Intermediate 2 Exam 2
Coupon Rate = Market Rate (issued at Par) Ex: On January 1, Year 1, Majors Company issues a ten-year $1,000,000 face value bond with a coupon rate of 12%, and the prevailing market rate is 12%. Interest payments are made semi-annually on July 1 and December 31 of each year. What does the proceeds equal using financial calculator?
$1,000,000 Note: - N (Periods) = 20 (10 x 2) - Market Rate = 12% / 2 = 6% - Int. Cash paid = $1,000,000 x 12% / 2 = $60,000 PV of principal = $1,000,000 x 0.31180 = $311,800 PV of Interest Payments = $60,000 x 11.46992 = $688,195 $311,800 + $688,195 = $1,000,000
Describe Dividends Payable.
- An amount owed by a corporation to its shareholders - Cash dividends declared (but not paid) are a current liability JE: 1. 12/1 Declaration - Debit: Retained Earnings - Credit: Dividend Payable 2. Date of Record = No JE 3. 2/1 Distribution - Debit: Dividend Payable - Credit: Cash
Describe Customer Advance Payments. What is the JE?
- Payments that companies receive before delivering goods or rendering services - The seller will recognize deferred revenue ( a form of contract liability) for its obligation to transfer goods or services in the future (Ex: subscription service, membership, gift cards, rent, etc.) JE: Debit: Cash Credit: Deferred Revenue (Unearned Revenue) At the point when the seller satisfies its performance obligation. Debit: Deferred Revenue (Unearned Revenue) Credit: Revenue
Describe long-term liabilities.
- over 1 year maturity - liquidated using LT asset or LT liability Common Types of Long-Term Liabilities 1. Bonds payable - borrowing money from multiple parties 2. Notes payable - borrowing money from a single party (Bank)
How are current liabilities typically measured?
- typically measured at face value (maturity value) - does not require separate accounting for interest
Describe Short-term Notes Payable.
- written promises to pay a certain sum of money on a specified future date - May arise from purchases, financing, or other transactions 1. Interest Bearing Note - Explicitly states an interest rate (stated rate) 2. Noninterest-Bearing Note - Interest is implicit because the borrower must pay back an amount greater than the cash received at issuance 3. Lines of credit - a borrowing facility offered to a borrower, in which the lender agrees to make funds available as needed on a short-term basis JE: - Debit: Cash - Credit: Note Payable
1. On December 5, the store received $500 from the Selig Players as a deposit to be returned after certain furniture to be used in stage production was returned on January 15. 2. During December, cash sales totaled $798,000, which includes the 5% sales tax that must be remitted to the state by the fifteenth day of the following month. 3. On December 10, the store purchased for cash three delivery trucks for $120,000. The trucks were purchased in a state that applies a 5% sales tax. Prepare all the journal entries necessary to record the transactions noted above as they occurred and any adjusting journal entries relative to the transactions that would be required to present fair financial statements on December 31. Date each entry. For simplicity, assume that adjusting entries are recorded only once a year on December 31.
1. 12/5 Debit: Cash $500 Credit: Customer Deposit $500 2. 12/31 (Seller) Debit: Cash $798,000 Credit: - Sales Revenue $760,000 - Sales Tax Payable $38,000 (1/15 Revenue JE. Cash = Revenue + Sales Tax. 798,000 = x + 0.05x. 798,000 = 1.05x. x = 760,000) (Revenue = cash received / (1 + tax rate)) 3. 12/10 (Buyer) Debit: Trucks $126,000 Credit: Cash $126,000 Trucks = $120,000(1.05) = 126,000
1. On February 2, the corporation purchased goods from Martin Company for $70,000 subject to cash discount terms of 2/10, n/30. Purchases and accounts payable are recorded by the corporation at net amounts after cash discounts. The invoice was paid on February 26. 2. On April 1, the corporation bought a truck for $50,000 from General Motors Company, paying $4,000 in cash and signing a 1-year, 12% note for the balance of the purchase price. 3. On May 1, the corporation borrowed $83,000 from Chicago National Bank by signing a $92,000 zero-interest-bearing note due 1 year from May 1. 4. On August 1, the board of directors declared a $300,000 cash dividend that was payable on September 10 to stockholders of record on August 31. Make all the journal entries necessary to record the transactions above using appropriate dates.
1. 2/2 Debit: Purchase $68,600 Credit: A/P $68,600 2/26 Debit: - AP $68,600 - Discount Forf. $1,400 Credit: Cash $70,000 2. 4/1 Debit: Truck $50,000 Credit: - Cash $4,000 - N/P $46,000 3. 5/1 Debit: - Cash $83,000 - Discount N/P $9,000 Credit: N/P $92,000 4. 8/1 Debit: Retained Earnings $300,000 Credit: Div. Payable $300,000 8/31 - No JE
Define Accounts payable. What is the usual journal entry?
1. Balances owed to others for goods or services purchased on an open account 2. Generally, these liabilities are recorded upon receipt of the goods or services JE: - Debit: Inventory - Credit: Accounts Payable
What is the cash flow in a typical bond issue over the bond term?
1. Bondholder (Investor) ----> Issue Price ---> Issuing Company (Debtor) 2. Issuing Company (Debtor) -----> Interest payments over bond term + Face value payment at end of the bond term --------> Bondholder (Investor)
What are the possible three scenarios for the issuance of bonds?
1. Bonds Sold at Par - Present value (Bond price) = Face value - Stated rate = Market rate 2. Bonds Sold at Discount - Present value (Bond price) < Face value - Market rate > stated rate 3. Bonds Sold at Premium - Present value (Bond price) > Face Value - Market rate < stated rate
Typical Loss Contingencies Legal Contingencies (Pending Litigation) Companies should accrue loss if:
1. Cause for litigation occurred on or before the end of the fiscal period 2. An unfavorable outcome is probable 3. The amount of loss can be estimated
Describe sales taxes payable. What is the journal entry to record sales and sales taxes payable?
