EXAMPLE TEST QUESTIONS

Chapter 16

Multiple Choice

1. Consolidated statements are proper for Neely, Inc., Randle, Inc., and Walker, Inc., ifa. Neely owns 80 percent of the outstanding common stock of Randle and 40 percent of Walker;

Randle owns 30 percent of Walker.b. Neely owns 100 percent of the outstanding common stock of Randle and 90 percent of

Walker; Neely bought the stock of Walker one month before the balance sheet date and sold it seven weeks later.

c. Neely owns 100 percent of the outstanding common stock of Randle and Walker; Walker is in legal reorganization.

d. Neely owns 80 percent of the outstanding common stock of Randle and 40 percent of Walker; Reeves, Inc., owns 55 percent of Walker.

Answer a

2. On October 1, Company X acquired for cash all of the outstanding common stock of Company Y. Both companies have a December 31 year end and have been in business for many years. Consolidated net income for the year ended December 31 should include net income of a. Company X for3 months and Company Y for 3 monthsb. Company X for 12 months and Company Y for 3 monthsc. Company X for 12 months and Company Y for 12 monthsd. Company X for 12 months, but no income from Company Y until Company Y distributed a

dividend

Answer b

3. Arkin, Inc., owns 90 percent of the outstanding stock of Baldwin Company. Curtis, Inc., owns 10 percent of the outstanding stock of Baldwin Company. On the consolidated financial statements of Arkin, Curtis should be considered asa. A holding companyb. A subsidiary not to be consolidatedc. An affiliated. A noncontrolling interest

Answer d

4. A sale of goods, denominated in a currency other than the entity’s functional currency, resulted in a receivable that was fixed in terms of the amount of foreign currency that would be received. Exchange rates between the functional currency and the currency in which the transaction was denominated changed. The resulting gain should be include as a (an)a. Other comprehensive incomeb. Deferred creditc. Component of income from continuing operationsd. Extraordinary item

Answer a

5. Which of the following is not a consideration in segment reporting for diversified enterprises?a. Allocation of joint costsb. Transfer pricingc. Defining the segmentsd. Consolidation policy

Answer d

6. Which of the following is the appropriate basis for valuing fixed assets acquired in a business combination carried out by exchanging cash for common stock?a. Historic costb. Book valuec. Cost plus any excess of purchase price over book value of asset acquiredd. Fair value

Answer d

7. Goodwill represents the excess of the cost of an acquired company over the a. Sum of the fair values assigned to identifiable assets acquired less liabilities assumedb. Sum of the fair values assigned to tangible assets acquired less liabilities assumedc. Sum of the fair values assigned to intangible assets acquired less liabilities assumedd. Book value of an acquired company

Answer a

8. The theoretically preferred method of presenting noncontrolling interest on a consolidated balance sheet isa. As a separate item with the deferred credits sectionb. As a reduction from (contra to) goodwill from consolidation, if anyc. By means of notes or footnotes to the balance sheetd. As a separate item within the stockholders’ equity section

Answer d

9. Meredith Company and Kyle Company were combined in an acquisition transaction. Meredith was able to acquire Kyle at a bargain price. The sum of the market or appraised values of identifiable assets acquired less the fair value of liabilities assumed exceeded the cost to Meredith. After revaluing noncurrent assets to zero there was still some of the bargain purchase amount remaining (formerly termed negative goodwill). Proper accounting treatment by Meredith is to report the amount asa. An extraordinary itemb. Part of current income in the year of combinationc. A deferred credit and amortize itd. Paid-in capital

Answer b

10. When translating foreign currency financial statements, which of the following accounts would be translated using current exchange rates?

Property, Plant, and Inventories Equipment carried at cost

a. Yes Yesb. No Noc. Yes Nod. No Yes

Answer d

11. In financial reporting for segments of a business enterprise, the operating profit or loss of a segment should include

Reasonably allocated Common Traceable Operating costs operating costs

a. No Nob. No Yesc. Yes Nod. Yes Yes

Answer d

12. The profitability information that should be reported for each reportable segment of a business enterprise consists of a. An operating profit-or-loss figure consisting of segment revenues less traceable costs and

allocated common costsb. An operating profit-or-loss figure consisting of segment revenues less traceable costs but not

allocated common costs

c. An operating profit-or-loss figure consisting of segment revenues less allocated common costs but not traceable costs

d. Segment revenues only

Answer a

13. A foreign subsidiary’s function currency is its local currency that has not experienced significant inflation. The weighted average exchange rate for the current year would be the appropriate exchange rate for translating

Sales to Wages expense Customers

a. Yes Yesb. Yes Noc. No Nod. No Yes

Answer a

14. A subsidiary’s functional currency is the local currency that has not experienced significant inflation. The appropriate exchange rate for translating the depreciation on plant assets in the income statement of the foreign subsidiary is the a. Exit exchange rateb. Historical exchange ratec. Weighted average exchange rate over the economic life of each plant assetd. Weighted average exchange rate for the current year

Answer b

15. In a business combination that is accounted for under the acquisition method the entity that obtains control over one or more businesses and establishes the acquisition date that control was achieved is called thea. Controller.b. Acquirer.c. Proprietor.d. Controlling interest.

