9-1
Chapter 9—Operating Activities
MULTIPLE CHOICE
1. Which of the following is not one of the GAAP classifications for derivatives?
a.
Speculative investment
b.
Fair value hedge
c.
Asset-Liability hedge
d.
Cash flow hedge
2. Derivatives are financial instruments that derive their value from changes in any of the following
underlying securitiesexcept:
a.
Stock prices
b.
Percentage discount on accounts receivable
c.
Interest rates
d.
Commodity prices
3. Which of the following best describes the accounting treatment for derivative instruments not held for
purposes of hedging?
a.
Record as an asset or liability and recognize changes in fair value in other comprehensive
income.
b.
Do not record as an asset or liability, record income from the transaction at maturity and
recognize in earnings.
c.
Record as an asset or liability, recognize changes in fair value currently in earnings.
d.
Record as an asset or liability if off-balance sheet risk is material.
4. Which of the following is not a distinguishing characteristic of a derivative instrument?
a.
Derivative instruments have terms that require or permit net settlement.
b.
Derivative instruments have a low initial net investment.
c.
Derivative instruments are highly effective throughout their term.
d.
Derivative instruments have one or more underlyings and notional amounts.
5. The accumulated benefit obligation measures
a.
the pension obligation on the basis of the plan formula applied to years of service to date
and based on existing salary levels.
b.
an estimated total benefit at retirement and then computes the level cost that will be
sufficient, together with interest expected to accumulate at the assumed rate, to provide the
total benefits at retirement.
c.
the pension obligation on the basis of the plan formula applied to years of service to date
and based on future salary levels.
d.
the shortest possible period for funding to maximize the tax deduction.
6. The projected benefit obligation measures
a.
the pension obligation on the basis of the plan formula applied to years of service to date
and based on existing salary levels.
b.
an estimated total benefit at retirement and then computes the level cost that will be
sufficient, together with interest expected to accumulate at the assumed rate, to provide the
total benefits at retirement.
c.
the pension obligation on the basis of the plan formula applied to years of service to date
and based on future salary levels.
d.
the shortest possible period for funding to maximize the tax deduction.
7. Presented below is pension information related to Roberts Corp. for the year 2012:
Service cost
36,000
Interest on projected benefit obligation
12,000
Amortization of prior service cost due to increase in benefits
6,000
Expected return on plan assets
8000
The amount of pension expense to be reported for 2012 is
a.
$46,000
b.
$48,000
c.
$54,000
d.
$40,000
8. A minimum liability for pension expense is reported when
a.
the projected benefit obligation exceeds the fair value of pension plan assets.
b.
the pension expense reported for the period is greater than the funding amount for the
same period.
c.
the accumulated benefit obligation exceeds the fair value of pension plan assets.
d.
vested benefits exceed the fair value of pension plan assets.
9. Gorilla, Corp. implemented a defined-benefit pension plan for its employees on January 2, 2012. The
following data are provided for year 2012, as of December 31
Accumulated benefit obligation
$103,000
Plan assets at fair value
78,000
Net period pension expense
90,000
Employer’s contribution
70,000
What amount should Gorilla record as additional minimum pension liability at December 31, 2012?
a.
$0
b.
$5,000
c.
$20,000
d.
$45,000
9-3
10. The major difference between accounting for pensions and the accounting for other postretirement
benefits is that firms
a.
do not need to report an excess of the accumulated benefits obligations over assets in a
postretirement benefits fund as a liability on the balance sheet.
b.
do not need to disclose any estimates used in calculating projected benefits.
c.
postretirement benefits are normally not material for most companies and do not need to
be disclosed.
d.
do not need to set aside funds for future postretirement benefits as they do for pension
benefits.
11. To calculate a company’s average tax rate an analyst would
a.
Divide income tax payable by income before taxes
b.
Divide income tax expense by income before taxes
c.
Multiply the statutory income tax rate by income before tax
d.
Average a firm’s Federal, State, Local and Foreign tax rates.
