Error Correction and Financial Statements

Question: TREPB-0001
Which of the following characteristics does not relate to prior period adjustments?
Answers
A: They can be specifically identified with business activity of a prior period.
B: They have a material effect on income from continuing operations of the

current year.
C: They could not have been reasonably estimated in a prior period.
D: They are attributable to economic events occurring subsequent to prior period

financial statements.
Answer Explanations
A. Answer A is incorrect. Per SFAS 16, one of the characteristics of a prior period
adjustment is that it can be specifically identified with business activity of a prior period.
B. Answer B is incorrect. Per SFAS 16, one of the characteristics of a prior period
adjustment is that it has a material effect on income from continuing operations of the
current year.
C. Answer C is incorrect. Per SFAS 16, one of the characteristics of a prior period
adjustment is that the amount could not have been reasonably estimated in a prior period.
D. Answer D is correct. Per SFAS 16, there are three criteria for a prior period
adjustment. These criteria are as follows: (1) the effect of the adjustment is material to
income from continuing operations, (2) the adjustment can be identified with a prior
period, and (3) the amount of the adjustment could not be estimated in prior periods.
SFAS 16 does not require that a prior period adjustment be attributable to economic
events occurring subsequent to the prior period financial statements.
During 2009, Olsen Company discovered that the ending inventories reported on its
financial statements were understated as follows:
Year Understatement
2006 $50,000
2007 $60,000
2008 $0
Olsen ascertains year-end quantities on a periodic inventory system. These quantities are
converted to dollar amounts using the FIFO cost flow method. Assuming no other
accounting errors, Olsen’s retained earnings at December 31, 2008, will be.
Answers
A: $0
B: $ 60,000 understated.
C: $ 60,000 overstated.
D: $110,000 understated.
Answer Explanations
A. Answer A is correct. If ending inventory is understated, cost of goods sold is

overstated, and net income is, therefore, understated. The opposite is true for
beginning inventory. Since ending inventory of one period is the beginning
inventory of the next period, errors in inventory determination affect income for only
two consecutive periods. Thus, the error in 2006 will be offset in 2007, and the error
in 2007 will be offset in 2008. Since ending inventory is correct in 2008, retained
earnings for 2008 will be correct even though 2008 net income was overstated. This
is summarized in the following table:
2006 2007 2008

Net Income 50,000 under *10,000 under 60,000 over
Retained Earnings 50,000 under 60,000 under -0-
* 2007 NI $10,000 under = $50,000 over + $60,000 under

B. Answer B is incorrect. Refer to the correct answer explanation.
C. Answer C is incorrect. Refer to the correct answer explanation.
D. Answer D is incorrect. Refer to the correct answer explanation.
At the end of 2007, Ritzcar Co. failed to accrue sales commissions earned during 2007
but paid in 2008. The error was not repeated in 2008. What was the effect of this error
on 2007 ending working capital and on the 2008 ending retained earnings balance?
2007 ending 2008 ending

working capital retained earnings
A. Overstated Overstated
B. No effect Overstated
C. No effect No effect
D. Overstated No effect
Answers
A: A.
B: B.
C: C.
D: D.
Answer Explanations
A. Answer A is incorrect. Refer to the correct answer explanation.

D. Answer D is correct. The entry Ritzcar should have made to accrue sales
commissions earned but unpaid at the end of its 2007 fiscal year is
Commission expense xxx

Commissions payable xxx
Since commissions payable is a current liability, the 2007 ending working capital is
overstated due to Ritzcar's failure to record this entry. Since this error was not repeated
at the end of Ritzcar's 2008 fiscal year, the income impact of the 2007 error “self-
corrected” during 2008, when Ritzcar recorded both the earned but unpaid 2007
commissions plus the 2008 earned commissions. Therefore, the 2008 ending retained
earnings would not be impacted by the error.
After the issuance of its 2007 financial statements Terry, Inc. discovered a computational
error of $150,000 in the calculation of its December 31, 2007 inventory. The error
resulted in a $150,000 overstatement in the cost of goods sold for the year ended
December 31, 2007. In October 2008, Terry paid $500,000 in settlement of litigation
instituted against it during 2007. Ignore income taxes. In the 2008 financial statements
the December 31, 2007 retained earnings balance, as previously reported, should be
adjusted by a
Answers
A: $150,000 credit.
B: $350,000 debit.
C: $500,000 debit.
D: $650,000 credit.
Answer Explanations
A. Answer A is correct. All corrections of errors (such as the $150,000
computational error) are treated as prior period adjustments. The $150,000 overstatement
in the cost of goods sold, for the previous year, should be credited to the beginning
balance of retained earnings.
C. Answer C is incorrect. The $500,000 paid in settlement of litigation in 2008 is
not a prior period adjustment. If we assume that the loss had been accrued as a
contingency in 2007, there would be a debit to the liability account established in 2007
If, in 2007 the potential award had not met the criteria of a contingency per SFAS 5 (i.e.,
probable and reasonably estimable), then it would appropriately be considered an expense
of 2008 when paid.
While preparing its 2008 financial statements, Dek Corp. discovered computational errors
in its 2007 and 2006 depreciation expense. These errors resulted in overstatement of
each year’s income by $25,000, net of income taxes. The following amounts were
reported in the previously issued financial statements:
2007 2006
Retained earnings, 1/1 $700,000 $500,000
Net income 150,000 200,000
Retained earnings, 12/31 $850,000 $700,000
Dek’s 2008 income is correctly reported at $180,000. Which of the following amounts
should be adjusted to retained earnings and presented for net income in Dek’s 2008 and
2007 comparative financial statements?
Retained
Year earnings Net income
A. 2007 -- $150,000
2008 ($50,000) 180,000
B. 2007 ($50,000) $150,000
2008 -- 180,000
C. 2007 ($50,000) $125,000
2008 -- 180,000
D. 2007 -- $125,000
2008 -- 180,000
Answers
A: A.
B: B.
C: C.
D: D.
Answer Explanations

C. Answer C is correct. SFAS 16 requires that items of profit or loss related to the
correction of an error in the financial statements of a prior period be accounted for
and reported as prior period adjustments and excluded from the determination of net
income for the current period. Per APB 9, when comparative financial statements are
prepared, it is necessary to adjust net income, its components, retained earnings
balances, and other affected balances for all of the periods presented to reflect
retroactive application of prior period adjustments. Hence, the amounts for each
period must be stated in the comparative statements as if the errors had not occurred.
Thus, both 2006 and 2007 net income and retained earnings would be retroactively
reduced by $25,000 to reflect the correct amounts for each period. After these
adjustments are made, the amounts for 2008 will be correctly stated. Note that this
retroactive treatment is only used for presentation purposes in the comparative
financial statements. The actual journal entry made to correct retained earnings at
1/1/08 is
Retained earnings 50,000

Accumulated depreciation 50,000
Miller Co. discovered that in the prior year, it failed to report $40,000 of depreciation
related to a newly constructed building. The depreciation was computed correctly for tax
purposes. The tax rate for the current year was 40%. What was the impact of the error
on Miller’s financial statements for the prior year?
Answers
A: Understatement of accumulated depreciation of $24,000.
B: Understatement of accumulated depreciation of $40,000.
C: Understatement of depreciation expense of $24,000.
D: Understatement of net income of $24,000.
Answer Explanations
Null
B. Answer B is correct. The requirement is to determine the impact of the error.
The result of this error would have been an understatement of depreciation by $40,000
and understatement of accumulated depreciation by $40,000 and an overstatement of net
income by $24,000 [$40,000 × (1 – 4)].
Null Null
Question: TREPD-0001
The following expenses were among those incurred by Sayre Company during 2008.
Accounting and legal fees $160,000

Interest 60,000
Loss on sale of office equipment 25,000
Rent for office space 200,000
One-quarter of the rented premises is occupied by the sales department. How much of
the expenses listed above should be included in Sayre’s general and administrative
expenses for 2008?
Answers
A: $310,000
B: $335,000
C: $360,000
D: $370,000
Answer Explanations
A. Answer A is correct. The accounting and legal fees ($160,000) and the portion
of office rent not allocable to sales (3/4 x $200,000 = $150,000) are all considered
general and administrative expenses. Therefore, general and administrative expense
should be $310,000 ($160,000 + $150,000). In addition, the interest expense ($60,000)
would be included with financial expense or other expenses. The $25,000 loss on the
sale of office equipment should be included in other expenses and losses. The office rent
for the sales department (1/4 x $200,000 = $50,000) is an operating expense and included
in selling expenses rather than general and administrative expenses.
Coffey Corp.’s trial balance of income statement accounts for the year ended December
31, 2008, was as follows:
Debit Credit
Net sales $1,600,000
Cost of goods sold $960,000
Selling expenses 235,000
Administrative 150,000
expenses
Interest expense 25,000
Loss from
discontinued
operation 40,000
Extraordinary loss 10,000 _______
$1,420,000 $1,600,000
Coffey’s income tax rate is 30%. Coffey prepares a multiple-step income statement for
2008. Income from operations before income tax is
Answers
A: $190,000
B: $200,000
C: $230,000
D: $240,000
Answer Explanations

C. Answer C is correct. All of the accounts given in the trial balance are components of
income from operations before income tax except for the adjustment due to loss on
discontinued operation and the extraordinary loss. The discontinued operation
($40,000) is reported, net of tax, as a separate component of income after income
from operations, in accordance with SFAS 144. Per APB 30, the extraordinary loss
is presented (net of taxes) after income from operations. Therefore, income from
operations before income tax is $230,000, as computed below.

