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Kaplan Middle East, CMA 1-2023 :: CMA Part 1 Review Course

SU 1-Prep

[ 1 ] Which basis of accounting is most likely to provide the best assessment of an entity’s
past and future ability to generate net cash inflows?

A. Cash basis of accounting.

B. Modified cash basis of accounting.
C. Accrual basis of accounting.
D. Tax basis of accounting.

[ 2 ] The profit and loss statement of an entity includes the following information for the
current fiscal year:
Sales $160,000
Gross profit 48,000
Year-end finished goods inventory 58,300
Opening finished goods inventory 60,190
The cost of goods manufactured by the entity for the current fiscal year is

A. $46,110
B. $49,890
C. $110,110
D. $113,890

[ 3 ] Which one of the following would be shown on a multiple-step income statement but
not on a single-step income statement?

A. Loss from discontinued operations.

B. Gross profit.
C. Cost of goods sold.
D. Net income from continuing operations.

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[ 4 ] According to U.S. GAAP, where on the income statement should a multinational

company report the loss from the disposal sale of a major operating unit?

A. Report the loss, pretax, in a separate section between income from continuing
operations and net income.
B. Report the loss, net of tax, in a separate section between income from continuing
operations and net income.
C. Report the loss, pretax, in a separate section between income from operations and
income before income tax.
D. Report the loss, net of tax, in a separate section between income before tax and net
income.

[ 5 ] During the month of October, a company purchased 1,000 units of inventory for $500
per unit and sold 900 of these units, which represented 10% of the company’s annual
sales budget in units. The company also incurred administrative costs of $300,000 during
October. By applying the matching principle, the total amount of the company’s expenses
on its October income statement is

A. $750,000
B. $800,000
C. $810,000
D. $860,000

[ 6 ] The major distinction made between the multiple-step and single-step income
statement formats is the separation of

A. Operating and nonoperating data.

B. Income tax expense and administrative expenses.
C. Cost of goods sold expense and administrative expenses.
D. The effect on income taxes due to extraordinary items and the effect on income
taxes due to income before extraordinary items.

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[ 7 ] Rock Co.’s financial statements had the following balances at December 31:
Infrequently occurring gain $ 50,000
Foreign currency translation gain 100,000
Net income 400,000
Unrealized holding gain on
available-for-sale debt securities 20,000
What amount should Rock report as comprehensive income for the year ended December
31?

A. $400,000
B. $420,000
C. $520,000
D. $570,000

[ 8 ] Items reported as prior-period adjustments

A. Do not include the effect of a mistake in the application of accounting principles, as

this is accounted for as a change in accounting principle rather than as a prior-period
adjustment.
B. Do not affect the presentation of prior-period comparative financial statements.
C. Do not require further disclosure in the body of the financial statements.
D. Are reflected as adjustments of the opening balance of the retained earnings of the
earliest period presented.

[ 9 ] How would a stock split affect the par value of the stock and the company’s
shareholders’ equity?

Par Value Shareholders’ Equity

A. Decrease Increase
B. Decrease No change
C. Increase Decrease
D. Increase No change

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[ 10 ] An undistributed stock dividend declared by the Board of Directors should be

reported as a(n)

A. Current liability.
B. Long-term liability.
C. Footnote to the financial statements.
D. Item in the shareholders’ equity section.

[ 11 ] Which one of the following transactions does not affect the balance of retained
earnings?

A. Declaration of a stock dividend.

B. A quasi-reorganization.
C. Declaration of a stock split.
D. Declaration of a property dividend.

[ 12 ] On December 15, a company distributed a previously declared cash dividend of

$120,000 and declared a 5% stock dividend with a market value of $100,000. If the
company uses U.S. GAAP, these two transactions would decrease the company’s total
shareholders’ equity by

A. $0
B. $100,000
C. $120,000
D. $220,000

[ 13 ] A corporation declared a 10% stock dividend on 15,000 shares outstanding of $5 par

common stock when the fair value was $10 per share. Which change in the corporation’s
stockholders’ equity accounts is correct?

A. Retained earnings is decreased by $15,000.

B. Additional paid-in capital is increased by $15,000.
C. Common stock is decreased by $7,500.
D. Common stock is increased by $15,000.

