D105 Intermediate Accounting III
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Free D105 Intermediate Accounting III Questions
1. Kassim Company purchased an asset by paying $35,000 cash and giving the seller its 3-year note for $240,000. Which of the following statements is true?
- Kassim's book basis is $275,000, but its tax basis is $35,000.
- If Kassim is a cash basis taxpayer, its initial tax basis in the asset is zero.
- Kassim's book basis and tax basis in the asset is $275,000.
- Kassim's book basis and tax basis in the asset is $35,000.
Explanation
The book basis of the asset includes all costs paid to acquire it, both cash and the note payable, totaling $35,000 + $240,000 = $275,000. For tax purposes, Kassim’s basis in the asset would generally be the same as the book basis unless special tax rules apply, such as for cash-basis taxpayers. Since the question does not specify special tax treatment, both the book and tax basis equal the total acquisition cost of $275,000.
2. Describe the impact of the tax rate increase on Raymond Corporation's deferred tax liability and how it affects income tax expense.
- The tax rate increase does not affect the deferred tax liability or income tax expense.
- The tax rate increase only affects future tax payments, not deferred tax liabilities.
- The increase in tax rate from 30% to 40% increases the deferred tax liability, resulting in an additional income tax expense of $9,000.
- The deferred tax liability decreases, leading to a reduction in income tax expense.
Explanation
When the corporate tax rate increases, any existing deferred tax liabilities must be remeasured to reflect the new enacted rate. For Raymond Corporation, a deferred tax liability originally calculated at 30% would increase proportionally when the rate rises to 40%. This increase in the liability is recorded as additional income tax expense in the period the rate change is enacted, ensuring the financial statements reflect the higher future tax obligation.
3. A company changes from percentage-of-completion to cost recovery method, which is also used for tax purposes. The entry to record this change should include a
- debit to construction in process
- debit tools on long-term contracts in the amount of the difference on prior years' income, net of tax
- debit to retained earnings in the amount of the difference on prior years' income, net of tax
- credit to deferred tax liability
Explanation
When a company changes from the percentage-of-completion method to the cost recovery method, it is considered a change in accounting principle. Such a change is accounted for retrospectively, and the cumulative effect of the change on prior years’ income is adjusted directly in retained earnings, net of tax. This ensures that the financial statements reflect the income that would have been reported under the new method as if it had been used all along.
4. Describe the significance of accurately reporting pension expenses in financial statements.
- Pension expenses are only important for internal management and have no external implications.
- Pension expenses are irrelevant to financial statements and do not affect company valuation.
- Pension expenses only impact tax liabilities and are not significant for investors.
- Accurate reporting of pension expenses is crucial as it affects the financial health and profitability of a company, influencing stakeholders' decisions.
Explanation
Pension expenses reflect the cost of providing post-employment benefits to employees and are a significant component of a company’s operating costs. Accurate reporting ensures that the financial statements present a true and fair view of the company’s obligations and profitability. Investors, creditors, and other stakeholders rely on this information to assess the company’s financial health, sustainability of operations, and ability to meet future obligations. Misreporting can lead to misinformed decisions and regulatory issues.
5. What type of deferred tax account is reported on Pitman’s balance sheet at the end of 2010?
- Deferred tax revenue
- Deferred tax asset
- Deferred tax expense
- Deferred tax liability
Explanation
Deferred tax accounts arise from temporary differences between accounting income and taxable income. If Pitman has paid more taxes than the amount recognized as expense for financial reporting purposes, or expects to recover taxes in the future due to deductible temporary differences, a deferred tax asset is reported on the balance sheet. Conversely, if future taxes are expected due to taxable temporary differences, a deferred tax liability would be reported. In this context, the correct classification is a deferred tax asset.
6. Which of the following is accounted for as a change in accounting estimate?
- A change from LIFO to FIFO method for inventory valuation
- a change in estimating bad debts from percentage of A/R to Aging of receivable method
- a change from the cost recovery method to the percentage-of-completion method
- None of the above
Explanation
A change in accounting estimate occurs when new information or developments lead to a revision of an estimate used in accounting, without changing the underlying accounting principle. Changing the method of estimating bad debts from a flat percentage of accounts receivable to an aging of receivables method reflects a change in the estimated uncollectible accounts and is accounted for prospectively as a change in estimate. Changes in inventory methods or revenue recognition methods are considered changes in accounting principles, not estimates.
7. 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.
8. Describe the implications of carrying forward a Net Operating Loss (NOL) for a company like C.J. Company in terms of deferred tax assets.
- Carrying forward a Net Operating Loss allows C.J. Company to recognize a deferred tax asset, which can reduce future taxable income.
- Carrying forward a Net Operating Loss has no impact on deferred tax assets or liabilities.
- Carrying forward a Net Operating Loss only affects cash flow, not tax reporting.
- Carrying forward a Net Operating Loss increases the company's current tax liability.
Explanation
When a company experiences a Net Operating Loss (NOL), it can carry the loss forward to offset taxable income in future periods. This creates a deferred tax asset because the company expects to reduce future taxes payable as the NOL is applied. The deferred tax asset represents the future tax benefit associated with the NOL, which will reduce taxable income and tax payments when realized.
9. Which of the following will result in a permanent difference?
- Product warranty liabilities
- Advance rental receipts
- Installment sales revenue
- Interest received on municipal bonds
Explanation
Permanent differences are items that affect either accounting income or taxable income but will never reverse in future periods. Interest received on municipal bonds is exempt from federal income tax and will never be taxable, creating a permanent difference. In contrast, product warranty liabilities, advance rental receipts, and installment sales revenue create temporary differences because they will eventually reverse in future periods, affecting taxable income later.
10. When a company amends a pension plan, for accounting purposes, prior service costs should be
- treated as a prior period adjustment because no future periods are benefited
- amortized in accordance with procedures used for income tax purposes
- initially recorded in other comprehensive income (PSC) and amortized later
- reported as an expense in the prior year the plan is amended
Explanation
When a pension plan is amended to provide additional benefits for service rendered in prior periods, the cost associated with these prior service benefits is initially recorded in other comprehensive income as prior service cost (PSC). This cost is then systematically amortized to pension expense over the remaining service periods of the affected employees. This approach aligns the recognition of expense with the periods that will benefit from the plan amendment.
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