Wahlen Intermediate Chapters | Roger CPA Review

Wahlen Intermediate Chapters

Wahlen Intermediate Chapters

 

Question 1

Required

Sigma Co. began operations on January 1, year 1. On December 31, year 1, Sigma provided for uncollectible accounts based on 1% of annual credit sales. On January 1, year 2, Sigma changed its method of determining its allowance for uncollectible accounts by applying certain percentages to the accounts receivable aging as follows:

Days past invoice date Percent deemed to be uncollectible
0-30 1%
31-90 5%
91-180 20%
Over 180 80%

In addition, Sigma wrote off all accounts receivable that were over one year old. The following additional information relates to the years ended December 31, year 2, and year 1:

Year 2 Year 1
Credit sales $3,000,000 $2,800,000
Collections 2,915,000 2,400,000
Accounts written off 27,000 None
Recovery of accounts

previously written off
7,000 None
Days past invoice

date at 12/31
0-30 300,000 25,000
31-90 80,000 90,000
91-180 60,000 45,000
Over 180 25,000 15,000

Items to be answered:

Complete the following schedules showing the calculation of the allowance for uncollectible accounts at December 31, year 2 and the calculation for uncollectible accounts expense for year 2.

Sigma Company SCHEDULE OF CALCULATION OF ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS December 31, Year 2

Amounts of accounts receivable Percentage of uncollectible accounts Allowance for bad debts
0 to 30 days
31 to 90 days
91 to 180 days
Over 180 days
Total accounts receivable
Total allowance for uncollectible accounts

Schedule of Uncollectible Accounts Expense

Balance December 31, year 1                                
Write-offs during year 2
Recoveries during year 2
Balance before year 2 provision
Required allowance at December 31, year 2
Year 2 Provision

SCHEDULE OF CALCULATION OF ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS December 31, Year 2

Amounts of accounts receivable Percentage of uncollectible accounts Allowance for bad debts
0 to 30 days $300,000 X 1% $3,000
31 to 90 days 80,000 X 5% 4,000
91 to 180 days 60,000 X 20% 12,000
Over 180 days 25,000 X 80% 20,000
Total accounts receivable $465,000
Total allowance for uncollectible accounts $39,000

Schedule of Uncollectible Accounts Expense

Balance December 31, year 1 $28,000 ($2,800,000 X 1%)
Write-offs during year 2 ($27,000) (given)
Recoveries during year 2 7,000 (given)
Balance before year 2 provision 8,000
Required allowance at December 31, year 2 39,000 (from above - target)
Year 2 Provision $31,000

SCHEDULE OF CALCULATION OF ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS

To complete the schedule of calculation of allowance for uncollectible accounts, the information provided will first be inserted for year 2. The first column will be the amounts of invoices falling into each column, $300,000, 0 to 30 days, $80,000 31 to 90, and so on. The total will simply be the sum of $300,000 + $80,000 + $60,000 + $25,000 = $465,000.

The next column will be completed by inserting the provided percentages such as 1% for 0 to 30 days, 5% for 31 to 90 days, and so on. An allowance amount is next calculated for each line by multiplying the amount in the first column by the percentage in the next column. The results are:

  • $300,000 x 1% = $3,000
  • $80,000 x 5% = $4,000
  • $60,000 x 20% = $12,000
  • $25,000 x 80% = $20,000

As a result, the total is $39,000, which represents the required ending balance in the allowance for doubtful accounts.

Schedule of Uncollectible Accounts Expense

The schedule of uncollectible accounts expense will be completed as follows:

  • In year 1, bad debts expense was 1% of credit sales of $2,800,000 for an expense of $28,000. Since no accounts were written off or recovered during the period, $28,000 would also be the balance in the allowance at December 31, year 1.
  • Write-offs during year 2 are given as $27,000, which would reduce the allowance.
  • Recoveries during year 2 are given as $7,000, which would increase the allowance.

As a result, the unadjusted balance in the allowance account is $28,000 - $27,000 + $7,000 = $8,000.

As determined above, the required ending balance is $39,000.

The amount of expense needed to attain the required ending balance is $39,000 - $8,000 = $31,000.

On January 2, 20X4, Bing Co. purchased 39,000 shares of Latt Co.'s 200,000 shares of outstanding common stock for $585,000. On that date, the carrying amount of the acquired shares on Latt's books was $405,000. Bing attributed the excess of cost over carrying amount to goodwill. Bing's policy is to evaluate goodwill each period for impairment. As of December 31, 20X4, goodwill has not been impaired.

During 20X4, Bing's president gained a seat on Latt's board of directors. Latt reported earnings of $400,000 for the year ended December 31, 20X4, and declared and paid dividends of $100,000 during 20X4. On December 31, 20X4, Latt's common stock was trading over-the-counter at $15 per share.

Question 1

This question consists of 12 items. Select the best answer for each item.

Edge Co., a toy manufacturer, is in the process of preparing its financial statements for the year ended December 31, 20X3. Edge expects to issue its 20X3 financial statements on March 1, 20X4.

Required

Items 1 through 12 represent various information that has not been reflected in the financial statements. For each item, the following two responses are required:

  1. Determine if an adjustment is required and select the appropriate amount, if any, from the list below.
  2. Determine (Yes/No) if additional disclosure is required, either on the face of the financial statements or in the notes to the financial statements.