Less expenses ($960,000 + $235,000 + $150,000 + 1,370,000
$25,000)
$ 230,000
Coffey Corp.’s trial balance of income statement accounts for the year ended December
31, 2008, was as follows:
Debit Credit
Cost of goods sold $ 960,000
Selling expenses 235,000
Administrative expenses 150,000
Interest expense 25,000
Loss from discontinued
operation 40,000
Extraordinary gain ________ 10,000
$1,410,000 $1,610,000
Coffey’s income tax rate is 30%. Coffey prepares a multiple-step income statement for
2008. Net income is
Answers
A: $140,000
B: $161,000
C: $168,000
D: $200,000
Answer Explanations
A. Answer A is correct. Income from operations before income tax is $230,000

($1,600,000 – $960,000 - $235,000 - $150,000 – $25,000). Income tax expense, the
extraordinary gain (net of taxes) and the cumulative effect adjustment (net of taxes)
must be included in the computation of net income, as illustrated below.
Income from ops. before taxes $230,000
Income tax expense (30% × $230,000) (69,000)
Income before extraordinary items and cum. effect 161,000
Loss from discontinued operation (net of $12,000 tax) (28,000)
Extraordinary gain (net of $3,000 tax) 7,000
Net income 140,000
A shortcut approach is to subtract the income statement debits ($1,410,000) from the
income statement credits ($1,610,000), giving a result of $200,000. From this amount,
the tax effect of $60,000 (30% × $200,000) must be subtracted, resulting in net income of
$140,000.
The effect of a material transaction that is infrequent in occurrence but not unusual in
nature should be presented separately as a component of income from continuing
operations when the transaction results in a
Gain Loss
A. Yes Yes
B. Yes No
C. No No
D. No Yes
Answers
A: A.
B: B.
C: C.
D: D.
Answer Explanations
A. Answer A is correct. APB 30 states that a material event or transaction which is

considered to be unusual in nature or infrequent in occurrence (but not both) that results
in either a gain or a loss should be presented as a separate component of income from
continuing operations.
How should an unusual event not meeting the current criteria for an extraordinary item be
disclosed in the financial statements?
Answers
A: Shown as a separate item in operating revenues or expenses and supplemented
by a footnote if deemed appropriate.
B: Shown in operating revenues or expenses but not shown as a separate item.
C: Shown after ordinary net earnings but before extraordinary items.
D: Shown after extraordinary items net of income tax but before net earnings.
Answer Explanations
A. Answer A is correct because items unusual in nature or infrequent in occurrence

are to be disclosed separately in the operating section of the income statement and also
may be supplemented by a footnote (APB 30). Note that such items should not be shown
net of income taxes.
During 2008 Kerr Company sold a parcel of land used as a plant site. The amount Kerr
received was $100,000 in excess of the land’s carrying amount. Kerr’s income tax rate
for 2008 was 30%. In its 2008 income statement, Kerr should report a gain on sale of
land of
Answers
A: $0
B: $ 30,000
C: $ 70,000
D: $100,000
Answer Explanations

D. Answer D is correct. Generally, gains and losses on the sale of land are not
accorded special treatment. The entire $100,000 gain should, therefore, be included in
income before taxes. The gain is not reported as an extraordinary item because it does
not meet the criteria of unusual and infrequent.
Ball Corporation had the following infrequent gains during 2008:
A $240,000 gain on sale of a plant facility; Ball continues similar operations at

another location.
A $90,000 gain on repayment of a long-term note denominated in a foreign currency.
A $190,000 gain on reacquisition and retirement of bonds.
In its 2008 income statement, how much should Ball report as total infrequent gains
which are not considered extraordinary?
Answers
A: $520,000
B: $430,000
C: $330,000
D: $280,000
Answer Explanations
A. Answer A is correct. Per APB 30, extraordinary items are material items which
are both unusual in nature and infrequent in occurrence. Neither a sale of plant facility
nor a foreign currency transaction is unusual in nature. Therefore, these two items would
be reported as infrequent but not extraordinary. In addition, the gain on retirement of
debt is no longer classified as extraordinary (SFAS 145). Note that the sale of the plant
facility is not classified as discontinued operations because similar operations are carried
on at another location (SFAS 144).
Thorpe Co.’s income statement for the year ended December 31, 2008, reported net
income of $74,100. The auditor raised questions about the following amounts that had
been included in net income:
Unrealized loss on decline in market value of

available-for-sale marketable equity securities $(5,400)
Gain on early retirement of bonds payable 33,000
Adjustment to profits of prior years for errors in
depreciation (net of $3,750 tax effect) (7,500)
Loss from fire (net of $7,000 tax effect) (14,000)
Thorpe did not elect the fair value option for reporting any of its financial assets. The
loss from the fire was an infrequent but not unusual occurrence in Thorpe’s line of
business. Thorpe’s December 31, 2008 income statement should report net income of
Answers
A: $65,000
B: $66,100
C: $81,600
D: $87,000
Answer Explanations

D. Answer D is correct. Net income as reported ($74,100) properly included the
gain on early retirement of bonds payable ($33,000) and the loss from fire ($14,000).
The fact that the loss was reported net of taxes in the income statement was incorrect, but
does not cause the net income amount to be in error. However, the other two items
should not be reported in the income statement. If Thorpe does not elect the fair value
option, the rules of SFAS 115 apply. Therefore, an unrealized loss on available-for-sale
investments in stock ($5,400) is reported in “other comprehensive income,” net of tax
under one of three acceptable alternatives and as part of “accumulated other
comprehensive income” in the stockholders' equity section. A correction of an error
($7,500) is treated as a prior period adjustment. It is reported in the financial statements
as an adjustment to the beginning balance of retained earnings, rather than in the income
statement. Since both of these items were subtracted in the computation of reported net
income, they must be added back to compute the correct net income of $87,000 ($74,100
+ $5,400 + $7,500).
When a company discontinues an operation and disposes of the discontinued operation
(component), the transaction should be included in the earnings statement as a gain or
loss on disposal reported as
Answers
A: A prior period adjustment.

B: An extraordinary item.
C: An amount after continuing operations and before extraordinary items.
D: A bulk sale of fixed assets included in earnings from continuing operations.
Answer Explanations

B. Answer B is incorrect because to qualify as an extraordinary item an event must
be both unusual in nature and infrequent in occurrence. Discontinued operations would
not be an extraordinary item.
C. Answer C is correct because both the gain or loss from discontinued operations
and the gain or loss on sale of the segment should be shown after income from continuing
operations, but before any extraordinary items (APB 30).
Which of the following is not normally an example of an exit activity?
Answers
A: Sale or termination of a line of business.
B: Changes in management structure.
C: Relocation of busines activities from one location to another.
D: Outsourcing a customer service.
Answer Explanations
A. Answer A is incorrect. This is an example of an exit activity.

B. Answer B is incorrect. This is an example of an exit activity.
C. Answer C is incorrect. This is an example of an exit activity.
D. Answer D is correct. This would normally not be of sufficient significance to
constitute an exit activity.
Gordon, Inc. is engaged in the process of restructuring its business. As a part of the
restructuring, Gordon is going to pay onetime termination benefits to involuntarily
terminated employees. Which of the following is true about the accounting for this cost?
Answers
A: The cost should be recorded when the employees are paid.
B: A liability for the cost should be recorded when the liability has been incurred.
C: The cost should be recorded as a prior period adjustment.
D: The cost should be amortized over the expected average life of the remaining
employees.
Answer Explanations

B. Answer B is correct. Termination benefits are exit costs that are recognized
when they are incurred.
On January 1, 2008, Dart, Inc. entered into an agreement to sell the assets and
product line of its Jay Division, considered a segment of the business. The sale
was consummated on December 31, 2008, and resulted in a gain on disposition of
$400,000. The division’s operations resulted in losses before income tax of
$225,000 in 2008 and $125,000 in 2007. Dart’s income tax rate is 30% for both
years. In a comparative statement of income for 2008 and 2007, Dart should
report a gain (loss) from discontinued operations for the years 2008 and 2007 of
2008 2007
A. $ $0
122,500
B. $ $(87,500
122,500 )
C. $(157,500 $(87,500
) )
D. $(157,500 $0
)
Answers
A: A.
B: B.
C: C.
D: D.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation.
B. Answer B is correct. SFAS 144 requires that “financial statements of current and
prior periods. . . should disclose the results of the operations of the disposed component,
less applicable taxes, as a separate component of income. . . .” Therefore, the
discontinued operations should be reported separately, net of taxes, for both 2008 and
2007. The computations are
2008 2007
Discontinued operations:
Loss from operating discontinued segment -0- $(87,500)**
Gain on disposal of discontinued segment 122,500* -0-
Loss from discontinued operations $122,500 $(87,500)
* [($400,000 – $225,000) – 30% ($400,000 – $225,000)].

