Text Problems for Exam 2
E7-21 (30 minutes)
a. Investments classified as trading
Balance Sheet
Transaction
MS 80,000
Cash 80,000
MS
80,000
Cash
80,000
Cash
DI
6,250
6,250
Cash
6,250
DI
Cash
Asset
1. Ohlson Co.
purchases
5,000 common -80,000
Cash
shares of
Freeman Co. at
$16 per share
2. Ohlson Co.
receives a cash
dividend of
$1.25 per
common share
from Freeman
+
Income Statement
Noncash
LiabilContrib.
Earned
=
+
+
Assets
ities
Capital
Capital
+80,000
Investment
=
+6,250
Cash
Revenues
+6,250
+6,250
=
Retained
Earnings
Dividend
Income
+7,500
+7,500
=
Retained Unrealized
Earnings
Gain
=
Retained
Earnings
–
Expenses
=
Net
Income
–
=
–
=
+6,250
–
=
+7,500
6,250
MS
7,500
3. Year-end
UG
7,500
MS
7,500
UG
market price of
Freeman
common stock
is $17.50 per
share
Investment
4. Ohlson Co.
+86,400
sells all 5,000
Cash
common shares
of Freeman for
$86,400 cash
Investment
+7,500
7,500
Cash 86,400
LS
1,100
MS
87,500
Cash
86,400
LS
1,100
MS
87,500
-87,500
-1,100
–
+1,100
Loss on
Sale
=
–1,100
E7-21 (concluded)
b. Investments classified as available-for-sale
Balance Sheet
Transaction
MS 80,000
Cash 80,000
MS
80,000
Cash
80,000
Cash
DI
6,250
6,250
Cash
6,250
DI
6,250
MS
7,500
AOCI 7,500
MS
7,500
AOCI
7,500
Cash
Asset
1. Ohlson Co.
purchases
5,000 common -80,000
Cash
shares of
Freeman Co. at
$16 per share
2. Ohlson Co.
receives a cash
dividend of
$1.25 per
common share
from Freeman
+80,000
Investment
=
Cash
+7,500
Investment
Revenues
=
+6,250
3. Year-end
market price of
Freeman
common stock
is $17.50 per
share
Income Statement
Noncash
LiabilContrib.
Earned
+
=
+
+
Assets
ities
Capital
Capital
=
+6,250
+6,250
Retained
Earnings
Dividend
Income
+7,500
AOCI
–
Expenses
=
–
=
–
=
–
=
–
=
Net
Income
+6,250
Cash 86,400
AOCI
7,500
GN
6,400
MS
87,500
Cash
86,400
4. Ohlson Co.
+86,400
sells all 5,000
Cash
common shares
of Freeman for
$86,400 cash
AOCI
7,500
GN
6,400
MS
87,500
-7,500
-87,500
Investment
AOCI
=
+6,400
Retained
Earnings
+6,400
Gain on
Sale
+6,400
E7-22 (15 minutes)
a. Cisco’s 2010 balance sheet reports the investment portfolio at the
current market value of $35,280 million.
b. Because unrealized gains and losses on investments are reported in
Other Comprehensive Income (OCI), rather than in its current income,
we know that the investment portfolio is accounted for as an availablefor-sale portfolio.
c. The $195 million is the unrealized gain on securities that arose during
2010 because stock prices increased during the year.
M9-24 (15 minutes)
a. 103,300,000 shares issued  $0.01 par = $1,033,000. This amount is
reported in thousands as $1,033.
b. Outstanding shares are equal to issued shares less repurchased shares.
For 2011, Abercrombie & Fitch has 103,300,000 – 16,054,000 = 87,246,000
shares outstanding.
c. Total proceeds from the sale are the sum of the common stock and
additional paid-in capital accounts. For 2011, this total is $350,291,000
($1,033,000 + $349,258,000). The average price at which Abercrombie
issued common stock is $3.39 ($350,291,000 / 103,300,000 shares).
d. The average price at which Abercrombie & Fitch repurchased treasury
stock is $45.18 ($725,308,000 / 16,054,000 shares).
P9-48 (30 minutes)
Focus on Journal Entries (left side), not spreadsheet template below.
a.
Balance Sheet
Income Statement
Transaction
Cash 476,000
CS
280,000
APIC
196,000
Jan 10
1
Cash
Asset
+476,000
Cash
+
Noncash
LiabilContrib.
Earned
=
+
+
Assets
ities
Capital
Capital
+280,000
=
Common
Stock
+196,000
Additional
Revenues
–
ExpenNet
=
ses
Income
–
=
Paid-in
Capital
Cash
476,000
CS
280,000
APIC
196,000
TS
152,000
Cash 152,000
TS
152,000
Jan 23 2
–152,000
Cash
=
–152,000
Treasury
Stock
–
=
–
=
–
=
Cash
152,000
Cash 84,000
TS
76,000
APIC
8,000
+76,000
Treasury
Stock
Cash
84,000
Mar 14 3
TS
+84,000
Cash
=
+8,000
Additional
Paid-in
Capital
76,000
APIC
8,000
Cash 128,000
PS
80,000
APIC
48,000
+80,000
Preferred
Stock
Cash
128,000
Jul 15 4
PS
80,000
APIC
48,000
+128,000
Cash
=
+48,000
Additional
Paid-in
Capital
P9-48 (continued)
Balance Sheet
Transaction
Cash
Asset
+
Noncash
LiabilContrib.