Falcon Networks
Falcon Networks is a leading semiconductor company with operations in 17 different countries.
Information about the company’s taxes appears below:
Falcon Networks
Components of Income Tax Expense
(in millions)
2012
2011
Current – Federal
$ 55.65
$ 47.52
– Foreign
83.85
78.95
– State and Local
14.69
12.5
Total Current
$154.19
$138.97
Deferred – Federal
$ 30.28
$ 42.90
– Foreign
23.89
14.58
Total Deferred
$ 54.17
$ 57.48
Total Income Tax Expense
$208.36
$196.45
Note: Falcon Networks has no current liability at year-end with
respect to total current taxes.
Components of Income before Taxes
2012
2011
United States
$256.35
$253.68
Foreign
236.85
198.85
Total
$493.20
$452.53
12. Based on the information provided by Falcon Networks how much cash did income taxes use during
2012?
9-4
a.
$154.19 million
b.
$54.17 million
c.
$208.36 million
d.
$284.84 million
13. Using the information provided by Falcon Networks determine the combined effective tax rate for
2012.
a.
33.52%
b.
35.00%
c.
42.25%
d.
45.49%
14. Using the information provided by Falcon Networks determine the federal effective tax rate for 2012.
a.
33.52%
b.
35.00%
c.
42.25%
d.
45.49%
15. Using the information provided by Falcon Networks determine the foreign effective tax rate for 2012.
a.
33.52%
b.
35.00%
c.
42.25%
d.
45.49%
16. Which of the following accounts would not be considered a reserve account?
a.
Allowance
for Doubtful Accounts
b.
Estimated Warranty Liability
c.
Prepaid Expense
d.
Accumulated Depreciation
17. Analysts concerns with postretirement benefits include all of the following except:
a.
should the underfunded postretirement benefit obligation be added to liabilities in
assessing risk?
b.
How reasonable are the firms’ assumptions regarding health care cost increases?
c.
Is the postretirement benefit fund adequately paying benefits.
9-5
d.
Is the postretirement benefit fund generating returns consistent with the expected rate of
return?
18. Which of the following calculations is used to determine the amount of the liability reported on the
balance sheet for underfunding?
a.
Plan assets less projected benefit obligation.
b.
Projected benefit obligation less plan assets.
c.
Plan assets less accumulated benefit obligation.
d.
Accumulated benefit obligation less plan assets.
19. All of the following are true regarding accrual accounting except:
a.
Accrual basis measures operating success by the extent to which accomplishments exceed
efforts.
b.
Accrual basis measures operating success by the extent to which revenues exceed
expenses.
c.
Accrual basis reports operating activities in terms of their success in generating value.
d.
Accrual basis for the recognition of expenses is not required under IFRS.
20. All of the following are conditions for revenue recognition outlined by SAB 104 except:
a.
There is pervasive evidence that an arrangement exists.
b.
Delivery has occurred or services have been performed.
c.
The seller’s price to the buyer can be variable.
d.
Collectability is reasonably assured.
21. Which of the following statements best describes the difference between U.S. GAAP and IFRS with
respect to revenue recognition?
a.
IFRS has a substantial amount of industry specific guidance for revenue recognition.
b.
IFRS revenue recognition is not consistent with U.S. GAAP in principle.
c.
There are subtle differences in the wording of U.S. GAAP as compared with IFRS.
d.
IFRS has four criteria and U.S. GAAP has five conditions for revenue recognition.
22. All of the following conditions signal that revenue recognition may have been recorded too early
except:
a.
large and volatile amounts of uncollectible accounts receivable.
b.
a decrease in the number of days accounts receivable are outstanding.
c.
unusually large amounts of returned goods.
d.
excessive warranty expenditures.
23. Which of the following will most likely help identify an increasing proportion of uncollectible sales?
a.
accounts receivable turnover
b.
the ratio of bad debt expense to sales
c.
the ratio of sales returns to sales
d.
the ratio of cost of sales to sales
9-6
24. All of the following are considered by analysts when assessing the quality of accounting except:
a.
