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Chapter 3
1. A balance sheet prepared according to U.S. GAAP lists assets from most liquid to least liquid, where liquid
refers to the ease of converting the asset into cash.
2. A balance sheet prepared according to U.S. GAAP lists liabilities starting with those that the firm will
discharge soonest (the most current or closest to maturity liabilities) and ending with those that it will pay latest
(the most noncurrent or distant to maturity liabilities).
3. Firms that use International Financial Reporting Standards (IFRS) may, but need not, list their assets from
least liquid to most liquid, with the same ordering used to list liabilities.
4. The current replacement cost of an asset is the amount a firm would have to pay to obtain another asset with
identical service potential; it is an entry value that reflects economic conditions at the measurement date.
5. The same asset can have different measurements for tax purposes, for financial reporting purposes, and for
internal managerial decision-making purposes.
6. Depreciation allocates the asset’s cost to the periods of benefit in some systematic and rational way, and it
attempts to track changes in the asset’s fair value.
7. Realization is the presumption that a firm will remain in operation long enough to carry out its current plans.
and in the normal course of its operations, realize changes in the fair values of its assets either by using those
assets or selling them.
8. Historically, recognition has described a preference for financial reporting such “that possible errors in
measurement be in the direction of understatement rather than overstatement of net income and net assets.”
9. Shareholders’ equity is a residual interest or claim—that is, the owners (shareholders) of a firm have a claim
on assets not required to meet the claims of creditors.
10. The amounts that firms report as received from owners are equal to the amounts the firm received when it
originally issued the shares of stock.
11. The balance sheet amount of shareholders’ equity does not, and is not intended to, provide the user of the
financial reports with a measure of the market value of common equity.
12. A potential investor can easily ascertain market value of common equity for a given publicly traded firm by
looking up the most recent share price (as reported in various online services) and then multiplying this share
price times the number of common shares outstanding, as reported on the balance sheet.
13. One can analyze the financial health of a business from a single financial statement considered in isolation
such as the balance sheet.
14. Many analysts use a common-size balance sheet, which expresses each balance sheet item as a percentage
of total assets.
15. The balance sheet portrays the effects of a firm’s investing and financing decisions.
16. Operating risk arises from the asset side of the business, and financing risk arises from debt.
17. The balance sheet does provides all the information an analyst wants or needs about a firm’s resources and
the claims on those resources.
18. Authoritative accounting guidance precludes the recognition of some resources as assets and some
obligations as liabilities.
19. The amounts reported on the balance sheet for assets, liabilities, and shareholders’ equity reflect current
market conditions.
20. In assessing the financial condition of a firm, an astute analyst recognizes that historical costs are reflected
on the balance sheet and adjusts the reported numbers.
21. Market-to-bookvalue ratios tend to be large for firms that make substantial expenditures on internally
developed assets, including research and development, advertising, and employee development.
22. The balance sheet perfectly describes both resources and financing (claims on those resources).
23. Applying asset and liability definitions and recognition criteria under U.S. GAAP and IFRS results in the
balance sheet including all economic benefits (resources) and obligations.
24. Investors would view measurements that reflect current conditions as the most relevant for making
investment decisions.
25. With the exception of internally developed software costs, U.S. GAAP requires that the firm expense both
research and development expenditures as incurred.
26. Balance sheets based on U.S. GAAP and IFRS omit some items and measure others with bias, relative to
measurements based on current economic conditions.
27. Conservatism emphasizes the early recognition of losses and delayed recognition of gains.
28. Both U.S. GAAP and IFRS require reporting that results in the more conservative measurement of
earnings.
29. The principal objective of accounting reports as currently prepared is to present accurately the results of
operations and the financial condition of the firm.
30. Acquisition cost includes all costs required to prepare an asset for its intended use.
31. Accounting records all executory promises.
32. In the recognition criteria for liabilities with uncertain amount and/or timing, probable is used in U.S.
GAAP to refer to a relatively high threshold of likelihood—a rule of thumb used in practice is approximately
80%.
33. In IFRS, probable as recognition criterion for liabilities with uncertain amount and/or timing means “more
likely than not”—approximately 51%.
34. Under U.S. GAAP, assets and liabilities are listed on the balance sheet in order of decreasing liquidity, so
the most liquid assets (liabilities) are shown first, under their respective categories.
35. Accounting does not normally recognize mutually unexecuted contracts as assets or liabilities.
36. What is a probable future economic benefit that a firm controls because of a past event or transaction
37. The criteria for asset recognition include
38. Which of the following are true?
39. Which of the following is true regarding the “reliability” of a reported amount?
40. The _____ of an asset is the amount a firm would have to pay to obtain another asset with identical service
potential; it is an entry value that reflects economic conditions at the measurement date.
41. This measurement attribute is used in U.S. GAAP to measure inventories whose usefulness (typically, in
terms of salability) to the firm has declined below the cost of the inventories.
