Name: __________________________________ Exam 1 Acct 414 Corporate Accounting & Reporting II Spring 2009 INSTRUCTIONS: {Not following instructions

s could cost you up to 10 points.}

Put your name on answer sheet and exam. Put your name and student ID number on answer sheet in both human and machine-readable formats. (For the ID number, do not put in a hyphen -- the last two columns will be blank.) MATCHING and MULTIPLE CHOICE: Darken your selected answer on the separate answer sheet. You should also clearly circle or otherwise mark your answer on the exam itself since the answer sheet will not be returned. There is no penalty for guessing. SHORT PROBLEMS & ESSAYS: Show any necessary computations if you want to be eligible for partial credit. Present your work in a neat, well-organized manner. Answer all parts of the problem. When you are using a

financial calculator, spell out what you put in for n, i, PMT, FV, PV, etc. You could also draw a time-line if that would explain your thinking to me. You may use abbreviations in your essay answers but I need complete thoughts.

Multiple Choice Questions 1-20 (6 points each, max=90) Leases Revenue recognition IFRS _______/6 _______/4 _______/5 _______/5

Other (TVM, fair value, troubled debt) 21. 22. 23. Leases (60 points total) Construction Accounting (30 points)

Other (TVM, fair value, troubled debt, etc.) Pick 3 of the 4 (7 points each, maximum 20 points) Total points earned (max = 200)

To be completed by professor: After Exam 1 - Course Grade Total Points = __________/__________ = _________% Quiz and HW percentage = Projects percentage = ___________% ___________%

Exam 1 Acct 414 Spring 2009

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Exam 1 Acct 414 Spring 2009

Multiple Choice Questions 1. Minimum lease payments may include a a. penalty for failure to renew. b. bargain purchase option. c. guaranteed residual value. d. any of these. e. none of the above Which of the following would not be included in the Lease Receivable account? a. Guaranteed residual value b. Unguaranteed residual value c. A bargain purchase option d. All would be included Which of the following statements is correct? a. In a sales-type lease, initial direct costs are added to the net investment in the lease. b. In a direct-financing lease, initial direct costs are expensed in the year of incurrence. c. For operating leases, initial direct costs are deferred and allocated over the lease term. d. All of these.

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2.

3.

4.

On December 31, 2008, Dodd Corporation leased a plane from Aero Company for an eight-year period expiring December 30, 2016. Equal annual payments of $150,000 are due on December 31 of each year, beginning with December 31, 2008. The lease is properly classified as a capital lease on Dodds books. The present value at December 31, 2008 of the eight lease payments over the lease term discounted at 10% is $880,264. Assuming the first payment is made on time, the amount that should be reported by Dodd Corporation as the lease liability on its December 31, 2008 balance sheet is a. $730,264. b. $792,238. c. $818,290. d. $880,264. Executory costs include a. maintenance. b. property taxes. c. insurance. d. all of these. e. none of the above

5.

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6.

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Barkley Corporation is a lessee with a capital lease. The asset is recorded at $450,000 and has an economic life of 8 years. The lease term is 5 years. The asset is expected to have a market value of $150,000 at the end of 5 years. The lease agreement provides a $10,000 purchase option at the end of the lease term. What amount of straight-line depreciation expense would the lessee record for the first year of the lease? a. $90,000 b. $60,000 c. $56,250 d. $55,000 e. $37,500

7. In selecting an accounting method for a newly contracted long-term construction project, the principal factor to be considered should be a. the terms of payment in the contract. b. the degree to which a reliable estimate of the costs to complete and extent of progress toward completion is practicable. c. the method commonly used by the contractor to account for other long-term construction contracts. d. the inherent nature of the contractor's technical facilities used in construction. 8. How should the balances of progress billings and construction in process be shown at reporting dates prior to the completion of a long-term contract? a. Progress billings as deferred income, construction in progress as a deferred expense. b. Progress billings as income, construction in process as inventory. c. Net, as a current asset if debit balance, and current liability if credit balance. d. Net, as income from construction if credit balance, and loss from construction if debit balance. Under the completed-contract method a. revenue, cost, and gross profit are recognized during the production cycle. b. revenue and cost are recognized during the production cycle, but gross profit recognition is deferred until the contract is completed. c. revenue, cost, and gross profit are recognized at the time the contract is completed. d. none of these. When the installment-method of revenue recognition is acceptable under US GAAP, a. income is recognized immediately. b. income is recognized on a proportionate basis as the cash is received on the sale of the product. c. income is recognized when the cash received from the sale of the product is greater than the cost of the product. d. none of these.

9.

10.