Adjustment amounts

  1. No adjustment is required
  2. $100,000
  3. $150,000
  4. $250,000
  5. $400,000
  6. $500,000

Items to be answered

  1. Edge owns a small warehouse located on the banks of a river in which it stores inventory worth approximately $500,000. Edge is not insured against flood losses. The river last overflowed its banks twenty years ago.
  2. During 20X3, Edge began offering certain health care benefits to its eligible retired employees. Edge's actuaries have determined that the discounted expected cost of these benefits for current employees is $150,000.
  3. Edge offers an unconditional warranty on its toys. Based on past experience, Edge esti¬mates its warranty expense to be 1% of sales. Sales during 20X3 were $10,000,000.
  4. On October 30, 20X3, a safety hazard related to one of Edge's toy products was discovered. It is considered probable that Edge will be liable for an amount in the range of $100,000 to $500,000.
  5. On November 22, 20X3, Edge initiated a lawsuit seeking $250,000 in damages from patent infringement.
  6. On December 17, 20X3, a former employee filed a lawsuit seeking $100,000 for unlawful dismissal. Edge's attorneys believe the suit is without merit. No court date has been set.
  7. On December 15, 20X3, Edge guaranteed a bank loan of $100,000 for its president's personal use.
  8. On December 31, 20X3, Edge's board of directors voted to discontinue the operations of its computer games division and sell all the assets of the division. The division was sold on February 15, 20X4. On December 31, 20X3, Edge estimated that losses from operations, net of tax, for the period January 1, 20X4, through February 15, 20X4, would be $400,000 and that the gain from the sale of the division's assets, net of tax, would be $250,000. These estimates were materially correct.
  9. On January 5, 20X4, a warehouse containing a substantial portion of Edges inventory was destroyed by fire. Edge expects to recover the entire loss, except for a $250,000 deductible, from insurance.
  10. On January 24, 20X4, inventory purchased FOB shipping point from a foreign country was detained at that country's border because of political unrest. The shipment is valued at $150,000. Edge's attorneys have stated that it is probable that Edge will be able to obtain the shipment.
  11. On January 30, 20X4, Edge issued $10,000,000 bonds at a premium of $500,000.
  12. On February 4, 20X4, the IRS assessed Edge an additional $400,000 for the 20X2 tax year. Edge's tax attorneys and tax accountants have stated that it is likely that the IRS will agree to a $100,000 settlement.
1. AN The fact that a company does not maintain an insurance policy for certain types of losses does not constitute a contingency that would be subject to accrual unless the condition that is not covered by insurance exists at the balance sheet date, it is probable that a loss will occur, and the amount of the loss can be reasonably estimated. Although the company may disclose the lack of insurance, it is not required to do so.
2. CY When a company has an obligation for postretirement benefits, such as providing health care benefits to retired employees, an amount equal to the present value of an estimate of the expected benefits must be accrued and reported as a liability. The amount, in this case, is given as $150,000. An obligation for postretirement benefits must also be disclosed.
3. BN Warranty expense represents a contingency that is probable, since it is likely that some products will require work that is covered by the warranty, and generally can be reasonably estimated. As a result, it requires accrual. The amount will be 1% of sales of $10,000,000 or $100,000. Since warranty expense is an ordinary cost of doing business, no special disclosure is required.
4. BY The discovery of a safety hazard related to one of Edge's products represents a contingent liability. Since it is probable that Edge will be liable, accrual of a loss would be appropriate provided the amount can be reasonably estimated. When the amount can only be estimated in terms of a range of loss with no single amount more probable than any other, the minimum amount of the range will be accrued. Edge will accrue a loss of $100,000. In addition, since this is not an ordinary cost of doing business, disclosure is required.
5. AN A lawsuit initiated by Edge constitutes a gain contingency. It is never appropriate to accrue a gain contingency. In addition, although Edge may disclose the gain contingency, disclosure is not required.
6. AN Since Edge's attorneys believe the suit filed by the former employee is without merit, it represents a contingent loss that is only remote. As a result, neither accrual nor disclosure would be appropriate.
7. AY The guarantee of a bank loan for Edge's president represents a loss contingency that would only be accrued if it were probable that the president would default requiring Edge to repay the loan. Whenever a company guarantees the indebtedness of another, however, disclosure is required.
8. AY When a company decides to discontinue the operations of a division, it is accounted for as a disposal of a segment of a business. That means that the results of operations of the segment, as well as gains and losses on the sale of assets or settlement of liabilities associated with the segment will be reported in the discontinued operations section of the income statement. Amounts, however, are recognized in the period in which they occur. As a result, no gain or loss would be recognized in 20X3 since operations and the sale will occur in 20X4. Disclosure would be required.
9. AY Since the warehouse fire did not occur until January 5, 20X4, after the balance sheet date, accrual would not be appropriate. The loss, however, represents a subsequent event that affects the amount reported on the balance sheet, requiring that it be disclosed.
10. AN The detaining of the inventory shipment on January 24, 20X4 is a subsequent event relating to a condition that did not exist at the balance sheet date. As a result, accrual would not be appropriate. In addition, since it is likely that Edge will obtain the shipment, it is not likely that a loss will be incurred and disclosure would not be required.
11. AY Issuance of debt after the balance sheet date is a subsequent event relating to a condition that did not exist at the balance sheet date. As a result, accrual would not be appropriate. The issuance of debt after the balance sheet date, but prior to the issuance of the financial statements, would require disclosure.
12. BY Although the IRS assessment occurred after the balance sheet date, it is a subsequent event that relates to a condition that did exist as of the balance sheet date since it relates to a previous tax period. It is a contingency loss that is probable and can be reasonably estimated at $100,000. As a result, it will be accrued and disclosed.

Question 1

On January 2, 20X4, Bing Co. purchased 39,000 shares of Latt Co.'s 200,000 shares of outstanding common stock for $585,000. On that date, the carrying amount of the acquired shares on Latt's books was $405,000. Bing attributed the excess of cost over carrying amount to goodwill. Bing's policy is to evaluate goodwill each period for impairment. As of December 31, 20X4, goodwill has not been impaired.

During 20X4, Bing's president gained a seat on Latt's board of directors. Latt reported earnings of $400,000 for the year ended December 31, 20X4, and declared and paid dividends of $100,000 during 20X4. On December 31, 20X4, Latt's common stock was trading over-the-counter at $15 per share.

