term1 Definition1term2 Definition2term3 Definition3
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On December 2, Year 1, Flint Corp.'s board of directors voted to discontinue operations of its frozen food division and to sell the division's assets on the open market as soon as possible. This decision represents a major strategic shift for Flint and will have a significant effect on operations and financial results. The division reported net operating losses of $20,000 in December and $30,000 in January. On February 26, Year 2, sale of the division's assets resulted in a gain of $90,000. Assuming that the frozen foods division qualifies as a component of the business and ignoring income taxes, what amount of gain/loss from discontinued operations should Flint recognize in its income statement for Year 2?
a.
$0
b.
$40,000
c.
$60,000
d.
$90,000
Choice "c" is correct. The $60,000 gain from discontinued operations would be reported in Flint's Year 2 income statement. The operating loss for January would offset the gain from disposal in February, and the net amount would be reported as a gain (in this case) from discontinued operations. The operating losses for December would have been reported in Flint's Year 1 income statement.
Choice "a" is incorrect per the above. It would be correct if all of the gains and losses were included in Year 1 instead of Year 2. However, gains and losses from discontinued operations are included in the year they occur.
Choice "b" is incorrect. It includes the operating loss for December, Year 1 in with the Year 2 amounts.
Choice "d" is incorrect. It ignores the January operating loss. Operating losses are included in gain/loss from discontinued operations, along with impairment losses and gains/losses on disposal.
At December 31, Year 2, Off-Line Co. changed its method of accounting for demo costs from writing off the costs over two years to expensing the costs immediately. Off-Line made the change in recognition of an increasing number of demos placed with customers that did not result in sales. Off-Line had deferred demo costs of $500,000 at December 31, Year 1, $300,000 of which were to be written off in Year 2 and the remainder in Year 3. Off-Line's income tax rate is 30%. In its Year 3 financial statements, what amount should Off-Line report as cumulative effect of change in accounting principle?
$200,000
$500,000
$350,000
Explanation
Choice "d" is correct. A change in method of accounting for demo costs is a change in accounting principle inseparable from a change in estimate. When a change in accounting principle is considered inseparable from a change in estimate, the change is handled as a change in estimate - prospectively. No cumulative effect adjustment is made.
Choices "a", "c", and "b" are incorrect since no cumulative effect adjustment is made.
How should the effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate be reported?
By footnote disclosure only.
As a correction of an error.
As a component of income from continuing operations.
By restating the financial statements of all prior periods presented.
Choice "c" is correct. When the effect of a change in accounting principle is inseparable from the effect of a change in accounting estimate, the reporting treatment for the overall effect is as a change in estimate. Thus, the effect is reported prospectively as a component of income from continuing operations.
Choice "d" is incorrect. Restatement of all prior periods is the retroactive accounting treatment that is applied to the correction of an error and the retrospective accounting treatment given to changes in accounting principle. However, a change in accounting principle that is inseparable from the effect of a change in accounting estimate is now treated as a change in accounting estimate.
Choice "b" is incorrect. Correction of an error is given retroactive treatment as a prior period adjustment to retained earnings with restatement of prior periods. This is not the treatment appropriate for the effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate.
Choice "a" is incorrect. While footnote disclosure is always appropriate for an accounting change, such disclosure alone is never the appropriate accounting treatment.
In September, Koff Co.'s operating plant was destroyed by an earthquake. Earthquakes are rare in the area in which the plant was located. The portion of the resultant loss not covered by insurance was $700,000. Koff's income tax rate for 1996 was 40%. In its year-end income statement, what amount should Koff report as extraordinary loss under U.S. GAAP?
$280,000
$420,000
$700,000
Choice "b" is correct. For a loss to be reported as an extraordinary loss under U.S. GAAP, the event causing the loss must be both unusual in nature and infrequent in occurrence. The earthquake in this case does meet these criteria so the loss is reported net of income tax effect as an extraordinary loss of $420,000 (60% of the total $700,000 loss).
Choice "c" is incorrect. Review the criteria for reporting an extraordinary loss.
Choice "a" is incorrect. This is the tax effect of the loss. Review your calculations.
Choice "d" is incorrect. It is not appropriate to report the full loss as an extraordinary loss.
During January Year 3, Doe Corp. agreed to sell the assets and product line of its Hart division. The decision represents a major strategic shift for Doe and will have a significant effect on its operations and financial results. The sale was completed on January 15, Year 4 and resulted in a gain on disposal of $900,000. Hart's operating losses were $600,000 for Year 3 and $50,000 for the period January 1 through January 15, Year 4. Disregarding income taxes, what amount of net gain (loss) should be reported in Doe's comparative Year 4 and Year 3 income statements?
Year 3Year 4
$(600,000)
$850,000
$250,000
$(650,000)
$900,000
Choice "a" is correct. The Year 3 operating losses would be reported in the Year 3 income statement. The Year 4 operating losses and the gain on disposal would be netted and reported in the Year 4 income statement. Each amount would be reported in the period it occurred.
