FAR 1 Final Exam Questions with Complete Solutions, Exams of Finance

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FAR 1 Final Exam Questions with

Complete Solutions

Acquisition and Disposal of PP&E - ANS: Acquisition of PP & E - ANS: Historical cost measures the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use Main reasons for historical cost valuation -Historical cost is reliable -Companies should not anticipate gains and losses but only recognize gains and losses when asset is sold Cost of Land - ANS: Includes all expenditures to acquire land and ready it for use, costs usually are

1. Purchase Price
2. Closing costs, things such as title to the land, attorney's fees, and recording fees

3. Cost of grading, filling, draining, and cleaning 4)Assumption of any liens, mortgages, , or encumbrances on the property, and

5. Additional land improvements that have an indefinite life Improvements with limited life, such as private driveways, walks, fences, and parking lots are recorded as Land Improvements and depreciated -Land acquired and held for speculation is classified as an investment -Land held for real estate concern for resale should be classified as inventory Cost of Buildings - ANS: Includes all expenditures related directly to acquisition or consumption. Costs include: -Materials, labor, and overhead costs incurred during construction and professional fees and building permits

Cost of Equipment - ANS: Include all expenditures incurred in acquiring the equipment and preparing for use. Costs include -Purchase Price -Freight and handling charges -Insurance of equipment while in transit -Cost of special foundations if required -Assembling and installation costs -Cost of conducting a trial run Self-Constructed Assets - ANS: Costs include 1)Materials and direct labor

2. Overhead can be handled in two ways a)Assign no fixed overhead b) Assign a portion of all overhead to the construction process - Companies use the second option extensively Interest Incurred During Construction - ANS: GAAP - Capitalize actual costs incurred during construction GAAP requires - capitalizing actual interest (with modification) consistent with historical cost Capitalization considers three items
3. Qualifying Assets 2)Capitalization Period
4. Amount to capitalize Qualifying Assets -Require a period of time to get them ready for their intended use

-Two Types of Assets ∆Assets under construction for company's own use ∆Assets intended for sale or lease that are constructed or produced as discrete projects Capitalization Period -Begins when ∆Expenditures for the asset have been made ∆Activities for readying the asset are in process ∆Interest costs are being incurred -Ends when ∆The asset is substantially complete and ready for use Amount to capitalize -Capitalize the lesser of ∆Actual interest costs ∆Avoidable interest - the amount of interest cost during the period that a company could theoretically avoid if it had not made expenditures for the asset Valuation of PP&E - ANS: Companies should record PP&E -At the Fair value of what they give up, or -At the fair value of the asset received Whichever is more clearly evident Cash Discount - Discount for prompt payment Deferred- Payment Contracts - Assets purchased on long-term credit contracts at the present value of the consideration exchanged Lump-Sum Purchases - Allocate the total cost among the various assets on the basis of their relative fair market value

Issuance of stock - The market price of the stock issued is a fair indication of the cost of property acquired Exchanges of nonmonetary asset -Ordinarily accounted for on the basis of: ∆The fair value of the asset given up, or ∆The fair value of the asset received -Whichever is more clearly evident -Companies should recognize immediately any gains or losses on the exchange when the transaction has commercial substance Meaning of commercial substance -If the future cash flows/economic positions change as a result of the transaction Exchanges -gain Situation -Has commercial substance. Company usually records the cost of a nonmonetary asset acquired in exchange for another nonmonetary asset at the fair value of the asset given up, and immediately recognize as a gain -Lacks commercial substance- no cash received -Lacks commercial substance, some cash received ∆When a company receives cash cash ("Boot"), it may immediately recognize a portion of the gain Accounting for Contributions - ANS: Companies should use -the fair value of the asset to establish its value on the books, and -should recognize contribution received as revenues in the period received When a company contributes a nonmonetary asset, it should record the amount of the donation as an expense at the fair value of the donated asset