Earned
=
+
+
Assets
ities
Capital
Capital
Income Statement
Revenues
–
ExpenNet
=
ses
Income
–
=
Cash 24,000
TS
19,000
APIC
5,000
+19,000
Treasury
Stock
Cash
24,000
Nov 15: 5
TS
+24,000
Cash
=
+5,000
Additional
Paid-in
Capital
19,000
APIC
5,000
1
Cash increases by the total proceeds of 28,000  $17 = $476,000. Common Stock increases by
the par value of the shares issued (28,000  $10 = $280,000) and Additional Paid-In Capital
increases by the remainder ($196,000).
2
Cash decreases and Treasury Stock increases by the purchase price of 8,000 shares  $19 =
$152,000. The increase in Treasury Stock reduces paid-in capital because Treasury Stock is a
contra-equity account.
3
Cash received is 4,000 shares  $21 = $84,000. Treasury Stock is reduced by the original cost of
$19 per share and the remainder of $8,000 is reflected as an increase in Additional Paid-In
Capital.
4
Gupta receives cash of $128,000. The Preferred Stock account increases by the par value of the
preferred shares issued (3,200  $25 = $80,000) and Additional Paid-In Capital increases by the
remainder ($48,000).
5
Gupta receives cash of 1,000 shares  $24 = $24,000. Treasury Stock is reduced by its original
cost of 1,000 shares  $19 = $19,000, thus increasing paid-in-capital, and Additional Paid-In
Capital increases by the remainder ($5,000).
P9-48 (concluded)
b.
Gupta Company
Stockholders' Equity
December 31, 2012
Paid-in capital
8% Preferred stock, $25 par value,
50,000 shares authorized; 10,000 shares
issued and outstanding
Common stock, $10 par value, 200,000
shares authorized; 78,000 shares issued,
(3,000 shares in treasury)
Additional paid-in capital
Paid-in capital in excess of par
value—preferred stock
Paid-in capital in excess of par
value—common stock
Paid-in capital from treasury stock
Total paid-in capital
Retained earnings
Less: Treasury stock (3,000 common
shares) at cost
Total Stockholders’ equity
$250,000
780,000
$1,030,000
116,000
396,000
13,000
525,000
1,555,000
329,000
1,884,000
(57,000)
$1,827,000
E10-21 (25 minutes)
a. Our analysis would capitalize the operating leases. To do this, we add the
present value of the expected lease payments to both assets and
liabilities. Assuming an 8% discount rate, the present value using Excel or
a financial calculator is computed as follows:
($ thousands)
Year
1
2
3
4
5
>5
Remaining life
Operating
Lease Payment
Discount Factor
(i=0.08)
$886,495
0.92593
798,958
0.85734
699,625
0.79383
594,819
0.73503
497,833
0.68058
1,499,789
2.57710*
3 years***
Present
Value
$820,832
684,979
555,383
437,210
338,815
873,161**
$3,710,380
* Present value of an annuity for 3 years at 8%
** $497,833 × 2.57710 × 0.68058 = $873,161
*** $1,499,789 ÷ $497,833/year = 3.013 years, rounded to 3 years
The present value of Staples’ operating leases is computed to be about
$3.7 billion. We might consider adjusting its balance sheet by adding this
amount to both operating assets and nonoperating liabilities.
b. Staples’ liabilities are 53% greater following this adjustment (adjusted
liabilities are $7 billion + $3.710380 billion = $10.710380 billion compared
with about $7 billion). Further, to adjust the income statement, we can
replace rent expense of $886,495,000 with the depreciation expense of
$463,797,500 [$3,710,380,000 / 8 years] (an operating item) and interest
expense of $296,830,400 [$3,710,380,000 × 0.08] (a nonoperating item).
E10-23 (25 minutes)
a. Assuming a 7% discount rate and a 3 year remaining life (rounded down
from 3.438 years), the present value of the lease obligation and asset is
computed by Excel, a financial calculator, or using tables as follows:
Operating Lease
Year ($ 000s)
Payment
1 .......................... $1,092,709
Discount Factor
(i=0.07)
0.93458
Present
Value
$1,021,224
2 ..........................
1,022,364
0.87344
892,974
3 ..........................
915,656
0.81630
747,450
4 ..........................
794,253
0.76290
605,936
5 ..........................
670,437
0.71299
478,015
>5 ..........................
