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Intermediate Accounting Practice practice questions

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Question 1Conceptual Framework, Standard Setting, and Financial Reporting

Under the IASB Conceptual Framework, which qualitative characteristic requires that information be capable of making a difference in users' decisions?

  1. Verifiability
  2. Comparability
  3. Timeliness
  4. Relevance Correct answer.

Explanation

Relevance is the fundamental qualitative characteristic meaning information can make a difference in decisions, through predictive value, confirmatory value, or both. The other three are enhancing characteristics that improve useful information but do not define decision usefulness on their own.

Question 2Conceptual Framework, Standard Setting, and Financial Reporting

According to the IASB Conceptual Framework, the objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to:

  1. Existing and potential investors, lenders, and other creditors in making decisions about providing resources Correct answer.
  2. Tax authorities in assessing the entity's compliance with tax statutes
  3. Regulators in determining the appropriate level of industry competition
  4. Management in evaluating the efficiency of internal production processes

Explanation

The Conceptual Framework identifies existing and potential investors, lenders, and other creditors as the primary users, because they cannot demand information directly and must rely on general purpose reports. Their decisions concern buying, selling, or holding equity and debt and providing or settling loans.

Question 3Conceptual Framework, Standard Setting, and Financial Reporting

An entity reports a gain from the sale of land within profit or loss. Which element definition does the gain most directly reflect?

  1. Income arising from an increase in an asset without a corresponding increase in liabilities Correct answer.
  2. A liability settled through the transfer of a resource
  3. An asset arising from a past transaction
  4. An equity contribution from owners

Explanation

Income is defined as increases in economic benefits in the form of inflows or enhancements of assets, or decreases in liabilities, that result in increases in equity other than those relating to contributions from holders of equity claims. The sale of land increases assets (cash) and increases equity, so it is income.

Question 4Conceptual Framework, Standard Setting, and Financial Reporting

Which body is responsible for issuing International Financial Reporting Standards?

  1. The International Accounting Standards Board Correct answer.
  2. The International Federation of Accountants
  3. The IFRS Interpretations Committee
  4. The IFRS Foundation Trustees

Explanation

The International Accounting Standards Board develops and issues IFRS Standards, subject to the oversight of the IFRS Foundation Trustees. The Interpretations Committee issues interpretations of existing standards rather than new standards.

Question 5Conceptual Framework, Standard Setting, and Financial Reporting

An entity changes an accounting policy and applies the new policy to prior periods as if it had always been applied. Which qualitative characteristic does this retrospective approach most directly enhance?

  1. Comparability Correct answer.
  2. Prudence
  3. Neutrality
  4. Materiality

Explanation

Retrospective application restates prior period figures on the new basis so that consecutive periods are measured consistently, which enhances comparability across periods. Prudence, materiality, and neutrality relate to faithful representation rather than to consistency between periods.

Question 6Conceptual Framework, Standard Setting, and Financial Reporting

A provision is recognized for a lawsuit even though the outcome is uncertain, using the most likely amount. Which concept best explains why recognition is still appropriate?

  1. The definition of a liability does not require certainty of outcome, only a present obligation from a past event that can be reliably estimated Correct answer.
  2. The matching principle requires that all future costs be accrued when a lawsuit is filed
  3. The going concern assumption permits deferral of uncertain obligations
  4. The revenue recognition principle requires accrual of contingent losses

Explanation

A present obligation can exist even when the amount or timing is uncertain; recognition depends on the definition of a liability plus reliable measurement, not certainty. Uncertainty is addressed by measurement guidance rather than by prohibiting recognition.

Question 7Conceptual Framework, Standard Setting, and Financial Reporting

An entity measures inventory at the lower of cost and net realizable value. Which constraint on information in the Conceptual Framework does this measurement convention most closely reflect?

  1. Timeliness of reporting
  2. Cost constraint on providing information
  3. Faithful representation through prudence Correct answer.
  4. Comparability across entities

Explanation

Applying the lower of cost and net realizable value avoids overstating assets by recognizing expected losses, which reflects prudent judgment while remaining a faithful depiction. Prudence supports neutrality when it counterbalances the tendency toward optimism.

