D103 Intermediate Accounting I

Correct answer

A. $66,667

Explanation

 To estimate the cost of ending inventory using the Retail Inventory Method, we use the following formula:

$\mathrm{Cost} \mathrm{of} \mathrm{ending} \mathrm{inventory} = \mathrm{Ending} \mathrm{inventory} \mathrm{at} \mathrm{retail} \times \frac{\mathrm{Cost} \mathrm{of} \mathrm{goods} \mathrm{available} \mathrm{for} \mathrm{sale}}{\mathrm{Retail} \mathrm{value} \mathrm{of} \mathrm{goods} \mathrm{available} \mathrm{for} \mathrm{sale}}$

First, calculate the cost-to-retail ratio:

$\mathrm{Cost}-\mathrm{to}-\mathrm{retail} \mathrm{ratio} = \frac{\mathrm{Cost} \mathrm{of} \mathrm{goods} \mathrm{available} \mathrm{for} \mathrm{sale}}{\mathrm{Retail} \mathrm{value} \mathrm{of} \mathrm{goods} \mathrm{available} \mathrm{for} \mathrm{sale}}$ 

               = $\frac{200,000}{300,000}$

                = 0.6667

Now, apply this ratio to the ending inventory at retail:

Cost of ending inventory = 100,000 × 0.6667 

     = 66,667 

Why other options are wrong

B. $75,000

This would be incorrect because it does not accurately reflect the cost-to-retail ratio applied to the ending inventory at retail.

C. $100,000

This is the ending inventory at retail, not at cost. The estimated cost is lower due to the ratio between cost and retail.

D. $150,000

This is incorrect because it overestimates the cost of the ending inventory and does not apply the correct cost-to-retail ratio.

Correct answer

A. It aligns with the matching principle of accounting

Explanation

Recognizing bad debt expense when accounts are estimated to be uncollectible, rather than at the time they are written off, aligns with the matching principle of accounting. This principle states that expenses should be recognized in the same period as the related revenues they help generate. By estimating uncollectible accounts in advance, companies can match the bad debt expense to the revenue that may have led to the uncollectible amounts, even if the debts are not written off until a later date.

Why other options are wrong

B. It simplifies the accounting process.

While recognizing bad debt in advance may help with accurate reporting, it is not primarily done for simplicity. It is about adhering to accounting principles like the matching principle.

C. It ensures all debts are collected before recognition.

This is incorrect because bad debt expense is recognized based on estimates, not the actual collection of debts. Some accounts may be written off after they are estimated to be uncollectible, so this statement is misleading.

D. It allows for more accurate cash flow projections.

While recognizing bad debt might give a clearer picture of expenses, it is not directly aimed at improving cash flow projections. Bad debt recognition is an accounting principle focused on matching revenues and expenses, rather than forecasting cash flow.

Correct answer

A. On December 15 when the service is rendered

Explanation

 According to the revenue recognition principle, revenue should be recognized when it is earned, not when payment is received. In this case, the service was provided on December 15, and the firm has fulfilled its obligation to the client. Therefore, the revenue should be recognized on the date the service is rendered, which is December 15. The receipt of payment on January 10 does not impact the timing of revenue recognition, as the service has already been completed and the firm is entitled to the revenue.

Why other options are wrong

B. On January 10 when payment is received

This option is incorrect because under the accrual basis of accounting, revenue is recognized when earned, not when cash is received. Even though payment is received on January 10, the revenue from the service was earned in December, and the payment timing does not change when the revenue should be recognized.

C. At the end of the fiscal year on December 31

This option is incorrect because the revenue recognition is based on when the service was rendered, not on the end of the fiscal year. The firm should recognize the revenue on December 15, the date the service was provided, regardless of the fiscal year-end.

D. When the invoice is sent to the client

This option is incorrect because revenue is not recognized just because an invoice is sent. The revenue recognition principle requires the service to be performed or the product delivered before recognizing revenue, not merely the issuance of an invoice. Therefore, the service must be completed before recognizing the revenue, which in this case occurred on December 15.

Correct answer:

B. Details about a company's cash inflows and outflows

Explanation:

The statement of cash flows provides detailed information about a company’s cash inflows and outflows over a specific period. This includes cash generated from operating activities, cash used in investing activities, and cash provided by or used in financing activities. It is important for understanding the liquidity and financial flexibility of a company, helping stakeholders evaluate how well the company can manage its cash to fund operations, pay debts, and reinvest in the business.

Why other options are wrong:

A. A summary of a company's assets and liabilities

This is incorrect because a summary of assets and liabilities is found in the balance sheet, not the statement of cash flows. The balance sheet provides a snapshot of a company’s financial position, while the statement of cash flows focuses on cash movements.

C. An overview of a company's revenue and expenses

This is incorrect because revenue and expenses are reported on the income statement, not the statement of cash flows. The income statement provides details about profitability, while the statement of cash flows deals with actual cash movement.

