U 1 - Financial Statements

STUDY UNIT ONE
EXTERNAL FINANCIAL STATEMENTS

AND REVENUE RECOGNITION
Question 1. Financial Statements
According to the conceptual framework, the most basic objective of financial reporting is
to convey information
A. About the economic resources and obligations of a company.

B. About the liquidity and solvency of a company.
C. About the future cash flows of a company.
D. That enables users to make decisions about a company.
Answer. D
All of the following support the objective of financial reporting, except providing information that
A. Is useful for making investment and credit decisions.

B. Helps management evaluate alternative projects.
C. Concerns enterprise resources and claims to those resources.
D. Helps investors and creditors predict future cash flows.
Answer. B
A statement of financial position provides a basis for all of the following except
A. Computing rates of return.

B. Evaluating capital structure.
C. Assessing liquidity and financial flexibility.
D. Determining profitability and assessing past performance.
Answer. D
Long-term debt should be included in the current section of the statement of financial position if
A. It is to be converted into common stock before maturity.

B. It matures within the year and will be retired through the use of current assets.
C. Management plans to refinance it within the year.
D. A bond retirement fund has been set up for use in its scheduled retirement during the next year.
Answer. B
Dixon Company has the following items recorded on its financial records.
Prepared by: Yossef E. Elsherif. CMA 1

Available-for-sale securities $200,000
Prepaid expenses 400,000
Treasury stock 100,000
The total amount of the above items to be shown as Assets on Dixon’s Statement of Financial
Position is
A. $400,000.
B. $500,000.
C. $600,000.
D. $700,000.
Answer. C
All of the following are examples of cash equivalents for presentation on the statement of
financial position except
A. Commercial paper.
B. Money market funds.
C. Treasury bills.
D. Treasury bonds.
Answer. D
A receivable classified as current on the statement of financial position is expected to be

collected within
A. The current operating cycle.

B. One year.
C.The current operating cycle or one year, whichever is longer.
D.The current operating cycle or one year, whichever is shorter.
Answer. C
The financial statement that provides a summary of the firm’s operations for a period of time is
the
A. Income statement.
B. Statement of financial position.
C.Statement of shareholders’ equity.
D.Statement of retained earnings.
Answer. A
All of the following are elements of an income statement except

A. Expenses.
B. Shareholders’ equity.
C. Gains and losses.
D. Revenue.
Answer. B
When a fixed asset is sold for less than book value, which one of the following will decrease?
A. Total current assets.

B. Current ratio.
C.Net profit.
D.Net working capital.
Answer. C
The following information applies to the Income Statement of Addison Company.

Gross sales $1,000,000
Net sales 900,000
Freight-in 10,000
Ending inventory 200,000
Gross profit margin 40%
Addison’s cost of goods available for sale is
A. $550,000.
B. $560,000.
C.$740,000.
D.$800,000.
C
Net Sales = Gross Sales - Discounts & Returns
COGS = (1- Gross profit margin) x Net Sales
= 60% x 900,000 = 540,000
COGAS = COGS + EI = 540,000+200,000 = $ 740,000
A change in the estimate for bad debts should be
A. Treated as an error.
B. Handled retroactively.
C. Considered as an extraordinary item.
D. Treated as affecting only the period of the change.
Answer. D

Which one of the following would result in a decrease to cash flow in the indirect method of
preparing a statement of cash flows?
A. Amortization expense.
B. Decrease in income taxes payable.
C.Proceeds from the issuance of common stock.
D.Decrease in inventories.
Answer. B
When using the statement of cash flows to evaluate a company’s continuing solvency, the most
important factor to consider is the cash
A. Balance at the end of the period.

B. Flows from (used for) operating activities.
C.Flows from (used for) investing activities.
D.Flows from (used for) financing activities.
Answer. B
During the year, Deltech Inc. acquired a long-term productive asset for $5,000 and also borrowed
$10,000 from a local bank. These transactions should be reported on Deltech’s Statement of Cash
Flows as
A. Outflows for Investing Activities, $5,000; Inflows from Financial Activities, $10,000.
B. Inflows from Investing Activities, $10,000; Outflows for Financing Activities, $5,000.
C.Outflows for Operating Activities, $5,000; Inflows from Financing Activities, $10,000.
D.Outflows for Financing Activities, $5,000; Inflows from Investing Activities, $10,000.
Answer. A
Atwater Company has recorded the following payments for the current period.
Purchase Trillium stock $300,000

Dividends paid to Atwater shareholders $200,000
Repurchase of Atwater Company stock $400,000
The amount to be shown in the Investing Activities Section of Atwater’s Cash Flow Statement
should be
A. $300,000.
B. $500,000.
C.$700,000.
D.$900,000.
Answer. A

Carlson Company has the following payments recorded for the current period.
Dividends paid to Carlson shareholders $150,000

Interest paid on bank loan $250,000
Purchase of equipment $350,000
The total amount of the above items to be shown in the Operating Activities Section of Carlson’s
Cash Flow Statement should be
A. $150,000.
B. $250,000.
C.$350,000.
D.$750,000.
Answer. B
Barber Company has recorded the following payments for the current period.
Interest paid on bank loan $300,000