1. Companies collect sales tax from customers and remit it to the proper governmental authority JE: Debit: Cash Credit: -- Sales Revenue -- Sales Tax Payable
Identify the type of Bond: 1. Issued by private and public corporations 2. Issued by governmental entities 3. Supported by a lien on specific assets where bondholders have first claim on the secured assets 4. Backed only by issuer's credit where bondholders are general creditors 5. Mature (pays principal) on a single, specified date 6. Mature (pays principal) on several installment dates 7. Subject to early redemption at the option of the issuer 8. Convertible to equity securities at the option of the bondholders
1. Corporate 2. Municipal 3. Secured 4. Debenture 5. Term 6. Serial 7. Callable (Redeemable) 8. Convertible
Ex: Blues Brothers Inc. is subject to a lawsuit, initiated in the last quarter of Year 1, because of an accident that occurred during Year 1 involving a vehicle owned and operated by the company. Blues Brothers Inc.'s year-end is December 31 and the Year 1 financial statements were issued on March 1 of Year 2. The plaintiff is seeking $100,000 in damages. Provide the information indicated for each of the following separate scenarios. A) Blues Brothers Inc. determines that a reasonable estimate of a probable loss on the settlement of the lawsuit is $50,000, although a settlement had not been reached prior to the issuance of the financial statements. On March 15 of Year 2, the lawsuit was settled in $40,000 cash. Record the required journal entries on December 31 of Year 1 and on March 15 of Year 2.
1. December 31, Year 1 - To accrue for a loss contingency Debit: Loss on Litigation Settlement $50,000 Credit: Estimated Litigation Liability $50,000 2. March 15, Year 2 - To record settlement of loss contingency Debit: Estimated Litigation Liability $50,000 Credit: - Gain on Litigation Settlement $10,000 - Cash $40,000
Several bond features affect the accounting for bonds. On January 1 of Year 1, Randolph Company issues $10,000 of 5% bonds dated January 1 of Year 1. Each of the 10 bonds has a $1,000 face value. The bonds mature in five years on December 31 of Year 5 and pay interest on June 30 and December 31. Five features of the Randolph Company bonds included in the bond indenture do not change over time. What are they?
1. Face Value = $10,000 2. Maturity date = December 31, Year 5 3. Stated Rate = 5% annual rate or 2.5% semiannual interest rate 4. Interest payment dates = June 30 and December 31 5. Bond authorization date = January 1, Year 1
Ex: On January 1 of Year 1, Randolph Company authorizes and issues $10,000, 5% interest-bearing bonds. Each bond has a $1,000 face value. The bonds mature on December 31 of Year 5 and pay interest semiannually on June 30 and December 31. Assume that the market rate for the bonds is 5%, but the bonds are issued on February 1 of Year 1 instead of January 1 of Year 1. 1. Compute the selling price of the bonds and record the entry on February 1 of Year 1 2. Record the first interest payment on June 30 of Year 1
1. February 1, Year 1 - To record bonds sold at par between interest payment dates - Debit: Cash ($10,000 + $42) $10,042 - Credit: -- Bonds Payable $10,000 -- Interest Payable ($10,000 x 5% x 1/12) $42 2. June 30, Year 1 - To record interest payment - Debit: -- Interest Payable $42 -- Interest Expense ($10,000 x 5% x 5/12) $208 - Credit: -- Cash ($10,000 x 5% x 6/12) $250
What is the accounting treatment for a service-type warranty?
1. First, record the entry at the time of the sale: Debit: Cash Credit: Sales Revenue + Unearned Revenue (Deferred Revenue) 2. Recognize revenue on a straight-line basis over the period the service-type warranty is in effect: Debit: Unearned Revenue (Deferred Revenue) Credit: Warranty Revenue
How do you distinguish between an assurance-type warranty and a service-type warranty?
1. If a customer has the option to purchase the warranty separately, the warranty is a service-type warranty 2. The longer the coverage period, the more likely it is that the warranty is a service-type warranty because it is more likely to be providing an additional service 3. If the entity is required by law to provide a warranty, the warranty is typically an assurance-type warranty because it is protecting customers from the risk of purchasing defective products
A liability has two essential characteristics, what are they?
1. It is a present obligation 2. The obligation requires an entity to transfer or otherwise provide economic benefits to others (Economic benefits could be cash, other assets, a service, etc.)
Ex: Blinds Inc. supplies high-end, custom-fit blinds to residential builders. Blinds Inc. collects a $2,000 deposit from a customer on January 1. The deposit will be held by the company until the customer submits payment on the order (this protects the company from order cancellations and nonpayment). The customer fulfills its commitment to fully pay for its order on March 30, and the deposit is released to the customer. Prepare the entries on January 1 and March 30 for Blinds Inc.
1. January 1 - To record cash received for customer deposit Debit: Cash $2,000 Credit: Liability - Returnable Deposit $2,000 2. March 30 - To record the return of the deposit to the customer Debit: Liability - Returnable Deposit $2,000 Credit: Cash $2,000
Ex: On January 1, Nakoma Co. purchases merchandise for resale. The merchandise has an invoice price of $5,000 and terms of 3/10, n/60. The company accounts for inventory using the gross method in a perpetual inventory system and pays the balance in full on January 8. Record the entries on January 1 and January 8.
1. January 1 - To record purchase of inventory Debit: Inventory $5,000 Credit: Accounts Payable $5,000 2. January 8 - To record payment on account within discount period Debit: Accounts Payable $5,000 Credit: - Inventory ($5,000 x 0.03) $150 - Cash ($5,000 x 0.97) $4,850
Ex: On January 8, Nakoma Co. sells merchandise with a sales price of $100 (cost of $80), and sales taxes of 5% to a customer on account (n/25). The company's accounting policy is to record sales taxes payable with each sale. On January 31, the customer pays the balance on account. On April 30, Nakoma Co. remits the sales taxes to taxing authorities. The company uses a perpetual inventory system. Record the company's entries for January 8, January 31, and April 30.
