I85PREP
⌘ K
JCE Commerce & Accounting 26 study materials
JCE Commerce & Accounting 26 study resources

JCE Commerce & Accounting 26 practice questions

One question at a time. Build your JCE Commerce & Accounting 26 understanding.

First 50 of 200 questions. Each one lists the choices, the correct answer, and an explanation. The checker at the top of this page saves progress in this browser when it is available.

Continue in the practice tool above to load more questions, 50 at a time.

Question 1Financial Accounting

Under the accrual basis of accounting, revenue is recognized when which of the following occurs?

  1. The performance obligation is satisfied Correct answer.
  2. An invoice is mailed to the customer
  3. A sales order is confirmed by the buyer
  4. Cash is received from the customer

Explanation

Accrual accounting recognizes revenue when the earnings process is complete, that is, when goods or services have been transferred to the customer. The timing of cash collection does not determine recognition under accrual accounting.

Question 2Financial Accounting

A company purchases equipment for 50,000 with an estimated residual value of 5,000 and a useful life of 5 years. Using straight-line depreciation, what is the annual depreciation expense?

  1. 9,000 Correct answer.
  2. 8,000
  3. 11,000
  4. 10,000

Explanation

Straight-line depreciation equals depreciable cost divided by useful life. Depreciable cost is 50,000 minus the 5,000 residual value, giving 45,000 spread over 5 years, or 9,000 per year.

Question 3Financial Accounting

Which account is increased by a debit entry?

  1. Accounts payable
  2. Equipment Correct answer.
  3. Unearned revenue
  4. Retained earnings

Explanation

Assets carry normal debit balances, so debits increase asset accounts such as equipment. Liabilities and equity accounts carry normal credit balances and are increased by credits.

Question 4Financial Accounting

The accounting equation can be stated as which of the following?

  1. Assets = Liabilities + Equity Correct answer.
  2. Assets = Liabilities - Equity
  3. Assets + Equity = Liabilities
  4. Equity = Assets + Liabilities

Explanation

The fundamental accounting identity holds that total assets always equal the sum of liabilities and owners' equity. Every recorded transaction preserves this equality by affecting at least two elements.

Question 5Financial Accounting

A company has current assets of 120,000 and current liabilities of 80,000. What is its current ratio?

  1. 0.80
  2. 2.00
  3. 0.67
  4. 1.50 Correct answer.

Explanation

The current ratio divides current assets by current liabilities. Dividing 120,000 by 80,000 yields 1.50, meaning the company holds 1.50 of current assets for each unit of current liability.

Question 6Financial Accounting

Which financial statement reports the cash inflows and outflows of a period classified into operating, investing, and financing activities?

  1. Income statement
  2. Statement of cash flows Correct answer.
  3. Balance sheet
  4. Statement of retained earnings

Explanation

The statement of cash flows explains changes in cash by grouping transactions into operating, investing, and financing activities. The other statements report performance, financial position, or equity changes rather than cash movements.

Question 7Financial Accounting

A company sells goods for 10,000 with terms 2/10, n/30 and uses the gross method. The customer pays within the discount period. What amount of cash is received?

  1. 9,800 Correct answer.
  2. 9,600
  3. 9,900
  4. 10,000

Explanation

The terms 2/10 allow a 2 percent discount if payment is made within 10 days. Two percent of 10,000 is 200, so the customer remits 9,800.

Question 8Financial Accounting

Which of the following best describes the matching principle?

  1. Recognize gains only when realized in cash
  2. Value assets at their current market price
  3. Report expenses in the same period as the revenues they help generate Correct answer.
  4. Record revenue only when cash is collected

Explanation

The matching principle directs that expenses be recognized in the same period as the revenues to which they relate. This produces a meaningful measure of periodic profit rather than a cash-based result.

Question 9Financial Accounting

A company begins the year with inventory of 30,000, purchases 90,000 of goods, and ends the year with inventory of 25,000. What is cost of goods sold?

  1. 85,000
  2. 120,000
  3. 95,000 Correct answer.
  4. 90,000

Explanation

Cost of goods sold equals beginning inventory plus purchases minus ending inventory. Adding 30,000 and 90,000 gives 120,000 of goods available, and subtracting the 25,000 ending balance leaves 95,000.

Question 10Financial Accounting

A company records bad debt expense using the allowance method. What is the effect of writing off a specific uncollectible account on total assets and net income?