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[ 14 ] The acquisition of treasury stock will cause the number of shares outstanding to
decrease if the treasury stock is accounted for by the

Cost Method Par-Value Method

A. Yes No
B. No No
C. Yes Yes
D. No Yes

[ 15 ] McGlinchy Company had 100,000 shares of $4 par value common stock

outstanding on June 12 of the current year. On this date, McGlinchy acquired 1,000 of its
own shares as treasury stock at a cost of $12 per share. The acquisition was accounted
for by the cost method. As a result of this treasury stock purchase,

A. Total assets and total equity decreased.

B. Total assets and total equity were unaffected.
C. Total assets, retained earnings, and total equity decreased.
D. Total assets were unaffected, but retained earnings decreased.

[ 16 ] On January 1, Year 1, LLA, Inc., was capitalized through the issuance of 10,000
shares of $30 par common stock that was sold at $50 per share. LLA had net income as
follows:
Year 1 $100,000
Year 2 200,000
If, during Year 2, LLA paid dividends to its shareholders at $25 per share, what amount
was LLA’s retained earnings balance and shareholders’ equity balance at the end of Year
2?

Retained earnings Shareholders’ equity

A. $50,000 $550,000
B. $50,000 $800,000
C. $300,000 $550,000
D. $300,000 $800,000

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[ 17 ] A company acquired land by assuming a mortgage for the full acquisition cost. This
transaction should be disclosed on its statement of cash flows as a(n)

A. Financing activity.
B. Investing activity.
C. Operating activity.
D. Noncash financing and investing activity.

[ 18 ] Which one of the following transactions should not be classified as a financing

activity in the statement of cash flows?

A. Issuance of common stock.

B. Purchase of treasury stock.
C. Payment of dividends.
D. Income tax refund.

[ 19 ] In preparing a statement of cash flows, an item included in determining net cash

flow from operating activities is the

A. Amortization of a bond premium.

B. Proceeds from the sale of equipment for cash.
C. Cash dividends paid.
D. Purchase of treasury stock.

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[ 20 ] An accountant has gathered the following information to prepare the statement of

cash flows for the current year. Net income of $456,900 includes a deduction of $45,600
for depreciation expense. The company issued $300,000 of dividends this year and
purchased one new building for $275,000. The balance sheets from the current period
and prior period included the following balances:
Prior Year Current Year
Accounts receivable, net $ 56,860 $ 45,300
Accounts payable 12,900 10,745
Inventory 186,700 194,320
Using the indirect method, what is the amount of cash provided by operating activities?

A. $202,500
B. $405,205
C. $504,285
D. $521,405

[ 21 ] A company has recorded the following payments for the current period:
Purchase of investment stock $300,000
Dividends paid to shareholders 200,000
Repurchase of company stock 400,000
The amount to be shown in the investing activities section of the statement of cash flows
should be

A. $300,000
B. $500,000
C. $700,000
D. $900,000

[ 22 ] A company has recorded the following payments for the current period:
Interest paid on bank loan $300,000
Dividends paid to shareholders 200,000
Repurchase of company stock 400,000
The amount to be shown in the financing activities section of the statement of cash flows
should be

A. $300,000
B. $500,000
C. $600,000
D. $900,000

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Fact Pattern:
Fact pattern: Selected financial information for Kristina Company for the year just ended
is shown below.
Net income $2,000,000
Increase in net accounts receivable 300,000
Decrease in inventory 100,000
Increase in accounts payable 200,000
Depreciation expense 400,000
Gain on the sale of available-for-sale securities 700,000
Cash receivable from the issue of common stock 800,000
Cash paid for dividends 80,000
Cash paid for the acquisition of land 1,500,000
Cash received from the sale of available-for-sale securities 2,800,000
[ 23 ] Kristina’s cash flow from financing activities for the year is

A. $(80,000)
B. $720,000
C. $800,000
D. $3,520,000

[ 24 ] For the fiscal year just ended, an entity had the following results:
Net income $920,000
Depreciation expense 110,000
Increase in accounts payable 45,000
Increase in net accounts receivable 73,000
Increase in deferred income tax liability 16,000
Net cash flow from operating activities is

A. $928,000
B. $986,000
C. $1,018,000
D. $1,074,000

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[ 25 ] A company had a balance of $100,000 in retained earnings at the beginning of the

year and of $125,000 at the end of the year. Net income for this time period was $40,000.
The statement of financial position indicated that the dividends payable account had
decreased by $5,000 throughout the year, despite the fact that both cash dividends and a
stock dividend were declared. The amount of the stock dividend was $8,000. When
preparing its statement of cash flows for the year, the company should show cash paid for
dividends as

A. $20,000
B. $15,000
C. $12,000
D. $5,000

[ 26 ] Consider the following financial data for a company that is preparing its cash flow
statement:
Amortization expense $ 150,000
Cash dividends paid to common shareholders 75,000
Net income 1,500,000
Work-in-process inventory increase over the prior year 300,000
Gain on sale of equipment 50,000
Using the indirect method, cash flow from operating activities would be

A. $1,225,000
B. $1,300,000
C. $1,350,000
D. $1,375,000

[ 27 ] Dunbarn Co. had the following activities during the year:

Purchase of inventory $120,000
Purchase of equipment 80,000
Purchase of available-for-sale securities 60,000
Purchase of treasury stock 70,000
Issuance of common stock 150,000
What amount should Dunbarn report as cash provided (used) by investing activities in its
statement of cash flows for the year?

