FAR 5

For a troubled debt restructuring involving only a modification of terms, which of the following items specified by the new terms would be compared to the carrying amount of the debt to determine if the debtor should report a gain on restructuring? a. The total future cash payments. b. The present value of the debt at the original interest rate. c. The present value of the debt at the modified interest rate. d. The amount of future cash payments designated as principal repayments. Explanation

Explanation Choice "a" is correct. Carrying amount - Total future cash payments = Gain.

The following information pertains to a sale and leaseback of equipment by Mega Co. on December 31 , Year 1: Sales price$400,000 Carrying amount$300,000 Present value of lease payment s$373,620 The estimated remaining life of the asset is 25 years and the lease term is 25 years. Mega uses IFRS. The sales price is equal to the fair value of the leaseback asset. What amount of deferred gain on the sale should Mega report at December 31 , Year 1? a. $0 b. $36,900 c. $63, 100 d. $100,000 Explanation

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In its Year 2 financial statements, Cris Co. reported interest expense of $85,000 in its income statement and cash paid for interest of $68,000 in its cash flow statement. There was no prepaid interest or interest capitalization either at the beginning or end of 1993. Accrued interest at December 31, Year 1, was $15,000. What amount should Cris report as accrued interest payable in its December 31, Year 2 balance sheet?

15000+85000-68000=32000

On January 1, Year 1, Babson, Inc. leased two automobiles for executive use. The lease requires Babson toFor an annuity due with 5 payments 4.240 For an ordinary annuity with 5 payments 3.890 Present value of $1 for 5 periods 0.650 make five annual payments of $13,000 beginning January 1, Year 1. At the end of the lease term, December 31, Year 5, Babson guarantees the residual value of the automobiles will total $10,000. The lease qualifies as a capital (finance) lease. The interest rate implicit in the lease is 9% . Present value factors for the 9% rate implicit in the lease are as follows: Babson's recorded capital (finance) lease liability immediately after the first required payment should be:

Choice "a" is correct. $48,620 capital (finance) lease liability after the first required payment. Annual payments PV of annuity due (at beginning of year) 42, 120 6,500 $ 48,620

A company issues bonds at 98, with a maturity value of $50,000. The entry the company uses to record the original issue should include which of the following? a. A debit to bond discount of $1,000. b. A credit to bonds payable of $49,000. c. A credit to bond premium of $1,000. d. A debit to bonds payable of $50,000

Choice "a" is correct. A bond issued at 98 is issued at 98°/o of face value. This bond will be issued for $49,000 ($50,000 x 98°/o), which is equal to the bonds payable of $50,000 less a discount of $1 ,000. The following journal entry would be used to record the issuance of the bond: Dr: Cash Dr: Discount on bonds payable Cr: Bonds payable $49,000 1,000 $50,000

On July 31, Year 1, Dome Co. issued $1 ,000,000of10°/o, 15-year bonds at par and (as a typical riskmanagement strategy to Dome Co.) used a portion of the proceeds to call its 600 outstanding 11 o/o, $1,000 face value bonds, due on July 31, Year 11 , at 102. On that date, unamortized bond premium relating to the 11°/o bonds was $65,000. In its Year 1 income statement, what amount should Dome report as gain or loss from retirement of bonds? a. $53,000 gain. b. $0 c. $(65,000) loss. d. $(77,000) loss

Choice "a" is correct. A gain of $53,000 is recognized because the $665,000 book value of the debt ($600,000 face value plus $65,000 unamortized premium) is settled for $612,000 ($600,000 at 102). There is no accrued interest because the redemption takes place on an interest date. The proceeds from the new bond issuance are not relevant. Note that the gain is reported as part of continuing operations because the transaction is a typical risk-management strategy of the company.