  1. Assets are unchanged and net income is unchanged Correct answer.
  2. Assets are unchanged and net income decreases
  3. Assets decrease and net income decreases
  4. Assets decrease and net income is unchanged

Explanation

A write-off debits the allowance for doubtful accounts and credits accounts receivable, so both the asset and its contra account fall by the same amount. Total assets and net income are therefore unaffected because expense was recognized when the allowance was estimated.

Question 11Financial Accounting

A company uses the percentage-of-completion method for a long-term contract. Which of the following is recognized in the current period?

  1. No revenue until the contract is fully complete
  2. Revenue based on the proportion of the performance obligation satisfied Correct answer.
  3. Revenue equal to cash collected from the customer
  4. Revenue equal to the total contract price

Explanation

Under percentage-of-completion, revenue is recognized in proportion to progress toward satisfying the performance obligation. Costs incurred relative to total expected costs commonly measure that progress.

Question 12Financial Accounting

A company issues bonds with a face value of 100,000 at 97. How should the discount be accounted for over the bond term?

  1. Amortized over the life of the bond, increasing interest expense Correct answer.
  2. Amortized over the life of the bond, decreasing interest expense
  3. Recognized as a loss in the year of issuance
  4. Ignored because the face amount is repaid at maturity

Explanation

A bond issued below face value carries a discount that represents additional interest cost to the issuer. The discount is amortized over the bond's life, which raises the effective interest expense above the stated coupon.

Question 13Financial Accounting

A company declares a cash dividend on its common shares. What is the effect of the declaration on the accounting equation?

  1. Assets decrease and equity decreases
  2. Equity increases and liabilities increase
  3. Liabilities increase and equity decreases Correct answer.
  4. Assets decrease and liabilities decrease

Explanation

Declaring a dividend creates a legal obligation, so dividends payable, a liability, increases. Retained earnings fall by the same amount, so equity decreases and total assets are unchanged until payment.

Question 14Financial Accounting

A company reports net income of 40,000, depreciation expense of 8,000, and an increase in accounts receivable of 6,000. What is cash flow from operating activities using the indirect method?

  1. 30,000
  2. 42,000 Correct answer.
  3. 54,000
  4. 40,000

Explanation

Starting with net income of 40,000, add back the non-cash depreciation of 8,000 and subtract the 6,000 increase in receivables. The result is 42,000 of operating cash flow.

Question 15Financial Accounting

A company exchanges a machine with a carrying amount of 20,000 for another machine with a fair value of 26,000, paying 4,000 cash. The exchange has commercial substance. What gain is recognized?

  1. 4,000
  2. 0
  3. 2,000
  4. 6,000 Correct answer.

Explanation

When an exchange has commercial substance, the asset received is measured at fair value and the full gain is recognized. The gain equals the 26,000 fair value received less the 20,000 carrying amount, or 6,000.

Question 16Financial Accounting

A company's inventory records show 100 units at 10 and then 100 units at 14. It sells 150 units. Under FIFO, what is the cost of goods sold?

  1. 1,800
  2. 1,600 Correct answer.
  3. 1,500
  4. 1,700

Explanation

FIFO assumes the earliest costs flow out first, so the 150 units sold consist of 100 units at 10 and 50 units at 14. That gives 1,000 plus 700, or 1,700.

Question 17Financial Accounting

Which of the following items would be reported as an intangible asset on the balance sheet?

  1. A trademark developed internally and expensed as incurred
  2. Goodwill generated by strong customer loyalty
  3. Research costs incurred before technical feasibility is established
  4. A patent purchased from another entity Correct answer.

Explanation

Intangible assets acquired in an arm's-length transaction are recognized at cost, so a purchased patent is capitalized. Internally generated research, internally developed trademarks, and self-generated goodwill generally fail recognition criteria.

Question 18Financial Accounting

A company reports sales of 500,000, beginning receivables of 60,000, and ending receivables of 90,000. What is the receivables turnover ratio?

  1. 5.56
  2. 7.14
  3. 6.67 Correct answer.
  4. 8.33

Explanation

Receivables turnover equals net credit sales divided by average receivables. Average receivables are 75,000, and 500,000 divided by 75,000 equals approximately 6.67.

Question 19Financial Accounting

A company records an accrued expense at year-end for services received but not yet billed. What is the effect on the financial statements?

  1. Assets and equity increase
  2. Expenses increase and liabilities decrease
  3. Liabilities and expenses increase Correct answer.
  4. Assets and liabilities increase

Explanation

An accrued expense recognizes cost in the period the service was consumed, before payment. The adjusting entry debits an expense and credits a payable, raising liabilities and reducing equity through the expense.