Exam 1 Acct 414 Spring 2009

11. How does IFRS guidance on revenue recognition differ from US GAAP? a. A greater number of authoritative sources are available for IFRS b. IFRS is principles-based while US GAAP is conceptual c. IFRS has limited guidance for specific industries or transactions d. All of the above e. b and c

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Use the following information to answer the next two questions Arnold Construction Company secured a $25,000,000 fixed-price contract to construct a new soccer facility. The company has incurred $5,000,000 of costs, and estimates an additional $18,000,000 to complete the project. 12. Using the percentage of completion method, how much does revenue under IFRS differ from revenue under US GAAP? a. IFRS revenue equals US GAAP revenue b. IFRS exceeds US GAAP by $5,000,000 c. US GAAP exceeds IFRS by $5,000,000 d. IFRS exceeds US GAAP by $434,782 e. US GAAP exceeds IFRS by $434,782 13. Assuming Arnold Construction Company could not reasonably estimate the cost of completion, how much would revenue under IFRS differ from revenue under US GAAP? a. IFRS revenue equals US GAAP revenue b. IFRS exceeds US GAAP by $5,000,000 c. US GAAP exceeds IFRS by $5,000,000 d. IFRS exceeds US GAAP by $434,782 e. US GAAP exceeds IFRS by $434,782

14.

Which of the following standards specifies bright line rules to determine lease type? a. IFRS b. US GAAP c. Both specify bright line rules d. Neither specify bright line rules

Exam 1 Acct 414 Spring 2009

15.

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A lessee and a lessor have specified all the payments to be made under a capital lease, including any anticipated residual value. The lessors implicit interest rate is 10% and is not specified in the contract although it could be estimated from the information known to the lessee. The lessees incremental borrowing rate is 9%. Which interest rate should be used to test whether the present value of the cash flows is a sufficient portion of the fair value of the leased asset? Under US GAAP Under IFRS Lessee Lessor Lessee Lessor A. 9% 10% 10% 10% B. 10% 10% 10% 10% C. 9% 10% 9% 10% D. 9% 9% 10% 10%

16.

Adam Inc. has the following investments securities: Security A: 30 bonds purchased last year at 98.5. The bonds are thinly traded, so no quoted price is available near the end of this year. However, prices and yield rates were available for bonds of similar duration and risk. Abbott used this data to estimate the end of the year fair value of the bonds at 97.8. Security B: 500 shares of stock of a company traded on the New York Stock Exchange. The shares sold for $60 on January 1. In September, the company purchased another 1,000 shares at $43 each.

Indicate the how the inputs for the fair value measurement of each security is categorized under the hierarchy described in FASB Statement No. 157. Level 1 Level 2 Level 3 A. Security B Security A B. Both A and B C. Both A & B Security B D. Security B Security A E. Security A Security B

17.

Miriam Company has one asset, an available for sale debt security (called Bond A) that it purchased on the day it was issued at face value. It also has one liability, one of its own bonds (called Bond L) that the company issued to finance the purchase of the Bond A investment. The company had no initial shareholder investment. Both bonds have the same terms: $1,000 face value, 20-year life, 8% coupon rate, and one interest payment made at the end of each year. On their issuance dates, both bonds were associated with a market interest rate of 8%. On the very next day, the market interest rate with respect to Bond A had risen to 12% and the market interest rate with respect to Bond Payable L had risen to 11%. What values will appear on the balance sheet related to these bonds?
A. B. C. D. The fair value option is NOT selected Bond A = $ 761 Bond L = $1,000 Bond A = $1,000 Bond L = $1,000 Bond A = $1,000 Bond L = $ 761 Bond A = $ 701 Bond L = $1,000 The fair value option is selected Bond A = $ 761 Bond L = $ 701 Bond A = $1,000 Bond L = $1,000 Bond A = $ 701 Bond L = $1,000 Bond A = $ 701 Bond L = $ 761

Exam 1 Acct 414 Spring 2009

18. In a troubled debt restructuring in which the debt is continued with modified terms and the carrying amount of the debt is less than the total future cash flows, the creditor should a. not recognize a loss. b. compute a new effective-interest rate. c. calculate its loss using the historical effective rate of the loan. d. calculate its loss using the current effective rate of the loan.

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19.

Casey Corp. entered into a troubled debt restructuring agreement with First State Bank. First State agreed to accept land with a carrying amount of $85,000 and a fair value of $120,000 in exchange for a note with a carrying amount of $185,000. What amount should First State Bank recognized as the loss from this troubled debt restructuring? A. B. C. D. $ 35,000 $ 65,000 $100,000 $0

20.