A. $(120,000)
B. $(140,000)
C. $(210,000)
D. $150,000

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[ 28 ] A company reports the following information for Year 1:

Sale of equipment $20,000
Issuance of the company’s bonds 10,000
Dividends paid 5,000
Purchase of stock of another
company 2,000
Purchase of U.S. Treasury note 2,000
Income taxes paid 2,000
Interest income received 500
What is the company’s net cash flow from financing activities?

A. $(9,000)
B. $5,000
C. $5,500
D. $15,000

[ 29 ] A conglomerate entity acquired 100% of the net assets of a target entity for $900
cash. The target entity’s statement of financial position just prior to the acquisition is
presented below.
Target Entity (as of acquisition date)
Carrying Fair
Amount Value
Cash $ 100 $100
Receivables 200 200
Inventory 150 200
Property, plant,
and equipment (net) 600 400
Total assets $1,050 $900
Current liabilities $ 200 $200
Share capital 200
Retained earnings 650
Total liabilities and equity $1,050
The amount of goodwill to be recorded by the conglomerate entity related to its purchase
of the target entity is

A. $(200)
B. $50
C. $200
D. None of the answers are correct.

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[ 30 ] A company should recognize goodwill in its balance sheet at which of the following
points?

A. Costs have been incurred in the development of goodwill.

B. Goodwill has been created in the purchase of a business.
C. The company expects a future benefit from the creation of goodwill.
D. The fair market value of the company’s assets exceeds the book value of the
company’s assets.

[ 31 ] Which one of the following statements about consolidated financial statements is

true?

A. No investment in the subsidiary is presented in the consolidated financial statements.

B. Consolidated financial statements report the assets and liabilities of the subsidiary in
accordance with the percentage owned by the parent.
C. Retained earnings of the consolidated entity at the acquisition date consists of the
retained earnings of the parent plus the retained earnings of the subsidiary.
D. The assets and liabilities of the subsidiary are added to the parent’s assets and
liabilities and reported at the carrying amount on the acquisition date.

[ 32 ] Rowe, Inc., owns 80% of Cowan Co.’s outstanding capital stock. On November 1,
Rowe advanced $100,000 in cash to Cowan. What amount should be reported related to
the advance in Rowe’s consolidated balance sheet as of December 31?

A. $0
B. $20,000
C. $80,000
D. $100,000

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Answer Explanations for Question 1:

A. The cash basis is inadequate to depict the financial performance of businesses. Their
activities are largely based on credit and often involve long and complex financial
arrangements or production or marketing processes. The accrual and deferral of costs
and benefits better reflects the current-period effects on economic resources and claims.
B. A modified cash basis does not adequately depict the long and complex financial
arrangements or production or marketing processes and extensive use of credit
employed by modern businesses.
C. *Correct Answer* Accrual accounting reports the effects of transactions and other
events and circumstances even if the resulting cash flows occur in a different period. The
advantage of accrual accounting is that information about an entity’s economic resources
and claims and changes in them during a period provides a better basis for assessing
past and future performance than information solely about cash flows.
D. The basis of accounting specified in the federal income tax code has objectives other
than those that users of financial statements seek to achieve (usefulness in investment
and credit decisions, etc.). The tax code has social and fiscal policy objectives that are
distinct from the goals of investors and grantors of credit.

Answer Explanations for Question 2:

A. Improperly beginning with gross profit instead of sales results in $46,110.
B. Improperly beginning with gross profit instead of sales, then improperly subtracting
ending finished goods and adding beginning finished goods results in $49,890.
C. *Correct Answer* The entity’s cost of goods manufactured can be calculated as
follows:
Sales $160,000
Less: Gross profit (48,000)
Cost of goods sold $112,000
Add: Ending finished goods 58,300
Goods available for sale $170,300
Less: Beginning finished goods (60,190)
Cost of goods manufactured $110,110

D. Improperly subtracting ending finished goods and adding beginning finished goods
results in $113,890.

Answer Explanations for Question 3:

A. Loss from discontinued operations is shown on both a multiple-step and a single-step
income statement.
B. *Correct Answer* A single-step income statement combines all revenues and gains,
combines all expenses and losses, and subtracts the latter from the former in a “single
step” to arrive at net income. Gross profit, being the difference between sales revenue
and cost of goods sold, does not appear on a single-step income statement.
C. Cost of goods sold is shown on both a multiple-step and a single-step income
statement.
D. Net income from continuing operations is shown on both a multiple-step and a single-
step income statement.