Dividends paid to Barber shareholders $200,000
Repurchase of Barber Company stock $400,000
The amount to be shown in the Financing Activities Section of Barber’s Cash Flow Statement
should be
A. $300,000.
B. $500,000.
C.$600,000.
D.$900,000.
Answer. C
Selected financial information for Kristina Company for the year just ended is shown below.
Net income $2,000,000
Increase in accounts receivable 300,000
Decrease in inventory 100,000
Increase in accounts payable 200,000
Depreciation expense 400,000
Gain on the sale of available-for-sale securities 700,000
Cash receivable from the issue of common stock 800,000
Cash paid for dividends 80,000
Cash paid for the acquisition of land 1,500,000
Cash received from the sale of available-for-sale securities 2,800,000
Kristina’s cash flow from financing activities for the year is
A. $(80,000).
B. $720,000.
C. $800,000.
D. $3,520,000.
Answer. B

In the previous Question, Kristina’s cash flow from investing activities for the year is
A. $(1,500,000).
B. $1,220,000.
C.$1,300,000.
D.$2,800,000.
Answer. C
In Question 19, assuming the indirect method is used, Kristina’s cash flow from operating activities
for the year is
A. $1,700,000.
B. $2,000,000.
C.$2,400,000.
D.$3,100,000.
Answer. A
Question 22 - Equity
The following information is available for Paragon as of November 30.

A. The market price of Paragon's common stock was $4 per share on November 30.
B. Common stock - $1 par value; 20,000,000 shares issued and outstanding - $20,000,000
C. Paid-in capital in excess of par value - $12,200,000
D. Retained earnings - $16,000,000
If Paragon had declared a 10% stock dividend on November 30, retained earnings would have
been:
A. Reduced by $8,000,000.
B. Reduced by $1,600,000.
C. Reduced by $6,000,000.
D. Reduced by $2,000,000.
A. A 10% stock dividend is a small stock dividend (a small stock dividend is less than or equal to
25% of the shares outstanding). In a small stock dividend, retained earnings is reduced by the fair
value of the shares that will be issued, using the value on the date of declaration to value the
shares. In a 10% dividend, Paragon would have issued 2,000,000 shares. At the date of
declaration the shares had a market value of $4, so the retained earnings of Paragon would have
decreased by $8,000,000 as a result of this stock dividend.
B. This amount is 10% of retained earnings, which does not mean anything in this problem.
C. This is the difference between the market price per share and the par value per share
multiplied by the number of new shares issued. That is not the way the amount of the reduction in
retained earnings is calculated.
D. This answer uses the par value of the shares to value the transaction. That is not the way the
amount of the reduction in retained earnings is calculated.
Morton Company declared and issued a 10% stock dividend during the current year. The effect of
this stock dividend on the following was:

Par Value per Share / Retained Earnings / Total Equity
A. No effect / Decrease / Decrease
B. Decrease / No effect / No effect
C. No effect / Decrease / No effect
D. Decrease / Decrease / No effect
C. A small stock dividend is recorded at the fair market value of the shares issued. The journal
entry is a debit to retained earnings and a credit to Common Shares and APIC. There is no
effect on the par value per share because the newly-issued shares have the same par value as
the existing shares. There is no effect on the total equity of the company since all of the
accounts used in the journal entry are equity accounts. Retained earnings is debited in the
journal entry and the debit decreases retained earnings.
A. Total equity is not decreased by a stock dividend because all of the accounts used in the
journal entry are equity accounts.
B. Par value per share is not affected by a small stock dividend because the newly-issued shares
have the same par value as the existing shares. Retained earnings is decreased.
D. Par value per share is not affected by a small stock dividend because the newly-issued shares
have the same par value as the existing shares.
Excerpts from the statement of financial position for Landau Corporation as of September 30 of
the current year are presented as follows.
Cash $ 950,000
Accounts receivable
(net) 1,675,000
Inventories 2,806,000
Total current assets $5,431,000
Accounts payable $1,004,000
Accrued liabilities 785,000
Total current liabilities $1,789,000
The board of directors of Landau Corporation met on October 4 of the current year and declared
the regular quarterly cash dividend amounting to $750,000 ($0.60 per share). The dividend is
payable on October 25 of the current year to all shareholders of record as of October 12 of the
current year.
Assume that the only transactions to affect Landau Corporation during October of the current year
are the dividend transactions and that the closing entries have been made.
Landau Corporation's working capital was
A. Unchanged by the dividend declaration and decreased by the dividend payment.

B. Decreased by the dividend declaration and increased by the dividend payment.
C. Decreased by the dividend declaration and unchanged by the dividend payment.
D. Unchanged by either the dividend declaration or the dividend payment.
C. Working capital is current assets minus current liabilities. In the process of declaring and paying
a dividend, the working capital of the company decreases at the declaration date and is unchanged
at all other dates. The decrease at declaration occurs because the liabilities of the company
increase with the dividend payable while all other assets and liabilities remain the same. When the
dividend is paid, both liabilities (dividends payable) and assets (cash) are decreased by the same
amount, which leaves working capital unchanged.

