Chapter 11
1. Many off-balance-sheet financings fall into one of two categories that accounting typically does not
recognize as liabilities: executory contracts and contingent obligations.
2. U.S. GAAP and IFRS provide guidance for deciding whether a given financing arrangement appears as a
liability on the balance sheet or is disclosed in the notes.
3. The accounting for transfers of receivables has come under the scrutiny of standard setters, as has the
accounting for transfers involving inventories and research and development
4. U.S. GAAP and IFRS require firms to recognize the cost of pension plans as an expense during the years as
the employees receive the retirement benefits.
5. The assets in a defined benefit pension plan will usually not equal the liabilities of the plan, resulting in an
overfunded or underfunded plan.
6. Under current accounting guidance, the employer consolidates the assets and liabilities of the firm’s pension
plan with its own assets and liabilities.
7. The total amount of cash that the employer contributes to the firm’s pension plan over time is the total
amount of pension expense that the employer must recognize in measuring net income.
8. The pension expense for a particular period is the amount of the cash contribution for defined contribution
pension plans.
9. The pension expense for a particular period for a firm’s defined benefit pension plans rarely equals the cash
contribution.
10. U.S. GAAP and IFRS require firms to report pension plan assets at the estimated future value.
11. U.S. GAAP defines the primary measurement of the pension liability of the pension plan as the projected
benefit obligation (PBO)—the future value of the amount the pension plan expects to pay to employees during
retirement based on accumulated service but using the level of salary expected to serve as a basis for computing
pension benefits.
12. The employer firm and the pension plan are legally separate entities, each with its own financial reports.
13. The balance sheet of a defined benefit pension plan includes the assets in the pension plan measured at fair
value and the projected benefit obligation measured using a current interest rate on high-quality fixed-income
investments. The difference between the assets and the liabilities indicates the extent to which a pension plan is
overfunded or underfunded.
14. In a defined benefit plan, the employer is ultimately responsible for either contributing cash or obtaining a
return on pension investments sufficient to pay promised amounts to retired employees.
15. Many entries in Other Comprehensive Income represent changes in fair value of the pension plan(s) that
receives delayed recognition in net income.
16. Under both U.S. GAAP and IFRS, the following formula calculates the Net Pension Expense (or Credit) for
a defined benefit pension plan,:
Interest Cost (the increase in the obligation because of the passage of time)
+ Service Cost (the increase in the obligation because of an additional year of employee service)
– Expected Return on Pension Investments
+/– Amortization of Performance and Actuarial Gains and Losses
+/– Amortization of Prior Service Cost
17. Pension expense for a defined contribution plan always exceeds the employer’s contribution to the plan.
18. Employer contributions to defined benefit pension plans are subject to several forms of government
regulation.
19. The accounting and reporting of health care, life insurance, and other postretirement plans follow the
concepts and procedures for defined benefit pension plans.
20. For many firms, the liability for the underfunded health care obligation exceeds the liability for underfunded
pensions.
21. Firms currently apply the fair value option to retirement plan obligations and report unamortized items in
net income as they arise.
22. U.S. GAAP and IFRS requires the recognition of changes in the plan assets or benefit obligations in
measuring pension or other benefits expense as those changes occur.
23. Permanent differences between pretax book income and taxable income arise from tax-exempt interest
revenue and certain fines.
24. The temporary difference associated with accelerated depreciation for tax purposes and straight-line
depreciation for financial reporting purposes means that a firm will pay lower income taxes in the early years of
the asset’s life, but this temporary difference will reverse over the entire asset life, resulting in higher taxes in
later years.
25. Total lifetime depreciation amounts on equipment for both financial reporting and tax reporting are the
same, only the timing may differ.
26. Income tax rates change over time, so the deferred tax liability need not represent the amount of taxes that
the firm must pay later.
27. U.S. international companies always have an effective tax rate equal to the 35% statutory tax rate.
28. Acquired in-process research and development (IPR&D) is never deductible for tax purposes and results in
an increased effective tax rate.
29. The notes to the financial statements provide information on the components of book income before taxes,
the current and deferred portions of income tax expense, a reconciliation between income taxes at the statutory
rate and the effective rate, and the components of deferred tax assets and deferred tax liabilities.
30. Managers frequently cite which of the following reason(s) for using off-balance sheet financing?
31. Firms frequently sign contracts promising to pay defined amounts in the future in return for future benefits.
If the firm has not received past or current benefits, but will receive the benefits in the future, accounting treats
the obligation as a(n) _____ contract and typically _____.