42. _____ is the net cash (selling price less selling costs) that the firm would receive if it sold the asset today, in
orderly fashion in an arm’s-length transaction. It is an example of an exit value, because it reflects a price that
the firm would receive in a transaction in which an asset leaves the firm.
43. U.S. GAAP explicitly defines _____ of an asset as “the price that would be received to sell an asset [or paid
to transfer a liability] in an orderly transaction between market participants at the measurement date.” Thus,
U.S. GAAP defines it as an exit value, namely, the amount the firm would receive if it sold an asset in an
orderly, arm’s-length transaction at the measurement date.
44. IFRS defines _____ as a current exchange value, which can mean either a current entry price or a current
exit price.
45. The _____ of an asset as defined in U.S. GAAP is an opportunity cost in the sense that it reflects an
amount that the firm could receive if it sold the asset today. It is the amount the firm forgoes by not selling the
asset. In U.S. GAAP, it reflects a market participant perspective, so that the intentions of managers regarding
how they plan to use the asset do not determine the measurement.
46. _____ is the amount that results from using an appropriate interest rate to discount one or more future cash
flows to the present. It is the sum of the present values of the individual future cash inflows and outflows
associated with an asset. It is not, in and of itself, a measurement attribute. Rather, it is a means of arriving at a
measurement attribute.
47. Both U.S. GAAP and IFRS specify the asset measurement basis for financial reporting and _____ is the
initial measurement attribute for most assets.
48. The presumption is that a firm will remain in operation long enough to carry out its current plans, and will,
in the normal course of its operations, realize changes in the fair values of its assets either by using those assets
or selling them.
49. The distinction between recognition and realization is essential to accrual accounting, hence the importance
accorded to recognition criteria. Firms recognize items that qualify for inclusion in the financial statements
when they enter the financial statements. In the case of value decreases, the firm
50. _____ means that the information is pertinent to the decisions of users of financial reports, in the sense that
the information can make a difference in those decisions.
51. _____ means that the information presented is reasonably free from error and bias and faithfully represents
what it purports to represent.
52. Historically, _____ has described a preference for financial reporting such “that possible errors in
measurement be in the direction of understatement rather than overstatement of net income and net assets.”
53. _____ is the basis for the practice of reporting certain assets at the lower of acquisition cost or fair value.
The requirement to test assets for impairment and to record impairment charges rests on the notion that balance
sheet carrying values of assets should not exceed the amount of cash that the firm expects to receive by using or
selling the asset.
54. An accounting _____ arises when a firm incurs an obligation to make a future sacrifice that, because of a
past event or transaction, it has little or no discretion to avoid.
55. Which of the following are true regarding accounting liabilities
56. _____ are probable future sacrifices of economic benefits arising from present obligations of a particular
entity to transfer assets or provide services to other entities in the future as a result of a past event or
transaction.
57. The criteria for liability recognition include:
58. _____ is a residual interest or claim—that is, the owners (shareholders) of a firm have a claim on assets not
required to meet the claims of creditors.
59. The measurement of the assets and liabilities on the balance sheet also determines the measurement of
______________..
60. Corporate laws within many jurisdictions require that, within _____, firms distinguish between amounts
received from owners and amounts generated by operations which the firm has not distributed to owners.
61. Many firms disaggregate the initial amounts they received from shareholders for common shares into the
_____ and the amounts received in excess of this value, called additional paid-in capital (APIC), share
premium, or capital contributed in excess of par value.
62. Many firms disaggregate the initial amounts they received from shareholders for common shares into the
par or nominal or stated value of the shares and the amounts received in excess of this value, called:
63. Which of the following is/are true about amounts received from shareholders for the firm’s shares when the
firm first issued them.?
64. The sum of the par value amount and the additional paid-in capital amount is the total amount received from
shareholders for the shares when the firm first issued them. This total amount is also called _____.
65. Any subsequent sale of a firm’s previously issued common shares from one investor to another (such as
occurs on public stock exchanges):
66. In a rising stock market, the result of any subsequent sale of a firm’s previously issued common shares
from one investor to another (such as occurs on public stock exchanges) :
67. An investor can easily ascertain the _____ of common equity for a given publicly traded firm by looking up
the most recent share price (as reported in various online services) and then multiplying this share price times
the number of common shares outstanding, as reported on the balance sheet.
68. _____ measures the net assets generated by a firm from operations exceeding dividends declared.
69. The _____ account accumulates the amounts of the undistributed earnings over time.
70. When a firm has accumulated losses, rather than profits, the Retained Earnings account is typically called:
71. Retained earnings are
72. Retained earnings represent the source of net assets generated by the earnings process that exceed the firm’s
dividend declarations. Common practice refers to the process of curtailing dividends to accumulate assets,
represented by retained earnings, as _____.