Cott, Inc. prepared an interest amortization table for a five-year lease payable with a bargain purchase option of $2,000, exercisable at the end of the lease. At the end of the five years, the balance in the leases payable column of the spreadsheet was zero. Cott has asked Grant, CPA, to review the spreadsheet to determine the error. Only one error was made on the spreadsheet. Which of the following statements represents the best explanation for this error? a. The beginning present value of the lease did not include the present value of the bargain purchase option. b. Cott subtracted the annual interest amount from the lease payable balance instead of adding it. c. The present value of the bargain purchase option was subtracted from the present value of the annual payments. d. Cott discounted the annual payments as an ordinary annuity, when the payments actually occurred at the beginning of each period. Explanation

Choice "a" is correct. Cott, Inc. made the error of not including the present value of the bargain purchase option in the beginning present value of the lease that it used on the schedule. A bargain purchase option payment is included as part of the minimum lease payments to be discounted to the date of inception of the lease because it is a future cash flow that is considered certain. When the spreadsheet showed zero at the bottom, Cott, Inc. still was required to make the bargain purchase option payment of $2,000, yet there was no liability left on the books to pay. The $2,000 should have been capitalized as part of the cost of the equipment (or whatever was purchased under the capital lease).

At the inception of a capital (finance) lease, the guaranteed residual value should be: a. Included as part of minimum lease payments at present value. b. Included as part of minimum lease payments at future value. c. Included as part of minimum lease payments only to the extent that guaranteed residual value is expected to exceed estimated residual value. d. Excluded from minimum lease payments. Explanation

Choice "a" is correct. Guaranteed residual value is, in effect, an additional lease payment and must be included in the calculation of the present value of the minimum lease payments.

A company issued a bond with a stated rate of interest that is less than the effective interest rate on the date of issuance. The bond was issued on one of the interest payment dates. What should the company report on the first interest payment date? a. An interest expense that is less than the cash payment made to bondholders. b. An interest expense that is greater than the cash payment made to bondholders. c. A debit to the unamortized bond discount. d. A debit to the unamortized bond premium. Explanation

Choice "b" is correct. Because the stated rate of interest is less than the effective interest rate when the bond is issued, this bond is issued at a discount. When the first interest payment is made, the discount is amortized. The discount amortization will increase interest expense for the period so that interest expense exceeds the interest payment to bondholders. Choice "a" is incorrect. Interest expense is less than the cash payment made to bondholders when a bond premium is amortized. This bond was issued at a discount, not a premium, because the stated rate was less than the effective interest rate when the bond was issued.

On January 1 of the current year, Lean Co. made an investment of $10,000. The following is the present value of $1.00 discounted at a 1 Oo/o interest rate: Periods 1 2 3 Present value of $1.00 discounted at 10% .909 .826 .751 What amount of cash will Lean accumulate in two years? a. $12,000 b. $12,107 c. $16,250 d. $27,002

Choice "b" is correct. The normal present value formula can be expressed as: Present value = Future amount x Present value factor $10,000 = Future amount x .826 (the present value factor is the discount rate for 2 years) Future amount= $10,000 I .826 = $12,107

Which of the following statements characterizes convertible debt under U.S. GAAP? a. The holder of the debt must be repaid with shares of the issuer's stock. b. No value is assigned to the conversion feature when convertible debt is issued. c. The transaction should be recorded as the issuance of stock. d. The issuer's stock price is less than market value when the debt is converted.

Choice "b" is correct. Under U.S. GAAP, because the conversion feature cannot be sold or transferred separate from the bonds themselves, no value is assigned to the conversion feature when the bonds are issued.

On July 1, of the current year, after recording interest and amortization, York Co. converted $1,000 ,000 of its 12°/o convertible bonds into 50,000 shares of $1 par value common stock. On the conversion date the carrying amount of the bonds was $1,300 ,000, the market value of the bonds was $1,400 ,000, and York's common stock was publicly trading at $30 per share. Using the book value method, what amount of additional paid-in capital should York record as a result of the conversion?

Choice "b" is correct. Under the book value method, the conversion of debt requires credits to common stock and paid-in capital equal to the book (carrying) value of the bonds. No gain or loss is recorded. The journal entry would be: Dr: Bonds payable 1,000,000 Dr: Bond premium 300,000 Cr: Common stock (par) 50,000 Cr: Add, paid-in capital (to balance) 1,250,000

On January 1, Stunt Corp. had outstanding convertible bonds with a face value of $1 ,000,000 and an unamortized discount of $100,000 accounted for using U.S. GAAP. On that date, the bonds were converted into 100,000 shares of $1 par stock. The market value on the date of conversion was $12 per share. The transaction will be accounted for with the book value method. By what amount will Stunt's stockholders' equity increase as a result of the bond conversion under U.S. GAAP? a. $100,000 b. $900,000 c. $1,000,000 d. $1,200,000

Choice "b" is correct. When the book value method is used to account for the conversion of bonds to stock, the stock issued is recorded at the carrying value of the bonds. In this problem, the bonds have a carrying value of $900,000 ($1 ,000,000 face value - $100,000 discount), so the 100,000 shares of stock will be recorded at $900,000, resulting in a $900,000 increase in stockholders' equity.