Items to be answered

  1. What criteria should Bing consider in determining whether to account for its investment in Latt under the equity method? Is the equity method consistent with accrual accounting? Explain.
  2. Assuming Bing accounts for the investment using the equity method, prepare a schedule of the amounts related to this investment to be reported on Bing's income statement for the year ended 20X4 and the amount in the investment in Latt account in the balance sheet at December 31, 20X4. Show all computations. Disregard income taxes.
  1. The primary criterion that Bing should consider in determining whether or not to use the equity method of accounting for its investment in Latt is whether or not Bing has the ability to exercise significant influence over the operating and financing policies of Latt. It is normally assumed that an investor has the ability to exercise significant influence when ownership is 20% or more. Despite the fact that Bing owns only 19 1/2% of Latt's stock, the fact that Bing's president gained a seat on Latt's board of directors makes it likely that Bing will have the ability to exercise significant influence indicating the equity method of accounting. The equity method of accounting is consistent with the accrual method of accounting since the investor recognizes its proportionate share of the investee's earnings in the period in which they are earned by the investee regardless of the period in which they are distributed.
  2. Bing will report its proportionate share of Latt's earnings as Equity in income of Latt Co. on its income statement. It will be reported as a component of income from continuing operations. Since Bing invested $585,000 for shares that had an underlying book value of $405,000, the difference of $180,000 will be attributed to goodwill, which has not been impaired. As a result, Bing's share of Latt's income will be:
    Latt's reported income $400,000
    Bing's ownership percentage 19 1/2%
    Bing's share of Latt's reported income $78,000

    Bing will report the investment as a long-term investment in the noncurrent asset section of its balance sheet. Under the equity method, the investment is initially recorded at its cost. It is increased by the investor's share of the investee's income and decreased by its share of dividends.

    Initial investment $585,000
    Equity in earnings of Latt Co. (above) 78,000
    $663,000
    Dividends - $100,000 x 19 1/2% 19,500
    Investment at 12/31/X4 $643,500

Question 1

Hamnoff, Inc.'s. $50 par value common stock has always traded above par. During 20X1 Hamnoff had several transactions that affected the following balance sheet accounts:

I. Bond discount
II. Bond premium
III. Bonds payable
IV. Common stock
V. Additional paid-in capital
VI. Retained earnings

Required

For each of the following items, determine whether the transaction Increased, Decreased, or had No effect for each of the items in the chart.

Bond discounts Bond premium Bond payable Common stock Additional paid-in capital Retained earnings
Hamnoff issued bonds payable with a nominal interest rate that was less than the market rate of interest.
Hamnoff issued convertible bonds, for an amount in excess of the bonds' face amount.
Hamnoff issued common stock when the convertible bonds described in item 2. were submitted for conversion. Each $1,000 bond was converted into twenty common shares. The book value method was used for the early conversion.
Hamnoff issued bonds, with detachable stock warrants, for an amount equal to the face amount of the bonds. The stock warrants have a determinable value.
Hamnoff declared and issued a 2% stock dividend.
  1. When bonds are issued with a nominal or stated rate that is below the market rate of interest, the bonds will be issued at a discount resulting in the following journal entry:
    • Cash (proceeds equal to present value of principal and interest payments at market interest rate)
    • Bond discount (difference)
      • Bonds payable (face)

    As a result, bond discount and bonds payable (I & III) increase (I) while all other items (II, IV, V, & VI) remain unchanged (N).

  2. The issuance of convertible bonds is recorded in the same manner as bonds that are not convertible. Since the bonds were issued for an amount in excess of face, the difference is a bond premium and will be recorded with the following entry:
    • Cash (proceeds)
      • Bonds payable (face)
      • Bond premium (difference)

    As a result, bond premium and bonds payable (II & III) increase (I) while all other items (I, IV, V, & VI) remain unchanged (N).

  3. Each $1,000 bond is convertible into 20 shares of $50 par common stock indicating that the par value of the stock will equal the face amount of the bonds. Since the bonds were issued at a premium, the carrying value of the bonds exceeds the par value of the stock indicating that the excess will be recognized as additional paid-in capital. The entry would be:
    • Bonds payable (face)
    • Bond premium (unamortized balance)
      • Common stock (par)
      • Additional paid-in capital (difference)

    As a result, bond premium and bonds payable (II & III) decrease (D), common stock and additional paid-in capital (IV & V) increase (I), and the remaining items (I & VI) remain unchanged (N).

  4. When bonds are issued with detachable stock purchase warrants, a portion of the proceeds is allocated to the warrants, which will be recorded in additional paid-in capital.. Since the entire proceeds are equal to the face value of the bonds and a portion is being allocated to the warrants, the portion allocated to the bonds is less than the face amount indicating a discount. The entry would be:
    • Cash (proceeds)
    • Bond discount (difference)
      • Bonds payable (face)
      • Additional paid-in capital (amount allocated to warrants)

    As a result, bond discount, bonds payable, and additional paid-in capital (I, III, & V) increase (I) while the other items (II, IV, & VI) remain unchanged (N).

  5. A stock dividend decreases retained earnings for the fair market value of the stock. Since the stock is trading at an amount that is greater than the par value, the excess is recognized as additional paid-in capital. The entry would be:
    • Retained earnings (fair value of stock)
      • Common stock (par)
      • Additional paid-in capital (difference)

    As a result, common stock and additional paid-in capital (IV & V) increase (I), retained earnings (VI) decreases (D), and the other items (I, II, & III) remain unchanged (N).

