Exam 1 – Acct 414 – Fall 2009 Page 10
Exam #______
Name: ______
Exam 1Acct 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 = ______%
1. From Spring 2008 exam, changed numbers
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. From 1995 Acct 302 Exam 1 (takehome) – so old were no solutions in file not used recently
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?
$______
3. From Fall 2006 exam, changed numbers
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)
4. Loan impairment (troubled debt) (very similar to F08 exam with some changes to numbers)
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)
5. From Exam 1 F94 Acct 302, #29 – changed date, cost, uncertainties and added IFRS
Lessee Accounting. On September 1, 2009, Missoula Mazda, Inc. and First Bank of Montana sign a lease with the following terms:
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
a. 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]
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 = $23,2033. 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 depreciation method with no salvage / 14. The fiscal year end for both lessor and lessee is Dec. 31
c. 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).
Date / Payment / Interest / Principal Portion / Balance0 / 9/1/09
1 / 9/1/10
d. 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
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 = $23,2033. 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 depreciation method with no salvage / 14. The fiscal year end for both lessor and lessee is 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 / Payment / Interest / Principal Portion / Balance0 / 9/1/09
1 / 9/1/10
9/1/09 – IFRS – for LESSOR
12/31/09 (end of fiscal year)
6. Similar to F08 exam – just changed numbers
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.
Face value / $1,000,000 / $1,000,000
Coupon rate (annual) / 10% / 8%
Term / 10 years / 8 years
Semiannual interest payment / $50,000 / $40,000
Yield rate at year end (simple interest) / 11% / 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 EquityCash / 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 EquityCash / Bonds payable
Bond Investment / Owner’s equity
Total / Total
From Acct 415-515 Exam 2 Fall 2004 and used F07 in Acct 414
7. 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]
SOLUTIONS
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.
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 / 1,784
Interest revenue / 1,784
#5a (29. From F94) 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).
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.