Question 20Financial Accounting

Which of the following is the primary objective of financial reporting according to the conceptual framework?

  1. To determine the taxable income of the entity
  2. To ensure that all entities use identical accounting policies
  3. To provide useful information to existing and potential investors and creditors Correct answer.
  4. To report the liquidation value of the entity's assets

Explanation

The conceptual framework states that general purpose financial reports aim to supply decision-useful information to capital providers. Tax determination, uniform policies, and liquidation values are not the stated objective.

Question 21Financial Accounting

A company has a deferred tax liability arising from accelerated tax depreciation. Which statement best explains its nature?

  1. It represents a tax refund receivable in future periods
  2. It reflects a penalty imposed by the tax authority
  3. It arises because taxable profit was lower than accounting profit in earlier periods and will reverse later Correct answer.
  4. It is a permanent difference that never reverses

Explanation

Accelerated tax depreciation reduces taxable profit early, creating a temporary difference that reverses when accounting depreciation exceeds tax depreciation. The resulting deferred tax liability represents tax payable in future periods.

Question 22Financial Accounting

A company leases equipment for five years with annual payments of 20,000 due at the end of each year and an implicit rate of 5 percent. The present value of an ordinary annuity of 1 for five periods at 5 percent is 4.3295. What liability is recognized at commencement?

  1. 86,590 Correct answer.
  2. 100,000
  3. 90,000
  4. 79,545

Explanation

A lease liability is measured at the present value of the lease payments discounted at the implicit rate. Multiplying 20,000 by the annuity factor of 4.3295 yields approximately 86,590.

Question 23Financial Accounting

A company holds a bond investment classified at fair value through other comprehensive income. Its amortized cost is 102,000 and its fair value is 98,000. How is the difference reported?

  1. As a reduction of the investment's amortized cost
  2. As a loss in profit or loss immediately
  3. As an unrealized loss in other comprehensive income Correct answer.
  4. As a deferred tax asset only

Explanation

For debt instruments measured at fair value through other comprehensive income, fair value changes are recognized in other comprehensive income. The 4,000 decline is therefore reported outside profit or loss until the asset is derecognized.

Question 24Financial Accounting

An entity discovers that a prior-period error understated depreciation by 30,000. The error is material, and comparative statements are presented. How should the error be treated?

  1. Treated as a change in accounting estimate applied to future periods
  2. Disclosed only in the notes with no adjustment to the statements
  3. Corrected by restating prior-period comparative figures and adjusting opening retained earnings Correct answer.
  4. Adjusted prospectively through current-year depreciation expense

Explanation

Material prior-period errors are corrected retrospectively by restating the comparatives and adjusting the opening balance of retained earnings. Prospective treatment applies to changes in estimates, not to corrections of errors.

Question 25Financial Accounting

A company reports profit before tax of 200,000, a tax rate of 25 percent, and non-deductible expenses of 20,000. What is the current tax expense?

  1. 55,000 Correct answer.
  2. 45,000
  3. 50,000
  4. 60,000

Explanation

Current tax is computed on taxable profit, which equals accounting profit plus non-deductible items. Taxable profit is 220,000, and applying the 25 percent rate yields 55,000.

Question 26Financial Accounting

A company receives a utility bill for services used during the current month but has not yet paid it. Under accrual accounting, what is the correct treatment?

  1. Record a prepaid asset and a liability in the current period.
  2. Record an expense and a liability in the current period. Correct answer.
  3. Record nothing until the bill is paid in the next period.
  4. Record an expense and reduce cash in the current period.

Explanation

Accrual accounting recognizes expenses when the related benefit is consumed, regardless of when cash is paid. Since the utility service was used this month, an expense and a corresponding liability must be recorded now. Waiting for payment would violate the matching principle and understate current-period expenses.

Question 27Financial Accounting

A company purchases equipment for 50,000 cash. What is the effect on the accounting equation?

  1. Assets increase and assets decrease by the same amount. Correct answer.
  2. Assets increase and liabilities increase.
  3. Assets increase and equity increases.
  4. Assets decrease and equity decreases.

Explanation

The purchase of equipment for cash is an asset exchange: one asset (equipment) increases while another asset (cash) decreases by the same amount. Total assets remain unchanged, and there is no effect on liabilities or equity because no obligation is created and no revenue or expense is recognized.

Question 28Financial Accounting

Which of the following is an example of an asset that would typically be classified as a current asset on a classified balance sheet?

