Chapter 2—Asset and Liability Valuation and Income Measurement
MULTIPLE CHOICE
1. Which of the following assets appears on the balance sheet at Historical cost?
a.
Equipment
b.
Notes Payable
c.
Investments in Marketable Securities
d.
Accounts Payable
2. Interest on Municipal Bonds represents what kind of tax difference?
a.
Permanent timing difference that results in that income item not being taxed.
b.
Temporary difference that will reversed in the future
c.
Tax rate on Municipal bonds are based on estimated tax rates.
d.
Not recognized in taxable income on the accrual basis of accounting.
3. Shareholders’ equity consists of what three components:
a.
Assets, liabilities, and contributed capital.
b.
Contributed capital, accumulated other comprehensive income, and retained earnings.
c.
Liabilities, contributed capital, and retained earnings.
d.
Liabilities, contributed capital, and accumulated other comprehensive income.
4. Which of the following valuation methods reflects current values?
a.
acquisition cost
b.
present value of cash flows using historical interest rates
c.
net realizable value
d.
adjusted acquisition cost
5. The use of acquisition cost as a valuation method is justified on the basis that acquisition cost is:
a.
timely
b.
relevant
c.
subjective
d.
objective
6. Firms use acquisition cost valuations and adjusted acquisition cost valuations for which of the following
types of assets?
a.
Assets that do not have fixed amounts of future cash flows.
b.
Assets that have fixed amounts of future cash flows.
c.
Assets with certain future economic benefits.
d.
monetary
7. The net amount a firm would receive if it sold an asset or the net amount it would pay to settle a liability
is referred to as
a.
current replacement cost
b.
net realizable value
c.
current cost
d.
acquisition cost
8. Disregarding cash flows with owners, over sufficiently long periods of time, net income equals:
a.
revenues minus dividends and expenses
b.
assets minus liabilities
c.
stockholders’ equity
d.
cash inflows minus cash outflows
9. When income tax expense for a period is greater than income tax payable the difference will be reported
how and on which financial statement?
a.
Deferred tax asset and Statement of Cash Flows
b.
Deferred tax asset and Balance Sheet
c.
Deferred tax liability and Statement of Cash Flows
d.
Deferred tax liability and Balance Sheet
10. Permanent tax differences are revenues and expenses
a.
that firms include in income tax returns, but do not appear in the income statement.
b.
that are included in both the tax return and income statement, but in different accounting
periods.
c.
that firms include in the income statement, but do not appear in income tax returns.
d.
that are not included in either the tax return or the income statement.
11. The traditional accounting model delays the recognition of value changes of assets and liabilities until
what event occurs?
a.
A change in value.
b.
A market transaction.
c.
A balance sheet date.
d.
Cash is received or cash is paid.
12. Fish Farm Corporation purchases a new tract of land on which it is going to build new growing and
holding tanks in order to expand its business. Which of the following costs would not be part of the cost
of the land?
a.
costs to run a title search
b.
costs of grading to level the land
c.
costs of tearing down an existing structure
d.
cost of the new holding tanks
13. Current replacement cost represents
a.
the amount a firm would have to pay currently to acquire an asset it now holds
b.
the amount a firm would have to pay currently to acquire an asset it does not now hold
c.
the amount a firm would have to pay in the future to acquire an asset it now holds
d.
the amount a firm would have to pay to purchase a comparably depreciated version of the
asset it now holds
14. Which of the following is not one of methods used by GAAP for treating value changes?
a.
Recognize value changes on the balance sheet and income statement when they are realized
in a market transaction
b.
Recognize value changes in the income statement when the value changes occur over time,
but recognize them on the balance sheet when they are realized in a market transaction
c.
Recognize value changes on the balance sheet when the value changes occur over time, but
recognize them in the income statement when they are realized in a market transaction
d.
Recognize value changes on the balance sheet and income statement when they occur over
time, even though they are not realized in a market transaction
15. Which of the following transactions is consistent with recognizing value changes on the balance sheet
and income statement when they are realized in a market transaction?
a.
Selling land at a cost greater than its original purchase price.
b.
Recording an increase in the fair value of investments at year end.
c.
Translating foreign operations accounted for in Yen back to U.S. dollars in order to prepare
consolidated financial statements.
d.
Writing down the value of an asset due to obsolescent.
16. At origination which of the following temporary differences would create a deferred tax asset?
a.
Tax basis of an asset exceeds its financial reporting basis.
b.
Tax basis of a liability exceeds its financial reporting basis.
c.