Answer Explanations for Question 4:

A. Loss on the disposal of a major operating unit is reported net of tax in discontinued
operations.

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B. *Correct Answer* Gain or loss on the disposal of a major operating unit is reported
net of tax in discontinued operations. Discontinued operations are reported between
income from continuing operations and net income.
C. Loss on the disposal of a major operating unit is reported net of tax between income
from continuing operations and net income.
D. Loss on the disposal of a major operating unit is reported in discontinued operations.

Answer Explanations for Question 5:

A. *Correct Answer* Under the matching principle, the recognition of expense and
recognition of related revenue occur in the same accounting period. Cost of goods sold, a
product cost, is recognized in the period during which the product is sold. Administrative
costs, which are period costs, are recognized in the period in which they were incurred.
Thus, the total expense in the month of October must include the cost of goods sold of
$450,000 (900 units sold × $500 per unit) and the administrative costs of $300,000,
which results in $750,000.
B. Expensing the entire inventory purchase results in $800,000. However, only the units
sold in October should be expensed in October.
C. Expensing the entire inventory purchase plus an unmentioned $10,000 results in
$810,000.
D. Expensing the entire inventory purchase plus an unmentioned $60,000 results in
$860,000.

Answer Explanations for Question 6:

A. *Correct Answer* Within the income from continuing operations classification, the
single-step income statement provides one grouping for revenue items and one for
expense items. The single-step is the one subtraction necessary to arrive at income from
continuing operations prior to the effect of income taxes. In contrast, the multiple-step
income statement matches operating revenues and expenses separately from
nonoperating items. This format emphasizes subtotals, such as gross profit or loss and
operating income or loss, within the presentation of income from continuing operations.
B. Either format separates income tax expense and administrative expenses.
C. Cost of goods sold and administrative expenses cannot be combined under GAAP
reporting.
D. Extraordinary items are not reported under U.S. GAAP or IFRS. Items that are unusual
in nature or infrequent in occurrence or both are presented separately as a component of
income from continuing operations. However, such items must not be reported on the
face of the income statement net of income taxes. Moreover, their earnings per share
(EPS) effects are not presented on the face of the income statement.

Answer Explanations for Question 7:

A. Certain foreign currency items and unrealized holding gains on available-for-sale debt
securities are components of OCI.
B. A foreign currency translation gain is a component of OCI.
C. *Correct Answer* Comprehensive income includes all changes in equity of a
business entity except those changes resulting from investments by owners and
distributions to owners. Comprehensive income includes two major categories: net
income and other comprehensive income (OCI). Net income includes the results of
continuing and discontinued operations. Components of comprehensive income not
included in the determination of net income are included in OCI. These include unrealized
holding gains and losses on available-for-sale debt securities and certain foreign
currency items, such as a translation adjustment. The infrequently occurring gain of
$50,000 has already been included in the determination of net income. Thus,

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comprehensive income equals $520,000 ($400,000 net income + $100,000 translation

gain + $20,000 unrealized holding gain on available-for-sale securities).
D. The infrequently occurring gain already is included in the net income amount of
$400,000.

Answer Explanations for Question 8:

A. Accounting errors of any type are corrected by a prior-period adjustment.
B. A prior-period adjustment will affect the presentation of prior-period comparative
financial statements.
C. Prior-period adjustments should be fully disclosed in the notes or elsewhere in the
financial statements.
D. *Correct Answer* Prior-period adjustments are made for the correction of errors. The
effects of errors on prior-period financial statements are reported as adjustments to
beginning retained earnings for the earliest period presented in the retained earnings
statement. Such errors do not affect the income statement for the current period.

Answer Explanations for Question 9:

A. A stock split leaves shareholders’ equity unchanged.
B. *Correct Answer* A stock split reduces the par value of the stock and increases the
number of shares outstanding, making it more attractive to investors. As with a stock
dividend, each shareholder’s proportionate interest in the company and total book value
remain unchanged.
C. After a stock split, the par value decreases and shareholders’ equity remains
unchanged.
D. A stock split reduces the par value of the stock.

