D105 Intermediate Accounting III
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Free D105 Intermediate Accounting III Questions
1. 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.
2. If a company experiences a significant loss in its pension plan that exceeds the corridor threshold, how should this loss be treated in its financial statements?
- The loss should be recorded as a liability on the balance sheet.
- The loss should be recorded immediately as an expense in the current period.
- The loss should be ignored unless it is realized in cash.
- The loss should be amortized over future periods using the corridor method.
Explanation
When actuarial losses on a defined-benefit pension plan exceed the corridor threshold, they are not immediately recognized as pension expense. Instead, the excess loss is amortized over future periods using the corridor method, which spreads the impact on pension expense gradually. This approach prevents significant volatility in the income statement while ensuring that the loss is ultimately recognized in a systematic manner.
3. What is a key characteristic of a defined-contribution pension plan regarding employer contributions?
- The employer bears the investment risk.
- The benefits are guaranteed regardless of contributions.
- The employer's contribution each period is based on a formula.
- The plan guarantees a fixed benefit amount.
Explanation
In a defined-contribution pension plan, the employer’s obligation is limited to making contributions according to a specified formula, typically based on a percentage of the employee’s salary. The actual benefits received by the employee depend on the contributions made and the investment performance of the plan assets. The employer does not guarantee a specific benefit amount and does not bear the investment risk, which is instead borne by the employee.
4. 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.
5. 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.
6. Which of the following is accounted for as a change in accounting estimate?
- a) A change from LIFO to FIFO method for inventory valuation
- b) a change in estimating bad debts from percentage of A/R to Aging of receivable method
- c) a change from the cost recovery method to the percentage-of-completion method
- d) 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. When a company has an obligation or right to purchase an asset for an amount greater than or equal to its selling price, the transaction should be accounted for as
- a) an outright sale
- b) a financing transaction
- c) a repurchase transaction
- d) a put option
Explanation
When a company retains the obligation or right to repurchase an asset at a price greater than or equal to its original selling price, the transaction does not represent a true sale because the company still bears the risks and rewards of ownership. Instead, it is treated as a repurchase transaction. This ensures that revenue is not prematurely recognized since the transfer of control is effectively temporary and the company may have to reacquire the asset.
8. What is the term for the minimum price at which a company's shares can be issued, as indicated on the stock certificate?
- uniform value stock
- par value stock
- fixed value stock
- stated value stock
Explanation
Par value stock is the nominal or face value assigned to a share of stock as indicated on the stock certificate. It represents the minimum legal capital that must be retained in the company and is often a very small amount compared to the market value. This value has no relation to the market trading price but serves as a legal benchmark for the issuance of shares.
9. If Pitman Co. switches from straight-line depreciation to double-declining balance for tax purposes, how would this change impact their financial statements in the first year?
- It would increase depreciation expense and decrease taxable income in the first year.
- It would have no effect on taxable income.
- It would decrease depreciation expense and increase taxable income.
- It would only affect cash flow, not net income.
Explanation
Switching to double-declining balance depreciation accelerates the recognition of depreciation expense, resulting in higher expense in the early years of the asset’s life compared to straight-line depreciation. This higher depreciation reduces taxable income in the first year, lowering taxes payable. The impact is primarily on the income statement and tax expense, not directly on cash flow, although lower taxes may indirectly improve cash flow.
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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