1. January 8 - To record sales and sales taxes payable Debit: Accounts Receivable ($100 + $5) $105 Credit: - Sales Revenue $100 - Sales Taxes Payable $5 2. January 8 - To record cost of sales Debit: Cost of Goods Sold $80 Credit: Inventory $80 3. January 31 - To record payment from customer on account Debit: Cash $105 Credit: Accounts Receivable $105 4. April 30 - To record payment to taxing authorities Debit: Sales Taxes Payable $5 Credit: Cash $5
On January 8, Nakoma Co. sells merchandise with a sales price of $100 (cost of $80), and sales taxes of 5% to a customer on account (n/25). The company's accounting policy is to not separately record sales taxes payable at the point of sale. Record the entries for (1) the sale and cost of sales on January 8 and (2) the adjusting entry on January 31 to identify amounts owed to taxing authorities.
1. January 8 - to record cash collected at the point of sale Debit: Cash $105 Credit: Sales Revenue ($100 x 1.05) $105 2. January 8 - To record cost of sales Debit: Cost of Goods Sold $80 Credit: Inventory $80 3. January 31 - To separately record sales taxes payable Debit: Sales Revenue $5 Credit: Sales Taxes Payable ($100 x 0.05) $5 (To record the portion of the cash collected that pertains to sales revenue, divide the cash collected of $105 by 1 plus the sales tax rate ($105/1.05 = $100 sales revenue). The difference of $5 ($105 - $100) is the sales taxes payable)
For Assurance-type warranty, what are the journal entries for 1. At the time of sale 2. Over the warranty period
1. Journal entries at the time of sale: Debit: Warranty Expense Credit: Warranty Liability 2. Journal entry over the warranty period: Debit: Warranty Liability Credit: (Cash, Inventory (parts), Wages Payable (labor)) - Credit Depends
The Randolph Company bonds are issued on January 1 of Year 1 for $9,573 when the market rate is 6%. Some features of this bond issue depend on market factors, and thus are not specified in the bond indenture and are subject to change. What are they?
1. Market rate = 6% annual rate or 3% semiannual interest rate 2. Bond selling price = $9,573 3. Bond issue date = January 1, Year 1
Looking at the question before: Edwardson Corporation's year-end is December 31. Assuming that no adjusting entries relative to the transactions above have been recorded, prepare any adjusting journal entries concerning interest that are necessary to present fair financial statements on December 31. Assume straight-line amortization of discounts.
1. No AJE 2. 46,000 x 12% x 9/12 = 4,140 Debit: Interest Expense $4,140 Credit: Interest Payable $4,140 3. $9,000 (Discount) x 8/12 = $6,000 Debit: Interest Expense $6,000 Credit: Discount N/P $6,000 4. 9/10 Debit: Dividend Payable $300,000 Credit: Cash $300,000
Ex: On November 1, Luxe Inc. collects an advance payment of $900 from a customer for six months of spa services. Record the company's entry on November 1 and its year-end adjusting entry on December 31.
1. November 1 - To record advance payment Debit: Cash $900 Credit: Deferred Revenue $900 2. December 31 - To recognize revenue (The company reduces its current liability (deferred revenue) for the two months of November and December) Debit: Deferred Revenue $300 Credit: Service Revenue ($900 x 2/6) $300 (Remaining deferred revenue of $600 ($900 - $300) is reported as a current liability on the company's December 31 balance sheet)
The selling price of a bond is equal to the total of the following two components:
1. Present value of the face value (principal) of the bond (calculated using the market rate as the discount rate) 2. Present value of cash interest payments calculated using the market rate as the discount rate (cash interest payments are calculated using the stated rate)
The proper accounting treatment for the loss contingency depends on the likelihood of an uncertain outcome (estimate from managers) relating to an existing condition occurring: Explain.
1. Probable: the future event or events are likely to occur The amount is reasonably estimable? - Yes = Accrue Loss - No = Disclose loss in Footnotes 2. Reasonably Possible: the chance of the future event or events occurring is more than remote but less than likely = Disclose Loss in Footnotes 3. Remote: the chance of the future event or events occurring is slight = N/A (Have the option to provide a footnote disclosure)
Bonds are simply a bundle of three sets of cash flows. What are they?
1. Proceeds = amount the company receives from issuing bonds 2. Principal = amount paid back at maturity 3. Interest payments = payments at regular intervals (typically semi-annual)
Give the two things that warranties can do.
1. Provide an assurance that the product or service will comply with agreed-upon specifications (manufacturer) 2. Provide a service in addition to assurance that the product will comply with agreed-upon specifications (Extended-warranty)
A company can receive cash in the form of a returnable deposit, also called a refundable deposit. What is a customer returnable deposit? What is the JE?
1. Returnable cash deposits received from customers and employees to guarantee future required customer payments, or to compensate for possible damage to property 2. Deposits are reported as current liabilities or long-term liabilities depending on the time involved between the date of deposit and the expected settlement of the obligation JE: 1. Date of Deposit Debit: Cash Credit: Customer Deposit 2. Return Debit: Customer Deposit Credit: Cash
Define current liabilities.
1. an obligation that will be due within one year of the date of the company's balance sheet 2. An obligation whose liquidation is reasonably expected to require the use of existing current assets or the creation of other current liabilities
Ex: Bower Inc. sold its hockey apparel division in December of Year 1. The sale agreement provides for $100 million to be paid to the company at closing plus an amount contingent on sales of apparel over a 12-month period beginning April 1 of Year 2. An estimate of the contingent amount based on Bower's 20 years of experience is $500,000. Record the journal entry on December 31 of Year 1 related to the contingent amount.
A contingent gain is not recorded in financial statements as an asset or as income. This means that the company would record no revenue in Year 1 for the gain contingency.
Describe a Service-Type Warranties.
A service-type warranty is sold separately from the product. - considered to be a separate performance obligation accounted for under revenue recognition and is not considered a loss contingency The cash collected for service-type warranties is recorded initially as deferred revenue and generally recognized as revenue on a straight-line basis over the service contract.