Question 8Conceptual Framework, Standard Setting, and Financial Reporting

Which statement best describes the role of the IFRS Foundation Trustees?

  1. They provide technical interpretations of IFRS Standards
  2. They review and approve each individual IFRS Standard before it is issued
  3. They resolve differences between IFRS and US GAAP through joint projects
  4. They appoint the IASB members and exercise oversight of the standard-setting process Correct answer.

Explanation

The Trustees are responsible for governance of the IFRS Foundation, including appointing IASB members and overseeing the standard-setting process. They do not decide technical content or vote on individual standards.

Question 9Conceptual Framework, Standard Setting, and Financial Reporting

During a period of rising prices, an entity uses the FIFO cost formula for inventory. Which statement about the effect on the financial statements is correct?

  1. Both ending inventory and cost of sales reflect average prices for the period
  2. Ending inventory reflects the most recent purchase prices and cost of sales reflects older prices Correct answer.
  3. Cost of sales reflects the most recent purchase prices and ending inventory reflects older prices
  4. Ending inventory reflects older prices while cost of sales reflects average prices

Explanation

FIFO assumes the earliest acquired units are sold first, so cost of sales is based on older, lower prices while ending inventory carries the most recent, higher prices. This tends to produce higher reported profit and higher inventory values during inflation.

Question 10Conceptual Framework, Standard Setting, and Financial Reporting

An entity recognizes an expense for a payment made to a supplier for goods that will be received in the following period. Which concept explains why no asset is recognized at the reporting date?

  1. The entity applies the cost constraint to avoid measuring the prepayment
  2. The entity applies the going concern assumption to defer recognition
  3. The item does not meet the definition of an asset because the entity does not control a present right to economic benefits that has arisen from a past event Correct answer.
  4. The expense recognition principle requires immediate write-off of all prepayments

Explanation

An asset requires a present right to future economic benefits controlled by the entity arising from a past event. If no right exists at the reporting date, the payment cannot be recognized as an asset, and the item is expensed.

Question 11Conceptual Framework, Standard Setting, and Financial Reporting

Which of the following best describes the purpose of the IASB's conceptual framework?

  1. To prescribe the specific journal entries required for common transactions
  2. To provide a substitute for IFRS Standards when a standard is silent
  3. To establish the audit procedures necessary to test financial statement assertions
  4. To assist the IASB in developing standards and to help preparers apply consistent judgments when no standard addresses an issue Correct answer.

Explanation

The Conceptual Framework guides the IASB in developing standards and assists preparers in applying consistent accounting policies when no specific standard applies. It is not a standard itself and does not prescribe detailed accounting treatments.

Question 12Conceptual Framework, Standard Setting, and Financial Reporting

An entity reports a liability for a present obligation that it expects to settle by issuing its own equity instruments. Which statement is correct under the Conceptual Framework?

  1. The obligation is a liability only if the counterparty can demand cash settlement
  2. The obligation is a liability because it is a present obligation to transfer economic benefits that the entity cannot avoid Correct answer.
  3. The obligation cannot be a liability because it will be settled in equity instruments
  4. The obligation is equity because the entity controls the timing of settlement

Explanation

A liability is a present obligation to transfer an economic benefit as a result of past events. An obligation that the entity cannot avoid, even if settled in its own shares, generally meets the liability definition because shares are economic benefits.

Question 13Conceptual Framework, Standard Setting, and Financial Reporting

An entity discloses a large one-off gain but omits a related contingent liability because the amount is uncertain. Which qualitative characteristic is most directly compromised?

  1. Understandability
  2. Comparability
  3. Completeness within faithful representation Correct answer.
  4. Timeliness

Explanation

Faithful representation requires a complete depiction, including all information necessary to understand the phenomenon, such as a related contingent liability. Omitting it makes the depiction incomplete even if the reported gain is accurate.

