Intermediate Financial Accounting III Final Exam

Distinguish between minimum rental payments and minimum lease payments, and indicate what is included in minimum lease payments

Minimum rental payments are the periodic payments made by the lessee and received by the lessor. These payments may include executory costs such as maintenance, taxes, and insurance. Minimum lease payments are payments required or expected to be made by the lessee. They include minimum rental payments less executory costs, a bargain purchase option, a guaranteed residual value, and a penalty for failure to renew the lease. The present value of the minimum lease payments is capitalized by the lessee.

Explain the distinction between a direct-financing lease and a sales-type lease for the lessor

The distinction between a direct-financing lease and a sales-type lease is the presence or absence of a manufacturer's or dealer's profit. A sales-type lease involves a manufacturer's or dealer's profit, and a direct-financing lease does not. The profit is the difference between the fair value of the leased property at the inception of the lease and the lessor's cost or carrying value.

Goofy Inc. bought a sizeable amount of Crazy Co.'s bonds for $150,000 on May 5, 2017, and classified the investment as available for sale. The market value of the bonds declined to $118,000 by December 31, 2017. Goofy reclassified this investment as trading securities in December of 2018 when the market value had risen to $125,000. What effect on 2018 income should be reported by Goofy for the Crazy Co. bonds?

Unrealized holding loss of $32,000 recorded in an allowance during 2017, but not included in the income statement. When the bonds are reclassified in 2018, the $32,000 goes into the income statement. In addition, $7,000 unrealized holding gain for 2018 goes directly to income.

Mays Company has a machine with a cost of $750,000 which also is its fair value on the date the machine is leased to Park Company. The lease is for 6 years and the machine is estimated to have an unguaranteed residual value of $75,000. If the lessor's interest rate implicit in the lease is 12%, the six beginning-of-the-year lease payments would be

[$750,000 - ($75,000 × .50663)] ÷ 4.60478 = $154,623

At December 31, 2017 Raymond Corporation reported a deferred tax liability of $240,000 which was attributable to a taxable temporary difference of $800,000. The temporary difference is scheduled to reverse in 2021. During 2018, a new tax law increased the corporate tax rate from 30% to 40%. Raymond should record this change by debiting

$800,000 × (.40 - .30) = $80,000 Income Tax Expense.

At the beginning of 2018, Pitman Co. purchased an asset for $1,800,000 with an estimated useful life of 5 years and an estimated salvage value of $150,000. For financial reporting purposes the asset is being depreciated using the straight-line method; for tax purposes the double-declining-balance method is being used. Pitman Co.'s tax rate is 40% for 2018 and all future years. At the end of 2018, which of the following deferred tax accounts and balances is reported on Pitman's balance sheet?

($1,470,000 - $1,080,000) × .40 = $156,000 Deferred tax liability.

On January 3, 2017, Moss Company acquires $500,000 of Adam Company's 10-year, 10% bonds at a price of $532,090 to yield 9%. Interest is payable each December 31. The bonds are classified as held-to-maturity. Reference: Ref 17-3 Assuming that Moss Company uses the straight-line method, what is the amount of premium amortization that would be recognized in 2019 related to these bonds?

($532,090 - $500,000) ÷ 10 = $3,209

Wright Co., organized on January 2, 2018, had pretax accounting income of $960,000 and taxable income of $3,120,000 for the year ended December 31, 2018. The only temporary difference is accrued product warranty costs which are expected to be paid as follows: 2019 $720,000 2020 360,000 2021 360,000 2022 720,000 The enacted income tax rates are 35% for 2018, 30% for 2019 through 2021, and 25% for 2022. If Wright expects taxable income in future years, the deferred tax asset in Wright's December 31, 2018 balance sheet should be

($720,000 + $360,000 + $360,000) × 30% = $432,000;$720,000 × 25% = $180,000;$432,000 + $180,000 = $612,000.

Possible disadvantages of leasing:

1. In an ever-increasing inflationary economy, retaining title to assets may be desirable as a hedge against inflation. 2. Interest rates for leasing often are higher and a profit factor may be included in addition. 3. In some cases, owning the asset provides unique tax advantages, such as when bonus depreciation is permitted.