On December 31, Moss Co. issued $1,000,000 of 11°/o bonds at 109. Each $1,000 bond was issued with 50 detachable stock warrants, each of which entitled the bondholder to purchase one share of $5 par common stock for $25. Immediately after issuance, the market value of each warrant was $4. On December 31, what amount should Moss record as discount or premium on issuance of bonds? a. $40,000 premium. b. $90,000 premium. c. $110,000 discount. d. $200,000 discount. Explanation

Choice "c" is correct. Dr: Cash $1,090,000 Dr: Discount on bond 110,000 Cr: Bonds payable $1,000,000 Cr: APIC - Warrants 200,000

On December 1, Year 1, Tigg Mortgage Co. gave Pod Corp. a $200,000, 12o/o loan. Pod received proceeds of $194,000 after the deduction of a $6,000 nonrefundable loan origination fee. Principal and interest are due in 60 monthly installments of $4,450, beginning January 1, Year 2. The repayments yield an effective interest rate of 12°/o at a present value of $200,000 and 13.4% at a present value of $194,000. What amount of accrued interest receivable should Tigg include in its December 31 , Year 1, balance sheet? a. $4,450 b. $2,166 c. $2,000 d. $0

Choice "c" is correct. $2,000 accrued interest receivable in December 31, Year 1 balance sheet. 200,000 x 12°/o x 1/12 = 2,000 While the calculation based on proceeds received of $194,000 (194,000 x 13.4% x 1/12) equals interest earned of $2, 166, only $2,000 is a receivable, since the $166 difference is amortization of deferred interest income.

On June 2, Year 1, Tory, Inc. issued $500,000 of 10°/o, 15-year bonds at par. Interest is payable semiannually on June 1 and December 1. Bond issue costs were $6,000. On June 2, Year 6, Tory retired half of the bonds at 98. What is the net amount that Tory should use in computing the gain or loss on retirement of debt? a. $249,000 b. $248,500 c. $248,000 d. $247,000

Choice "c" is correct. The amount used to compute a gain or loss on bond retirement is the carrying amount of the bond and the pro rata portion of bond issue cost. Original carrying amount $500,000 Bond issue cost ($6,000 x 10/15) (4,000) Net carrying amount 6/2/Year 6 Portion retired 496,000 x 50°/o Amount used to compute gain/loss $248,000

Farm Co. leased equipment to Union Co. on July 1, Year 1, and properly recorded the sales-type (finance) lease at $135,000, the present value of the lease payments discounted at 1 Oo/o. The first of eight annual lease payments of $20,000 due at the beginning of each year was received and recorded on July 3, Year 1. Farm had purchased the equipment for $110,000. What amount of interest revenue from the lease should Farm report in its Year 1 income statement? a. $0 b. $5,500 c. $5, 750 d. $6,750

Choice "c" is correct. The initial lease receivable equals $135,000. After the first lease payment is received two days later, the lease receivable equals $115,000 ($135,000 less $20,000). Year 1 interest revenue equals $5,750 ($115,000 x 10°/o x 6/12

On December 30, Year 1, Fort, Inc. issued 1,000 of its 8o/o, 10-year, $1 ,000 face value bonds with detachable stock warrants at par. Each bond carried a detachable warrant for one share of Fort's common stock at a specified option price of $25 per share. Immediately after issuance, the market value of the bonds without the warrants was $1 ,080,000 and the market value of the warrants was $120,000. In its December 31 , Year 1, balance sheet, what amount should Fort report as bonds payable? a. $1,000,000 b. $975,000 c. $900,000 d. $880,000

Choice "c" is correct. The net bonds payable is $1 ,000,000 less $100,000 or $900,000. The issuance of bonds with detachable stock warrants would be recorded as: Dr: Cash $1,000,000 Dr: Discount 100,000 CR: Paid-in-capital, warrants* $ 100,000 Cr: Bonds payable 1,000,000 *$120,000 I ($1,080,000 + $120,000) = 10o/o 10°/o x $1,000,000 = $100,000

During Year 2, Colt Co. experienced financial difficulties and is likely to default on a $1,000,000, 15o/o, 3-year note dated January 1, Year 1, payable to Cain National Bank. On December 31, Yea r 2, the bank agreed to settle the note and unpaid Year 2 interest of $150,000 for $820,000 cash payable on January 31, Year 3. The event is deemed extraordinary under U.S. GAAP. What is the amount of gain, before income taxes , from the debt restructuring?