Price variation and the speed at which inventory turns over
b.
Any liquidation of FIFO inventory layers
c.
Any physical deterioration or obsolescence of inventory
d.
The inventory cost-flow assumption chosen by management
25. Which of the following is not part of the balance sheet approach when computing income tax
expense?
a.
Identifying at each balance sheet date all differences between the book basis of assets,
liabilities, and tax loss carryforwards
b.
Eliminating permanent differences between book and tax basis.
c.
Eliminating deferred tax assets.
d.
Assessing the likelihood that the firm will realize the benefits of deferred tax assets in
the future.
26. Typical U.S. GAAP disclosures for deferred income taxes include all of the following except:
a.
Components of income tax expense
b.
Components of income before taxes
c.
Reconciliation of income taxes at statutory rate with income tax expense
d.
Components of permanent tax differences
27. If the portions of the firm’s foreign operations in higher-tax-rate countries grew more rapidly than
foreign operations in lower-tax-rate countries, the company may seek out more tax effective ways of
operating abroad through all of the following means except:
a.
Assess whether transfer prices or cost allocations can be adjusted to shift income
from high-tax-rate to low-tax-rate jurisdictions.
b.
Shift from domestic to foreign borrowing to increase deductions for interest against
foreign-source income.
c.
Shift from debt to equity financing of foreign operations to increase interest deductions
against foreign-source income.
d.
Shift some operations, like marketing, to the United States where the average tax rate is
lower.
28. A typical defined benefit pension plan formula includes all of the following except:
a.
the number of years of employee service
b.
the fair market value of pension plan assets
c.
a credit for each year of annual service
d.
the final salary at retirement date
29. All of the following are events that can change the projected benefit obligation (PBO) during a period
except:
a.
The payment of retirement benefits.
b.
Amendments to the pension plan agreement
c.
The interest accumulated on the liability.
d.
All of these can change the PBO.
30. All of the following are most likely to change the FMV of pension plan assets during a given period
except:
a.
Employer cash payments are made to the plan trustee.
b.
Changes in Internal Revenue Service regulations for future tax deductible amounts of
contributions.
c.
Actual returns on invested plan assets.
d.
Retirement benefits paid.
31. Regarding actuarial assumptions, firms must disclose in notes to the financial statements all of the
following except:
a.
the discount rate used to compute the pension benefit obligation.
b.
the expected rate of return on pension investments.
c.
estimates of the number of retirees over the future 10 years.
d.
the rate of compensation increase.
32. Which of the following is not a disclosure for derivatives required under SFAS No. 133?
a.
Firms must describe their risk management strategy and how particular derivatives
help accomplish their hedging objectives.
b.
For fair value and cash flow hedges, firms must disclose the net gain or loss recognized
in earnings resulting from the hedges’ ineffectiveness and the line item on the income
statement that includes this net gain or loss.
c.
For cash flow hedges, firms must describe the transactions or events that will result
in reclassifying gains and losses from other comprehensive income to net income
and the estimated amount of such reclassifications during the next 12 months.
d.
The specifics of a model that simulates with a 95 percent or other confidence level the
minimum, maximum, or average amount of loss that a firm would incur.
33. Under current U.S. GAAP unrealized gains and losses from four balance sheet items are reported in
accumulated other comprehensive income or loss. Which of the following is not one of the balance
sheet items?
a.
Derivatives held as cash flow hedges.
b.
Deferred tax assets related to net operating loss carryforwards.
c.
Minimum pension obligations.
d.
Investment securities classified as available for sale.
34. Which of the following would not be suggestive of a company recognizing sales too early?
a.
large and volatile amounts of uncollectible accounts receivable
b.
excessive warranty expenditures
c.
large growth in accounts receivable
d.
unusually large amount of returned goods
35. When input prices are increasing, companies that use the LIFO method of accounting for inventory
will report
a.
Lower cost of goods sold amounts in comparison to the FIFO method
b.