During Year 1, Ward Company introduced a new product carrying a two-year warranty against defects, which is included in the selling price of the product. The estimated warranty costs are 2% of sales within the first 12 months following the sale and 4% in the second 12 months following the sale. Sales and actual warranty expenditures for the years ended December 31 of Year 1 and Year 2 follow. Sales; Actual Warranty Expenditures Year 1: $360,000; $5,400 Year 2: $600,000; $18,000 Total: $960,000; $23,400 a. Record the entries in Year 1 to (1) record actual cash warranty costs and (2) accrue for warranties at year-end. b. At December 31 Year 1, what would Ward report as estimated warranty liability on its balance sheet?
A) 1. Dec. 31 Year 1: To accrue for warranty expense Debit: Warranty Expense $21,600 Credit: Warranty Liability $21,600 ($360,000 x 0.02 + $360,000 x 0.04 = 21,600) 2. Dec. 31 Year 1: To record actual warranty costs Debit: Warranty Liability $5,400 Credit: Cash $5,400 B) $16,200 ($21,600 - $5,400 = $16,200)
During Year 1, Ward Company introduced a new product carrying a three-year warranty against defects, which has a separate purchase price. The company collected $12,000 and $21,000 for this separate warranty in Year 1 and Year 2, respectively. The company uses straight-line recognition of warranty revenue. For simplification, assume that sales occurred at the first of the year. Sales and actual warranty expenditures for the years ended December 31 Year 1 and Year 2 follow: Sales; Actual Warranty Expenditures Year 1: $360,000; $5,400 Year 2: $600,000; $18,000 Total: $960,000; $23,400 A) Record the journal entries for Year 1 and 2 for (1) the sale of the products and warranties on credit, (2) incurred cash warranty costs, and (3) recognition of warranty revenue. B) What liability would be reported on the balance sheet at the end of Year 1 and Year 2?
A) 1. Year 1 to record sale of products and warranties Debit: Accounts Receivable $372,000 Credit: - Sales Revenue $360,000 - Deferred Warranty Revenue $12,000 2. Year 1 to record incurred warranty costs Debit: Warranty Expense $5,400 Credit: Cash $5,400 3. Year 1 To recognize warranty revenue Debit: Deferred Warranty Revenue $4,000 Credit: Warranty Revenue $4,000 ($12,000 / 3 = $4,000) 4. Year 2 To record sale of products and warranties Debit: Accounts Receivable $621,000 Credit: - Sales Revenue $600,000 - Deferred Warranty Revenue $21,000 5. Year 2 To record incurred warranty costs Debit: Warranty Expense $18,000 Credit: Cash $18,000 6. Year 2 to recognize warranty revenue Debit: Deferred Warranty Revenue $11,000 Credit: Warranty Revenue $11,000 B) Current Liabilities - Deferred Warranty Revenue -- Year 1 $8,000 -- Year 2 $18,000 (21,000 - 11,000 + 8,000 = 18,000)
Choice Company buys equipment on October 1, providing as payment a noninterest-bearing note for $52,000 to be paid one year from today. The equipment could be purchased for $47,273 in cash today. Record the entries for Choice Company on the following dates. A) Issuance of the note for the equipment on October 1. B) Adjusting entry on December 31, the company's year-end. Amortize any discount on the note using the straight-line method. C) Payment of the note payable on October 1 of the following year.
A) Debit: - Equipment $47,273 - Discount on Note Payable $4,727 Credit: Note Payable $52,000 (52,000 - 47,273 = $4,727) B) Debit: Interest Expense $1,182 Credit: Discount on Note Payable $1,182 ($4,727 x 3/12 = 1,182) C) Debit: - Note Payable $52,000 - Interest Expense $3,545 Credit: - Cash $52,000 - Discount on Note Payable $3,545 (4,727 - 1,182 = 3,545)
Target Shoppers Inc. reported cash sales of $36,000 for the month of June. Sales taxes payable are recorded at the point of sale. A) Assume that sales are subject to a 6% sales tax. Record the sales entry. B) Now assume that the cash collected on sales includes the 6% sales tax. Record the sales entry. Round your answers to the nearest whole dollar.
A) Debit: Cash $38,160 Credit: - Sales Revenue $36,000 - Sales Taxes Payable $2,160 ($36,000 x 0.06 = $2,160) B) Debit: Cash $36,000 Credit: - Sales Revenue $33,962 - Sales Taxes Payable $2,038 ($36,000 / 1.06 = 33,962. 36,000 - 33,962 = 2,038)
On November 5, a Dune Corporation truck was in an accident with an auto driven by R. Bell. Dune received notice on January 12 of the following year, of a lawsuit for $210,000 in damages for personal injuries suffered by Bell. Dune Corporation's legal counsel believes it is probable that Bell will be awarded an estimated amount in the range between $60,000 and $135,000, and that $90,000 is a better estimate of potential liability than any other amount. Dune's accounting year ends on December 31, and the current calendar year-end financial statements were issued on March 2 of the following year. A) What liability should Dune accrue on December 31? B) How would your answer to (a) change if Dune Corporation's legal counsel believes it is reasonably possible that Bell will be awarded a settlement? C) How would your answer to (a) change if Dune Corporation's legal counsel believes there is only a remote possibilit
A) Amount to accrue = $90,000 B) Amount to accrue = $0 C) Amount to accrue = $0
Recording Interest-Bearing Note Payable Entries On August 31, Pine Company issued a 9-month, 12% note payable to National Bank in the amount of $1,080,000. Interest is due at maturity. Record the entries for Pine Company on the following dates. A) Issuance of the note on August 31. B) Adjusting entry on December 31, the company's year-end. C) Payment of the note payable on May 31 of the following year
A) August 31 Debit: Cash $1,080,000 Credit: Note Payable $1,080,000 B) December 31 Debit: Interest Expense $43,200 Credit: Interest Payable $43,200 (1,080,000 x .12 x 4/12 = 43,200) C) May 31 Debit: - Note Payable $1,080,000 - Interest Payable $43,200 - Interest Expense $54,000 Credit: Cash $1,177,200 (1,080,000 x .12 x 5/12 = $54,000)
Ex: Ocean Inc. rents out vacation units. The company offers its guests access to beach equipment including umbrellas and chairs for a returnable deposit. During March the company collected $5,000 in customer deposits. Deposits forfeited (due to equipment not being returned or damaged) amounted to $500. The cost of the beach equipment is 75% of the deposit amount. It is the company's policy to include beach equipment as inventory unless a deposit is forfeited. Provide summary entries for March for the following transactions. a. Collection of customer deposits b. Return of customer deposits c. Forfeiture of customer deposits. Assume the company received no usable equipment on the forfeited deposits.