A creditor is properly using the cost-recovery method for a receivable from a customer involved in a troubled debt situation. Under the new terms, the interest rate was reduced and a portion of the principal was forgiven. Which of the following statements is not correct? a. The creditor writes the note receivable down to the present value of the modified cash flows using the original interest rate. b. The loss may be debited to the allowance for doubtful accounts. c. Subsequent income statements report no interest revenue from the account until all principal has been collected. d. Interest revenue may be recognized before all principal has been recovered. e. All of the above are correct.

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[21]. Lease Accounting (60 points)

On June 1, 2009, Harrison Ford, Inc. and Oregon First Bank sign a lease with the following terms: 1. Term: 5 years 2. Annual payment = $23,203 3. Implicit interest rate (not known to lessee) 9% 4. Est. fair value of asset at end of lease $10,000 5. Fair value of asset $100,000 6. Cost of asset $85,000 7. Incremental borrowing rate: 10% 8. First payment due immediately 9. Estimated useful life of asset: 7 years 10. Purchase option at end of lease: $2,500 11. Both lessor and lessee use the straight-line 12. There are no collection uncertainties and no depreciation method (no salvage value) cost uncertainties for the lessor. 13. The lessor paid $500 to an attorney to draw up the lease agreement.

a.

This is a capital lease for the lessee. Prepare a lease amortization schedule for the first two years. [12 points] Date Lease Payment Interest Expense or Revenue Amortized Principal Balance

b. 6/1/09

Prepare all lessee journal entries necessary in 2009 (this is a capital lease) [20 points]

12/31/09

Exam 1 Acct 414 Spring 2009

Problem 21 (lease) continued facts repeated for your convenience

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On June 1, 2009, Harrison Ford, Inc. and Oregon First Bank sign a lease with the following terms: 1. Term: 5 years 2. Annual payment = $23,203 3. Implicit interest rate (not known to lessee) 9% 4. Est. fair value of asset at end of lease $10,000 5. Fair value of asset $100,000 6. Cost of asset $85,000 7. Incremental borrowing rate: 10% 8. First payment due immediately 9. Estimated useful life of asset: 7 years 10. Purchase option at end of lease: $2,500 11. Both lessor and lessee use the straight-line 12. There are no collection uncertainties and no cost depreciation method (no salvage value) uncertainties for the lessor. 13. The lessor paid $500 to an attorney to draw up the lease agreement.

d.

Classify the lease for the lessor: Check the appropriate box and write a very brief explanation. [8 points] Operating Direct Finance Sales-type

e.

Prepare all necessary journal entries for the lessor during 2009. [20 points]

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[22]. Long-term construction accounting (30 points)

On February 14, 2009 Easterly Construction Co. entered into a contract with the City of Summer to build a bridge for $7,000,000. Construction began immediately and was completed in November 2010. Data relating to the construction are: 2009 2010 Costs incurred $2,640,000 $3,500,000 Estimated costs to complete 2,160,000 For items a, b and c, assume that Easterly uses the percentage-of-completion method. Instructions a. How much revenue should be reported for 2009? Show your computation.

b. Make the entry to record the revenue and gross profit for 2009.

c.

Make the entry to record progress billings of $2,500,000 and collections of $2,000,000 during 2009.

d.

If Easterly used the completed contract method, how much gross profit would be reported for 2009?

e.

If Easterly used the completed contract method, what amounts (with title) would appear on the 12/31/2009 balance sheet (indicate whether the amount(s) is a current asset or current liability.)

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[23] Short problems other topics

7 points each, pick 3 of the 4 to earn 20 points (maximum). If you work all 4, Ill count the best 3 scores.

[23a]. Fair Value Disclosures Bonds. Sunlight Mines issued $5,000,000 in semi-annual bonds on January 1, 2001 at face value. The bonds mature on January 1, 2016. The coupon interest rate was 8% per annum (4% each six months). It is now early January in 2009, eight years until maturity. Sunlight Mines is preparing its December 31, 2008 financial statements and, according to FASB No. 107, needs to disclose the fair value of the bonds. The bonds are not actively traded but Level 2 (FASB No. 157) information is available: the interest rate for semiannual bonds with similar bond ratings and maturities were being sold to yield 9% per annum (simple interest) as of 12/31/08. REQUIRED: What is the estimated fair value of the bonds at 12/31/08? (Hint: If the bonds were issued on 12/31/08, what would people be willing to pay to buy them?) $_____________________________

[23b]. Troubled debt restructuring. Parts R Us Inc., is one of Carlson Car Care Companys major creditors. Carlson Car Care Company is experiencing substantial financial difficulties. Its original note with Parts R Us, Inc. was dated February 1, 2006 and has a face value of $50,000 and specifies a 10% interest rate. The interest for the period ending Feb. 1, 2009 has not been paid. On Feb. 1, 2009, Carlson Car Care Company persuaded Brakes R Us to reduce the principal from $50,000 to $35,000 and to reduce interest payments to $2,800 per year for the remaining 4-year life of the debt. The modified terms also waive payment of the accrued interest currently due. Instructions: Prepare the journal entry that Parts R Us Inc. would make on February 1, 2009. The creditor uses the effective interest rate method.