  1. Land held for future expansion
  2. Inventory expected to be sold within the operating cycle Correct answer.
  3. A patent with a remaining legal life of 10 years
  4. Accounts receivable expected to be collected in 18 months

Explanation

Current assets are expected to be realized in cash, sold, or consumed within one year or the normal operating cycle, whichever is longer. Inventory that will be sold within the operating cycle meets this definition. Land held for expansion, long-term receivables, and patents are typically noncurrent because their realization or consumption extends beyond the coming year.

Question 29Financial Accounting

A company uses the straight-line method to depreciate a machine that cost 60,000, has an estimated residual value of 6,000, and a useful life of 6 years. What is the annual depreciation expense?

  1. 11,000
  2. 9,000 Correct answer.
  3. 10,000
  4. 6,000

Explanation

Straight-line depreciation equals the depreciable base divided by the useful life. The depreciable base is cost minus residual value, or 60,000 − 6,000 = 54,000. Dividing 54,000 by 6 years gives 9,000 per year.

Question 30Financial Accounting

Which of the following best describes the purpose of the trial balance?

  1. To ensure that all transactions have been recorded.
  2. To provide a listing of assets and liabilities at fair value.
  3. To prove that total debits equal total credits in the ledger. Correct answer.
  4. To determine the amount of net income for the period.

Explanation

A trial balance lists all ledger accounts and their balances to check that total debits equal total credits. It is a mechanical check of double-entry arithmetic, not a guarantee that transactions are complete or correctly classified. It does not measure net income or report fair values.

Question 31Financial Accounting

A company issues 10,000 shares of common stock with a par value of 1 per share for 8 per share. What is the amount credited to additional paid-in capital?

  1. 70,000 Correct answer.
  2. 80,000
  3. 8,000
  4. 10,000

Explanation

When stock is issued above par, the par value of the shares is credited to common stock and the excess is credited to additional paid-in capital. The par amount is 10,000 shares × 1 = 10,000, and the total proceeds are 10,000 × 8 = 80,000. The excess of 80,000 − 10,000 = 70,000 is credited to additional paid-in capital.

Question 32Financial Accounting

Which of the following is an example of an internal control procedure designed to safeguard cash receipts?

  1. Depositing cash receipts only at the end of each month.
  2. Allowing the same employee to receive cash and record cash receipts.
  3. Requiring monthly bank reconciliations prepared by someone independent of cash handling. Correct answer.
  4. Using a single signature on all checks regardless of amount.

Explanation

Segregation of duties is a fundamental internal control: the person who handles cash should not also record or reconcile it. Having an independent person prepare bank reconciliations helps detect errors and misappropriation. Combining custody and recordkeeping, delaying deposits, or relying on one signer weakens control.

Question 33Financial Accounting

Which inventory cost flow method typically results in the highest ending inventory during a period of rising prices?

  1. First-in, first-out (FIFO) Correct answer.
  2. Last-in, first-out (LIFO)
  3. Weighted average
  4. Specific identification

Explanation

Under FIFO, the oldest costs are assigned to cost of goods sold and the most recent, higher costs remain in ending inventory when prices are rising. LIFO assigns the newest costs to cost of goods sold, leaving older, lower costs in inventory. Weighted average smooths price changes and generally falls between FIFO and LIFO results.

Question 34Financial Accounting

A company uses the allowance method and estimates that 2% of net credit sales of 400,000 will be uncollectible. The allowance account currently has a credit balance of 1,000. What is the bad debt expense for the period?

  1. 8,000 Correct answer.
  2. 9,000
  3. 1,000
  4. 7,000

Explanation

Under the percentage-of-sales approach, bad debt expense is simply the estimated percentage of net credit sales, regardless of the existing allowance balance. Two percent of 400,000 equals 8,000. The existing 1,000 credit balance affects the ending allowance balance, not the expense amount under this method.

Question 35Financial Accounting

A company uses the effective interest method to amortize a bond premium. How does the annual interest expense compare with the cash interest paid over the life of the bond?

  1. Interest expense is higher than cash interest paid in early years and lower in later years.
  2. Interest expense is always equal to cash interest paid.
  3. Interest expense is lower than cash interest paid in early years and higher in later years. Correct answer.
  4. Interest expense is always greater than cash interest paid.

Explanation

When a bond is issued at a premium, the carrying amount exceeds face value and is amortized downward toward face value over the term. Because interest expense equals the effective rate multiplied by the declining carrying amount, it is lower than the constant cash coupon in early years and higher in later years. Total expense over the life equals total cash interest minus the premium.