Possible advantages of leasing:

1. Leasing permits the write-off of the full cost of the assets (including any land and residual value), thus providing a possible tax advantage. 2. Leasing may be more flexible in that the lease agreement may contain less restrictive provisions than the bond indenture. 3. Leasing permits 100% financing of assets. 4. Leasing may permit more rapid changes in equipment, reduce the risk of obsolescence, and pass the risk in residual value to the lessor or a third party. 5. Leasing may have favorable tax advantages. 6. Potential of off-balance-sheet financing with certain types of leases.

What are the two objectives of accounting for income taxes?

1. Recognize the amount of taxes payable or refundable for the current year 2. Recognize deferred tax liabilities and assets for the future tax consequences of events already recognized in the F/S or tax returns

Q: Distinguish Between a debt security and an equity security?

A: Debt Security: an instrument representing a creditor relationship with an entity. Examples: US Govt securities, municipal securities, corporate bonds, convertible debt, commercial paper. Note: Trade accounts receivable and loans receivable are not debt securities because they do not meet the definition of security. Equity Security: described as a security representing an ownership interest such as common, preferred, or other capital stock. It also includes rights to acquire or dispose of an ownership interest at an agreed-upon or determinable price, such as warrants, rights, and call options or put options. Note: Convertible debt securities and redeemable preferred stocks are not treated as equity securities

Q: Identify and Explain the 3 types of classifications for investments in debt securities?

A: Held- to-maturity: Debt investments that the company has the positive intent and ability to hold to maturity. Trading: Debt investments bought and held primarily for sale in the near term to generate income on short-term price differences. Available-for-sale: Debt investments not classified as held-to-maturity or trading securities.

Q: When should a debt security be classified as held-to-maturity?

A: Only if the company has both A) positive intent B) ability to hold the securities to maturity

Q: Explain how trading securities are accounted for and reported?

A: Reported at fair value, with unrealized holding gains and losses reported as part of net income. Any discount or Premium is amortized.

Q: What is the cost of long-term investment in bonds?

A: Total consideration to acquire the investment; including brokerage fees and other costs incidental to the purchase.

On August 1, 2018, Dambro Company acquired 1,200, $1,000, 9% bonds at 97 plus accrued interest. The bonds were dated May 1, 2018, and mature on April 30, 2024, with interest paid each October 31 and April 30. The bonds will be added to Dambro's available-for-sale portfolio. The preferred entry to record the purchase of the bonds onAugust 1, 2018 is

Dr. Debt Investments: 1,200 × $1,000 × .97 = $1,164,000Dr. Interest Revenue: $1,200,000 × .09/2 × 3/6 = $27,000Cr. Cash: $1,164,000 + $27,000 = $1,191,000.

Describe the effect of a bargain purchase option on accounting for a capital lease transaction by a lessee

If a bargain-purchase option exists, the lessee must increase the present value of the minimum lease payments by the present value of the option price. A bargain purchase option also affects the depreciable life of the leased asset since the lessee must depreciate the asset over its economic life rather than the term of the lease. If the lessee fails to exercise the option, the lessee will recognize a loss to the extent of the net book value of the leased asset in the period that the option expired.

Lee's Company's current income taxes payable related to its taxable income for 2017 is $320,000. In addition, Lee's deferred tax liability increased $40,000 and its deferred tax asset increased $10,000 during 2017. What is Lee's income tax expense for 2017?

In this case, the increase in the deferred tax liability increased income tax expense by $40,000 and the increase in the deferred tax asset decreased income tax expense by $10,000 Income tax expense for 2017 is therefore $350,000 ($320,000 + $40,000 − $10,000).

On January 1, 2018, Dean Corporation signed a ten-year noncancelable lease for certain machinery. The terms of the lease called for Dean to make annual payments of $220,000 at the end of each year for ten years with the title passing to Dean at the end of this period. The machinery has an estimated useful life of 15 years and no salvage value. Dean uses the straight-line method of depreciation for all of its fixed assets. Dean accordingly accounted for this lease transaction as a capital lease. The lease payments were determined to have a present value of $1,342,016 at an effective interest rate of 8%. With respect to this capitalized lease, Dean should record for 2018

$1,342,016 × .08 = $107,361, $1,342,016 ÷ 15 = $89,468 interest expense of $107,361 and depreciation expense of $89,468.

