Intermediate Accounting II, ACCT 3322
Solutions to Review Questions for Chapters 15 and 16
Exercise #1
Spencer Company leases equipment to its customers under direct-financing leases. Typically
the equipment has no residual value at the end of the lease and the contract call for payments at
the beginning of each year. Spencer’s target rate of return is 10%. On a ten-year lease of
equipment with a fair value of $1,351,805, the annual payments would be how much? How
much interest will Spencer Company earn over the life of the lease?
PV
1,351,805
R
R
=
=
=
=
R
1,351,805
200,000
Pmt
*
Periods
200,000
*
10
Less PV of minimum lease payments
Interest expense
Date
1
1
2
3
4
5
6
7
8
9
10
Payment
$200,000
200,000
200,000
200,000
200,000
200,000
200,000
200,000
200,000
200,000
$2,000,000
Interest
$115,181
106,699
97,369
87,105
75,816
63,398
49,737
34,711
18,179
$648,195
*
*
÷
PVAD, n = 10, i = 10%
6.75902
6.75902
=
=
Total Payments
$2,000,000
1,351,805
$648,195
Principal
$200,000
84,819
93,301
102,631
112,895
124,184
136,602
150,263
165,289
181,821
$1,351,805
Page 1
Balance
$1,351,805
1,151,805
1,066,986
973,685
871,054
758,159
633,975
497,373
347,110
181,821
0
Exercise #2
Spencer Manufacturing leased equipment to Sophia Company on September 1, 2001. Spencer
recorded the lease as a sales-type lease at $405,391, the present value of the minimum lease
payments discounted at 5%. The lease called for 10 annual lease payments of $50,000 due at
the beginning of each year. The first payment was received on September 1, 2001. Spencer
had manufactured the equipment at a cost of $182,425. The total pretax earnings in 2001 to
Spencer as a result of this lease contract would be:
Sales price
Cost of goods sold
Gross profit
$405,391
182,425
$222,966
PV of minimum lease payments
Initial payment
Carrying value at inception
Annual interest rate
Annual interest earned
Short period
Interest earning in short period
Increase in pretax earnings
Date
9/1/01
9/1/01
9/1/02
9/1/03
9/1/04
9/1/05
9/1/06
9/1/07
9/1/08
9/1/09
9/1/10
Payment
$50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000
$500,000
405,391
50,000
355,391
5%
17,770
4/12
5,923
$228,889
Interest
$17,770
$16,158
$14,466
$12,689
$10,824
$8,865
$6,808
$4,649
$2,380
$94,609
Page 2
Principal
$50,000
32,230
33,842
35,534
37,311
39,176
41,135
43,192
45,351
47,620
$405,391
Balance
$405,391
355,391
323,161
289,319
253,785
216,474
177,298
136,163
92,971
47,620
0
Exercise #3
Spencer Company had taxable income of $100,000 in the current year. The amount of MACRS
depreciation was $50,000 while the amount of depreciation reported on the income statement
was $5,000. Assuming no other temporary differences What would Spencer Company’s pretax
accounting income be?
$145,000
Pretax accounting income
Temporary differences:
Accounting depreciation
MACRS depreciation
Excess depreciation
Taxable income
$5,000
50,000
(45,000)
$100,000
Exercise #4
The following is a reconciliation of pretax financial statement income to taxable income for
Spencer Company for the year ended December 31, 2004, its first year of operations.
Pretax accounting income
Interest revenue on municipal securities
Warranty expense in excess of deductible amount
Depreciation in excess of financial statement amount
Taxable income
$900,000
(10,000)
25,000
(200,000)
$715,000
The company’s effective income tax rate is 25%.
Prepare a schedule of deferred tax assets and liabilities at December 31, 2004.
Temporary Difference
Warranty expense
Excess depreciation
Totals
Deferred Tax
Future
Deductable
(Taxable)
Amount Tax Rate Asset (Liability)
25,000
25% 6,250
(200,000)
25%
(50,000)
(175,000)
6,250
(50,000)
Page 3
Prepare a t-account analysis of Spencer Company’s deferred tax asset as of December 31, 2004.
Deferred Tax Asset
Description
Beginning balance
Adjusting journal entry
Ending balance
Debit
Credit
0
6,250
6,250
Prepare a t-account analysis of Spencer Company’s deferred tax liability as of December 31,
2004.
Deferred Tax Liability
Description
Beginning balance
Adjusting journal entry
Ending balance
Page 4
Debit
Credit
0
50,000
50,000
Prepare a schedule of net deferred tax expense (benefit) for Spencer Company for the year.
Analysis of net deferred tax expense:
Deferred tax benefit
Deferred tax expense
Net deferred tax expense
(6,250)
50,000
43,750
Prepare a schedule of Spencer Company’s income tax payable.
Income Tax Payable
Taxable income
Income tax rate
Income tax payable
715,000
25%
178,750
Prepare a schedule of Spencer Company’s income tax expense.
Income Tax Expense
Deferred tax expense
Income tax payable
Income tax expense
43,750
178,750
222,500
Prepare the year end journal entry to record income tax expense.
Account
Income tax expense
Deferred tax assets
Deferred tax liabilities
Income tax payable
Debit
222,500
6,250
Credit
50,000
178,750
Page 5
Exercise #5
Spencer Company reported the following pretax accounting income and taxable income for its
first three years of operations.