Choice "b" is incorrect. It reports the total projected gains and losses in Year 4 and nothing in Year 3. Each amount should be reported in the period it occurred.
Choice "c" is incorrect. It reports the total projected gains and losses in Year 3 and nothing in Year 4. Each amount should be reported in the period it occurred.
Choice "d" is incorrect. It reports the total projected losses in Year 3 and the gain in Year 4. Each amount should be reported in the period it occurred.
On April 30, Deer Corp. approved a plan to dispose of a component of its business. The decision represents a major strategic shift for Deer and will have a significant effect on its operations and financial results. For the period January 1 through April 30, the component had revenues of $500,000 and expenses of $800,000. The assets of the component were sold on October 15 at a loss. In its income statement for the year ended December 31, how should Deer report the component's operations from January 1 to April 30?
$500,000 and $800,000 should be included with revenues and expenses, respectively, as part of continuing operations.
$300,000 should be reported as an extraordinary loss.
$300,000 should be reported as a loss from operations of a component and included in loss from discontinued operations.
$300,000 should be reported as part of the loss on disposal of a component and included as part of continuing operations.
Choice "c" is correct. Once the decision has been made to dispose of a component of a business and that component meets the criteria to be classified as held for sale, the operating results of the component for the period reported on, and any gain or loss from the disposal, should be reported separately from continuing operations, net of tax. In this question, the component was classified as held for sale and was sold in the same year.
Thus, the results of operations, the $300,000 ($500,000-$800,000) loss, are reported as a loss from discontinued operations. The loss on disposal would be reported as part of that loss from discontinued operations also.
Choice "a" is incorrect. The results of operations prior to the decision date, and also after the decision date, are reported separately from the results of continuing operations as a part of discontinued operations.
Choice "d" is incorrect. The results of operations prior to the decision date, and also after the decision date, are reported separately from the results of continuing operations as a loss from operations of a component and included in loss from discontinued operations.
Choice "b" is incorrect. The results of discontinued operations are not reported as an extraordinary item.
In open market transactions, Gold Corp. simultaneously sold its long-term investment in Iron Corp. bonds and purchased its own outstanding bonds. The broker remitted the net cash from the two transactions. Gold's gain on the purchase of its own bonds exceeded its loss on the sale of the Iron bonds. Assume the transaction to purchase its own outstanding bonds is unusual in nature and has occurred infrequently. Under U.S. GAAP, Gold should report the:
Effect of its own bond transaction gain in income before extraordinary items, and report the Iron bond transaction as an extraordinary loss.
Net effect of the two transactions in income before extraordinary items.
Net effect of the two transactions as an extraordinary gain.
Effect of its own bond transaction as an extraordinary gain, and report the Iron bond transaction loss in income before extraordinary items.
Choice "d" is correct. These are two separate transactions because Gold Corp. (1) sold Iron Corp. bonds (an investment) for a loss, and, (2) bought back its own (Gold) Corp. bonds (a debt) for a gain.
This is not a "refinancing" (where one would sell new bond debt to buy back old bond debt outstanding). The gain from the purchase of its own bonds is an "extraordinary gain" because it is both unusual in nature and infrequently occurring. The Iron Corp. transaction is a loss in "income before extraordinary items" under U.S. GAAP.
Choices "c" and "b" are incorrect. The two transactions are separate and cannot be netted.
Choice "a" is incorrect. Just the opposite. The sale of the investment is a loss in "income before extraordinary items," while the purchase of its bond debt is an "extraordinary gain" under U.S. GAAP.
During the current year, both Raim Co. and Cane Co. suffered losses due to the flooding of the Mississippi River. Raim is located two miles from the river and sustains flood losses every two to three years. Cane, which has been located 50 miles from the river for the past 20 years, has never before had flood losses. How should the flood losses be reported in each company's income statement under U.S. GAAP?
Raim
As a component of incomefrom continuing operations
Cane
As an extraordinary item
Lore Co. changed from the cash basis of accounting to the accrual basis of accounting during the current year. The cumulative effect of this change should be reported in Lore's current year financial statements as a:
Prior period adjustment resulting from the correction of an error.
Prior period adjustment resulting from the change in accounting principle.
Component of income before extraordinary item.
Component of income after extraordinary item.
Choice "a" is correct. The cash basis for financial reporting is not a generally accepted accounting basis of accounting (GAAP); therefore, it is an error. Correction of an error from a prior period is a reported as prior period adjustment to retained earnings.
Choice "b" is incorrect. Cash basis reporting is not an accounting principle under accrual accounting principles. Thus, the change from cash basis is not reported as a change in accounting principle. In addition, changes in accounting principle are not prior period adjustments; instead, they are treated retrospectively.
Choices "c" and "d" are incorrect. Correction of prior period errors has no effect on the current year's income statement.
Which of the following should be included in general and administrative expenses?
InterestAdvertising
None
Choice "c" is correct. Interest expense is classified as a separate line item on the income statement. Advertising is classified as a selling expense.
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