11/18/24, 12:13 AM SU 4-Prep :: Kaplan Middle East, CMA 1-2023 :: CMA Part 1 Review Course

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

Study Unit 4-Prep

[ 1 ] A company is the plaintiff in two lawsuits. The first suit involves a competitor who has
made an exact copy of one of the company’s products, and the company is suing for
patent infringement. The attorneys estimate a $5,000,000 award for the company;
however, it is anticipated that the case will be in litigation for 2 to 3 years before final
resolution. The second case also involves patent infringement; however, in this instance,
the attorneys do not believe the company has a strong case. It is estimated that the
company has a 50% chance of winning and the award, if any, would be in the $250,000 to
$1,000,000 range. The most appropriate amount to be recorded as a gain contingency is

A. $0
B. $5,000,000
C. $5,125,000
D. $5,250,000

[ 2 ] An entity sells appliances that include a 3-year assurance-type warranty. Service calls
under the warranty are performed by an independent mechanic under a contract with the
entity. Based on experience, warranty costs are estimated at $30 for each machine sold.
When should the entity recognize these warranty costs?

A. Evenly over the life of the warranty.

B. When the service calls are performed.
C. When payments are made to the mechanic.
D. When the machines are sold.

[ 3 ] On November 10, Year 4, a Garry Corp. truck was in an accident with an auto driven
by Dacey. On January 10, Year 5, Garry received notice of a lawsuit seeking $800,000 in
damages for personal injuries suffered by Dacey. Garry Corp.’s counsel believes it is
reasonably possible that Dacey will be awarded an estimated amount in the range
between $250,000 and $500,000, and that $400,000 is a better estimate of potential
liability than any other amount. Garry’s accounting year ends on December 31, and the
Year 4 financial statements were issued on March 6, Year 5. What amount of loss should
Garry accrue at December 31, Year 4?

A. $0
B. $250,000
C. $400,000
D. $500,000

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[ 4 ] Ace Co. settled litigation on February 1, Year 2, for an event that occurred during
Year 1. An estimated liability was determined as of December 31, Year 1. This estimate
was significantly less than the final settlement. The transaction is considered to be
material. The year-end financial statements for Year 1 have not been issued. How should
the settlement be reported in Ace’s Year 1 financial statements?

A. Disclosure only of the settlement.

B. Only an accrual of the settlement.
C. Neither a disclosure nor an accrual.
D. Both a disclosure and an accrual.

[ 5 ] If the lease term is less than 12 months, when may a lessee elect not to recognize
the right-of-use asset and lease liability?

A. The lease transfers ownership of the leased asset to the lessee by the end of the
lease term.
B. The present value of the sum of (1) the lease payments and (2) any residual value
guaranteed by the lessee is 90% or more of the fair value of the leased asset.
C. The lease does not include a purchase option that the lessee is reasonably certain to
exercise.
D. The term of the lease is for the major part of the remaining economic life of the
leased asset.

[ 6 ] The amount recorded initially by the lessee as a lease liability should normally

A. Exceed the total of the lease payments.

B. Exceed the present value of the lease payments at the beginning of the lease.
C. Equal the total of the lease payments.
D. Equal the present value of the lease payments at the beginning of the lease.

[ 7 ] Which of the following is a criterion for a lease to be classified as a finance lease in

the books of a lessee?

A. The lease contains a purchase option that the lessee is reasonably certain to
exercise.
B. The lease does not transfer ownership of the property to the lessee.
C. The lease term is equal to 65% or more of the estimated useful life of the leased
property.
D. The present value of the minimum lease payments is 70% or more of the fair market
value of the leased property.

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[ 8 ] On January 1, Year 1, Frost Co. entered into a 2-year lease agreement with Ananz
Co. to lease a new computer. The lease term begins on January 1, Year 1, and ends on
December 31, Year 2. The lease agreement requires Frost to pay Ananz two annual lease
payments of $8,000. The present value of the minimum lease payments is $13,000.
Which of the following circumstances would require Frost to classify and account for the
arrangement as a finance lease?

A. The economic life of the computer is 3 years.

B. The fair value of the computer on January 1, Year 1, is $14,000.
C. Frost does not have the option of purchasing the computer at the end of the lease
term.
D. Ownership of the computer remains with Ananz throughout the lease term and after
the lease ends.

[ 9 ] If a lessee uses off-balance-sheet financing, assets have been acquired

A. For cash.
B. With short-term leases.
C. With finance leases.
D. With a line of credit.

[ 10 ] On July 1, Year 1, V Co. leased manufacturing equipment to W Co. to use in the

production of widgets. The lease contained a transfer of title and was noncancelable. At
the commencement of the lease, the equipment had an amortizable base of $10,000 and
will be amortized using the straight-line method over its remaining useful life of 5 years.
For the period ending December 31, Year 2, what amount of amortization should be
claimed, and by which party?