32. Eagle Airlines (Eagle) needs additional aircraft to expand internationally, and it could borrow the needed
funds and purchase the aircraft. This arrangement places additional debt on the balance sheet. Instead, Eagle
signs an lease agreement in which it agrees to pay the owner of the aircraft certain amounts each year for 12
years. The aircraft has an estimated service life of 18 years. Eagle paints its name on the aircraft, uses the
aircraft in operations, and makes the required lease payments. Which of the following is/are true?
33. Eagle Airlines (Eagle) needs additional aircraft to expand internationally, and it could borrow the needed
funds and purchase the aircraft. This arrangement places additional debt on the balance sheet. Instead, Eagle
signs an lease agreement in which it agrees to pay the owner of the aircraft certain amounts each year for 12
years. The aircraft has an estimated service life of 18 years. Eagle paints its name on the aircraft, uses the
aircraft in operations, and makes the required lease payments. Which of the following is not true?
34. Eaglet Airlines (Eaglet) needs additional aircraft to expand internationally, and it could borrow the needed
funds and purchase the aircraft. This arrangement places additional debt on the balance sheet. Instead, Eaglet
signs an lease agreement in which it agrees to pay the owner of the aircraft certain amounts each year for 18
years. The aircraft has an estimated service life of 18 years. Eaglet paints its name on the aircraft, uses the
aircraft in operations, and makes the required minimum lease payments that compensates the lessor for the cost
of the aircraft and provides a reasonable return for the risk involved. Which of the following is true?
35. Tweedledee Corporation and Tweedledum Company (forest products companies) need additional
pulp-processing capacity. Each firm could borrow the needed funds and build its own manufacturing plant.
Instead, they form a joint venture to build a pulp-processing plant. Each firm agrees to use half of the new
plant’s capacity each year for 20 years and to pay half of all operating and debt service costs. The joint venture
uses the purchase commitments of Tweedledee Corporation and Tweedledum Company to obtain a loan to
build the facility. The firms structure the arrangement so that neither firm controls the joint venture. Which of
the following is/are true?
36. Tweedledee Corporation and Tweedledum Company (forest products companies) need additional
pulp-processing capacity. Each firm could borrow the needed funds and build its own manufacturing plant.
Instead, they form a joint venture to build a pulp-processing plant. Each firm agrees to use half of the new
plant’s capacity each year for 20 years and to pay half of all operating and debt service costs. The joint venture
uses the purchase commitments of Tweedledee Corporation and Tweedledum Company to obtain a loan to
build the facility. The firms structure the arrangement so that neither firm controls the joint venture. The lender
requires both firms to guarantee payment of the loan in case the joint venture defaults, Which of the following
is/are true?
37. Red Queen Corporation and Red King Company (forest products companies) need additional
pulp-processing capacity. Each firm could borrow the needed funds and build its own manufacturing plant.
Instead, they form a joint venture to build a pulp-processing plant. Each firm agrees to use half of the new
plant’s capacity each year for 20 years and to pay half of all operating and debt service costs. The joint venture
uses the purchase commitments of Red Queen Corporation and Red King Company to obtain a loan to build the
facility. The firms structure the arrangement so that neither firm controls the joint venture. Which of the
following is not true?
38. Wonderland Corporation extends credit to its customers to purchase appliances, furniture, and other goods.
Wonderland Corporation could borrow from a bank using its accounts receivable as collateral, thereby placing
debt on the balance sheet. Wonderland Corporation would then use the cash collections from the receivables to
repay the bank loan with interest. Instead, Wonderland Corporation sells the accounts receivable to the bank for
an amount that is less than the cash the bank expects to collect from receivables purchased. The amount takes
account of expected defaults, which would reduce the cash generated by the receivables. This difference
between the amount paid to Wonderland Corporation by the bank for the receivables and the amount that the
bank expects to collect from the receivables provides the bank with its expected return. Which of the following
is/are true?