Answer Explanations for Question 10:

A. Stock dividend distributable is an item of shareholders’ equity.
B. Stock dividend distributable is an item of shareholders’ equity.
C. Stock dividend distributable is an item of shareholders’ equity.
D. *Correct Answer* In accounting for a stock dividend, the fair value of the additional
shares issued is reclassified from retained earnings to capital stock and the difference to
additional paid in capital. Stock dividend distributable is an item of shareholders’ equity
and not a liability.

Answer Explanations for Question 11:

A. In a stock dividend, the fair value of the additional shares issued is reclassified from
retained earnings to common stock (at par value) and the difference to additional paid-in
capital.
B. A quasi-reorganization is accomplished by closing the retained earnings account
(which, in a cumulative loss situation, would have a debit balance).
C. *Correct Answer* In a stock split, no journal entry is recorded and no retained
earnings are reclassified.
D. In a property dividend, the property is first remeasured at fair value as of the date of
declaration. Retained earnings is then decreased for the fair value of the property.

Answer Explanations for Question 12:

A. *Correct Answer* The distribution of previously declared cash dividends will not have
any effect on a company’s shareholders’ equity. At the time that a dividend is declared,
the amount of the dividend becomes a liability. It was at the time of declaration that the
dividend reduced equity. The payment of that liability at a later date does not affect equity.
The distribution of a stock dividend never affects the amount of equity since it merely
represents a repackaging of the company’s equity accounts.

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B. The distribution of a stock dividend does not affect a company’s stockholders’ equity
since it is only a way of repackaging a company’s equity into a greater number of shares.
C. The distribution of a cash dividend does not affect equity; it is merely the payment of a
liability that was put on the books at the date that the dividend was initially declared.
D. The distribution of previously declared cash dividends will not have any effect on a
company’s shareholders’ equity. At the time that a dividend is declared, the amount of the
dividend becomes a liability. It was at the time of declaration that the dividend reduced
equity. The payment of that liability at a later date does not affect equity. The distribution
of a stock dividend never affects the amount of equity since it merely represents a
repackaging of the company’s equity accounts.

Answer Explanations for Question 13:

A. *Correct Answer* Because the corporation issues shares for less than 20% to 25% of
the previously outstanding common shares, the stock issuance should be recognized as
a stock dividend. To account for a stock dividend, the fair value of the additional shares
issued is reclassified from retained earnings to capital stock (par value) and the
difference to additional paid-in capital. The corporation issued 1,500 shares (15,000 ×
10%) at a total fair value of $15,000 (1,500 × $10 per share). Thus, retained earnings is
debited for $15,000, common stock is credited for the par value of the stock issued of
$7,500 (1,500 × $5 par value per share), and additional paid-in capital is credited for the
excess of the fair value over the par value of the stock issued of $7,500 ($15,000 –
$7,500).
B. The additional paid-in capital account is increased for the excess of the fair value over
the par value of the stock issued.
C. Common stock is increased by $7,500 for the par value of the stock issued.
D. The increase in common stock is the par value of the stock issued.

Answer Explanations for Question 14:

A. Outstanding shares also decrease under the cost method.
B. Outstanding shares decrease under both methods.
C. *Correct Answer* When treasury stock is acquired, the effect will be to decrease the
number of shares of common stock outstanding whether the treasury stock is accounted
for by the cost method or the par-value method.
D. Outstanding shares also decrease under the par-value method.

Answer Explanations for Question 15:

A. *Correct Answer* Under the cost method, the acquisition of treasury stock is
recorded to treasury stock and cash equal to the amount of the purchase price. This
transaction results in a decrease in both total assets and total equity.
B. Both total assets and total equity decrease.
C. Retained earnings are unaffected.
D. Total assets decrease and retained earnings are unaffected.

Answer Explanations for Question 16:

A. *Correct Answer* The common stock was issued for a total of $500,000 (10,000
shares × $50). Of this amount, $300,000 (10,000 shares × $30) should be classified as
common stock and the remaining $200,000 should be allocated to additional paid-in
capital. LLA’s total net income of $300,000 ($100,000 + $200,000) from Year 1 and 2
would increase its retained earnings account, while dividends of $250,000 (10,000 shares
× $25) paid during Year 2 would decrease the account. As a result, the balance of the
retained earnings account at the end of Year 2 should be $50,000 ($300,000 –
$250,000). In addition, because shareholders’ equity includes the amount of common

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stock, additional paid-in capital, and retained earnings accounts, the amount of
shareholders’ equity at the end of Year 2 is $550,000 ($300,000 + $200,000 + $50,000).
B. The amount of dividends paid will reduce the amount of shareholders’ equity.
C. The amount of dividends paid will reduce the retained earnings account.
D. The amount of dividends paid will concurrently reduce the amount of retained earnings
and shareholders’ equity.