Financial reporting basis of an asset is equal to its tax basis.
d.
Financial reporting basis of an asset exceeds its tax basis.
17. Plaxo Corporation has a tax rate of 35% and uses the straight-line method of depreciation for its
equipment, which has a useful life of four years. Tax legislation requires the company to depreciate its
equipment using the following schedule: year 1- 50%, year 2 – 30%, year 3 – 15% and year 4 – 5%. In
2014 Plaxo purchases a piece of equipment with a four year life and an original cost of $100,000. What
amount will Plaxo record as a deferred tax asset or liability in 2010?
a.
Deferred tax asset of $25,000.
b.
Deferred tax liability of $25,000.
c.
Deferred tax asset of $8,750.
d.
Deferred tax liability of $8,750.
18. The income statement approach to measuring income tax expense
a.
is required by FASB Statement No. 109.
b.
compares revenues and expenses recognized for book and tax purposes, eliminates
permanent differences, and computes income tax expense based on book income before
taxes excluding permanent differences.
c.
computes income tax expense as a difference between the tax basis of an asset or a liability
and its reported amount in the [balance sheet] that will result in taxable or deductible
amounts in some future year(s) when the reported amounts of assets are recovered and the
reported amounts of liabilities are settled.
d.
is required by IAS 12.
19. Future tax deductions
a.
result in deferred tax assets.
b.
result in deferred tax liabilities.
c.
occur where the tax basis of liabilities is more than the financial reporting basis.
d.
occur where the tax basis of assets is less than financial reporting basis.
20. Future taxable income is characteristic of all of the following situations except:
a.
where deferred tax assets result.
b.
where deferred tax liabilities result.
c.
where the tax basis of liabilities exceed the financial reporting basis.
d.
where the tax basis of assets is less than financial reporting basis.
21. When recognizing deferred tax assets and liabilities, the income statement approach and the balance
sheet approach yield identical results
a.
when enacted tax rates applicable to future periods do not change.
b.
when the firm recognizes no valuation allowance on deferred tax assets.
c.
Both (a) and (b) are correct.
d.
None of these answers is correct.
22. Firms may not include all income taxes for a period on the line for income tax expense in the income
statement. Other places that income tax expenses may occur include all of the following except:
a.
Discontinued Operations
b.
Extraordinary Items
c.
Other Comprehensive Income
d.
Common Stock
23. U.S. GAAP, IFRS, and other major accounting standards are best characterized as
a.
historical accounting models.
b.
current value accounting models.
c.
acquisition cost accounting models.
d.
mixed attribute accounting models.
24. Which of the following would not represent an acquisition cost to be added to the purchase price of
building:
a.
Sales Tax.
b.
Cost of grading the land.
c.
Capital repairs to get the building ready for occupancy.
d.
Renovations that would extend the life of the building.
25. Valuation methods that reflect current values or a combination of historical and current values include
all of the following except:
a.
fair value for assets and liabilities.
b.
current replacement cost for assets.
c.
net realizable value for assets.
d.
adjusted acquisition costs for assets.
26. Historical costs include all of the following except:
a.
acquisition costs for assets
b.
net realizable values for assets.
c.
adjusted acquisition costs for assets.
d.
initial present value for assets and liabilities
27. The existence of subjectivity in an asset valuation does not necessarily mean the valuation will not be
reliable. All of the following are examples of this except:
a.
where historical cost is used for accounts receivable, fixed assets, and other assets with
values that remain relatively stable.
b.
where market value is used for marketable equity securities, commodities, and financial
assets are traded in liquid markets
c.
where historical cost is used for LIFO inventory layers where inventory has seen an
inflationary increase in costs.
d.
where historical cost is used for internally generated intangible asset valuations.
28. What level are inputs for estimating fair values are based on inputs that are readily available via prices
for identical assets or liabilities in actively traded markets such as securities exchanges?
a.
Level 1.
b.
Level 2.
c.
Level 3.
d.
None of these.
29. What level are inputs for estimating fair values are those inputs include quoted prices for similar assets
or liabilities in active or inactive markets, other observable information such as yield curves and price
indexes, and other observable data such as market-based correlation estimates?
a.
Level 1.
b.
Level 2.
c.
Level 3.
d.
None of these.
30. What level are inputs for estimating fair values based on a firm’s own assumptions about the fair value of
an asset or a liability, such as using various data to estimate present values?
a.
Level 1.
b.
Level 2.
c.
Level 3.
d.
None of these.