Question 36Financial Accounting

A company uses the indirect method to prepare its operating cash flow section. Which of the following adjustments is added to net income?

  1. A gain on the sale of equipment
  2. A loss on the sale of equipment Correct answer.
  3. An increase in accounts receivable
  4. A decrease in accounts payable

Explanation

Under the indirect method, noncash losses are added back to net income because they reduced income without using cash. A loss on sale of equipment is a noncash charge that must be reversed. Increases in receivables and decreases in payables use cash and are subtracted, while gains are subtracted because the related cash inflow is reported in investing activities.

Question 37Financial Accounting

A company acquires a patent for 80,000 and expects it to provide economic benefits for 10 years. What is the annual amortization expense?

  1. 8,000 Correct answer.
  2. 10,000
  3. 0, because patents are not amortized
  4. 4,000

Explanation

Intangible assets with finite useful lives are amortized over that life, typically using the straight-line method. Dividing the 80,000 cost by the 10-year useful life gives 8,000 per year. Patents with finite lives are amortized; only intangibles with indefinite lives are not.

Question 38Financial Accounting

A company has 100,000 of taxable temporary differences that will reverse in future years, and the enacted tax rate is 25%. What is the deferred tax liability?

  1. 100,000
  2. 25,000 Correct answer.
  3. 0
  4. 75,000

Explanation

A taxable temporary difference creates a deferred tax liability because future taxable income will be higher when the difference reverses. The liability equals the temporary difference multiplied by the expected tax rate: 100,000 × 25% = 25,000. This amount is reported as a noncurrent liability.

Question 39Financial Accounting

A company enters into a five-year finance lease for equipment. Which of the following will the lessee report at the inception of the lease?

  1. A prepaid asset for the full lease term.
  2. No asset or liability until the first payment is made.
  3. A lease liability equal to the present value of future lease payments. Correct answer.
  4. Rental expense equal to the total lease payments.

Explanation

Under a finance lease, the lessee recognizes a right-of-use asset and a lease liability measured at the present value of the lease payments. This reflects the substance of financing the acquisition of the right to use the asset. Rental expense is not recognized at inception for a finance lease.

Question 40Financial Accounting

A company has bonds payable with a face value of 200,000 and a carrying amount of 195,000. It redeems the bonds early at 101. What is the gain or loss on redemption?

  1. A gain of 2,000
  2. A loss of 2,000
  3. A gain of 5,000
  4. A loss of 7,000 Correct answer.

Explanation

The cash paid to redeem is 200,000 × 101% = 202,000. The carrying amount is 195,000, so the loss on redemption is 202,000 − 195,000 = 7,000. The loss arises because the company pays more than the book value of the debt.

Question 41Financial Accounting

A company declares a 10% stock dividend on its 50,000 outstanding shares with a par value of 2 and a market price of 15 per share. What amount is transferred from retained earnings to paid-in capital?

  1. 50,000
  2. 7,500
  3. 75,000 Correct answer.
  4. 10,000

Explanation

For a small stock dividend (generally less than 20–25%), retained earnings is reduced by the fair value of the additional shares. The number of new shares is 50,000 × 10% = 5,000, and the market value is 5,000 × 15 = 75,000. This amount is transferred to common stock and additional paid-in capital.

Question 42Financial Accounting

A company reports net sales of 600,000, cost of goods sold of 360,000, and operating expenses of 150,000. What is its gross profit margin?

  1. 15%
  2. 25%
  3. 60%
  4. 40% Correct answer.

Explanation

Gross profit equals net sales minus cost of goods sold: 600,000 − 360,000 = 240,000. The gross profit margin is gross profit divided by net sales: 240,000 ÷ 600,000 = 40%. Operating expenses are not deducted in calculating gross profit.

Question 43Financial Accounting

A company uses the allowance method. It writes off a specific customer account of 5,000 as uncollectible. What is the effect of this write-off on total assets and net income?

  1. Total assets are unchanged and net income decreases.
  2. Total assets are unchanged and net income is unchanged. Correct answer.
  3. Total assets decrease and net income is unchanged.
  4. Total assets decrease and net income decreases.

Explanation

Under the allowance method, a write-off reduces accounts receivable and the allowance for doubtful accounts by the same amount. Because the allowance is a contra-asset, total assets and net income are unaffected at the time of write-off; the expense was recognized when the allowance was estimated. This is a common area of confusion with the direct write-off method.