A. This is not the correct answer.
B. This is not the correct answer.
D. This is not the correct answer.
In the previous question, Landau Corporation's current ratio was
A. Decreased by the dividend declaration and increased by the dividend payment.

B. Increased by the dividend declaration and unchanged by the dividend payment.
C. Decreased by the dividend declaration and unchanged by the dividend payment.
D. Unchanged by either the dividend declaration or the dividend payment.
A. The current ratio is calculated as current assets divided by current liabilities. Prior to the dividend
events, the current ratio of the company was 3.04 ($5,431,000 ÷ $1,789,000). After the declaration
of the dividend, the current liabilities increased by $750,000 and this would decrease the current
ratio to 2.14 ($5,431,000 ÷ $2,539,000).
When the dividend is paid, both current assets and current liabilities will decrease by $750,000,
with current liabilities returning to its pre-dividend level of $1,789,000. Now, the current ratio is 2.62
($4,681,000 ÷ $1,789,000). Since the current ratio was 2.14 before the dividend payment, the
dividend payment increased the current ratio.
B. The declaration of the dividend decreased the current ratio, and the payment of the dividend
increased the current ratio.
C. The payment of the dividend increased the current ratio.
D. The current ratio is changed by both of these events.
In the previous question, Landau Corporation's total equity was
A. Unchanged by the dividend declaration and decreased by the dividend payment.

B. Decreased by the dividend declaration and increased by the dividend payment.
C. Unchanged by either the dividend declaration or the dividend payment.
D. Decreased by the dividend declaration and unchanged by the dividend payment.
D. When the dividend was declared, retained earnings was debited (decreased). All of the
remaining events do not affect any of the equity accounts. Therefore, equity was decreased by the
dividend declaration and unchanged by the dividend payment.
A. The declaration of the dividend decreased retained earnings (an equity account) but the payment
of the dividend did not affect any equity account.
B. While total equity is decreased by the dividend declaration, the payment of the dividend does
not change the equity of the company.
C. The total equity of the company was decreased by the dividend declaration.
In the previous question, if the dividend declared by Landau Corporation had been a 10%
stock dividend instead of a cash dividend,
Landau's current liabilities would have been
A. Unchanged by the dividend declaration and increased by the dividend distribution.

B. Unchanged by either the dividend declaration or the dividend distribution.
C. Increased by the dividend declaration and unchanged by the dividend distribution.
D. Unchanged by the dividend declaration and decreased by the dividend distribution.

B. A stock dividend is not recorded as a liability, even if the shares are not distributed at the
declaration date. All of the journal entries to record the declaration and distribution of a stock
dividend are made within the equity section. Therefore a stock dividend will not impact the current
liabilities of the company.
A. This is not the correct answer.

C. This is not the correct answer.
In the previous question, if the dividend declared by Landau Corporation had been a 10%
stock dividend instead of a cash dividend,
Landau's total shareholders' equity would have been
A. Decreased by the dividend declaration and increased by the dividend distribution.

B. Increased by the dividend declaration and unchanged by the dividend distribution.
C. Unchanged by either the dividend declaration or the dividend distribution.
D. Unchanged by the dividend declaration and increased by the dividend distribution.
C. A stock dividend does not result in a change to total equity. In the stock dividend there is a debit
to Retained Earnings (decreasing total equity) and a credit that is made to Common Stock and
Additional Paid in Capital (increasing total equity). So, a stock dividend does not change total
equity.
A. A stock dividend does not affect total equity.

B. A stock dividend does not affect total equity.
D. A stock dividend does not affect total equity.
On December 1, Charles Company's board of directors declared a cash dividend of $1.00 per share
on the 50,000 shares of common stock outstanding. The company also has 5,000 shares of treasury
stock. Shareholders of record on December 15 are eligible for the dividend, which is to be paid on
January 1. On December 1, the company should
A. Debit retained earnings for $55,000.

B. Debit retained earnings for $50,000 and paid-in capital for $5,000.
C. Make no accounting entry.
D. Debit retained earnings for $50,000.
D. On the date that dividends are declared the company should record a journal entry that debits
Retained Earnings for the amount of the dividend that is expected to be paid and credits Dividends
Payable for the same amount. The dividend is paid only to shares that are outstanding. This means
that treasury stock does not receive the dividend. The company declared a $1 per share dividend
and the company has 50,000 shares outstanding, so retained earnings should be debited for
$50,000.
A. The debit to retained earnings is incorrect because treasury shares do not receive the dividend.
The dividend is paid only to shares outstanding, and treasury shares are not outstanding.
B. The debit to retained earnings is correct, but there is no debit to paid-in-capital.
C. On the date of declaration the company should make a journal entry that reduces retained
earnings and establishes a dividend payable.

Which one of the following is true regarding small stock dividends?
A. Each common shareholder's percentage of ownership in the corporation increases.

B. The amount of equity capital available for future dividends is increased.
C. An amount equal to the current fair value of shares issued is transferred from retained earnings
to contributed capital.
D. Retained earnings equal to the par value of shares issued is converted to contributed capital.
C. In a small stock dividend, retained earnings is debited for the fair value of the shares issued, the
common stock account is credited for the par value of the newly issued shares, and additional paid-
in capital is credited for the difference. The effect of this is to transfer an equal amount of money
from retained earnings to contributed capital.
A. In a stock dividend the proportional ownership of each of the owners is unchanged.