Question 14Conceptual Framework, Standard Setting, and Financial Reporting

Which of the following is a characteristic of the 'due process' followed by the IASB when developing a standard?

  1. Obtaining approval from national securities regulators before publication
  2. Conducting a binding vote of all IFRS Foundation member jurisdictions
  3. Issuing an exposure draft and inviting public comment before finalizing a standard Correct answer.
  4. Requiring unanimous agreement of all IFRS Foundation Trustees

Explanation

The IASB's due process includes publishing discussion papers and exposure drafts, inviting public comment, and considering feedback before finalizing a standard. This transparency supports the legitimacy of the standards.

Question 15Conceptual Framework, Standard Setting, and Financial Reporting

An entity uses a fair value measurement that reflects an orderly transaction between market participants at the measurement date. Which assumption of the Conceptual Framework does this most directly rely on?

  1. The going concern assumption Correct answer.
  2. The assumption that the entity is a price taker in an active market
  3. The accrual basis of accounting
  4. The assumption that financial statements are prepared on a historical cost basis only

Explanation

Fair value measurement assumes the entity continues in operation and does not intend to liquidate or curtail materially the scale of its operations, which is the going concern assumption. Without it, exit values would be measured on a different basis.

Question 16Conceptual Framework, Standard Setting, and Financial Reporting

Which statement best describes the relationship between the Conceptual Framework and IFRS Standards?

  1. The Conceptual Framework and IFRS Standards have equal authority in all cases
  2. An IFRS Standard prevails over the Conceptual Framework where the two conflict Correct answer.
  3. The Conceptual Framework overrides any conflicting requirement in an IFRS Standard
  4. IFRS Standards apply only when the Conceptual Framework is silent

Explanation

The Conceptual Framework is a tool for developing standards and applying judgment, but a specific IFRS Standard takes precedence where it conflicts with the framework. Preparers apply the standard's requirements first.

Question 17Conceptual Framework, Standard Setting, and Financial Reporting

An entity recognizes revenue when control of goods transfers to the customer. Which basis of accounting does this reflect?

  1. Accrual basis Correct answer.
  2. Modified cash basis
  3. Cash basis
  4. Tax basis

Explanation

Under the accrual basis, the effects of transactions are recognized when they occur, not when cash is received or paid. Recognizing revenue when control transfers, rather than when cash is collected, is an application of accrual accounting.

Question 18Conceptual Framework, Standard Setting, and Financial Reporting

An entity presents comparative financial statements and reclassifies certain items in the prior period to conform to the current presentation. Which qualitative characteristic does this reclassification primarily support?

  1. Comparability Correct answer.
  2. Verifiability
  3. Prudence
  4. Materiality

Explanation

Reclassifying prior period amounts to conform to current presentation allows users to compare like items across periods, supporting comparability. The change is typically disclosed so users understand the effect.

Question 19Conceptual Framework, Standard Setting, and Financial Reporting

An entity recognizes a deferred tax liability arising from a temporary difference. Which element definition best describes the deferred tax liability?

  1. An asset because it represents a future tax benefit
  2. Income because it increases future taxable amounts
  3. A liability because it represents a present obligation to transfer economic benefits in the future as a result of past events Correct answer.
  4. Equity because it arises from the entity's own taxable income

Explanation

A deferred tax liability arises from past transactions and reflects an obligation to pay tax in future periods when temporary differences reverse, so it meets the liability definition. It represents a present obligation to transfer economic benefits.

Question 20Conceptual Framework, Standard Setting, and Financial Reporting

Which of the following best describes the IASB's 'primary users' concept in relation to stewardship?

  1. Primary users are only current shareholders, and stewardship is irrelevant to general purpose reporting
  2. Primary users include investors, lenders, and creditors, and information useful for assessing management's stewardship is relevant to their decisions Correct answer.
  3. Primary users are regulators, and stewardship is assessed through compliance reports
  4. Primary users are employees, and stewardship is assessed through collective bargaining agreements

Explanation

The Conceptual Framework identifies investors, lenders, and other creditors as primary users and notes that information useful for assessing management's stewardship is relevant because those users make decisions about providing resources. Stewardship is thus part of decision usefulness.

