Exam #__________
Name: __________________________________
Exam 1
Acct 414 – Corporate Accounting & Reporting II
Fall 2009
Show any necessary computations if you want to be eligible for partial credit. Present your work
in a neat, well-organized manner. When you are using a financial calculator, spell out what you
put in for n, i, PMT, FV, PV, etc. You could also draw a time-line if that would explain your
thinking to me. You may use abbreviations in your essay answers but I need complete thoughts.
Follow the instructions and answer all parts of the question as directed.
1-3.
Time Value of Money (45 points total)
4.
Loan Impairment (30 points total)
5.
Leases (70 points total)
IFRS points______________ (items b & e)
US GAAP points____________ (items a, c & d)
6.
Fair value & fair value option (30 points)
7.
Serial Bonds (25 points)
Total points earned (max = 200)
To be completed by professor:
After Exam 1 - Course Grade
Total Points = __________/__________ = _________%
Quiz and HW percentage =
Projects percentage =
___________%
___________%
Exam 1 – Acct 414 – Fall 2009
1.
Page 2
Felix Corporation wants to accumulate $1,500,000 on December 31, Year 2019 to retire
preferred stock. The company deposits $500,000 in a savings account on January 1, 2010
which will earn interest at 8% per annum simple interest, compounded quarterly. Felix
Corporation wants to know what additional amount it has to deposit at the end of each
quarter for 10 years to have $1,500,000 available at the end of 2019. The periodic
deposits will also earn interest at 8% per annum, compounded quarterly.
What is the amount of the quarterly deposit? $______________________
2.
On April 1, 2009, Harkins Hamburger Heaven purchased a plant asset under an
agreement that specified no interest rate or separate interest payments. The agreement
calls for $10,000 down and $25,000 at the end of each of the next 36 months. The firm’s
incremental borrowing rate is 12% per annum.
What was the cost of the plant asset for financial accounting purposes?
$______________________
Exam 1 – Acct 414 – Fall 2009
3.
Page 3
Assume that you are working for a leasing company. The original lease agreement
specified an annual payment of $45,000 over a five-year lease term. The first payment
was to be made immediately and the asset was to be returned to the lessor at lease end.
These terms gave a healthy return to the leasing company. However, the lessee wants to
be able to buy the asset for $25,000 at the end of the lease (when the estimated fair value
will be $60,000). Since the leasing company bought the asset for $215,725, the original
rate of return was about 12%. You boss wants you to compute the new rate of return to
be sure it is adequate. Find the interest rate implicit in the lease assuming the terms are
modified to include a purchase option for $25,000 at the end of 5 years. Carry
computation to two decimal places.
The implicit rate is _____________________%
Extra credit: If the lessor still wants to earn 12%, what lease payment would be needed (instead of the
$45,000 in the proposed lease agreement)? (5 points)
Exam 1 – Acct 414 – Fall 2009
4.
Page 4
Loan impairment (troubled debt)
As of October 31, 2009, Ferdinand Farms owes Oregon First Bank and Trust $150,000 at 12%
interest. Fancy Farms has been unable to make any payments toward principal or interest during
2009. A troubled debt restructuring is negotiated with the following terms: (a) The interest rate
is reduced to 9%. (b) Interest will be paid annually on a reduced balance of $100,000. (c) The
principal and final interest payment is due on October 31, 2014.
Instructions
Show any entries needed on the books of the creditor, Idaho First Bank & Trust at the following dates –
note the variations in revenue recognition methods shown by each date. [30 points]
October 31, 2009, Date of restructuring
(assuming the bank uses the cost recovery method to recognize revenue)
December 31, 2009, end of fiscal year
(assuming the bank uses the cost recovery method to recognize revenue)
December 31, 2009, end of fiscal year
(assuming the bank uses the effective interest method to recognize revenue)
Exam 1 – Acct 414 – Fall 2009
Page 5
5.
Lessee Accounting. On September 1, 2009, Missoula Mazda, Inc. and First Bank of
Montana sign a lease with the following terms:
1.
3.
5.
7.
9.
11.
Term: 5 years
2.
Implicit interest rate (not known to lessee) 9% 4.
Fair value of asset $100,000
6.
Incremental borrowing rate: 10%
8.
Estimated useful life of asset: 7 years
10.
Purchase option at end of lease: $2,500
12.
a.