B. The amount of capital available for future dividends is decreased by a small stock dividend
because the retained earnings account is debited (reduced) by the amount of the fair value of the
shares issued in the dividend.
Hessler received cash in the amount of $180,000 on March 11 for 10,000 shares of common stock.
Hessler's common stock has $5 per share par value. The amount recorded as a credit to common
stock for this transaction would have been
A. $130,000
B. $50,000
C. $180,000
D. $80,000
B. In the issuance of shares the Common Stock account is credited for the par value of the shares
issued. There were 10,000 shares issued and the par value of each share is $5. This gives a total
of $50,000 as the credit to Common Stock.
A. This is the amount credited to Paid in Capital.

C. This is the amount of cash received in the transaction.
Question 32 – Equity
Which one of the following items most likely increases earnings per share (EPS) of a corporation?
A. Declaration of a stock split.

B. A reduction in the amount of cash dividends paid to common shareholders.
C. Declaration of a stock dividend.
D. Purchase of treasury stock.
D. When the company purchases treasury shares, they are reducing the number of shares
outstanding. This will result in an increase in the earnings per share of the common shares that
remain outstanding.
A. A stock split increases the number of shares outstanding, which therefore decreases earnings
per share.
B. A reduction in the cash dividends paid to common shareholders will have no impact on the
earnings per share of the company.
C. A stock dividend increases the number of shares outstanding, which therefore decreases
earnings per share.
A stock dividend
A. Increases the debt-to-equity ratio of a firm.

B. Decreases future earnings per share.
C. Increases shareholders' wealth.
D. Decreases the size of the firm.
B. In a stock dividend more shares are issued to existing shareholders. Since there is no increase
in income from this event but there are more shares outstanding, future earnings per share will
decrease as a result of the stock dividend.
A. A stock dividend has no impact on the book value of the company's total equity. Therefore, there
is no effect on the debt-to-equity ratio.
C. A stock dividend does not in itself increase shareholder wealth. The stock dividend provides
more shares to each shareholder, but the total value of the shares remains unchanged.
D. A stock dividend does not impact the size of the firm.
An appropriation of retained earnings by the board of directors of a corporation for future

plant expansion will result in:
A. The disclosure that management does not intend to distribute, in the form of dividends, assets
equal to the amount of the appropriation.
B. A decrease in cash on the balance sheet with an equal increase in the investments and funds
section of the balance sheet.
C. The establishment of a fund to help finance future plant expansion.
D. A decrease in the total amount of retained earnings presented on the balance sheet.
A. All that happens in an appropriation of retained earnings is that the company informs the readers
of the financial statement that the amount of retained earnings that has been appropriated is not
available for distribution. The only journal entry made is one to reclassify the retained earnings.
B. In an appropriation, the only journal entry is to reclassify the retained earnings into the account
call Appropriated Retained Earnings. There is no change in the cash or investment accounts.
C. In the appropriation of retained earnings, no fund is established. The appropriation simply
informs readers of the financial statements that the amount that has been appropriated is not
available for distribution as a dividend.
D. In an appropriation there is no change in the total retained earnings on the balance sheet. There
is only a reclassification of the amount that has been appropriated.
The par value of common stock represents
A. The liability ceiling of a shareholder when a company undergoes bankruptcy proceedings.

B. The total value of the stock that must be entered in the issuing corporation's records.
C. The amount that must be recorded on the issuing corporation's record as paid-in capital.
D. The estimated fair value of the stock when it was issued.

A. The par value of a share is the amount of the legal capital that share represents. It also
represents, the maximum liability of a shareholder when the company goes through bankruptcy.
Many companies have shares with a low par value. The amount of the legal capital is also unable
to be distributed by the company.
B. The value that is entered into the company's records for the stock is the fair value of all assets
or services received in exchange for the stock. This amount will be split between two accounts, but
the total fair value of what was received is entered into the company's books.
C. The amount that is recorded as paid in capital is the difference between the fair value of what
was received and the par value of the shares that were issued.
D. Though the par value may in some cases be equal to the fair value of the stock, this is not what
par value represents.
Brady Corporation has 6,000 shares of 5% cumulative, $100 par value preferred stock outstanding
and 200,000 shares of common stock outstanding. Brady's board of directors last declared
dividends for the year ended May 31, 2010, and there were no dividends in arrears at that time. For
the year ended May 31, 2012, Brady had net income of $1,750,000. The board of directors is
declaring a dividend for common shareholders equivalent to 20% of net income.
The total amount of dividends to be paid by Brady at May 31, 2012 is:
A. $350,000
B. $380,000
C. $206,000
D. $410,000
D. There are two dividends that Brady must pay. Before paying the common dividend, all
cumulative dividends that have been earned this period or are in arrears need to be paid. A total of
$600,000 par value of preferred, cumulative shares are outstanding that earn a 5% dividend. The
last dividend was declared for the year ended May 31, 20X0. Therefore, the company needs to pay
two years worth of preferred, cumulative dividends before it can pay a common dividend.
At 5%, the dividend is $30,000 per year, for a total of $60,000 for the two years that needs to be
paid. The second dividend is the common dividend. It is 20% of net income.
Net income was $1,750,000 and 20% of this is $350,000. Adding together the two dividends, we
get a total dividend to be paid of $410,000.
A. This is the amount of the common dividend only. The preferred dividend also needs to be paid.
B. This includes only one year of the preferred cumulative dividend. However, since the company
has not paid the preferred, cumulative dividend for two years, two years of the preferred dividend
needs to be paid.
C. 206,000 is the total number of common and preferred shares outstanding. It is not the total
dividends to be paid.
Question 37. The purchase of treasury stock is recorded on the statement of financial position as a
(n)
A. Increase in assets.
B. Decrease in assets.
C. Increase in shareholders’ equity.
D. Decrease in shareholders’ equity.
Answer. D