** [$125,000 – (30% x $125,000)].
The following condensed statement of income of Helen Corporation, a diversified
company, is presented for the two years ended December 31, 2008 and 2007:
2008 2007
Net sales $10,000,000 $9,600,000
Cost of sales 6,200,000 6,000,000
Gross profit 3,800,000 3,600,000
Operating expenses 2,200,000 2,400,000
Operating income 1,600,000 1,200,000
Gain on sale of division 900,000 ________
2,500,000 1,200,000
Provision for income taxes 1,000,000 480,000
Net income $ 1,500,000 $ 720,000
On January 1, 2008, Helen entered into an agreement to sell for $3,200,000 the assets and
product line of one of its separate operating divisions. The sale was consummated on
December 31, 2008, and resulted in a gain on disposition of $900,000. This division’s
contribution to Helen’s reported income before income taxes for each year was as
follows:
2008 $(640,000) loss
2007 $(500,000) loss
Assume an income tax rate of 40%. In the preparation of a revised comparative

statement of income, Helen should report income from continuing operations after
income taxes for 2008 and 2007, respectively, amounting to
Answers
A: $1,344,000 and $ 720,000
B: $1,344,000 and $1,020,000
C: $1,500,000 and $ 720,000
D: $1,500,000 and $1,020,000
Answer Explanations

B. Answer B is correct. The requirement is to determine the amount of income
from continuing operations after income taxes for 2008 and 2007 to be
reported on a revised comparative income statement. Helen discontinued a
component in 2008. SFAS 144 requires that “financial statements of current
and prior periods . . . should disclose the results of operations of the disposed
segment, less applicable taxes, as a separate component of income . . . .”
Therefore, the discontinued operations should be reported separately, net of
taxes, for both 2008 and 2007. Income from continuing operations must be
adjusted so the effect of the discontinued segment is taken out.
2008 2007
Operating income, as reported $1,600,000 $1,200,000
Add back loss from discontinued operations 640,000 500,000
Income from continuing operations, before taxes 2,240,000 1,700,000
Less 40% income taxes 896,000 680,000
Income from continuing operations $1,344,000 $1,020,000

A transaction that is unusual in nature and infrequent in occurrence should be reported
Answers
A: After discontinued operations of a segment of a business.
B: Before cumulative effect of accounting changes and before discontinued

operations of a segment of a business.
C: As an operating expense on the income statement.
D: As other income or other loss on the income statement.
Answer Explanations
A. Answer A is correct because per APB 30, a transaction that is unusual in nature
and infrequent in occurrence is considered an extraordinary item. An extraordinary item
is reported after discontinued operations. APB 30 indicates that results for discontinued
operations are to be reported before extraordinary items. SFAS 154 requires that an
accounting change is accounted for on a retrospective basis.
B. Answer B is incorrect. Per SFAS 154, cumulative effect of accounting changes
are no longer reported at the bottom of the income statement.
C. Answer C is incorrect because a transaction which is unusual in nature and infrequent
in occurrence is considered an extraordinary item.
D. Answer D is incorrect because a transaction which is unusual in nature and
infrequent in occurrence is considered an extraordinary item, and reported after
discontinued operations.
Which of the following items, if material, should be presented in the income statement
separately as a component of income, net of applicable income taxes?
Answers
A: Write-off of goodwill.
B: Losses due to a strike.
C: Losses from translation of foreign currencies.
D: Earthquake loss.
Answer Explanations
A. Answer A is incorrect because the write-off of goodwill is specifically

disallowed as an extraordinary item by APB 30.
B. Answer B is incorrect because losses due to a strike are specifically disallowed as
extraordinary items by APB 30.
C. Answer C is incorrect because losses from translation of foreign currencies are
specifically disallowed as extraordinary items by APB 30.
D. Answer D is correct. An earthquake loss would generally be unusual and
infrequent, meeting the definition of an extraordinary item.
On July 1, 2007, an erupting volcano destroyed Coastal Corporation’s operating plant,
resulting in a loss of $1,500,000, of which only $500,000 was covered by insurance.
Coastal’s income tax rate is 30%. How should this event be shown in Coastal’s income
statement for the year ended December 31, 2007?
Answers
A: As an operating loss of $700,000, net of $300,000 income tax.
B: As an extraordinary loss of $700,000, net of $300,000 income tax.
C: As an operating loss of $1,000,000.
D: As an extraordinary loss of $1,000,000.
Answer Explanations

B. Answer B is correct. To qualify as an extraordinary item an event must be both
unusual and infrequent. A volcanic eruption would generally meet these criteria
(APB 30). Per APB 30, extraordinary items should be shown net of taxes in a
separate section in the income statement.
Loss from volcano ($1,500,000 – $500,000) $1,000,000
Less: Tax effect (30% tax rate) (300,000)
Net loss after tax effect $ 700,000

A company changes from the double-declining balance method of depreciation for
previously recorded assets to the straight-line method. According to SFAS 154, the
effect of the change should be reported separately as a(n)
Answers
A: Extraordinary item.
B: Component of income after extraordinary items.
C: Component of income from continuing operations on a prospective basis.
D: Prior period adjustment.
Answer Explanations
A. Answer A is incorrect because a switch from the double-declining method to the

straight-line method is a change in accounting estimate effected by a change in
accounting principle and is accounted for on a prospective basis.
B. Answer B is incorrect because SFAS 154 treats change in depreciation methods
as a change in accounting estimate, and the change is handled on a prospective basis in
the current and future periods.
C. Answer C is correct. SFAS 154 requires changes in depreciation method to be
treated as a change in estimate and handled on a prospective basis.
D. Answer D is incorrect because a change in accounting principle does not meet
the criteria for a prior period adjustment, which is reported as an adjustment to beginning
retained earnings.
According to SFAS 154, the cumulative effect of changing to a new accounting principle
should be included in net income of
Future The period

periods of change
A. No No
B. Yes No
C. Yes Yes
D. No Yes
Answers
A: A.
B: B.
C: C.
D: D.
Answer Explanations
A. Answer A is correct. Per SFAS 154, a change in accounting principle is
accounted for through retrospective application to all prior periods, unless it is
impracticable to do so.
D. Answer D is incorrect. APB 20 has been superseded by SFAS 154.
The cumulative effect of an accounting change should generally be given retrospective
application for a
Change in Change in
accounting principle accounting entity
A. Yes Yes
B. Yes No
C. No Yes
D. No No
Answers
A: A.
B: B.
C: C.
D: D.
Answer Explanations
A. Answer A is correct. Per SFAS 154, a change in accounting principle and a

change in accounting entity are accounted for by retrospective application.
The correction of an error in the financial statements of a prior period should be reflected,
net of applicable income taxes, in the current
Answers
A: Income statement after income from continuing operations and before
extraordinary items.
B: Income statement after income from continuing operations and after

extraordinary items.
C: Retained earnings statement as an adjustment of the opening balance.
D: Retained earnings statement after net income but before dividends.
Answer Explanations
A. Answer A is incorrect. The correction of an error is never to be shown on the

income statement.
B. Answer B is incorrect. The correction of an error is never to be shown on the
income statement.
C. Answer C is correct because the correction of an error in the financial statements
of a prior period is a prior period adjustment (SFAS 154) which is to be shown net of tax
as an adjustment to the beginning balance of retained earnings (APB 9).
D. Answer D is incorrect because the correction of an error is to be shown net of tax
on the retained earnings statement as an adjustment to the beginning balance (APB 9) and
not between net income and dividends.
What is the purpose of reporting comprehensive income?
Answers
A: To report changes in equity due to transactions with owners.
B: To report a measure of overall enterprise performance.
C: To replace net income with a better measure.
D: To combine income from continuing operations with income from

discontinued operations and extraordinary items.
Answer Explanations
A. Answer A is incorrect. Refer to correct answer explanation.

B. Answer B is correct. Per SFAS 130, the purpose of reporting comprehensive
income is to report a measure of overall enterprise performance by displaying all changes
in equity of an enterprise that result from recognized transactions and other economic
events of the period other than transactions with owners in their capacity with owners.
An enterprise should continue to display an amount for net income with equal
prominence to the comprehensive income amount displayed.
C. Answer C is incorrect. Refer to correct answer explanation.
D. Answer D is incorrect. Refer to correct answer explanation.
Which of the following describes how comprehensive income should be reported?
Answers
A: Must be reported in a separate statement, as part of a complete set of financial

statements.
B: Should not be reported in the financial statements but should only be disclosed
in the footnotes.
C: May be reported in a separate statement, in a combined statement of income

and comprehensive income, or within a statement of stockholders' equity.
D: May be reported in a combined statement of income and comprehensive

income or disclosed within a statement of stockholders' equity; separate
statements of comprehensive income are not permitted.
Answer Explanations
A. Answer A is incorrect because it may be presented in any of three formats.

B. Answer B is incorrect because it may be presented in any of three formats.
C. Answer C is correct. The requirement is to describe how comprehensive
income should be reported. Answer C is correct because comprehensive income
may be reported in a separate statement, in a combined statement of income and
comprehensive income, or within a statement of stockholders’ equity.
D. Answer D is incorrect because it may be presented in any of three formats.
Assume the fair value option of SFAS 159 is not elected. Which of the following would
not be an item classified separately under other comprehensive income?
Answers
A: Foreign currency items.
B: Adjustments to record funded status of pension plans.