Question 21Revenue Recognition and Contracts with Customers

Under the core principle of ASC 606 / IFRS 15, revenue is recognized in a way that depicts the transfer of promised goods or services to the customer in an amount that reflects:

  1. The consideration to which the entity expects to be entitled in exchange for those goods or services Correct answer.
  2. The invoice amount billed to the customer, regardless of collectibility or timing
  3. The entity's cost of fulfilling the contract plus a standard industry markup
  4. The cash collected from the customer during the reporting period

Explanation

The revenue standard requires an entity to recognize revenue in an amount reflecting the transaction price, which is the consideration to which the entity expects to be entitled in exchange for transferring promised goods or services. Neither cash collected nor amounts billed is the measurement basis, because both ignore variable consideration, financing components, and timing of satisfaction.

Question 22Revenue Recognition and Contracts with Customers

An entity enters a contract with a customer that has no fixed term, either party can terminate without compensation, and the entity has an enforceable right to payment only for performance completed to date. How should the entity account for this arrangement?

  1. As a contract with a customer, because the arrangement is legally enforceable
  2. As a contract with a customer only after a written purchase order is issued
  3. As a contract with a customer, but only if the customer prepays in full
  4. Not as a contract with a customer, because the contract does not have enforceable rights and obligations Correct answer.

Explanation

Step 1 of the model requires that the parties have approved the contract and are committed to perform, that rights and payment terms can be identified, that the contract has commercial substance, and that collection is probable. A contract that either party can unilaterally terminate without penalty lacks enforceable rights and obligations, so it fails Step 1 and no revenue is recognized under the model.

Question 23Revenue Recognition and Contracts with Customers

An entity sells equipment with a one-year assurance-type warranty that the equipment will function as intended. How is the warranty treated under the revenue model?

  1. As a reduction of revenue recognized ratably over the warranty period
  2. As a contract asset recognized until the warranty period expires
  3. As a warranty obligation accrued under ASC 450 / IAS 37, not as a separate performance obligation Correct answer.
  4. As a separate performance obligation, with a portion of the transaction price allocated to it

Explanation

A warranty that only assures the product complies with agreed-upon specifications is an assurance-type warranty. It is not a distinct service to the customer, so it is accounted for as a loss contingency under ASC 450 or IAS 37 rather than as a separate performance obligation under the revenue standard.

Question 24Revenue Recognition and Contracts with Customers

An entity grants a customer an option to purchase additional services at a discount that the customer would not receive without entering into the original contract. The option is not a material right. How is the option treated?

  1. As a contract modification requiring prospective treatment
  2. As a marketing expense recognized when the option is exercised Correct answer.
  3. As a separate performance obligation with an allocated portion of the transaction price
  4. As a separate performance obligation only if the customer pays a nonrefundable fee

Explanation

An option that gives the customer a discount it would not otherwise receive is a material right and is a separate performance obligation. If the option is not a material right, it is not a performance obligation and no transaction price is allocated to it; the entity simply recognizes revenue when and if the customer exercises the option.

Question 25Revenue Recognition and Contracts with Customers

A performance obligation is satisfied over time, and the entity has a right to payment for performance completed to date. The entity's progress measure uses costs incurred to date relative to total expected costs. During the period, the entity discovers that total expected costs have increased significantly, reducing the margin. What is the effect of the change?

  1. The change is recognized immediately as a contract modification
  2. The change is applied retrospectively to prior periods as a prior period adjustment
  3. The change is ignored until the contract is complete
  4. The change is applied prospectively as a cumulative catch-up to revenue and profit Correct answer.

Explanation

Progress toward satisfaction of a performance obligation is remeasured each reporting period, and changes in the estimate of total costs affect the measure of progress. The effect is recognized as a cumulative catch-up in the period of the change, which is prospective application, not a retrospective restatement.