Choice "d" is correct. $330,000. The amount of the gain, before taxes, is calculated as follows: Principal$1,000 ,000 Interest accrued150,000 Net carrying amount Settlement price - cash1,150,000 Gain from debt restructuring, before tax (820,000) $ 330,000

The discount resulting from the determination of a note payable's present value should be reported on the balance sheet as a (an): a. Addition to the face amount of the note. b. Deferred charge separate from the note. c. Deferred credit separate from the note. d. Direct reduction from the face amount of the note.

Choice "d" is correct. Although the discount is a separate account from the note payable account, the note payable is reported on the balance sheet at the net of the note payable face value less the unamortized discount. Choice "a" Choice "c" is incorrect. The discount account will have a debit balance rather than a credit balance

Able sold its headquarters building at a gain, and simultaneously leased back the building. The lease was reported as a capital lease under U.S. GAAP. At the time of sale, the gain should be reported as: a. Operating income. b. An extraordinary item, net of income tax. c. A separate component of stockholders' equity. d. An asset valuation allowance.

Choice "d" is correct. An asset valuation allowance. Rule: Any profit or loss on a sale/leaseback classified as a capital lease shall be deferred and amortized in proportion to depreciation taken on the leased back asset. Choice "a" is incorrect. The gain should be deferred.

A bond issued on June 1, of the current year, has interest payment dates of April 1 and October 1. Bond interest expense for the current year ended December 31 is for a period of: a. Three months. b. Four months. c. Six months. d. Seven months.

Choice "d" is correct. Interest expense is recognized for the entire period from bond issuance (June 1) through the fiscal year end (December 31 ). Choice "a" is incorrect. Three months would only be the time period from October 1 (most recent interest payment date) through December 31 (fiscal year end). This amount represents the interest accrual.

On March 1, Year 1, Evan Corp. issued $500,000 10°/o nonconvertible bonds at 103, due on February 28, Year 11. Each $1,000 bond was issued with 30 detachable stock warrants, each of which entitled the holder to purchase, for $50, one share of Evan's $25 par common stock. On March 1, Year 1, the market price of each warrant was $4. By what amount should the bond issue proceeds increase stockholders' equity? a. $0 b. $15,000 c. $45,000 d. $60,000 Explanation

Choice "d" is correct. Stockholders' equity is increased by the value of the warrants. There are 500 bonds with 30 warrants worth $4 each. 500 x 30 x $4 = $60,000.

On January 1 of the current year, Tell Co. leased equipment from Swill Co. under a 9-year sales-type (finance) lease. The equipment had a cost of $400,000 and an estimated useful life of 15 years. Semiannual lease payments of $44,000 are due every January 1 and July 1. The present value of lease payments at 12°/o was $505,000, which equals the sales price of the equipment. Using the straight-line method, what amount should Tell recognize as depreciation expense on the equipment in the current year? a. $26,667 b. $33,667 c. $44,444 d. $56, 111

Choice "d" is correct. The lessee records the lease as an asset and a liability at the lower (lesser) of the fair market value of the asset at the inception of the lease, or cost (present value of the minimum lease payments). Lease should be depreciated (amortized) over the lease term if the lessee does not take ownership of the asset by the end of the lease or if there is not a bargain purchase option. Present value of minimum lease payments $505,000 Lease term 9 = Straight-line depreciation expense Choice "d" is correct. The entire gain is deferred. The leaseback will be classified as a finance lease because the lease transfers substantially all the risks and rewards inherent in ownership to the lessee (the present value of the lease payments is substantially all of the fair value of the leased asset and the lease term is the entire economic life of the asset). When the lease in an IFRS sale-leaseback transaction is classified as a finance lease, all profit is deferred and amortized over the lease term. Deferred gain = $400,000 sales price - $300,000 carrying amount= $100,000

The market price of a bond issued at a premium is equal to the present value of its principal amount: a. Only, at the stated interest rate. b. And the present value of all future interest payments, at the stated interest rate. c. Only, at the market (effective) interest rate. d. And the present value of all future interest payments, at the market (effective) interest rate. Expl anation

Choice "d" is correct. To determine the market price of a bond, the present value of the principal is added to the present value of all interest payments, using the market interest rate.