C: Unrealized gains (losses) on available-for-sale securities.
D: Gains (losses) on sale of treasury stock.
Answer Explanations

B. Answer B is incorrect. Refer to correct answer explanation.
D. Answer D is correct. Other comprehensive income items should be classified
based on their nature. Therefore, there should be separate classifications for foreign
currency items, pension liability adjustments, and unrealized gains and losses on certain
investments in debt and equity securities. Gains (losses) on the sale of treasury stock
result from a transaction with owners in their capacity as owners and are not included in
comprehensive income.
Comprehensive income can be displayed in the financial statements in all of the
following formats except
Answers
A: A separate statement that begins with other comprehensive income.
B: A separate statement that begins with net income
C: A continuation of net income presented at the bottom of the income statement.
D: Part of the statement of changes in stockholders’ equity
Answer Explanations
A. Answer A is correct. A separate statement would begin with net income to

determine comprehensive income, not with other comprehensive as stated. The FASB
prefers options B and C. Answers B, C, and D are incorrect because the three formats (a
separate statement that begins with net income, a continuation of net income presented at
the bottom of the income statement, and part of the statement of changes in stockholders'
equity) are all allowable formats according to SFAS 130.
Which of the following is false?
Answers
A: The components of other comprehensive income may be displayed before tax-

related effects with the aggregate income tax effects shown as one amount.
B: Reclassification adjustments shall be made in order to avoid double counting

of items included in other comprehensive income and also in net income.
C: Components of other comprehensive income may not be shown net of tax-

related effects.
D: Other comprehensive income includes revenues, expenses, gains, and losses

that under generally accepted accounting principles are included in
comprehensive income but excluded from net income.
Answer Explanations

C. Answer C is correct. According to SFAS 130, components of other
comprehensive income can be shown either net of tax-related effects or before tax-related
effects with the aggregate income tax effects shown as one amount. Answer A is
incorrect because it is true that components of other comprehensive income may be
displayed before tax-related effects with the aggregate income tax effects shown as one
amount. Answer B is incorrect because classification adjustments shall be made in order
to avoid double counting of items included in other comprehensive income and also in
net income. Answer D is incorrect because revenues, expenses, gains, and losses that
under generally accepted accounting principles are excluded from net income are
included in comprehensive income.
SFAS 130, Reporting for Comprehensive Income, applies to which of the following
entities?
I. Enterprises that develop a full set of financial statements which report
cash flows, results of operations, and financial position.
II. All enterprises even if no items classified as other comprehensive
income exist for the periods presented.
III. Not-for-profit organizations that follow the reporting requirements of
SFAS 117, Financial Statements of Not-for-Profit Organizations.
Answers
A: I
B: I and II.
C: I and III.
D: I, II and III
Answer Explanations
A. Answer A is correct. SFAS 130, Reporting for Comprehensive Income, applies

to enterprises that develop a full set of financial statements which report cash flows,
results of operations, and financial position. Answer B is incorrect because SFAS 130
does not apply to enterprises that have no items classified as other comprehensive income
for the period. Answer C is incorrect because the standard does not apply to not-for-
profit organizations that follow SFAS 117. Answer D is incorrect because the standard
does not apply to either entities that do not have items classified as other comprehensive
income for the period or not-for-profit organizations that follow the requirements of
SFAS 117.
Comprehensive income is defined as
Answers
A: Changes in equity for a period resulting from all sources.
B: Changes in retained earnings for a period resulting from owner sources.
C: Changes in equity for a period from all sources except those by nonowner
sources.
D: Net income plus other comprehensive income.
Answer Explanations

D. Answer D is correct. According to SFAS 130, comprehensive income is the net
income plus other comprehensive income. Answer A is incorrect because comprehensive
income does not result from changes in equity from all sources, only nonowner sources.
Answer B is incorrect because comprehensive income results from changes in equity
resulting from nonowner transactions, not owner transactions. Answer C is incorrect
because comprehensive income results only from changes in equity resulting from
nonowner sources, not all sources except nonowner sources.
What is a reclassification adjustment as used when reporting comprehensive income?
Answers
A: Adjustment made to avoid double counting items.
B: Adjustment made to reclassify an item of comprehensive income as another

item of comprehensive income.
C: Adjustment made to make net income equal to comprehensive income.
D: Adjustment made to adjust for the income tax effect of reporting

comprehensive income.
Answer Explanations
A. Answer A is correct. A reclassification adjustment is an adjustment made to avoid

double counting in comprehensive income items that are displayed as part of net
income for a period that also had been displayed as part of other comprehensive
income in that period or earlier periods.
B. Answer B is incorrect. Refer to correct answer explanation.

If losses in the amount of $2,750 (net of tax) on available-for-sale securities have been
previously included in other comprehensive income, what amount would be the
reclassification adjustment when the securities are sold? Assume a 30% tax rate.
Answers
A: $2,750
B: $(2,750)
C: $3,575
D: $(3,575)
Answer Explanations
A. Answer A is correct. $2,750 had been a deduction of other comprehensive

income in prior years. When the securities are sold, the loss will be included in net
income, so the $2,750 must be added back to other comprehensive income to avoid
taking the loss twice. Answer B is incorrect because deducting the $2,750 would mean
that the loss is deducted three times, once in net income upon sale of the securities and
twice in other comprehensive income. Answer C is incorrect because it is not net of tax.
Other comprehensive income items should be shown net of tax. Answer D is incorrect
because ($3,575) is what is included in net income when the securities are sold.
Where on the statement of financial position (balance sheet) should accumulated other
comprehensive income be reported?
Answers
A: As a component of retained earnings.
B: As a separate item under stockholders’ equity.
C: As part of additional paid-in capital.
D: As a contra asset account.
Answer Explanations

B. Answer B is correct. Accumulated other comprehensive income shall be
reported in the stockholders' equity section in the statement of financial position (balance
sheet).
Taft Inc. began operations in 2008. For the year ended December 31, 2008, the company
reported the following information:
Net income $300,000

Dividends paid on common stock 40,000
Unrealized loss from available-for-sale securities (42,000)
Credit translation adjustments 17,000
Taft does not elect the fair value option for reporting its financial assets. Taft Inc. has
comprehensive income in 2008 of
Answers
A: $275,000
B: $258,000
C: $235,000
D: $317,000
Answer Explanations
A. Answer A is correct. Taft's comprehensive income for 2008 is $275,000.

Comprehensive income for 2008 consists of the following amounts:
Net income for 2008 $300,000

Other comprehensive loss:
Unrealized loss on available-for-sale securities $(42,000)
Translation adjustments $ 17,000 (25,000)
Comprehensive income for 2008 $275,000
The dividends paid on the common stock do not affect the amount reported
for comprehensive income. Other comprehensive income (loss) is comprised
of the following components.
•Unrealized gains and loss on available-for-sale securities;

•Translation adjustments related to investments in foreign companies;
•Minimum pension liability adjustment;
•Reclassification to avoid double counting of items reported in other
comprehensive income (loss) in a prior or current year that are reported in net
income of the current year.
Watson Company acquired available-for-sale securities at a cost of $150,000 in 2007. At
December 31, 2007, the securities had a market value of $172,000. In 2008, Watson sold
all of its available-for-sale securities for $185,000. Watson uses SFAS 115 for reporting
its available-for-sale securities. As a result of the information presented, what amount of
gain should be reported in Watson’s net income for 2007 and 2008? Ignore income
taxes.
Income Income
statement for 2007 statement for 2008
A. $0 $13,000
B. $22,000 $13,000
C. $0 $35,000
D. $22,000 $35,000
Answers
A: A.
B: B.
C: C.
D: D.
Answer Explanations

C. Answer C is correct. The amount of gain reported in Watson's net income would
be $0 for 2007 and $35,000 for 2008. The gain reported in net income for 2008 is the
excess of the selling price of $185,000 over the cost of $150,000. The unrealized gain of
$22,000 ($172,000 less $150,000) for 2007 is reported as a component of other
comprehensive income in 2007. Since the securities were available-for-sale, unrealized
gains and losses prior to their sale are not reported in net income. This is why there was
$0 reported for the gain in 2007.
Harris Inc. received $50,000 from the sale of available-for-sale securities in 2008. The
securities were acquired in 2007 at a cost of $62,000, and had a market value of $55,000
at December 31, 2007. Harris does not elect the fair value option to report any of its
financial assets. Ignoring income taxes, how would this information affect other
comprehensive income (loss) for 2007 and 2008?
2007 2008
A. $(7,000) $ (5,000)
B. $(7,000) $ 7,000
C. $0 $(12,000)
D. $(7,000) $ 12,000
Answers
A: A.
B: B.
C: C.
D: D.
Answer Explanations

B. Answer B is correct. Since the securities were available-for-sale, unrealized gains
and losses are reported as a component of other comprehensive income (loss) for
2007. The decline in market value from $62,000 to $55,000 should be reported as a
$7,000 reduction in other comprehensive income for 2007. In 2008, the further
reduction in the market value from $55,000 to $50,000 should be reported as a
$5,000 reduction in other comprehensive income for 2008. Since the securities were
sold in 2008 for $50,000, a realized loss of $12,000 would be reported in net income
for 2008. The realized loss is computed by subtracting the selling price of $50,000
from the cost of $62,000. To avoid double counting the loss in comprehensive
income, $12,000 should be reported as a reclassification adjustment in other
comprehensive income for 2008. The reclassification adjustment of $12,000, when
netted with the $5,000 unrealized loss recognized in 2008, causes a net positive effect
of $7,000 in comprehensive income for 2008. This results in answer “B” being the
correct answer. The schedule below shows how the effects described above would
be reported in net income and other comprehensive income for 2007 and 2008.
2007 2008
Loss from sale of securities (reported in net $ 0 $(12,000)
income)
Net income $ xxxx $ xxxx
Other comprehensive income:
Unrealized loss on available-for-sale securities $(7,000) $ (5,000)
Reclassification adjustment $ 0 12,000
Net effect on other comprehensive income $(7,000) $ 7,000