Answer Explanations for Question 17:

A. To be classified as a financing activity, the transaction must have involved a cash flow.
B. To be classified as an investing activity, the transaction must have involved a cash
flow.
C. To be classified as an operating activity, the transaction must have involved a cash
flow.
D. *Correct Answer* The exchange of debt for a long-lived asset does not involve a
cash flow. It is therefore classified as a noncash financing and investing activity.

Answer Explanations for Question 18:

A. Issuance of common stock is classified as a financing activity.
B. Purchase of treasury stock is classified as a financing activity.
C. Payment of dividends is classified as a financing activity.
D. *Correct Answer* Financing activities include obtaining resources from owners and
providing them with a return on, and a return of, their investment. Cash inflows from
financing activities include proceeds from issuing equity instruments. Cash outflows
include outlays to reacquire the enterprise’s equity instruments, and outlays to pay
dividends. However, an income tax refund is an operating activity.

Answer Explanations for Question 19:

A. *Correct Answer* The debtor (issuer) on a bond sold at a premium debits or reduces
the bond premium for the excess of cash interest paid over interest expense recognized
under the effective interest method. The lender (buyer) likewise reduces the bond
premium (by a credit) for the excess of cash interest received over interest income
recognized. Interest paid (received) is a cash outflow (inflow) from an operating activity.
In a reconciliation of net income to net cash flow from operating activities, both the issuer
of the bond and the purchaser must make an adjustment for the difference between the
cash flow and the effect on net income. Because the issuer’s cash outflow exceeded
interest expense, it must deduct the difference (premium amortization) from net income in
performing the reconciliation. The purchaser’s cash inflow is greater than interest income,
so it must add the difference (premium amortization) to net income to arrive at net cash
flow from operating activities.
B. The sale of equipment is an investing activity, not an operating activity.
C. A cash dividend paid is a cash outflow from a financing activity.
D. The purchase of treasury stock is a financing activity since it involves a change in the
amount of capital stock outstanding.

Answer Explanations for Question 20:

A. The amount of $202,500 incorrectly subtracts the dividends issued of $300,000 and
fails to include the $11,560 decrease in accounts receivable, $2,155 decrease in
accounts payable, and $7,620 increase in inventory.
B. The amount of $405,205 incorrectly subtracts depreciation expense, subtracts the
decrease in accounts receivable, and adds the increase in inventory.
C. *Correct Answer* Net operating cash flow may be determined by adjusting net
income. Depreciation is an expense not directly affecting cash flows that should be added
back to net income. The decrease in accounts payable is subtracted from net income

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because it indicates that an expense has been paid, while the decrease in accounts
receivable should be added to net income. The increase in inventory should be
subtracted from net income because cash was used to purchase the inventory. The
dividends paid on preferred stock are cash outflows from financing, not operating,
activities and do not require an adjustment. Thus, net cash flow from operations is
$504,285 ($456,900 + $45,600 + $11,560 – $2,155 – $7,620).
D. The amount of $521,405 incorrectly includes the dividends issued and the building
purchase. Additionally, the decrease in accounts receivable should be added and the
increase in inventory should be subtracted.

Answer Explanations for Question 21:

A. *Correct Answer* Financing activities include paying dividends and treasury stock
transactions. Investing activities include acquiring and disposing of debt and equity
instruments. Thus, the amount to be shown in the investing activities section of the
statement of cash flows is $300,000.
B. The $200,000 of dividends paid is a cash outflow from a financing activity.
C. Treasury stock purchases ($400,000) are financing activities.
D. Payment of $200,000 of dividends and the $400,000 treasury stock purchase are cash
outflows from financing activities.

Answer Explanations for Question 22:

A. The payment and collection of interest are cash flows from operating activities.
B. This amount ($500,000) includes the interest paid and excludes the purchase of
treasury stock.
C. *Correct Answer* The payment and collection of interest are treated as cash flows
from operating activities. Financing activities include paying dividends and treasury stock
transactions. Thus, the amount to be reported in the financing activities section of the
statement of cash flows is $600,000 ($200,000 + $400,000).
D. This amount ($900,000) includes the interest paid.