D. A breakdown of a company's equity and dividends

This is incorrect because equity and dividends are primarily detailed in the statement of changes in equity, not the statement of cash flows. The statement of cash flows focuses on cash transactions.

Correct answer

A. It provides a detailed breakdown of revenues and expenses, allowing for better analysis of operational performance.

Explanation

A multiple-step income statement enhances financial reporting clarity by breaking down revenues and expenses into several distinct sections, including operating and non-operating activities. This breakdown allows analysts, investors, and other stakeholders to assess the company’s operational performance more easily, such as understanding gross profit, operating income, and non-operating income. This structure provides greater insight into the business’s core profitability and how its various activities contribute to financial results.

Why other options are wrong

B. It simplifies the reporting process by combining all items into one section.

 This is incorrect because the multiple-step income statement does the opposite of simplifying; it provides a detailed breakdown that separates different categories of income and expenses, giving a clearer understanding of performance.

C. It focuses solely on net income without providing any additional information.

This is incorrect because the multiple-step income statement provides much more detail than just net income. It separates gross profit, operating income, and other income/expenses, giving a fuller picture of financial performance.

D. It is more suitable for small businesses with limited financial activities.

This is incorrect because multiple-step income statements are typically more beneficial for larger organizations with more complex financial activities. Small businesses with simple financial transactions might prefer a single-step income statement for ease of use.

Correct answer:

B. It offers principles that help determine how to recognize and report financial information.

Explanation:

The Conceptual Framework in U.S. accounting provides a set of underlying principles that guide how accounting events should be recognized, measured, and reported in financial statements. It is a foundational document that ensures consistency and coherence in financial reporting, helping accountants make decisions about how to treat various transactions. Rather than specifying exact numbers, it offers guidance on how to measure financial events, ensuring that financial statements reflect the economic reality of transactions and are comparable across different companies.

Why other options are wrong:

A. It dictates the exact numerical values to be used in financial statements.

This is incorrect because the Conceptual Framework does not dictate exact numerical values but rather sets out principles for how to measure and recognize financial transactions. Specific numerical values are determined using more detailed standards like GAAP.

C. It eliminates the need for GAAP standards.

This is incorrect because the Conceptual Framework does not eliminate the need for GAAP. Instead, it complements GAAP by providing foundational principles that guide the application of the more detailed rules in GAAP.

D. It focuses solely on the reporting of revenue recognition

This is incorrect because the Conceptual Framework covers a broad range of topics beyond just revenue recognition, including asset and liability recognition, measurement, and the overall presentation of financial information.

Correct answer:

C. Specific criteria related to the delivery of goods or services must be met.

Explanation:

For revenue to be recognized over time, specific criteria outlined by accounting standards (such as IFRS or US GAAP) must be met. This typically involves recognizing revenue progressively as work on a contract progresses, often based on the percentage of completion or when certain milestones are achieved. This method is used in long-term contracts or service agreements where the transfer of goods or services occurs over a period of time, rather than at a single point in time.

Why other options are wrong:

A. The goods or services must be delivered immediately.

This is incorrect because revenue is not recognized immediately unless the transaction is complete. In cases where services or goods are provided over time, revenue is recognized gradually as the work is completed, not instantly.

B. The customer must pay in advance.

This is incorrect because prepayment does not determine when revenue is recognized. Revenue is recognized based on when the goods or services are provided, not when the payment is made, although payment timing can influence cash flow.

D. The transaction must be recorded in the financial statements.

This is incorrect because simply recording the transaction in financial statements is not enough. Revenue recognition over time is conditional on specific criteria being met, such as the progress in completing the contract or project, not just recording the transaction itself.

Correct answer

B. It indicates the amount of assets financed by shareholders' investments.

Explanation

Shareholders' equity represents the ownership interest in a company, essentially showing the residual value of the company after all liabilities have been deducted from the assets. It is calculated as total assets minus total liabilities, and it reflects how much of the company's assets are financed through shareholder investments, as opposed to debt. This metric is crucial for assessing a company's financial health because a higher shareholders' equity typically suggests that the company is less reliant on debt and has a solid base of capital provided by its owners.

Why other options are wrong

A. It represents the total liabilities of a company.

This is incorrect because shareholders' equity is not the same as liabilities. Liabilities refer to the company's financial obligations, such as debts and accounts payable, while shareholders' equity represents the net value that belongs to the shareholders after subtracting these liabilities from total assets. The two concepts are opposites in the accounting equation.

C. It reflects the company's revenue generation capabilities.

Revenue generation capabilities are not directly related to shareholders' equity. While a company’s revenue impacts its overall financial position and, over time, can contribute to the increase in equity, shareholders' equity itself is not a measure of how well a company generates revenue. It is more about the ownership stake and the balance between assets and liabilities.

D. It shows the total cash available for operations.

This is incorrect because shareholders' equity does not specifically reflect cash available for operations. Cash available for operations is more closely related to a company's cash flow, which is tracked in the cash flow statement, not in the shareholders' equity section of the balance sheet. Equity involves ownership interests, not just liquid assets.

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.