Financial Reporting and Analysis 【Reading 26】Sample benefits, tangible, following, 2012

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Which of the following characteristics are required for recognition of a balance sheet asset?
Characteristic #1: Future economic benefits to the firm are probable.
Characteristic #2: The asset is tangible and is obtained at a cost.

Characteristic #1

Characteristic #2

A) Yes No

B) Yes Yes

C) No No

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An asset is recognized on the balance sheet only if it is probable that it will provide future economic benefits. Assets can be tangible or intangible. In some cases, assets are acquired without cost, but will be reported to the extent that they will provide future economic benefit, and thus have value.

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Galaxy Corporation manufactures custom motorcycles. Galaxy finances the motorcycles over 36 months for customers who make a minimum down payment of 10%. Historically, Galaxy has experienced bad debt losses equal to 1% of sales. Galaxy also provides a 24 month unlimited warranty on all new motorcycles. In the past, warranty expense has averaged 3% of sales. Ignoring taxes, how does the recognition of bad debt expense and warranty expense at the time of sale affect Galaxy’s liabilities?

Bad debt expense

Warranty expense

A) No effect No effect

B) Increase Increase

C) No effect Increase

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The recognition of bad debt expense has no effect on liabilities, current revenues are reduced by the expected amount of uncollectable accounts. Bad debt expense reduces net income and reduces assets. The recognition of expected warranty expense decreases net income (following the matching principle), and since it is not currently paid (doesn’t reduce assets) it creates or increases a liability at the time of sale.

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Duster Company reported the following financial information at the end of 2007:

	in millions
Unearned revenue	$240
Common stock at par	30
Capital in excess of par	440
Accounts payable	1,150
Treasury stock	2,000
Retained earnings	5,160
Accrued expenses	830
Accumulated other comprehensive loss	210
Long-term debt	1,570

Calculate Duster’s liabilities and stockholders’ equity as of December 31, 2007.

Liabilities

Stockholders' equity

A) $3,790 million $7,420 million

B) $3,550 million $7,840 million

C) $3,790 million $3,420 million

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Liabilities are equal to $3,790 million ($240 million unearned revenue + $1,570 long-term debt + $1,150 accounts payable + $830 accrued expenses). Stockholders’ equity is equal to $3,420 million ($30 common stock at par + $440 capital in excess of par – $2,000 treasury stock + $5,160 retained earnings – $210 accumulated other comprehensive loss).

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Which of the following statements about a classified balance sheet is least likely accurate? A classified balance sheet:

A) groups accounts by subcategories.

B) presents the net equity of each asset by subtracting its related liability.

C) distinguishes between current and noncurrent assets.

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A classified balance sheet groups assets and liabilities by subcategories. It distinguishes between current and noncurrent assets and current and noncurrent liabilities. The assets and related liabilities are reported separately, they are not netted.

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Do the following characteristics have to be met in order to classify a liability as current on the balance sheet? Characteristic #1 – Settlement is expected within one year or operating cycle, whichever is less.
Characteristic #2 – Settlement will require the use of cash within one year or operating cycle, whichever is greater.

Characteristic #1

Characteristic #2

A) Yes No

B) No Yes

C) No No

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A current liability is expected to be settled within one year or operating cycle, whichever is greater. It is not necessary to settle a current liability with cash. There are a number of ways to settle a current liability. For example, unearned revenue is a liability that is settled by providing goods or services.

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Firebird Company reported the following financial information at the end of 2007:

	in millions
Merchandise inventory	$240
Minority interest	70
Cash and equivalents	275
Accounts receivable	1,150
Accounts payable	225
Property & equipment	2,160
Accrued expenses	830
Current portion of long-term debt	120
Long-term debt	1,570
Retained earnings	4,230

Calculate Firebird’s current assets and working capital.

Current assets

Working capital

A) $1,665 million $490 million

B) $1,665 million $420 million

C) $1,735 million $490 million

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Current assets are equal to $1,665 ($275 cash and equivalents + $1,150 accounts receivable + $240 inventory). Working capital (current assets minus current liabilities) is equal to $490 ($1,665 current assets – $225 accounts payable – $830 accrued expenses – $120 current portion of long-term debt).

