Exam 1 – Acct 414 – Spring 2007 Page 13
Name: ______
Exam 1Acct 414 – Corporate Accounting & Reporting II Spring 2007
Show any necessary computations if you want to be eligible for partial credit. Present your work in a neat, well-organized manner. When you are using a financial calculator, spell out what you put in for n, i, PMT, FV, PV, etc. 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.
Follow the instructions and answer all parts of the question as directed.
1-4. Time Value of Money (60 points total)5. Troubled debt (30 points total)
6-7. Leases. (70 points total)
8. Long-term contracts (20 points)
9. Serial Bonds (20 points)
10. Extra credit points (if any) total: ______(max = 10)
Total points earned (max = 200)
Do not attempt the extra credit section until you have completed all other sections of the exam!
To be completed by professor:
After Exam 1 - Course Grade
Total Points = ______/______= ______%
Quiz and HW percentage = ______%
Projects percentage = ______%
1. From 415 F02 Assume that you are working for a leasing company. The boss asks you to compute the annual lease payment that the company should charge to earn a 12% return on the following lease: Fair market value of leased asset $100,000. The first payment on the lease will be made immediately. The lease term is 5 years. The property should be worth 30,000 at the end of the lease but the lessee can buy it for $15,000. [15 points]
2. from 1992 302 exam Standard Corporation wants to accumulate $500,000 on December 31, Year 10 to retire preferred stock. The company deposits $125,000 in a savings account on January 1, Year 1 which will earn interest at 8% compounded quarterly. Standard Corporation wants to know what additional amount it has to deposit at the end of each quarter for 10 years to have $500,000 available at the end of Year 10. The periodic deposits will also earn interest at 8% compounded quarterly. [15 points]
3. Gleim #: 14.1.30 -- Source: CPA 592 I-34 from Exam 2 F04 Acct415
Lease accounting [10 points]. Law Co. leased a machine from Order Co. The lease qualifies as a capital lease and requires 10 annual payments of $10,000 with the first payment to be made upon signing the lease. The lease specifies an interest rate of 12% and a purchase option of $5,000 at the end of the tenth year, even though the machine's estimated value on that date is $20,000. The fair value of the machine is $66,500 at the inception of the lease. Law's incremental borrowing rate is 14%. What amount should Law record as the leased asset at the beginning of the lease term?
4. from 415 f05 Troubled debt restructuring. [20 points] A debtor owes $50,000 plus $5,000 in accrued interest on a note payable. The original interest rate on the loan was 10%. The debtor is unable to make any payments toward principal or interest at this time. The creditor agrees to modify the terms of the agreement as follows: (1) The total amount due is reduced to $40,000. (2) The interest rate on the debt will be lowered to 8%. (3) The term of the restructured debt is four years with interest only due during the first three years. Principal and interest will be due at the end of the fourth year. Compute the creditor’s LOSS from this troubled debt restructuring.
5. Modified Problem from 1996 302 exam Troubled debt restructuring. [30 points]
Colfax Combines (CC) had signed a $100,000 note to Pullman First Bank and Trust (PFBT). The note specified annual payments of $20,000 per year plus 12% interest on the unpaid balance. Colfax Combines finds itself unable to make its loan payments. The bank has agreed to restructure the terms of the loan. The balance due at October 1, 2006, the date of the troubled debt restructuring, was $100,000 plus $12,000 in unpaid accrued interest. The new agreement specifies an interest rate of 10% on a reduced principal balance of $80,000. The debtor will pay interest only for 4 years. On October 1, 2011, the entire principal balance will be due with the final interest payment.
Required: Prepare any necessary journal entries for Colfax Combines (debtor) for 2006 including year end accruals at December 31, 2006.
