D105 Intermediate Accounting III
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Free D105 Intermediate Accounting III Questions
1. Describe the difference between book basis and tax basis as it pertains to the asset in the context of the provided question.
- The book basis represents the value of the asset recorded in the financial statements, while the tax basis reflects the value used for tax purposes.
- The book basis and tax basis are identical in all cases.
- The book basis is always higher than the tax basis.
- The tax basis is determined by market value, while the book basis is determined by historical cost.
Explanation
The book basis of an asset is its carrying amount in the company’s financial statements, typically based on historical cost minus accumulated depreciation or amortization. The tax basis, on the other hand, is the value of the asset determined according to tax regulations, which may differ due to differences in depreciation methods, allowable deductions, or other temporary differences. The distinction between book and tax basis is essential for calculating deferred tax assets or liabilities.
2. What financial metric is typically used to assess a company's profitability before taxes?
- Operating income
- Gross profit
- Revenue
- Net income
Explanation
Operating income represents a company’s profitability from core business operations before considering the impact of taxes and interest. It measures the efficiency and performance of the business in generating profits from its primary activities. Unlike gross profit, which only accounts for the difference between sales and cost of goods sold, operating income incorporates operating expenses and provides a clearer picture of overall operational profitability before taxes.
3. In selecting an accounting method for a newly contracted long-term construction project, the principal factor to be considered should be
- the terms of payment of the contract
- the degree to which a reliable estimate of the costs to complete and extent of progress toward completion is practicable
- the method commonly used by the contractor to account for other long-term construction contracts
- the inherent nature of the contractor's technical facilities used in construction
Explanation
The choice of accounting method for long-term construction projects primarily depends on whether the contractor can make reliable estimates of total contract costs and the extent of progress toward completion. If reliable estimates can be made, the percentage-of-completion method can be used to recognize revenue and expenses over time. If reliable estimates are not feasible, the completed contract method is appropriate. Other factors like payment terms, prior methods, or technical facilities are secondary considerations.
4. A value assigned to a share of stock and printed on the stock certificate.
- Par value
- Gross profit
- Income from operations
- Net sales
Explanation
Par value is the nominal or face value assigned to a share of stock and printed on the stock certificate. It represents the minimum legal capital that must be retained in the company and serves as a benchmark for stock issuance. Par value is not related to market price, gross profit, or income from operations.
5. In computing the service cost component of pension expense, the FASB concluded that
- the accumulated benefit obligation using current salary levels provides a more realistic measure of the pension obligation on a going concern basis
- a company should employ an actuarial funding method to report pension expense that best reflects the cost of benefits to employees
- the projected benefit obligation using future compensation levels provides a realistic measure of present pension obligation and expense
- the projected benefit obligation using current compensation levels provides a realistic measure of present pension obligation and expense
Explanation
The FASB requires that the service cost component of pension expense be based on the projected benefit obligation, which takes into account future compensation levels expected at the time of retirement. This approach provides a more accurate estimate of the pension obligation and expense because pension benefits often increase with future salary growth, ensuring that the expense reflects the economic cost of providing retirement benefits to employees over their service period.
6. 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.
7. 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 | |
|---|---|---|
| a. | Deducted From | Deducted From |
| b. | Added To | Added To |
| c. | Deducted From | Added To |
| d. | Added To | Deducted From |
- Deducted From | Deducted From
- Added To | Added To
- Deducted From | Added To
- 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.
8. The rate of return on common shareholders' equity shows
- the amount that each common shareholder would receive if the company were liquidated.
- how the market value of the shares relates to the current earnings per share.
- how many dollars of net income were earned for each dollar invested by the owners.
- the amount of leverage the corporation employs.
Explanation
The rate of return on common shareholders’ equity (ROE) measures the profitability of a company in relation to the equity invested by common shareholders. It shows how many dollars of net income the company earned for each dollar of shareholders’ equity, providing insight into the efficiency with which the company uses owners’ capital to generate profits. It does not measure liquidation value, market price, or leverage.
9. What term describes the duration over which an asset is expected to be used?
- Estimated useful life
- Asset lifespan
- Depreciation period
- Service life
Explanation
The estimated useful life of an asset refers to the period over which a company expects to utilize the asset for its intended purpose. This estimate is used to calculate depreciation expense and reflects the time during which the asset will contribute to generating revenue. While terms like service life and depreciation period are related, the standard accounting term is “estimated useful life.”
10. If the fair value of plan assets increased to $2,300,000 by December 31, 2014, what impact would this have on the accounting for post-employment benefits?
- The increase would increase the company's tax liability.
- The increase in fair value would reduce the underfunded status of the plan and potentially decrease the expense recognized in the income statement.
- The increase would have no effect on the accounting for post-employment benefits.
- The increase would require an immediate cash outflow from the company.
Explanation
An increase in the fair value of plan assets reduces the underfunded status of a defined-benefit post-employment plan, as the plan’s assets move closer to covering the projected benefit obligations. This improvement may reduce pension or post-employment benefit expense recognized in the income statement because the expected return on plan assets, a component of expense, is higher. It does not trigger an immediate cash outflow or directly affect tax liability.
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