FREEMAN SCHOOL OF BUSINESS
ACCN 4110
Midterm Examination #2
Spring 2018
Practice exam for exam to be held on March 22, 2018.
Prof. Lakshmana K. Krishna Moorthy
Name (Please Print): ________________________________
Section: ______
Statement of Academic Honesty
Please read and agree to the academic honesty statement below.
I have neither provided assistance to nor received assistance from anyone in regards to the
administration of this examination. All work shown is my own and all answers given are the
product of my independent judgment. Unless explicitly allowed by the instructor, electronic
devices (such as cell phones, notebooks, calculators, etc.) are not allowed to be out of backpacks
or purses during quizzes and exams. These electronic devices must be packed away and turned
off. Any student who is caught with one of these devices out will have his/her test taken and will
be charged with the Honor Code violation of cheating.
Signature: ________________________________________
Examination Contents
Number
of
Questions
Suggested
Time (in
minutes)
Points
Available
Multiple Choice Questions
15
45
45
Long Problems
2
30
30
Total
17
75
75
BEFORE YOU BEGIN, PLEASE VERIFY THAT THIS TEST HAS *** PRINTED PAGES
EXCLUDING THIS COVER PAGE
Good Luck!
PART I: Multiple Choice Questions (15 questions, 3 points each; 45 points). Choose the one alternative
that best completes the statement or answers the question. Please use your bubble sheet to answer the
questions in this section. Questions answered elsewhere will not be graded.
1.
A.
B.
C.
D.
Prepayments made by the lessee on an operating lease are considered to be:
A lease expense.
A depreciable asset.
Deferred revenue.
A prepayment of rent expense.
2. Company Q leases the following asset from Company T:
•
•
•
•
•
•
Fair value of $200,000.
Useful life of 5 years with no salvage value.
Lease term is 4 years.
Annual lease payment is $30,000 and the lease rate is 11%.
The company’s overall borrowing rate is 9.5%.
The firm can purchase the equipment at the end of the lease period for $45,000.
What type of lease is this for Company Q?
A. Operating.
B. Finance.
C. Sales type.
D. Long term.
The 4 year lease term is greater than 75% of the asset's 5 year life making this a Finance lease
for lessee (Company Q) and sales type lease for lessor (Company T).
3. Neal Corp. entered into a nine-year capital lease on a warehouse on December 31, 2016.
Lease payments of $52,000, which includes real estate taxes of $2,000, are due annually,
beginning on December 31, 2017, and every December 31 thereafter. Neal does not
know the interest rate implicit in the lease; Neal’s incremental borrowing rate is 9%. The
rounded present value of an ordinary annuity for nine years at 9% is 6.0. What amount
should Neal report as lease liability at December 31, 2016?
A. $300,000
B. $327,000
C. $450,000
D. $468,000
The lease liability should be the annual lease payments less the executory cost (real estate taxes)
times the present value factor for an ordinary annuity of 1 for nine years at 9%. The calculation
would be: ($52,000 – 2,000) × 6.0 = $300,000. The real estate taxes are a period cost and should
be charged to expense. Note here this is an ordinary annuity, first payment is due on December
31,2017.
4. On January 2, 2016, Nori Mining Co. (lessee) entered into a 5-year lease for drilling
equipment. Nori accounted for the acquisition as a financel lease for $240,000, which
includes a $10,000 bargain purchase option. At the end of the lease, Nori expects to
exercise the bargain purchase option. Nori estimates that the equipment’s fair value will
be $20,000 at the end of its 8-year life. Nori regularly uses straight-line amortization on
similar equipment. For the year ended December 31, 2016, what amount should Nori
recognize as amortization expense on the leased asset?
A. $27,500
B. $30,000
C. $48,000
D. $46,000
In a finance lease with a bargain purchase option, the lessee will control the asset for its total
useful life. Therefore, the depreciation should be allocated over the 8-year life of the asset.
$240,000 cost – 20,000 salvage value = 220,000 / 8 years = $27,500 per year.
5. Peg Co. leased equipment from Howe Corp. on July 1, 2016, for an eight-year period
expiring June 30, 2024. Equal payments under the lease are $600,000 and are due on
July 1 of each year. The first payment was made on July 1, 2016. The rate of interest
contemplated by Peg and Howe is 10%. The cash selling price of the equipment is
$3,520,000, and the cost of the equipment on Howe’s accounting records is $2,800,000.