6. From 1996 302 exam Lease Accounting. On September 1, 2006, Post Falls Ford, Inc. and First Bank of Bozeman signed a lease with the following terms:
3. Implicit interest rate (not known to lessee) 9% / 4. Est. fair value of asset at end of lease $20,000
5. Fair value of asset $450,000 / 6. Cost of asset $450,000
7. Incremental borrowing rate: 10% / 8. First payment due 9/1/06
9. Equipment is returned to lessor at end of lease if the purchase option is not exercised / 10. Estimated useful life of asset: 7 years
11. Purchase option at end of lease: $20,000 / 12 Lessee uses straight-line depreciation method
13. Collectibility of the lease payments is reasonably predictable and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. / 14. Lessor and lessee both use straight-line depreciation for fixed assets and have fiscal years that end on December 31.
a. Essay question. [18 points] Classify this lease from the perspective of the lessee and the lessor. Explain fully so that I know that you know all the basic rules – abbreviations are okay.
b. Regardless of your answer to part (a), assume this is a capital lease for the lessee. Prepare a lease amortization schedule for Post Falls Ford (the lessee) for the first two years. [12 points]
Date / Lease Payment / Interest Expense / Amortized Principal / Balance9/1/06
9/1/07
9/1/08
c. What is the amount of depreciation expense that would be recognized by the lessee at 12/31/06? (Show or explain computations. [10 points]
7. From 1996 302 exam Lease Accounting. On March 1, 2007, Joel Jewelers (lessee) and Fairview Fixtures Corp. (lessor) signed a lease with the following terms:
3. Implicit interest rate (not known to lessee) 10% / 4. Lessor retains ownership of asset at end of lease
5. Fair value of asset $180,000 / 6. Cost of asset $130,000 (not known to lessee)
7. Incremental borrowing rate: 12% / 8. First payment due upon signing
9. Estimated useful life of asset: 12 years / 10. No collection or cost uncertainties for lessor
11. Est. fair value of asset at end of lease: $35,000 / 12. The residual value is NOT guaranteed by lessee
13. A commission of 1% of the fair value of the leased asset is paid to the salesperson who negotiated the lease. / 14. Lessor and lessee both use straight-line depreciation for fixed assets and have fiscal years that end on December 31
15. The present value of the minimum lease payments for the lessor is $163,670 / 16. The present value of the minimum lease payments for the lessee is $155,173
a. Fill in the blanks [10 points]
This is a(n) ______lease for the lessee.
This is a(n) ______lease for the lessor
b. Problem: Prepare all necessary journal entries 2007 journal entries for Fairfield Fixtures (the LESSOR). [20 points]
3/1/07
12/31/07
8. Long-term construction accounting (20 points)
Garnet Construction Co. contracted to build a bridge for $5,000,000. Construction began in 2007 and was completed in 2008. Data relating to the construction are:
2007 2008
Costs incurred $1,650,000 $1,375,000
Estimated costs to complete 1,350,000 - 0 -
Garnet uses the percentage-of-completion method.
Instructions
(a) How much revenue should be reported for 2007? Show your computation.
(b) Make the entry to record progress billings of $1,500,000 during 2007.
(c) Make the entry to record the revenue and gross profit for 2007.
(d) What amount will be reported on the balance at 12/31/07 with respect to this contract? Give the account title and whether it is a current or noncurrent asset or liability.
9. Serial Bonds. [20 points] On July 1, 2006, Koors Corporation issued $2,000,000 in serial bonds. The bond principal will be repaid in $500,000 increments beginning on July 1, 2007 with the final payment to be made on July 1, 2010. The bonds pay interest semi-annually on January 1 and July 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. (Hint: If you decide to use the effective interest method, the effective simple interest rate per year is either 8% or 14%.)
Required: Prepare all necessary journal entries at 7/1/06 and 12/31/06 using EITHER the effective interest method or the bonds outstanding method to amortize bond discounts and premiums. (You choose the method!) Koors Corporation’s fiscal year ends December 31. Do NOT prepare entire amortization tables – they are not necessary and will not earn you any extra points.