Question 38. A company pays more than the fair market value to acquire treasury stock in
order to avoid a takeover attempt. The difference between the price paid to acquire the treasury
stock and the fair market value should be recorded as
A. An asset.
B. A liability.
C. Shareholders’ equity.
D. An expense.
Answer. D
Question 39. On December 1, Noble Inc.’s Board of Directors declared a property dividend,
payable in stock held in the Multon Company. The dividend was payable on January 5. The
investment in Multon stock had an original cost of $100,000 when acquired two years ago. The
market value of this investment on December 1 was $150,000, on December 31 was $175,000, and
on January 5 was $160,000. The amount to be shown on Noble’s Statement of Financial Position at
December 31 as Property Dividends Payable would be
a. $100,000.
b. $150,000.
c. $160,000.
d. $175,000.
Answer. B
Question 40. How would a stock split affect the par value of the stock and the company’s
shareholders’ equity?
Par Value Shareholders’ Equity

A. Decrease Increase.
B. Decrease No Change.
C. Increase Decrease.
D. Increase No Change.
Answer. B
Question 41 - Revenue Recognition
Depending upon the circumstances, revenue can be recognized at different times for
accounting purposes. Generally accepted revenue recognition methods do not include
A. Present value of a contract to sell merchandise.

B. During production.
C. End of production.
D. Receipt of cash.
A. The present value of a contract to sell merchandise is not an accepted revenue recognition
method.
B. Revenue may be recognized during production in the case of long-term construction contracts.
C. Revenue may be recognized at the end of production if certain conditions are met.
D. Revenue may be recognized at the receipt of cash in some methods (cost and installment
methods) and in many cases when the purchase and the exchange of the good or service take
place simultaneously, revenue is recognized with the receipt of cash.

Citizen Metals Corporation produces precious metals from its mining activities. The selling price for
its product is reasonably assured, the units are interchangeable, and the costs of selling and
distributing the product are insignificant. In order for Citizen to recognize revenue as early in the
revenue cycle as is permitted by generally accepted accounting principles, the revenue recognition
method that Citizen should use is the
A. Cost recovery method.

B. Percentage-of-completion method.
C. Completion of production method.
D. Cash method.
C. In order to recognize revenue at the completion of production, three criteria must be met. These
three criteria are: 1) the item is readily saleable as soon as it is completed, 2) there is a known
market price for the item and there are minimal selling costs, and 3) the units are homogenous
(identical to each other). Since all of these criteria are met, Citizen can recognize revenue as soon
as production is complete. This is the earliest that they could recognize revenue.
A. Under the cost recovery method of revenue recognition, they would not recognize revenue until
the cash collected exceeds the cost of production. This is not the earliest that they would be able
to recognize revenue.
B. The percentage-of-completion method would not be appropriate in the situation that is described.
D. Under the cash method of revenue recognition, they would not recognize revenue until the cash
is collected. This is not the earliest that they would be able to recognize revenue.
On September 1, 2014, Beach Construction Company entered into a $10 million contract with City
University to build a five-story parking garage. On that date, Beach's estimated total cost of
constructing the building was $8 million. The estimated completion date for the garage was August
2016. Beach accounts for long-term construction contracts using the percentage-of-completion
method. Beach's fiscal year ends May 31. Data regarding the contract are as follows.
At May 31 (in thousands of dollars)