Exam 1 Acct 414 Spring 2009

[23c]

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Lease Computations. Assume that you are working for a leasing company. The boss asks you to compute the monthly lease payment that the company should charge to earn a 12% return on the following lease: Fair market value of leased asset is $370,000. The first payment on lease will be made immediately upon signing and the second payment will be made at the end of the first month. The lease term is 4 years and the useful life of the asset is 6 years. At the end of the lease, the lessee guarantees that the asset will be worth $40,000 which is its estimated fair value at that time. REQUIRED: What is the monthly payment? $__________________________

[23d]

Serial Bonds On April 1, 2009, Falstaff Corporation issued $2,000,000 in serial bonds. The bond principal will be repaid in $500,000 increments beginning on April 1, 2010 with the final payment to be made on April 1, 2013. The bonds pay interest semi-annually on Oct. 1 and April 1. The coupon rate is 10% per annum. An investment banker handled the transaction and you have just received a check for $1,840,669.

Required: (1) Using the bonds outstanding method, what fraction would you use as part of the computation of interest expense related to the payment on October 1, 2009?

(2)

If the yield rate is 14% per annum (simple interest), what is the amount of interest expense for the six months ending October 1, 2009 using the effective interest method?

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Solutions
Multiple choice 1. D 2. D 3. C 4. A 6. C 7. B 8. C 9. C 11. C 12. A 13. B 14. B 16. A 17. D 18. C 19. B

5. D 10. B 15. A 20. D Selected Notes on MC questions: 4. $880,264 $150,000 = $730,264. 6. $56,250 (450,000/8 years because there is a bargain purchase option & lessee will use asset over its economic life) 15. Explanation: For the FMV test, under US GAAP, the lessee users the lower of the two rates if both are known. In this case, the implicit rate is not known so the lessee uses the incremental borrowing rate of 9% while the lessor uses 10%. Under IFRS, the lessee uses the implicit interest rate if it is practicable to determine. Therefore both lessee and lessor would use 10% in the situation described.

21a Lessee amortization table Not the same as the lessors table because the implicit interest rate is NOT known to lessee
the amortization table starts with the PVMLP of the lease payments using 10% interest rate. Determine the present value as follows: PMT=23203, FV=2,500 BPO, i=10%, n=5, annuity due (BEGIN), PVLMP= 98,306. Depreciation expense for 2009 = $98,306 divided by 7 years = 14,044 * 7/12 proration = $8,192. We use the life of the asset rather than lease term because the lessee is presumed to buy the asset at the end of the lease since there is a bargain purchase option. The shaded rows are what I was asking for: 10% Reduction in Lease Date Lease Interest Lease Obligation Payment Expense Obligation BALANCE 06/01/09 98,305.69 06/01/09 23,203.00 0.00 23,203.00 75,102.69 06/01/10 23,203.00 7,510.27 15,692.73 59,409.96 06/01/11 23,203.00 5,941.00 17,262.00 42,147.96 06/01/12 23,203.00 4,214.80 18,988.20 23,159.75 06/01/13 23,203.00 2,315.98 20,887.02 2,272.73 06/01/14 2,500.00 227.27 2,272.73 0 21b 6/1/09 Leased asset (pmt=23203, i=10%, n=5, fv=2500) Cash Lease obligation 12/31/09 Interest expense (7510 * 7/12) Interest payable Depreciation expense (98,306 divided by 7 yrs * 7/12) Accumulated depreciation Debit 98,306 23,230 75,103 Credit

4,381 4,381 8,192 8,192

21c Sales type lease for lessor since there is a BPO, the 2nd set of 2 rules for lessors are both met (item 12), and the FV > cost of asset (there is a profit). LESSOR AMORTIZATION TABLE (NOT REQUIRED)
0 1 2 3 4 5 Date Lease Payment 06/01/09 06/01/09 23,203 06/01/10 23,203 06/01/11 23,203 06/01/12 23,203 06/01/13 23,203 06/01/14 2,500 Interest 0 6,912 5,446 3,847 2,105 205 Principal 23,203 16,291 17,757 19,356 21,098 2,295 Balance 100,000 76,797 60,506 42,748 23,393 2,295 0

