1. Which of the following is accounted for as a change in accounting principle? a. A change in the estimated useful life of plant assets. b. A change from the cash basis of accounting to the accrual basis of accounting. c. A change from expensing immaterial expenditures to deferring and amortizing them as they become material. d. A change in inventory valuation from average cost to FIFO. 2. A company changes from straight-line to an accelerated method of calculating depreciation, which will be similar to the method used for tax purposes. The entry to record this change should include a a. credit to Accumulated Depreciation. b. debit to Retained Earnings in the amount of the difference on prior years. c. debit to Deferred Tax Asset. d. credit to Deferred Tax Liability. 3. Which type of accounting change should always be accounted for in current and future periods? a. Change in accounting principle b. Change in reporting entity c. Change in accounting estimate d. Correction of an error 4. An example of a correction of an error in previously issued financial statements is a change a. from the FIFO method of inventory valuation to the LIFO method. b. in the service life of plant assets, based on changes in the economic environment. c. from the cash basis of accounting to the accrual basis of accounting. d. in the tax assessment related to a prior period. 5. If, at the end of a period, a company erroneously excluded some goods from its ending inventory and also erroneously did not record the purchase of these goods in its accounting records, these errors would cause a. the ending inventory and retained earnings to be understated. b. the ending inventory, cost of goods sold, and retained earnings to be understated. c. no effect on net income, working capital, and retained earnings. d. cost of goods sold and net income to be understated. 6. On January 1, 2005, Lynn Corporation acquired equipment at a cost of $600,000. Lynn adopted the double-declining balance method of depreciation for this equipment and had been recording depreciation over an estimated life of eight years, with no residual value. At the beginning of 2008, a decision was made to change to the straight-line method of depreciation for this equipment. Assuming a 30% tax rate, the cumulative effect of this accounting change on beginning retained earnings, net of tax, is a. $121,875. b. $85,313. c. $78,750. d. $77,109. Use the following information for questions 7 and 8. Washington Inc. is a calendar-year corporation. Its financial statements for the years ended 12/31/08 and 12/31/09 contained the following errors: 2008 2009 Ending inventory $15,000 overstatement $24,000 understatement Depreciation expense 6,000 understatement 12,000 overstatement 7. Assume that the 2008 errors were not corrected and that no errors occurred in 2007. By what amount will 2008 income before income taxes be overstated or understated? a. $21,000 overstatement b. $9,000 overstatement c. $21,000 understatement d. $9,000 understatement 8. Assume that no correcting entries were made at 12/31/08, or 12/31/09. Ignoring income taxes, by how much will retained earnings at 12/31/09 be overstated or Understated. a. $24,000 overstatement b. $21,000 overstatement c. $30,000 understatement d. $9,000 understatement 9. On December 31, 2008, special insurance costs, incurred but unpaid, were not recorded. If these insurance costs were related to work in process, what is the effect of the omission on accrued liabilities and retained earnings in the December 31, 2008 balance sheet? Accrued Liabilities Retained Earnings a. No effect No effect b. No effect Overstated c. Understated No effect d. Understated Overstated 10. Early, Inc. is a calendar-year corporation whose financial statements for 2007 and 2008 included errors as follows: Year Ending Inventory Depreciation Expense 2007 $162,000 overstated $135,000 overstated 2008 54,000 understated 45,000 understated Assume that purchases were recorded correctly and that no correcting entries were made at December 31, 2007, or at December 31, 2008. Ignoring income taxes, by how much should Early's retained earnings be retroactively adjusted at January 1, 2009? a. $144,000 increase b. $36,000 increase c. $18,000 decrease d. $9,000 increase 11. It is an objective of the statement of cash flows to a. disclose changes during the period in all asset and all equity accounts. b. disclose the change in working capital during the period. c. provide information about the operating, investing, and financing activities of an entity during a period. d. none of these. 12. Of the following questions, which one would not be answered by the statement of cash flows? a. Where did the cash come from during the period? b. What was the cash used for during the period? c. Were all the cash expenditures of benefit to the company during the period? d. What was the change in the cash balance during the period? 13. The first step in the preparation of the statement of cash flows requires the use of information included in which comparative financial statements? a. Statements of cash flows b. Balance sheets c. Income statements d. Statements of retained earnings 14. A company borrows $10,000 and signs a 90-day nontrade note payable. In preparing a statement of cash flows (indirect method), this event would be reflected as a(n) a. addition adjustment to net income in the cash flows from operating activities section. b. cash outflow from investing activities. c. cash inflow from investing activities. d. cash inflow from financing activities. 