31. The accounting equation is represented by Assets= Liabilities + Stockholders’ Equity which of the
following would cause a change in the stockholders’ equity accounts:
a.
Sale of Land for cash and a note receivable for the balance
b.
Collection of an account receivable
c.
Purchased an asset for cash and 10,000 shares of preferred stock
d.
Purchase of common stock back from shareholders
32. Reporting financial assets and liabilities at fair values also is referred to as:
a.
historical cost.
b.
acquisition cost.
c.
mark-to-market.
d.
mortgage-backed cost
33. U.S. GAAP and IFRS allows the use of present value to calculate the cost of an asset except:
a.
When assets are held for more than one year.
b.
When assets are held for less than one year.
c.
When assets are depreciated using the straight line method
d.
When asset are sold in the middle of the accounting cycle.
34. If a portfolio manager had to estimate the fair value of private equity funds invested in a young,
privately-held start-up company, which of the following would he/she most likely identify as the level of
inputs to determine this?
a.
Level 1.
b.
Level 2.
c.
Level 3.
d.
None of these.
35. If a portfolio manager had to estimate the fair value of illiquid mortgage-backed securities, which of the
following would he/she most likely identify as the level of inputs to determine this?
a.
Level 1.
b.
Level 2.
c.
Level 3.
d.
None of these.
36. If a portfolio manager had to estimate the fair value of investments in timber, which of the following
would he/she most likely identify as the level of inputs to determine this?
a.
Level 1.
b.
Levels 1 and 2.
c.
Levels 2 or 3.
d.
All levels would be applicable.
37. If a portfolio manager had to estimate the fair value of real estate, which of the following would he/she
most likely identify as the level of inputs to determine this?
a.
Level 1.
b.
Level 2.
c.
Level 3.
d.
None of these.
38. If a portfolio manager had to estimate the fair value of privately placed bond issues, which of the
following would he/she most likely identify as the level of inputs to determine this?
a.
Level 1.
b.
Level 2.
c.
Level 3.
d.
None of these.
39. All of the following can be used to describe reliability of accounting information except:
a.
biased.
b.
credible.
c.
verifiable.
d.
supported by source documents.
40. Relevant asset valuations refer to all of the following except:
a.
they are timely.
b.
they have the capacity to affect a user’s decisions, based on the information.
c.
they incorporate all available information.
d.
they are always subjective.
COMPLETION
1. The amount initially paid to acquire an asset is called ______________________________.
2. Firms recognize the reduction in service potential of assets such as patents and trademarksusing the
process of ____________________.
3. The amount that a company would have to pay today to acquire an asset it now holds is called
________________________________________.
4. The difference between income tax payable and income tax expense is reported on the balance sheet as
either ___________________________________ or a ___________________________________.
5. Items, such as interest revenue on municipal bond holdings, that do not affect taxable income or income
taxes paid in any year are referred to as _____________________________________________.
6. Revenues and expenses that firms include in both net income to shareholders and in taxable income, but
in different periods are referred to as _____________________________________________.
7. Stockholders’ equity can be expanded into the following three accounts: Accumulated other
comprehensive income, retained earnings and
_________________________________________________________________.
Balance Sheet Equation
Cash
+
Non-Cash
Assets
=
Liabilities
+
Contributed
Capital
+
Accumulated Other
Comprehensive
Income
+
Retained
Earnings
8. Refer to the Balance Sheet Equation. If ORP Corporation sells $25,000 of its product on account, it
will see an increase in non-cash assets and ___________________________________.
9. Refer to the Balance Sheet Equation. To recognize the cost of goods sold ORP Corporation will reduce
retained earnings and reduce ______________________________.
10. Refer to Balance Sheet Equation. ORP Corporation Purchases land $9,000 cash and 1000 shares of
common stock values at 10 per share. This transaction results in ORP recording an decreasein cash of
$9,000, an increase in non-cash assets of $ 19,000 and a increase in
______________________________ of $ $10,000
11. Refer to Balance Sheet Equation. JCP Company purchased marketable securities for $5,000 during the
year, at the end of the year the company revalues the securities to $5,700. This revaluation would result
in an increase to non-cash assets and
____________________________________________________________.
12. Refer to Balance Sheet Equation. The payment of a note payable by a firm reduces cash and
______________________________.
13. Acquisition costs includes all costs necessary to get an asset ready for its
_________________________.
14. ____________________ assets and liabilities represent amounts of cash a firm can expect to receive or
pay in the future.
15. ________________________________________ is the net amount that a firm would receive if it sold
an asset or the net amount it would have to pay to settle a liability.