Question 1

Min Co. is a publicly held company whose shares are traded in the over-the-counter market. The stockholders' equity accounts at December 31, 20X1, had the following balances:

Preferred stock, $100 par value, 6% cumulative; 5,000 shares authorized; 2,000 issued and outstanding $200,000
Common stock, $1 par value, 150,000 shares authorized; 100,000 issued and outstanding 100,000
Additional paid-in capital 800,000
Retained earnings 1,586,000
Total stockholders' equity $2,686,000

Transactions during 20X2 and other information relating to the stockholders' equity accounts were as follows

  • February 1, 20X2 - Issued 13,000 shares of common stock to Ram Co. in exchange for land. On the date issued, the stock had a market price of $11 per share. The land had a carrying value on Ram's books of $135,000, and an assessed value for property taxes of $90,000.
  • March 1, 20X2 - Purchased 5,000 shares of its own common stock to be held as treasury stock for $14 per share. Min uses the cost method to account for treasury stock. Transactions in treasury stock are legal in Min's state of incorporation.
  • May 10, 20X2 - Declared a property dividend of marketable securities held by Min to common shareholders. The securities had a carrying value of $600,000; fair value on relevant dates were
    Date of declaration (May 10, 20X2) $720,000
    Date of record (May 25, 20X2) 758,000
    Date of distribution (June 1, 20X2) 736,000
  • October 1, 20X2 - Reissued 2,000 shares of treasury stock for $16 per share.
  • November 4, 20X2 - Declared a cash dividend of $1.50 per share to all common shareholders of record November 15, 20X2. The dividend was paid on November 25, 20X2.
  • December 20, 20X2 - Declared the required annual cash dividend on preferred stock for 20X2. The dividend was paid on January 5, 20x3.
  • January 16, 20x3 - Before closing the accounting records for 20X2, Min became aware that no amortization had been recorded for 20X1 for a patent purchased on July 1, 20X1. Amortization expense was properly recorded in 20X2. The patent was properly capitalized at $320,000 and had an estimated useful life of eight years when purchased. Min's income tax rate is 30%. The appropriate correcting entry was recorded on the same day.
  • Adjusted net income for 20X2 was $838,000.

Calculate the following amounts to be reported on Min's financial statements at December 31, 20X2.

Amount
1. Prior period adjustment, 20X2
2. Preferred dividends, 20X2
3. Common dividends-cash, 20X2
4. Common dividends-property, 20X2
5. Number of common shares issued at December 31, 20X2
6. Amount of common stock issued
7. Additional paid-in capital, including treasury stock transactions
8. Treasury stock

Items 9 and 10 represent other financial information for 20X1 and 20X2.

Amount
9. Book value per share at December 31, 20X1, before prior period adjustment
10. Numerator used in calculation of 20X2 earnings per share for the year

Because of the format of this question, the most effective approach is to first scan the information provided to familiarize yourself with what is available. Next evaluate each requirement and find the information that is relevant to it.

  1. ($14,000) A prior period adjustment would be appropriate for recording a correction of an error. In this case, an error was discovered in that an intangible with a limited useful life was not amortized in the previous year. Annual amortization will be the cost of the asset divided by its useful life ($320,000/8) or $40,000 per year. Since the intangible was acquired on July 1, only 1/2 year's amortization, $20,000, will be recognized. The adjustment will be a credit to the intangible, or accumulated amortization, for $20,000. The tax effect of ($20,000 x 30%) $6,000 will be recognized as a debit to taxes receivable, if the correction is also being made for tax purposes, or a deferred tax asset or liability if not. The remainder of $14,000 is the prior period adjustment, recorded as a reduction to beginning retained earnings.
  2. ($12,000) The facts indicate that the required annual preferred dividend was declared on December 20 and paid the following January 5. The dividend will be calculated as a percentage of par value. Since the 6% preferred stock has a total par value of $200,000, the preferred dividend is ($200,000 x 6%) $12,000.
  3. ($165,000) A cash dividend of $1.50 per common share was declared on November 4, to shareholders of record on November 15. Dividends are not paid on treasury shares and the dividend will be calculated on the basis of the number of shares issued and outstanding on November 15. There were 100,000 shares outstanding at the beginning of the year. On February 1, 13,000 shares were issued, on March 1, 5,000 treasury shares were acquired, and on October 1, 2,000 of the treasury shares were reissued. As a result, there were (100,000 + 13,000 - 5,000 + 2,000) 110,000 shares outstanding on November 15, resulting in a cash dividend to common stockholders of (110,000 x $1.50) $165,000.
  4. ($720,000) Property dividends are recognized at an amount equal to the fair value of the property on the declaration date. If the fair value differs from the carrying value, a gain or loss on disposal is recognized for the difference. The property dividend was declared on May 10, at which time the fair value of the property, and the amount of the dividend, was $720,000.
  5. (113,000) The number of shares issued does not take into account treasury stock. As a result, the 100,000 shares issued at the beginning of the year would be increase by the 13,000 issued on February 1, for a total of 113,000. The 5,000 treasury shares purchased and the 2,000 resold affect shares outstanding but not shares issued.
  6. ($113,000) The amount reported for common stock issued would be the number of shares issued multiplied by the par or stated value per share. There were a total of 113,000 shares issued, including the 100,000 issued at the beginning of the year and the 13,000 issued on February 1. At a par value of $1 per share, the amount of common stock is (113,000 x $1) $113,000.
  7. ($934,000) To determine the total APIC, each transaction will have to be analyzed. The beginning balance of APIC is $800,000. The 13,000 shares issued for land on February 1 would be recognized at their fair value of $11 per share, including $10 per share, or $130,000 APIC. Under the cost method, the purchase of treasury shares does not affect APIC, but the subsequent resale of 2,000 shares does. The shares cost $14 per share, or $28,000, and they were resold for $16 per share or $32,000. The difference of $4,000 would be recognized in APIC. The resulting total is ($800,000 + $130,000 + $4,000) $934,000.
  8. ($42,000) As a result of the purchase of 5,000 shares of treasury stock on March 1, and the resale of 2,000 shares on October 1, there are 3,000 shares in the treasury at December 31. Under the cost method, they are recognized at their cost of $14 per share or $42,000.
  9. ($24.86) The total book value of common stock is equal to total stockholders' equity minus amounts attributable to preferred shareholders. The book value per share is that amount divided by the number of common shares outstanding at the end of the period. Since there is no liquidation preference for preferred stock and cumulative dividends were apparently not in arrears, the only portion of stockholders' equity that is attributable to preferred stockholders is the par value of preferred stock. All remaining accounts are attributable to the common stockholders. Common stock at the end of year 1 was $100,000, APIC was $800,000, and retained earnings was $1,586,000, for a total of $2,486,000, excluding preferred stock. There were 100,000 shares issued and outstanding, resulting in book value per share of ($2,486,000/100,000) $24.86 per share.
  10. ($826,000) The numerator in the calculation of earnings per share consists of net income attributable to common stockholders. This will be equal to net income minus preferred dividends. In the case on noncumulative preferred stock, preferred dividends include those declared during the period. When it is cumulative, preferred dividends consist of the current dividend, whether declared or not. Adjusted income is given as $838,000. The preferred dividend is $12,000, leaving the difference of $826,000 as net income attributable to common stockholders.