Differentiate between an originating temporary difference and a reversing difference

An originating temporary difference is the initial difference between book basis and tax basis of an asset or liability A reversing difference occurs when a temporary difference in prior years is eliminated and related tax effect is removed from tax account

Richman Company purchased $1,200,000 of 8%, 5-year bonds from Carlin, Inc. on January 1, 2018, with interest payable on July 1 and January 1. The bonds sold for $1,249,896 at an effective interest rate of 7%. Using the effective interest method, Richman Company decreased the Available-for-Sale Debt Securities account for the Carlin, Inc. bonds on July 1, 2018 and December 31, 2018 by the amortized premiums of $4,248 and $4,392, respectively. Reference: Ref 17-4 At February 1, 2019, Richman Company sold the Carlin bonds for $1,236,000. After accruing for interest, the carrying value of the Carlin bonds on February 1, 2019 was $1,240,500. Assuming Richman Company has a portfolio of available-for-sale debt investments, what should Richman Company report as a gain (or loss) on the bonds?

$1,240,500 - $1,236,000 = ($4,500)

Q:Garfield Company purchased, on January1,2017, as held to maturity investment, $80,000 of the 9%, 5 year bonds of Chester Corporation for $74,086, which provides an 11% return. Prepare Garfield's journal entries for A) the purchase of the investment , and B) the receipt of annual interest and discount amortization. Assume effective interest amortization is used.

A: January 1, 2017 (a) Debt Investments 74,086 Cash 74,08 December 31, 2017 (b) Cash ($80,000 X .09) 7,200 Debt Investments 949 Interest Revenue ($74,086 X .11) 8,149

On January 1, 2018, Sauder Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Sauder to make annual payments of $200,000 at the beginning of each year for five years beginning on January 1, 2018 with the title passing to Sauder at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Sauder uses the straight-line method of depreciation for all of its fixed assets. Sauder accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $833,972 at an effective interest rate of 10%. In 2019, Sauder should record interest expense of

[$633,972 - ($200,000 - $63,397)] × .10 = $49,737.

On December 31, 2018, Kuhn Corporation leased a plane from Bell Company for an seven-year period expiring December 31, 2025. Equal annual payments of $450,000 are due on December 31 of each year, beginning with December 31, 2018. The lease is properly classified as a capital lease on Kuhn's books. The present value at December 31, 2018 of the eight lease payments over the lease term discounted at 10% is $2,640,792. Assuming the first payment is made on time, the amount that should be reported by Kuhn Corporation as the lease liability on its December 31, 2018 balance sheet is

$2,640,792 - $450,000 = $2,190,792

Lyons Company deducts insurance expense of $210,000 for tax purposes in 2018, but the expense is not yet recognized for accounting purposes. In 2019, 2020, and 2021, no insurance expense will be deducted for tax purposes, but $70,000 of insurance expense will be reported for accounting purposes in each of these years. Lyons Company has a tax rate of 40% and income taxes payable of $180,000 at the end of 2018. There were no deferred taxes at the beginning of 2018. What is the amount of the deferred tax liability at the end of 2018?

$210,000 × .40 = $84,000.

On January 1, 2018, Sauder Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Sauder to make annual payments of $200,000 at the beginning of each year for five years beginning on January 1, 2018 with the title passing to Sauder at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Sauder uses the straight-line method of depreciation for all of its fixed assets. Sauder accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $833,972 at an effective interest rate of 10%. In 2018, Sauder should record interest expense of

($833,972 - $200,000) × .10 = $63,397

Q: Identify and explain the different types of classifications for investments in equity securities?

A: Holdings of less than 20%: (fair value method) investor has passive interest. Holdings between 20% and 50%: (equity method) investor has significant influence Holdings more than 50% : (consolidated statements) investor has controlling interest

Cady Salons leased equipment from Smith Co. on January 1, 2018, in an operating lease. The present value of the lease payments discounted at 10% was $80,000. Ten annual lease payments of $12,000 are due at each January 1 beginning January 1, 2018. The amortization of the right-of-use asset for the reporting year ending December 31, 2018, would be:

In an operating lease, the lessee amortizes its right-of-use asset at an amount so that the total of interest expense and amortization will be a straight-line amount equal to the annual payments, $12,000 per year. Interest the first year will be 10% × ($80,000 − 12,000) = $6,800. So, amortization will be $12,000 − 6,800 = $5,200.