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Peterson Painting Company is a commercial painting contractor. At the beginning of 20X7, Peterson’s net working capital was $350,000. The following transactions occurred during 20X7:

Performed services on credit	$150,000
Purchased office equipment for cash	10,000
Recognized salaries expense	54,000
Purchased paint supplies on on credit	25,000
Consumed paint supplies	20,000
Paid salaries	50,000
Collected accounts receivable	157,000
Recognized straight-line depreciation expense	2,000
Paid accounts payable	15,000

Calculate Peterson’s working capital at the end of 20X7 and the change in cash for the year 20X7.

Working capital

Change in cash

A) $414,000 $82,000

B) $416,000 $82,000

C) $416,000 $80,000

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Transaction	Amount	Working capital	Cash
Performed services on credit	$150,000	Increase A/R
Purchased PP&E for cash	10,000	Decrease cash	-$10,000
Recognized salaries expense	54,000	Increase A/P
Purchased paint supplies on on credit	25,000	Increase inventories, increase A/P
Consumed paint supplies	20,000	Decrease inventories
Paid salaries	50,000	Decrease cash, decrease A/P	-$50,000
Collected accounts receivable	157,000	Increase cash, decrease A/R	+$157,000
Recognized straight-line depreciation expense	2,000
Paid accounts payable	15,000	Decrease cash, decrease A/P	-$15,000

The change in cash was $82,000 ($157,000 collections – $10,000 from equipment purchase – $50,000 salaries paid – $15,000 for payables). Working capital at the end of 20X7 is $416,000 ($350,000 beginning working capital + $150,000 increase in accounts receivable from services – $10,000 office equipment purchase – $54,000 salaries expense accrual – $20,000 consumed supplies).

• Purchasing $25,000 of paint supplies on credit has no net effect on working capital (current assets and current liabilities increase). Consuming $20,000 of these supplies reduces working capital (current assets decrease).
• Salary expense reduces working capital by $54,000 when recognized (current liabilities increase). Paying $50,000 of these salaries has no net effect on working capital (current assets and current liabilities decrease).
• Collecting accounts receivable has no net effect on working capital (one current asset increases and another decreases).
• Recognizing depreciation does not affect working capital.
• Paying accounts payable has no net effect on working capital (current assets and current liabilities decrease).

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GTO Corporation purchased all of the common stock of Charger Company for $4 million. At the time, Charger reported total assets of $3 million and total liabilities of $1 million. At the acquisition date, the fair value of Charger’s assets was $3.5 million and the fair value of Charger’s liabilities was $1.3 million. What amount of goodwill should GTO report as a result of the acquisition and is it necessary for GTO to amortize the goodwill?

Goodwill

Amortization required

A) $1.8 million No

B) $1.8 million Yes

C) $2.2 million No

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The acquisition goodwill is equal to $1.8 million [$4 million purchase price – $2.2 million fair value of net assets acquired ($3.5 million assets at fair value – $1.3 million liabilities at fair value)]. Under IFRS or U.S. GAAP, goodwill is not amortized but is subject to an annual impairment test.

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Consider the following:Statement #1 – Copyrights and patents are tangible assets that can be separately identified.
Statement #2 – Purchased copyrights and patents are amortized on a straight line basis over 30 years.
With respect to the statements about copyrights and patents acquired from an independent third party:

A) only statement #2 is incorrect.

B) only statement #1 is incorrect.

C) both are incorrect.

Acquired copyrights and patents are intangible assets that can be separately identified. Identifiable intangible assets are amortized over their useful lives.

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According to the Financial Accounting Standards Board, what is the appropriate measurement basis for equipment used in the manufacturing process and inventory that is held for sale?

Equipment

Inventory

A) Historical cost Lower of cost or market

B) Historical cost Historical cost

C) Fair value Lower of cost or market

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Equipment is reported in the balance sheet at historical cost less accumulated depreciation. Inventory is reported in the balance sheet at the lower of cost or market.