A) Collection of Customer Deposits (March - to record collection of customer deposits) Debit: Cash $5,000 Credit: Liability - Returnable Deposit $5,000 B) Return of Customer Deposits (March - To record return of deposits to customer) Debit: Liability - Returnable Deposit $4,500 Credit: Cash ($5,000 - $500) $4,500 C) Forfeiture of Customer Deposits 1. March - to recognize revenue on deposit for forfeiture Debit: Liability - Returnable Deposit $500 Credit: Sales Revenue $500 2. March - to recognize COGS on deposit forfeiture Debit: Cost of Goods Sold (0.75 x $500) $375 Credit: Inventory $375
Ulta Inc. allows each employee to earn 15 paid vacation days each year with full pay. Unused vacation time can be carried over to the next year. If not taken during the next year, unused vacation time is lost. By the end of Year 1, all but 3 of the 30 employees had taken their earned vacation time. The three employees carried over to Year 2 a total of 20 vacation days, which represented Year 1 salary of $12,000. During Year 2, all of these three used their Year 1 vacation carryover; none of them had received a pay rate change from Year 1 until the time they used their carryover. Total cash wages paid: Year 1, $1,400,000; Year 2, $1,480,000. There was no carryover of vacation time earned in Year 2. A) Provide the entry for Ulta Inc. to (1) accrue compensated absences on December 31 of Year 1, and (2) make payment of vacation days in Year 2. Disregard payroll taxes.
A) Dec. 31, Year 1 Debit: Salaries Expense $12,000 Credit: Accrued Compensation $12,000 B) Year 2 Debit: Accrued Compensation $12,000 Credit: Cash $12,000
On January 1 of Year 1, Randolph Company authorizes and issues $10,000 of 5% interest-bearing bonds. The stated rate and market rate are equal (so the bonds were sold at face value). The bonds mature in five years on December 31 and pay cash interest on June 30 and December 31. A) Record the entry for the issuance of bonds on January 1 of Year 1 B) Record the interest payment entry on June 30 of Year 1 C) Record the entry upon maturity of the bonds on December 31 of Year 5. Ignore the final interest payment entry.
A) January 1, Year 1 - To record bonds sold at face value - Debit: Cash $10,000 - Credit: Bonds Payable $10,000 B) June 30, Year 1 - To record interest payment - Debit: Interest Expense $250 - Credit: Cash ($10,000 x 2.5%) $250 C) December 31, Year 5 - To derecognize bonds payable at maturity - Debit: Bonds Payable $10,000 - Credit: Cash $10,000
Manchester Co. operates as a manufacturer of industrial equipment. On March 28, Manchester Co. received an advance payment of $200,000 from a customer on a special order of equipment. On May 1, Manchester Co. prepared an invoice and delivered the equipment to the customer. Total sales price is $800,000 and the remaining balance is due upon delivery of the equipment. A) Record the entry on March 28 for Manchester Co.'s receipt of the advance payment. B) Indicate how the payment would be reported on Manchester's March 31 financial statements. Ignore the cash account. C) Record the entry on May 1 for the sale of the equipment assuming that the advance payment was applied to the balance due. Ignore the cost of goods sold entry.
A) March 28 - Debit: Cash $200,000 - Credit: Deferred Revenue $200,000 B) Balance Sheet Current Liabilities - Deferred Revenue $200,000 C) May 1 Debit: - Cash $600,000 - Deferred Revenue $200,000 Credit: Sales Revenue $800,000
Ex: On October 1 of Year 1, Blues Company signs a $10,600, one-year, noninterest-bearing note when the market rate is 6%. The present value of the note is $10,000, assuming a market rate of 6%. A) Record the entry for the issuance of the note on October 1 of Year 1 B) Record the entry for the accrual of interest on December 31 of Year 1. Amortize the discount on the note using the straight-line method. C) Provide the financial statement presentation related to the note payable on December 31 of Year 1 D) Prepare the entry for the payment of the note on September 30 of Year 2
A) October 1, Year 1 - To record note payable issuance Debit: - Cash $10,000 - Discount on Note Payable ($10,600 - $10,000) $600 Credit: Note Payable (face value of note) $10,600 B) December 31, year 1 - To record accrual of interest Debit: Interest Expense $150 Credit: Discount on Note Payable ($600 x 3/12) $150 C) Financial Statement Presentation 1. Balance Sheet excerpt December 31, Year 1 - Current liabilities -- Note payable, net $10,150 (Net value of the note payable on December 31 of Year 1 is $10,150, which is the face value of the note of $10,600 less the unamortized discount of $450 ($600 - $150)) 2. Income Statement excerpt For Year Ended December 31, Year 1 - Other revenues (expenses) -- Interest expense $(150) D) September 30, Year 2 - To record payment of note Debit: - Note Payable $10,600 - Interest Expense $450 Credit: - Cash $10,600 - Discount on Note Payable ($600 x 9/12) $450
Ex: On October 1 of Year 1, Blues Company borrows $10,000 cash on a one-year note with 6% cash interest payable at the maturity date. The maturity date of the note is one year later on September 30, and the stated rate of 6% equals the market rate. a. Record the entry for the issuance of the note on October 1 of Year 1 b. Record the entry for the accrual of interest on December 31 of Year 1, the company's year-end c. Provide the financial statement presentation related to the note payable on December 31 of Year 1 d. Prepare the entry for the full payment of the note on September 30 of Year 2
A) October 1, year 1 - To record note payable issuance Debit: Cash $10,000 Credit: Note Payable $10,000 B) December 31, Year 1 - To record accrual of interest Debit: Interest Expense $150 Credit: Interest Payable ($10,000 x 0.06 x 3/12) $150 C) Financial Statement Presentation 1. Balance Sheet excerpt December 31, Year 1 - Current liabilities -- Note payable $10,000 -- Interest payable $150 2. Income Statement excerpt For Year Ended December 31, Year 1 - Other revenues (expenses) -- Interest expense $(150) D) September 30, Year 2 - To record payment of note plus interest Debit: - Note Payable $10,000 - Interest Payable $150 - Interest Expense ($10,000 x 0.06 x 9/12) $450 Credit: Cash ($10,000 + [$10,000 x 0.06]) $10,600