A. $1,000; V Co.
B. $2,000; W Co.
C. $1,000; W Co.
D. $2,000; V Co.

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[ 11 ] Which of the following lease payments is not classified as an outflow from operating
activities on the statement of cash flows?

A. Payments for operating leases.

B. Payments for short-term leases.
C. The principal portion of a payment for a finance-type lease.
D. The interest portion of a payment for a sales-type lease.

[ 12 ] Selected financial information for the year just ended is shown below.
Pretax income $5,000,000
Interest received on municipal bonds 600,000
Gain on the sale of land reported this
year but not taxable until next year 1,000,000
Tax rate for all years 40%
Beginning balances:
Income taxes payable 0
Deferred tax liability $50,000
The total income tax expense reported on the income statement for the year just ended
should be

A. $960,000
B. $1,360,000
C. $1,760,000
D. $2,640,000

[ 13 ] Income-tax-basis financial statements differ from those prepared under GAAP

because they

A. Do not include nontaxable revenues and nondeductible expenses in determining

income.
B. Include detailed information about current and deferred income tax liabilities.
C. Contain no disclosures about finance and operating lease transactions.
D. Recognize certain revenues and expenses in different reporting periods.

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Fact Pattern:
Fact pattern:
Lucas Company computed the following deferred tax balances for the 2 most recent
years. Deferred tax assets are considered fully realizable.
Year 1 Year 2
Deferred tax asset $ 9,000 $17,000
Deferred tax liability 13,000 23,000
[ 14 ] If Lucas calculates taxable income of $1,000,000 for Year 2 and is taxed at an
effective income tax rate of 40%, how much income tax expense will be reported on
Lucas’s income statement for Year 2?

A. $400,000
B. $402,000
C. $404,000
D. $406,000

[ 15 ] A liability that represents the accumulated difference between the income tax
expense reported on the firm’s books and the income tax actually paid is

A. Capital gains tax.

B. Deferred taxes.
C. Taxes payable.
D. Value-added taxes.

[ 16 ] Intraperiod income tax allocation arises because

A. Items included in the determination of taxable income may be presented in different

sections of the financial statements.
B. Income taxes must be allocated between current and future periods.
C. Certain revenues and expenses appear in the financial statements either before or
after they are included in taxable income.
D. Certain revenues and expenses appear in the financial statements but are excluded
from taxable income.

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[ 17 ] The purpose of interperiod income tax allocation is to

A. Reconcile the tax consequences of permanent and temporary differences that

appear on the company’s current financial statements.
B. Recognize a tax asset or liability for the tax consequences of temporary differences
that exist at the date of the balance sheet.
C. Adjust the income tax expense on the income statement to be consistent with the
income tax liability shown on the balance sheet.
D. Provide proper disclosure of a distribution of earnings to a taxing authority.

[ 18 ] A company uses straight-line depreciation for financial reporting purposes, but uses
accelerated depreciation for tax purposes. Which of the following account balances would
be lower in the financial statements used for tax purposes than it would be in the general
purpose financial statements?

A. Accumulated depreciation.
B. Cash.
C. Retained earnings.
D. Gross property, plant, and equipment.

[ 19 ] When the effective interest method of amortization is used for bonds issued at a
premium, the amount of interest payable for an interest period is calculated by multiplying
the

A. Face value of the bonds at the beginning of the period by the contractual interest
rate.
B. Face value of the bonds at the beginning of the period by the effective interest rates.
C. Carrying value of the bonds at the beginning of the period by the contractual interest
rate.
D. Carrying value of the bonds at the beginning of the period by the effective interest
rates.

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[ 20 ] How is the carrying amount of a bond payable affected by amortization of the

following?

Discount Premium
A. Increase Increase
B. Decrease Decrease
C. Increase Decrease
D. Decrease Increase

[ 21 ] When debt is issued at a discount, interest expense over the term of debt equals the
cash interest paid

A. Minus discount.
B. Minus discount minus par value.
C. Plus discount.
D. Plus discount plus par value.

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Answer Explanations for Question 1:

A. *Correct Answer* Gain contingencies are not recorded; they are recognized only
when realized. A gain contingency must be adequately disclosed.
B. Gain contingencies are not recorded.
C. Gain contingencies are not recorded.
D. Gain contingencies are not recorded.