Answer Explanations for Question 23:

A. *Correct Answer* Cash flows from financing activities for the year consist of the
$80,000 outflow for dividends paid. The issue of common stock is a financing activity, but
the $800,000 of proceeds have not yet been received.
B. This amount ($720,000) results from including cash receivable from the issue of
common stock.
C. This amount ($800,000) is the amount of the receivable for the issue of common
stock.
D. This amount ($3,520,000) results from including the cash received from the sale of
available-for-sale securities (a cash inflow from an investing activity) and the receivable
(a noncash item) for the issue of common stock.

Answer Explanations for Question 24:

A. This amount ($928,000) results from subtracting, not adding, the increase in accounts
payable.
B. This amount ($986,000) results from subtracting, not adding, the increase in the
deferred tax liability.
C. *Correct Answer* The following is the net cash flow from operating activities
calculated using the indirect method:
Net income $ 920,000
Add: Increase in accounts payable 45,000
Add: Increase in deferred tax liability 16,000

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Add: Depreciation expense 110,000

Minus: Increase in net accounts receivable (73,000)
Net cash provided by operating activities $1,018,000

The adjustment from cost of goods sold (an accrual accounting amount used to calculate
net income) to cash paid to suppliers requires two steps: (1) from cost of goods sold to
purchases and (2) from purchases to cash paid to suppliers. An increase in inventory is
subtracted from net income. It indicates that purchases were greater than cost of goods
sold. A decrease in inventory is added to net income. It indicates that purchases were
less than cost of goods sold. However, the change in inventory is not given, so it is
assumed to be zero. The increase in accounts payable is added to net income. It
indicates that cash paid to suppliers was $45,000 less than purchases. Thus, the net
effect of the changes in inventory and accounts payable is that cash paid to suppliers
was $45,000 ($0 + $45,000) less than the accrual basis cost of goods sold. The increase
in a deferred income tax liability (debit income tax expense, credit deferred liability) is a
noncash item. The adjustment is a $16,000 addition to net income. Depreciation
($110,000) also is a noncash item that is added to net income. The net accounts
receivable balance increased by $73,000, implying that cash collections were less than
sales. If sales, collections, write-offs, and recognition of bad debt expense were the only
relevant transactions, $73,000 should be subtracted from net income. Use of the change
in net accounts receivable as a reconciliation adjustment is a short-cut method. It yields
the same net adjustment to net income as separately including the effects of the change
in gross accounts receivable, bad debt expense (a noncash item resulting in an addition),
and bad debt write-offs (reflecting that write-offs did not result in collections).
D. This amount ($1,074,000) results from subtracting, not adding, the increase in
accounts payable, and adding, not subtracting, the increase in net accounts receivable.

Answer Explanations for Question 25:

A. The amount of $20,000 results from treating stock dividends as cash dividends.
B. The amount of $15,000 is the total amount of dividends (cash and stock) that were
declared during the year.
C. *Correct Answer* The amount of total dividends declared during the year can be
calculated as follows:
Beginning retained earnings $100,000
Net income for the year 40,000
Ending retained earnings (125,000)
Dividends declared during the year $ 15,000

Since $8,000 is the amount of stock dividends declared, the amount of cash dividends
declared this year is $7,000 ($15,000 – $8,000). The amount of cash dividends paid
during the year can be calculated as follows:
Decrease in the cash dividends payable account
during the period $ 5,000
Cash dividends declared during the year 7,000
Cash paid for dividends during the year $12,000

NOTE: Stock dividends declared does not affect the dividends payable account.
D. The amount of $5,000 is only the amount of dividends payable that were distributed.

Answer Explanations for Question 26:

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A. The amount of $1,225,000 results from subtracting the $75,000 cash dividend paid to
common shareholders. However, because dividends do not affect net income, this
amount should be ignored in calculating cash flows from operating activities.
B. *Correct Answer* Under the indirect method, net income must be adjusted for any of
the following items:
1. Noncash revenue and expenses that were included in net income,
2. Items included in net income whose cash effects relate to investing or financing
cash flows,
3. All deferrals of past operating cash flows, and
4. All accruals of expected future operating cash flows.
Thus, amortization expense (noncash expense) must be added back, and the gain on the
sale of equipment (investing activity) and the increase in inventory over the prior year
(deferral of past operating cash flows) must be subtracted.
Net income $1,500,000
Amortization expense 150,000
Gain on sale of equipment (50,000)
Increase in WIP inventory (300,000)
Cash flow from operations $1,300,000

C. The amount of $1,350,000 results from neglecting to subtract the $50,000 gain on the
sale of equipment. Because this gain is an investing activity that affects net income, it
must be subtracted to determine net cash flows from operating activities.
D. The amount of $1,375,000 includes the $75,000 dividend. Dividends do not affect net
income and should be ignored in the calculation of net cash flows from operating
activities.