Explain the difference between pretax financial income and taxable income

Pretax financial income is reported on the income statement and is often referred to as income before taxes. Taxable income is reported on the tax return and is the amount upon which a company's income taxes payable are computed

Lyons Company deducts insurance expense of $210,000 for tax purposes in 2018, but the expense is not yet recognized for accounting purposes. In 2019, 2020, and 2021, no insurance expense will be deducted for tax purposes, but $70,000 of insurance expense will be reported for accounting purposes in each of these years. Lyons Company has a tax rate of 40% and income taxes payable of $180,000 at the end of 2018. There were no deferred taxes at the beginning of 2018. Reference: Ref 19-5 Assuming that income taxes payable for 2019 is $240,000, the income tax expense for 2019 would be what amount?

$240,000 - ($70,000 × .40) = $212,000.

Landis Company purchased $3,000,000 of 8%, 5-year bonds from Ritter, Inc. on January 1, 2018, with interest payable on July 1 and January 1. The bonds sold for $3,124,740 at an effective interest rate of 7%. Using the effective-interest method, Landis Company decreased the Available-for-Sale Debt Securities account for the Ritter, Inc. bonds on July 1, 2018 and December 31, 2018 by the amortized premiums of $10,620 and $10,980, respectively. Reference: Ref 17-2 At April 1, 2019, Landis Company sold the Ritter bonds for $3,090,000. After accruing for interest, the carrying value of the Ritter bonds on April 1, 2019 was $3,097,440. Assuming Landis Company has a portfolio of Available-for-Sale Debt Securities, what should Landis Company report as a gain or loss on the bonds?

$3,097,440 - $3,090,000 = ($7,440)

On January 1, 2018, Rupar Retailers purchased $100,000 of Anand Company bonds at a discount of $5,000. The Anand bonds pay 6% interest but were purchased when the market interest rate was 7% for bonds of similar risk and maturity. The bonds pay interest semiannually on January 1 and July 1 of each year. Rupar accounts for the bonds as a held-to-maturity investment, and uses the effective interest method. In Rupar's December 31, 2018 journal entry to record the second period of interest, Rupar would record a credit to interest revenue of:

$3336

On October 1, 2017, Wenn Company purchased 800 of the $1,000 face value, 8% bonds of Loy, Inc., for $936,000, including accrued interest of $16,000. The bonds, which mature on January 1, 2024, pay interest semiannually on January 1 and July 1. Wenn used the straight-line method of amortization and appropriately recorded the bonds as available-for-sale. On Wenn's December 31, 2018 balance sheet, the carrying value of the bonds is

$936,000 - $16,000 = $920,000??

On January 2, 2018, Gold Star Leasing Company leases equipment to Brick Co. with 5 equal annual payments of $160,000 each, payable beginning January 2, 2018. Brick Co. agrees to guarantee the $100,000 residual value of the asset at the end of the lease term. Brick's incremental borrowing rate is 10%, however it knows that Gold Star's implicit interest rate is 8%. What journal entry would Brick Co. make at January 1, 2019 to record the second lease payment? PV Annuity Due PV Ordinary Annuity PV Single Sum 8%, 5 periods 4.31213 3.99271 .68508 10%, 5 periods 4.16986 3.79079 .62092

($160,000 × 4.31213) + ($100,000 × .68508) = $758,449($758,449 - $160,000) × .08 = $47,876 Interest$160,000 -$47,876 = $112,124. A. Lease Liability 1126,124 Interest Payable 47,876 Cash 160,000

Metcalf Company leases a machine from Vollmer Corp. under an agreement which meets the criteria to be a capital lease for Metcalf. The six-year lease requires payment of $170,000 at the beginning of each year, including $25,000 per year for maintenance, insurance, and taxes. The incremental borrowing rate for the lessee is 10%; the lessor's implicit rate is 8% and is known by the lessee. The present value of an annuity due of 1 for six years at 10% is 4.79079. The present value of an annuity due of 1 for six years at 8% is 4.99271. Metcalf should record the leased asset at

($170,000 - $25,000) × 4.99271 = $723,943.

