at beginning of year 192,615 204,101

Cash at end of year $ 384,514 $ 192,615

2005 2004

Reconciliation of net income to net cash

provided by operations:

Net income $1,747,833 $2,382,027

Depreciation and amortization 3,505,504 3,525,087

Deferred income taxes 205,000 344,766

Changes in assets and liabilities, net of

acquisitions:

Decrease (increase) in receivables -2,897,353 4,120,668

Decrease (increase) in inventories -355,508 6,041,490

Increase (decrease) in prepaid expenses 361,648 -94,350

Increase (decrease) in controlled

disbursements

373,394 83,718

Increase (decrease) in accounts payable 1,768,676 -8,164,148

Increase (decrease) in accrued expenses -14,585 417,616

Other, net 1,969

Cash provided by operations $4,694,609 $8,658,843



136. Assuming the decrease in accrued expenses during fiscal year 2005 included a $20,000

reduction due to taxes, compute the income tax expense for Kinney in that year.

Answer:

The reduction in accrued taxes is actually a reduction in taxes payable, a liability. Therefore,

beg. taxes payable + income tax expense – income tax deferred – income taxes paid = end.

taxes payable

Therefore, income tax expense = (end. taxes payable - beg. taxes payable) + income taxes

deferred + income taxes paid = $(20,000) + $205,000 + $406,650

= $591,650


137. Assuming the decrease in accrued expenses during fiscal year 2005 included a $14,000

reduction due to interest on debt, compute the interest expense (net) for Kinney in that year.

Answer:

The reduction in accrued expenses is actually a reduction in interest payable, a liability.

Therefore,

beg. interest payable + interest expense (net) – interest paid = end. interest payable

Therefore, interest expense =

(end. interest payable – beg. interest payable) + interest paid

= $(14,000) + 1,563,990

= $1,549,990


138. Kinney reported cost of goods sold of $168,114,150 in its fiscal 2005 income statement.

Compute its net inventory purchases during the year.

Answer:

Assuming that there were no inventory impairments, the computation is as follows:

CGS = beg. inventory + net purchases – end. inventory. Therefore,

net purchases = CGS + (end. inventory – beg. inventory)

= $168,114,150 + 355,508

= $168,469,658




139. Kinney reported cost of goods sold of $168,114,150 in its fiscal 2005 income statement.

Assuming that Kinney uses accounts payable strictly for inventory purchases and that all such

purchases are on credit, how much cash did Kinney pay during the year for inventories:

(a) to inventory suppliers?

(b) to employees?

Answer:

(a.) Assuming that there were no inventory impairments, the computation is as follows:

CGS = beg. inventory + net purchases – end. inventory. Therefore,

net purchases = CGS + (end. inventory – beg. inventory)

= $168,114,150 + 355,508

= $168,469,658

end. acct. payable = beg. acct. payable + net inventory purchases – cash paid to suppliers

Therefore,

(end. acct. payable - beg. acct. payable) + cash paid to suppliers = net inventory purchases

$1,768,676 + cash paid to suppliers = $168,469,658

Cash paid to suppliers = $168,469,658 - $1,768,676

= $166,700,982

(b.) Cash paid to suppliers and employees is $191,276,791. Therefore,

Cash paid to employees = $191,276,791 - $166,700,982

= $24,575,809


Essay

Instructions:

The following answers point out the key phrases that should appear in students' answers. They are not

intended to be examples of complete student responses. It might be helpful to provide detailed

instructions to students on how brief or in-depth you want their answers to be.

140. Since the statement of cash flows has been required only since 1988, is the reporting of cash

flows a new concept? Explain.

Answer: No. Financial reporting on a cash basis was common several decades ago. The

requirement for a cash flow statement represents a renewed emphasis on cash flow reporting.

Prior to the mid-1930s, preparing financial statements on the cash basis, rather than the

accrual basis, was a common practice.




141. Is depreciation a source of cash? Explain.

Answer: No. Depreciation is simply the systematic and rational allocation of an asset's cost.

The expenditure to acquire the item being depreciated was a use of cash. When the indirect

method is used to determine cash flows from operating activities, depreciation is added back

to net income on the statement of cash flows because it was deducted on the accrual basis

income statement but it did not require the use of cash.