Annual payment = $23,203
Est. fair value of asset at end of lease $2,500
Cost of asset $80,000
First payment due 9/1/09
There are major cost uncertainties for lessor
Equipment is returned to lessor at end of lease
if the purchase option is not exercised
Classify the lease under US GAAP for both the lessor and the lessee. Explain. Let me know that
YOU know all the rules. Abbreviations are fine as long as they are obvious. Please find PVMLP
even if not necessary and show the inputs. [15 points]
LESSEE = ______________________________________
LESSOR = ______________________________________
b.
Discuss briefly the way the classification process would be different under International
Financial Reporting Standards (IFRS) for both the lessor and lessee.. [10 points]
Exam 1 – Acct 414 – Fall 2009
Page 6
Problem 5 (continued)
Repeat of facts:
On September 1, 2009, Missoula Mazda, Inc. and First Bank of Montana sign a lease with the following terms
1.
Term: 5 years
2.
Annual payment = $23,203
3.
Implicit interest rate (not known to lessee) 9% 4.
Est. fair value of asset at end of lease $2,500
5.
Fair value of asset $100,000
6.
Cost of asset $80,000
7.
Incremental borrowing rate: 10%
8.
First payment due 9/1/09
9.
Estimated useful life of asset: 7 years
10.
There are major cost uncertainties for lessor
11.
Purchase option at end of lease: $2,500
12.
Equipment is returned to lessor at end of lease
if the purchase option is not exercised
13.
Lessee and lessor both uses straight-line
14.
The fiscal year end for both lessor and lessee is
depreciation method with no salvage
Dec. 31
c.
d.
Regardless of your answer to part a, assume that Missoula Mazda (the lessee) follows US GAAP
and classifies the lease as a capital lease. Prepare the appropriate amortization table for the first
two payments (10 points).
Principal
Date
Payment
Interest
Balance
Portion
0
9/1/09
1
9/1/10
Regardless of your answer to (a), assume that (under US GAAP) the lease is a capital lease for
the lessee. Provide the necessary journal entries to record the transactions for the dates indicated
below (15 points).
9/1/09 –US GAAP – LESSEE
12/31/09
Exam 1 – Acct 414 – Fall 2009
Page 7
Problem 5 (continued)
Repeat of facts:
On September 1, 2009, Missoula Mazda, Inc. and First Bank of Montana sign a lease with the following terms
1.
Term: 5 years
2.
Annual payment = $23,203
3.
Implicit interest rate (not known to lessee) 9% 4.
Est. fair value of asset at end of lease $2,500
5.
Fair value of asset $100,000
6.
Cost of asset $80,000
7.
Incremental borrowing rate: 10%
8.
First payment due 9/1/09
9.
Estimated useful life of asset: 7 years
10.
There are major cost uncertainties for lessor
11.
Purchase option at end of lease: $2,500
12.
Equipment is returned to lessor at end of lease
if the purchase option is not exercised
13.
Lessee and lessor both uses straight-line
14.
The fiscal year end for both lessor and lessee is
depreciation method with no salvage
Dec. 31
e.
Regardless of your answer to part b, assume that the lessor has a finance lease under IFRS.
Prepare any journal entries that would be required at the dates listed. Completion of the
amortization table is optional but possibly helpful. [20 points]
Date
0
9/1/09
1
9/1/10
Payment
9/1/09 – IFRS – for LESSOR
12/31/09 (end of fiscal year)
Interest
Principal Portion
Balance
Exam 1 – Acct 414 – Fall 2009
6.
Page 8
Fair Value Option. Benjamin Inc. has one asset, a bond issued by Franklin Company that
Benjamin Inc. purchased at face value as an investment (accounted for at fair value as trading
security). Benjamin Inc. has only one liability, a bond that was issued at face value to finance the
purchase of the Franklin Company bond. There is no initial shareholder investment.
Terms of the bonds
Face value
Coupon rate (annual)
Term
Semiannual interest payment
Yield rate at year end (simple interest)
Franklin Company Bond
Investment
$1,000,000
10%
10 years
$50,000
11%
Benjamin Inc. Bond Payable
$1,000,000
8%
8 years
$40,000
9%
a. Prepare a balance sheet for Benjamin Company at the END of the first year assuming that the fair
value option was not selected for the bond payable.
Assets
Liabilities & Owners Equity
Cash
Bonds payable
Bond Investment
Owner’s equity
Total
Total
b. Prepare a balance sheet for Benjamin Company at the END of the first year assuming that the fair value
option was selected for the bond payable.
