Valuing Assets, Liabilities & Equity

Question 1

What is the net realizable value of accounts receivable?

Answer 1

The net amount expected to be collected from receivables, considering future returns, allowances, and credit losses.

This value is crucial for accurately presenting short-term receivables on financial statements.

Question 2

What is the purpose of the Allowance for Credit Losses-Trade Receivables account?

Answer 2

To report the portion of receivables estimated to be uncollectible, reducing the carrying amount of receivables on the balance sheet.

This account ensures that assets are not overstated by reflecting expected credit losses.

Question 3

How is the credit loss expense recorded at the end of each period?

Answer 3

• Debit: Credit loss expense-trade receivables
• Credit: Allowance for credit losses-trade receivables

This entry adjusts the allowance account to reflect management’s current estimate of expected credit losses.

Question 4

What costs are included in the valuation of inventory when purchased?

Answer 4

• Cost of the inventory
• Shipping costs
• Insurance in transit
• Taxes and tariffs
• Duties

All of the costs that are necessary to get the inventory ready and available for sale are included in the value of the inventory.

Question 5

Who owns goods shipped FOB Shipping Point while in transit?

Answer 5

Buyer

Title transfers at the shipping point, so the buyer should include these goods in their ending inventory.

Question 6

What is the formula for calculating Cost of Goods Sold?

(COGS)

Answer 6

Beginning Inventory + Purchases - Ending Inventory

This formula is essential for determining the cost associated with goods sold during a period.

Question 7

What are the main cost flow assumptions for inventory?

Answer 7

• First in First Out (FIFO)
• Last in First Out (LIFO)
• Average Cost
• Specific Identification

For the FMAA exam, only FIFO and LIFO are tested.

Question 8

Under FIFO, which inventory items are assumed to be sold first?

Answer 8

The oldest items in inventory.

This assumption affects both the balance sheet and income statement, particularly in periods of rising costs.

Question 9

Under LIFO, which inventory items are assumed to be sold first?

Answer 9

The newest items in inventory.

This method results in higher COGS and lower ending inventory in periods of rising prices.

Question 10

True or False:

Under IFRS, LIFO is prohibited.

Answer 10

True

LIFO is not allowed under International Financial Reporting Standards (IFRS).

Question 11

What is the FIFO method used for in inventory accounting?

Answer 11

• Calculating ending inventory
• Determining cost of goods sold (COGS)

FIFO assumes that the oldest inventory items are sold first, so ending inventory consists of the most recently purchased items.

Question 12

How does the LIFO method differ from FIFO in terms of inventory valuation?

Answer 12

• LIFO (Last-In, First-Out): Assumes the most recently purchased items are sold first, so ending inventory consists of the oldest units, and COGS includes the newest units.
• FIFO (First-In, First-Out): Assumes the oldest items are sold first, so ending inventory consists of the most recent purchases, and COGS includes the oldest units.

In a period of rising prices, LIFO results in lower ending inventory and a higher COGS (which leads to a lower profit) than FIFO would.

Question 13

What is the periodic method in inventory accounting?

Answer 13

Inventory calculations are done at the end of the accounting period.

The periodic method contrasts with the perpetual method, where calculations are made after each inventory transaction.

Question 14

What costs are included in the initial recording of fixed assets?

Answer 14

• Historical cost
• Costs necessary to get the asset ready for use

This includes purchase price, installation costs, and any other expenses required to prepare the asset for its intended use.

Question 15

What is the purpose of depreciation?

Answer 15

Systematic allocation of the cost of a fixed asset over its useful life.

Depreciation matches the cost of acquiring the asset with the revenues it generates over its useful life.

Question 16

How is net book value of fixed assets calculated?

Answer 16

Historical cost minus accumulated depreciation

Net book value represents the carrying value of fixed assets on the balance sheet.

Question 17

What information is needed to calculate depreciation?

Answer 17

• Estimated useful life
• Estimated salvage value
• Depreciable base
• Depreciation method

These factors determine the amount of depreciation to be recorded each period.

Question 18

What is straight-line depreciation?

Answer 18

Equal amount of depreciation taken each period.

Straight-line depreciation is the simplest method and is often used in questions that include depreciation.

Question 19

How does the double declining balance method calculate depreciation?

Answer 19

• Uses 200% of the straight-line rate
• Applied to the net book value at the beginning of each year

This method results in higher depreciation in the early years of an asset’s life.

Question 20

What is the sum-of-the-years’-digits method?

