ACC 510 Test 1

Group I Criteria

1 - Title passes to lessee 2 - A bargain purchase option exists 3 - Lease term is a "major part" of economic life 4 - Present value of lease payments (include BPO) is "substantially all" of fair value. 5 - Specialized for lessee

Please describe at least three indicators of the ability to exert significant influence on a company we have invested in (note: 20% or more ownership is not what I'm looking for here)

1. Investor representation on the board of the investee 2. Investor participation in policy making processes of the investee 3. The extent of ownership of investee voting shares by the investor in relation to the concentration of other shareholdings 4. Material intercompany transactions between the investor and the investee 5. Interchange of managerial personnel between the investor and the investee 6. Technological dependency of the investee on the investor

four different types of transactions that create other comprehensive income

1. Unrealized holding gains and losses on available for sale (AFS) investments 2. Changes in the funded status of a defined benefit pension plan 3. Changes in fair value of derivatives used as cash flow hedging instruments 4. Changes in the cumulative translation adjustment resulting from converting foreign currency denominated account balances to US dollar balances

On January 1, 2018, Renee Corp., a lessor who has adopted ASC 842, entered into a five-year lease for new equipment, which has a cost of $30,000. The lease requires annual payments of $8,000 and the lessee guarantees the residual value of $2,000. The first payment is due on Jan. 1, 2018 (subsequent payments are made on the first day of the respective year) and Renee's implicit interest rate is 11%. Which of the following would appear on Renee's Dec. 31, 2018 financial statements with respect to the lease (amounts rounded to the nearest dollar)? A. Gross profit of $4,006 B. Lease Receivable of $28,539 C. Unearned Interest Income of $2,283 D. Lease Receivable of $30,822

A. Gross profit of $4,006 The PV of the lease payments plus the GRV = $34,006. This will be recognized as sales revenue by Renee. COGS will be $30,000 so gross profit = $4,006.

Please briefly discuss how initial direct costs are accounted for by the lessor

Any initial direct costs (IDC) paid by the lessor will be accounted for based on the type oflease. IDC will be capitalized for both operating and direct-financing leases initially and will be expensed over the life of the lease (straight-line for operating and as an adjustment to interest revenue for direct-financing). IDC in a sales-type lease are expensedimmediately.

On January 1, Nole purchased 10% of Gator's common stock. On August 1, it purchased another 30% of Gator's common stock. During October, Gator declared and paid a cash dividend on its common stock. How much equity method income from Gator should Nole report on its income statement? A) 10% of Gator's income for January 1 to July 31, plus 40% of Gator's income for the remainder of the year. B) 40% of Gator's income from August 1 to December 31 only. C) 40% of Gator's income. D) 30% of Gator's income from August 1 to December 31 only. E) 40% of Gator's income from August 1 to December 31, less the amount of dividends received from Gator.

B) 40% of Gator's income from August 1 to December 31 only. We would recognize our 40% share of their 8/1 - 12/31 NI. Dividends are not recognized as income under the equity method.

When a company owns between 20% and 50% of the outstanding stock of an investee, which of the following statements applies? A) The investor should always use the equity method to account for its investment. B) The investor should use the equity method to account for its investment unless circumstances indicate that it is unable to exercise "significant influence" over the investee. C) The investor must use the fair value method unless it can clearly demonstrate the ability to exercise "significant influence" over the investee. D) The investor should always use the fair value method to account for its investment.

B) The investor should use the equity method to account for its investment unless circumstances indicate that it is unable to exercise "significant influence" over the investee. The ability to exert significant influence is presumed to apply at 20% - 50% ownership levels. If conditions prevent the exercise of significant influence, you should not use the equity method regardless of ownership percentage.

Which of the following items would not be included in comprehensive income for a period? A) Unrealized holding loss on an available for sale investment. B) Unrealized holding gain on a held to maturity investment. C) Unrealized holding gain on a trading security. D) Change in the funded status of a defined benefit pension plan. E) Realized gain on sale of an equity method investment.

B) Unrealized holding gain on a held to maturity investment.