Costs subsequent to Acquisition - ANS: In general, costs incurred to achieve greater future befits should be capitalized, whereas expenditures that maintain a given level of services should be expensed In order to capitalize costs, one of three conditions must be present

1. useful life must be increased
2. Quantities of units must increase, or
3. Quality of units produced must be enhanced Disposition of PP&E - ANS: A company may retire plant assets voluntarily or dispose of them by -Sale -Exchange -Involuntary conversion -Abandonment Depreciation must be taken up to the day of disposition Involuntary Conversion

• Sometimes an assets services is terminated through some type of involuntary conversion such as fire, flood, or condemnation -Companies report the difference between amount recovered, if any, and the assets book value as a gain or a loss They treat these gains or losses like any other type of disposition Depreciation- Method of Cost Allocation - ANS: Depreciation is the accounting process of allocating the cost of tangible assets to expense in a systemic and rational manner to those periods expected to benefit from the use of the asset -Fixed Assets = Depr exp -Intangibles = Amortization Expense -Natural Resources = Depletion Expense

Methods of Depreciation - ANS: The profession requires the method to be "systematic and rational". Methods used include

1. Activity method (Units of use or production)
2. Straight-Line Method
3. Sum-of-the-year's digits
4. Declining-Balance Method
5. Group and Composite Method
6. Hybrid or Combination Method Activity Method - ANS: ((Cost less Salvage) x Hours this year) / Toal Estimated Average = Depreciation Expense Decreasing Charge Method - ANS: Sum-of-the-years digits. Each fraction uses the sum of the years as a denominator. The numerator is the number of years of estimated life remaining as of the beginning of the year n(n+1)/ Declining Balance Method -Utilizes a depreciation rate that is some multiple (usually double) of the straight line method -Does not deduct the salvage value in computing the depreciation base Special Depreciation Methods - ANS: Two methods of depreciating multiple-asset accounts exist: -Group method used when the assets are similar in nature and have approx. the same useful life -Composite method used when the assets are dissimilar and have different lives The choice of method depends on the nature of the assets immediately

The computation for group or composite method is essentially the same : find an average and depreciate on that basis Impairments - ANS: When the carrying amount of an asset is not recoverable, a company records a write-off referred to as impairment Events leading to an impairment -A sig. decrease in the fair value of an asset -A sig. change in the way an asset is used -A sig. adverse change in legal factors or in the business climate that affects the value of an asset -An accumulation of costs in excess of the amount originally expected to acquire or construct an asset -A projection or forecast that demonstrates continuing losses associated with an asset Measuring impairments - ANS: 1. Review events for possible impairment

2. If the review indicates impairment, apply recoverability test. If the sum (Exp future net cash flows from assets, NO DISCOUNTING) < carrying amount (asset), an impairment has occured
3. Assuming impairment, impairment loss = carrying amount of the asset - fair value of the asset, where fair value is the market value of the present value (discounted) of expected future net cash flows Restoration of impairment loss - ANS: After recording an impairment loss -The reduced carrying amount becomes its new cost basis -No change in the new cost basis except for depreciation or amortization in future periods or for additional impairments -No restoration of impairment loss for an asset held for use ∆Rationale is that the new cost basis puts the impaired asset on an equal basis with other assets that are unimpaired Impairment of an asset to be disposed of

-Assets held for disposal are like inventory, companies ∆Should report them at the lesser of cost or net realizable value ∆Can write up or down an asset held for disposal in future periods, as long as the carrying value after the write-up never exceeds the carrying amount of the asset before impairment ∆Should report losses or gains related to these impaired assets as a part of income from continuing operations Depletion - ANS: Natural resources , often called wasting resources, including petroleum, minerals, and timber Have two main features

