D103 Intermediate Accounting I

Correct answer

C. In proportion to the stand-alone selling prices of the obligations

Explanation

When a contract includes multiple performance obligations, the contract price is allocated to each obligation based on the stand-alone selling prices of those obligations. The stand-alone selling price is the price at which an entity would sell a good or service separately, and this method ensures that the revenue recognized for each obligation is appropriate in relation to its value within the contract. This approach follows revenue recognition principles under the ASC 606 framework.

Why other options are wrong

A. Equally among all performance obligations

This is incorrect because allocating the contract price equally among all performance obligations does not reflect the relative value of each obligation. The allocation should be based on the stand-alone selling prices, not an equal split, which ensures the contract's total price is allocated fairly.

B. Based on the total cost of the contract

This is incorrect because the allocation of the contract price should be based on the stand-alone selling prices of the individual performance obligations, not the total cost of the contract. The total cost method does not reflect the value of each specific obligation.

D. According to the order of performance

This is incorrect because the order in which performance obligations are completed does not influence the allocation of the contract price. The allocation is based on the value of each obligation, as determined by the stand-alone selling price, not the sequence of performance.

Correct answer

B. To ensure consistency and transparency in financial statements

Explanation

Accounting principles, such as Generally Accepted Accounting Principles (GAAP), provide a standardized framework for preparing financial statements. This ensures that the financial information presented by different companies is consistent, comparable, and transparent. This allows stakeholders such as investors, creditors, and regulators to make informed decisions based on reliable and standardized financial data.

Why other options are wrong

A. To provide a framework for tax calculations

While accounting principles may influence tax calculations, their primary purpose is not for tax purposes but to ensure transparency and consistency in financial reporting. Tax laws and accounting principles are separate areas, although they may overlap in some instances.

C. To dictate the types of inventories a company can hold

This is incorrect. Accounting principles do not dictate the types of inventories a company can hold but rather how inventories should be valued and reported in financial statements. Inventory management decisions are made by the company based on its operations and needs.

D. To establish the rules for revenue recognition

While revenue recognition is an important part of accounting principles, it is only one aspect. The broader purpose of accounting principles is to ensure consistency and transparency across all aspects of financial reporting, not just revenue recognition.

Correct answer:

B. It provides a snapshot of the company's financial position at a specific date.

Explanation:

The balance sheet is a critical financial statement that provides a snapshot of a company's financial position at a specific point in time. It lists the company’s assets, liabilities, and shareholders' equity, offering a clear view of what the company owns, owes, and the owners' stake in the business. The balance sheet is essential for assessing the company's financial health, its ability to meet its obligations, and its overall stability. It helps investors, creditors, and other stakeholders evaluate the company's financial standing and make informed decisions based on its resources and financial obligations.

Why other options are wrong:

A. It shows the company's profitability over a period.

This statement is incorrect because profitability over a period is shown in the income statement, not the balance sheet. The income statement provides information about the company’s revenues, expenses, and profits over a specific period, usually a quarter or a year, while the balance sheet focuses on the company’s financial position at a single point in time.

C. It details the cash inflows and outflows of the company.

This option is incorrect because cash inflows and outflows are detailed in the cash flow statement, not the balance sheet. The cash flow statement tracks the movement of cash into and out of the business during a period, whereas the balance sheet reflects the overall financial position of the company at a specific moment, including the value of assets, liabilities, and equity.

D. It summarizes the company's revenue recognition policies.

This statement is incorrect because the balance sheet does not summarize revenue recognition policies. Revenue recognition policies are typically discussed in the notes to the financial statements or in the income statement, where the actual revenues are recognized. The balance sheet is concerned with presenting a company’s financial position, not its revenue recognition methods.

Correct answer

B. It tracks purchases at cost and retail prices

Explanation

The Retail Inventory Method helps retailers manage inventory by estimating the cost of their ending inventory based on the relationship between the cost of inventory and its retail price. This method tracks both the cost of goods purchased and the retail prices at which those goods are sold. Retailers can use this information to estimate the value of their ending inventory without needing a full physical count, making it a more efficient system for managing inventory on a day-to-day basis. The key components tracked in this method include the cost of purchases, sales at retail prices, and the markup percentage, which allows the retailer to estimate the ending inventory's cost.

Why other options are wrong

A. It tracks only the cost of goods sold.

This is incorrect because the Retail Inventory Method tracks both the cost of goods purchased and the retail prices of the items, not just the cost of goods sold. The method uses these to estimate the value of inventory.

C. It focuses solely on sales revenue.

This is incorrect because while the Retail Inventory Method uses sales revenue to calculate the cost of goods sold and inventory value, it does not focus solely on sales revenue. It considers both the cost of purchases and the retail prices to provide an inventory estimate.

D. It eliminates the need for physical inventory counts.

This is incorrect because, while the Retail Inventory Method simplifies inventory tracking and provides estimates, it doesn't eliminate the need for occasional physical counts. Physical counts are still needed to verify inventory and ensure the estimates are accurate.

Correct answer

C. Investors and creditors may lose trust and withdraw their support.

Explanation

Accurate financial reporting is critical for building trust with investors and creditors. When a company fails to provide accurate financial information, it undermines the reliability of its financial statements, causing stakeholders to question the company’s true financial position. This loss of trust can lead to investors withdrawing their investments and creditors withdrawing or tightening their support, such as reducing available credit or refusing to offer loans. Therefore, this option reflects the likely and significant consequence of inaccurate financial reporting.

