Accounting Theory and Analysis

11th Edition

Test Bank

By

Richard G. Schroeder
University of North Carolina at Charlotte

Myrtle W. Clark
University of Kentucky

Jack M. Cathey
University of North Carolina at Charlotte

Accounting Theory & Analysis: Text and Cases

Test Bank, Chapter 16 Page 1
Chapter 16

Multiple Choice

1. Consolidated statements are proper for Neely, Inc., Randle, Inc., and Walker, Inc., if
a. 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 months
b. Company X for 12 months and Company Y for 3 months
c. Company X for 12 months and Company Y for 12 months
d. 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 as
a. A holding company
b. A subsidiary not to be consolidated
c. An affiliate
d. 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)

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 a. Other comprehensive income
b. Deferred credit
c. Component of income from continuing operations
d. Extraordinary item

Answer a

5. Which of the following is not a consideration in segment reporting for diversified

enterprises?
a. Allocation of joint costs
b. Transfer pricing
c. Defining the segments
d. 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 cost
b. Book value
c. Cost plus any excess of purchase price over book value of asset acquired
d. 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
assumed
b. Sum of the fair values assigned to tangible assets acquired less liabilities assumed
c. Sum of the fair values assigned to intangible assets acquired less liabilities
assumed
d. Book value of an acquired company

Answer a

8. The theoretically preferred method of presenting noncontrolling interest on a

consolidated balance sheet is
a. As a separate item with the deferred credits section
b. As a reduction from (contra to) goodwill from consolidation, if any
c. By means of notes or footnotes to the balance sheet
d. As a separate item within the stockholders’ equity section

Answer d

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 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 as
a. An extraordinary item
b. Part of current income in the year of combination
c. A deferred credit and amortize it
d. 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 Yes
b. No No
c. Yes No
d. 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 No
b. No Yes
c. Yes No
d. 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 costs
b. An operating profit-or-loss figure consisting of segment revenues less traceable
costs but not allocated common costs

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 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 Yes
b. Yes No
c. No No
d. 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 rate
b. Historical exchange rate
c. Weighted average exchange rate over the economic life of each plant asset
d. 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 the
a. 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 are
a. 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.

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 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 are
a. 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 to
a. 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

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 21. Under the acquisition method of accounting for a business combination, a bargain
purchase is
a. 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

sheet
a. 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

Essay
1. List and explain three reasons why businesses combine.

Several factors 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.

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  Growth and diversification. —The purchasing corporation may wish to acquire 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-

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 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

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 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 users

2. Revenues from transactions with other operating segments of the same enterprise
3. Interest revenue
4. Interest expense
5. Depreciation, depletion, and amortization expense
6. Unusual items
7. Equity in the net income of investees under the equity method
8. Income tax expense or benefit
9. Extraordinary items
10. 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.

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  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 methods
a. 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.

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 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 an English subsidiary of a U.S. company
payable in French euros). 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

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 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. IFRS No. 10 changes the method of reporting noncontrolling interests from what was
previously required in IAS No.27. How are noncontrolling interest now defined and
where are they to be disclosed?

Noncontrolling interests are now defined as”noncontrolling interests,” rather than as

minority interests. They are to be disclosed in the consolidated balance sheet within
equity, but separate from the parent's shareholders' equity.

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