1. Complete removal (consumption0 of the asset, and
2. Replacement of the asset only by an act of nature Depletion is the process of allocating the cost of natural resources Establishing a depreciation base -Computation of the depletion base involves four factors
3. Acquisition cost
4. Exploration Cost
5. Development Cost
6. Restoration Cost Write-off of resource cost -Normally, companies compute depletion on a units-of-production method (activity approach). Depletion is a function of the number of units extracted during the period Liquidating Dividends - ANS: Dividends greater than the amount of accumulated net income Presentation and Analysis - ANS: Presentation of PP and E and Natural Resources

Asset Turnover Ration - ANS: Net Sales / Avg Total Assets Profit Margin On Sales - ANS: Net Income / Net Sales Return on Assets - ANS: Net Income / Avg Total Assets Intangible Asset Issues - ANS: 1. Lack Physical existence

2. Not financial instruments Normally classified as long-term assets Common types of intangibles -Patents -Copyrights -Franchise or Licenses -Trademark or trade names -Goodwill Valuation - ANS: Purchased intangibles -Recorded at cost -Includes all cost necessary to make the intangible assets ready for its intended use -Typical costs include: ∆Purchase Price

∆Legal fees ∆Other incidental expenses Internally created intangibles - ANS: Recorded at cost Generally expensed Only capitalize direct costs incurred in developing the intangible, such as legal costs Amortization of Intangibles - ANS: Limited Life Intagibles -Amortize to expense over useful life -Credit asset account or accumulated amortization -Useful life should reflect the periods over which the asset will contribute to cash flows -Amortization should be cost less residual value -Companies should evaluate the limited life intangibles for impairment Indefinite-Life Intangibles -No foreseeable limit on the asset is expected to provide cash flows -Must test indefinite-life intangibles for impairment at least annually -No amortization Types of Intangible asset - ANS: Six major categories

1. Marketing Related
2. Customer-Related
3. Artistic-Related
4. Contract-Related
5. Technology- Related
6. Goodwill

Marketing Related Intangible Assets - ANS: Example -Trademarks or trade names, newspaper mastheads, internet domain names, and non-competition agreements In the United States, Trademarks or trade names have legal protection for indefinite number of 10 year renewal periods Capitalize acquisition costs No amortization Customer Related Intangible Assets - ANS: Example: Customer lists, order or production backlogs, and both contractual and non-contractual customer relationships Capitalize acquisition costs Amortized to expense over useful life Artistic-Related intangible Assets - ANS: Examples: Plays, literary works, musical works, pictures, photographs, and video and audiovisual materials Copyright Granted for the life of creator plus 70 years Capitalize cost of acquiring and defending Amortized to expense over useful life Contract related intangibles - ANS: Examples: Franchise and licensing agreements, construction permits, broadcast rights, and service or supplies contracts

Franchise (or license) with a limited life should be amortized to expense over the life of the franchise Franchise with an indefinite life should be carried at cost and amortized Technology related intangible assets - ANS: Examples: Patented technology and trade secrets granted by the US Patent and Trademark Office Patent gives holder exclusive use for 20 years Capitalize cost of purchasing a patent Expense any R and D costs in developing a patent Amortize over legal life or useful life, whichever is shorter Goodwill - ANS: Conceptually, represents the future economic benefits arising from the other assets acquired in a business combination that are not individually identified and separately recognized Goodwill is measured as the -Excess of cost of the purchase over the fair market value of the identifiable net assets (assets less liabilities purchased Goodwill Write-Off -Goodwill considered to have an indefinite life -Should not be amortized Bargain Purchase -Purchase price less than the fair value of net assets acquired -Amount is recorded as a gain by purchaser

Impairment of Limited-Life Intangibles - ANS: Same as impairment of long-life intangibles