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21e Lessor journal entries remember that initial direct costs are expensed for sales type leases. debit credit 06/01/09 Net Investment in Lease 76,797 Sales 100,000 COGS 85,000 Inventory 85,000 Cash 23,203 Legal expense (initial direct costs) Cash or A/P 12/31/09 Interest receivable (76,797 * 9% = 6912 * 7/12) Interest Revenue 500 500 4,032 4,032

22. Construction accounting (US GAAP) (a) $2,640,000 costs so far divided by $4,800,000 total estimate costs = Percentage of completion of 55% 55% $7,000,000 = $3,850,000 construction revenue. Sometimes I ask for gross profit which would be $1,210K or ($7,000K total revenue - $4,800K estimated costs)* 55%. (b) Construction Expenses........................................................................................ Construction in Process ...................................................................................... Revenue from Long-Term Contracts .................................................... Accounts Receivable .......................................................................................... Billings on Construction in Process .......................................... Cash .............................................................................................................. Accounts receivable ............................................................................. 2,640,000 1,210,000 3,850,000 2,500,000 2,500,000 2,000,000 2,000,000

(c)

(d)

Under the completed contract method, no revenue or profit would be recognized on the contract until completion in 2009. So the answer is ZERO or NONE Current assets Costs of uncompleted contracts in excess of related billings

(e)

$140,000

Explanation: Progress billings has $2,500,000 ending balance and CIP has $2,640,000 ending balance for 2009. {Note that CIP does not include any profit under completed contract or zero-profit methods.} These two accounts work as a pair and since the debits > credits, we would report cost of uncompleted contracts in excess of related billings under current assets in the amount of $140,000 for 2009. If I had said using the percentage of completion method instead, the answer would have been $3,850,000 - $2,500,000 = $1,350,000 because the gross profit recognized so far is debited to construction in progress under the percentage of completion method.
Problem 23a - Fair value of bonds

Principal (FV) Yield rate Number of payments PMT= ordinary=0; due=1 Solve for PV

Stated rate= Problem 23c - determine lease payment for lessor 5,000,000 4.00% n= 48 4.50% =i i= 1.00% 16 =n pv= (370,000.00) 200,000 =PV fv= 40,000.00 ordinary annuity = 0; 0 annuity due = 1 1 $4,719,149.62 =PVMLP =PMT $9,000.16

Exam 1 Acct 414 Spring 2009

Problem 23b - PV of troubled receivable n= 4 i= 10.00% PMT= (2,800) Face value = (35,000) ordinary annuity=0;annuity due=1 0 Solve for PV 32,781.09 Carrying value of note 55,000.00 Loss on TDR (22,218.91)

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yrs original rate new terms new terms

23b journal entry (required see computations above) Note Receivable (restructured) Note receivable (old) Accrued interest receivable Loss on troubled debt restructuring (or Allowance for bad debts) [23d] Serial bonds (1) The fraction is 20/100 FACE Amortization VALUE percent 2,000,000 0.20000 2,000,000 0.20000 1,500,000 0.15000 1,500,000 0.15000 1,000,000 0.10000 1,000,000 0.10000 500,000 0.05000 500,000 0.05000 10,000,000 1.00000 32,781 50,000 5,000 22,219

Fraction 20/100 20/100 15/100 15/100 10/100 10/100 5/100 5/100 100/100

The bonds outstanding method journal entries (not requested): Debit 10/01/09 Interest expense [plug] 131,866 Discount on Bonds Payable (20/100 * 159,331) Cash (2,000,000 * 10%/2) 12/31/09 Interest Expense Interest Payable (100,000 * 3/6 mos.) Discount on Bonds Payable (20/100 * 159,331 * 3/6) 65,933

Credit 31,866 100,000

50,000 15,933

(2) The interest expense is computed as follows: 1,840,669 * .07 = 128,847 for April 1 through Sept. 30 Since the instructions werent clear, I also accepted the bonds outstanding method interest expense $131,866. Effective interest method journal entries (not required): 10/01/09 Interest expense (.07 % 1,840,669) Discount on Bonds Payable (plug) Cash (face value * coupon rate) 12/31/09 Interest Expense (3/6*130,866) Interest Payable Discount on Bonds Payable

128,847 28,847 100,000 65,433 50,000 15,433 2,194,280

2,194,280

See solutions from Exam 1- Spring 2008 for amortization tables related to this problem