Service-Type Warranty Ex: Rollex sells merchandise for $10,000 cash on January 1 but also sells extended 2-year warranties for $50 per product, beginning on January 1. The stand-alone selling price of the merchandise is $10,000 and the stand-alone selling price of the extended warranties is $50 per warranty. Rollex sold 10 extended warranties on January 1 and incurred costs of $200 related to servicing the warranties during the year. A) Record the sale of warranties and merchandise on January 1, ignoring the cost entry for the merchandise B) Record the expenditures for actual warranty costs of $200 during the year C) Record the recognition of warranty revenue on a straight-line basis on December 31
A) Sale of Merchandise and Warranties January 1 - To record sale of merchandise and extended warranties Debit: Cash ($10,000 + ($50 x 10)) $10,500 Credit: - Deferred Warranty Revenue ($50 x 10) $500 - Sales Revenue $10,000 B) Actual Warranty Costs To record warranty service costs incurred Debit: Warranty Expense $200 Credit: Cash $200 C) Recognition of Warranty Revenue December 31 - To recognize warranty revenue Debit: Deferred Warranty Revenue ($500/2) $250 Credit: Warranty Revenue $250
Assurance-Type Warranty Ex: Rollex Company sells merchandise for $200,000 cash during the year. The merchandise includes a two-year warranty against manufacturing defects as part of the selling price of the product. The company's experience has indicated that warranty costs will approximate 0.5% of sales. A) Record the sale of merchandise during the year, ignoring the cost entry B) Record the accrual of warranty costs on December 31. Assume no actual warranty costs were incurred during the year C) Record the expenditures for actual warranty costs of $1,100 in the following year
A) Year 1 - to record sale of merchandise Debit: Cash $200,000 Credit: Sales Revenue $200,000 B) December 31 - To accrue warranty costs Debit: Warranty Expense $1,000 Credit: Warranty Liability ($200,000 x 0.005) $1,000 C) Year 2 - To record warranty services incurred Debit: - Warranty Liability $1,000 - Warranty Expense ($1,100 - $100) $100 Credit: Cash (and other resources used) $1,100
- obligations arising from a company's ongoing operations related to the acquisition of inventories, supplies, and services used in the production and sale of goods or services
Accounts payable
The Occupational Safety and Health Administration (OSHA) is in the process of conducting a workplace inspection at Kenny's Corp. to determine whether the company is in compliance with standards on health and safety in the workplace. While the investigation is currently in process, Kenny's Corp. estimates that it is probable that an assessment will be made. The range of a reasonably possible assessment is between $25,000 and $100,000. How should this potential loss be treated for financial statement purposes?
Accrue potential loss in the income statement = $25,000 (If the best estimate is a range, then accrue the amount at the lower end)
Explain Short-Term Note Payable - Interest-Bearing.
An interest-bearing note payable explicitly states a rate of interest. - debtor receives cash, other assets, or services and pays back the face amount of the note plus cash interest at the stated rate on one or more interest dates
How do businesses finance their operations?
Assets = Liabilities + Stockholders' Equity
Looking at last problem... B) Compute the total amount of salaries expense for Year 1 and for Year 2. C) How would the vacation time carried over from Year 1 affect the December 31 of Year 1 balance sheet?
B) Salaries expense for Year 1 = $1,412,000 Salaries expense for Year 2 = $1,468,000 (Year 1 = 1,400,000 + 12,000) (Year 2 = 1,480,000 - 12,000) C) Balance Sheet Current liabilities - Accrued compensation $12,000
Ex: Blues Company borrowed $500,000 through a 5% note payable dated December 31. Interest is due annually on December 31, and the principal is due annually in $100,000 installment payments, beginning on December 31, one year later. Show the balance sheet presentation for the note payable on December 31.
Balance Sheet - Liabilities -- Current liabilities --- Current payment on note payable (due in one year) $100,000 -- Noncurrent liabilities --- Note payable (less current portion of $100,000) $400,000 (Because $100,000 of the total debt amount is due within the next year, this amount will be classified as current while the remaining amount of $400,000 ($500,000 - $100,000) will be classified as noncurrent)
Ex: Blues Brothers Inc. is subject to a lawsuit, initiated in the last quarter of Year 1, because of an accident that occurred during Year 1 involving a vehicle owned and operated by the company. Blues Brothers Inc.'s year-end is December 31 and the Year 1 financial statements were issued on March 1 of Year 2. The plaintiff is seeking $100,000 in damages. Provide the information indicated for each of the following separate scenarios. D) Blues Brothers Inc. determines that a loss on the lawsuit is remote. Indicate the proper financial statement impact on December 31 of year 1
Because the loss is considered remote, the company is not required to record an entry or disclose information relating to the lawsuit in the Year 1 financial statements - NO JE + NO Disclosure required
- a debt security issued by companies and governmental units to secure large amounts of capital on a long-term basis
Bond
- Earliest date the bonds can be issued and represents the planned date of the issuance
Bond authorization date
- date the bonds are sold to investors
Bond issue date
- price of the bonds paid by the investors on the bond issue date, which is not necessarily the same as the face value
Bond selling price - equals the present value of the periodic cash interest payments and the maturity value
During Year 1, Ward Company introduced a new product carrying a two-year warranty against defects, which is included in the selling price of the product. The estimated warranty costs are 2% of sales within the first 12 months following the sale and 4% in the second 12 months following the sale. Sales and actual warranty expenditures for the years ended December 31 of Year 1 and Year 2 follow. Sales; Actual Warranty Expenditures Year 1: $360,000; $5,400 Year 2: $600,000; $18,000 Total: $960,000; $23,400 c. Record the entries in Year 2 to (1) record actual cash warranty costs and (2) accrue for warranties at year-end. d. At December 31 Year 2, what would Ward report as estimated warranty liability on its balance sheet?