10. Extra credit - MATCHING: For each term, select the best phrase or description from the answers listed below. An answer may be used once, more than once, or not at all. [Maximum 10 points]
_____ 1. Implicit interest rate
_____ 2. Non-renewal penalty
_____ 3. Unearned interest
_____ 4. Bargain purchase option
_____ 5. Direct financing lease
_____ 6. Contingent rentals
_____ 7. Sales type lease
_____ 8. Gross investment in lease
_____ 9. Unguaranteed residual value
_____ 10. Incremental borrowing rate
_____ 11 Initial direct costs
_____ 12. Lease term
CHOICES:
A. Minimum lease payments plus any unguaranteed residual value. Gross investment in lease
B. Depreciation expense related to the leased asset is reported on the lessor's income statement over the lease term. Operating lease (lessor)
C. The fair value of the leased asset is equal to the cost of the asset to the lessor. Direct financing lease
D. The income statement includes a profit or loss as well as interest revenue. Sales type lease
E. The rate used by the lessee to determine the present value of the minimum lease payments if the lessee's incremental borrowing rate is less than the lessor's implicit interest rate (known to lessee). Incremental borrowing rate
F. Always included in minimum lease payments unless there is a title transfer or a bargain purchase option. Guaranteed residual value.
G. Included in the lessor's gross investment, whether guaranteed or unguaranteed. Residual value
H. Included in the lessor's gross investment in lease. Unguaranteed residual value
I. Produces a desired rate of return which causes the aggregate present value to be equal to the fair value of the leased property. Implicit interest rate
J. Is not included in the minimum lease payments if it is large enough to assure that the lease will be renewed. Non-renewal penalty
K. Includes any periods covered by bargain renewal options. Lease term
L. Increases or decreases in lease payments based upon sales volume or machine useage. Contingent rentals
M. Amount recorded as sales revenue when the cost of the leased asset is less than its fair value. Present value of minimum lease payments
N. Costs which are expensed immediately by lessor when the fair value of the leased asset exceeds its carrying value. Initial direct costs
O. Amortized over the term of the lease using the effective interest method. Unearned interest
P. Included in the lessee’s minimum lease payments. Bargain purchase option
SOLUTIONS
[1] Annuity due, n=5, i=12%, PV = -100,000 (negative), FV = 15,000 (positive), PMT= 22,660.56
[2] Ordinary annuity, n=40 quarters, i=2%, PV=125,000, FV=(500,000), solve for PMT = 3,708.41
[3] annuity due, n=10, PMT=10,000, FV=5,000 , i=12% (lower of two rates since both are known)
Solve for PV= $64,892.36
[4] Step 1 – find PV of cash flows under new terms using historical interest rate:
ordinary annuity, n=4, i=10%, PMT=3200, FV=40,000, PV=37,464.11.
Step 2 – the loss is the difference between carrying value ($55,000) and the PV computed in step 1:
$55,000 - $37,464 = $17,536
[5] Debtor accounting. The carrying value of the debt is $112,000. The total future cash flows is only $120,000 (80,000 + [80,000 * .10]*5). Therefore, the difference will be recognized as interest expense over the 5 years of the new term and no gain will be recognized. The interest rate is found on a financial calculator: PV=(112,000), PMT=8,000, FV=80,000, n=5, solve for interest = 1.61%
10/1/06 (to reorganize accounts)
Note payable (old) 100,000
Accrued interest payable 12,000
Note payable - restructured 112,000
12/31/06 (end of fiscal year)
Interest expense ($112,000 * 1.61% * 3/12) 451
Note payable – restructured 451
[6a] From 1996 302 exam Essay: There is no title transfer or bargain purchase option, and the lease term is only 71% of economic life. The residual value is not guaranteed and is therefore irrelevant to the lessee. The present value of the minimum lease payment is 96% of fair market value (429,801 > 405,000). Therefore, the lessee has a capital lease. The lessor uses a different interest rate to find the present value of the minimum lease payments but $437,001 is 97% of fair market value so the lessor meets one of the four necessary criteria. The lessor has a direct financing lease because the two extra criteria for lessors (collectibility and no cost uncertainties) are met and there is no dealer or manufacturers profit since the cost of the leased asset is equal to its fair market value.