Notes Fo Financial Statements

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					                          ACCTG 301 – Intermediate Accounting I
                               Widdison, Summer 2007
                                   Examination #1B


NAME:                          ________SOLUTION__________

STUDENT NUMBER:                ____________________________


                                                    Suggested
                                                    Maximum
                                                     Time per       Points       Points
                                                     Section       Available     Earned
Part I.        Miscellaneous Multiple Choice         30 minutes            45

Part II.       Financial Reporting Essay             15 minutes           15

Part III       Accounting Process/Analysis           30 minutes           25

Part IV        Conceptual Framework Essay            15 minutes           15

Totals                                              1 hr 30 mins         100

Notes:

 This exam package contains 9 pages, including this page. Please check
  immediately that you have a complete package.
 Demonstration of your work in computational multiple-choice questions will not be
  considered in grading your paper.
 Select the best answer in multiple-choice questions based on the information given.
 Essays are to be presented in good form (i.e. complete sentences, clear language,
  etc.) and confined to the space provided.

This exam is a closed-note, closed-book, and closed-“contact with other people” exam.
The work you do must be the results of your own legitimate efforts. You may not consult
any kind of resource for assistance. Please sign in the space below to indicate that you
understand this and will conduct yourself ethically and with integrity in this exam.


____________________________________
      Student Signature



Acctg 301, Summer 2007 – Widdison. Examination 1B                          Page 1 of 9 pages.
PART 1.       Miscellaneous Multiple Choice. Please select the best answer from the options
provided. (3 points each question; 45 total)

1.            The due process procedure of financial accounting standard-setting in the United
States

         a. is a legislative process based on rules established by governmental agencies.
         b. can be described as a social process which reflects “political” actions of various
            interested user groups as well as opinions based on research and logic.
         c. is based solely on research and empirical findings.
         d. is democratic in the sense that a majority of accountants must agree with a standard
            before it becomes enforceable.

2.       One objective of financial reporting is to provide

         a.      information that will attract new investors.
         b.      information about the investors in the business entity.
         c.      information about the liquidation values of the resources held by the enterprise.
         d.      information that is useful in assessing cash flow prospects.
2. The information provided by financial reporting relates to

         a. business industries, rather than to individual enterprises or an economy as a whole
            or to members of society as consumers.
         c. an economy as a whole and to members of society as consumers, rather than to
            individual enterprises or industries.
         d. individual business enterprises, rather than to industries or an economy as a whole
            or to members of society as consumers.
         b. individual business enterprises, industries, and an economy as a whole, rather than
            to members of society as consumers.

4.       The overall pervasive constraint in the supply of accounting information is

         a.      decision usefulness.
         b.      cost vs. benefit.
         c.      materiality.
         d.      conservatism.
5        The underlying theme of the conceptual framework is

         a.      reliability.
         b.      comparability.
         c.      decision usefulness.
         d.      understandability.




Acctg 301, Summer 2007 – Widdison. Examination 1B                                  Page 2 of 9 pages.
6.    The following is selected information from Gates-Buffet, Inc.’s balance sheet for 2006:
       common stock increased by $500,000; retained earnings increased by $125,000, and
       accumulated other comprehensive income decreased by $10,000. Notes to the financial
       statement indicated the $25,000 of cash dividends had been declared and paid during
       the year. Comprehensive income for the year must have been

       a.   $990,000.
       b.   $135,000.
       c.   $140,000. (Net income of $150,000 less decrease in OCI.)
       d.   $590,000.

7.     In order for accounting information to be useful, it must have both relevance and
       reliability. There is, however, an inherent trade-off between these primary
       characteristics. Which of the following pairs of attributes causes the conflict between
       relevance and reliability?
       a.   Consistency and comparability.
       b.   Timeliness and verifiability.
       c.   Predictive value and representational faithfulness.
       d.   Neutrality and feedback value.

8.     Which of the following attributes is demonstrated when a high degree of consensus can
       be secured among independent measurers using the same measurement methods?

       a.      verifiability.
       b.      neutrality.
       c.      relevance.
       d.      reliability.
9.     Which of the following statements about materiality is not correct?

       a. An item must be capable of making a difference to a decision-maker or it need not be
          treated in conformance with GAAP.
       b. Materiality is a matter of relative size or importance.
       c. An item is material if its inclusion or omission would influence or change the
          judgment of a reasonable person.
       d. All of these are correct statements about materiality.


10.    Application of the full disclosure principle

       a. is theoretically desirable but not practical because the costs of complete disclosure
           exceed the benefits.
       b. is violated when important financial information is disclosed in the notes to the
           financial statements rather than on the face of those statements.
       c. is demonstrated by the presentation of supplementary information presenting
           selected financial information about significant segments of a business
       d.. requires that the financial statements be consistent and comparable.