Higher sales amounts in comparison to the FIFO method
c.
Higher ending inventory amounts in comparison to the FIFO method
d.
Lower gross profit margins in comparison to the FIFO method
36. Upton Company has consistently used the percentage-of-completion method of recognizing income. In
2010, Upton started on an $18,000,000 construction contract that was completed in 2012. The
following information was taken from Upton’s 2010 accounting records:
Progress billing
Costs incurred
Collections
Estimated costs to complete
What amount of revenue should Upton recognize on the contract in 2010?
a.
$6,000,000
b.
$5,400,000
c.
$9,000,000
d.
$0
33.3% x $18,000,000 = $6,000,000
37. Under the completed contract method
a.
revenue and cost are recognized during the production cycle, but gross profit recognition
is deferred until the contract is completed.
b.
revenue, cost, and gross profit are recognized during the production cycle.
c.
revenue, cost, and gross profit are recognized at the time the contract is completed.
d.
none of these
38. An inventory pricing procedure in which the current costs have a direct impact on the inventory is:
a.
FIFO
b.
LIFO
c.
Base stock
d.
Weighted-average
39. The installment method of revenue recognition can be used when cash collectibility is uncertain. The
installment method
a.
requires that no income is recognized until all installments are received.
b.
requires that gross profit is recognized as each installment payment is received.
c.
requires that entire cost of the sale be recovered prior to any income being recognized.
d.
allows revenue recognition at the time of the sale.
9-9
Parnell Industries
Parnell Industries sold a copy machine to Ranger Inc. on January 1, 2012. The sale price of the
machine was $4,000,000 and the machine cost $3,200,000 for Parnell to manufacture. Ranger will
make four payments at the end of each year, beginning with 2012, of $1,261,883 each. The four
payments of $1,261,883 when discounted at 10% have a present value of $4,000,000. An amortization
table appears below:
Interest
Repay.
Note Rec.
Revenue
Cash Pmt
of
Note Rec.
Year
Jan. 1
at 10%
Rec’d
Princ.
Dec. 31
2012
$4,000,000
$ 400,000
$1,261,883
$ 861,883
$3,138,117
2013
3,138,117
313,812
1,261,883
948,071
2,190,046
2014
2,190,046
219,005
1,261,883
1,042,878
1,147,168
2015
1,147,168
114,716
1,261,883
1,147,168
0
$1,047,533
$5,047,532
$4,000,000
40. If Parnell Industries is certain that it will collect all four payments from Ranger Inc. what amount of
gross profit should Parnell recognize in 2012 from the sale?
a.
$0
b.
$861,883
c.
$172,377
d.
$800,000
41. If Parnell Industries is uncertain that it will collect all four payments from Ranger Inc. and uses the
installment method of accounting for revenue recognition what amount of gross profit should Parnell
recognize in 2012 from the sale?
a.
$0
b.
$861,883
c.
$172,377
d.
$800,000
42. If Parnell Industries is uncertain that it will collect all four payments from Ranger Inc. and uses the
cost recovery method of accounting for revenue recognition what amount of gross profit should
Parnell recognize in 2012 from the sale?
a.
$0
b.
$861,883
c.
$172,377
d.
$800,000
43. A LIFO liquidation during periods when prices are increasing results in a company
a.
recording a large inventory write down.
b.
recording higher earnings than it would have if it had used FIFO.
c.
recording lower earnings than it would have if it had used FIFO.
d.
having operational problems, but no financial statement effects.
Playtime Corporation
Assume that Playtime Corp. has agreed to construct a new playground for SurreyCounty for
$2,450,000. Construction of the new playground will begin on March 17, 2012 and is expected to be
completed in August 2013. At the signing of the contract Playtime Corp. estimates that the it will cost
$1,750,000 to build the playground.
44. At the end of 2012 Funtime provided the following information about the project:
Costs incurred
Estimated costs
Year
to date
remaining
2012
$1,200,000
$600,000
If Playtime uses the percentage of completion to recognize revenue on the long-term contract how
much gross margin should Playtime recognize in 2012?
a.
