FSA 3321 – Summer (2009)
Exam 2 – Version 1
Moore
Second Examination – Finance 3321
Summer 2009 (Moore) – Version 1
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Clearly Circle the BEST response for each of the following questions:
1. Aggressive use of which of the following accounting choices can lead to the problem of
“off-balance sheet financing”?
a. Operating leases
b. Failure to write down obsolete inventory
c. Reporting all related party transactions
d. Overstating depreciation for long-term assets
e. Using the intrinsic method to account for executive stock options
2. Which of the following adjustments to the accounts must always be made when it is
found (suspected) a company has taken the “Big Bath” approach to managing earnings?
a. Increase the right-hand side of the balance sheet
b. Decrease liabilities
c. Decrease income tax expense
d. Increase retained earnings
e. Increase total assets
3. Which of the following must result in understated liability balances?
a. Delays in the write-down (expensing) of current assets such as inventory.
b. Understating the growth rate in future post-retirement benefit costs
c. Overstated amortization of goodwill
d. Overstating the growth rate in future post-retirement benefit costs
e. Understating the discount rate used in discounting future defined benefit payments.
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FSA 3321 – Summer (2009)
Exam 2 – Version 1
Moore
Questions 4-7 (Operating and Capital Lease Adjustments)
Use the following information for questions 4-7
ABC Company is a startup company in an industry that exclusively uses capital leases for it’s
expensive medical testing equipment. ABC, however, used operating lease accounting in its
first year of operations. Assume the average lifespan of ABC’s leased equipment is 15 years
and that their annual cost of debt is 8.00%. The annual lease payments are $3,500,000.
ABC’s industry commonly uses straight-line depreciation and the effective tax rate is 30%.
4. Adjust ABC’s books to reflect the lease as being capitalized. Assume the appropriate
interest expense in the second year would be $2,308,386. What amount should have
been recognized as the adjusted capital lease liability in the contract signing year?
a. $52,500,000
b. $30,000,000
c. $29,958,175
d. $28,854,829
e. $27,663,216
5. Now, assume the present value of the lease payments over the entire life of the contract
was $30,000,000. Adjust ABC’s books to reflect the lease as being capitalized. The
depreciation expense that should be charged against income in the 8th year is:
a. $3,500,000
b. $2,871,700
c. $2,000,000
d. $1,758,804
e. $1,410,000
6. Adjust ABC’s books to reflect the lease as being capitalized. Maintain the $30,000,000
assumption. Compute the appropriate charge for interest expense in the second year.
a. $2,400,000
b. $2,312,000
c. $2,308,386
d. $2,216,960
e. $2,114,317
7. Compute the overall effect on Net Income in the second year for ABC (had the lease
been capitalized) would be (relative to the reported Net Income, net of tax). Keep the
$30,000,000 assumption.
a. $900,000 Lower
b. $812,000 Lower
c. $630,000 Lower
d. $568,400 Lower
e. $243,600 Lower
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FSA 3321 – Summer (2009)
Exam 2 – Version 1
Moore
8. What is the second step of the method for a structured accounting analysis (per text)
a. Identify potential “red flags”
b. Assess the degree of potential accounting flexibility
c. Evaluate the actual accounting strategy
d. Undo accounting distortions
e. Identify key accounting policies
f. Evaluate the quality of disclosure
9. What is the fifth step of the method for a structured accounting analysis (per text)
a. Identify potential “red flags”
b. Assess the degree of potential accounting flexibility
c. Evaluate the actual accounting strategy
d. Undo accounting distortions
e. Identify key accounting policies
f. Evaluate the quality of disclosure
10. Assume a company has been classified as belonging in a purely highly competitive
(commodity, cost leadership) industry. Which one of the following disclosures would be
considered a key accounting policy?
a. Net Sales/Warranty Liabilities
b. Inventory is measured on a Lifo basis at lower of cost or market
c. Disclosure regarding new product development R&D expenses
d. Disclosure new customer service programs
e. Disclosure regarding the strategic placement of new distribution centers
11. Assume a company has been classified as belonging in a purely differentiated product
(specialty) industry. Which one of the following disclosures would be not be considered
a key accounting policy?
a. Disclosure regarding product returns and warranties
b. Disclosure regarding R&D outcomes leading to new patents
c. Disclosure regarding cost cutting activities
d. Disclosure regarding new investment in marketing programs
e. Disclosure regarding new products introduced to the market
12. Which organization has been delegated the responsibility to establish US GAAP?
a. AICPA
b. FASB
c. IASB
d. SEC
13. In
a.
b.