In the third year of a six-year finance lease, the portion of the lease payment applicable to the reduction of the lessee's lease liability should be: A) less than in the second year B) more than in the second year C) the same as in the fourth year D) more than in the fourth year

B) more than in the second year The portion of each payment devoted to interest expense will decline over time so the portion associated with principal will be increasing from one payment to the next.

On January 1, 2018, an investor purchases 16,000 shares of an investee for $11/share. These shares represent a 20% ownership interest in the investee. On January 1, 2018, the book value of the investee's assets and liabilities equaled $850,000 and $300,000, respectively. On that date the appraised fair values of the investee's identifiable net assets equaled the recorded book values, except for an unrecognized customer list. The customer list has an estimated fair value of $50,000 and a five year remaining life. During 2018, the investee earned net income of $60,000 and paid a $20,000 dividend. The 12/31/18 fair value of the shares owned by the investor is $13.50/share. Assume the investor can exert significant influence over the investee. What is the balance in the "Investment in Investee" account at 12/31/18? A. $176,000 B. $182,000 C. $184,000 D. $188,000 E. $216,000

B. $182,000 Since it is an equity method investment we will adjust beginning balance of $176,000 (16,000 sh x $11/sh) as follows: add $60,000 NI x 20% = $12,000, subtract $20,000 Div x 20% = $4,000, and subtract amortization of customer list ($50,000 x 20% = $10,000/5 years = $2,000). $176,000 + $12,000 - $4,000 - $2,000 = $182,000.

We have determined that a bond investment we own is other-than-temporarily impaired (OTTI). The bond investment is classified as available-for-sale (AFS). What portion, if any, of the loss should be recognized in other comprehensive income (OCI)? A) None—the impairment loss must be recognized in net income B) The portion od the loss identified as a credit loss C) The portion of the loss attributed to general economic conditions (e.g., interest rates) D) All of the loss is recognized in OCI

C) The portion of the loss attributed to general economic conditions (e.g., interest rates) Losses that arise due to general economic conditions may be recognized in OCI.

The fair value option allows firms to A) elect fair value treatment for almost all assets and liabilities B) recognize changes in fair value in other comprehensive income instead of in net income C) elect fair value treatment for almost all financial assets and liabilities D) fair value their own common stock

C) elect fair value treatment for almost all financial assets and liabilities The fair value option may be applied to almost all financial assets and liabilities.

Rent received in advance by the lessor under an operating lease agreement should be recognized as revenue A) When received B) at the lease's inception C) over the lease term D) at the lease's expiration

C) over the lease term

For a lease that transfers ownership of the leased asset to the lessee by the end of the lease term, the lessee should: A. Record each lease payment as lease expense. B. Combine interest expense and amortization expense and report as a single lease expense. C. Amortize the right-of-use (ROA) asset over the lease term. D. Amortize the right-of-use (ROA) asset over the economic life of the asset.

D. Amortize the right-of-use (ROA) asset over the economic life of the asset.

On January 1, 2018, an investor purchases 16,000 shares of an investee for $11/share. These shares represent a 20% ownership interest in the investee. On January 1, 2018, the book value of the investee's assets and liabilities equaled $850,000 and $300,000, respectively. On that date the appraised fair values of the investee's identifiable net assets equaled the recorded book values, except for an unrecognized customer list. The customer list has an estimated fair value of $50,000 and a five year remaining life. During 2018, the investee earned net income of $60,000 and paid a $20,000 dividend. The 12/31/18 fair value of the shares owned by the investor is $13.50/share. Assume the investor cannot exert significant influence over the investee. What is the balance in the "Investment in Investee" account at 12/31/18? A. $176,000 B. $182,000 C. $184,000 D. $188,000 E. $216,000

E. $216,000 If it is a passive investment it would be carried at fair value (16,000 shares x $13.50/sh)

Which of these three characteristics (I, II, and III) are required in order for a promised good or service to be considered distinct? I. Results in commercial modification of the contract II. Distinct within the context of the contract III. Capable of being distinct

I and II only

Provide a brief discussion of the Fair Value Hierarchy (i.e., what do Level I, II, and III fair values represent and how do we choose which to use)