Assets
Liabilities & Owners Equity
Cash
Bonds payable
Bond Investment
Owner’s equity
Total
Total
Exam 1 – Acct 414 – Fall 2009
7.
Page 9
Serial Bonds (25 points maximum). On Nov. 1, 2009, Moses Corporation issued $2,000,000 in serial
bonds. The bond principal will be repaid in $1,000,000 increments beginning on Nov. 1, 2010 with the
final payment to be made on Nov. 1, 2011. The bonds pay interest semi-annually on May 1 and Nov. 1.
The coupon rate is 10% per annum. An investment banker handled the transaction and you have just
received a check for $2,055,160. Moses’ fiscal year ends on December 31.
You may choose either the bonds outstanding method or the effective interest method of amortizing bond
premiums. Check the appropriate box so I’ll know what you are attempting! You do NOT need to prepare an
amortization table – just the journal entries.
[ ] I’m using the bonds outstanding method.
[ ] I’m using the effective interest method
If you choose this option, you may assume that the effective simple interest rate per year is 8%.
November 1, 2009 [6 points]
December 31, 2009 [14 points]
Exam 1 – Acct 414 – Fall 2009
Page 10
SOLUTIONS
Problem 3 - determine implicit interest rate
n=
pmt=
pv=
fv=
Problem 1 - accumlation
5
45,000.00
(215,725.00)
25,000.00
ordinary annuity = 0;
annuity due = 1
1
i= ?
=rate
6.889%
Problem 3 - Find lease payment (extra credit)
Fair value (PV)
Yield rate
Number of payments
Future value (residual)
Solve for payment
ordinary=0; due=1
Solve for PV
n=
i=
PMT=
pv=
$
(215,725)
12%
5
25,000
1
$49,918.72 =Pmt
Face value =
Annual rate=
40
8%
2.00% pmts are quarterly
500,000
(1,500,000)
ordinary annuity=0;annuity
due=1
0
Solve for pmt $
6,555.75
Problem 2 non-interest bearing note
n=
36
i=
1.00%
PMT=
(25,000)
pv=
?
Face value =
ordinary annuity=0;annuity
due=1
0
Solve for PV
752,687.63
Down pmt
10,000.00
Capitalize at
762,687.63
Problem 4 journal entries:
The creditor always finds the present value of the revised cash flows using the original interest rate (both
US GAAP and IFRS). In this case: PMT=$100,000 * 9% (new rate) = 9,000; i=12% (original rate)
FV=$100,000, n=5. Don’t forget to remove accrued interest (old balance * original rate). For the effective
interest method, multiply new carrying value times original interest rate and prorate for partial year. In this
case: $89,186 * 12% = 10,702 * 2/12 = 1,784. No cash changes hands until Oct 31, 2010 (entry shown
below was not required. Under the cost recovery method, no entry is needed at 12/31/09 since we never
accrue principal.
Creditor journal entries
Debit
Credit
10/31/2009 Restructured note receivable
89,186
Loss on loan impairment
78,814
Accrued interest receivable
18,000
Note receivable (old)
150,000
12/31/2009
Cost recovery method = no entry
12/31/2009
Effective interest method:
Interest receivable
Interest revenue
-
1,784
1,784
#5a
There is no title transfer or bargain purchase option and the lease term is only 71% of economic
life. However, the present value of the minimum lease payments is $96,753 [n=5, i=10%, pmt=23203,fv=0,
type=begin] which exceeds 90% of fair market value. Therefore, this is a capital lease for the lessee. Note that the
lessee uses the incremental borrowing rate of 10% per US GAAP. Some students said there was a bargain purchase
option (untrue) and then failed to follow instructions to compute PVMLP anyways. Many of you included the
$2,500 purchase option in the PVMLP which is incorrect because this is an unguaranteed residual value for both
lessee and lessor. Recall that we always exclude unguaranteed residual values from PVMLP although the lessor
includes the residual value as part of the receivable (unless there is a TT or BPO).
Exam 1 – Acct 414 – Fall 2009
Page 11
For lessor, it is an operating lease because there are cost uncertainties – even though it meets the FMV rule because
the PVMLP = 98,374.22 [n=5, i=9%, pmt=23203,fv=0, type=begin] (using 9% rate) which is > 90% of FMV. If
there were no uncertainties, it would be a sales type lease because there is a profit. Also, note that the instruction
say that you MUST show computation of PVMLP even if not necessary.
#5b The essay questions was “open” so that you could tell me about the differences between US GAAP and IFRS.