Comprehensive income can be disclosed in various formats. Which of the following is
not an acceptable format for disclosing comprehensive income?
Answers
A: At the bottom of the income statement, continue from net income and add
other comprehensive income to arrive at comprehensive income for the year.
B: In a separate statement, start with net income and add other comprehensive
income to arrive at comprehensive income for the year.
C: In the statement of stockholders’ equity, net income is adjusted for other

comprehensive income to arrive at comprehensive income for the year.
D: After retained earnings in the stockholders’ equity section of the statement of

financial position, start with net income and add other comprehensive income to
arrive at comprehensive income for the year.
Answer Explanations

D. Answer D is correct. Comprehensive income can be disclosed in one of the
following three ways:
1. On a combined income statement where other comprehensive income is added to

net income to arrive at comprehensive income for the period; or
2. On a two income statement format in which a separate statement follows the
typical income statement. The separate statement start with net income and adds
other comprehensive income to arrive at comprehensive income for the period; or
3. On the statement of stockholders' equity, other comprehensive income is added
to net income to arrive at comprehensive income for the period.
Reporting comprehensive income on the statement of financial position after retained

earnings is not an acceptable format for displaying comprehensive income for the period.
The comparative balance sheets for Wellington Inc. reported the following information at
December 31, 2007 and 2008:
December 31
2008 2007
Retained earnings $210,000 $140,000
Accumulated other comprehensive income 30,000 35,000
Wellington declared cash dividends of $20,000 in 2007. The decrease in accumulated

other comprehensive income for 2008 was due to unrealized losses on available-for-sale
securities. For the year ended December 31, 2008, what was Wellington’s
comprehensive income?
Answers
A: $65,000
B: $95,000
C: $90,000
D: $85,000
Answer Explanations

D. Answer D is correct. Wellington's comprehensive income for 2008 is computed as
follows:
Increase in retained earnings for 2008 ($210,000 less $140,000) $70,000

Add cash dividends declared for 2008 20,000
Net income for 2008 $90,000
Deduct the decrease in accumulated other comprehensive income
for 2008 ($35,000 less $30,000) (5,000)
Comprehensive income for 2008 $85,000
To arrive at net income for 2008, an analysis of the retained earnings account may be
necessary. This analysis is shown below.
Retained earnings
$140,000 (given) 1/1/08
Dividends declared in $20,000 $ 90,000 Net income for
2008 (given) (computed) 2008
$210,000 (given) 12/31/08
The $5,000 decrease in accumulated other comprehensive income for 2008 was
caused by the recognition of unrealized losses on available-for-sale securities. This
decrease resulted in an other comprehensive loss for 2008. The other comprehensive
loss for 2008 of $5,000 would be deducted from net income of $90,000 to arrive at
comprehensive income as shown below.
Accumulated other comprehensive

income
$35,000 (given) 1/1/08
Other comprehensive loss for $5,000 (computed)
2008
$30,000 (given) 12/31/08
In single period statements, which of the following should be reflected as an adjustment
to the opening balance of retained earnings?
Answers
A: Effect of a failure to provide for uncollectible accounts in the previous period.
B: Effect of a decrease in the estimated useful life of depreciable equipment.
C: Results from the disposal of a discontinued segment.
D: Cumulative effect of a change from an accelerated method to straight-line

depreciation.
Answer Explanations
A. Answer A is correct. Per SFAS 154, the correction of an error in the financial
statements of a prior period which is discovered after issuance should be reported as a
prior period adjustment to the opening balance of retained earnings. Such errors are
described in and include oversights or misuse of facts that existed at the time the financial
statements were prepared. Failure to provide for uncollectible accounts would be such an
error.
B. Answer B is incorrect because a decrease in the estimated useful life of
depreciable equipment is a change in accounting estimate (described in SFAS 154). Such
a change is included in the net income of the period of change and (if affected) future
periods.
C. Answer C is incorrect. Results of discontinued operations are presented in the
current year at the bottom of the income statement after income from continuing
operations.
D. Answer D is incorrect because a change from an accelerated method to straight-
line depreciation is a change in accounting principle (described in SFAS 154). Such a
change is recognized as a change in estimate effected by a change in principle and is
accounted for in the current period and future periods.
The following changes in account balances of the Marvel Corporation during 2008 are
presented below:
Increase
Assets $356,000
Liabilities 108,000
Capital stock 240,000
Additional paid-in capital 24,000
Assuming there were no charges to retained earnings other than for a dividend payment
of $52,000, the net income for 2008 should be
Answers
A: $16,000
B: $36,000
C: $52,000
D: $68,000
Answer Explanations

B. Answer B is correct. Net income is closed out each year to retained earnings. Since
retained earnings is one of the components of owners' equity, the change in owners'
equity must first be determined. This can be done through the use of the basic
accounting equation
Change in assets = Change in liab. + Change in equity

$356,000 = $108,000 + Change in equity
$248,000 = Change in equity
The $248,000 increase shown above is not all due to net income. Owners' equity
increased $264,000 because of the issuance of additional stock ($240,000 + $24,000).
The dividend payment decreased owners' equity by $52,000. Thus, net income must
have been $36,000 ($248,000 – $264,000 + $52,000).
When preparing a draft of its 2008 balance sheet, Mont, Inc. reported net assets totaling
$875,000. Included in the asset section of the balance sheet were the following:
Treasury stock of Mont, Inc. at cost $24,000

Idle machinery 11,200
Cash surrender value of life insurance
on corporate executives 13,700
At what amount should Mont’s net assets be reported in the December 31, 2008 balance
sheet?
Answers
A: $851,000
B: $850,100
C: $842,600
D: $834,500
Answer Explanations
A. Answer A is correct. Idle machinery ($11,200) and cash surrender value of life
insurance ($13,700) are both assets. The only item listed which should not be included in
the asset section of the balance sheet is the treasury stock ($24,000). Although the
treasury stock account has a debit balance, it is not an asset; instead, it is reported as a
contra equity account. Therefore, the $24,000 must be excluded from the asset section,
reducing the net asset amount to $851,000 ($875,000 – $24,000).
Mirr, Inc. was incorporated on January 1, 2008, with proceeds from the issuance of
$750,000 in stock and borrowed funds of $110,000. During the first year of operations,
revenues from sales and consulting amounted to $82,000, and operating costs and
expenses totaled $64,000. On December 15, Mirr declared a $3,000 cash dividend,
payable to stockholders on January 15, 2009. No additional activities affected owners’
equity in 2008. Mirr’s liabilities increased to $120,000 by December 31, 2008. On
Mirr’s December 31, 2008 balance sheet, total assets should be reported at
Answers
A: $885,000
B: $882,000
C: $878,000
D: $875,000
Answer Explanations
A. Answer A is correct. Mirr began operations on 1/1/08 with the following balance
sheet elements:
Assets = Liabilities + Owners' equity

$860,000 = $110,000 + $750,000
During 2008, liabilities increased to $120,000, and owners' equity increased to

$765,000 [$750,000 beginning balance + $18,000 net income ($82,000 revenues –
64,000 expenses) - $3,000 dividends declared]. Therefore, 12/31/08 assets must be
$885,000.
Assets = Liabilities + Owners' equity

$885,000 = $120,000 + $765,000

APB 22, Disclosure of Accounting Policies,
Answers
A: Requires description of every accounting policy followed by a reporting entity.
B: Provides a specific listing of all types of accounting policies which must be

disclosed.
C: Requires disclosure of the format for the statement of cash flows.
D: Requires description of all significant accounting policies to be included as an

integral part of the financial statements.
Answer Explanations
A. Answer A is incorrect because of APB 22 does not require that every accounting
policy be described.
B. Answer B is incorrect because APB 22 does not provide a specific listing of all
types of accounting policies which must be disclosed.
C. Answer C is incorrect because APB 22 does not require disclosure of the format
for the statement of cash flows.
D. Answer D is correct because of APB 22 requires a description of all significant
accounting policies to be included as an integral part of the financial statements. It does
not require a description of every policy nor does it list which types of policies need to be
disclosed.
Which of the following should be disclosed in the summary of significant accounting
policies?
Answers
A: Composition of plant assets.
B: Pro forma effect of retroactive application of an accounting change.
C: Basis of consolidation.
D: Maturity dates of long-term debt.
Answer Explanations
A. Answer A is incorrect because while composition of plant assets should be

disclosed, it is not an accounting policy.
B. Answer B is incorrect because while the pro forma effect of retroactive
application of an accounting change may be a required disclosure, it is not an accounting
policy.
C. Answer C is correct because APB 22 states that the summary of significant
accounting policies should encompass those accounting principles and methods that
involve a selection from existing acceptable alternatives (or are peculiar to the industry in
which the entity operates). Of the answers listed, only basis of consolidation involves a
choice among acceptable methods.
D. Answer D is incorrect because while the maturity dates of long-term debt should
be disclosed, they are not an accounting policy.
Which of the following should be disclosed in a summary of significant accounting
policies?
I. Management’s intention to maintain or vary the dividend payout ratio.

