Exam 4 ACC 305

Most common loss contingencies include

litigation, claims, and assessments Guarantee and warranty costs

a company issues $15,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2020. Interest is paid on June 30 and December 31. The proceeds from the bonds are $14,703,108. Using effective-interest amortization, what will the carrying value of the bonds be on December 31, 2020 balance sheet?

$14,709,481 15M x 7.8% x 6/12=585,000 14,703,108 x 8% x 6/12=588,124.32 588,124.32-585,000=3124.32 14,703,108 + 3,124.32=14,706,232.32 14,706,232.32 x 8% x 6/12=588,249.29 588,249.29 - 585,000=3249.29 14,706,232.32 + 3249.29=14,709,481.61

Effective interest rate method is used to compute the amortization of a discount or premium

(Carrying value of bonds at beginning of period x market interest rate)- (face amount of bonds x stated interest rate) =Amortization amount

Times Interest Earned

(Net Income + Interest Expense + Income Tax Expense) / Interest Expense Indicates the company's ability to meet interest payments as they come due

Acid-test (quick) ratio

(cash + short-term investments + accounts receivable (net)) / current liabilities Is a better indicator of current liability coverage because it excludes inventories and prepaid

Common Stock

-Bears ultimate risk of loss -Receives ultimate benefits of success -No guarantee of dividends or assets -Voting rights

Preferred Stock

-No voting rights -Preference for dividends and asset liquidation

Values of stock issued:

-Par value stock - No par stock - Stock issued with other securities (Lump-sum transactions) -Stock issued in non cash transactions

Litigation, Claims, or Assessments are recorded depending on

-Time period in which action occurred -Probability of an unfavorable outcome -Ability to make a reasonable estimate of loss -Amount accrued is the smallest amount estimable

Exclude maturing portion of long-term debt from current liabilities if BOTH conditions are met

1. The liability is contractually due to be settled more than one year after the balance sheet date 2. The entity has contractual right to defer settlement of the liability for at least one year after the balance sheet date

If state rate is 8%

6% is premium 8% is par value 10% is discount

Soundgarden Company sold 200 color laser copiers on July 10, 2020, for $4,000 a piece, together with a 1-yearwarranty. Maintenance on each copier during the warranty period is estimated to be $330.Prepare entries to record the sale of the copiers, the related warranty costs, and any accrual on December31, 2020. Actual warranty costs (inventory) incurred in 2020 were $17,000.

7/10/2020 Dr.Cash (200 X $4,000) 800,000 Cr.Sales Revenue 800,000 During 2020 Dr.Warranty Expense 17,000 Cr.Inventory 17,000 12/31/2020 Dr.Warranty Expense 49,000 Cr.Warranty Liability 49,000* (*$66,000 - $17,000)

contingency

A contingency is defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur.

contingent liability

A contingent liability is a liability incurred as a result of a loss contingency

Under what conditions of bond issuance does a discount on bonds payable arise? Under what conditions of bond issuance does a premium on bonds payable arise?

A discount on bonds payable results when investors demand a rate of interest higher than the rate stated on thebonds. The investors are not satisfied with the nominal interest rate because they can earn a greater rate onalternative investments of equal risk. They refuse to pay par for the bonds and cannot change the nominal rate.However, by lowering the amount paid for the bonds, investors can alter the effective rate of interest. A premiumon bonds payable results from the opposite conditions. That is, when investors are satisfied with a rate of interestlower than the rate stated on the bonds, they are willing to pay more than the face value of the bonds in order toacquire them, thus reducing their effective rate of interest below the stated rate.

Bond Premiums are

Additions to the face value of a bond Considered a liability account

Employee-Related Liabilities

Amounts owed to employees for salaries or wages are reported as a current liability. Payroll deductions, compensated absences, bonuses

Contributed capital contains

Capital stock additional paid in capital other comprehensive income LESS: T-Stock

Bond v. Long term notes payable

Both have fixed maturity dates and have a stated or implicit interest rate A note is valued at the present value of its future interest and principal cash flows Company amortizes any discount or premium over the life of the note

Par Value Stock

Can be issued as common or preferred Paid- In Capital in Excess of par or Par=Additional Paid- In Capital (APIC) Helps companies avoid continent liabilities

When a company enters into what is referred to as off balance sheet financing, the company

Can enhance the quality of the balance sheet and permits credit to be obtained more readily and at less cost

Special-Purpose Entity (SPE)

Created to take on ad -hoc protects such as new plant construction

Distinguish between a current liability and a long-term debt.