The lease is appropriately recorded as a sales-type lease. What is the amount of profit on
the sale and interest revenue that Howe should record for the year ended December 31,
2016?
Profit on sale
A. $5,000
B. $ 45,000
C. $720,000
D. $720,000
Interest Revenue
$146,000
$176,000
$146,000
$292,000
The profit on the sale is the difference between the cash selling
price and the book value, $3,520,000 – 2,800,000 = $720,000.
The interest is computed as follows:
Present value of minimum lease
payments
and lease obligation, 7/1/2016
Initial payment made 7/1/2016
Liability balance
Interest rate 10% =
For one-half year =
$3,520,000
(600,000)
$2,920,000
$292,000
$146,000
6. Which of the following differences between financial accounting and tax accounting ordinarily
creates a deferred tax asset?
A. Depreciation early in the life of an asset.
B. Municipal bond interest income.
C. Subscriptions collected in advance.
D. None of these answer choices are correct.
7. Scott Corp. received cash of $20,000 that was included in revenues in its 2016 financial
statements, of which $12,000 will not be taxable until 2017. Scott’s enacted tax rate is
30% for 2016, and 25% for 2017. What amount should Scott report in its 2016 balance
sheet for deferred income tax liability?
A. $3,000
B. $2,000
C. $3,600
D. $2,400
The deferred tax liability is recognized at the rate anticipated in the period when the temporary
difference reverses. Therefore, the deferred tax liability is $12,000 x 25% or $3,000.
8. Black Co. organized on January 2, 2016, had pretax financial statement income of
$500,000 and taxable income of $800,000 for the year ended December 31, 2016. The
only temporary differences are accrued product warranty costs, which Black expects to
pay as follows:
2017
2018
2019
2020
$100,000
$ 50,000
$ 50,000
$100,000
The enacted income tax rates are 25% for 2016, 30% for 2017 through 2019, and 35% for 2020.
Black believes that future years’ operations will produce profits. In its December 31, 2016,
balance sheet, what amount should Black report as deferred tax asset?
A. $75,000
B. $50,000
C. $90,000
D. $95,000
Deferred taxes are calculated using future enacted tax rates.
Temporary
Enacted
×
Differences
Tax Rates
2017 $100,000
× 30%
2018 $ 50,000
× 30%
2019 $ 50,000
× 30%
2020 $100,000
× 35%
Total Deferred Tax Asset:
Year
Deferred
Tax Asset
= $30,000
= 15,000
= 15,000
= 35,000
$95,000
=
9. Dix, Inc., a calendar-year corporation, reported the following operating income (loss)
before income tax for its first three years of operations:
2014
2015
2016
$100,000
(200,000)
400,000
There are no permanent or temporary differences between operating income (loss) for financial
and income tax reporting purposes. When filing its 2015 tax return, Dix did not elect to forego
the carryback of its loss for 2015. Assume a 40% tax rate for all years. What amount should Dix
report as its income tax liability at December 31, 2016?
A. $120,000
B. $60,000
C. $160,000
D. $80,000
The tax benefit of loss carryback would be $40,000 ($100,000 x 40%) and would result in a tax
refund for 2015. The other $100,000 of the loss would be carried forward to offset a portion of
the 2016 income. The tax liability would be the 2016 pretax income of $400,000 less the loss
carryforward of $100,000 times the 40% (300,000* 40%) tax rate for a total liability of
$120,000.
10. Which of the following circumstances creates a future taxable amount?
A. Service fees collected in advance from customers: taxable when received, recognized for
financial reporting when earned.
B. Accrued compensation costs for future payments.
C. Straight-line depreciation for financial reporting and accelerated depreciation for tax
reporting.
D. Investment expenses incurred to obtain tax-exempt income (not tax deductible).
11. Of the following temporary differences, which one ordinarily creates a deferred tax asset?
A. Fines paid for violating environmental laws.
B. Installment sales for tax reporting.
C. Accrued warranty expense.
D. Accelerated depreciation for tax reporting.
12. Wolf Inc. began a defined benefit pension plan for its employees on January 1, 2016.
The following data are provided for 2016 as of December 31, 2016:
Projected benefit obligation
Accumulated benefit obligation
Plan assets at fair value
Pension expense
$385,000
340,000
255,000
95,000
Employer’s cash contribution (end of
255,000
year)
What amount should Wolf report as a net pension liability at December 31, 2016?