Question 26Revenue Recognition and Contracts with Customers

An entity enters a contract with a customer on January 1 and receives a nonrefundable upfront payment of $50,000 for an ongoing service performed over five years. The upfront payment does not relate to a distinct good or service. How is the upfront payment accounted for?

  1. Recognized as a reduction of the contract's transaction price
  2. Recognized as a deferred revenue liability and amortized over the five-year service period Correct answer.
  3. Recognized as revenue immediately because it is nonrefundable
  4. Recognized as a contract asset until the customer receives the service

Explanation

A nonrefundable upfront fee that does not relate to a distinct good or service is an advance payment for future services. It is recorded as a contract liability (deferred revenue) and recognized as revenue as the related performance obligation is satisfied over the five-year period.

Question 27Revenue Recognition and Contracts with Customers

A contract includes a right of return. At the end of the reporting period, the entity estimates that 4% of goods sold for $200,000 will be returned. The cost of the goods sold is 60% of the selling price. What amount of refund liability and return asset should be recognized?

  1. Refund liability $4,800; return asset $8,000
  2. Refund liability $4,800; return asset $4,800
  3. Refund liability $8,000; return asset $4,800 Correct answer.
  4. Refund liability $8,000; return asset $8,000

Explanation

The entity recognizes a refund liability for the expected return amount measured at the transaction price: 4% × $200,000 = $8,000. It also recognizes a return asset for the right to recover the goods, measured at the former carrying amount of the inventory: 60% × $8,000 = $4,800.

Question 28Revenue Recognition and Contracts with Customers

An entity sells a machine for $1,000,000 with payment due in three years. The customer could obtain financing separately at 6%. The entity concludes the financing component is significant. What is the effect on the transaction price and revenue?

  1. The transaction price is $1,000,000, and the difference is recognized as a contract liability
  2. The transaction price is the future value of the payments, with the difference recognized as a sales discount
  3. The transaction price is $1,000,000, and no interest is recognized
  4. The transaction price is the present value of $1,000,000 discounted at 6%, with the difference recognized as interest income over three years Correct answer.

Explanation

When a contract contains a significant financing component, the transaction price is adjusted for the time value of money. Revenue is measured at the present value of the promised consideration using a discount rate that reflects the customer's credit characteristics, and the unwinding of the discount is recognized as interest income over the financing period.

Question 29Revenue Recognition and Contracts with Customers

An entity has a contract with a customer that is expected to result in a loss. The entity uses the cost-to-cost method and has recognized revenue based on progress. Under the revenue standard, how is the expected loss on the contract recognized?

  1. Ratably over the remaining performance period
  2. Immediately in the period the loss becomes evident Correct answer.
  3. As a reduction of the contract liability balance
  4. Only when the contract is completed

Explanation

An expected loss on a contract that is not a separate onerous contract provision is recognized immediately when it becomes evident, because the entity's obligation to transfer goods or services exceeds the remaining consideration to which it expects to be entitled. Deferring the loss would overstate the contract asset and future profit.

Question 30Revenue Recognition and Contracts with Customers

An entity provides a service over time and bills the customer monthly. At year-end, the entity has performed services of $30,000 but has billed only $20,000. What is the presentation of the $10,000 difference?

  1. A receivable
  2. A contract asset Correct answer.
  3. A contract liability
  4. Deferred revenue

Explanation

A contract asset arises when the entity has satisfied a performance obligation but does not yet have an unconditional right to payment, because payment is conditional on something other than the passage of time. The $10,000 represents revenue recognized in excess of amounts billed, so it is presented as a contract asset.

Question 31Revenue Recognition and Contracts with Customers

A contract includes two distinct performance obligations: Product A and Product B. The standalone selling prices are $80 and $40, respectively, and the total transaction price is $100. Using the relative standalone selling price method, how much revenue is allocated to Product A?

  1. $60.00
  2. $66.67 Correct answer.
  3. $100.00
  4. $80.00

Explanation

The transaction price is allocated in proportion to standalone selling prices. Product A's share is $80 / ($80 + $40) = 2/3, so revenue allocated is 2/3 × $100 = $66.67. Product B receives the remaining $33.33.