II. Criteria for determining which investments are treated as cash equivalents.
III. Composition of the sales order backlog by segment.
Answers
A: I only.
B: I and III.
C: II only.
D: II and III.
Answer Explanations

C. Answer C is correct. Per APB 22, disclosure of accounting policies should
identify and describe the accounting principles followed by the reporting entity and the
methods of applying those principles that materially affect the determination of financial
position, cash flow, or results of operations. However, financial statement disclosure of
accounting policies should not duplicate details presented elsewhere as part of the
In this problem, both (I) management's intention to vary the dividend payout ratio
and (III) the composition of the sales order backlog by segment are not required to be
disclosed under Generally Accepted Accounting Principles. As such, these should not be
disclosed in a summary of significant accounting policies. Per SFAS 95, an enterprise
shall disclose its policy for determining which items are treated as cash equivalents.
Thus, the criteria for determining which investments are treated as cash equivalents (II)
should be disclosed in a summary of significant accounting policies.
Which of the following facts concerning inventories should be disclosed in the summary
of significant accounting policies?
Composition Pricing
A. Yes Yes
B. Yes No
C. No Yes
D No No
Answers
A: A.
B: B.
C: C.
D: D.
Answer Explanations

C. Answer C is correct because per APB 22, inventory pricing would be considered
a significant accounting policy. Additionally, APB 22 states that financial statement
disclosure of accounting policies should not duplicate details (e.g., composition of
inventories or of plant assets) presented elsewhere as part of the financial statements.
Which of the following facts concerning plant assets should be disclosed in the summary
of significant accounting policies?
Depreciation
Compositio expense amount
n
A. No Yes
B. No No
C. Yes No
D. Yes Yes
Answers
A: A.
B: B.
C: C.
D: D.
Answer Explanations

B. Answer B is correct because APB 22 states that disclosure of accounting policies
should identify and describe the accounting principles and the methods of applying them.
Information and details presented elsewhere as a part of the financial statements should
not be repeated. Thus, the depreciation expense amount should not be disclosed in the
summary of significant accounting policies. APB 22 specifically states that composition
of plant assets should not be presented.
Which of the following should be disclosed in the summary of significant accounting
policies?
Answers
A: Rent expense amount.
B: Maturity dates of long-term debt.
C: Methods of amortizing intangibles.
D: Composition of plant assets.
Answer Explanations
A. Answer A is incorrect because it is not an accounting policy and, thus, will not be
disclosed in the summary of significant accounting policies. However, the rent expense
amount will be disclosed in other parts of the financial statements.
B. Answer B is incorrect because it is not an accounting policy and, thus, will not be
disclosed in the summary of significant accounting policies. However, the maturity dates
of long-term debt will be disclosed in footnotes in other parts of the financial statements.
C. Answer C is correct because APB 22 recommends that when financial statements
are issued, a statement identifying the accounting policies adopted and followed by the
reporting entity should be presented as an integral part of the financial statements. The
accounting policies are the specific accounting principles and the methods of applying the
principles that have been adopted for preparing the financial statements.
D. Answer D is incorrect because this item is not an accounting policy and, thus,
will not be disclosed in the summary of significant accounting policies. However, the
composition of plant assets will be disclosed in other parts of the financial statements.
In accordance with SFAS 89, the Consumer Price Index for All Urban Consumers is used
to compute information on a
Answers
A: Historical cost basis.
B: Current cost basis.
C: Constant dollar basis.
D: Nominal dollar basis.
Answer Explanations

B. Answer B is incorrect because information on a current cost basis would be
restated using a specific, rather than a general price index.
C. Answer C is correct. In accordance with SFAS 89, the Consumer Price Index is
used to compute information on a “constant dollar” basis. The index is used to restate
financial statement elements to dollars which have the same purchasing power.
Loy Corp. purchased a machine in 2006 when the average Consumer Price Index (CPI)
was 180. The average CPE was 190 for 2007, and 200 for 2008. Loy prepares
supplementary constant dollar statements (adjusted for changing prices). Depreciation on
this machine is $200,000 a year. In Loy’s supplementary constant dollar statement for
2008, the amount of depreciation expense should be stated as
Answers
A: $180,000
B: $190,000
C: $210,526
D: $222,222
Answer Explanations

D. Answer D is correct. Depreciation is a nonmonetary item. Therefore, it must be
adjusted to current year dollars. The $200,000 of historical cost depreciation is
converted into 2008 dollars by multiplying it by the To/From ratio of 200/180.
200
$200,000 × – $222,222
800
Therefore, 2008 depreciation stated in constant dollars is $222,222.
During a period of inflation, an account balance remains constant. When supplemental
statements are being prepared, a purchasing power gain is reported if the account is a
Answers
A: Monetary asset.
B: Monetary liability.
C: Nonmonetary asset.
D: Nonmonetary liability.
Answer Explanations

B. Answer B is correct. Per SFAS 89, the dollar amounts of monetary assets and
liabilities are fixed or determinable without reference to future prices or specific goods or
services. If the general price level changes, a purchasing power gain (loss) may occur on
monetary items. A monetary liability held constant during a period of inflation creates a
purchasing power gain because the liability could be paid using a fixed amount of cash
which is worth less than the cash borrowed earlier.
C. Answer C is incorrect. The dollar amount of nonmonetary assets is not fixed;
and, therefore, changes in the general price level will not result in a purchasing power
gain (loss).
D. Answer D is incorrect. The dollar amount of nonmonetary liabilities is not fixed;
and, therefore, changes in the general price level will not result in a purchasing power
gain (loss).
When computing information on a historical cost-constant dollar basis, which of the
following is classified as nonmonetary?
Answers
A: Accumulated depreciation of equipment.
B: Advances to unconsolidated subsidiaries.
C: Allowance for doubtful accounts.
D: Unamortized premium on bonds payable.
Answer Explanations
A. Answer A is correct because per SFAS 89, nonmonetary items include assets and
liabilities whose amounts may change over time in terms of a monetary unit (e.g., the
U.S. dollar). Examples of nonmonetary assets and liabilities included inventory,
property, plant, equipment, and obligations under warranties. Accumulated depreciation
is a nonmonetary item because it relates to equipment.
B. Answer B is incorrect because the advance represents a claim to receive a fixed
amount in terms of a monetary unit and is therefore a monetary item.
C. Answer C is incorrect because the allowance account relates to the accounts
receivable, which is a monetary item.
D. Answer D is incorrect because the unamortized premium relates to the bonds
payable account, which is a monetary item.
Information with respect to Bruno Co.’s cost of goods sold for 2008 is as follows:
Historical
Cost Units
Inventory, 1/1/08 $1,060,00 20,000
0
Production during 2008 5,580,000 90,000
6,640,000 110,000
Inventory, 12/31/08 2,520,000 40,000
Cost of goods sold $4,120,00 70,000
0
Bruno estimates that the current cost per unit of inventory was $58 at January 1, 2008,
and $72 at December 31, 2008. In Bruno’s supplementary information restated into
average current cost, the cost of goods sold for 2008 should be
Answers
A: $5,040,000
B: $4,550,000
C: $4,410,000
D: $4,060,000
Answer Explanations

B. Answer B is correct. Per SFAS 89, cost of goods sold is restated into average current
cost by multiplying units sold (70,000) by the average current cost during the year.
Average current cost is the current cost at the beginning of the year, plus the current
cost at the end of the year, divided by 2.
($58 + $72) ÷ 2 = $65
Therefore, cost of goods sold restated into average current cost is $4,550,000 (70,000 x
$65).
SFAS 89 requires that the current cost for inventories be measured as the
Answers
A: Recoverable amount regardless of the current cost.
B: Current cost regardless of the recoverable amount.
C: Higher of current cost or recoverable amount.
D: Lower of current cost or recoverable amount.
Answer Explanations

D. Answer D is correct. SFAS 89 requires that the current cost for inventories be
measured at the lower of current cost or recoverable amount at the measurement date.
In a period of rising general price levels, Pollard Corp. discloses income on a current cost
basis in accordance with SFAS 89, Financial Reporting and Changing Prices.
Compared to historical cost income from continuing operations, which of the following
conditions increases Pollard’s current cost income from continuing operations?
Answers
A: Current cost of equipment is greater than historical cost.
B: Current cost of land is greater than historical cost.
C: Current cost of cost of goods sold is less than historical cost.
D: Ending net monetary assets are less than beginning net monetary assets.
Answer Explanations
A. Answer A is incorrect. The current costs in excess of historical cost for assets
held during the year are treated as unrealized holding gains. Unrealized holding gains are
reported after income from continuing operations on the current cost income statement.
B. Answer B is incorrect. The current costs in excess of historical cost for assets
held during the year are treated as unrealized holding gains. Unrealized holding gains are
reported after income from continuing operations on the current cost income statement.
C. Answer C is correct. The requirement of this item is to determine which condition
increases Pollard's current cost income from continuing operations. A current cost
income statement appears below.
Current Cost Income Statement

Sales xxx
Cost of goods sold xxx
Current cost income from continuing operations xxx
Realized holding gain (loss) xxx
Realized income xxx
Unrealized holding gain (loss) (xxx)
Current cost net income xxx
Current cost income from continuing operations is sales revenue less expenses on a
current basis. Realized holding gains (losses), the difference between current cost and
historical costs of assets consumed, are then added (subtracted) to arrive at realized
income (loss). Realized income (loss) is always the same as historical net income (loss).
Finally, unrealized holding gains (increases in the current cost of assets held during the
year) are included to arrive at current cost net income. Therefore, if current cost of goods
sold is less than historical cost of goods sold, then current cost income from continuing
operations will be increased compared to historical cost income from operations.
D. Answer D is incorrect. The information regarding a situation in which ending net
monetary assets are less than beginning net monetary assets is only relevant for constant
dollar accounting, not current cost income.
Financial statements shall include disclosures of material transactions between related
parties except
Answers
A: Nonmonetary exchanges by affiliates.
B: Sales of inventory by a subsidiary to its parent.
C: Expense allowances for executives which exceed normal business practice.
D: A company’s agreement to act as surety for a loan to its chief executive

officer.
Answer Explanations
A. Answer A is incorrect because nonmonetary exchanges by affiliates are not

specifically exempted from disclosure by SFAS 57, and therefore must be disclosed as
related-party transactions.
B. Answer B is correct. SFAS 57 requires disclosure of any material related-party
transactions except
1. Compensation agreements, expense allowances, and similar items in the ordinary

course of business.
2. Transactions which are eliminated in the preparation of consolidated or combined
Since sales of inventory between subsidiary and parent are eliminated in preparing
consolidated financial statements, such sales need not be disclosed as a related-party
transaction.
C. Answer C is incorrect. SFAS 57, states that compensation arrangements,

expense allowances, and similar items in the ordinary course of business need not be
disclosed as related-party transactions. However, in this case the allowances are in
excess of normal business practice and therefore must be disclosed.
D. Answer D is incorrect because surety and guaranty agreements between related
parties are not specifically exempted from disclosure by SFAS 57, and therefore must be
disclosed as related-party transactions.
Which of the following accounting bases may be used to prepare financial statements in
conformity with a comprehensive basis of accounting other than generally accepted
accounting principles?
I. Basis of accounting used by an entity to file its income tax return.