The fair value hierarchy refers to the desired approach to estimating a fair value where Level I fair values are deemed to be most desirable and Level III fair values are the least desirable. A Level I fair value is found by observing market transactions for identical assets and liabilities. A Level II fair value is also based on observable inputs. However, these fair value estimates are based on market transactions involving similar (not identical) assets and liabilities (or are stale prices). Finally, Level III fair values are based, at least in part, on unobservable inputs. We should use a fair value estimate derived from the highest level possible.

briefly describe the Fair Value Hierarchy

There are three levels in the fair value hierarchy: Level one fair values are based on observed market transactions for identical assets/liabilities Level two fair values are based on observed market transactions for similar assets/liabilities (or stale prices for identical assets/liabilities) Level three fair values are based on unobservable inputs Must use a fair value estimate from the highest level available

describe how we would determine whether an impaired investment in bonds qualifies as an other-thantemporary-impairment (OTTI)

This decision is based on judgment and the specific facts and circumstances of the situation. Three factors should be considered: 1 - How long and to what magnitude is the impairment? 2 - Issuer problems such as financial distress that may indicate difficulty in making principal and interest payments as scheduled 3 - Our problems - can we hold investment long enough to allow for an anticipated recovery in value?

Bowler Inc. owns 40% of Yarby Co. and applies the equity method. During the current year, Bowler sold inventory to Yarby and recognized gross profit of $54,000. At year- end, only 20% of this merchandise was still being held by Yarby. What amount of unrealized EI profit must be deferred by Bowler? a. $ 4,320 b. $ 3,240 c. $10,800 d. $13,200 e. $ 0

a. $ 4,320 $54,000 gross profit x 20% still in EI = $10,800 EI profit. Defer 40% x $10,800 = $4,320.

Noles, Inc. owned bonds with a face value of $100,000 that were classified as an available-forsale investment. On 12/31/19, the amortized cost of these bonds equaled $96,000. Their fair value on that date was $102,000. A decision was made on 12/31/19 to transfer this bond investment to the held-to-maturity portfolio. The journal entry to record this transfer includes a. A debit to the held-to-maturity investment account of $102,000. b. A credit to the available-for-sale investment account of $100,000. c. A debit to realized gain of $6,000. d. A debit to the held-to-maturity investment account of $96,000. e. A credit to OCI Gain for $6,000.

a. A debit to the held-to-maturity investment account of $102,000. The transfer to the new category (HTM) would occur at fair value ($102,000).

Panther, Inc. purchased 20% of the 1,000,000 outstanding common shares of Seahawks, Corp. on January 1, 2018 for $1,500,000 and accounted for the investment using the equity method. However, there were no indications that Panther was able or would be able to exert significant influence over Seahawks operations or decision-making. Seahawks recorded $300,000 of net income during 2018 and paid a special dividend of $0.80 per share on November 1, 2018. Seahawks common shares are trading for $8.00 per share on December 31, 2018. Based on this information Panther's financial statements report a. assets understated by $200,000 b. dividend revenue overstated by $160,000 c. AOCI overstated by $100,000 d. liabilities understated by $200,000

a. assets understated by $200,000 Under equity method accounting the balance in the account will be $1,400,000 at 12/31 ($1,500,000 + $60,000 Equity income - $160,000 dividend). Under fair value accounting the balance at 12/31 would be $1,600,000. So this asset is understated by $200,000.

On both December 31, 2017 and December 31, 2018, WP Corporation's only available-for-sale investment had a fair value below cost. On December 31, 2017, WP considered the decline in value to be temporary. On December 31, 2018, the decline was determined to be other-than-temporary in nature and entirely attributable to a deterioration of the credit-worthiness of the issuer. In both years, the investment was classified as a non-current asset. What should be the effects of the determination that the decline in value was other-than-temporary on WP's 2018 net income and on the balance reported on the December 31, 2018 balance sheet? a. No effect on either 2018 net income or on the year-end balance reported for non-current assets. b. No effect on the year-end balance reported for non-current assets and a decrease in 2018 net income. c. A decrease in the non-current asset balance reported on the December 31, 2018 balance sheet and no effect on 2018 net income. d. A decrease in both 2018 net income and in the reported year-end balance of non-current assets.

b. No effect on the year-end balance reported for non-current assets and a decrease in 2018 net income Since the AFS investment is OTTI we must recognize loss in net income (which will cause a decrease relative to what we would have recognized if the impairment was still considered temporary). The balance sheet value will be fair value regardless of whether investment is OTTI or temporary (all AFS investments are at fair value).