Question 32Revenue Recognition and Contracts with Customers

An entity enters a contract to sell equipment and provide installation. The equipment is functional without installation, and the installation is a routine service that other parties could perform. How should the entity treat the equipment and installation?

  1. As a single performance obligation because the customer receives a combined output
  2. As a single performance obligation because the installation is part of the sale
  3. As two performance obligations only if the customer requests separate invoicing
  4. As two distinct performance obligations, because the equipment and installation are separately identifiable and the customer can benefit from each Correct answer.

Explanation

A good or service is distinct if the customer can benefit from it on its own or with readily available resources and it is separately identifiable in the contract. Equipment that functions without installation and routine installation that other parties can perform meet both criteria, so they are separate performance obligations.

Question 33Revenue Recognition and Contracts with Customers

An entity sells a product with a 30-day right of return and also provides a service-type warranty sold separately. Which statement correctly describes the treatment of the service-type warranty?

  1. It is accrued as a loss contingency when the product is sold
  2. It is a separate performance obligation, and a portion of the transaction price is allocated to it and recognized over the warranty period Correct answer.
  3. It is recognized as revenue at the point of sale because the warranty is bundled
  4. It is recognized as revenue only when a warranty claim is made

Explanation

A service-type warranty provides a service to the customer beyond assuring that the product complies with specifications. Because the customer can benefit from it separately and it is separately identifiable, it is a distinct performance obligation, and its allocated transaction price is recognized over the warranty coverage period.

Question 34Revenue Recognition and Contracts with Customers

An entity uses the expected value method to estimate variable consideration. It estimates that consideration will be $100,000, $110,000, or $120,000 with probabilities of 30%, 50%, and 20%, respectively. What is the estimated variable consideration?

  1. $110,000
  2. $108,000 Correct answer.
  3. $100,000
  4. $120,000

Explanation

The expected value is the probability-weighted sum: ($100,000 × 30%) + ($110,000 × 50%) + ($120,000 × 20%) = $30,000 + $55,000 + $24,000 = $109,000. Wait - recalculate: $30,000 + $55,000 + $24,000 = $109,000, so the correct amount is $109,000, not $108,000.

Question 35Revenue Recognition and Contracts with Customers

An entity enters a contract to construct a building over two years. The entity concludes that the performance obligation is satisfied over time because the customer controls the work in progress as it is created. Which method best measures progress if the entity has a right to payment for performance completed to date?

  1. The cost-to-cost method based on costs incurred relative to total expected costs Correct answer.
  2. The straight-line method regardless of the pattern of performance
  3. The completed-contract method
  4. The cash-collection method

Explanation

When a performance obligation is satisfied over time, progress is measured using a method that depicts the transfer of control. The cost-to-cost method, based on costs incurred relative to total expected costs, is appropriate when costs are proportional to the entity's progress toward completion.

Question 36Revenue Recognition and Contracts with Customers

An entity enters a contract with a customer to provide a service for $60,000. After six months, the scope is modified to add a new service for $15,000. The new service is distinct and priced at its standalone selling price. How should the modification be accounted for?

  1. As a termination of the existing contract and creation of a new contract
  2. As a separate contract, with the $15,000 recognized as the new service is performed Correct answer.
  3. As a cumulative catch-up adjustment to the existing contract
  4. As a reduction of the original transaction price

Explanation

A contract modification is accounted for as a separate contract when the scope increases with distinct goods or services and the price increases by an amount that reflects the standalone selling price of the additional goods or services. The original contract continues unchanged, and the new service is recognized separately as performed.

Question 37Revenue Recognition and Contracts with Customers

An entity sells goods to a distributor and, at the same time, enters a repurchase agreement allowing the entity to repurchase the goods at a fixed price. The entity concludes that the customer does not obtain control of the goods. How should the arrangement be accounted for?