Acctg 301, Summer 2007 – Widdison. Examination 1B                               Page 3 of 9 pages.
11.    Why are certain costs of doing business capitalized when incurred and then depreciated
       or amortized over subsequent accounting cycles?

       a.   To reduce the federal income tax liability
       b.   To match the costs of effort expended with revenues as earned
       c.   To adhere to the accounting constraint of conservatism
       d.   To aid management in cash-flow analysis

12.    While auditors are concerned that all necessary year-end adjustments be made, which
       of the following types of adjustments are the most difficult to track to be sure that all
       have been properly included?
       a.   Valuations.
       b.   Inventory adjustments.
       c.   Accruals.
       d.   Prepayments (deferrals).
13.    On October 1, 2004, Allen Corp. borrowed $1,800,000 and signed a 3-year, 8% note
       payable. The note is to be paid in three annual installments of $600,000 each plus
       interest on the outstanding balance on October 1 of 2005, 2006, and 2007. Allen’s fiscal
       year-end is June 30. The first interest and principal payment was made on October 1,
       2005. In Allen's June 30, 2006 balance sheet, what amount should be reported as
       accrued interest payable for this note? (Hint. You might find it helpful to depict the
       events on a timeline to identify what is happening and when.)

       a.   $72,000. (Loan balance of $1,200,000 x 8% x 9/12)
       b.   $96,000.
       c.   $108,000.
       d.   $144,000.

14.    The purpose of adjusting entries is to:
       a.      convert accrual basis accounting procedures to a cash basis.
       b.      reduce the balances in all temporary accounts to zero.
       c.      transfer net income or net loss to Retained Earnings.
       d.      capture all economic events that have occurred because of the passage of time.

15. Retained earnings on the 12/31/06 and 12/31/07 balance sheets for XYZ Company were
    reported at $150,000 and $200,000 respectively. During 2007, cash dividends of $30,000
    had been declared and paid. Which of the following would have been included as part of
    the closing process at the end of 2007?

       a.      A debit to income summary of $80,000
       b.      A credit to income summary of $50,000
       c.      A debit to dividends declared of $30,000
       d.      None of the above would have been included as part of the closing process.




Acctg 301, Summer 2007 – Widdison. Examination 1B                                Page 4 of 9 pages.
PART II – Financial Reporting Essay. (Please confine your response to the space provided
on this page only. Responses beyond this page will not be read. 15 points)

Neutrality is an essential attribute of reliable information. Of which primary characteristic of
useful information is neutrality an attribute? What is specifically meant by presenting neutral
financial information? Why is it such an important attribute? (Include in your response a
discussion of considerations of aspects of this issue that are discussed in the article “The
Critical Nature of Neutral Financial Reporting.”)

1.     The primary characteristic of which neutrality is an attribute is reliability. (4
points)

2.     Neutrality means that the financial reports are free from bias and that there has
been no manipulation of the information so as to present a particular or slanted view of
the economic position of a company. (5 points)

3.     The importance of neutrality in financial reporting speaks to the underlying
confidence that investors have in the capital markets. The article “The Critical Nature of
Neutral Financial Reporting” identifies two key issues: misallocation of capital and the
introduction of financial reporting risk.

       Misallocation of capital resources will occur if investors are making investment
decisions based on misleading (biased) information. Firms whose financial statements
present an economic picture that is better than the reality of their situation will receive
capital funding that is not justified. Firms which might be better deserving of investors’
interest are disregarded. As a consequence, capital is being wasted. To the extent that
biased reporting is pervasive, the economy as a whole is affected.

        Financial reporting risk arises as a consequence of investors losing confidence in
financial accounting reporting as more incidences of biased information occur. There
has been a significant reduction in investor confidence as a result of the audit failures
and misreporting incidents of the last few years. As a result, those investors who are
still participating in the markets will be looking for a higher return on their investment
dollars to compensate them for this new “financial reporting risk.” ( 6 points for an
adequate discussion in this part of your essay.)

(The article also discussed neutrality within the context of the accounting standard
setting process. However, the essay requirements were directing your attention towards
neutrality within the context of the preparation of the statements themselves rather than
in standard-setting.)

Key issues in response highlighted in yellow.




Acctg 301, Summer 2007 – Widdison. Examination 1B                                 Page 5 of 9 pages.
PART III – The Accounting Process. [25 points]

A.      Data relating to the balances of various accounts affected by adjusting entries appear
below. The entries which caused the changes in the balances are not given. You are asked to
supply the missing adjusting journal entries that must have been made on 12/31/07 (the
end of the company’s fiscal year) which would logically complete the accounting for the changes
in the account balances. Do not include explanations for your entries. Show any necessary
calculations in the space provided below each journal entry table provided. Additionally,
identify each entry as either an accrual, prepayment (deferral), or valuation adjustment
(circle one). [16 pts] ] GRADING NOTE: For each item 2 through 5, I allowed 2 points
for the correct accounts, 1 point for the correct amount, and 1 point for correct type.
The first question has been done for you to provide an example. (Hint. You might find it useful to
do reverse account analysis using T-accounts to help you with these items.)

