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According to International Financial Reporting Standards, how do cash dividends received from trading securities and available-for-sale securities affect net income?

Trading securities

Available-for-sale securities

A) No effect Increase

B) Increase Increase

C) Increase No effect

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Dividends received from trading securities and available-for-sale securities are recognized in the income statement. The difference in trading and available-for-sale classifications relates to the treatment of any unrealized gains and losses.

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Current assets that arise from the accrual process most likely include:

A) cash equivalents.

B) accounts receivable.

C) marketable securities.

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The accrual process refers to accounting for transactions when revenue or expense recognition does not coincide with the exchange of cash. Accounts receivable, for example, represent sales of goods and services that have been recognized as revenue, but for which the firm has not yet been paid cash. Cash equivalents are highly liquid marketable securities, such as Treasury bills, in which a firm typically invests its short-term cash balances.

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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 $30,000

B) $15,000 $15,000

C) $45,000 $15,000

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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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At the beginning of 20X7, 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 20X7 and what amount should Bryan report as assets related to these recipes on its balance sheet at the end of 20X7?

Recipe expense

Balance sheet

A) $5,000 $25,000

B) $7,500 $22,500

C) $3,000 $30,000

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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 20X7 is $7,500 ($2,500 amortization expense + $5,000 cake recipe expense). The balance sheet value of the purchased recipe at the end of 20X7 is $25,000 – $2,500 = $22,500.

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At the beginning of the year, Alpha Corporation purchased 10,000 shares of Beta Corporation for $20 per share. During the year, Beta paid a $2,000 cash dividend to Alpha. At the end of the year, Beta’s stock was selling for $22 per share. What amount should Alpha recognize in its year-end income statement if the investment is treated as an available-for-sale security and what amount should be recognized in the income statement if the investment is treated as a trading security?

Available-for-sale

Trading security

A) $2,000 $22,000

B) $2,000 $20,000

C) $0 $22,000

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Unrealized gains and losses from trading securities are recognized in the income statement while unrealized gains and losses from available-for-sale securities bypass the income statement and are reported as other comprehensive income, a component of stockholders’ equity. Cash dividends are recognized in the income statement for both trading and available-for-sale securities. Thus, Alpha will recognize only the $2,000 dividend if the shares are considered available-for-sale and will recognize $22,000 ($2,000 dividend + $20,000 unrealized gain) if the shares are considered trading securities.

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Earlier this year, Ponca Corporation purchased non-dividend paying equity securities which it classified as trading securities. Information related to the securities follows:

Security	Cost	Fair value at year-end
X	$400,000	$435,000
Y	$550,000	$545,000

What amounts should Ponca report in its year-end income statement and balance sheet as a result of its investment in securities X and Y?

Income Statement

Balance Sheet

A) $30,000 unrealized gain $950,000

B) $30,000 unrealized gain $980,000

C) No gain or loss $980,000

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Trading securities are reported in the balance sheet at fair value. At the end of the year, the fair value of the securities was $980,000 ($435,000 + $545,000). The unrealized gains and losses from trading securities are recognized in the income statement. Thus, Ponca would recognize an unrealized gain of $30,000 ($980,000 fair value – $950,000 cost).

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When the market value of an investment in a debt security is less than its carrying value, how should the investor report the investment on the balance sheet if the security is classified as held-to-maturity and what amount should be reported if the security is classified as available-for-sale?

Held-to-maturity

Available-for-sale

A) Amortized cost Amortized cost

B) Amortized cost Fair value

C) Fair value Fair value

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Held-to-maturity securities are reported on the balance sheet at amortized cost while available-for-sale securities are reported at fair value. Amortized cost includes the amortization of a premium or discount that was created when the security was purchased.

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Consider the following statements.

Statement #1:	Par value is a nominal dollar value assigned to shares of stock in a corporation’s charter.
Statement #2:	The par value of common stock represents the amount the corporation received when the stock was issued.

With respect to these statements:

A) both statements are correct.

B) only statement #2 is correct.

C) only statement #1 is correct.

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The par value of common stock is the stated or nominal value assigned to the stock. Par value has no relationship to market value. The amount the corporation receives from the issuance of common stock is equal to the par value plus the additional paid-in-capital (proceeds in excess of par).

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Carpenter Corporation reported the following statement of shareholders’ equity as of December 31, 2006:

Common stock at par	$600,000
Additional paid-in-capital	900,000
Treasury stock	(200,000)
Retained earnings	10,500,000
Accumulated other comprehensive income	450,000
	$12,250,000

During 2007, Carpenter:

• earned net income of $1,700,000.
• declared dividends of $300,000. $75,000 of the dividends remain unpaid.
• purchased held-to-maturity securities for $100,000. The securities have a fair value of $110,000 at year-end.
• purchased available-for-sale securities for $250,000. The securities have a fair value of $225,000 at year-end.
• translated the financial statements of a foreign subsidiary and calculated a $90,000 unrealized gain.
• purchased treasury stock for $75,000. The stock was valued at $60,000 when issued.

Calculate Carpenter’s retained earnings and accumulated other comprehensive income as of December 31, 2007.

Retained earnings

Accumulated other comprehensive income

A) $11,900,000 $65,000

B) $11,900,000 $515,000

C) $12,125,000 $515,000

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As of December 31, 2007, Carpenter’s retained earnings is $11,900,000 [$10,500,000 beginning balance + $1,700,000 net income – $300,000 dividends declared]. Accumulated other comprehensive income is $515,000 [$450,000 beginning balance – $25,000 unrealized loss from available for sale securities ($225,000 fair value – $250,000 cost) + $90,000 unrealized translation gain]. There is no impact on retained earnings or accumulated other comprehensive income from unrealized gains and losses on held-to-maturity securities since the securities are not reported at fair value on the balance sheet. The purchase of treasury stock does not affect comprehensive income because it is a transaction with shareholders.

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Ascot Corporation has 4 million shares of common stock authorized, 2.4 million shares of common stock issued, and 1.8 million shares of common stock outstanding. How many shares of treasury stock does Ascot own and is the treasury stock reported as an asset in Ascot’s balance sheet?

Treasury shares

Reported as an asset

A) 600,000 Yes

B) 600,000 No

C) 1.6 million No

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Shares that were issued previously but are not outstanding are treasury shares (owned by the firm). Thus, there are 600,000 treasury shares (2.4 million issued – 1.8 million outstanding). Treasury shares are reported as a reduction in shareholders’ equity on the balance sheet. Treasury stock is not an asset.