Why other options are wrong

A. Investors may increase their investments due to perceived growth.

This option is incorrect because inaccurate financial reporting can actually create the opposite effect. Investors rely on transparent, truthful financial statements to make informed decisions. If these reports are unreliable, investors may see it as a red flag rather than an opportunity for growth, which could ultimately lead them to withdraw or avoid investing in the company.

B. Creditors may offer more favorable loan terms.

Creditors typically assess the financial health of a company before offering loan terms. If a company’s financial reporting is inaccurate, creditors would likely view this as a risk factor rather than an opportunity to offer better terms. Inaccurate reporting creates uncertainty about the company’s ability to repay loans, so creditors are more likely to tighten loan conditions or refuse credit rather than offer more favorable terms.

D. There would be no impact as financial reporting is not crucial.

This option is incorrect because financial reporting is extremely crucial for decision-making by investors, creditors, and other stakeholders. Accurate reporting is foundational to maintaining confidence in the company’s financial health. The failure to provide accurate financial information would have significant consequences, including the loss of trust from investors and creditors, making this statement entirely untrue.

Correct answer

D. Office supplies used in operations

Explanation

Inventory refers to the goods a company holds for sale in the ordinary course of business or goods that are in the process of being produced for sale. This includes assets intended for sale, items currently in production, and finished goods ready for sale. Office supplies used in operations are not part of inventory because they are typically classified as operational expenses and not items held for resale.

Why other options are wrong

A. Assets intended for sale

These are considered inventory because they are goods that the company plans to sell as part of its normal business operations.

B. Items currently in production

These are considered work-in-progress inventory, which is part of the inventory classification. Items being produced are considered inventory until they are completed and ready for sale.

C. Finished goods ready for sale

These are part of inventory as well. Finished goods are products that have been completed and are ready for sale to customers.

Correct answer

A. At $50,000, its historical cost

Explanation

According to standard accounting principles, assets are reported on the financial statements at their historical cost, which is the original price paid for the asset at the time of purchase. This is in accordance with the cost principle, which dictates that assets should be recorded at the amount paid for them, not their current market value or adjusted for inflation. Therefore, despite the increase in market value to $70,000, the machinery should be reported on the balance sheet at the original purchase price of $50,000.

Why other options are wrong

B. At $70,000, its current market value

This is incorrect because under standard accounting practices, assets are not generally adjusted to reflect changes in market value. Unless the company is applying specific fair value accounting methods (which is not typical for most assets), the asset will remain recorded at its historical cost rather than being adjusted for its current market value.

C. At $60,000, the average of historical and market value

This option is incorrect because accounting principles do not support using an average of historical cost and market value for asset reporting. The asset should be recorded at its historical cost unless the company is using fair value accounting, which is not standard practice for most assets.

D. At $50,000, adjusted for inflation

This is incorrect because the historical cost principle does not involve adjusting for inflation. Inflation adjustments are not typically made to asset values unless the company uses specific accounting methods that allow for such adjustments (like inflation accounting, which is rare in practice). The asset should be recorded at its original purchase price of $50,000 without considering inflation.

Correct answer

B. It reflects the company's ongoing profitability and operational efficiency.

Explanation

Income from continuing operations provides insight into the company's ability to generate profit from its core activities, which is crucial for evaluating its long-term sustainability. By excluding income or losses from discontinued operations, it focuses only on ongoing activities, giving stakeholders a clearer view of the company's operational performance and profitability over time.

Why other options are wrong

A. It provides a snapshot of the company's total assets.

This is incorrect because income from continuing operations reflects profitability and not the company's assets. The snapshot of total assets is shown on the balance sheet, not the income statement.

C. It shows the cash flow generated from investing activities.

This is incorrect because cash flow from investing activities is reported separately in the cash flow statement, not in income from continuing operations.

D. It indicates the total equity of the shareholders.

This is incorrect because equity is shown on the balance sheet, not directly through income from continuing operations. The income statement reports profitability, which can contribute to changes in shareholder equity, but it does not directly reflect total equity.

Correct answer:

B. Long-term investments

Explanation:

Long-term investments are not considered a typical component of current assets because they are investments that are intended to be held for a period longer than one year. Current assets, on the other hand, are assets that are expected to be converted into cash or consumed within one year or within the company’s normal operating cycle, whichever is longer. Cash and cash equivalents, accounts receivable, and inventory are all typical examples of current assets, as they are expected to be used or converted into cash within a short time frame.

Why other options are wrong:

A. Cash and cash equivalents

Cash and cash equivalents are a typical component of current assets. They represent the most liquid form of assets that a company can use immediately in operations or for settling liabilities. This makes them a critical part of current assets as they are expected to be available for short-term financial needs.

C. Accounts receivable

Accounts receivable is a typical component of current assets, as it represents amounts owed to the company by customers for goods or services already delivered. These amounts are generally expected to be collected within one year, making them part of current assets.

D. Inventory

Inventory is a typical component of current assets as it represents goods that are held for sale in the ordinary course of business. Since inventory is generally sold within a year or during the normal operating cycle, it is classified as a current asset.