Question 1

The following partially completed worksheet contain Lane Co.'s reconciliation between financial statement income and taxable income for the three years ended April 30, 20x3, and additional information.

Lane Co. INCOME TAX WORKSHEET For the Three Years Ended April 30, 20x3

April 30, 20X1 April 30, 20X2 April 30, 20x3
Pretax financial income $900,000 $1,000,000 $1,200,000
Permanent differences 100,000 100,000 100,000
Temporary differences 200,000 100,000 150,000
Taxable income $600,000 $800,000 $950,000
Cumulative temporary differences (future taxable amounts) $200,000 $(2) $450,000
Tax rate 20% 25% 30%
Deferred tax liability $40,000 $75,000 $(4)
Deferred tax expense -- (3) --
Current tax expense $(1) -- --

The tax rate changes were enacted at the beginning of each tax year and were not known to Lane at the end of the prior year.

Items to be answered

Items 1 through 4 represent amounts omitted from the worksheet. For each item, determine the amount omitted from the worksheet. Select the amount from the following list. An answer may be used once, more than once, or not at all.

Amount
A. $25,000 H. $135,000
B. $35,000 I. $140,000
C. $45,000 J. $160,000
D. $75,000 K. $180,000
E. $100,000 L. $200,000
F. $112,500 M. $300,000
G. $120,000 N. $400,000
  Specific audit objective (A) (B) (C) (D) (E) (F) (G) (H) (I) (J) (K) (L) (M) (N)
1. Current tax expense for the year ended April 30, 20X1. ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦
2. Cumulative temporary differences at April 30, 20X2. ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦
3. Deferred tax expense for the year ended April 30, 20X2. ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦
4. Deferred tax liability at April 30, 20x3. ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦
  Specific audit objective (A) (B) (C) (D) (E) (F) (G) (H) (I) (J) (K) (L) (M) (N)
1. Current tax expense for the year ended April 30, 20X1. ◦ ◦ ◦ ◦ ◦ ◦ • ◦ ◦ ◦ ◦ ◦ ◦ ◦
2. Cumulative temporary differences at April 30, 20X2. ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ • ◦
3. Deferred tax expense for the year ended April 30, 20X2. ◦ • ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦
4. Deferred tax liability at April 30, 20x3. ◦ ◦ ◦ ◦ ◦ ◦ ◦ • ◦ ◦ ◦ ◦ ◦ ◦

Explanation of solutions

  1. (G) Current income tax expense is always equal to taxable income, given as $600,000, multiplied by the tax rate, also given as 20%, resulting in current taxes of $120,000.
  2. (M) The cumulative temporary differences at 4/30/X2 can be determined in one of two ways. The deferred tax liability is calculated by multiplying the cumulative differences by the tax rate. If there is a deferred tax liability of $75,000 when the rate is 25%, there must be cumulative temporary differences of $300,000 ($300,000 x 25% = $75,000). This can also be determined by adding the $200,000 in temporary differences in the first year to the $100,000 identified in the second year.
  3. (B) Deferred tax expense in any year is measured as the change in the net amount of all deferred tax assets and liabilities. There was a deferred tax liability of $40,000 at 4/30/X1, and $75,000 at 4/30/X2 indicating an increase of $35,000, which will be deferred tax expense.
  4. (H) The deferred tax liability will be equal to the cumulative temporary differences of $450,000 multiplied by the 30% tax rate, resulting in a deferred tax liability of $135,000.

Question 1

Situation

The following information pertains to Sparta Co.'s defined benefit pension plan.

Discount rate 8%
Expected rate of return 10%
Average service life 12 years
At January 1, 20x5:
Projected benefit obligation $600,000
Fair value of pension plan assets 720,000
Unrecognized prior service cost 240,000
Unamortized prior pension gain 96,000
At December 31, 20x5:
Fair value of pension plan assets 825,000

Service cost for 20x5 was $90,000. There were no contributions made or benefits paid during the year. Sparta's unfunded accrued pension liability was $8,000 at January 1, 20x5. Sparta uses the straight-line method of amortization over the maximum period permitted.

Items to be answered:

Calculate the following amounts for Sparta's pension cost for 20x5.

1. ______ Interest cost
2. ______ Expected return on plan assets
3. ______ Actual return on plan assets
4. ______ Amortization of prior service costs
5. ______ Minimum amortization of unrecognized gain

For the following items determine whether the component Increases, Decreases, or has No effect on Sparta's unfunded accrued pension liability.

Increase Decrease No effect
6. Service cost
7. Interest cost
8. Actual return on plan assets
9. Amortization of prior service costs
10. Amortization of unrecognized pension gain
1. $48,000 Interest cost
2. $72,000 Expected return on plan assets
3. $105,000 Actual return on plan assets
4. $20,000 Amortization of prior service costs
5. $2,000 Minimum amortization of unrecognized gain

Explanations:

  1. Interest cost is equal to the beginning PBO of $600,000 multiplied by the discount rate of 8%, which is $48,000.
  2. The expected return on plan assets is equal to the beginning balance in plan assets of $720,000 multiplied by the expected rate of return of 10% to provide an expected return of $72,000.
  3. The actual return on plan assets is the increase of $105,000 during the period ($825,000 - $720,000) after adjusting for contributions made to the plan and benefits paid from the plan, neither of which occurred. As a result, the actual return would be the entire increase of $105,000.
  4. Since Sparta uses straight-line amortization over the maximum period, unamortized prior service costs of $240,000 will be amortized over the expected average service life of covered employees of 12 years resulting in amortization of ($240,000/12) $20,000.
  5. An unrecognized gain is amortized when the amount as of the beginning of the period exceeds 10% of the greater of the beginning PBO or the beginning fair value of plan assets. In this case, the fair value of plan assets was greater at $720,000 vs $600,000. Unrecognized gains of $96,000 exceed 10% of PA of $72,000 by $24,000. This will be amortized over the expected average service life of employees, which is 12 years, resulting in amortization of $2,000 ($24,000/12).