C) 1. Dec. 31 Year 2: To accrue for warranty expense Debit: Warranty Expense $36,000 Credit: Warranty Liability $36,000 (600,000 x 0.02 + 600,000 x 0.04 = $36,000) 2. Dec. 31 Year 2: To record actual warranty costs Debit: Warranty Liability $18,000 Credit: Cash $18,000 D) $34,200 ($36,000 + $16,200 - $18,000 = $34,200)
- requires the lender to lend money up to the credit line limit in exchange for a fee
Committed credit line
Describe Assurance-Type Warranties.
Connected to the sale of the product or service and the warranty is typically included as part of the selling price of the product. - accounted for on an accrual basis and are considered loss contingencies because they relate to existing but unidentified defects in products sold - recognize a warranty expense in the year the product or service is provided, even though repairs or exchanges may take place in later periods
- an existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur
Contingency
What is the accounting treatment for a gain contingency?
Contingent gains are never accrued but may be disclosed in footnotes when the probability that the gain will be realized is HIGH. - Gain should only be recognized in the financial statements when realized
For long-term liabilities, we focus on debt instruments. What do debt instruments provide to a creditor (lender)? What do they provide to a debtor?
Creditor (lender) = provide legally enforceable interest payments, return of principal, and a preferred claim to assets upon corporate liquidation Debtor = debt capital provides an attractive means of financing
- to designate obligations whose liquidation is reasonably expected to require the use of existing resources properly classifiable as current assets, or the creation of other current liabilities
Current liabilities
- payments on long-term debt due in the next accounting period (within 1 year)
Current maturities of long-term debt
What is the Journal Entry for when the loss contingency is probable and the amount is reasonably estimable?
Debit: Loss Contingency Credit: Contingent Liability
Ex: Blues Brothers Inc. is subject to a lawsuit, initiated in the last quarter of Year 1, because of an accident that occurred during Year 1 involving a vehicle owned and operated by the company. Blues Brothers Inc.'s year-end is December 31 and the Year 1 financial statements were issued on March 1 of Year 2. The plaintiff is seeking $100,000 in damages. Provide the information indicated for each of the following separate scenarios. C) Blues Brothers Inc. estimates that a loss on the lawsuit is reasonably possible and the company is not able to reasonably estimate the settlement prior to the issuance of the financial statements. On June 30 of Year 2, the suit was settled in $25,000 cash. Record the required journal entries on December 3 of Year 1 and on June 30 of Year 2.
December 31, Year 1 - No entry is recorded because the loss is reasonably possible and not reasonably estimable, but the company will disclose information relating to the lawsuit in the notes accompanying the financial statements June 30, Year 2 - To record settlement of legal contingency Debit: Loss on Litigation Settlement $25,000 Credit: Cash $25,000
Ex: Blues Brothers Inc. is subject to a lawsuit, initiated in the last quarter of Year 1, because of an accident that occurred during Year 1 involving a vehicle owned and operated by the company. Blues Brothers Inc.'s year-end is December 31 and the Year 1 financial statements were issued on March 1 of Year 2. The plaintiff is seeking $100,000 in damages. Provide the information indicated for each of the following separate scenarios. B) Blues Brothers Inc. estimates that a loss on the lawsuit is probable but the company is not able to reasonably estimate the settlement prior to the issuance of the financial statements. On March 15 of Year 2, the suit was settled in $40,000 cash. Record the required journal entries on December 31 of Year 1 and on March 15 of Year 2.
December 31, Year 1 - No entry is recorded because the loss is not reasonably estimable but the company will disclose information relating to the lawsuit in the notes accompanying the financial statements March 15, Year 2 - To record settlement of legal contingency Debit: Loss on Litigation Settlement $40,000 Credit: Cash $40,000
Describe Gain Contingencies.
Events with an uncertain outcome that may have a material favorable effect on financial position. - Ex: pending court cases with a potentially favorable outcome, possible refund in a tax dispute
What are loss contingencies?
Events with an uncertain outcome that may have a material unfavorable effect on the financial position of an entity. Ex: litigation, warranties, asset retirement obligations, insurance, etc. - loss contingencies can have an impact on periodic financial reporting through accruals of losses or through disclosures
- amount due at bonds' maturity date
Face Value (AKA Principal)
When a disclosure of a loss contingency is required, what does the disclosure include?
Includes the nature of the contingency and an estimate of the loss (or range of loss) or a statement that an estimate is not possible at this time.
- dates the cash interest payments are due (annual or semiannual basis)
Interest payment dates
Ex: On January 1 of Year 1, Randolph Company authorizes and issues $10,000, 5% interest-bearing bonds. Each bond has a $1,000 face value. The bonds mature on December 31 of Year 5 and pay interest semiannually on June 30 and December 31. Compute the selling price of the bonds and record the entry on January 1 of Year 1 for the following scenario: - Market rate for the bonds is 6%
January 1, Year 1 - To record bonds sold at a discount - Debit: -- Cash $9,573 -- Discount on Bonds Payable ($10,000 - $9,573) $427 - Credit: -- Bonds Payable $10,000 Note: - Semiannual market rate = 6% / 2 = 3% - Semiannual periods = 5 x 2 = 10 - Semiannual cash interest payment = 5% / 2 x $10,000 = $250 Financial Calculator - Rate = 3% - NPER = 10 - PMT = 250 - FV = 10,000 = PV $9,573
Ex: On January 1 of Year 1, Randolph Company authorizes and issues $10,000, 5% interest-bearing bonds. Each bond has a $1,000 face value. The bonds mature on December 31 of Year 5 and pay interest semiannually on June 30 and December 31. Compute the selling price of the bonds and record the entry on January 1 of Year 1 for the following scenario: - Market rate for the bonds is 4%
January 1, Year 1 - To record bonds sold at a premium - Debit: Cash $10,449 - Credit: -- Premium on Bonds Payable ($10,449 - $10,000) $449 -- Bonds Payable $10,000 Note: - Semiannual market rate = 4% / 2 = 2% - Semiannual periods = 5 x 2 = 10 - Semiannual cash interest payment = 5% / 2 x $10,000 = $250 Financial Calculator - Rate = 2% - NPER = 10 - PMT = 250 - FV = 10,000 = PV $10,449
Ex: On January 1 of Year 1, Randolph Company authorizes and issues $10,000, 5% interest-bearing bonds. Each bond has a $1,000 face value. The bonds mature on December 31 of Year 5 and pay interest semiannually on June 30 and December 31. Compute the selling price of the bonds and record the entry on January 1 of Year 1 for the following scenario: - Market rate for the bonds is 5%
January 1, Year 1 - To record bonds sold at face value - Debit: Cash $10,000 - Credit: Bonds Payable $10,000 Note: - semiannual market rate = 5% / 2 = 2.5% - semiannual periods = 5 years x 2 = 10 periods - semiannual cash interest payment = 5% / 2 x 10,000 = $250 The present value of the principal and cash interest payments on January 1 of Year 1 is $10,000 because the stated and market rates are equal.
