D105 Intermediate Accounting III
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Free D105 Intermediate Accounting III Questions
1. Describe the significance of retained earnings in relation to a company's financial health.
- Retained earnings are solely used for paying dividends to shareholders.
- Retained earnings are irrelevant to a company's financial health.
- Retained earnings represent the cash available for immediate use.
- Retained earnings reflect the cumulative profits retained in the business, indicating the company's ability to reinvest in operations or pay dividends.
Explanation
Retained earnings represent the portion of a company’s net income that is retained in the business rather than distributed as dividends. They indicate the company’s capacity to reinvest in operations, fund growth initiatives, or meet future obligations. A healthy level of retained earnings reflects sustained profitability and financial stability, providing insight into the company’s long-term financial health and its ability to support strategic initiatives.
2. If Shaw Company had an increase in taxable income due to a change in tax law, how might this affect the deferred tax liability reported on the balance sheet?
- The deferred tax liability may increase due to higher taxable income leading to more future tax obligations.
- The deferred tax liability would decrease as taxable income increases.
- The deferred tax liability would be eliminated entirely.
- The deferred tax liability would remain unchanged regardless of taxable income changes.
Explanation
Deferred tax liabilities arise from temporary differences between the financial reporting and tax bases of assets and liabilities. If taxable income increases due to a change in tax law, it can increase the amount of taxes the company expects to pay in the future. Consequently, the deferred tax liability is adjusted upward to reflect the higher future tax obligation that will arise when the temporary differences reverse.
3. A company signs a 90-day trade and 180-day nontrade note payable. In preparing a statement of cash flows (indirect method) this event would be reflected as a(n)
- a) addition to net income in the cash flows from operating activities section
- b) cash outflow from investing activities
- c) cash inflow from investing activities
- d) both (a) and (c)
Explanation
Signing a note payable, whether trade or nontrade, does not involve an immediate cash transaction; it is simply an obligation to pay in the future. Since no cash is received or paid at the time of signing, it would not appear as a cash inflow or outflow in the statement of cash flows. Therefore, this event is not reflected in the cash flows from operating, investing, or financing activities until cash is actually exchanged, such as when the note is paid or proceeds are received. Correct Answer: None of the options accurately reflect the cash flow at the time of signing.
4. A company provides a defined benefit pension plan for all of its employees. The fair value of the plan assets at year-end is $45,000,000. The values of the accumulated benefit obligation and projected benefit obligation at year-end are $46,000,000 and $60,000,000, respectively. The company expects to make benefit payments totaling $2,000,000 next year. What amount should the company report in the year-end financial statements as a liability in connection with the defined benefit pension plan?
- $17,000,000
- $15,000,000
- $3,000,000
- $1,000,000
Explanation
The pension liability reported on the balance sheet is the projected benefit obligation (PBO) minus the fair value of plan assets. The PBO is $60,000,000, and the plan assets are $45,000,000. The difference, $60,000,000 – $45,000,000 = $15,000,000, represents the net pension liability that should be recognized in the financial statements. Expected benefit payments next year do not affect the year-end liability reported.
5. Which of the following components should be included in the calculation of net periodic pension cost (NPPC) recognized for a period by an employer sponsoring a defined benefit pension plan? (Interest cost – return on plan assets)
- no – yes
- yes – no
- no – no
- yes – yes
Explanation
Net periodic pension cost (NPPC) for a defined benefit plan includes several components: service cost, interest cost, expected return on plan assets, amortization of prior service cost, and gains or losses. Interest cost increases NPPC, while the expected return on plan assets decreases NPPC. Therefore, interest cost is included as an addition, and the return on plan assets is included as a deduction in the NPPC calculation.
6. Crabbe Company reported $80,000 of selling and administrative expenses on its income statement for the past year. The company had depreciation expenses and an increase in prepaid expenses associated with the selling and administrative expenses for the year. Assuming use of the direct method, how would these items be handled in converting the accrual-based selling and administrative expenses to the cash basis?
Increase in
Depreciation | Prepaid Expenses
Increase in
Depreciation | Prepaid Expenses
- a. Deducted From | Deducted From
- b. Added To | Added To
- c. Deducted From | Added To
- d. Added To | Deducted From
Explanation
Depreciation expense is a non-cash expense, so it must be added back to convert accrual-based expenses to cash-based expenses. An increase in prepaid expenses represents cash paid that is not yet expensed, so it reduces cash available. Therefore, depreciation is added to convert to cash basis, while an increase in prepaid expenses is deducted.
7. What does EPBO stand for in the context of postretirement benefits?
- Estimated Postretirement Benefit Obligation
- Expected Pension Benefit Obligation
- Estimated Pension Benefit Obligation
- Expected Postretirement Benefit Obligation
Explanation
EPBO stands for Estimated Postretirement Benefit Obligation. It represents the actuarial present value of benefits expected to be paid to employees after retirement, based on services rendered to date. EPBO is used to measure a company’s liability for postretirement benefits, such as health care, in its financial statements.
8. For financial reporting (to stockholders and creditors), the great majority of firms use which method of depreciation?
- calculate depreciation using the straight-line method.
- use the weighted-average method for calculating depreciation.
- only record depreciation expenses in years in which revenues exceed expenses.
- calculate depreciation using an accelerated method.
Explanation
The straight-line method of depreciation is the most widely used for financial reporting purposes because it allocates the cost of an asset evenly over its estimated useful life. This method provides a consistent and easily understandable expense pattern, making financial statements more comparable and predictable for investors and creditors. While accelerated methods may be used for tax purposes, straight-line depreciation is preferred for external reporting due to its simplicity and relevance.
9. Describe why a fine from OSHA violations results in a permanent difference in accounting and taxable income.
- A fine from OSHA violations can be deducted, affecting only accounting income.
- A fine from OSHA violations only affects future tax liabilities.
- A fine from OSHA violations is not deductible for tax purposes, leading to a permanent difference.
- A fine from OSHA violations is treated the same for both accounting and tax purposes.
Explanation
OSHA fines are not deductible for tax purposes, meaning they increase accounting expenses but do not reduce taxable income. This creates a permanent difference between accounting income and taxable income because the difference will never reverse in future periods. Unlike temporary differences, which eventually reconcile, the nondeductibility of fines results in a permanent divergence.
10. Under the completed contract method for long-term contracts
- a) revenue and expenses are recognized every year
- b) income may be recognized before the completion of the contract
- c) Loss may be recognized before the completion of the contract
- d) Both income and loss may be recognized only on the completion of the contract
Explanation
The completed contract method recognizes both revenue and expenses only when the contract is finished. This method is used when estimates of costs and progress are not reliable. Income and losses are deferred until the completion of the project, reflecting the uncertainty of interim financial results. Exceptions exist for anticipated losses, which must be recognized immediately to comply with the conservatism principle, but generally, the recognition is reserved for the end of the contract.
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