$389,200
b.
$278,000
c.
$556,000
d.
$433,550
45. At the end of 2012 Funtime provided the following information about the project:
Costs incurred
Estimated costs
Year
to date
remaining
2012
$1,200,000
$600,000
What percentage is playground complete?
a.
62.5%
b.
66.7%
c.
55.6%
d.
50.0%
COMPLETION
1. A derivative has one or more ____________________, which are a specified interest rate, commodity
price, foreign exchange rate, or other variable.
2. Derivative instruments acquired to hedge exposure to variability in expected future cash are
_________________________ hedges.
3. Gains and losses on cash flow hedges affect earnings ____________________ than those on fair value
hedges.
4. The _____________________________________________ is equal to the actuarial present value of
amounts that the employer expects to pay to retired employees based on the employees’ service to date
and using expected future salary amounts.
5. Dividing a company’s income tax expense by its book income before income taxes provides the
company’s ___________________________________.
6. Deferred tax assets result in future tax ____________________ when temporary differences reverse.
7. Deferred tax liabilities result in future tax ____________________ when temporary differences
reverse.
8. When firms use derivatives effectively to manage risks, the net gain or loss each period should be
relatively ____________________.
9. U.S. GAAP requires firms to report the assets and liabilities of defined benefit plans
_______________________________________________________.
9-12
10. Income tax expense consists of two components, the ____________________ portion and the
____________________ portion.
11. Differences between income before taxes and taxable income are either ____________________ or
____________________.
12. Recording municipal bond interest received in the general ledger will generate a _________________
difference
13. ____________________ differences result from including revenues and expenses in income before
taxes in a different period than those items affect taxable income.
14. The statement of cash flows allows the accountant to agree the net cash provided to the
_________________________ the general ledger
15. Derivative instruments acquired to hedge exposure to changes in the fair value of an asset or liability
are ______________________________ hedges.
16. Companies that engage in long-term contracts can recognize income using either the
_____________________________________________ method or the
________________________________________ method.
17. A contractor would not use ________________________________________ method of income
recognition when there is substantial uncertainty regarding the total costs it will incur in completing
the project.
18. When cash collectibility is uncertain the ___________________________________ method matches
the costs of generating revenues dollar for dollar with cash receipts until the firm recovers all such
costs.
19. When cash collectibility is uncertain, a firm using the ____________________ method recognizes
revenue as it collects portions of the selling price in cash.
20. Under the accrual method of accounting when a firm has substantially completed its value-adding
activities it should recognize ____________________.
21. One sign that a company may be recognizing sales too early is that it has unusually large amounts of
______________________________.
22. The difference between the economic resources received from customers and the economic resources
paid to suppliers, employees and other providers of goods and services is called
____________________.
23. A company that uses FIFO will find that its ___________________________________ account tends
to be somewhat out of date.
24. A company that uses LIFO will find that its ______________________________ account will be
somewhat out of date.
9-14
25. A company that uses LIFO will experience a ______________________________ during a period it
sells more units than it purchases.
26. Although LIFO generally provides higher quality earnings measures, FIFO generally provides higher
_____________________________________________ measures.
27. The process of allocating the historical cost of certain assets to the periods of their use in a reasonably
systematic manner is referred to as ____________________.
28. ___________________________________ is primarily a question of timing.
SHORT ANSWER
1. Please answer the following questions about defined benefit pension plans:
1.
Companies with defined benefit pension plans must recognize pension expense each period.
What are the five components of pension expense? Briefly describe each component.
2.
How does each component of pension expense effect pension expense during the period
(increase, decrease, or uncertain)?
3.
What is the difference between the accumulated pension obligation and the projected pension
obligation?
4.
What determines whether a pension plan is underfunded or overfunded?
1.
Expected Return on Pension Investments – the expected change in the market value of
d.