In this case, I was looking for a discussion of the fact that IFRS does not have bright-line rules and therefore
requires more judgment in classifying leases. You could have said that the leases are given different titles under
IFRS but that the journal entries are basically the same (a finance lease instead of a capital lease for the lessee, etc.)
You might also have recalled that there are FIVE basic guidelines and mentioned that a highly specialized asset
might need to be capitalized even if it failed the four US rules. You also might have noted that IFRS doesn’t have
the collectability and cost uncertainty “extra rules” for lessors. The last item I was looking for was the different
interest rate used under IFRS by the lessee: the lessee uses the implicit rate unless it is not practical to figure it out.
Some of you answered a different question and told me how this particular lease should be handled under IFRS. For
the facts presented, the lessee would have a finance lease which would be capitalized at $98,374 because the lessee
would use the implicit rate (see above). Reason: the lease term is a majority of useful life and the PVMLP is close to
fair market value. The lessor would also have a finance lease for the same reasons as lessee because IFRS doesn’t
have the extra collectability and cost uncertainty rules. This is the type of lease that has a profit so a sale would be
recorded at PVMLP and any initial direct costs would be expensed in the year the lease begins – just like accounting
for a sales-type lease under US GAAP.
#5c amortization table – uses 10% under US GAAP because implicit rate is not known. The lessee’s table always
begins with the PVMLP unless that amount is greater than fair value (in which case we would start with fair value).
Date
09/01/09
09/01/09
09/01/10
09/01/11
09/01/12
09/01/13
Lease
Payment
96,753.39
23,203.00
23,203.00
23,203.00
23,203.00
23,203.00
10%
Interest
Expense
Reduction in
Lease
Obligation
0.00
7,355.04
5,770.24
4,026.97
2,109.36
#5d – Lessee journal entries under US GAAP
9/1/09
Leased asset
Lease obligation
Cash
12/31/09
Depreciation expense
(4/12)*(96753/5)
Acc’d depreciation
Interest expense (73,550 * .1 * 4/12)
Lease obligation
23,203.00
15,847.96
17,432.76
19,176.03
21,093.64
Lease
Obligation
BALANCE
96,753.39
73,550.39
57,702.43
40,269.67
21,093.64
0.00
96,753
73,550
23,203
6,450
6,450
2,452
2,452
Note that we use FIVE years for depreciation since there is no BPO or TT: the asset will be returned to lessor at end of lease.
The entries in 2010 were not required:
9/1/10
Lease obligation
18,300
Interest expense
4,903
Cash
23,203
12/31/10
Depreciation expense
19,351
Acc’d depreciatiojn
19,351
Interest expense
1,923
Lease obligation
1,923
Exam 1 – Acct 414 – Fall 2009
Page 12
#5e Lessor JEs under IFRS –which would be same as a sales-type lease under US GAAP because there is
a profit (FMV not equal to cost). The lessor uses the implicit rate and begins the amortization table with
fair market value if there is a profit, or with fair market value plus any initial direct costs if there is no
profit (a finance lease that we’d call “direct financing” under US GAAP).
Date
100,000.00
09/01/09
09/01/09
09/01/10
09/01/11
09/01/12
09/01/13
09/01/14
LESSOR
Fall 2009
Lease
Payment
100,000.00
Interest
8.9994%
23,203.00
23,203.00
23,203.00
23,203.00
23,203.00
2,500.00
0.00
6,911.31
5,445.14
3,847.03
2,105.10
206.41
IFRS FINANCE LEASE WITH PROFIT
same as Sales Type Lease
09/01/09 Net Investment in Lease
Sales Type Lease
PVMLP
Cost of goods sold
Cost - PV of UNGRV
Inventory
Cash
total
4/12 months
Yearfrac=
Prorated:
12/31/09 Net Investment in Lease
Interest Revenue
Reduction
in lease
receivable
23,203.00
16,291.69
17,757.86
19,355.97
21,097.90
2,293.59
debit
LEASE
Receivable
BALANCE
100,000.00
76,797.00
60,505.31
42,747.45
23,391.48
2,293.59
0.00
credit
76,797.00
78,374.22
23,203.00
178,374.22
98,374.22
0.00
80,000.00
178,374.22
0.33333
0.33
2,303.77
2,303.77
Problem 6 – Fair Value Option (FASB 159)
Fair value option is NOT adopted
Assets
Cash
Bond Investment
Total
20,000
943,770
963,770
Fair value option is
adopted
Assets
Cash
Bond Investment
Total
20,000
943,770
963,770
Bond payable at face
value
Liabilities & Owners
Equity
Bonds payable
Owner’s equity
Total
Bond payable at fair
value
Liabilities & Owners
Equity
Bonds payable
Owner’s equity
Total
1,000,000
-36,230
963,770
948,886
14,884
963,770
Exam 1 – Acct 414 – Fall 2009
Page 13
#6 Supporting computations:
Note that facts gave the SEMIANNUAL payment, not the annual amount.