On June 15, Red Buckle Inc. purchased merchandise for resale for $14,400 on credit terms 2/10, n/30. On June 20, Red Buckle paid for the merchandise. Record the entry on June 15 and the entry on June 20 using the perpetual inventory system and the gross method for recording discounts.
June 15 - Debit: Inventory $14,400 - Credit: Accounts Payable $14,400 June 20 - Debit: Accounts Payable $14,400 - Credit: -- Inventory $288 -- Cash $14,112 ($14,400 x .02 = $288)
- probable future sacrifice of economic benefit arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future because of past transactions or events
Liabilities
Regardless of maturity, any liability is current if it is callable by the creditor. What does this mean?
Long-term debt that is callable by the creditor is classified on the balance sheet as SHORT-TERM because the debtor cannot control the payment date. - callable by the creditor because of a violation of the terms of the debt at the date of the balance sheet - Callable by the creditor because a violation was not cured within a specified grace period
- an obligation that does not meet the definition of a current liability, they extend beyond one year from the current balance sheet date or the operating cycle of the debtor (borrower) , whichever is longer
Long-term liabilities
- interest rate on a similar investment in the market involving similar risk and where the issuer has a similar credit rating (stated as an annual rate) (the actual prevailing rate in the open market)
Market rate
- end of the bond term and the due date for the repayment of the face value
Maturity Date
- amounts due to a third party (such as financial lending institution) based upon formal, written agreements with specified terms
Notes Payable (can be current or noncurrent)
Describe current maturities of long-term debt.
Payments on long-term debt (bonds, mortgage) due in the next fiscal period. (within 1 year) - current maturities are generally classified as current liability Excluded from current liabilities if they are to be: - retired by assets other than current assets - Refinanced or retired with the proceeds of new debt issuance - Converted into equity (e.g. common stock)
What is the formula to calculate Proceeds?
Present value of interest payments + present value of the principal payment
A bond represents a formal promise by the issuing company to pay what?
Principal and interest in return for the capital invested.
Coupon Rate < Market Rate (issued at Discount) Ex: On January 1, Year 1, Majors Company issues a ten-year $1,000,000 face value bond with a coupon rate of 10%, and the prevailing market rate is 12%. Interest payments are made semi-annually on July 1 and December 31 of each year. What does the proceeds equal using financial calculator? What is the JE on Issuance?
Proceeds = $885,296 Journal Entry: - Debit: -- Cash $885,296 -- Discount BP $114,704 - Credit: -- Bonds Payable $1,000,000 Notes: - N (Periods) = 20 (10 x 2) - Market Rate = 12% / 2 = 6% - Int. Cash paid = $1,000,000 x 10% / 2 = $50,000 PV of Principal = $1,000,000 x 0.31180 = $311,800 PV of Interest = $50,000 x 11.46992 = $573,496 $311,800 + $573,496 = $885,296 Proceeds $1,000,000 - $885,296 = $114,704 Discount
- interest rate used to determine the cash interest payments, which can be 0% if no cash payments are required (stated as an annual rate) (on bond contract)
Stated Rate
A transaction with a supplier is documented through an invoice with specific amounts and terms. Most supplier invoices do not require interest payments because of the short-term nature of accounts payable. However, a larger number of invoices include a cash discount for early payment. Give examples.
Terms of 2/10, n/30 allow for a 2% discount on purchases paid within 10 days, while the account balance is due in 30 days.
What happens if a bond is not sold on an interest payment date?
The investor will pay the issuer the interest accrued from the most recent payment date to the bond issuance date
If the market rate is greater than the stated rate of the bond, what will happen?
The investors will demand a higher rate of return than the stated (contractual) rate -- Investors will not be satisfied with the periodic cash interest payments on the bond and will counter by paying a lower price for the bond to effectively yield a higher rate of return = discount (difference between lower price and the face value of the bond)
When a company is involved in a legal dispute over an action that took place prior to a company's accounting year-end of December 31. This legal matter will not be settled until after the calendar year-end financial statements are issued in March of the following year. What does this mean?
The litigation is a contingency for purposes of financial reporting for the year. - the definition of a contingency indicates that an uncertain outcome impacts the settlement of an existing condition
Explain Short-Term Note Payable - Noninterest-Bearing.
The present value of future payments (discounted at the market rate) does not equal a note's face value when the stated rate is not equal to the market rate. - Company credits the Note Payable at its face value - Debits Discount on Note Payable (a contra account to note payable)
Unlike a note that is issued to one lender such as a financial institution, bonds are issued....
To multiple lenders
- an informal agreement between a lender and a borrower where the lender makes available short-term funding for temporary needs (such as seasonal funding needs)
Uncommitted credit line
- a guarantee or a commitment by a company selling a product or providing a service, to provide repairs or substitutions in the event that the product or service does not function as planned or intended
Warranty