2015 2016
Actual costs incurred to date $2,000 $6,750
Estimated costs to complete 6,000 2,250
Progress billings to date 1,800 6,000
Cash collected to date 1,450 5,500
The gross profit recognized for the fiscal year ended May 31, 2016 from this contract would be
A. $750,000
B. $250,000
C. $1,000,000
D. $500,000
B. The amount of profit that is recognized for the year ended May 31, 2016 is calculated as follows:
[(total expected profit × percentage complete) − profit previously recognized]. The total expected
profit is calculated by taking the contract price ($10,000,000) and subtracting the total of the costs
already incurred ($6,750,000) and the expected costs to be incurred to complete the project
($2,250,000). The expected profit is $1,000,000 ($10,000,000 − $9,000,000).
The calculation of the percentage complete is done by dividing the costs incurred to date
($6,750,000) by the total expected costs for the project ($9,000,000). Thus, at May 31, 2016, the
project is 75% complete. This means that Beach should have recognized in total $750,000 in profit
by May 31, 2016. However, some of that profit was recognized in 2015, so that profit recognized in
2015 needs to be subtracted from $750,000 to determine the profit that needs to be recognized at
May 31, 2016.
The profit recognized in 2015 was calculated in the same manner as we calculated it for 2016. At
that time, the expected profit on the contract was $2,000,000 ($10,000,000 − $8,000,000).
$2,000,000 of actual costs had been incurred to date at that point, which was 25% of the expected
total costs at that time of $8,000,000. Therefore, the amount of profit recognized by Beach for 2015
was 25% of $2,000,000, or $500,000.
Therefore, at May 31, 2016, only $250,000 of additional profit needs to be recognized ($750,000 −
$500,000).
A. This is the total amount of profit that needs to be recognized by May 31, 2016. However, some
of this profit was recognized at May 31, 2015. See the correct answer for a complete explanation.
C. This is the total expected profit on the project as of May 31, 2016. See the correct answer for a
complete explanation.
D. This is the amount of profit that was recognized at May 31, 20X5. See the correct answer for a
complete explanation.
Question 44 -Revenue Recognition
The percentage-of-completion method of accounting for long-term construction contracts is

an exception to the
A. Going concern assumption.

B. Revenue recognition principle.
C. Matching principle.
D. Historical cost principle.
B. Revenue recognition normally occurs when the product is complete and has been delivered to
the customer. The percentage-of-completion method allows revenue to be recognized before the
asset has been completed (perhaps years before is it complete) and before the customer has
possession of the asset. The percentage-of-completion method is acceptable for GAAP and IFRS
purposes for long-term contracts, but it is an exception to the normal revenue recognition methods.
A. The going concern assumption is the assumption that the business will remain in operations for
the foreseeable future. This is not really relevant here.
C. The percentage-of-completion method of long-term contracts attempts to match the revenues
and expenses of the contract more evenly than the completed contract method, so it is not an
exception to the matching principle.
D. The historical cost principle is related to recording assets on the balance sheet at the amount
that was paid for them. The percentage-of-completion method does this.
After a successful drive aimed at members of a specific national association, Gorham Publishing
Company received a total of $90,000 for three-year subscriptions to a monthly publication
beginning April 1, 2015 and recorded this amount in the unearned revenue account. Assuming
Gorham only records adjustments at the end of the calendar year, the adjusting entry required to
reflect the proper balances in the accounts at December 31, 2015, would be to:
A. Debit subscription revenue for $67,500 and credit unearned revenue for $67,500.
B. Debit unearned revenue for $67,500 and credit subscription revenue for $67,500.
C. Debit unearned revenue for $30,000 and credit subscription revenue for $30,000.
D. Debit unearned revenue for $22,500 and credit subscription revenue for $22,500.

D. When the subscriptions were recorded the journal entry was a debit to cash for $90,000 and a
credit to unearned revenue for $90,000. At the end of 20X5, Gorham needs to recognize the
revenue that has been earned. Since there are 36 months in the subscriptions and nine months
have passed, Gorham should recognize 25% of the amount collected as revenue. This is done by
debiting unearned revenue for $22,500 and crediting subscription revenue for $22,500.
The correct amount can also be calculated by dividing $90,000 by 36 to find the amount of revenue
earned per month and multiplying the monthly revenue by nine months. $90,000 ÷ 36 × 9 = $22,500.
A. This would be the answer if the initial entry had been to revenue and not unearned revenue.
However, in the question we are told that the initial entry was to unearned revenue.
B. This answer assumes 75% of the subscription period has passed instead of 25%.
C. This answer assumes that 1/3 of the subscription period has passed. Since the subscriptions
started April 1, only 9 months have passed.
Diamond Clover Construction Inc. uses the percentage-of-completion method of accounting. In year
1, the company began work on job #4115, with a contract price of $5,000,000. Other data are
shown below.
Year 1 Year 2
Costs incurred during the year $ 900,000 $2,350,000
Estimated costs to complete 2,700,000 0
Billings during the year 1,000,000 4,000,000
Collections during the year 700,000 4,300,000
The amount of total gross profit to be recognized in year 1 is:
A. $700,000
B. $766,667
C. $1,400,000
D. $350,000
D. The amount of profit that is recognized in year 1 is calculated as follows: [(total expected profit
× percentage complete) − profit previously recognized]. The total expected profit is calculated by
taking the contract price ($5 million) and subtracting the actual costs incurred to date ($900,000)
and the estimated cost to complete ($2.7 million). The expected profit is $1,400,000. The
calculation of the percentage complete is done by dividing the costs incurred to date ($900,000) by
the total expected costs for the project ($3,600,000). Thus, at the end of year 1, the project is 25%
complete. This means that the company should have recognized in total $350,000 in profit at the
end of year 1. Since this is the first year of the project, there is no previously recognized profit to
subtract in year 1.
A. This is the amount of cash collected during year 1.