Answer b

16. Under the acquisition method for a business combination, the cost incurred to effect the business combination, such as finders and legal fees area. Considered part of the historical cost of the business.b. Expensed as incurred.c. Allocated, along with the purchase price of the acquired company’s stock to the assets of the

acquiree company.

d. Deferred until a full accounting of all costs to acquire the acquire company are known.

Answer b

17. Under which of the theories of equity is a manager’s goals considered as important as those of the common stockholder. a. Proprietary theory.b. Commander theory.c. Entity theory.d. Enterprise theory.

Answer c

18. For a business combination, we measure all assets and liabilities of an acquired company at fair value. Fair value a. Is an exit value.b. Is an entry value.c. Is an appraisal value.d. Can be either an exit value or an entry value depending on the circumstances.

Answer a

19. Under the acquisition method of accounting for a business combination, restructuring costs area. Capitalized and amortized over a period not exceeding ten years.b. Fees paid to lawyers and accountants to bring about the business combination .c. Costs incurred to effect the business combination.d. Treated as post acquisition expenses.

Answer d

20. Under the acquisition method of accounting for a business combination, goodwill is equal toa. The acquired company’s ability to generate excess profits .b. The excess of the cost of the acquisition plus the fair value of the noncontrolling interest over

the fair value of the acquiree’s net assets.c. The excess of the cost of the acquisition over the fair value of the acquiree’s net assets.d. The excess of the fair value of acquiree’s net assets over the cost of acquisition.

Answer b

21. Under the acquisition method of accounting for a business combination, a bargain purchase isa. Reported as goodwill in the balance sheet.

b. Tested annually for impairment.c. Reported as a gain in the income statement.d. Reported as an adjustment to other comprehensive income.

Answer c

22. The acquisition method of accounting for a business combination is consistent with a. Entity theory.b. Proprietary theory.c. Parent company theory.a. Residual interest theory.

Answer a

23. Under the acquisition method of accounting for a business combination when the parent company has acquired only 90% of the voting stock of a subsidiary, a. 10% of the goodwill will be reported in a separate section of the balance sheet because it

belongs to the noncontrolling interest .b. The consolidated balance sheet will report 100% of the value of goodwill.c. The consolidated balance sheet will report 90% of the value of goodwill.d. Goodwill will be amortized over its useful life or 40 years whichever comes first.

Answer b

24. The noncontrolling interest in a subsidiary is reported in the consolidated balance sheeta. As an investment.b. As a liability.c. At fair value, as determined on the acquisition date.d. As an element of stockholders’ equity.

Answer d

Essay1. List and explain three reasons why businesses combine.

Several actors may cause a business organization to consider combining with another organization:

Tax consequences. —The purchasing corporation may accrue the benefits of operating loss carryforwards from acquired corporations.

Growth and diversification. —The purchasing corporation may wish to ac-quire a new product or enter a new market.

Financial considerations. —A larger asset base may make it easier for the corporation to acquire additional funds from capital markets.

Competitive pressure. —Economies of scale may alleviate a highly competitive market situation.

Profit and retirement. —The seller may be motivated by a high profit or the desire to retire.

2. Discuss the issues that are to be addressed in an acquisition method business combination effected by an exchange of equity shares.

When a business combination is effected by an exchange of equity shares, the acquiring entity may not be so clearly evident. In this case, FASB ASC 805-10-55-12 requires that the following “pertinent facts and circumstances” be taken into consideration:

1. The relative voting rights of the combined entity. All else being equal, the acquiring entity would be the one whose owners retained or received the larger portion of the voting rights of the combined entity.

2. The existence of a large minority voting interest in the combined entity when no other owner or group of owners has a significant voting interest. All else being equal, the acquiring entity would be the one with the large minority voting interest.

3. The composition of the governing body of the combined entity. All else being equal, the acquiring entity’s owners or governing body would be the one that has the ability to elect or appoint a majority of the governing body of the combined entity.

4. The composition of senior management of the combined entity. All else being equal, the acquiring entity’s senior management would dominate that of the combined entity.The terms of exchange of equity securities. All else being equal, the acquiring entity would be the one that pays a premium over the market value of the equity securities of the other combining entities.