1. If the sum of the expected future cash flows (undiscounted) is less than the carrying amount of the asset, an impairment has occurred (recoverability test)
2. The impairment loss is the amount by which the carrying amount of the asset exceeds the carrying value of the asset (fair value test) The loss is reported as part of income from continuing operations "Other Losses and expenses" section Impairment of Indefinite Life Intangible other than Goodwill - ANS: Should be tested for impairment at least annually Impairment test is a fair value test -If the fair value of an asset is less than the carrying amount, an impairment loss is recognized for the difference -Recoverability test is not used Impairment of goodwill - ANS: Two step process
3. If fair value is less than the carrying amount of the net assets (including goodwill), then perform a second step to determine possible impairments
4. Determine the fair value of goodwill (implied value of goodwill) and compare to carrying value Presentation of Intangible Assets (Balance Sheet) - ANS: Intangible Assets shown as a separate item Reporting is similar to the reporting of property, plant, and equipment Contra accounts are not normally shown for intangibles Company should report as a special items all intangible assets other than goodwill Presentation of Intangible Assests - Income Statement - ANS: Report amortization expense and impairment losses in continuing operations

Goodwill impairment loss should also be presented as a separate line item in the continuing operations section, unless goodwill impairment is associated with a discontinued operation Research and Development Costs - ANS: R&D costs are not in themselves intangible assets Frequently results in something that a company patents or copyrights, such as: -New product -Process -Idea -Formula -Composition -Literary Work Companies must expense all R&D costs when incurred Accounting for R&D costs -Costs associated with R&D Costs ∆Materials, equipment, facilities, personnel ∆Purchased Intangibles ∆Contract Services ∆Indirect Costs Costs similar to R&D costs -Start-up costs for a new operation -Initial operating losses -Advertising Costs -Computer Software costs

Current Liabilities - ANS: Typical Current Liabilities - ANS: (Trade) Account Payable Notes Payable Current Maturities of long-term debt Dividends Payable Customer advances and deposits Unearned Revenues Sales Tax Payable Income taxes Payable Employee-Related Liabilitues Current Liabilities are "obligation whose liquidations is reasonably expected to require use of existing resources properly classified as current assets, or the creation of other current liabilities" Notes Payable - ANS: Written promises to pay a certain sum of money on a secured future date Classified as short-term or long-term May be interest-bearing or zero-interest bearing

Discount of Notes Payable is a contra account to Notes Payable, and therefor is subtracted from Notes Payable on the Balance Sheet -Represents the cost of borrowing (i.e. interest expense chargeable to future periods) -Debited to interest expense over the life of the notes Dividends Payable - ANS: Amount owed by a corporation to the stockholders as a result of board of director's authorization -Generally paid within three months -Undeclared dividends on cumulative preferred stocks not recognized as a liability -Dividends payable in the form of additional shares of stock are reported in stockholders' equity Income Tax Payable - ANS: Businesses must prepare an income tax return and compute the income tax payable -Taxes Payable are a current liability -Corporations must make periodic tax payments -Difference between taxable income (tax law) and accounting income (GAAP) often occur Employee-Related Liabilities - ANS: Amounts owed to employees for salaries or wages are reported as current liabilities Current Liabilities related to employee compensation may include -Payroll Reductions -Compensated Acbsences -Bonuses Payroll Deductions - ANS: Social Security Taxes Federal Old Age, Survivor, and Disability Insurance (OASDI) Funded from taxes levied on both employer and employee

In 1965, Congress passed health insurance for elderly - medicare Payroll Taxes - ANS: Unemployment Taxes to fund unemployment insurance, paid by employer -Federal Unemployment Tax Act (FUTA) -Rate is 6% of the first $7,000 of compensation per employee per year -If employer is subject to a state unemployment tax it receives a tax credit State unemployment compensation laws differ both from the federal law and among various states Employers must refer to the unemployment tax laws in each state in which they pay wages and salaries Compensated Absences - ANS: Paid absences for vacation, illness, and holidays Accrue a liability if all of the following conditions exist -The employer's obligation is attributable to employer services already rendered -The obligation relates to rights that vest or accumulate -Payment of the compensation is probable -The amount can be reasonably estimated Bonus Agreements - ANS: Payments to certain or all employees in addition to their regular salaries and wages Unpaid bonuses should be reported as a current liability Current maturities of long-term debt - ANS: Portion of bonds, mortgage notes, and other long-term indebtedness that matures within the next fiscal year Exclude long-term debts maturing currently f they are to be