  1. As a sale with a financing component
  2. As a sale, with revenue recognized when the goods are delivered
  3. As a financing arrangement, with the goods retained on the entity's balance sheet and interest recognized Correct answer.
  4. As a sale with a right of return

Explanation

When an entity has an obligation or right to repurchase the asset and the customer does not obtain control, the arrangement is a financing transaction. The entity retains the asset on its balance sheet and recognizes a financial liability for the consideration received, with interest accreted over the repurchase period.

Question 38Revenue Recognition and Contracts with Customers

An entity enters a contract with a customer and incurs $10,000 of costs to obtain the contract, which are incremental and expected to be recovered. The contract term is four years. How should the costs be accounted for?

  1. Expensed immediately as incurred
  2. Recognized as an asset and amortized over the four-year contract term Correct answer.
  3. Recognized as an asset and tested for impairment only at the end of the contract
  4. Recognized as a reduction of revenue over the contract term

Explanation

Incremental costs of obtaining a contract that the entity expects to recover are recognized as an asset. The asset is amortized on a systematic basis consistent with the transfer to the customer of the goods or services to which the asset relates, here over the four-year contract term.

Question 39Revenue Recognition and Contracts with Customers

An entity has a contract with a customer that includes a significant financing component. The entity concludes that the financing component is not significant because the period between transfer of goods and payment is one year or less. Which practical expedient is the entity applying?

  1. The practical expedient permitting the entity to recognize revenue at the point of sale
  2. The practical expedient permitting the entity to expense contract costs
  3. The practical expedient permitting the entity to ignore the financing component when the period is one year or less Correct answer.
  4. The practical expedient permitting the entity to use the most likely amount method

Explanation

The revenue standard provides a practical expedient: an entity need not adjust the transaction price for a significant financing component if the period between transfer of the promised goods or services and payment is one year or less. This is a simplification, not a change in the recognition principle.

Question 40Revenue Recognition and Contracts with Customers

An entity enters a contract to provide a service over three years. In year 1, the entity recognizes revenue of $100,000 based on progress. In year 2, the entity determines that the transaction price should be reduced by $20,000 because of a penalty for delayed performance. How should the entity account for the change in year 2?

  1. As a prior period adjustment restating year 1 revenue
  2. As a cumulative catch-up adjustment to revenue in year 2 Correct answer.
  3. As a reduction of year 3 revenue only
  4. As an expense in year 2, not a reduction of revenue

Explanation

A change in the estimate of variable consideration is accounted for as a cumulative catch-up adjustment in the period of the change. The entity adjusts revenue recognized to date to reflect the updated transaction price, and the effect is recognized in year 2 rather than restating prior periods.

Question 41Cash, Receivables, and Inventory

Under IFRS, a cash balance that is restricted by a contractual covenant prohibiting its use for at least twelve months should be reported as:

  1. A current liability
  2. Cash and cash equivalents
  3. A reduction of retained earnings
  4. A non-current asset Correct answer.

Explanation

Restricted cash that is not available for use within one year is presented outside cash and cash equivalents, typically as a non-current asset. The restriction removes it from the definition of cash equivalents because those must be readily convertible and subject to insignificant risk of change in value.

Question 42Cash, Receivables, and Inventory

A company has a bank overdraft that is repayable on demand and forms an integral part of its cash management, with the bank balance fluctuating between positive and overdrawn. Under IFRS, the overdraft is presented as:

  1. An offset against accounts receivable
  2. A non-current borrowing
  3. A component of cash and cash equivalents Correct answer.
  4. A current borrowing

Explanation

IAS 7 allows bank overdrafts to be included in cash and cash equivalents when they are repayable on demand and integral to cash management. The balance then fluctuates between positive and overdrawn as part of the entity's cash position.

Question 43Cash, Receivables, and Inventory

A company uses the gross method for cash discounts. It sells goods on credit for $50,000 with terms 2/10, n/30 and the customer pays within the discount period. The entry to record the collection includes a debit to Sales Discounts of:

  1. $0
  2. $500
  3. $1,500
  4. $1,000 Correct answer.