3. How is the recorded cost determined in an acquisition business combination?

Under the revised standard for business combinations, the acquirer must recognize all assets acquired, liabilities assumed and any noncontrolling interest at fair value, measured as of the acquisition date (the date that control is attained). Fair value is defined by the FASB ASC (820-10-20) as an exit value. It is the exchange price that would occur in an orderly transaction to sell an asset or transfer a liability in the most advantageous market. Thus, fair value is market based and is not entity specific. Fair value excludes transaction costs because they are the incremental direct costs incurred to sell an asset or settle a debt. As such, they are specific to the transaction, and have nothing to do with the value of the asset acquired itself or the liability assumed.

Fair value must be applied to assets and liabilities that meet the definition of assets and liabilities under SFAC No. 6. This means that the acquirer must recognize all assets and liabilities of the acquiree – even those that are not on the acquiree’s books. Thus, the acquirer must identify and measure intangibles such as brand names and even in-process research and development as well as advertising jingles. In order to recognize such an intangible asset it must

meet either of the two following criteria: (1) separability or (2) contractual or legal. Separability means that the intangible can be sold, transferred, licensed, rented or exchanged. The contractual/legal criterion is that the asset arises from some contractual or legal right.

4. What are the two principles that are used to guide the preparation of consolidated financial statements? .In the preparation of consolidated financial statements, two overriding principles prevail. The first is balance sheet oriented and the second is income statement oriented.

1. The entity cannot own or owe itself.2. The entity cannot make a profit by selling to itself.

5. Explain the concept of control as it applies to recording consolidated financial statement.

Control is defined as “the power of one entity to direct or cause the direction of the management and operating and financing policies of another entity.” Control is normally presumed when the parent owns, either directly or indirectly, a majority of the voting stock of the subsidiary. The following exceptions indicating an inability to control a majority-owned subsidiary are cited in FASB ASC 810-10-15-10:

1. The subsidiary is in a legal reorganization or bankruptcy.2. There are severe governmentally imposed uncertainties.

In some cases control may exit with less than a majority ownership, for example, by contract, by lease, as the result of an agreement with stockholders, or by court decree

6. Discuss the following two theories of consolidation:a. Entity

According to entity theory, the consolidated group (parent company and subsidiaries) is an entity separate from its owners. Thus, the emphasis is on control of the group of legal entities operating as a single unit. Consolidated assets belong to the consolidated entity, and the income earned by investing in those assets is income to the consolidated entity rather than to the parent company stockholders. Consequently, the purpose of consolidated statements is to provide information to all shareholders—parent company stockholders and outside noncontrolling stockholders of the subsidiaries.

b. Patent company

Parent company theory evolved from the proprietary theory of equity. Under parent company theory, parent company stockholders are viewed as having a proprietary interest in the net assets of the consolidated group. The purpose of consolidated statements is to provide information primarily for parent company stockholders. Thus, prior to the issuance of SFAS No. 160, consolidated financial statements reflected a parent company perspective. The assets

reported on a consolidated balance sheet were those of the subsidiary adjusted by the parent company’s share of the difference between subsidiary historical cost and the asset’s fair value at the date of the acquisition. The net income reported in the consolidated income statement was equal to the net income of the parent company. Noncontrolling interest income was reported as a deduction to arrive at consolidated net income and noncontrolling interest was not considered an equity interest.

7. Define noncontrolling interest. Historically, how has noncontrolling interest been disclosed on corporate balance sheets

When a portion of a subsidiary’s stock is owned by investors outside the parent company, this ownership interest is referred to as noncontrolling interest or previously termed minority interest in financial statements. . In prior practice, noncontrolling interest has been variously (1) disclosed as a liability, (2) separately presented between liabilities and stockholders’ equity, and (3) disclosed as a part of stockholders’ equity.

8. According to SFAS No. 131(FASB ASC 280-10-50-20 to 25), what information should be disclosed for each operating segment?Under the provisions of SFAS No. 131 (See FASB ASC 280-10-50-20 to 25), companies are required to report separately income statement and balance sheet information about each operating segment. In addition to a measure of a segment’s profit or loss and total assets, companies are to report specific information if it is included in the measure of segment profit or loss by the chief operating decision maker. The list of such segment disclosures is as follows:

1. Revenues from external users2. Revenues from transactions with other operating segments of the same enterprise3. Interest revenue4. Interest expense5. Depreciation, depletion, and amortization expense6. Unusual items7. Equity in the net income of investees under the equity method8. Income tax expense or benefit9. Extraordinary items10. Significant noncash items other than depreciation, depletion, and amortization expense

9. How are operating segments defined by SFAS No. 131 (FASB ASC 280-10-50-1)?

A goal of the guidance contained at FASB ASC 280 is to use the enterprise’s internal organization in such a way that reportable operating segments will be readily evident to the financial statement preparer. The resulting “management approach” to identifying operating segments is based on the manner in which management organizes the segments for making operating decisions and assessing performance.