Answer Explanations for Question 2:

A. The accrual method matches the costs and the related revenues.
B. When material warranty costs are probable and can be reasonably estimated, the
accrual method should be used. Recognizing the costs when the service calls are
performed is the cash basis.
C. Recognizing costs when paid is the cash basis.
D. *Correct Answer* An assurance-type warranty creates a loss contingency. The
accrual method therefore should be used if (1) incurrence of warranty expense is
probable, (2) the amount can be reasonably estimated, and (3) the amount is material.
Thus, a provision for costs incurred under an assurance-type warranty is made when the
related revenue is recognized.

Answer Explanations for Question 3:

A. *Correct Answer* A contingent loss is accrued when it is probable that, at a balance
sheet date, an asset is overstated or a liability has been incurred and the amount of the
loss can be reasonably estimated. If both conditions are not met but the probability of the
loss is at least reasonably possible, the amount of the loss must be disclosed. This loss is
reasonably possible and reasonably estimable. Hence, it should be disclosed but not
accrued.
B. No loss should be accrued.
C. No loss should be accrued.
D. No loss should be accrued.

Answer Explanations for Question 4:

A. The settlement amount must also be accrued.
B. The settlement must also be disclosed.
C. The settlement must be disclosed and accrued.
D. *Correct Answer* A contingent loss must be accrued when, based on information
available prior to the issuance of the financial statements, two conditions are met: (1) It is
probable that an asset has been impaired or a liability has been incurred at a balance
sheet date, and (2) the amount of the loss can be reasonably estimated. Because the
liability was settled before the financial statements were issued, it was certain that a
liability had been incurred, and the amount could be specifically determined. Thus, the
contingent loss must be accrued. Disclosure of the amount of the accrual is necessary to
keep the financial statements from being misleading, given that the settlement was
significantly greater than expected.

Answer Explanations for Question 5:

A. Transfer of ownership of the leased asset to the lessee by the end of the lease term is
a basis for classifying a lease as a finance lease. It is not a condition of the short-term
lease exception.
B. Meeting the “substantially all of the fair value” criterion is a basis for classifying the
lease as a finance lease. It is not a condition of the short-term lease exception.
C. *Correct Answer* As an accounting policy for short-term leases, a lessee may elect
not to recognize the right-of-use asset and lease liability if, at the commencement date,

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the lease (1) has a term of 12 months or less and (2) does not include a purchase option
that the lessee is reasonably certain to exercise.
D. Meeting the “major part of the remaining economic life” criterion is a basis for
classifying the lease as a finance lease. It is not a condition of the short-term lease
exception.

Answer Explanations for Question 6:

A. The amount recorded initially should be a present value. Thus, it is less than the total
of the lease payments.
B. The amount recorded initially should be the present value of the lease payments.
C. The amount recorded initially should be a present value. Thus, it is less than the total
of the lease payments.
D. *Correct Answer* The lessee records a lease as an asset and a liability at the present
value of the lease payments. The discount rate is the lessor’s implicit interest rate (if
known) or the lessee’s incremental borrowing rate of interest. Lease payments include
the rental payments required during the lease term and the amount of a purchase option
if the lessee is reasonably certain to exercise it. If no such option exists, the lease
payments equal the sum of (1) the rental payments, (2) the amount of residual value
guaranteed by the lessee, and (3) any nonrenewal penalty imposed.

Answer Explanations for Question 7:

A. *Correct Answer* A lease is classified as a finance lease by the lessee if, at lease
commencement date, any of the following five criteria is satisfied: (1) the lease transfers
ownership of the leased asset to the lessee by the end of the lease term, (2) the lease
includes an option to purchase the leased asset that the lessee is reasonably certain to
exercise, (3) the lease term is for the major part (generally is considered to be at least
75%) of the remaining economic life of the leased asset, (4) the present value of the sum
of the lease payments and any residual value guaranteed by the lessee equals or
exceeds substantially all (generally is considered to be at least 90%) of the fair value of
the leased asset, or (5) the leased asset is of such a specialized nature that it is expected
to have no alternative use to the lessor at the end of the lease term.
B. Transfer of ownership to the lessee is one of the criteria to classify the lease as a
finance lease.
C. The lease term of 75% or more of the remaining economic life of the leased asset is
generally considered to be a major part of its remaining economic life.
D. Fair value of 90% or more of the leased asset is generally considered to be
substantially all of its fair value.