142. Why is the statement of cash flows required as part of the set of external financial statements?

Answer: The FASB in statement No. 95 requires the statement of cash flows in direct response

to FASB Concept Statement No. 1, which states as the primary objective of financial reporting

to "provide information to help investors and creditors, and others assess the amounts, timing,

and uncertainty of prospective net cash inflows to the related enterprise."


143. Why are "cash equivalents" included as part of cash on the statement of cash flows?

Answer: Skilled managers will invest temporarily idle cash in short-term investments to earn a

return on those funds, rather than maintaining an unnecessarily large checking account. The

FASB views short-term, highly liquid investments that can be easily converted into cash, with

little risk of loss, to be the equivalent of cash.


144. What are the general guidelines for an investment to be considered a cash equivalent?

Answer: To be classified as a cash equivalent, an investment must have a maturity date not

longer than three months from the date of purchase. The investment must be easily convertible

into cash, with little risk of loss on the conversion. However, flexibility is permitted in

designating cash equivalents. Each company must establish a policy regarding which short-

term, highly liquid investments it classifies as cash equivalents. The policy should be

consistent with the company's customary motivation for acquiring various investments and

should be disclosed in the notes accompanying the financial statements.


145. What activities are included on the statement of cash flows under the section entitled "Cash

flows from investing activities"?

Answer: Cash flows from investing activities include the sale or purchase of operating assets,

the sale or purchase of nontrading investments, and the collection or making of loans to others.




146. What activities are included on the statement of cash flows under the section entitled "Cash

flows from financing activities"?

Answer: Cash flows from financing activities include the issuance and repurchase of stock, the

issuance and repayment of bonds and notes, and the payment of cash dividends.


147. Do "cash flows from operating activities" report all the elements of the income statement on a

cash basis? Explain.

Answer: Although the cash flows from operating activities section of a statement of cash

flows reports income statement elements on a cash basis, not all the elements from the income

statement are necessarily reported on a cash basis. No cash effects are reported for

depreciation and amortization. Further, no cash effect is reported for gains or losses from the

sale of operational assets. When these operational assets are bought and sold, the effect is

reported under "cash flows from investing activities."


148. Does the statement of cash flows report only transactions that cause an increase or decrease in

cash? Explain.

Answer:

A statement of cash flows reports transactions that cause an increase or decrease in cash.

However, some transactions that do not increase or decrease cash, but which result in

significant investing and financing activities, must be reported in related disclosure notes.

Examples of noncash transactions that are important or significant enough to be reported

include:

1) Acquiring an asset by incurring debt or issuing stock,

2) Acquiring an asset by entering into a capital lease,

3) Converting debt into common stock,

4) Exchanging noncash assets or liabilities for other noncash assets or liabilities.





In its 2005 Annual; Report to Shareholders, Netherlands Corporation included the following

information on cash flows from operations:

CONSOLIDATED STATEMENTS OF CASH

FLOWS

(In thousands)

2005 2004

Operating activities:

Net income $ 10,680 $30,100

Adjustments to reconcile to net cash provided

by operating activities:

Depreciation and amortization 25,734 20,051

Deferred income taxes 5,156 9,885

Equity income (486 ) (864 )

Changes in operating assets and liabilities:

Receivables 17,888 (33,018 )

Inventories 39,331 (10,173 )

Accounts payable and accrued expenses (23,737 ) 13,515

Prepaids and other-net (10,913 ) 5,893

Net Cash Provided By Operating Activities 63,653 35,389

149. Explain why Netherlands Corporation subtracts equity income from its net income in its

measurement of operating cash flows.

Answer: Under the equity method, income accrues to the investor company when it is earned

by the investee company, not when dividends are distributed. In effect, Netherlands

Corporation has earned investment revenue that has been included in its income statement.

However, this amount does not involve cash until PVH receives dividends (that will be

reported as investment inflows). Therefore, Netherlands Corporation makes an adjustment to

eliminate this non-cash equity income from the company's operating cash flows.


150. Did accounts receivable increase or decrease during 2005?

Answer: The accounts receivable balance decreased during 2005. This is apparent because

adjustments for current assets are inversely related to the direction of the change in balance.

Because the adjustment for accounts receivable was positive, its balance must have decreased.


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