II. Cash receipts and disbursements basis of accounting.
Answers
A: I only.
B: II only.
C: Both I and II.
D: Neither I nor II.
Answer Explanations

C. Answer C is correct. Both bases mentioned in I and II are comprehensive bases
of accounting which may be used to prepare financial statements.
Users of prospective financial information can include
I.General users with whom the responsible party is not negotiating directly.
II.The responsible party.
III. Third parties with whom the responsible party is negotiating directly.
Answers
A: I, II, and III.
B: II and III.
C: II.
D: None of the above.
Answer Explanations
A. Answer A is correct. Prospective financial information can be used by general

users with whom the responsible party is not negotiating directly, the responsible party,
and third parties with whom the responsible party is negotiating directly.
Which of the following is not a reason to prepare prospective financial information?
Answers
A: To aid in considering a change in accounting or operations.
B: To aid in preparation of the budget.
C: To obtain external financing.
D: To meet the requirements of GAAP.
Answer Explanations

D. Answer D is correct. The preparation of prospective financial information is not
required by GAAP. The preparation does aid in considering a change in accounting or
operations, so answer A is incorrect. Answer B is incorrect because the preparation of
prospective financial information does aid in preparing a budget. Answer C is incorrect
because the prospective financial information may be needed to obtain external financing.
Which one of the following areas does not require disclosures about the risks and
uncertainties that exist?
Answers
A: Nature of operations.
B: Use of estimates in preparation of financial statements.
C: Current vulnerability due to a possible recession.
D: Current vulnerability due to concentrations

Answer Explanations

C. Answer C is correct. Current vulnerability due to a possible recession is not a
required disclosure regarding risks and uncertainties. The nature of operations, the use of
estimates in preparation of financial statements, and current vulnerability due to
concentrations are all required disclosures according to AICPA Statement of Position 94-
6, Disclosure of Certain Significant Risks and Uncertainties.
Which of the following should be disclosed in a summary of significant accounting
policies?
Answers
A: Basis of profit recognition on long-term construction contracts.
B: Future minimum lease payments in the aggregate and for each of the five
succeeding fiscal years.
C: Depreciation expense.
D: Composition of sales by segment.
Answer Explanations
A. Answer A is correct. The requirement is to identify the item that should be

disclosed in a summary of significant accounting policies. Answer A is correct because
the summary of significant accounting policies should include the basis of profit
recognition on long-term construction contracts.
B. Answer B is incorrect because it refers to additional or supporting calculations
contained in the notes to the financial statements.
C. Answer C is incorrect because the depreciation method, not expense, should be
included in the significant accounting policies.
D. Answer D is incorrect because it refers to additional or supporting calculations
contained in the notes to the financial statements.
Which of the following must be included in a company’s summary of significant
accounting policies in the notes to the financial statements?
Answers
A: Description of current year equity transactions.
B: Summary of long-term debt outstanding.
C: Schedule of fixed assets.
D: Revenue recognition policies.
Answer Explanations
A. Answer A is incorrect because, although it may be included in the notes to

financial statements, it is not considered a significant accounting policy.
B. Answer B is incorrect because, although it may be included in the notes to
C. Answer C is incorrect because, although it may be included in the notes to
D. Answer D is correct. The requirement is to identify the item that must be
included in the summary of significant accounting policies. According to APB 22,
revenue recognition policies are included in the summary of significant accounting
policies in the notes to the financial statements.
Which of the following is correct concerning financial statement disclosure of accounting
policies?
Answers
A: Disclosures should be limited to principles and methods peculiar to the

industry in which the company operates.
B: Disclosure of accounting policies is an integral part of the financial statements.
C: The format and location of accounting policy disclosures are fixed by

generally accepted accounting principles.
D: Disclosures should duplicate details disclosed elsewhere in the financial

statements.
Answer Explanations
A. Answer A is incorrect because disclosures are not limited to only the principles
and methods of the particular industry, but include items pertinent to recognition of
revenue and expenses, and the selection of principles from different alternatives.
B. Answer B is correct. The requirement is to identify the correct statement about
disclosure of accounting policies. Answer B is correct because APB 22 requires
disclosure of accounting policies and states that they are essential to users and are an
integral part of the financial statements
C. Answer C is incorrect because the format and location of disclosures are not
fixed by GAAP.
D. Answer D is incorrect because disclosures should NOT duplicate details
disclosed elsewhere in the financial statements.
Dex Co. has entered into a joint venture with an affiliate to secure access to additional
inventory. Under the joint venture agreement, Dex will purchase the output of the
venture at prices negotiated on an arm’s-length basis. Which of the following is(are)
required to be disclosed about the related-party transaction?
I. The amount due to the affiliate at the balance sheet date.
II. The dollar amount of the purchases during the year.
Answers
A: I only.
B: II only.
C: Both I and II.
D: Neither I nor II.
Answer Explanations
Null Null
C. Answer C is correct. The requirement is to identify the required disclosure for
related-party transactions. Per SFAS 57, for related-party transactions an entity must
disclose the nature of the relationship involved, a description of the transactions, the
dollar amounts of the transactions for each of the periods, amounts due from or to related
parties as of each balance sheet date, and the terms and manner of settlement.
Null
According to SFAS 157, the fair value of an asset should be based upon
Answers
A: The price that would be paid to acquire the asset.
B: The price that would be paid to replace the asset.
C: The price that would be received to sell the asset.
D: The price that the item is appraised at balance sheet date.
Answer Explanations
C. Answer C is correct. SFAS 157 requires that the fair value of an asset be
based upon the price that would be received to sell the asset, which is an exit
price.
According to SFAS 157, which of the following is an assumption used in fair value
measurements?
Answers
A: The asset is being held for sale.
B: The asset is in its highest and best use.
C: The asset must be conservatively valued.
D: The asset is currently in use.
Answer Explanations
A. Answer A is incorrect because the asset does not have to be held for sale.
B. Answer B is correct. SFAS 157 provides that the asset should be in its highest
and best use to determine the fair value of the asset.
C. Answer C is incorrect because SFAS 157 requires the highest and best use.
D. Answer D is incorrect because the asset can be valued at its highest and best use,
which can be either in-use or in-exchange.
According to SFAS 157, which level has the lowest priority for valuation purposes?
Answers
A: Level 1
B: Level 2
C: Level 3
D: Level 4
Answer Explanations
A. Answer A is incorrect because Level 1 has the highest priority for valuation
purposes and uses objective inputs such as quoted prices from active markets.
B. Answer B is incorrect because Level 2 is lower priority than Level 1.
C. Answer C is correct. Level 3 is the lowest priority for valuation purposes and
includes unobservable inputs, such as an entity’s own assumptions, expected cash flows,
or a firm’s forecasts.
D. Answer D is incorrect because there is no Level 4.
Which of the following is an accepted valuation technique for fair value estimates?
Answers
A: The conservative approach.
B: The residual value approach.
C: The cost approach.
D: The consistent approach.
Answer Explanations
Null Null
C. Answer C is correct. The accepted valuation approaches in SFAS 157 are the
cost approach, the market approach, and the income approach.
Null
Which of the following items does not require fair value measurement for reporting on
the balance sheet?
Answers
A: Asset impairments.
B: Treasury stock.
C: Business combinations.
D: Goodwill.
Answer Explanations
Null
B. Answer B is correct. SFAS 157 provides rules for measuring the fair
value of balance sheet items such as asset impairments, business combinations,
and goodwill.
Null Null
Which of the following statements is true regarding developing fair value measurements
for financial statement purposes?
Answers
A: It assumes the most conservative use of the asset.
B: It assumes the asset is held for sale in the normal course of business.
C: It assumes an appraisal by a licensed appraiser.
D: It assumes the highest and best use of the asset.
Answer Explanations
A. Answer A is incorrect because fair value measurements assume the highest and
best use of the asset.
B. Answer B is incorrect because it assumes the asset is either in-use or in-
exchange.
C. Answer C is incorrect because a licensed appraiser is not required for fair value
measurements.
D. Answer D is correct. SFAS 157 provides that the highest and best use of the
asset is used to determine fair value.
Which of the following is an appropriate income approach for developing fair value
measurements?
Answers
A: Using the relevant information from recent transactions.
B: Using present value techniques to discount cash flows.