c.
d.
e.
the earnings management literature, income smoothing will only result in:
Overstated reported earnings
Understated earnings
Companies taking the “big bath”
Either understated or overstated earnings
Cannot be answered
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FSA 3321 – Summer (2009)
Exam 2 – Version 1
Moore
Use the following information for problems 14 through 17
You are performing an accounting analysis on ABC Company and noted excessive goodwill
balances relative to reported PPE. The following table was constructed from ABC’s 10-K
information. Assume all new goodwill is recognized at the end of the year for the purpose of
restatement. Further, assume a tax rate of 30%. Finally, you are starting the restatement
process from 2005’s financial statements. ABC has a December 31 fiscal year end. Assume
goodwill has a 5-year useful life and that you are adjusting the account.
Beginning Balance
New Goodwill
Goodwill Impaired
Ending Goodwill
2005
2006
20,000,000 25,000,000
5,000,000 10,000,000
0
2,000,000
25,000,000 33,000,000
2007
33,000,000
8,000,000
1,000,000
40,000,000
2008
40,000,000
2,000,000
30,000,000
12,000,000
14. How much goodwill should be impaired in 2005?
a. nothing
b. $2,000,000
c. $2,400,000
d. $4,000,000
e. $5,000,000
15. How much additional impairment of ABC’s goodwill would be needed in 2007?
a. $7,000,000
b. $6,000,000
c. $5,000,000
d. $4,000,000
e. $3,000,000
16.The adjusted Goodwill balance at the end of 2006 should be:
a. $21,000,000
b. $28,000,000
c. $30,000,000
d. $22,000,000
e. $17,000,000
17. The overall decrease to Owners’ Equity in 2005 for ABC after adjustment would be?
a. $4,000,000
b. $5,000,000
c. $1,200,000
d. $2,800,000
e. $3,000,000
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FSA 3321 – Summer (2009)
Exam 2 – Version 1
Moore
18. Which of the following is the correct approach for hedging foreign exchange risk?
a. If you buy raw materials that are denominated in a foreign currency, you are long in
the currency.
b. If you make an overseas sales denominated in the foreign currency, you are short in
the currency.
c. An appropriate hedge when you purchase materials denominated in foreign currency
is to buy a futures contract in that currency for the foreign currency at risk.
d. An appropriate hedge when you purchase materials denominated in foreign currency
is to sell a futures contract in that currency for the foreign currency at risk.
Use the following information for questions 19 and 20.
On December 1, 2008, you sell merchandise on account in Europe for 10,000,000 Euros.
Account receivables terms are net due in 2-months. The exchange rate is 1.4000 Dollars per
Euro at the sale date. On December 31, the exchange rate is 1.3530 dollars per Euro. At
the payment date in 2009, the exchange rate is 1.3000 dollars per Euro. A futures contract
on December 1 for two months in the amount of $10 million Euros costs $25,000 and is set
at a rate of 1.4000 dollars per Euro. Futures contracts settle for the spot rate on the
expiration date.
19. Assume the company doesn’t hedge the risk. What is the unrealized gain or loss at the
end of the 2008 financial year?
a. $470,000 gain
b. $470,000 loss
c. $445,000 gain
d. $445,000 loss
e. $530,000 loss
20. Assume the company hedges the currency risk. How much profit has been protected (net
of costs) when the account is finally collected in 2009?
a. $445,000
b. $470,000
c. $505,000
d. $975,000
e. $1,000,000
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FSA 3321 – Summer (2009)
Exam 2 – Version 1
Moore
Problem 1 – Overs and Unders (20 Points)
Analyze the following transactions (omissions or incorrect accounting treatments) and assess
whether the accounts are Overstated, Understated, or No Effect. Fill in the appropriate
boxes as (O), (U), (N)
Assets
1
The company recorded half the
proceeds from 4-year service contracts
sold in the current year
2
The company overstated the writedown
(impairment) of plant assets due to a
corporate restructuring
3
The company took a big bath regarding
the write-down obsolete inventory
4
The company used too small a growth
rate in future medical costs in
estimating "other" post-retirement
benefits
5
The company recorded equipment
maintenance costs as asset
improvements
6
Google failed to write down impaired
auction rate securities investments
7
The company improperly capitalized
R&D costs
8
The company depreciated assets over
a 5 year life when a 10 year life is
appropriate.
9
The company failed to increase its
allowance for doubtful accounts rate
when customer credit quality declined
10
The company shipped unordered
merchandise to a customer and
recorded the shipment as a sale
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Liabilities
Equity
Revenues Expenses Net Income