For the following items determine whether the component Increases, Decreases, or has No effect on Sparta's unfunded accrued pension liability.

The unfunded accrued pension liability is the excess of the PBO over the fair value of plan assets. It is increased by pension cost. It is decreased by contributions to the plan and earnings on plan assets. It is not affected by the payment of benefits since that decreases both the PBO and plan assets for the same amount.

Increase Decrease No effect
6. Service cost
7. Interest cost
8. Actual return on plan assets
9. Amortization of prior service costs
10. Amortization of unrecognized pension gain

Explanations:

  1. (I) - Service cost increases pension cost, so that would also increase unfunded accrued pension liability.
  2. (I) - Interest cost increases pension cost, so that would also increase unfunded accrued pension liability.
  3. (D) - Actual return on plan assets decreases pension cost, but this is netted with the deferred gain to get the expected return on plan assets.
  4. (I) - Amortization of PSC increases pension cost since we are increasing employee benefits, this increases our cost or pension expense for the period.
  5. (D) - The amortization of the unrecognized pension gain would decrease pension cost for the period since we are now using up our gain and amortizing it into the pension cost. If we had to amortize a loss, that however would increase our pension cost.

Question 1

Required

Situation

On January 2, 20X1, Elsee Co. leased equipment from Grant, Inc. Lease payments are $100,000, payable annually every December 31 for twenty years. Title to the equipment passes to Elsee at the end of the lease term. The lease is noncancellable.

  • The equipment has a $750,000 carrying amount on Grant's books. Its estimated economic life was twenty-five years on January 2, 20X1.
  • The rate implicit in the lease, which is known to Elsee, is 10%. Elsee's incremental borrowing rate is 12%.
  • Elsee uses the straight-line method of depreciation.

The rounded present value factors of an ordinary annuity for twenty years are as follows:

12% 7.5
10% 8.5

Items to be answered:

Prepare the necessary journal entries, without explanations, to be recorded by Elsee for

  1. Entering into the lease on January 2, 20X1.
  2. Making the lease payment on December 31, 20X1.
  3. Expenses related to the lease for the year ended December 31, 20X1.
  4. Making the lease payment on December 31, 20X2.

At 1/2/X1, the inception of the lease, Elsee will record the lease as a capital lease since title transfers (TT), but they could also qualify since lease term of 20 years and the useful life of 25 years equals 20/25 = 80%, which is > 75% of useful life. Elsee then records both an asset and a liability equal to the present value of the minimum lease payments. The present value will be based on the 10% rate implicit in the lease since it is lower than Elsee's incremental borrowing rate of 12% and the rate implicit in the lease is known to Elsee. The present value will be $100,000 x 8.5 or $850,000.

Leased equipment 850,000
Lease liability 850,000
Incremental Lease Liability   x Implicit Interest Rate   = Interest expense/income   - Amortization Of Lease Payment  = Lease Liability
850,000 10% 85,000 100,000 15,000
(15,000)
835,000 10%    = 83,500    - 100,000    = 16,500
(16,500)
818,500 10%

The payment was then made on 12/31/X1 at the end of the year. As a result, it will be allocated to both principal and interest.

Lease liability 15,000
Interest expense 85,000
Cash 100,000

At December 31, 20X1, depreciation will be recognized. Even though the lease is only for a 20 year period, title transfers to Elsee at the end of the lease term. As a result, Elsee will depreciate the asset over its economic life of 25 years. Annual depreciation will be $850,000 / 25 years or $34,000.

Depreciation expense 34,000
Accumulated depreciation 34,000

The payment on 12/31/X2 will be recorded as follows, using the amounts from the table:

Lease liability 16,500
Interest expense 83,500
Cash 100,000

Question 1

Situation

The following is a condensed trial balance of Probe Co., a publicly held company, after adjustments for income tax expense.

Probe Co. CONDENSED TRIAL BALANCE

12/31/X10 Balances Dr. (Cr.) 12/31/X9 Balances Dr. (Cr.) Net change Dr. (Cr.)
Cash $484,000 $817,000 $(333,000)
Accounts receivable, net 670,000 610,000 60,000
Property, plant, and equipment 1,070,000 995,000 75,000
Accumulated depreciation (345,000) (280,000) (65,000)
Dividends payable (25,000) (10,000) (15,000)
Income taxes payable (60,000) (150,000) 90,000
Deferred income tax liability (63,000) (42,000) (21,000)
Bonds payable (500,000) (1,000,000) 500,000
Unamortized premium on bonds (71,000) (150,000) 79,000
Common stock (350,000) (150,000) (200,000)
Additional paid-in capital (430,000) (375,000) (55,000)
Retained earnings (185,000) (265,000) 80,000
Sales (2,420,000)
Cost of sales 1,863,000
Selling and administrative expenses 220,000
Interest income (14,000)
Interest expense 46,000
Depreciation 88,000
Loss on sale of equipment 7,000
Gain on redemption of bonds (90,000)
Income tax expense 105,000 _____ _____
$0 $0 $195,000

Additional Information

  • During 20X10 equipment with an original cost of $50,000 was sold for cash, and equipment costing $125,000 was purchased.
  • On January 1, 20X10, bonds with a par value of $500,000 and related premium of $75,000 were redeemed. The $1,000 face value, 10% par bonds had been issued on January 1, 20X1, to yield 8%. Interest is payable annually every December 31 through 20X20.
  • Probe's tax payments during 20X10 were debited to Income Taxes Payable. Probe recorded a deferred income tax liability of $42,000 based on temporary differences of $120,000 and an enacted tax rate of 35% at December 31, 20X9; prior to 20X9 there were no temporary differences. Probe's 20X10 financial statement income before income taxes was greater than its 20X10 taxable income, due entirely to temporary differences, by $60,000. Probe's cumulative net taxable temporary differences at December 31, 20X10, were $180,000. Probe's enacted tax rate for the current and future years is 35%.
  • 60,000 shares of common stock, $2.50 par, were outstanding on December 31, 20X9. Probe issued an additional 80,000 shares on April 1, 20X10.
  • There were no changes to retained earnings other than dividends declared.