73. Comparing firms using a common-size balance sheet rests on the assumption that
74. Firms use short-term financing for
75. Firms use long-term financing for
76. Firms with tangible long-term assets and predictable cash flows, such as electric utilities, tend to have
balance sheets with a
77. Firms with tangible long-term assets and less predictable cash flows, such as auto manufacturers and steel
companies, whose sales vary with changes in economic conditions, tend to use
78. Firms with high proportions of intangibles, whether recognized as assets on the balance sheet or not, tend to
rely more on
79. Operating risks
80. Long-term debt imposes financing risk because it
81. The more variable the firm’s cash flows from operating activities, the more risk that the firm will not have
sufficient cash to meet the required payments. Failure to meet these obligations can result in
82. Which of the following is true regarding the balance sheet
83. The current price of a share of common stock reflects current economic conditions, not the requirements of
authoritative guidance. Market-to-bookvalue ratios tend to be large for firms that
84. Key factors in preparing a balance sheet is/are deciding
85. For a firm to recognize an asset
86. Under both U.S. GAAP and IFRS, the firm must immediately expense all expenditures on _____.
87. The principal objective of accounting reports as currently prepared is to present ______ the results of
operations and the financial condition of the firm.
88. Accountants record assets at
89. In the recognition criteria for liabilities with uncertain amount and/or timing, probable is used in U.S.
GAAP to refer to a threshold of likelihood—a rule of thumb used in practice is approximately _____ In IFRS,
probable as recognition criterion for liabilities with uncertain amount and/or timing means approximately
_____.
90. Assume that Trader Pete’s, an organic food retailer in the United States, recently purchased a new
refrigeration system for its Washington, DC, store. Trader Pete’s paid $1.3 million for the refrigeration unit and
paid an additional $120,000 to modify the unit to meet its specific needs. Trader Pete’s paid $55,000 for the
transportation and installation of the unit, plus $48,000 for an annual insurance premium for the first year,
which begins next month. Finally, assume that Trader Pete’s hired a refrigeration technician, who is charged
with the maintenance of the unit; that technician’s annual salary is $80,000. How much should Trader Pete’s
record as the acquisition cost of the refrigeration unit?
91. On January 1, Year 3, All Business Machines (ABM) issued 1,000 shares of its common stock for a
building. Real estate appraisers estimated the building to have a market value of $55,000 on the date of
acquisition. The common stock of ABM sold for $50 per share on the date of the acquisition. On January 1,
Year 3, ABM paid $650 in real estate transfer taxes, $500 in real estate legal fees for recording the transaction,
$1,750 in property taxes for Year 3, and $2,000 for a two-year insurance policy beginning January 1, Year 3. At
what amount should the building appear in the Building account of ABM on January 1, Year 3?
92. Grand Metropolitan is a consumer foods company headquartered in the United Kingdom. It has followed the
common practice in the U.K. of treating expenditures on product development, quality control, and advertising
as an expense each year. Grand Metropolitan has now decided to recognize the full value of its brand names as
an asset on the balance sheet as of September 30, Year 6. To keep the balance sheet in balance and in
accordance with U.K. practice, Grand Metropolitan will likely
93. Intangible assets make up 40 percent of the total assets of a particular firm. This firm is most likely to be:
94. The acquisition cost for nonmonetary assets includes
95. When analyzing a balance sheet
96. Which of the following is not cash?
97. At December 31, Year 1, Adam Corporation has 5,000 shares of par value common stock, additional paid-in
capital of $25,000, total shareholders' equity of $80,000, and retained earnings of $45,000. What is the par value
per share?
98. At December 31, Year 1, Bubba Corporation has par value common stock with a par value of $1.50 per
share, Additional paid-in capital of $60,000, total shareholders' equity of $100,000, and retained earnings of
$25,000. What is the number of common stock shares?
99. At the end of the third year of operation, GreenWash Corporation has total assets equal to $100,000,
liabilities totaling $90,000, and contributed capital of $30,000. What is the balance in retained earnings?
100. Peter Company signed a new $36,000 three-year lease beginning October 1, Year 1, for a storage facility
for holding merchandise inventory. On October 1, Year 1, Peter Company recorded the first year's payment of
$12,000 in the Prepaid Rent account. There was no balance in the Prepaid Rent account prior to this entry. Peter
Company records adjustments only at the calendar year end. At December 31, Year 1, the adjusting entry
needed to accurately reflect the correct balances in the Prepaid Rent and Rent Expense accounts would be to
debit:
101. On December 30, Year 1, PBE Company entered into a contract to purchase inventory over the next year.
This is an example of a(n)
102. A prefabricated steel storage shed is purchased for $20,000 cash and a $80,000 interest-bearing note
payable over a 5-year period at an annual interest rate of 10 percent per annum. The cost to be recorded as an
asset (in addition to the $100,000 purchase price) should include all of the following except
103. The value of fixed assets (such as plant, property, and equipment) included in total assets on the statement
of financial position is/are the
104. (CMA adapted, Dec 94 #5) Several alternatives have been identified for measuring items on the statement
of financial position. Which of the following alternatives may be used?
Present Value Current Cost Net Realizable Value
105. Generally accepted accounting principles in the United States require firms to
106. Assets are classified as current for reporting purposes when
107. A liability arises when a firm
108. The stockholders' equity of a firm can be defined as