FASB ASC 280-10-50-1 defines an operating segment as a component of the enterprise

That engages in business activities from which it may earn revenues and incur expenses.

Whose operating results are regularly reviewed by the chief operating decision maker of the enterprise in making decisions about allocating resources to the segment and in assessing segment performance.

For which discrete financial information is available.

10. Discuss the criteria used to determine if an operating segment is a reportable segment.

Reportable segments include those operating segments that meet any of the following quantitative thresholds:

1. Reported revenue is at least 10 percent of combined revenue.2. Reported profit (loss) is at least 10 percent of combined profit (loss).3. Assets are 10 percent or more of combined assets.

11. Discuss how foreign currency translation occurs under each of the following methodsa. Current – noncurrent

The current–noncurrent method is based on the distinction between current and noncurrent assets and liabilities. Under this method all current items (cash, receivables, inventory, and short-term liabilities) are translated at the foreign exchange rate existing at the balance sheet date. The noncurrent items (plant, equipment, property, and long-term liabilities) are translated using the rate in effect when the items were acquired or incurred (the historical rate).

b. Monetary – nonmonetary

The monetary–nonmonetary method requires that a distinction be made between monetary items (accounts representing cash or claims on cash, such as receivables, notes payable, and bonds payable) and nonmonetary items (accounts not representing claims on a specific amount of cash such as land, inventory, plant, equipment, and capital stock). Monetary items are translated at the exchange rate in effect at the balance sheet date, whereas nonmonetary items retain the historical exchange rate.

c. Current

The current rate method requires the translation of all assets and liabilities at the exchange rate in effect on the balance sheet date (current rate). It is, therefore, the only method that translates fixed assets at current rather than historical rates.

d. Temporal

Under this method monetary measurements depend on the temporal characteristics of assets and liabilities. That is, the time of measurement of the elements depends on certain characteristics. That is, money and receivables and payables measured at the amounts promised should be translated at the foreign exchange rate in effect at the balance sheet date. Assets and liabilities measured at money prices should be translated at the foreign exchange rate in effect at the dates to which the money prices pertain. This principle is simply an application of the fair value principle in the area of foreign translation.

12. How does SFAS No. 52 (FASB ASC 830) define functional currency?

FASB ASC 830 adopts the functional currency approach to translation. An entity’s functional currency is defined as the currency of the primary economic environment in which it operates, which will normally be the environment in which it expends cash (See FASB ASC 830-30).

13. What are the two situations in which the local currency would not be the functional currency:?

The two situations in which the local currency would not be the functional currency are:

1. The foreign country’s economic environment is highly inflationary (over 100 percent cumulative inflation

2. The company’s investment is not considered long term.

14. Discuss the difference between translation and remeasurement.

Translation is the process of expressing in the reporting currency of the enterprise those amounts that are denominated or measured in a different currency. The translation process is performed in order to prepare financial statements and assumes that the foreign subsidiary is freestanding and that the foreign accounts will not be liquidated into U.S. dollars. Therefore, translation adjustments are disclosed as a part of other comprehensive income rather than as adjustments to net income.

Remeasurement is the process of measuring transactions originally denominated in a different unit of currency (e.g., purchases of a German subsidiary of a U.S. company payable in French francs). Remeasurement is required when:

1. A foreign entity operates in a highly inflationary economy.2. The accounts of an entity are maintained in a currency other than its functional currency.3. A foreign entity is a party to a transaction that produces a monetary asset or liability

denominated in a currency other than its functional currency.

15. Describe the four general procedures involved in the foreign currency translation process when the local currency is defined as the functional currency.

Most frequently the functional currency will be the local currency, and four general procedures are involved in the translation process when the local currency is defined as the functional currency:

1. The financial statements of each individual foreign entity are initially recorded in that entity’s functional currency. For example, a Japanese subsidiary would initially prepare its financial statements in terms of yen, for that would be the currency it generally uses to carry out cash transactions.

2. The foreign entity’s statements must be adjusted (if necessary) to comply with generally accepted accounting principles in the United States.

3. The financial statements of the foreign entity are translated into the reporting currency of the parent company (usually the U.S. dollar). Assets and liabilities are translated at the current exchange rate at the balance sheet date. Revenues, expenses, gains, and losses are translated at the rate in effect at the date they were first recognized, or alternatively, at the average rate for the period.

4. Translation gains and losses are accumulated and reported as a component of other comprehensive income.

16. How are noncontrolling interested defined in IAS No. 27 and where are they to be disclosed?

Noncontrolling interests are still defined as minority interests in IAS No. 27. Minority interests are to be disclosed in the consolidated balance sheet within equity, but separate from the parent's shareholders' equity.