On December 31, 2018, Burton, Inc. leased machinery with a fair value of $1,575,000 from Cey Rentals Co. The agreement is a six-year noncancelable lease requiring annual payments of $300,000 beginning December 31, 2018. The lease is appropriately accounted for by Burton as a capital lease. Burton's incremental borrowing rate is 11%. Burton knows the interest rate implicit in the lease payments is 10%.The present value of an annuity due of 1 for 6 years at 10% is 4.7908.The present value of an annuity due of 1 for 6 years at 11% is 4.6959.In its December 31, 2018 balance sheet, Burton should report a lease liability of

($300,000 × 4.7908) - $300,000 = $1,137,240.

On January 3, 2017, Moss Company acquires $500,000 of Adam Company's 10-year, 10% bonds at a price of $532,090 to yield 9%. Interest is payable each December 31. The bonds are classified as held-to-maturity. Reference: Ref 17-3 Assuming that Moss Company uses the effective-interest method, what is the amount of interest revenue that would be recognized in 2018 related to these bonds?

($532,090 × .09) - ($500,000 × .10) = ($2,112) - 2017 Amortization($532,090 - $2,112) × .09 = $47,698 - 2018 Interest Revenue.

In its 2018 income statement, Cohen Corp. reported depreciation of $3,700,000 and interest revenue on municipal obligations of $700,000. Cohen reported depreciation of $5,500,000 on its 2018 income tax return. The difference in depreciation is the only temporary difference, and it will reverse equally over the next three years. Cohen's enacted income tax rates are 35% for 2018, 30% for 2019, and 25% for 2020 and 2021. What amount should be included in the deferred income tax liability in Hertz's December 31, 2018 balance sheet?

($600,000 × 30%) + ($600,000 × 25%) + ($600,000 × 25%) = $480,000.

Emporia Corporation is a lessee with a capital lease. The asset is recorded at $900,000 and has an economic life of 8 years. The lease term is 5 years. The asset is expected to have a fair value of $300,000 at the end of 5 years, and a fair value of $100,000 at the end of 8 years. The lease agreement provides for the transfer of title of the asset to the lessee at the end of the lease term. What amount of depreciation expense would the lessee record for the first year of the lease?

($900,000 - $100,000) ÷ 8 = $100,000.

What is the difference between a future taxable amount and a future deductible amount? When is it appropriate to record a valuation account for a deferred tax asset?

A future taxable amount will increase taxable income relative to pretax financial income in future periods due to temporary differences existing at the balance sheet date. A future deductible amount will decrease taxable income relative to pretax financial income in future periods due to existing temporary differences. A deferred tax asset is recognized for all deductible temporary differences. However, a deferred tax asset should be reduced by a valuation account if, based on all available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. More likely than not means a level of likelihood that is slightly more than 50%.

Q: Carow Corporation purchased on January 1, 2017, as a held-to-maturity investment, $60,000 of the 8% , 5 year bonds of Harrison, Inc. for $65,118, which provides a 6% return. The bonds pay interest semiannually. Prepare Carow's journal entries for A) the purchase of the investment B) the receipt of the semi-annual interest and Premium amortization. Assume effective-interest amortization is used.

A: January 1, 2017 (a) Debt Investments 65,118 Cash 65,118 June 30, 2017 (b) Cash ($60,000 X .08 X 6/12) 2,400 Debt Investments 446 Interest Revenue 1954 ($65,118 X .06 X 6/12)

Q:Garfield Company purchased, on January1,2017, as held to maturity investment, $80,000 of the 9%, 5 year bonds of Chester Corporation for $74,086, which provides an 11% return. Prepare Garfield's journal entries for A) the purchase of the investment , and B) the receipt of annual interest and discount amortization. Assume effective interest amortization is used. Q: Use above information but assume the bonds are purchased as an available -for-sale security. Prepare Garfield's journal entries for A) the purchase of the investment B) the receipt of annual interest and discount amortization C) the year end fair value adjustment. (Assume a zero balance in the fair value adjustment account) The bonds have year-end fair value of $75,500.