Question 44Financial Accounting

A company has a beginning inventory of 20,000, purchases of 80,000, and a ending inventory of 25,000. What is its cost of goods sold?

  1. 75,000 Correct answer.
  2. 80,000
  3. 70,000
  4. 85,000

Explanation

Cost of goods sold equals beginning inventory plus purchases minus ending inventory. Adding 20,000 and 80,000 gives 100,000 of goods available for sale. Subtracting the 25,000 ending inventory leaves 75,000 of cost of goods sold.

Question 45Financial Accounting

A company's debt-to-equity ratio is 1.5. If total liabilities are 300,000, what is total equity?

  1. 450,000
  2. 300,000
  3. 150,000
  4. 200,000 Correct answer.

Explanation

The debt-to-equity ratio equals total liabilities divided by total equity. Rearranging, total equity equals total liabilities divided by the ratio: 300,000 ÷ 1.5 = 200,000. This means the company uses 1.50 of debt for every 1.00 of equity.

Question 46Financial Accounting

A company uses the percentage-of-completion method for a long-term construction contract. Which of the following is true about revenue recognition?

  1. Revenue is recognized only when the contract is completed.
  2. Revenue is recognized when cash is collected from the customer.
  3. Revenue is recognized based on the progress toward completion each period. Correct answer.
  4. Revenue is recognized equally over the contract term regardless of progress.

Explanation

Under the percentage-of-completion method, revenue and gross profit are recognized as the work progresses, measured by costs incurred or another reliable measure of progress. This reflects the transfer of control over time. Recognizing revenue only at completion describes the completed-contract method, which is generally not permitted when performance obligations are satisfied over time.

Question 47Financial Accounting

A company has a defined benefit pension plan. Which of the following best describes the nature of a net pension liability?

  1. The excess of the projected benefit obligation over the fair value of plan assets. Correct answer.
  2. The amount of cash contributed to the plan during the year.
  3. The annual pension expense reported in the income statement.
  4. The excess of the fair value of plan assets over the projected benefit obligation.

Explanation

A net pension liability arises when the projected benefit obligation exceeds the fair value of plan assets, indicating the plan is underfunded. If plan assets exceed the obligation, a net pension asset is reported instead. The liability is a balance sheet measure, not the annual expense or cash contribution.

Question 48Financial Accounting

A company reports net income of 50,000, including a gain on sale of land of 10,000. During the year, accounts receivable increased by 5,000 and accounts payable decreased by 3,000. What is cash flow from operating activities using the indirect method?

  1. 38,000
  2. 32,000 Correct answer.
  3. 48,000
  4. 52,000

Explanation

Start with net income of 50,000, subtract the 10,000 noncash gain because the proceeds are investing cash flow, subtract the 5,000 increase in receivables, and subtract the 3,000 decrease in payables. The result is 50,000 − 10,000 − 5,000 − 3,000 = 32,000. Each adjustment converts accrual income to operating cash flow.

Question 49Financial Accounting

A company uses the effective interest method for a bond issued at a discount. Which statement correctly describes the pattern of interest expense and the carrying amount over the bond term?

  1. Interest expense remains constant and the carrying amount increases.
  2. Interest expense increases and the carrying amount decreases toward face value.
  3. Interest expense decreases and the carrying amount decreases toward face value.
  4. Interest expense increases and the carrying amount increases toward face value. Correct answer.

Explanation

A discount means the carrying amount starts below face value. Interest expense equals the effective rate multiplied by the carrying amount, so as the carrying amount is increased by discount amortization, interest expense rises each period. By maturity, the carrying amount equals face value and the total discount has been amortized to interest expense.

Question 50Financial Accounting

A company has a deferred tax asset of 40,000 related to a deductible temporary difference. Management concludes that it is more likely than not that only 30,000 of the asset will be realized. What is the required accounting treatment?

  1. Recognize the full 40,000 asset and disclose the uncertainty.
  2. Derecognize the entire 40,000 deferred tax asset.
  3. Recognize a valuation allowance of 10,000, reducing the net deferred tax asset to 30,000. Correct answer.
  4. Recognize a deferred tax liability of 10,000.

Explanation

A valuation allowance is recognized when it is more likely than not that some or all of a deferred tax asset will not be realized. The allowance equals the portion not expected to be realized, or 40,000 − 30,000 = 10,000, leaving a net deferred tax asset of 30,000. The allowance is reassessed at each reporting date.