Current liabilities are obligations whose liquidation is reasonably expected to require use of existing resourcesproperly classified as current assets, or the creation of other current liabilities. Long-term debt consists of allliabilities not properly classified as current liabilities

Compensated Absence Example: Amutron Inc. employs 10 individuals and pays each $480 per week. Employees earned 20 unused vacation weeks in 2017. In 2018, the employees used the vacation weeks, but now they each earn $540 per week. Amutron accrues the accumulated vacation pay on December 31, 2017, as follows.

Debit salaries and wages expense: 9600 Credit salaries and wages payable: 9600(480*20) 2018 debit salaries and wages payable: 9600 Debit salaries and wages expense: 1200 Credit: cash: 10,800(540*20)

Buchanan Company issues at par 10-year term bonds with a par value of $800,000, dated January 1, 2020, at 103, and bearing interest at an annual rate of 10 percent payable semiannually on January 1 and July 1, it records the following entry. Assuming straight line amortization of the bond discount, Buchanan records the first semiannual interest payment and the bond discount on July1, 2020, as follows:

Dr. Cash (800,000*.1.03) 824,000 Cr. Premium on bonds payable 24,000 Cr. Bonds payable 800,000 Dr. Interest Expense: 38,800 Dr. Discount on bonds payable (24,000/20) 1,200 Cr. Interest Payable (800,000 * .1 * 6/12) 40,000

Buchanan Company issues at par 10-year term bonds with a par value of $800,000, dated January 1, 2020, at 97, and bearing interest at an annual rate of 10 percent payable semiannually on January 1 and July 1, it records the following entry. Assuming straight line amortization of the bond discount, Buchanan records the first semiannual interest payment and the bond discount on July1, 2020, as follows:

Dr. Cash (800,000*.97) 776,000 Dr. Discount on bonds payable 24,000 Cr. Bonds payable 800,000 Dr. Interest Expense: 41,200 Cr. Discount on bonds payable (24,000/20) 1,200 Cr. Cash (800,000 x .1 x 6/12) 40,000

Lump-Sum Transactions: Incremental Method: (get percentages) Beveridge Corp. issued 300 shares of $10 par value common stock and 100 shares of $50 par value preferred stock for a lump sum of $13,500. Common stock has a market value of $20 per share and preferred stock has a market value of $90 per share

Dr. Cash: 13,500 Cr. Preferred Stock: (100*50) 5,000 Cr. Paid in Capital Excess of Par-Preferred :3,000 Common Stock: (300*10) 3,000 Paid in Capital in Excess of Par-Common: 2,400

Par Value Stock Example: Blue Diamond Corporation issued 300 shares of $10 par value common stock for $4,500. Prepare the journal entry to record the issuance of the shares

Dr. Cash: 4,500 Cr. Common Stock: 3,000 Cr. Paid in Capital in Excess of Par Value: 1,500

Non-Cash Transaction Example: The following illustrates recording the issuance of 10,000 shares fo $10 par value common stock for a patent: Fair Value of Stock is $140,000

Dr. Patents: 140,000 Cr. Common stock: 100,000 Cr. Paid in Capital in Excess of Par-Common: 40,000

No Par Value Stock Example: Video Electronics Corporation is organized with authorized common stock of 10,000 shares without par value. If Video Electronics issues 500 shares for cash at $10 per share, it makes the following entry

Dr.Cash: 5,000 Cr. Common Stock: 5,000

No Par Value Stock

Eliminates confusion of par value v. market value Can be highly taxes and dividend payment is less flexible

reasonably possible

Footnote

Remote

Ignore

When the effective-interest method is used to amortize bond premium or discount, the periodic amortization amount will

Increase if the bonds were issued at wither a discount or a premium

Presenting Long term debt, must disclose:

Nature of liabilities Maturity dates interest rates Call provisions Conversion privelges Restrictions imposed by the creditors Assets designed or pledged as security Fair value

Stock issued in Non-cash transactions

Recorded at either fair value of stock issued or consideration received, whichever is more clearly evident.

actual interest paid to bondholder

Stated Rate x Face Value of the Bond x Time (i=prt)

The currently maturing portion of long-term debt should be classified as a current liability if:

The portion so classified will be liquidated within one year of using current assets

Both the straight line and effective interest method of amortization result in the same total amount of interest expense over the term of the bonds. When annual amounts are materially different, effective interest method is used.