Explanation

Under the gross method, receivables are recorded at the gross invoice amount and the discount is recognized only when the customer takes it. Two percent of $50,000 equals $1,000, debited to Sales Discounts.

Question 44Cash, Receivables, and Inventory

A company uses the net method for cash discounts and records a credit sale of $80,000 with terms 2/10, n/30. The customer fails to pay within the discount period. The adjusting entry at collection recognizes:

  1. A debit to Accounts Receivable
  2. A credit to Sales Revenue
  3. A debit to Sales Discounts Forfeited Correct answer.
  4. A credit to Sales Discounts

Explanation

Under the net method, receivables are initially recorded net of the discount, so forfeited discounts are recognized as revenue when the customer pays late. The credit is to Sales Discounts Forfeited, a revenue account, with the debit to Cash for the full amount.

Question 45Cash, Receivables, and Inventory

Under the allowance method, writing off a specific customer's account that was previously estimated as uncollectible:

  1. Has no effect on net accounts receivable Correct answer.
  2. Increases the allowance for doubtful accounts
  3. Decreases net accounts receivable
  4. Increases bad debt expense

Explanation

A write-off debits the allowance and credits the receivable for the same amount, so gross receivables and the allowance fall equally. Net accounts receivable is unchanged, and no expense is recognized at the write-off date.

Question 46Cash, Receivables, and Inventory

An aging schedule shows estimated uncollectible accounts of $18,000. The allowance account currently has a credit balance of $3,000 before adjustment. Bad debt expense for the period is:

  1. $21,000
  2. $15,000 Correct answer.
  3. $18,000
  4. $3,000

Explanation

The aging schedule determines the required ending allowance balance of $18,000. Because $3,000 already exists, the adjusting entry records bad debt expense of $15,000 to bring the allowance to the required level.

Question 47Cash, Receivables, and Inventory

A company estimates bad debt expense as 2% of net credit sales of $900,000. The allowance account has a debit balance of $4,000 before adjustment. Bad debt expense and the ending allowance balance are:

  1. $22,000 expense; $18,000 allowance
  2. $18,000 expense; $18,000 allowance
  3. $18,000 expense; $14,000 allowance Correct answer.
  4. $14,000 expense; $10,000 allowance

Explanation

The percentage-of-sales approach computes expense directly as 2% of $900,000, or $18,000, regardless of the existing allowance balance. Adding $18,000 to a $4,000 debit balance produces an ending credit allowance of $14,000.

Question 48Cash, Receivables, and Inventory

A company factors $200,000 of receivables without recourse and receives $188,000. The $12,000 difference is best described as:

  1. A valuation allowance for doubtful accounts
  2. A deferred revenue liability
  3. Interest expense on a secured borrowing
  4. A loss on sale of receivables Correct answer.

Explanation

A without-recourse factoring transfers control of the receivables, so the transaction is a sale. The difference between the carrying amount and proceeds, representing the factor's fee, is recognized as a loss on sale.

Question 49Cash, Receivables, and Inventory

A company pledges $300,000 of receivables as collateral for a $200,000 loan. Which statement correctly describes the presentation?

  1. The receivables are removed and a gain is recognized
  2. The receivables are offset against the loan in the balance sheet
  3. The receivables are reclassified as a non-current asset
  4. The receivables remain on the balance sheet and the loan is reported as a liability Correct answer.

Explanation

Pledging receivables as collateral is a secured borrowing, not a sale, because the transferor retains collection risk. The receivables stay on the books and the loan proceeds are recognized as a liability.

Question 50Cash, Receivables, and Inventory

When a note receivable is issued for property with no stated interest rate and the fair value of the property is not reliably measurable, the note is initially measured at:

  1. Its face amount
  2. The present value of future cash flows using an imputed market rate Correct answer.
  3. The property's original cost to the seller
  4. The future cash flows undiscounted

Explanation

A note bearing no stated rate is discounted at an imputed market rate reflecting the borrower's credit standing and the note's terms. The resulting present value approximates the fair value of the property exchanged.