Answer Explanations for Question 8:

A. The lease term of 75% or more of the remaining economic life of the leased asset is
generally considered to be a major part of its remaining economic life. However, the lease
term is only 66 2/3% (2 ÷ 3) of the economic life.
B. *Correct Answer* A lease is classified as a finance lease by the lessee if, at lease
commencement date, any one of five criteria is satisfied. One criterion is that the present
value of the sum of the lease payments and any residual value guaranteed by the lessee
equals or exceeds substantially all (generally considered to be at least 90%) of the fair
value of the leased asset. Consequently, if the fair value of the computer on January 1,
Year 1, is $14,000, the lease is a finance lease because the present value of the lease
payments is 93% ($13,000 ÷ $14,000) of the fair value of the computer.
C. A purchase option that the lessee is reasonably certain to exercise, not the lack of
such an option, is a criterion to classify the lease as a finance lease by the lessee.
D. A provision for transfer of ownership is a criterion to classify the lease as a finance
lease by the lessee.

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Answer Explanations for Question 9:

A. No liability arises if the assets were paid for with cash.
B. *Correct Answer* A short-term lease has a term of 12 or fewer months and does not
include a purchase option reasonably expected to be exercised. For this type of lease,
the lessee may elect not to recognize the right-of-use asset and lease liability.
C. The liability for a finance lease must be reported on the face of the balance sheet.
D. The liability associated with a line of credit is reported on the face of the balance
sheet.

Answer Explanations for Question 10:

A. The amount of $1,000 is the applicable amortization expense that may be claimed by
W Co. in Year 1.
B. *Correct Answer* The lease transfers ownership; thus, W Co. is entitled to claim
amortization on the equipment. Given an amortizable base of $10,000 and a 5-year
useful life, the annual amortization expense is $2,000 ($10,000 ÷ 5 years).
C. W Co. is entitled to claim amortization expense of $1,000 in Year 1.
D. Due to the transfer of title clause within the lease, V Co. is no longer able to claim
amortization once the lease commences.

Answer Explanations for Question 11:

A. Payments for operating leases are classified as cash outflows from operating
activities.
B. Payments associated with short-term leases are classified as cash outflows from
operating activities.
C. *Correct Answer* The principal portion of a finance-type lease payment is reported as
a cash outflow from financing activities.
D. Interest is a standard expense for all businesses. Accordingly, payments related to the
interest portion of a sales-type lease are considered cash outflows from operating
activities.

Answer Explanations for Question 12:

A. Subtracting, rather than adding, the increase in deferred tax liability and current
income tax expense results in $960,000.
B. The amount of $1,360,000 is only the current portion of income tax expense.
C. *Correct Answer* Taxable income consists of pretax income adjusted for those items
that give rise to tax differences. Taxable income is therefore $3,400,000 ($5,000,000 –
$600,000 – $1,000,000), and current tax expense is $1,360,000 ($3,400,000 × 40%). The
interest on municipal bonds is a permanent difference because it is tax-exempt, i.e., it is
recognized in GAAP income but never in taxable income. Permanent differences have no
deferred tax effects. However, the gain on the sale of land is a temporary difference
because it is included in GAAP income this year and is included in taxable income in the
future. This temporary difference gives rise to a future taxable amount, specifically, a
$400,000 deferred tax liability ($1,000,000 × 40%). This credit to the deferred tax liability
account is balanced by a debit to income tax expense. Total income tax expense for the
year is therefore $1,760,000 ($1,360,000 current portion + $400,000 deferred portion).
D. Failing to recognize the deferred nature of the temporary difference and improperly
including the permanent difference results in $2,640,000.

Answer Explanations for Question 13:

A. Even when financial statements are prepared on the income tax basis, permanent
difference items, e.g., nondeductible expenses, are included as revenues or expenses in

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the income statement. They do not have to be presented in a special category of the
income statement.
B. Detailed information about current and deferred income tax liabilities is necessary in
financial statements prepared on the income-tax basis and in conformity with GAAP.
Temporary differences, which result in deferred tax amounts, arise under either basis of
accounting.
C. Lease disclosures would be the same under either basis of accounting.
D. *Correct Answer* Financial statements prepared under the income tax basis of
accounting and financial statements prepared under GAAP differ when the tax basis of
an asset or a liability and its reported amount in the GAAP-based financial statements are
not the same. The result will be taxable or deductible amounts in future years when the
reported amount of the asset is recovered or the liability is settled. Thus, certain revenues
and expenses are recognized in different periods. An example is subscriptions revenue
received in advance, which is recognized in taxable income when received and
recognized in financial income when earned in a later period. Another example is a
warranty liability, which is recognized as an expense in financial income when a product
is sold and recognized in taxable income when the expenditures are made in a later
period.