Which of the following statements characterizes convertible debt under IFRS? a. There is no recognition of the conversion feature at the time of issuance because it is difficult to determine the value of the conversion feature. b. Convertible bonds are generally issued for less than face value. c. The conversion feature can be traded separately. d. An equity component should be recognized upon issuance equal to the difference between the proceeds received and the fair value of the bond liability.

Choice "d" is correct. Under IFRS, both a liability (bond) and an equity component (conversion feature) should be recognized when convertible bonds are issued. The bond liability is valued at fair value, with the difference between the actual proceeds received and the fair value of the bond liability recorded as a component of equity. Choice "a" is incorrect. The conversion feature is recognized as a component of equity under IFRS. No recognition is given to the conversion feature under U.S. GAAP.

On July 1, Year 1, York Co. purchased as a held-to-maturity investment $1,000,000 of Park, lnc.'s 8°/o bonds for $946,000, including accrued interest of $40,000. The bonds were purchased to yield 10°/o interest. The bonds mature on January 1, Year 8, and pay interest annually on January 1. York uses the effective interest method of amortization. In its December 31, Year 1, balance sheet, what amount should York report as investment in bonds? a. $911,300 b. $916,600 c. $953,300 d. $960,600

Explanation Choice "a" is correct. The carrying amount of the bonds is $906,000 on July 1, Year 1 ($946,000 - $40,000). The discount is amortized for 6 months (July 1 to December 31): Interest revenue ($906,000 x 1Oo/o x 6/12) Interest receivable ($1,000 ,000 x 8°/o x 6/12) Discount amortized $45,300 (40,000) $ 5,300 The carrying amount on December 31, Year 1, is $906,000 + $5 ,300 = $911,300 .

On March 15, Year 1, Ashe Corp. adopted a plan to accumulate $1,000,000 by September 1, Year 5. Ashe plans to make four equal annual deposits to a fund that will earn interest at 10°/o compounded annually. Ashe made the first deposit on September 1, Year 1. Future value and future amount factors are as follows: Future value of 1 at 1Oo/o for 4 periods Future amount of ordinary annuity of 1 at 10°/o for 4 periods Future amount of annuity in advance of 1 at 1Oo/o for 4 periods Ashe should make four annual deposits (rounded) of: a. $250,000 b. $215,500 c. $195,700 d. $146,000

Explanation Choice "c" is correct. Four annual deposits (rounded) of $195,700.

A twenty-year property lease, classified as an operating lease, provides for a 1 0% increase in annual payments every five years. In the sixth year compared to the fifth year, the lease will cause the following expenses to increase: Rent Interest

No change in rent; no change in interest. Rule: Lessee shall record an operating lease as rental expense using the straight line basis even if payments are made on some other basis, unless another systematic and rational basis is more representative. There is no interest component for an "operating lease."

On December 1, Year 1, Money Co. gave Home Co. a $200,000, 11°/o loan. Money paid proceeds of $194,000 after the deduction of a $6,000 nonrefundable loan origination fee. Principal and interest are due in 60 monthly installments of $4,310, beginning January 1, Year 2. The repayments yield an effective interest rate of 11°/o at a present value of $200,000 and 12.4% at a present value of $194,000. What amount of income from this loan should Money report in its Year 1 income statement? a. $0 b. $1,833 c. $2,005 d. $7,833

Rule: Loan origination fees shall be deferred and recognized over the life of the loan as an adjustment of interest income (similar to the treatment of bond discount amortization). Choice "c" is correct. $2,005 income from this loan in Year 1. Face amount of loan$200,000 Nonrefundable loan origination fee (6,000) Net amount loaned194,000 Effective interest rate (yield) 12.4°/o Outstanding one month (12/1/Y1 - 12/3 1/Y 1) Interest income for Year1 24,056 x 1/12 $ 2,005