Q1. When a firm recognizes revenue in excess of expenses on a product not covered by a warranty before cash is collected, what is the impact on the firm’s assets and liabilities, ignoring taxes?

          Assets                               Liabilities

A) Increase                                    No effect

B) Increase                                    Increase

C) No effect                                   Increase

Q2. Bug-Be-Gone is a residential pest control company that offers a 12 month home-service contract to eliminate insect infestation. Customers are required to prepay for the service at the beginning of each year. If Bug-Be-Gone erroneously records these payments as revenue and include the estimated cost of performing the service, what is the most likely effect on the firm’s liabilities and equity compared to the correct treatment?

Liabilities                      Equity

A) Overstated                                Overstated  

B) Understated                             Overstated

C) Overstated                                Understated

Q3. At the beginning of 2007, Bryan’s Bakery Company purchased a secret cookie recipe for $25,000. In addition, Bryan developed a new cake recipe at a cost of $5,000. Bryan expects to use both recipes indefinitely; however, the useful (economic) life of similar recipes has been 10 years. Assuming straight-line amortization, what amount of recipe expense should Bryan report for the year ended 2007 and what amount should Bryan report as a tangible asset on its balance sheet at the end of 2007?

          Recipe expense                          Balance sheet

A)                                                      $7,500 $22,500

B)                                                     $7,500 $0

C)                                                     $3,000 $30,000

Q4. On January 1, 20x7, Omega Corporation paid $45,000 to renew its property insurance for 3 years. What amount of insurance expense should Omega report for the year-ended December 31, 20x7 and what is the balance of Omega’s prepaid insurance account on December 31, 20x8?

          Insurance expense        Prepaid insurance

A) $15,000                                     $15,000

B) $15,000                                    $30,000

C) $45,000                                    $15,000

答案和详解如下：

Q1. When a firm recognizes revenue in excess of expenses on a product not covered by a warranty before cash is collected, what is the impact on the firm’s assets and liabilities, ignoring taxes?

          Assets                               Liabilities

A) Increase                                    No effect

B) Increase                                    Increase

C) No effect                                   Increase

Correct answer is A)

When a firm recognizes revenue before cash is collected, equity increases (retained earnings) and assets increase (accounts receivable). Liabilities would not be affected.

Q2. Bug-Be-Gone is a residential pest control company that offers a 12 month home-service contract to eliminate insect infestation. Customers are required to prepay for the service at the beginning of each year. If Bug-Be-Gone erroneously records these payments as revenue and include the estimated cost of performing the service, what is the most likely effect on the firm’s liabilities and equity compared to the correct treatment?

Liabilities                      Equity

A) Overstated                                Overstated  

B) Understated                             Overstated

C) Overstated                                Understated

Correct answer is B)

When payment is received, the firm has an obligation to provide the service. This obligation is reported as a liability ‘unearned revenue’ as a liability, offsetting the increase in cash. If they book the revenue and estimated expenses of providing the service this will overstate equity (assuming revenue greater than expected expense) and liabilities will be understated.

Q3. At the beginning of 2007, Bryan’s Bakery Company purchased a secret cookie recipe for $25,000. In addition, Bryan developed a new cake recipe at a cost of $5,000. Bryan expects to use both recipes indefinitely; however, the useful (economic) life of similar recipes has been 10 years. Assuming straight-line amortization, what amount of recipe expense should Bryan report for the year ended 2007 and what amount should Bryan report as a tangible asset on its balance sheet at the end of 2007?

          Recipe expense                          Balance sheet

A)                                                      $7,500 $22,500

B)                                                     $7,500 $0

C)                                                     $3,000 $30,000

Correct answer is B)

The recipes are intangible assets. The purchased cookie recipe is capitalized and amortized over 10 years at $2,500 per year ($25,000 cost / 10 years). Since the cake recipe was developed internally, it is expensed immediately. Thus, total expense for 2007 is $7,500 ($2,500 amortization expense + $5,000 cake recipe expense).

Q4. On January 1, 20x7, Omega Corporation paid $45,000 to renew its property insurance for 3 years. What amount of insurance expense should Omega report for the year-ended December 31, 20x7 and what is the balance of Omega’s prepaid insurance account on December 31, 20x8?

          Insurance expense        Prepaid insurance

A) $15,000                                     $15,000

B) $15,000                                    $30,000

C) $45,000                                    $15,000

Correct answer is A)

At the beginning of 20x7, the prepaid insurance account (asset) will have a balance of $45,000. Insurance expense will be recognized at a rate of $15,000 per year. At the end of 20x8, one year’s insurance remains; thus, the balance of the prepaid insurance account will equal $15,000 ($45,000 beginning balance – $15,000 insurance expense for 20x7 – $15,000 insurance expense for 20x8).

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