39. Looking Glass Corporation extends credit to its customers to purchase appliances, furniture, and other
goods. Looking Glass Corporation could borrow from a bank using its accounts receivable as collateral, thereby
placing debt on the balance sheet. Looking Glass Corporation would then use the cash collections from the
receivables to repay the bank loan with interest. Instead, Looking Glass Corporation sells the accounts
receivable to the bank for an amount that is less than the cash the bank expects to collect from receivables
purchased. The amount takes account of expected defaults, which would reduce the cash generated by the
receivables. This difference between the amount paid to Looking Glass Corporation by the bank for the
receivables and the amount that the bank expects to collect from the receivables provides the bank with its
expected return. Looking Glass Corporation must transfer additional uncollected receivables to the
lender/purchaser bank under either of two conditions: (1) if any receivables become uncollectible, and (2) if
interest rates rise above a specified level. Which of the following is/are true?
40. Red Rabbit Company, a distiller of liquors, ages its whiskeys for approximately 10 years. The firm must pay
the costs to produce the whiskey and to store it during the aging process. Using the whiskey as collateral, Red
Rabbit could borrow to finance the costs incurred during the aging process; doing so would, however, lead to
Red Rabbit reporting increased liabilities. Instead, Red Rabbit sells the whiskey to a bank and agrees to oversee
the aging process on the bank’s behalf. At the completion of the aging, Red Rabbit assists the bank in finding a
buyer but is not responsible for ensuring that a sale occurs at a specific price, or at all. Under this arrangement,
the bank bears the risk of changes in selling prices for the whiskey. Red Rabbit will probably treat this
transaction as a(n)
41. White Rabbit Company, a distiller of liquors, ages its whiskeys for approximately 10 years. The firm must
pay the costs to produce the whiskey and to store it during the aging process. Using the whiskey as collateral,
White Rabbit could borrow to finance the costs incurred during the aging process; doing so would, however,
lead to White Rabbit reporting increased liabilities. Instead, White Rabbit sells the whiskey to a bank and agrees
to oversee the aging process on the bank’s behalf. At the completion of the aging, White Rabbit Company
guarantees an ultimate selling price that pays the lender both the original purchase price and a reasonable return
over that amount. White Rabbit
42. A complicated financing arrangement, whereby firms sell batches of receivables to a legally separate entity
whose sole purpose is to hold the receivables and issue claims on their cash flows. The process is referred to as
_____ of the receivables.
43. In more complicated financing arrangements, firms sell batches of receivables to a legally separate entity
whose sole purpose is to hold the receivables and issue claims on their cash flows. The entity holding the
receivables issues securities to investors in return for cash and transfers the cash to the transferor in payment for
the receivables. The investors in securities issued by the entity receive payments out of the cash flow from the
transferred receivables. Common terminology refers to such an entity as a
44. Merlin Corporation sets up a pension plan that is legally separate from Merlin. The pension plan specifies
the eligibility of employees, the types of promises to employees, the method of funding, and the pension plan
administrator. Merlin Corporation specifies the benefit that employees will receive during retirement.
Employer contributions plus earnings from investments made with those contributions pay the specified benefit.
Common terminology refers to such plans as ____________. The assets in the plan will usually not equal the
liabilities of the plan, resulting in an overfunded or underfunded plan.
45. Pension plans are usually organized as a
46. Which of the following is/are true concerning pension plans?
47. Which of the following is/are not true concerning pension plans?
48. The actual earnings from pension plan investments include
49. The computation of the pension liability for a defined benefit plan uses actuarial estimates or actuarial
assumptions of
50. The computation of the pension liability for a defined benefit plan uses actuarial estimates or actuarial
assumptions of
51. The liability of the pension plan equals the
52. The discount rate that firms use in measuring the pension plan liability is the rate of return on
53. The typical benefit formula for a defined benefit plan takes into account the employee’s
54. U.S. GAAP defines the primary measurement of the pension liability of the pension plan as the _____the
_____ of the amount the pension plan expects to pay to employees during retirement based on accumulated
service but using the level of salary expected to serve as a basis for computing pension benefits.
55. U.S. GAAP and IFRS require firms to base both pension expense and funded status on the Projected Benefit
Obligation (PBO). The liability of the pension plan usually changes each period as follows: PBO at End of the
Period =
56. U.S. GAAP treatment of a defined benefit pension plan requires employers to recognize the funded status as
_____, if the pension plan(s) is/are overfunded and _____, if the pension plan(s) is/are underfunded, and an
adjustment to Other Comprehensive Income, a shareholders’ equity account that is _____, for the offsetting
amount.