Relative to the prior lease accounting guidance, under the new lease accounting standard ASC 842, companies that lease equipment from manufacturers over multi-year lease terms and whose leases do not meet any of the Group I lessee lease classification criteria will experience: a. decreased operating activities cash flow b. increases in assets and liabilities c. decreases in assets and liabilities d. larger amounts of lease expense in the early years of each lease

b. increases in assets and liabilities Operating leases under the new standard will require recognition of a right-ofuse asset and a lease liability (except for short-term leases).

The purpose of reporting comprehensive income is to a. provide information about the non-cash effects of certain transactions affecting contributed capital. b. to summarize all changes in equity from non-owner sources. c. to provide a consolidation of income of the firms' non-entity income. d. to summarize all changes in equity from owner sources.

b. to summarize all changes in equity from non-owner sources.

Raleigh Corp. reported an Accumulated Other Comprehensive Income (AOCI) balance as of Jan. 1, 2018 of $195,000 (debit) in its trial balance. The company reported the following information for fiscal year 2018: Unrealized gain on cash flow hedge derivative $10,000 Realized gain on sale of equipment $50,000 Foreign Currency translation adjustment (loss) $15,000 Net Income $200,000 Unrealized gain on AFS Securities $20,000 What amount should Raleigh report as its AOCI balance as of Dec. 31, 2018? a. $155,000 debit b. $5,000 credit c. $220,000 debit d. $180,000 debit

d. $180,000 debit $195,000 (DR) starting balance + $10,000 unrealized gain on CF hedge (CR) - $15,000 FX Translation Loss (DR) + $$20,000 unrealized gain on AFS (CR) = $180,000 (DR) ending balance

Bloomfield Bakers accounts for its investment in Clor Confectionary under the equity method of accounting. Bloomfield initially purchased their Clor shares at a price that equaled both book and fair value of the net assets acquired. Bloomfield carried theClor investment at $145,000 and $165,000 at December 31 of 2018 and 2019, respectively. During 2019 Clor recognized $80,000 of net income and paid dividends of $30,000. Assuming that Bloomfield owned the same percentage of Clor throughout 2019, the percentage ownership must have been: a. 15% b. 25% c. 30% d. 40%

d. 40% The increase in the equity method investment is $20,000. This is explained by recording our share of NI and reducing the investment balance by any dividend we received. The net increase in Clor RE = $50,000 ($80,000 NI - $30,000 dividend). We must own 40% because $50,000 x 40% =$20,000

Noles, Inc. owned bonds with a face value of $100,000 that were classified as an available-for-sale investment. On 1/1/18, the amortized cost of these bonds equaled $102,000. Their fair value on that date was $105,000. A decision was made on 1/1/18 to transfer this bond investment to the held-tomaturity portfolio. The journal entry to record this transfer includes a. A debit to the held-to-maturity investment account of $102,000. b. A credit to the available-for-sale investment account of $100,000. c. A debit to FVA - AFS of $3,000. d. A debit to the held-to-maturity investment account of $105,000. e. A credit to OCI Gain for $3,000.

d. A debit to the held-to-maturity investment account of $105,000. All transfers occur at fair value on the transfer date

At December 31, 2019 the accountant for Brady Corp. mistakenly accounted for its Trading Securities portfolio as an Available for Sale portfolio. The portfolio consists of three debt securities with a total amortized cost of $57,400 and a December 31, 2019 fair market value of $62,000. No securities were sold during the year. The effect of this error on assets, net income and comprehensive income (respectively) would be: a. Understate, overstate and overstate. b. No effect, overstate and no effect. c. No effect, no effect and no effect. d. No effect, understate and no effect. e. Overstate, Overstate and no effect.

d. No effect, understate and no effect The $4,600 gain was incorrectly recognized in OCI but should be in NI. The investments will appear on the balance sheet at fair value either way and the gain should be in CI (and is). So assets are fine, NI is understated by $4,600, and CI is fine.