C: Using the current replacement cost of the asset.
D: Using the undiscounted cash flows from the asset.
Answer Explanations
A. Answer A is incorrect. Relevant information from recent transactions does not

estimate income.
B. Answer B is correct. An income approach to fair value measurement includes
using present value techniques to discount cash flows.
C. Answer C is incorrect. Current replacement cost does not address income.
D. Answer D is incorrect because undiscounted cash flows ignores the time value of
money and is not used in an income approach for fair value measurement.
Which of the following is an appropriate market approach for determining fair value
measurements?
Answers
A: Using relevant information from recent transactions.
Answer Explanations
A. Answer A is correct. Relevant information from recent transactions is a

market approach to determining fair value measurement.
B. Answer B is incorrect. Using present value techniques to discount cash flows is
an income approach.
C. Answer C is incorrect. Current replacement cost is a cost approach to measuring
fair value.
D. Answer D is incorrect because undiscounted cash flows ignores the time
value of money and is not used in an income approach or a market approach.
Which of the following is an appropriate cost approach for determining fair value
measurements?
Answers
A: Using relevant information from recent transactions.
Answer Explanations
A. Answer A is incorrect. Using relevant information from recent transactions is a

market approach.
B. Answer B is incorrect. Using present value techniques to discount cash flows is
an income approach.
C. Answer C is correct. Current replacement cost adjusted for obsolescence
can be used for determining fair value measurements under the cost approach.
D. Answer D is incorrect because undiscounted cash flows ignores the time
value of money and is not used in an income approach or a cost approach for fair
value measurement.
According to SFAS 157, the market that has the greatest volume and level of activity is
the
Answers
A: Most advantageous market.
B: The most relevant market.
C: The independent market.
D: The principal market.
Answer Explanations
A. Answer A is incorrect because the most advantageous market is the market that
maximizes the price received for the asset.
B. Answer B is incorrect because SFAS 157 does not use the terminology
relevant market.
C. Answer C is incorrect because SFAS 157 does not use the term
independent market.
D. Answer D is correct because SFAS 157 defines the principal market as the
market with the greatest volume and level of activity.
According to SFAS 157, the market that maximizes the price received for the asset is the
Answers
A: Most advantageous market.
B: Most relevant market.
C: Independent market.
D: Principal market.
Answer Explanations
A. Answer A is correct because the most advantageous market is the market

that maximizes the price received for the asset.
B. Answer B is incorrect because SFAS 157 does not use the terminology
relevant market.
C. Answer C is incorrect because SFAS 157 does not use the term
independent market.
D. Answer D is incorrect because SFAS 157 assumes that the greatest
volume and level of activity occurs in the principal market.
According to SFAS 157, a stock market quotation from the New York Stock Exchange is
considered what level of valuation input for determining fair value measurement?
Answers
A: Level 1.
B: Level 2.
C: Level 3.
D: Level 4.
Answer Explanations
A. Answer A is correct. Level 1 inputs include quoted prices from active markets
for identical assets or liabilities.
B. Answer B is incorrect because Level 2 inputs are directly or indirectly observable
inputs other than Level 1.
C. Answer C is incorrect because Level 3 inputs are unobservable inputs.
D. Answer D is incorrect because there is no level 4 category.
The SFAS 159 fair value option election applies to all of the following items except for
Answers
A: Firm commitments that involve financial instruments.
B: Warranties that can be settled by paying a third party.
C: Held-to-maturity investments.
D: Leases.
Answer Explanations
A. Answer A is incorrect because the fair value election applies for firm
commitments that involve financial instruments.
B. Answer B is incorrect because the fair value election applies for
warranties that can be settled by paying a third party.
C. Answer C is incorrect because the fair value election applies for held-to-
maturity investments.
D. Answer D is correct. SFAS 159 provides that the fair value option does
not apply to leases.
The SFAS 159 fair value option election applies to all of the following items except for
Answers
A: Pensions.
B: Long-term notes payable.
C: Warranties that can be settled by paying a third party.

D: Held-to-maturity investments.
Answer Explanations
A. Answer A is correct. SFAS 159 provides that the fair value option does
not apply to pensions.
B. Answer B is incorrect because the fair value election applies for financial
liabilities, which includes long-term notes payable.
C. Answer C is incorrect because the fair value election applies for
warranties that can be settled by paying a third party.
D. Answer D is incorrect because the fair value election applies for held-to-
maturity investments.
Which of the following statements is true regarding the fair value option for valuing
financial assets and liabilities?
Answers
A: The fair value option must be applied to all instruments in that classification.
B: The fair value option must be applied to all interests in the same entity.
C: The fair value option cannot be revoked until the next balance sheet date.
D: The fair value option can be applied to a portion of a financial instrument.
Answer Explanations
A. Answer A is incorrect because the fair value option may be applied on an

instrument-by-instrument basis.
B. Answer B is correct. The fair value option must be applied to all interests
in the same entity.
C. Answer C is incorrect because once the fair value option is elected, it is
irrevocable.
D. Answer D is incorrect because the fair value option must be applied to all
portions of the instrument.
Which of the following statements is true regarding the fair value option for valuing
financial assets and liabilities?
Answers
A: The fair value option can be applied to a portion of a financial instrument.
B: Unrealized gains and losses from reporting items using the fair value option
are reported in other comprehensive income for the period.
C: The fair value option can be elected on an instrument-by-instrument basis.
D: The fair value option cannot be applied to insurance contracts.
Answer Explanations
A. Answer A is incorrect because the fair value option must be applied to all
portions of the instrument.
B. Answer B is incorrect because unrealized gains and losses are reported in
earnings for the period.
C. Answer C is correct. The fair value option can be elected on an instrument-by-
instrument basis.
D. Answer D is incorrect because the fair value option may be applied to
insurance contracts that can be settled by a third party.
Which of the following items is eligible for the fair value election under SFAS 159?
Answers
A: Pension liability.
B: Available-for-sale investments.
C: Leases.
D: Share-based payments.
Answer Explanations
A. Answer A is incorrect. SFAS 159 specifically excludes pension liabilities.

B. Answer B is correct. The fair value option may be elected on an instrument-by-
instrument basis for available-for-sale securities.
C. Answer C is incorrect. SFAS 159 specifically excludes leases for fair value
treatment.
D. Answer D is incorrect. SFAS 159 specifically excludes share-based payments
for the fair value option election.

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Question: TREPB-0001

A: They can be specifically identified with business activity of a prior period.

B: They have a material effect on income from continuing operations of the

C: They could not have been reasonably estimated in a prior period.

D: They are attributable to economic events occurring subsequent to prior period

A. Answer A is correct. If ending inventory is understated, cost of goods sold is

2006 2007 2008

* 2007 NI $10,000 under = $50,000 over + $60,000 under

2007 ending 2008 ending

A. Answer A is incorrect. Refer to the correct answer explanation.

Commission expense xxx

A. Answer A is incorrect. Refer to the correct answer explanation.

Retained earnings 50,000

D. Answer D is incorrect. Refer to the correct answer explanation.

A: Understatement of accumulated depreciation of $24,000.

B: Understatement of accumulated depreciation of $40,000.

C: Understatement of depreciation expense of $24,000.

D: Understatement of net income of $24,000.

Accounting and legal fees $160,000

A. Answer A is incorrect. Refer to the correct answer explanation.

Net sales $1,600,000

A. Answer A is correct. Income from operations before income tax is $230,000

A. Answer A is correct. APB 30 states that a material event or transaction which is

B: Shown in operating revenues or expenses but not shown as a separate item.

C: Shown after ordinary net earnings but before extraordinary items.

A. Answer A is correct because items unusual in nature or infrequent in occurrence

A. Answer A is incorrect. Refer to the correct answer explanation.

A $240,000 gain on sale of a plant facility; Ball continues similar operations at

Unrealized loss on decline in market value of

A. Answer A is incorrect. Refer to the correct answer explanation.

A: A prior period adjustment.

C: An amount after continuing operations and before extraordinary items.

D: A bulk sale of fixed assets included in earnings from continuing operations.

A. Answer A is incorrect. Refer to the correct answer explanation.

A: Sale or termination of a line of business.

B: Changes in management structure.

C: Relocation of busines activities from one location to another.

D: Outsourcing a customer service.

A. Answer A is incorrect. This is an example of an exit activity.

A: The cost should be recorded when the employees are paid.

C: The cost should be recorded as a prior period adjustment.

A. Answer A is incorrect. Refer to the correct answer explanation.

This answer is incorrect. Refer to the correct answer explanation.

* [($400,000 – $225,000) – 30% ($400,000 – $225,000)].

Assume an income tax rate of 40%. In the preparation of a revised comparative

A: $1,344,000 and $ 720,000

B: $1,344,000 and $1,020,000

C: $1,500,000 and $ 720,000

D: $1,500,000 and $1,020,000

A. Answer A is incorrect. Refer to the correct answer explanation.

C. Answer C is incorrect. Refer to the correct answer explanation.

B: Before cumulative effect of accounting changes and before discontinued

C: As an operating expense on the income statement.

D: As other income or other loss on the income statement.

B: Losses due to a strike.

C: Losses from translation of foreign currencies.

A. Answer A is incorrect because the write-off of goodwill is specifically

A: As an operating loss of $700,000, net of $300,000 income tax.

B: As an extraordinary loss of $700,000, net of $300,000 income tax.

C: As an operating loss of $1,000,000.

D: As an extraordinary loss of $1,000,000.

A. Answer A is incorrect. Refer to the correct answer explanation.