57. U.S. GAAP treatment of a defined benefit pension plan requires employers to recognize the funded status
as
58. Which of the following is true regarding the accounting for defined contribution plans?
59. Which of the following is not true regarding the accounting for defined contribution plans?
60. Both the regulatory treatment and the tax treatment of employer contributions
61. Sky King Airlines discloses the funded status of pension plans and the health and life insurance plans for
two recent years. Both the pension plan and other benefit plans are underfunded. The underfunded amounts for
these plans appear in
62. Sky King Airlines discloses the funded status of pension plans and the health and life insurance plans for
two recent years. Both the pension plan and other benefit plans are underfunded. The amounts that Sky
King includes in _____, _____, represent unamortized prior service costs and net actuarial losses.
63. Income tax expense affects assessments of profitability as much as any other expense. A common ratio for
analyzing the effect of income taxes on profitability is the _____ rate, equal to income tax expense divided by
financial reporting income before income taxes:
64. What equals the income tax expense divided by financial reporting income before income taxes:
65. Permanent differences between pretax book income and taxable income arises from
66. Temporary differences between pretax book income and taxable income arises from
67. Firms compute income tax payable for a period using _____ as the base.
68. Taxable income excludes _____ and uses the accounting methods that the _____ either require or permit
firms to use for tax reporting.
69. Which of the following is/are true regarding U.S. GAAP and IFRS requirements for income tax accounting
for financial reporting purposes?
70. Which of the following is/are not true regarding U.S. GAAP and IFRS requirements for income tax
accounting for financial reporting purposes?
71. The basis for both U.S. GAAP and IFRS requirements for income tax accounting for financial reporting
purposes focuses on which of the following financial reporting objectives?
72. Using U.S. GAAP and IFRS requirements for income tax accounting for financial reporting purposes,
permanent differences
73. Using U.S. GAAP and IFRS requirements for income tax accounting for financial reporting purposes, the
accountant computes income tax expense using
74. The temporary difference associated with accelerated depreciation for tax purposes and straight-line
depreciation for financial reporting purposes means that a firm will pay _____ income taxes in the early years of
the asset’s life, but this temporary difference will reverse over the entire asset life, resulting in _____ taxes in
later years.
75. U.S. GAAP and IFRS require complex procedures in accounting for income taxes. Complexities in the
accounting for income taxes include(s)
76. U.S. GAAP and IFRS require complex procedures in accounting for income taxes. A deferred tax asset
arises when
77. U.S. GAAP and IFRS require complex procedures in accounting for income taxes. For example, firms
provide for estimated uncollectible accounts when they recognize sales on account but delay the tax deduction
until later, when firms judge that particular customers’ accounts are uncollectible. In this example, a
78. U.S. GAAP and IFRS require complex procedures in accounting for income taxes. For example, firms
provide for estimated warranty cost in the year they sell warranted products but delay the tax deduction until
later, when firms make actual expenditures for warranty repairs. In this example, a
79. U.S. GAAP and IFRS require that some temporary differences create deferred tax assets. The temporary
differences include the
80. Firms recognize deferred tax assets only to the extent that they expect to generate sufficient taxable income
to realize the assets in the form of tax savings in the future. U.S. GAAP requires use of a deferred _____ to
reduce the balance in the _____ account to the amount the firm expects to realize in tax savings in the future.
81. Firms recognize deferred tax assets only to the extent that they expect to generate sufficient taxable income
to realize the assets in the form of tax savings in the future. IFRS requires that firms recognize the _____of
deferred tax assets, with explanatory disclosures .
82. Deferred Tax Asset or Deferred Tax Liability accounts on the balance sheet can change each period due to
which of the following factors?
83. Acquired in-process research and development (IPR&D) is _____ for tax purposes and results in a(n) _____
effective tax rate.
84. Notes to the financial statements provide additional information about income tax expense and deferred tax
assets and deferred tax liabilities. Firms report which of the following?
85. Notes to the financial statements provide additional information about income tax expense and deferred tax
assets and deferred tax liabilities. Firms do not report which of the following?
86. Often cited reasons for using off-balance-sheet financing include that this accounting technique
87. When firms have obligations that do not meet the formal definition of a liability, U.S. GAAP require that
firms
88. GKC Corporation
GKC Corporation entered into noncancelable, long-term material contracts with suppliers for the purchase of
raw materials beginning in the calendar Year 4. These contracts amounted to $500,000 at December 31, Year 4,
relating to raw materials with a market price of $575,000. This amount was considered material for GKC.
(CMA adapted, Dec 95 #16) Refer to the GKC Corporation example. GKC Corporation’s financial statements
at December 31, Year 4,