Pretax and
Taxable Income
$100,000
(500,000)
600,000
Year
2002
2003
2004
The enacted tax for all years was 35%. Spencer Company elected to carryback the original
loss to 2002 and then carryforward the excess to 2004.
Prepare a schedule of NOL carryback and NOL carryforward.
Description
2003 NOL carryback
NOL
(500,000)
2003 NOL carryforward
100,000
(400,000)
Taxable
Year Income
2002 100,000
(100,000)
0
Tax
Rate
Tax Paid Refund
35%
35,000
35%
0
35,000
Prepare an analysis of the deferred tax asset.
Temporary Difference
NOL Carryforward
Deferred Tax
Future
Tax
Amounts Rate Asset Liability
400,000 35% 140,000
Prepare a partial balance sheet for Spencer Company at December 31, 2003 demonstrating how
the effects of the NOL will be reported.
Partial Balance Sheet
December 31, 2003
Income tax refund receivable
Deferred tax asset
$35,000
140,000
Page 6
Prepare a partial income statement for Spencer Company for the year ended December 31, 2003
demonstrating how the effects of the NOL carryback and carryforward would be reported.
Partial Income Statement
For the Year Ended December 31, 2003
loss before income tax benefit
Income tax benefit:
Deferred tax benefit
Current tax benefit
Net loss
(500,000)
$140,000
35,000
175,000
(325,000)
Prepare a partial income statement for Spencer Company for the year ended December 31, 2004
demonstrating how the effects of the NOL carryforward would be reported.
Partial Income Statement
For the Year Ended December 31, 2004
Income before income taxes
Income taxes:
Deferred tax expense
Current tax expense
Net income
$600,000
$140,000
70,000
210,000
$390,000
Exercise #6
Spencer Company reports bad debt expense using the allowance method. For tax purposes the
direct write-off method is used. At the end of the current year, Spencer Company has accounts
receivable and an allowance for uncollectible accounts of $200,000 and $16,000 respectively,
and taxable income for the year is $15,000. At the beginning of the current year, Spencer
Company reported a deferred tax asset of $7,000 related to the difference in reporting bad
debts, its only temporary difference. The enacted tax rate is 25% each year.
Prepare an analysis of the deferred tax asset or deferred tax liability related to this temporary
difference.
Temporary Difference
Bad debt expense
Future
Deductable
(Taxable)
Amount
16,000
Page 7
Tax Rate
25%
Asset
4,000
Prepare a t-account analysis of the deferred tax asset and/or deferred tax liability account as of
the end of year.
Deferred Tax Asset
Description
Debit
Beginning balance
7,000
Adjusting journal entry
Ending balance
4,000
Credit
3,000
Calculate income tax payable
Income Tax Payable
Taxable income
Income tax rate
Income tax payable
15,000
25%
3,750
Calculate income tax expense
Income Tax Expense
Deferred tax expense
Income tax payable
Income tax expense
3,000
3,750
6,750
Prepare the year-end journal entry to record income tax expense.
ACCOUNT
Income tax expense
Deferred tax asset
Income tax payable
To record income tax for the year
DEBIT
6,750
CREDIT
3,000
3,750
Page 8
Exercise #7
Spencer Company leased a machine on December 31, 2004, for a five-year period. The lease
agreement calls for annual payments in the amount of $25,000 on December 31 of each year
beginning on December 31, 2004. Spencer Company has the option to purchase the machine on
December 31, 2009, for $5,000 when its fair value is expected to be $15,000. The machine's
estimated useful life is expected to be 10 years with no residual value. Spencer Company uses
straight-line depreciation for this type of machinery. The appropriate interest rate for this lease
is 8%.
Calculate the amount to be recorded as a leased asset and the associated lease liability.
PV of minimum lease payments:
Payments
PVOA, n = 5, i = 8%
1 + 8%
PVAD, n = 5, i = 8%
PV of minimum lease payments
PV of bargain purchase option
Bargain purchase
PV of $1, n = 5, i = 8%
PV of bargain purchase option
PV of lease contract
25,000
3.99271
1.08000
4.31213
107,803
5,000
0.68058
3,403
111,206
In the space prepare the amortization schedule of 2004 and 2005.
Amortization Schedule for Bond Investment
Date
12/31/04
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
12/31/09
Payment
25,000
25,000
25,000
25,000
25,000
5,000
Interest
0
6,896
5,448
3,884
2,195
371
Page 9
Amortization
of Principal
25,000
18,104
19,552
21,116
22,805
4,629
Balance
111,206
86,206
68,102
48,550
27,434
4,629
0
Prepare all of the necessary journal entries associated with this lease for 2004 and 2005.
ACCOUNT
DEBIT
111,206
CREDIT
Leased asset
Lease payable
111,206
To record the capitalized lease of an asset on December 31, 2004
Lease payable
25,000
Cash
25,000
To record the initial payment on the lease on December 31, 2004
Interest expense
6,896
Lease payable
18,104
Cash
25,000
To record the payment on the lease and the amortization of interest on
December 31, 2005
ACCOUNT
Depreciation expense
Accumulated depreciation
To record depreciation expense for 2005
Analysis of depreciation expense:
Value of leased asset
Salvage value
Depreciable base
Service life (economic life)
Annual depreciation
DEBIT
11,121
CREDIT
11,121
111,206
0
111,206
10
11,121
Page 10