Answer Explanations for Question 27:

A. Cash payments to suppliers for inventory are cash outflows included in the operating
activities section of the statement of cash flows.
B. *Correct Answer* Cash flows from investing activities represent the extent to which
expenditures have been made for resources intended to generate future income and
cash flows. These expenditures include (1) cash payments for property, plant, and
equipment; (2) other long-lived assets; (3) equity and debt instruments held for
investment purposes; and (4) cash advances and loans made to other parties. The cash
outflows used by investing activities is $140,000 ($80,000 purchase of equipment +
$60,000 purchase of AFS securities).
C. The amount of $(210,000) inappropriately includes the purchase of treasury stock as
an investing activity. Purchases of treasury stock are cash outflows that should be
included in the financing activities section of the statement of cash flows.
D. Issuance of common stock is a cash inflow that should be included in the financing
section of the statement of cash flows.

Answer Explanations for Question 28:

A. The amount of $(9,000) does not include the issuance of the company’s bonds
($10,000). It also falsely includes the purchase of stock of another company ($2,000) and
the purchase of a U.S. Treasury note ($2,000). These items belong to cash flows from
investing activities.
B. *Correct Answer* Cash flows from financing activities generally involve the cash
effects of transactions and other events that relate to the issuance, settlement, or
reacquisition of the entity’s debt and equity instruments. In addition, payments of cash

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dividends are classified as cash outflows from financing activities. Therefore, the items
that should be classified as cash flows from financing activities are the dividends paid
($5,000) and the issuance of the company’s bonds ($10,000). The net cash flow should
be an inflow of $5,000 ($10,000 – $5,000). Cash flows from investing activities include
the sale of equipment ($20,000), the purchase of stock of another company ($2,000), and
the purchase of a U.S. Treasury note ($2,000). Cash flows from operating activities
include income taxes paid ($2,000) and interest income received ($500).
C. The amount of $5,500 incorrectly includes interest income received of $500. Cash
received in the form of interest or dividends is included in operating activities.
D. The amount of $15,000 incorrectly adds the dividends paid of $5,000 to the issuance
of the company’s bonds of $10,000. The issuance of the company’s bonds is a cash
inflow, while the dividends paid are cash outflows. These two amounts should be netted.

Answer Explanations for Question 29:

A. Goodwill is positive, not negative.
B. The amount of $50 is based on carrying amounts.
C. *Correct Answer* Given no prior equity interest and no noncontrolling interest,
goodwill is the excess of the fair value of the consideration transferred over the net of the
fair values of the identifiable net assets acquired. This net fair value equals the sum of
cash, receivables, inventory, and PPE, minus liabilities. Hence, the net fair value acquired
is $700, and goodwill is $200 ($900 fair value of the consideration transferred – $700).
D. The goodwill recorded is $200.

Answer Explanations for Question 30:

A. Internally generated goodwill may not be recognized as an asset on the balance sheet.
B. *Correct Answer* Goodwill can be recognized only in a business combination.
Goodwill is an asset representing the future economic benefits arising from other assets
acquired in a business combination that are not individually identified and separately
recognized.
C. Internally generated goodwill may not be recognized as an asset on the balance
sheet, even if the company expects a future benefit.
D. Goodwill is recognized only in a business combination.

Answer Explanations for Question 31:

A. *Correct Answer* No investment in the subsidiary account is presented in the
consolidated financial statements. Consolidated statements report the assets and
liabilities of the subsidiary and the parent as if they are a single economic entity.
B. All line items of assets and liabilities of a subsidiary are added item by item to those of
the parent. These items are reported at the consolidated amount and not adjusted for the
percentage of the subsidiary owned.
C. Retained earnings of the consolidated entity at the acquisition date consists solely of
the retained earnings of the parent.
D. The assets and liabilities are reported at 100% of their fair value.

Answer Explanations for Question 32:

A. *Correct Answer* Because consolidated statements present amounts for the parent
and subsidiary as if they were one economic entity, the effects of intraentity transactions
must be eliminated. Thus, reciprocal balances, e.g., a receivable and a payable for an
advance, between the parent and subsidiary are eliminated in full. This procedure is
followed even if a noncontrolling interest exists. Accordingly, no amount for the advance
is reported in the consolidated statements.
B. The amount of $20,000 is based on the assumption that a portion of the transaction is
allocated to the noncontrolling interest.

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C. The amount of $80,000 is based on the assumption that only the portion of the
transaction allocated to the noncontrolling interest is eliminated.
D. The amount of $100,000 is based on the assumption that the transaction was with an
external party.

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