Which of the following definitions used in accounting for income taxes is least accurate?

Consider an asset whose carrying amount was revalued downwards in 2014. In 2015, if the value of the asset is revised upwards, the impact on reported leverage and return on equity will most likely be: Reported Leverage and Return on Equity

Improves Increases

Under the revaluation model (IFRS), if the upward revaluation is reversing a previous downward revaluation, the gain flows through the income statement (to increase net income) and then increases shareholders’ equity. If the upward revaluation is not reversing a previous downward revaluation, the gain flows through the revaluation surplus and increases shareholders’ equity directly.
• In 2015, assets increase along with shareholders’ equity so reported leverage ratios improve (decrease).
• The return on equity also increases as net income and shareholders’ equity both increase. The numerator effect dominates and results in an increase in the ratio.

A company that receives a cash payment for a service it will provide in the next accounting period is least likely to recognize:

accrued revenue.

Accrued (unbilled) revenue is recorded at the end of an accounting period for revenue that the company has earned but has not yet recognized. Unearned revenue results from collecting cash in an earlier period than the goods or services will be delivered (which is when the revenue can be recognized). Unearned revenue is an accrued liability because the company owes goods or services to the buyers.

Data for a manufacturing industry indicate that inventories of work in progress are increasing faster than sales. This is most likely to indicate that:

firms expect demand to increase.

An increase in work-in-progress inventory relative to sales is likely to result from firms increasing production because they expect an increase in demand. An increase in finished goods inventories relative to sales would be more likely to indicate a decrease in demand that may be caused by obsolete inventory or a business cycle peak.

An increase in which of the following will not always result in an improvement in a company’s return on equity?

Financial leverage ratio

An increase in the financial leverage will not always lead to a higher ROE. As a company takes on more debt, its interest costs rise and the interest burden ratio falls (so does the net profit margin).

A dealer of large earth movers that leases the machinery to its customers most likely to treat the leases as:

sales-type leases, and account for inventory using specific identification.

Lessors that are dealers or manufacturers of the leased assets typically recognize sales revenue at the inception of a lease and thus account for their leases as sales-type capital (finance) leases. Dealers of high-value items that can be distinguished one from another, such as large earth movers, typically use-specific identification to account for inventory

Which of the following items affects owners’ equity but is not included as a component of net income?

Foreign currency translation gains and losses.

Foreign currency translation gains and losses are not reported on the income statement as a component of net income, but affect owners’ equity because they are included as other comprehensive income. The other items are included on the income statement so they affect both net income and owners’ equity.

ABC Corp. purchases a milling machine. The company considers the machine’s rotating cutter to be a significant component. Which of the following is least likely an additional estimate that the company will be required to make if it depreciates the milling machine using the component method instead of depreciating it as a whole?

Useful life of milling machine

ABC would need to estimate the useful life of the milling machine regardless of whether it chooses to depreciate it using the component method or not. However, the company would be required to estimate the useful life and residual value of the cutter (component) only if it plans to use the component method.

A firm that reports its lease of a conveyer system as an operating lease must disclose:

minimum lease payments for each of the next five years and the sum of lease payments more than five years in the future.

Whether a lease is an operating or a finance (capital) lease, both U.S. GAAP and IFRS require disclosure of the minimum lease payments for each of the next five years and the sum of minimum lease payments more than five years in the future.

During a period when net income is unexpectedly weak, managers who attempt to smooth earnings are most likely to:

capitalize an expense.

Management may attempt to increase reported earnings in the current period by capitalizing an expense. Capitalizing a lease would decrease earnings in the current period compared to recording an operating lease. Classifying a nonrecurring gain as recurring income would not increase net income because it already includes nonrecurring gains.

A manufacturing firm shuts down production at one of its plants and offers the facility for rent. Based on the market for similar properties, the firm determines that the fair value of the plant is €500,000 more than its original cost. If this firm uses the cost model for plant and equipment and the fair value model for investment property, should it recognize a gain on its income statement?

No, because the increase in value does not reverse a previously recognized loss.

When a question does not specify which accounting standards apply, candidates are instructed to assume International Financial Reporting Standards (IFRS). According to IFRS, property held for the purpose of earning rental income is classified as investment property. However, when a property is transferred from owner-occupied to investment property, a firm using the fair value model must treat any increase in the property’s value as a revaluation. That is, the firm may only recognize a gain on the income statement to the extent that it reverses a previously recognized loss.

Consider the following statements:
Statement 1: When the tax base of a liability exceeds its carrying value, it results in a deferred tax asset.
Statement 2: Permanent differences result in a difference between the company’s statutory and effective tax rate.
Which of the following is most likely?

Only Statement 2 is correct.

• When the tax base of a liability exceeds its carrying value, it results in a deferred tax liability.
• Statement 2 is correct.

Which of the following most likely contributes toward faithful representation of financial statements?

Neutrality

Faithful representation requires that information should be complete, neutral, and free from error. Materiality is an aspect of relevance. Understandability is one of the four supplementary qualitative characteristics of financial statements.

Which of the following statements regarding the financial statement reporting of leases is most accurate ?

Under an operating lease, the lessee treats the entire lease payment as a cash outflow from operations.

With an operating lease, the entire lease payment is recorded as rent expense and classified as an operating cash outflow. A finance lease results in a lower current ratio than an operating lease because the current portion of the principal repayment component will be added to current liabilities. The lessor does not recognize any profit at the inception of a direct financing lease.

Which of the following is least likely regarding the classification of various items on the cash flow statement under IFRS and U.S. GAAP?

Interest received , CFO or CFF , CFO

Under IFRS, interest received can be classified as CFO or CFI.

Which of the following sources of changes in the net pension asset/liability is most likely to be recognized in other comprehensive income?

Actuarial losses.

Under IFRS, actuarial losses are included in re-measurements, which are recognized in other comprehensive income.

Which of the following definitions used in accounting for income taxes is least accurate?

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