Principal (FV)
Yield rate
Number of payments
PMT=
ordinary=0; due=1
Solve for PV
$
1,000,000 $
6%
18
50,000
0
$943,769.63
Beginning cash balance
Interest revenue
Interest expense
Ending cash
1,000,000
4.5%
14
40,000
0
$948,885.87
FV
=i
=n
=PV
=fair value
0
100,000
-80,000
20,000
Income statements
Fair value option
Fair value option
NOT adopted
ADOPTED
Interest revenue
100,000
100,000
Interest expense
-80,000
-80,000
Gain/loss on bond investment
-56,230
-56,230 *
Gain/loss on bond payable
0
51,114 *
Net income
-36,230
14,884
* Note that gains and losses approximately offset each other when we use fair value option
#7 Serial bonds. Easiest is to do bonds outstanding method. Just count up the face values outstanding: 2M + 2M +
1M + 1M = $6 million total. So the discount/premium will be amortized with the 2/6 fraction for the first 2 interest
payments. Since this bond was issued at a premium, the amortization of the premium DECREASES interest
expense (as compared to interest paid). To use the effective interest rate, you need to know what it is – the 8%
given. I’ve pasted in complete answers for study purposes but the amortization tables are NOT necessary.
Period
0
1
2
3
4
Bonds Outstanding Method
5.00%
Date
Interest
Paid
11/01/09
05/01/10
100,000
11/01/10
100,000
05/01/11
50,000
11/01/11
50,000
Principal
Payment
1,000,000
1,000,000
Interest
Expense
81,613
81,613
40,807
40,807
Amortization
18,387
18,387
9,193
9,193
Face Value:
Carrying
Value
2,055,160
2,036,773
1,018,387
1,009,193
0
2,000,000
BALANCE
PREMIUM
55,160
36,773
18,387
9,193
-
Exam 1 - Fall 2009
Journal entries:
Bonds Outstanding Method
Debit
Credit
2,055,160
55,160
2,000,000
11/01/09 Cash
Premium on Bonds Payable
Bonds Payable
2 mo
12/31/09 Interest Expense
Premium on Bonds Payable
Interest payable
27,204
6,129
Note that the entry to record the loan proceeds is the same under both methods
33,333 ok
FACE
VALUE
2,000,000
2,000,000
1,000,000
1,000,000
0
6,000,000
Amortization
Fraction
0.33333
0.33333
0.16667
0.16667
1.00000
Exam 1 – Acct 414 – Fall 2009
Page 14
Alternate answer for #7
Computation of interest expense for effective interest method = carrying value $2,055,160 * 4% yield rate * 2/6
months. The interest payable is the coupon rate 5% * face value $2,000,000 * 2/6 months. We then BACK INTO
the amortization of the premium.
Period
0
1
2
3
4
11
EFFECTIVE INTEREST AMORTIZATION SCHEDULE
5.00%
4.000%
Face Value:
2,000,000
Date
Interest
Principal
Interest
AmortiCarrying
BALANCE
Paid
Payment
Expense
zation
Value
PREMIUM
11/01/09
0
0
0
2,055,160
55,160
05/01/10
100,000
82,206
17,794
2,037,366
37,366
11/01/10
100,000
1,000,000
81,495
18,505
1,018,861
18,861
05/01/11
50,000
40,754
9,246
1,009,615
9,615
11/01/11
50,000
1,000,000
40,385
9,615
0
0
05/01/15
0
0
(0)
0
0
Exam 1 - Fall 2009
Journal entries:
Effective Interest Method
Debit
Credit
11/01/09 Cash
2,055,160
Premium on Bonds Payable
55,160
Bonds Payable
2,000,000
2 mo
12/31/09 Interest Expense
27,402
Premium on Bonds Payable
5,931
Interest payable
33,333
FACE
VALUE
2,000,000
2,000,000
1,000,000
1,000,000
0
0
ok