Answer Explanations for Question 14:

A. The current tax expense is $400,000.
B. *Correct Answer* Deferred tax expense or benefit is the net change during the year
in the entity’s deferred tax liabilities and assets. It is aggregated with the current tax
expense or benefit to determine total income tax expense for the year. The amount of
income taxes payable (current tax expense) is $400,000 ($1,000,000 × 40%). The
deferred tax assets increased by $8,000 ($17,000 – $9,000) and the deferred tax
liabilities increased by $10,000 ($23,000 – $13,000). Thus, Lucas’s income tax expense
for Year 2 is $402,000 ($400,000 current tax expense – $8,000 increase in the deferred
tax assets + $10,000 increase in the deferred tax liabilities).
C. Improperly netting deferred tax assets and liabilities results in $404,000.
D. Excluding the effects of noncurrent deferred tax items results in $406,000.

Answer Explanations for Question 15:

A. Capital gains taxes arise from transactions involving capital assets.
B. *Correct Answer* Deferred tax liabilities arise when temporary differences in book
and taxable income result in future taxable amounts. Deferred tax assets arise when
temporary differences in book and taxable income result in future deductible amounts.
C. Taxes payable arise from the tax liability due within the next fiscal year or operating
cycle.
D. Value-added taxes are taxes paid on the incremental increase in value of a good at
each stage of production.

Answer Explanations for Question 16:

A. *Correct Answer* To provide a fair presentation, GAAP require that income tax
expense for the period be allocated among continuing operations, discontinued
operations, other comprehensive income, and items debited or credited directly to equity.
B. Allocation among periods is interperiod tax allocation.
C. Differences in the timing of revenues and expenses for financial statement and tax
return purposes create the need for interperiod income tax allocation.
D. Permanent differences do not create a need for tax allocation.

Answer Explanations for Question 17:

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A. Interperiod tax allocation does not apply to permanent differences–only temporary

differences.
B. *Correct Answer* Interperiod tax allocation is designed to recognize a tax asset or
liability for the tax consequences of temporary differences that exist between a
company’s financial accounting records and its tax records at the balance sheet date.
These temporary differences result when the GAAP basis and the tax basis of an asset
or liability differ.
C. An interperiod tax allocation is designed to make the income tax expense on the
income statement consistent with the income shown on the income statement.
D. Interperiod tax allocation is not for proper disclosure; that is shown on the balance
sheet.

Answer Explanations for Question 18:

A. The balance of accumulated depreciation is higher in the tax-basis financial
statements.
B. Depreciation expense is a noncash charge. The cash balance is unaffected by the
depreciation method used.
C. *Correct Answer* Because the tax basis uses an accelerated method, depreciation
expense and accumulated depreciation will be greater. Moreover, taxable income will be
lower than financial net income. Consequently, tax-basis retained earnings will be less
than that in the general purpose financial statements.
D. The historical cost of property, plant, and equipment is recorded in the gross property,
plant, and equipment account. This amount is unaffected by depreciation.

Answer Explanations for Question 19:

A. *Correct Answer* Interest payable does not vary with the issue price of bonds. It
equals their face amount times the stated (contractual) rate at the beginning of the
period.
B. The contractual rate and the face amount determine the amount payable. The effective
rate and the carrying amount determine the amount of interest expense.
C. The contractual rate and nominal (face) amount determine the amount of bonds
payable. The carrying amount and the effective rate determine the amount of interest
expense.
D. The carrying amount and the effective rate determine the amount of interest expense.

Answer Explanations for Question 20:

A. Amortization of discount increases and amortization of premium decreases the
carrying amount of a bond payable.
B. Amortization of discount increases and amortization of premium decreases the
carrying amount of a bond payable.
C. *Correct Answer* The carrying amount of a bond payable is equal to its maturity
(face) amount plus any unamortized premium or minus any unamortized discount.
Amortization results in a reduction of the discount or premium. Consequently, the carrying
amount of a bond is increased when discount is amortized and decreased when premium
is amortized.
D. Amortization of discount increases and amortization of premium decreases the
carrying amount of a bond payable.

Answer Explanations for Question 21:

A. The discount is added.
B. Debt has no par value.
C. *Correct Answer* Debt is sold at a discount when it sells for less than its face
amount, that is, when the contract (stated) interest rate is less than the market (effective)

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interest rate. Under the effective interest method required by GAAP, the difference
between interest expense and interest paid is the discount amortization. When debt is
issued at a discount, interest expense exceeds interest (cash) paid. The entry is to debit
interest expense, credit discount, and credit cash. Consequently, interest expense equals
the sum of the periodic interest payments and the discount.
D. Debt has no par value.

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