15. An increase in inventory balance would be reported in a statement of cash flows using the indirect method (reconciliation method) as a(n) a. addition to net income in arriving at net cash flow from operating activities. b. deduction from net income in arriving at net cash flow from operating activities. c. cash outflow from investing activities. d. cash outflow from financing activities. 16. Which of the following would be classified as a financing activity on a statement of cash flows? a. Declaration and distribution of a stock dividend b. Deposit to a bond sinking fund c. Sale of a loan receivable d. Payment of interest to a creditor 17. The amortization of bond premium on long-term debt should be presented in a statement of cash flows (using the indirect method for operating activities) as a(n) a. addition to net income. b. deduction from net income. c. investing activity. d. financing activity. 18. Which of the following is shown on a statement of cash flows? a. A stock dividend b. A stock split c. An appropriation of retained earnings d. None of these Use the following information for questions 19 and 20. Lange Co. provided the following information on selected transactions during 2008: Purchase of land by issuing bonds $250,000 Proceeds from issuing bonds 500,000 Purchases of inventory 950,000 Purchases of treasury stock 150,000 Loans made to affiliated corporations 350,000 Dividends paid to preferred stockholders 100,000 Proceeds from issuing preferred stock 400,000 Proceeds from sale of equipment 50,000 19. The net cash provided (used) by investing activities during 2008 is a. $50,000. b. $(300,000). c. $(550,000). d. $(1,250,000). 20. The net cash provided by financing activities during 2008 is a. $550,000. b. $650,000. c. $800,000. d. $900,000. PART II: PROBLEMS (60 points) 1. Matching accounting changes to situations. The four types of accounting changes, including error correction, are: Code a. Change in accounting principle. b. Change in accounting estimate. c. Change in reporting entity. d. Error correction. Instructions Following are a series of situations. You are to enter a code letter to the left to indicate the type of change. 1. Change from presenting nonconsolidated to consolidated financial statements. 2. Change due to charging a new asset directly to an expense account. 3. Change from expensing to capitalizing certain costs, due to a change in periods benefited. 4. Change from FIFO to LIFO inventory procedures. 5. Change due to failure to recognize an accrued (uncollected) revenue. 6. Change in amortization period for an intangible asset. 7. Changing the companies included in combined financial statements. 8. Change in the loss rate on warranty costs. 9. Change due to failure to recognize and accrue income. 10. Change in residual value of a depreciable plant asset. 11. Change from an unacceptable to an acceptable accounting principle. 12. Change in both estimate and acceptable accounting principles. 13. Change due to failure to recognize a prepaid asset. 14. Change from straight-line to sum-of-the-years'-digits method of depreciation. 15. Change in life of a depreciable plant asset. 16. Change from one acceptable principle to another acceptable principle. 17. Change due to understatement of inventory. 18. Change in expected recovery of an account receivable. 2. Changes in depreciation methods, estimates. On January 1, 2003, Sauder Company purchased a building and machinery that have the following useful lives, salvage value, and costs. Building, 25-year estimated useful life, $4,000,000 cost, $400,000 salvage value Machinery, 10-year estimated useful life, $500,000 cost, no salvage value The building has been depreciated under the straight-line method through 2007. In 2008, the company decided to switch to the double-declining balance method of depreciation for the building. Sauder also decided to change the total useful life of the machinery to 8 years, with a salvage value of $25,000 at the end of that time. The machinery is depreciated using the straight-line method. Instructions (a) Prepare the journal entry necessary to record the depreciation expense on the building in 2008. (b) Compute depreciation expense on the machinery for 2008. 3. Statement of cash flows (direct and indirect methods). Donelly, Inc. has prepared the following comparative balance sheets for 2007 and 2008: 2008 2007 Cash $ 297,000 $ 153,000 Receivables 159,000 117,000 Inventory 150,000 180,000 Prepaid expenses 18,000 27,000 Plant assets 1,260,000 1,050,000 Accumulated depreciation (450,000) (375,000) Patent 153,000 174,000 $1,587,000 $1,326,000 Accounts payable $ 153,000 $ 168,000 Accrued liabilities 60,000 42,000 Mortgage payable 450,000 Preferred stock 525,000 Additional paid-in capitalpreferred 120,000 Common stock 600,000 600,000 Retained earnings 129,000 66,000 $1,587,000 $1,326,000 1. The Accumulated Depreciation account has been credited only for the depreciation expense for the period. 2. The Retained Earnings account has been charged for dividends of $138,000 and credited for the net income for the year. The income statement for 2008 is as follows: Sales $1,980,000 Cost of sales 1,089,000 Gross profit 891,000 Operating expenses 690,000 Net income $ 201,000 Instructions From the information above, prepare a statement of cash flows (indirect method) for Donelly, Inc. for the year ended December 31, 2008