A. $0
B. $45,000
C. $85,000
D. $130,000
The company must report the net difference between those two amounts, referred to as the
“funded status” of the plan. The funded status for Wolf at Dec. 31, 2016, is $385,000 – 255,000
= $130,000. Note here that you are given the end of period PBO and plan assets. These values
have already taken into consideration the pension expense, contributions etc.
13. The projected benefit obligation (PBO) is best described as the
A. Present value of benefits accrued to date based on future salary levels.
B. Present value of benefits accrued to date based on current salary levels.
C. Increase in retroactive benefits at the date of the amendment of the plan.
D. Amount of the adjustment necessary to reflect the difference between actual and estimated
actuarial returns.
The PBO is the actuarial present value of all future benefits attributable to past employee service
at a moment in time. It is based on assumptions as to future compensation if the pension plan
formula is based on future compensation.
14. A company's defined benefit pension plan had a PBO of $265,000 on January 1, 2016. During
2016, pension benefits paid were $40,000. The discount rate for the plan for this year was 10%.
Service cost for 2016 was $80,000. Plan assets (fair value) increased during the year by $45,000.
The amount of the PBO at December 31, 2016, was:
A. $225,000.
B. $305,000.
C. $331,500.
D. None of these answer choices is correct.
PBO/1/1 (Credit Balance)
$265,000
Service cost (Credit)
80,000
Settlement cost ($265,000 × 10%) (Credit)
26,500
Benefits paid (Debit)
PBO 12/31
(40,000)
$331,500
15. The component of pension expense that results from amending a pension plan to give recognition
to previous service of currently enrolled employees is the amortization of:
A. Prior service costs.
B. Amendment costs.
C. Retiree service costs.
D. Transition costs.
PART II: Long Problems (2 questions, 15 points each; 30 points). Answer should be in the proper
format and legible with clear labels for items. Limit your answers to the space provided. Show all
computations.
16.
The DeVille Company reported pretax accounting income on its income statement as follows:
2016
2017
2018
2019
$350,000
270,000
340,000
380,000
Included in the income of 2016 was an installment sale of property in the amount of $50,000.
However, for tax purposes, DeVille reported the income in the year cash was collected. Cash
collected on the installment sale was $20,000 in 2017, $25,000 in 2018, and $5,000 in 2019.
Included in the 2018 income was $15,000 interest from investments in municipal bonds.
The enacted tax rate for 2016 and 2017 was 30%, but during 2017 new tax legislation was
passed reducing the tax rate to 25% for the years 2018 and beyond.
Required:
Prepare the year-end journal entries to record income taxes for the years 2016–2018.
Answer:
Date
General Journal
Debit
Dec 31, 2016
Income tax expense
105,000
Dec 31, 2017
Credit
Deferred tax liability
15,000
Income tax payable
90,000
Income tax expense
79,500
Deferred tax liability
7,500
Income tax payable
87,000
Dec 31, 2018
Income tax expense
81,250
Deferred tax liability
6,250
Income tax payable
87,500
Explanation:
2016
Pretax
accountin
g income
Install
ment sale
Munic
ipal bond
interest
Taxable
income
Tax
rate
Income
tax
payable
2017
350,000
(50,000
)
2018
270,000
340,000
20,000
25,000
(15,000
300,000
290,000
350,000
30%
30%
25%
90,000
87,000
87,500
Temporary difference:
2016
2017
2018
2016
$(50,000
2017
) $20,000
20,000
2018
$25,000
25,000
25,000
2019
$5,000
5,000
5,000
5,000
Cumulative
Temporary
Difference
=$ 0
= $ 50,000
= $ 30,000
= $ 5,000
)
2016
Cumula
tive
differenc
e
Tax
rate
Yearend
balance
Previ
ous
balance
Credit /
$
(debit)
2017
2018
50,000
30,000
5,000
30%
25%
25%
15,000
7,500
1,250
0
(15,000
)
(7,500
)
15,000
$
$
(7,500
)
(6,250
)