Amortization of Prior Service Cost – the amortization of any plan changes that
increase future benefits.
when actual returns differ from expectations and when the actuarial assumptions
9-15
2. Accountants use reserve accounts for various reasons, for each of the scenarios below describe a
specific account example that matches the scenario.
1.
The use of a reserve account in order to match expense with revenues.
2.
The use of a reserve account in order to keep expense out of the income statement.
3.
The use of a reserve account in order to revalue an asset, but delay the income
recognition effect.
States) or Reserve for Retirement Benefits (Accrued Retirement Liability in the United
3. Derivative instruments acquired to hedge exposure may be classified as either a fair value hedge or a
cash flow hedge. Distinguish between the two types of hedges.
9-17
4. A company may try to paint a favorable picture of itself by accelerating the timing of revenues or
estimating the collectible amounts too aggressively. In these cases the quality of accounting
information declines because it does not represent the company’s true economic condition and may
not be sustainable. List four conditions which might suggest that a company is recognizing revenues
too early?
5. Assume that Madison Corp. has agreed to construct a new basketball arena for Gator Town for $70
million dollars. Construction of the new arena begins in July, 2012 and is expected to be completed in
March 2009. At the signing of the contract Madison Corp. estimates that the new arena will cost $60
million dollars to build. Given the following cost and building schedule determine the cumulative
degree of completion and how much revenue and gross margin Madison Corp. should recognize in
years 2012, 2013 and 2014.
Costs incurred
Estimated costs
Year
to date
remaining
2012
$18,000,000
$42,000,000
2013
$48,000,000
$12,000,000
2014
$60,000,000
$0
Year
to date
Complete
Revenue
Margin
2012
$18,000,000
30%
$21 M
$3 M
2013
$48,000,000
80%
$35 M
$5 M
2014
$60,000,000
100%
$14 M
$2 M
6. Pronto, Inc. is a major producer of printing equipment. Pronto uses a LIFO cost-flow assumption for
inventories. The company’s tax rate is 35%. Below is selected financial data for the company.
Pronto, Inc.
Selected Financial Data
December 31,
2013
2012
2011
(amounts in thousands)
Inventories (LIFO)
$ 48,454
$ 42,369
$ 45,388
Total Assets
395,685
384,545
378,122
Common Shareholders’ Equity
102,754
98,564
89,455
Sales
$546,258
$488,965
Cost of Goods Sold
393,857
348,920
Interest Expense
14,253
15,689
Net Income
24,581
21,025
1.
Large and volatile amounts of uncollectible accounts receivable.
2.
Unusually large amounts of returned goods.
3.
Excessive warranty expenditures.
4.
A significant increase in days accounts receivable are outstanding.
Required:
a.
The excess of FIFO over LIFO inventories was $25 million on December 31, 2013, $28.5
million on December 31, 2012 and $22 million on December 31, 2011. Compute the cost
of goods sold for Pronto, Inc. for years 2013 and 2012 assuming that it had used a FIFO
assumption.
b.
Compute the inventory turnover ratio for Pronto, Inc. for years 2013 and 2012 using a
LIFO cost-flow assumption.
c.
Compute the inventory turnover ratio for Pronto, Inc. for years 2013 and 2012 using a
FIFO cost-flow assumption.
d.
Compute the rate of return on assets for years 2013 and 2012 based on the reported
amounts. Disaggregate ROA into profit margin and asset turnover components.
e.
Compute the rate of return on assets for years 2013 and 2012 assuming that Pronto, Inc.
had used the FIFO method of accounting for inventories. Disaggregate ROA into profit
margin and asset turnover components.
assumption.
b.
Compute the inventory turnover ratio for Pronto, Inc. for years 2013 and 2012 using a
LIFO cost-flow assumption.
c.
Compute the inventory turnover ratio for Pronto, Inc. for years 2013 and 2012 using a
d.
Compute the rate of return on assets for years 2013 and 2012 based on the reported
amounts. Disaggregate ROA into profit margin and asset turnover components.