A: January 1, 2017 (a) Debt Investments 74,086 Cash 74,086 December 31, 2017 (b) Cash ($80,000 X .09) 7,200 Debt Investments 949 Interest Revenue ($74,086 X .11) 8,149 December 31, 2017 (c) Fair Value Adjustment 465 Unrealized Holding Gain or Loss—Equity 465 [($74,086 + $949) - $75,500]

Feagler Company's current income taxes payable related to its taxable income for 2017 is $460,000. In addition, deferred tax asset decreased $20,000 during 2017. What is Feagle's income tax expense for 2017?

In this case, the decrease in the deferred tax asset of $20,000 is added to income taxes payable of $460,000 to compute income tax expense of $480,000 for the year. 460,000+20,000=480,000

Francisco leased equipment from Julio on December 31, 2018. The lease is a 10-year lease with annual payments of $150,000 due on December 31 of each year beginning December 31, 2018. The present value of the lease payments is $1,020,000. Francisco's incremental borrowing rate is 12% for this type of lease. The implicit rate of 10% is known by the lessee. What should be the balance in Francisco lease liability at December 31, 2019?

Initial liability $ 1,020,000 Payment Dec. 31, 2018 (150,000 ) Liability Dec. 31, 2018 $ 870,000 × 10 % Interest, 2019 $ 87,000 Payment $ 150,000 Interest (87,000 ) Reduced balance $ 63,000 Liab. Dec. 31, 2018 $ 870,000 Reduced balance (63,000 ) Liab. Dec. 31, 2019 $ 807,000

Differentiate between loss carry back and loss carry forward. Which can be accounted for with the greater certainty when it arises? why?

The loss carryback provision permits a company to carry a net operating loss back two years and receive refunds for income taxes paid in those years. The loss must be applied to the second preceding year first and then to the preceding year. The loss carryforward provision permits a company to carry forward a net operating loss twenty years, offsetting future taxable income. The loss carryback can be accounted for with more certainty because the company knows whether it had taxable income in the past; such is not the case with income in the future.

What is the nature of a sale-leaseback transaction?

The term "sale-leaseback" describes a transaction in which the owner of property sells such property to another and immediately leases it back from the new owner. The property is sold generally at a price equal to or less than current fair value and leased back for a term approximating the property's useful life for lease payments sufficient to repay the buyer for the cash invested plus a reasonable return on the buyer's investment. The purpose of the transaction is to raise money with certain property given as security. For accounting purposes the sale-leaseback should be accounted for by the lessee as a capital lease if the criteria are satisfied and by the lessor as a purchase and a direct-financing lease if the criteria are satisfied. Any income experienced by the seller-lessee from the sale of the assets that are leased back should be deferred and amortized over the lease term (or the economic life if either criteria (1) a bargain-purchase option or (2) a transfer of ownership occurs at the end of the lease is satisfied) in proportion to the amortization of the leased assets. Losses should be recognized immediately. Furthermore, minor leasebacks (present value of rentals less than 10% of fair value) should be reported as a sale with related gain recognition.

Outline the accounting procedures involved in applying the operating method by a lessee

Under the capital-lease method, the lessee treats the lease transactions as if the asset were being purchased on an installment basis: a financial transaction in which an asset is acquired and a liability is created. The asset and the liability are stated in the lessee's balance sheet at the lower of: (1) the present value of the minimum lease payments (excluding executory costs) during the lease term or (2) the fair value of the leased asset at the inception of the lease. The present value of the lease payments is computed using the lessee's incremental borrowing rate unless the implicit rate used by the lessor is lower and the lessee has knowledge of it. The effective-interest method is used to allocate each lease payment between a reduction of the lease obligation and interest expense. If the lease transfers ownership or contains a bargain-purchase option, the asset is depreciated in a manner consistent with the lessee's normal depreciation policy on assets owned, using the economic life of the asset and allowing for salvage value. If the lease does not transfer ownership or contain a bargain-purchase option, the leased asset is amortized over the lease term.