1.        Unearned rent revenue at 1/1/07 was $7,500 and at 12/31/07 was $6,000. The records
          indicate cash receipts from rental sources during 2007 amounted to $35,000, all of which
          was credited to the Unearned Rent Revenue Account. Prepare the missing adjusting
          entry.

                           Account Name                         Debit          Credit
          Unearned rent                                       36,500
             Rent earned                                                   36,500


      Accrual           Prepayment (deferral)                Valuation

     Unearned Rent                     Rent Earned                          Cash
             7,500
            35,000                                                    35,000
      ?                                         ?
             6,000


                          Account Name                          Debit          Credit
          Depreciation expense                                   85,000
             Accumulated depreciation                                            85,000


      Accrual           Prepayment (deferral)                Valuation (Either accepted.)

The accumulated depreciation account would increase by the amount of depreciation expense
   recorded for the year and decrease by the amount of accumulated depreciation relating to
   the asset that was sold. Since the book value of the asset that was sold was $10,000,
   $40,000 be the related accumulated depreciation, Therefore …

      BB$175,000 + depreciation expense - $40,000 = EB$220,000
      Depreciation expense = $85,000




Acctg 301, Summer 2007 – Widdison. Examination 1B                                  Page 6 of 9 pages.
3. Interest receivable at 1/1/07 was $700. During 2007, cash received from debtors for interest
   on outstanding notes receivable amounted to $3,000; however, the 2007 income statement
   showed interest revenue in the amount of $2,800. Please provide the missing adjusting
   entry.

                          Account Name                        Debit        Credit
        Interest receivable                                      500
            Interest revenue                                                     500


     Accrual           Prepayment (deferral)               Valuation

Of the $3,000 cash interest received, $700 had been earned the previous period and was
   revenue of that period, leaving $2,300 as revenue of the current period. Since total revenue
   reported was $2,800, an additional $500 of interest revenue must have been accrued at the
   end of the year.

4.   Allowance for doubtful accounts on 1/1/07 was $25,000. The balance in the allowance
     account on 12/31/07 after making the annual adjusting entry was $28,000, and during 2007
     bad debts written off amounted to $27,000. Provide the missing adjusting entry.

                        Account Name                          Debit        Credit
        Bad debts expense                                      30,000
           Allowance for doubtful accounts                                   30,000


     Accrual           Prepayment (deferral)               Valuation

BB$25,000 - $27,000 written off + Increase in allowance = $28,000
Increase in allowance = $30,000


5. During 2007, supplies in the amount of $15,000 were purchased. They were not capitalized
   since it was expected that they would all be consumed during the year. However, as of
   12/31/07, a count of supplies on-hand indicated that $3,000 of those supplies had not been
   used and would be available for use in 2008. Prepare the necessary adjusting entry

                         Account Name                         Debit        Credit
        Supplies inventory                                      3,000
           Supplies expense                                                   3,000


     Accrual           Prepayment (deferral)               Valuation


$3,000 of unused supplies must be removed from the income statement account and set up as
supplies inventory.




Acctg 301, Summer 2007 – Widdison. Examination 1B                              Page 7 of 9 pages.
B.     For each of the following situations, indicate how each would be treated under first the
cash-basis of accounting and then under the accrual basis. What aspect of their treatment
under the cash basis would either conflict with or ignore basic concepts and theory set forth in
the Conceptual Framework? Company fiscal year-end is December 31. An example question
and response have been given for you to use as a model. Additionally, you should think about
how we analyzed similar situations in the Tom and Jerry Pet Store class activity discussed in
Lecture 4. [9 pts]

Example:       Q. Received $5,000 from a customer this period for service to be performed next period.
               R. Cash basis -- $5,000 revenue would be recognized.
                  Accrual basis -- $5,000 unearned revenue (liability) would be recorded.
                  Cash basis defects: Criteria for revenue recognition ignored - -has not been earned.
                  Liability for obligation relating to future performance is ignored on the balance sheet.

1.     Paid $350,000 of operating expenses during 2007. Of this, $5,000 was for wages
earned by employees in December 2006, but paid during January, 2007. In addition, $7,000 of
wages were incurred during December 2007 which will be paid in January 2008.