C. This is the total expected profit over the life of the project. See the correct answer for a complete
explanation.
In the previous question, if Diamond Clover Construction Inc. were to use the completed-
contract method of accounting, the total amount to be recognized as income in year 2 would be:
A. $1,400,000
B. $1,750,000
C. $700,000
D. $2,650,000
B. Under the completed contract method, no profit is recognized until the project is complete. In
the year that the project is completed, the entire profit is recognized. The profit is calculated as the
contract price ($5,000,000) minus the total costs incurred to complete the contract ($900,000 +
$2,350,000). So, the total profit was $1,750,000.
A. This is the expected profit at the end of year 1.

C. This answer is incorrect.
D. This answer does not include the $900,000 of costs that were incurred in year 1. These costs
also need to be included to calculate the profit on the project.
On May 28, Markal Company purchased a tooling machine from Arens and Associates for
$1,000,000, payable as follows: 50 percent at the transaction closing date and 50 percent due June
28. The cost of the machine to Arens is $800,000. Markal paid Arens $500,000 at the transaction
closing date and took possession of the machine. On June 10, Arens determined that a change in
the business environment has created a great deal of uncertainty regarding the collection of the
balance due from Markal, and the amount is probably uncollectible. Arens and Markal have a fiscal
year end of May 31.
The revenue recognized by Arens and Associates on May 28 is
A. $800,000
B. $200,000
C. $0
D. $1,000,000
D. On the date of the sale (May 28) there was no indication that the receivable would not be
collectible. Therefore, on May 28, the entire $1,000,000 selling price is recognized as revenue.
A. This is the cost of goods sold in the transaction, not the revenue recognized.
B. This is the profit on the sale, not the revenue that was recognized.
C. Because there is no indication that the receivable was not going to be collected, the entire sales
price (including the amount represented by the receivable) should have been recognized as
revenue on May 28.
Genova Corporation sold equipment for $200,000 on November 11. The book value of the equipment
on the date of sale was $80,000. The buyer paid $20,000 to Genova on the date of sale and the
balance was due in three equal annual installments beginning on December 1. The buyer made the
scheduled payment to Genova on December 1. Genova uses the calendar year for reporting
purposes.
If Genova uses the installment sales method for internal reporting purposes, the gross profit
that Genova would realize in the current year on the sale of the equipment is:
A. $48,000.
B. $120,000.
C. $0.
D. $80,000.
A. This question asks how much profit should be recognized this period, and this is done by
multiplying the cash received this period by the profit % on the sale. The cash received this period
was $80,000 ($20,000 down payment and $60,000 from the first of the three equal installments),
and the profit % is calculated as the profit from the sale divided by the sales price. This gives a
profit percentage of 60% ($120,000 profit ÷ $200,000 sales pr ice). Multiplying this by the cash
received during the period gives $48,000 of profit to recognize in the current period.

B. This is the total profit on the sale. Under the installment method, this profit will be recognized
only as cash is collected.
C. There would not be any profit recognized under the cost recovery method, but the question is
about the installment method.
D. This is the amount of cash collected during the period.
In the previous question, if Genova uses the cost recovery method for internal reporting purposes,
the gross profit that Genova would realize in the current year on the sale of the equipment is
A. $0.
B. $120,000.
C. $48,000.
D. $80,000.
A. Under the cost recovery method, profit will not be recognized until the cash collected exceeds
the cost of the item sold. In this case the cost of the item sold is the book value of the equipment,
or $80,000. Since at the end of the current year Genova has collected only $80,000, no profit will
be recognized in the current year.
B. This is the profit from the sale.

C. This is the answer if Genova used the installment method. However, the question is in respect
to the cost recovery method.
D. This is the amount of cash that Genova collected during the period.
Allan Construction signed a $48,000,000 contract on September 1, 20X4 with the City of
Springfield to construct a tunnel under the Maple River. On that date, the estimated cost to
complete the tunnel, which was to be completed by June 20X7, was $36,000,000. Allan's fiscal
year ends November 30, and the company uses the percentage-of-completion method of revenue
recognition.
Data regarding the tunnel contract, which was begun December 1, 20X4, are as follows.
At November 30 (in thousands)

20X5 20X6
Actual costs to date $12,000 $30,000
Estimated costs to complete 24,000 10,000
Progress billings to date 10,000 28,000
Cash collected to date 8,000 24,000
The gross profit or loss recognized in the fiscal year ended November 30, 20X5 from the
tunnel contract is:
A. $4,000,000 gross profit.

B. $6,000,000 gross profit.
C. $12,000,000 gross profit.
D. $3,000,000 gross profit.
A. The amount of profit that is recognized for the year ended November 30, 2015 is calculated as
follows: [(total expected profit × percentage complete) − profit previously recognized]. The total
expected profit is calculated by taking the contract price ($48,000,000) and subtracting the total of
the costs already incurred ($12,000,000) and the expected costs to be incurred to complete the
project ($24,000,000). The expected profit is $12,000,000. The calculation of the percentage
complete is done by dividing the costs incurred to date ($12,000,000) by the total expected costs
for the project ($36,000,000). Thus, at November 30, 2015, the project is 1/3 complete. This means
that Allan should have recognized in total $4,000,000 in profit by November 30, 2015. Since this is
the first year of the project, there are no previously recognized profits to subtract and the answer is
$4,000,000.
B. This is the total profit to be recognized during 2015 and 2016.