1. Retired by assets accumulated that have not been shown as current assets
2. Refinanced, or retired from the proceeds of a new debt issue, or
3. Conversion into capital stock Contingencies - ANS: Gain Contingencies -Typical Gain Contingencies
4. Possible receipts of monies from gifts, donations, asset sales, and so on
5. Possible refunds from the government in tax disputes
6. Pending court cases with a probable favorable outcome
7. tax loss carryforwards Gain contingencies are not recorded Disclosed only if probability of receipt is high Loss Contingencies - ANS: Probable -Accrue -Footnoe Reasonable Possible -Footnote Remote -Ignore Common Loss Contingencies
8. Litigation, Claims, and Assessments
9. Guarantee and Warranty Cots
10. Premiums and coupons

4. Environmental Liabilities Litigation, Claims, and Assessments - ANS: Companies must consider the following factors in determining whether to record a liability with respect to pending or threatened litigation and actual or possible claims and assessments -Time period in which the action occured -Probability of an unfavorable outcome -Ability to make a reasonable estimate of the loss Guarantee and Warranty Cost - ANS: Promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product Cash Basis method: Expense the costs as incurred
5. It is not probable that a liability has been incurred, or
6. Seller cannot reasonably estimate the amount of the liability Accrual-Basis Method: Expense costs in the year of sale 1.Method is the generally accepted method
7. Referred to as the expense warranty approach Assurance Type Warranty - ANS: Warranty that the product meets agreed-upon specifications in the contract at the time the product is sold -Should be expensed in the period the hoods are produced or services performed -Should record warranty liability Service Type Liability - ANS: Warranty that provides additional service beyond the assurance type warrant -Record as a separate performance and obligation -Usually recorded in an unearned warranty revenue accunt -Recognize revenue on a straight-line basis over the period the service-type warranty is in effect

Consideration Payable - ANS: Companies should charge the costs of premiums and coupons to expense, in the period of the sale that benefits from the plan -Company estimates the number of outstanding premiums offers that customers will present for redemption -Company charges the cost of premium offers to premium expense and credits premium liability Environmental Liabilities - ANS: A company must recognize an asset retirement obligation (ARO) when it has an existing legal obligation associated with the retirement of a long-lived asset when it can reasonably estimate the amount of liability ARO's should be recorded at fair value Examples of obligating events -Decommissioning nuclear facilities -Dismantling; restoring; and reclamation of oil and gas properties -Certain closure, reclamation and removal costs of mining favilities -Closure and post-closure cost of landfills Self Insurance - ANS: Self-insurance is not insurance, but risk assumption there is little theoretical justification for the establishment of a liability based on a hypothetical charge to insurance expense Presentation and Analysis - ANS: Presentation of Current Liabilities -Usually reported at their full maturity value -Difference between present value and the maturity value is considered immaterial -Companies may list the accounts in ∆Order of maturity ∆Descending order of amount, or

∆ Order of liquidation preference If a company excluded a short-term obligation from current liabilities because of refinancing, it should include the following in the note to the financial statements

1. A general description of the financing agreements
2. The terms of any new obligation incurred or to be incurred
3. The terms of any equity security issued or to be issued Presentation of Contingencies - ANS: Disclosure should include -Nature of the contingencies -An estimate of the possible loss or range of loss or a statement that an estimate cannot be made Companies should disclose certain other contingent liabilities
4. Guarantees of indebtedness of others
5. Obligations of commercial banks under "stand by letters of credit"
6. Guarantees for repurchase receivables (or any related properties) that have been sold or assigned