True

Companies should recognize the expense and related liability for compensated absences in the year earned by employees (t/f)

True

Magazine subscriptions and airline ticket sales both result in unearned revenues. (t/f)

True

Off-balance-sheet financing is an attempt to borrow monies in such a way to minimize the reporting of debt on the balance sheet (t/f)

True

Exclude current matures of debt that are:

a. not retired by current assets b. refinanced by new long term debt c. converted into capital stock

Probable

accrue and footnote

Bonuses

amounts paid in addition to regular wages -Operating expense -Unpaid bonuses are current liabilities

What is a contingency?

an existing situation where uncertainty exists as to possible gain or loss that will be resolved when one or more future events occur or fail to occur

Dividends payable

are amounts owed by a corporation to its stockholders as a result of board of directors authorization. paid within 3 month, dividends are NOT liabilities

Payroll deductions

are costs taken from employees paychecks and paid to governmental agencies -Social security taxes: FICA/Medicare -Unemployment taxes:FUTA,SUTA -Income Taxes: Withholding taxes payable -Union Dues:UAW

unearned revenues

are payments received before delivering goods or rendering services Adjusting journal entries done at the end of the reporting period

Customer advances and returnable cash deposits

are received from customers and employees Guarantees performance on a contract or covers payment of future obligations, short term or long term

Guarantee and Warranty Costs

commitments to compensate for deficiencies in quality, quantity, or performance of a product Assurance-type warranty guarantees the product meets agreed upon specifications - Expense cost at the time the product is sold and record a warranty liability Service-type warranty provides a service above and beyond the assurance-type warranty -Recorded as a separate obligation called Unearned Warranty Revenue -Recognize service revenue on a straight line basis over the life of the warranty

Current ratio

current asset/current liabilities Shows how many times a company can cover their current liabilities using their current assets; ideal for 1.0 or better

The ratio of current assets to current liabilities is called the

current ratio

Which of the following is a condition for accruing a liability for the cost of compensation for future absences? a. The obligation relates to the rights that best or accumulate b. payment of the compensation is probable c. The obligation is attributable to employee services already performed. d. All of these are conditions for the accrual

d. All of these are conditions for the accrual

The interest rate written in terms of the bond indenture is known as the a. nominal rate b. stated rate c. coupon rate d. all of the above

d. all of the above

Nominal Rate/Stated rate

he rate set by the party issuing the bonds and expressed as a percentage of the par value; it issynonymous with the stated rate.

Loss contingencies

include possible losses from lawsuits, asset sales, or tax disputes Recorded based on probability of outcome -Probable -Reasonably possible -Remote

gain contingencies

include possible receipts of monies from gifts, donations, or asset sales; refunds from the government in tax dispute; pending court cases with a favorable outcome, and tax loss carry forwards Never record a gain contingency, but we disclose is if probability of receipt is high

The times interest earned is computed by dividing

income before income taxes and interest expense by interest expense

Contingency

is a situation involving uncertainty as to the outcome resulting in a possible loss or gain

Off balance sheet financing

is an attempt to borrow monies in such a way to prevent recording the obligations. -Less debt looks better to potential investors -Loan covenants limite total debt -Because of historical cost principle, asset values may be understated, therefore less reporting of liabilities is necessary

interest recorded by bond issuer

market rate * carrying value of the bond

non-consolidated subsidiary

non reporting of company less than 50% owned

Compensated balances

paid absences for vacation, illness or holidays -service has been rendered -Time off has been vested or accumulated -payment is probable -amount is reasonable estimated

Current maturities of long-term debt

portions of bonds, mortgage notes, and other long term indebtedness that matures within the next fiscal year

Which of the following terms is associated with needing to record a contingent liability possible likely remote probable

probable

Market Rate (yield)

rate of acceptable return in accordance with risk, this is what is normally earned by the bond holder

stated/coupon/nominal rate

rate written on bon indenture, set by the issuer and normally a percentage of the bond face value

Bond discounts are

reductions from the face value of the bond Considered a contra-liability account (not an asset)

Valuing bonds

selling prices are determined by supply and demand, risk, market, and economic conditions Valued at the present value of future cash flows, including both interest and principal

Stock Splits

so not reduce total stockholders equity

Income taxes payable

taxes on business income corporations make period tax payments

What does the acid test ratio inform you about a company

the company's liquidity

Yield Rate/ Market Rate/ Effective Rate

the rate of interest actually earned by the bondholders; it is synonymous with the effective and market rates

Debt to assets ratio

total liabilities / total assets higher ratio means greater financing risk