2,304,674
2.62432*
1,254,464**
Remaining life ........... 3.438 years***
$5,000,063
* Present value of an annuity for 3 years at 7%
** $670,437 × 2.62432 × 0.71299 = $1,254,464
*** $2,304,674 ÷ $670,437/year = 3.438 years
The present value of TJX’ operating leases is computed to be just a bit
larger than $5.0 billion (table above). We might consider adjusting the
balance sheet by adding this amount to both operating assets and
nonoperating liabilities. Further, to adjust the income statement, we
would replace rent expense with the depreciation of the lease assets
and interest on the lease liability.
a. The capitalized operating lease liability more than doubles the total
liabilities for TJX from $4.9 billion to $9.9 billion. This is an extreme
change that we would want to consider as we analyze TJX.
E10-25 (20 minutes)
a. Service cost represents the additional pension benefits earned by
employees during the current year but paid to employees in the future.
Interest cost is an expense (financing) that accrues on the pension
obligation (PBO) during the year.
b. In 2010, Xerox recorded an “actual” return on pension investments of
$846 million (which increases the pension plan assets). There is no actual
return on the health care (“Other”) plan assets.
The expected return (not the actual return) of $570 million on the pension
plan assets impacts Xerox’s income for 2010. Pension expense is reduced
by this amount. Because the health care (“Other”) plan is not funded,
there are no assets generating a return, hence there is no expected return
offset for this plan.
c. Actuarial losses (gains) generally arise as a result of reductions
(increases) in the discount rate used to compute the pension and health
care obligation. Because the pension and health care obligations are the
present value of expected future payouts to retirees, a reduction
(increase) in the discount rate results in an increase (decrease) in the
obligation. An increase in the obligation is called an actuarial loss.
d. Payments to retirees are made from the pension and health care assets.
There is a corresponding reduction in the pension and health care
obligations as cash payments are made. For 2010, the pension plan had
sufficient assets from which to make this payment. By contrast, the health
care plan is not funded. Consequently, Xerox must make a direct cash
contribution to the plan assets as benefits are paid (partial funding for this
also comes from participant contributions).
e. In 2010, Xerox contributed $237 million to its pension plan and $92 to its
health care plan.
E10-25 (concluded)
f. In 2010, retirees received $669 million from the Xerox pension plan and
$118 million from the health care plan. For the pension plan, Xerox did not
make these payments directly; rather, they came from the plan
investments. For the health plan, Xerox and employees made the
contributions necessary to fund payments during the year. Because there
are no assets in the health plan, any payments must be matched by
contributions each year.
g. The funded status is the obligation less the fair value of the plan
investments. The pension plan is underfunded by $1,791 million ($9,731
million - $7,940 million).
The health care plan is underfunded by the full $1,006 million obligation as
none of the health care obligation has been funded. This is not atypical as
companies only fund health care plans to the extent that the contributions
are tax deductible, unless mandated by federal law.
h. Actuarial gains and losses, together with the difference between actual
and estimated returns on pension assets, are recorded in Other
Comprehensive Income in the year they arise and are accumulated on the
balance sheet in the Accumulated Other Comprehensive Income account,
which is part of Stockholders’ Equity. These amounts remain in AOCI
unless they exceed prescribed limits (the greater of 10% of Pension
assets or PBO at the beginning of the year). If the accumulated amounts
exceed the maximum, the excess is amortized to income over the
remaining service lives of the employees. During the year, Xerox
recognized additional pension expense relating to the amortization of a
deferred loss – this is the $143 million amount. It also recognized income
relating to the amortization of prior service cost of $3 million – the $22
million less the $19 million. The net amount of $121 million relating to
these amortizations reduced AOCI and profitability and, thus, retained
earnings. The $198 increase in AOCI relating to net actuarial loss has not
yet affected profitability.
Appendix B, Statement of Cash Flow
Q B-4.
a.
b.
c.
d.
e.
f.
g.
h.
Investing; outflow
Investing; inflow
Financing; outflow
Operating (direct method, not shown separately under indirect
method); inflow.
Financing; inflow
Operating (direct method, not shown separately under indirect
method); inflow.
Operating (direct method, shown as supplemental information
under indirect method); outflow.
Operating (direct method, not shown separately under indirect
method); inflow.
M B-22 (10 minutes)
a.
b.
c.
d.
e.
f.
g.
Cash inflow from an operating activity.
Cash inflow from an investing activity.
Cash outflow from an investing activity.
Cash outflow from an operating activity.
Cash inflow from a financing activity.
Cash outflow from a financing activity.
Cash outflow from an investing activity.
M B-23 (10 minutes)
a.
b.
c.
d.
e.
f.
Cash outflow from a financing activity.
Cash inflow from an operating activity.
Noncash investing and financing activity.
Cash inflow from an operating activity.
Cash outflow from an operating activity.
None of the above (a change in the composition of cash and cash
equivalents).
M B-24 (15 minutes)—Indirect Method
Net Income
Add (Deduct) Items to Convert Net Income to Cash Basis
Depreciation
Gain on Sale of Investments
Accounts Receivable Increase
Inventory Increase
Prepaid Rent Decrease
Accounts Payable Increase
Income Tax Payable Decrease
Net Cash Provided by Operating Activities
$ 45,000
8,000
(9,000)
(9,000)
(6,000)
2,000
4,000
(2,000)
$ 33,000