Items to be answered:

Part A

For each transaction in items 1 through 6 two responses are required:

  • Determine the amount to be reported in Probe's 20X10 statement of cash flows prepared using the direct method.
  • Select from the list the appropriate classification of the item on the statement of cash flows.
O Operating
I Investing
F Financing
S Supplementary information
N Not reported on Probe's statement of cash flows
Amount Classification of Activity
1. Cash paid for income taxes
2. Cash paid for interest
3. Redemption of bonds payable
4. Issuance of common stock
5. Cash dividends paid
6. Proceeds from sale of equipment
Amount Classification of Activity
1. Cash paid for income taxes 174,000 Operating Activity (Supplementary Info if Indirect method)
2. Cash paid for interest 50,000 Operating Activity (Supplementary info if indirect method)
3. Redemption of bonds payable 485,000 Financing Activity
4. Issuance of common stock 255,000 Financing Activity
5. Cash dividends paid 65,000 Financing Activity
6. Proceeds from sale of equipment 20,000 Investing

Explantations:

  1. Cash paid for income taxes can be calculated as follows:
    • Income tax expense is $105,000.
    • There is a $90,000 decrease in income taxes payable, indicating that the entity paid $90,000 in addition to the current expense.
    • Deferred income taxes payable increased by $21,000, indicating that this portion of income tax expense was not actually paid.
    • As a result, payments for income taxes are $105,000 + $90,000 - $21,000 = $174,000
  2. Cash paid for interest can be calculated as follows:
    • Interest expense is $46,000
    • The unamortized premium on bonds decreased by $79,000, of which $75,000 was eliminated due to the redemption of bonds, indicating amortization of $4,000
    • Amortization of bond premium decreases interest expense and should be added back to determine interest payments
    • As a result, payments for interest are $46,000 + $4,000 = $50,000
  3. The payment for the redemption on bonds payable can be calculated as follows:
    • On the date of redemption, the bonds had a face value of $500,000 and unamortized premium of $75,000, resulting in a carrying value of $575,000.
    • The bonds were redeemed at a gain of $90,000, indicating that it cost the company less than their carrying value to redeem them.
    • As a result, the payment to redeem the bonds would be $575,000 - $90,000 = $485,000
  4. The proceeds from issuance of common stock can be calculated as follows:
    • The company issued 80,000 shares of $2.50 par value common stock, which has a total par value of $200,000, the increase to common stock.
    • There was an increase in additional paid-in capital of $55,000 and, since there is no indication of any other stock related transactions, it must have been derived from the issuance of the common stock.
    • As a result, proceeds from the sale of the stock would be $200,000 |+ $55,000 = $255,000
  5. Payments for dividends can be calculated as follows:
    • The $80,000 decrease in retained is indicated as being entirely due to the declaration of dividends.
    • Dividends payable increased by $15,000, indicating that the entity paid $15,000 less than the amount declared.
    • As a result, payments for dividends were $80,000 - $15,000 = $65,000
  6. Proceeds from the sale of equipment can be calculated as follows:
    • The cost of the equipment sold was $50,000
    • Depreciation expense for the period was $88,000, but the increase in accumulated depreciation was only $65.000.
    • As a result, the difference of $23,000 represents the accumulated depreciation on the equipment sold.
    • The book value of the equipment sold was, therefore, $50000 - $23,000 = $27,000
    • There was a loss of $7,000 on the sale of equipment, indicating that it was sold for $7,000 less than the book value.
    • As a result, proceeds from the sale of equipment were $27,000 - $7,000 = $20,000

Question 1

Situation

On January 2, 20X2, Quo, Inc. hired Reed to be its controller. During the year, Reed, working closely with Quo's president and outside accountants, made changes in accounting policies, corrected several errors dating from 20X1 and before, and instituted new accounting policies. Quo's 20X2 financial statements will be presented in comparative form with its 20X1 financial statements.

Required:

Items 1 through 10 represent Quo's transactions.

List A represents possible classifications of these transactions as: a change in accounting principle, a change in accounting estimate, a correction of an error in previously presented financial statements, or neither an accounting change nor an accounting error.

List B represents the general accounting treatment for these transactions. These treatments are

  • Retrospective application approach–Apply the new accounting principle to all prior periods presented showing the cumulative effect of the change in the carrying value of assets and liabilities at the beginning of the first period presented, and adjust financial statements presented to reflect period-specific effects of the change.
  • Retroactive restatement approach–Restate the 20X1 financial statements and adjust 20X1 beginning retained earnings if the error or change affects a period prior to 20X1 financial statements.
  • Prospective approach–Report 20X2 and future financial statements on the new basis, but do not restate 20X1 financial statements.

Items to be answered:

For each item, select one from List A and one from List B.