16. A change in the _________________________ or _________________________ will not change a
preset series of cash flows, however it will change the present value of those cash flows.
17. Net income equals revenues plus ____________________ minus expenses and
____________________.
18. The application of GAAP requires firms to write down assets whose fair values decrease below their
book values, but does not allow firms to revalue upward the values of assets whose fair values have
increased. This asymmetric treatment rests on the ________________________________________.
SHORT ANSWER
1. What valuation methods reflect historical cost? Discuss the advantages and disadvantages of valuing
assets and liabilities using historical valuations.
2. What valuation methods reflect current values? Discuss the advantage(s) and disadvantage(s) of valuing
assets and liabilities using current values.
3. Discuss the three ways in which GAAP allows value changes to be treated in the financial statements.
Provide an example of each value change treatment.
4. When income tax expense differs from income taxes currently payable on taxable income companies
recognize deferred tax assets and deferred tax liabilities. What type of event would create a deferred tax
asset and deferred tax liability?
5. Discuss the two principal reasons income before taxes for financial reporting differs from taxable
income.
ANS:
1.
Permanent Differences—Revenues and expenses that firms include in net income to
shareholders, but which never appear in the income tax return.
2.
Temporary Differences—Revenues and expenses that firms include in both net income to
shareholders and in taxable income but in different periods.
6. The analytical framework used to evaluate transactions is reproduced below:
Cash
+
Non-Cash
Assets
=
Liabilities
+
Contributed
Capital
+
Accumulated Other
Comprehensive
Income
+
Retained
Earnings
Using this analytical framework indicate the effect of each of the following transactions for TX
Corporation:
1.
TX Corporation sold additional shares of common stockmarketable securities for for
$250,000 cash
2.
At the end of the period TX Corporation revalued the securities to $125,000.
3.
During the next period TX Corporation sells equipment with a book value of $100,000 for
$$90,000
1.
+250,000
+250,000
2.
-25,000
-25,000
1.
Value changes recognized on the balance sheet and the income statement when realized in a
market transaction. Examples include selling inventory or land.
3.
Value changes recognized on the balance sheet and the income statement when they occur.
7. The analytical framework used to evaluate transactions is reproduced below:
Cash
+
Non-Cash
Assets
=
Liabilities
+
Contributed
Capital
+
Accumulated Other
Comprehensive
Income
+
Retained
Earnings
Using this analytical framework indicate the effect of each of the following transactions for CX
Corporation:
1.
CX Corporation purchases land for $450,000 cash.
2.
At the end of the period CX Corporation receives an appraisal that values the land at
$540,000.
3.
During the next period CX Corporation sells the land for $665,000.
4.
CX pays taxes at a rate of 40%.
Income
1.
-450,000
+450,000
2.
No Entry
3.
+665,000
-450,000
+215,000
4.
-86,000
-86,000
8a. Plaxo Corporation has a tax rate of 35% and uses the straight-line method of depreciation for its
equipment, which has a useful life of four years. Tax legislation requires the company to depreciate this
type of equipment using the following schedule: year 1- 50%, year 2 – 30%, year 3 – 15% and year 4 –
5%. In 2011 Plaxo purchases a piece of equipment with a four year life and an original cost of $100,000.
Discuss how this transaction will effect Plaxo’s income taxes in 2011.
PTS: 1
8b Assuming that Plaxo Corporation decides to use accelerated depreciation for both financial and
tax reporting purposes for 2011 would there still be a deferred tax liability?
3.
+90,000
-100,000
-10,000
+15,000
9. For some transactions GAAP requires that value changes are recognized on the balance sheet and the
income statement when they occur, even if not realized. Discuss what types of transactions get this type
of treatment and the logic behind this accounting.
10. Deferred tax assets and liabilities are created due to temporary differences between the tax and financial
reporting basis of certain assets and liabilities. Discuss which scenarios result in a deferred tax asset and
which result in deferred tax liabilities.
11. H. Solo Company purchased a new piece of equipment with a list price of $175,000 and subject to a 5
percent discount if paid within 45 days. H. Solo paid within the discount period. The company also paid
$1,500 to obtain title to the equipment and $600 as the license fee for the first year of operation. It paid
$2,500 to level the area in which the equipment would be located and $12,500 to relocate other
equipment that would have interfered with the proper operation of the new equipment. H. Solo paid $400
for property and liability insurance for the first year of operation. What is the acquisition cost of this
equipment that H. Solo should record in its accounting records? Indicate the treatment of any amount not
included in acquisition cost.