Answer 20

• Uses fractions based on the estimated useful life.
• Depreciable base multiplied by a fraction

The denominator is the sum of the asset’s useful life years, and the numerator is the remaining years.

Question 21

How are intangible assets initially recorded?

Answer 21

Initially recorded at their acquisition cost, which includes the purchase price plus any directly attributable costs necessary to prepare the asset for use.

Internally generated intangible assets, such as patents or customer goodwill, are not recorded on the balance sheet unless they arise from a past transaction.

Question 22

What is the accounting treatment for research and development costs?

Answer 22

Generally expensed as incurred.

This means they are not capitalized and amortized, except for registration and legal fees related to patents.

Question 23

How is amortization of intangible assets with a finite life determined?

Answer 23

The cost minus any residual value, amortized over the useful life.

Amortization should reflect the pattern in which the asset is used, if determinable.

Question 24

What happens if the estimated life of a limited-life intangible asset changes?

Answer 24

The remaining carrying amount should be amortized prospectively over the revised remaining useful life.

This ensures that the amortization reflects the updated useful life of the asset.

Question 25

How are **intangible assets** with an **indefinite life** treated?

Answer 25

They are not amortized but must be **tested regularly** for impairment. ## Footnote If impaired, the asset should be written down to its fair value.

Question 26

What is a **liability**?

Answer 26

A present **obligation of an entity** to transfer or provide an economic benefit to others. ## Footnote Liabilities are obligations that exist at the financial statement date and may require payment of cash, transfer of assets, or provision of services.

Question 27

What creates an **obligation** for a liability?

Answer 27

Receiving cash with the expectation to **provide a good or service or refund** the cash if not provided by a certain date. ## Footnote This obligation arises from the entity's commitment to fulfill the terms of the transaction.

Question 28

What is **owners' equity**?

Answer 28

It is the **residual interest** in the assets of an entity **after deducting its liabilities**. ## Footnote It represents what the company owes to the owners and is the balancing element of the balance sheet.

Question 29

What are the two main classifications of **corporate shareholders' equity**?

Answer 29

* Contributed capital * Retained earnings

Question 30

What does **contributed capital** consist of?

Answer 30

It consists of the **assets** put into the company by the owners in return for their **share of ownership**. ## Footnote It is recorded in the capital stock account and additional-paid-in-capital (APIC) account.

Question 31

What are **retained earnings**?

Answer 31

Retained earnings represent the **undistributed profits of the company** that were **reinvested** in the company. ## Footnote They may also be called undistributed earnings.

Question 32

What is **par value** in relation to common stock?

Answer 32

Par value is the **stated value of each share of stock** and represents the legal or stated capital of a company. ## Footnote It is usually a small amount and does not impact the selling price of the stock.

Question 33

What happens if stock is issued at **less than its par value**?

Answer 33

The owners of the stock may be called upon to **pay in the amount of the discount** to creditors if the corporation is subsequently liquidated.

Question 34

What is the journal entry for issuing **common shares for cash**?

Answer 34

**Dr** Cash **Cr** Common shares **Cr** Additional paid-in capital – common shares

Question 35

What are **dividends**?

Answer 35

Dividends are the **distribution of current profits** or **retained earnings** of the company to its owners.

Question 36

What are the **three dates** related to the payment of a cash dividend?

Answer 36

* Date of **declaration** * Date of **record** * Date of **payment**

Question 37

What is a **stock dividend**?

Answer 37

A stock dividend occurs when the company **distributes a dividend** in the form of **additional shares**.

Question 38

What is the **difference** between a small stock dividend and a large stock dividend?

Answer 38

* **Small stock dividend**: Usually less than 20-25% of total shares outstanding, valued at fair value. * **Large stock dividend**: Usually more than 20-25% of total shares outstanding, valued at par value.

Question 39

What is the role of the **retained earnings** account?

Answer 39

The retained earnings account represents the **accumulated undistributed income** of the corporation from its inception.

Question 40

What are **authorized shares**?

Answer 40

Authorized shares are the **maximum number of shares** the company can issue, specified in the company’s charter or articles of incorporation.

Question 41

What are **issued shares**?

Answer 41

Issued shares are the **number of shares** that have been **sold to investors** at any point in the past and have not been retired.

Question 42

What are **outstanding shares**?

Answer 42

Outstanding shares are the **number of shares** that are **currently owned by other parties**, equal to issued shares minus treasury shares.