  List A (Select one treatment)   List B (Select one approach)
A. Change in accounting principle. X. Retrospective application approach.
B. Change in accounting estimate. Y. Retroactive restatement approach.
C. Correction of an error in previously presented financial statements. Z. Prospective approach.
D. Neither an accounting change nor an accounting error.
List A Treatment (A) (B) (C) (D) List B Approach (X) (Y) (Z)
1. Quo manufactures heavy equipment to customer specifications on a contract basis. On the basis that it is preferable, accounting for these long-term contracts was switched from the completed-contract method to the percentage-of-completion method. ◦ ◦ ◦ ◦ ◦ ◦ ◦
2. As a result of a production breakthrough, Quo determined that manufacturing equipment previously depreciated over fifteen years should be depreciated over twenty years. ◦ ◦ ◦ ◦ ◦ ◦ ◦
3. The equipment that Quo manufactures is sold with a five-year warranty. Because of a production breakthrough, Quo reduced its computation of warranty costs from 3% of sales to 1% of sales. ◦ ◦ ◦ ◦ ◦ ◦ ◦
4. Quo changed from LIFO to FIFO to account for its finished goods inventory. ◦ ◦ ◦ ◦ ◦ ◦ ◦
5. Quo changed from FIFO to average cost to account for its raw materials and work in process inventories. ◦ ◦ ◦ ◦ ◦ ◦ ◦
6. Quo sells extended service contracts on its products. Because related services are performed over several years, in 20X2, Quo changed from the cash method to the accrual method of recognizing income from these service contracts. ◦ ◦ ◦ ◦ ◦ ◦ ◦
7. During 20X2, Quo determined that an insurance premium paid and entirely expensed in 20X1 was for the period January 1, 20X1, through January 1, 20x3. ◦ ◦ ◦ ◦ ◦ ◦ ◦
8. Quo changed its method of depreciating office equipment from an accelerated method to the straight-line method to more closely reflect costs in later years. ◦ ◦ ◦ ◦ ◦ ◦ ◦
9. Quo instituted a pension plan for all employees in 20X2 and adopted the accounting standards related to pensions. Quo had not previously had a pension plan. ◦ ◦ ◦ ◦ ◦ ◦ ◦
10. During 20X2, Quo increased its investment in Worth, Inc. from a 10% interest, purchased in 20X1, to 30%, and acquired a seat on Worth's board of directors. As a result of its increased investment, Quo changed its method of accounting for investment in subsidiary from the cost adjusted for fair value method to the equity method. Quo did not elect to use the fair value method to report its 30% investment in Worth. ◦ ◦ ◦ ◦ ◦ ◦ ◦
List A Treatment (A) (B) (C) (D) List B Approach (X) (Y) (Z)
1. Quo manufactures heavy equipment to customer specifications on a contract basis. On the basis that it is preferable, accounting for these long-term contracts was switched from the completed-contract method to the percentage-of-completion method. • ◦ ◦ ◦ • ◦ ◦
2. As a result of a production breakthrough, Quo determined that manufacturing equipment previously depreciated over fifteen years should be depreciated over twenty years. ◦ • ◦ ◦ ◦ ◦ •
3. The equipment that Quo manufactures is sold with a five-year warranty. Because of a production breakthrough, Quo reduced its computation of warranty costs from 3% of sales to 1% of sales. ◦ • ◦ ◦ ◦ ◦ •
4. Quo changed from LIFO to FIFO to account for its finished goods inventory. • ◦ ◦ ◦ • ◦ ◦
5. Quo changed from FIFO to average cost to account for its raw materials and work in process inventories. • ◦ ◦ ◦ • ◦ ◦
6. Quo sells extended service contracts on its products. Because related services are performed over several years, in 20X2, Quo changed from the cash method to the accrual method of recognizing income from these service contracts. ◦ ◦ • ◦ ◦ • ◦
7. During 20X2, Quo determined that an insurance premium paid and entirely expensed in 20X1 was for the period January 1, 20X1, through January 1, 20x3. ◦ ◦ • ◦ ◦ • ◦
8. Quo changed its method of depreciating office equipment from an accelerated method to the straight-line method to more closely reflect costs in later years. ◦ • ◦ ◦ ◦ ◦ •
9. Quo instituted a pension plan for all employees in 20X2 and adopted the accounting standards related to pensions. Quo had not previously had a pension plan. ◦ ◦ ◦ • ◦ ◦ •
10. During 20X2, Quo increased its investment in Worth, Inc. from a 10% interest, purchased in 20X1, to 30%, and acquired a seat on Worth's board of directors. As a result of its increased investment, Quo changed its method of accounting for investment in subsidiary from the cost adjusted for fair value method to the equity method. Quo did not elect to use the fair value method to report its 30% investment in Worth. ◦ ◦ ◦ • ◦ • ◦

Explanation of solutions

  1. (A, X) A change in the method of accounting for a long-term construction contract is a change in accounting principle and is given retrospective treatment.
  2. (B, Z) A change in the useful life of a depreciable asset is a change in accounting estimate that is accounted for prospectively.
  3. (B, Z) A change in the estimated cost of fulfilling a warranty obligation is a change in accounting estimated that is accounted for prospectively.
  4. (A, X) A change from LIFO to FIFO is a change in accounting principle that is given retrospective treatment.
  5. (A, X) A change from FIFO to average cost is a change in accounting principle that is given retrospective treatment.
  6. (C, Y) A change from the cash method to the accrual method for recognizing income is a change from an unacceptable accounting principle to an acceptable one. It is considered a correction of an error and requires restatement of prior period financial statements.
  7. (C, Y) Recognizing the entire 2 year premium as an expense in the first year is an error. A correction of an error is accounted for by retroactively restating prior period financial statements.
  8. (B, Z) A change in the method of calculating deprecation is a change in accounting principle that cannot be distinguished from a change in accounting estimate. As a result, it is accounted for as a change in accounting estimate and is applied prospectively.
  9. (D, Z) When a company adopts a new accounting principle for a transaction that is new or unlike previous transactions, it is not considered an accounting change but rather the establishment of an accounting policy. It is neither an accounting change nor an error but it is accounted for by applying the approach prospectively to the current and future periods.
  10. (D, Y) An increase in ownership from 10% to 30%, coupled with acquiring a seat on the board of directors gives the company the ability to exercise significant influence over the investee and would require a change from the cost method to the equity method. This would not be considered an accounting change or a correction of an error. Requirements under ASC 323 indicate that when an investment qualifies for the equity method, it is to be applied retroactively and prior period financial statements are to be restated.