C. This is the total expected profit on the project. However, not all of it can be recognized in the
year ended November 30, 2015.
In the previous question, assume that the estimated costs to complete at November 30, 2016 were
$20 million rather than the $10 million shown in the given schedule. The gross loss recognized on
the contract from its inception through November 30, 2016 is
A. $2,000,000.
B. $7,500,000.
C. $8,000,000.
D. $1,200,000.
A. The actual costs to date as of November 30, 2016 were $30,000,000. If the estimated costs to
complete at the end of 2016 were $20,000,000, the anticipated total cost for the project is
$30,000,000 + $20,000,000, or $50,000,000. Since revenue from the contract will be only
$48,000,000, the entire project would have an expected loss of $2,000,000. Expected losses
always need to be recognized in full in the period in which they arise, so by the end of 2016, Allan
would need to have recognized a $2,000,000 loss on the contract from its inception through
November 30, 2016.

C. This is not the correct answer.
D. This is the loss that would be recognized if the loss were recognized based on the percentage
complete the project is. Expected losses are always recognized in full in the period in which they
arise.
Although a transfer of ownership has not occurred, the percentage-of-completion method is

acceptable under the revenue recognition principle because
A. The assets are readily convertible into cash.

B. The earning process is completed at various stages.
C. The production process can be readily divided into definite stages.
D. Cash has been received from the customer.
B. In a long-term contract some of the profits from the whole contract are earned as the contract is
completed. Because of the fact that the earnings take place throughout the contract, the recognition
of earnings is acceptable even though the transfer of ownership has not yet occurred.
A. Long-term construction contracts are probably not readily convertible into cash and therefore
this is not the reason for the use of the percentage-complete method.
C. Though it may be that the construction process can be divided into definite stages, this is not
the reason that profit can be recognized before the transfer of ownership.
D. Though it may be that cash has been received from the customer, this is not the reason that
profit can be recognized before the transfer of ownership.

Paulson Company uses the percentage-of-completion method to account for long-term

construction contracts. The following information relates to a contract that was awarded
at a price of $700,000. The estimated costs were $500,000, and the contract duration
was three years.
Year 1 Year 2 Year 3

Cumulative cost to date $300,000 $390,000 $530,000
Costs to complete at year end 250,000 130,000 -0-
Progress billings 325,000 220,000 155,000
Collections on account 300,000 200,000 200,000
Assuming that $65,000 was recognized as gross profit in Year 1, the amount of gross profit
Paulson recognized in Year 2 was
A.$59,950.
B. $70,000.
C. $124,950.
D. $135,000.
Answer. B

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STUDY UNIT ONE

EXTERNAL FINANCIAL STATEMENTS

A. About the economic resources and obligations of a company.

Question 2. Financial Statements

A. Is useful for making investment and credit decisions.

Question 3. Financial Statements

A. Computing rates of return.

Question 4. Financial Statements

A. It is to be converted into common stock before maturity.

Question 5. Financial Statements

Prepared by: Yossef E. Elsherif. CMA 1

Question 6. Financial Statements

Question 7. Financial Statements

A receivable classified as current on the statement of financial position is expected to be

A. The current operating cycle.

Question 8. Financial Statements

Question 9. Financial Statements

All of the following are elements of an income statement except

Prepared by: Yossef E. Elsherif. CMA 2

Question 10. Financial Statements

A. Total current assets.

Question 11. Financial Statements

The following information applies to the Income Statement of Addison Company.

Question 12. Financial Statements

A change in the estimate for bad debts should be

Prepared by: Yossef E. Elsherif. CMA 3

Question 14. Financial Statements

A. Balance at the end of the period.

Question 15. Financial Statements

Question 16. Financial Statements

Purchase Trillium stock $300,000

Prepared by: Yossef E. Elsherif. CMA 4

Dividends paid to Carlson shareholders $150,000

Question 18. Financial Statements

Interest paid on bank loan $300,000

Question 19. Financial Statements

Kristina’s cash flow from financing activities for the year is

Prepared by: Yossef E. Elsherif. CMA 5

Question 21. Financial Statements

The following information is available for Paragon as of November 30.

Prepared by: Yossef E. Elsherif. CMA 6

Landau Corporation's working capital was

A. Unchanged by the dividend declaration and decreased by the dividend payment.

Prepared by: Yossef E. Elsherif. CMA 7

In the previous question, Landau Corporation's current ratio was

A. Decreased by the dividend declaration and increased by the dividend payment.

In the previous question, Landau Corporation's total equity was

A. Unchanged by the dividend declaration and decreased by the dividend payment.

A. Unchanged by the dividend declaration and increased by the dividend distribution.

Prepared by: Yossef E. Elsherif. CMA 8

A. This is not the correct answer.

A. Decreased by the dividend declaration and increased by the dividend distribution.

A. A stock dividend does not affect total equity.

A. Debit retained earnings for $55,000.

Prepared by: Yossef E. Elsherif. CMA 9

Which one of the following is true regarding small stock dividends?

A. Each common shareholder's percentage of ownership in the corporation increases.

A. In a stock dividend the proportional ownership of each of the owners is unchanged.

A. This is the amount credited to Paid in Capital.