Cash basis -- $350,000 of operating expenses +1 point


Accrual basis -- $352,000 of operating expenses. ($350,000 - $5,000 expense of 2006 +
$7,000 accrued wages expense (and related liability) at end of 2007.) +2 points


Cash basis defects: Matching of expense with revenue in correct period has been violated.
                    (Some of 2006 expense deducted in 2007 and some of 2007 expense
                    ignored.) +1 point
                    Liability obligation for $5,000 of wages to be paid in the future has been
                    ignored. +1 point

2.     Sold $350,000 of merchandise, of which $280,000 were cash sales with the balance
being sales on account.

Cash basis -- $280,000 revenue. +1 point


Accrual basis -- $350,000 revenue +1 point


Cash basis defects: Asset (receivable) for $70,000 of revenues owed by customers ignored.
                    +1 point
                    Revenue that has been earned and is realizable has not been
                    recognized. +1 point.




Acctg 301, Summer 2007 – Widdison. Examination 1B                                      Page 8 of 9 pages.
PART IV – Conceptual Framework Essay. (Please confine your answer to this page. 15 pts.)

CEOs of successful companies often state that their most valuable asset is their employees and the
collective skills and knowledge that these employees develop “in-house.” It could be argued that these
are components of intellectual capital and, as such, are intangible beneficial resources for the company.
The balance sheets of these corporations do include intangible assets; however, none of these reported
values is due to the recognition value of intellectual capital generated “in-house.” Do you believe that an
asset related to this “component” of intellectual capital should be recognized on these companies’
balance sheets? Why or why not? Your response should be a careful analysis based on the specific
criteria set forth in Concept Statement No. 5 with respect to criteria for recognition.

(There were 3 points each for an adequate discussion of whether employee skills and
knowledge meet the four tests: element definition, measurability, relevance, and
reliability. There were an additional 3 points for your indicating a conclusion based on
the position you took in your analysis.)

(Obviously, your essays will vary in wording and length; however, expectations are that
you would address the problem with respect to each of the 4 criteria for recognition
identified and discussed in CON 5. These are: meets the definition of an asset, is
measurable with reasonable certainty, has relevance, and has reliability. A possible
essay is presented. I was looking for these issues to be addressed in your response. A
complete answer will include discussion of all four criteria. My response is significantly
longer than I am anticipating from you – but the essence of what I have written is, what I
hope, you will have captured.)

“The determination of whether employee skills/knowledge should be included in the
financial statements of a company depends upon whether the item meets the recognition
criteria as identified in Concept Statement #5. These criteria are the element-definition
test, measurability, relevance, and reliability.

The element under consideration is asset. According to CON 1, an asset is a probable
future benefit that will be used or consumed in a business which arises from a past event
and which is owned or controlled by the business. The value of employee skills &
knowledge recognition is clear. The results of the efforts of these employees does
provide future benefits to the company and these benefits have arisen from the past
interactions of the employees. Some would argue that the “know-how” generated by the
employees is, indeed, owned and controlled by the business. This is evidenced by the
“non-compete” agreements employees sign and the fact that any new knowledge they
develop is patented by the company and not owned by the individuals. It is possible,
therefore, to meet the element definition criterion.

The criterion of measurability is much more problematic. Since financial events are
generally measured using some historical exchange price, it is clear it is not possible to
determine a dollar amount that measures the value of a company’s employees. Is it
possible to estimate such a value? After all, financial reporting does use estimates and
subjective judgment. The difficulty here would be how to assess the reliability of such
an internally developed number. Reliability requires that the financial data be such that
independent entities would separately arrive at a similar value, given the circumstances.
It is extremely unlikely that this would be the case. Management would, more than likely,
be inclined to attach an optimistic value to the element; one which an independent
auditor would not be able to verify.

For investors, all information that impacts the financial health of a company is relevant.
The relevance characteristic requires that the information being disclosed has the ability

Acctg 301, Summer 2007 – Widdison. Examination 1B                                        Page 9 of 9 pages.
to help investors predict future outcomes of a company, to provide feedback on previous
predictions, and to provide timely information. Since employee skills & knowledge
appear to meet the asset test, and since complete disclosure of all such elements would
be relevant to a decision-maker, then it is probable that disclosing this information in the
balance sheet would provide enhanced relevance to the user.

However, the final test, reliability, is compromised as a result of the problem of
measurability. In addition to it not having the verifiability attribute, the subjectivity of any
estimate used would compromise neutrality. It is also questionable that all users would
understand what was being represented by a classification “knowledge capital,” and
thus representational faithfulness might not be present.

Since all the criteria for recognition are not present, it is not possible to include
employee skills and knowledge on corporate balance sheets at this time.”




Acctg 301, Summer 2007 – Widdison. Examination 1B                             Page 10 of 9 pages.

				
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