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Week 2 Quiz
Acct 5341

  1. In 1981, U.S. Steel reported an inflationary gain of $164.5 million. What is the main reason companies might have inflationary gains after adjusting for general price levels?
    The inflationary gains are due to long-term debt acquired with dear
    dollars having higher purchasing power. If there has been inflation
    the debt can be paid back in “cheap” dollars having less purchasing
    power.
  2. It is more common for companies to report net inflationary losses during times of inflation. What are the main reasons for these losses?

The inflationary losses are due to fixed assets acquired with dear
dollars having higher purchasing power. When restated into current
cheap dollars, depreciation expenses increase after PLA adjustment.

  1. Does the WTD Case assigned for this class have monetary gains or losses? Explain the reason for these outcomes?
    The general PLA balance sheet entails plugging in Net Monetary Gains and Losses after PLA adjustments as follows at the end of Year 2 in the WTD Case:
    Year 2
    PLA Capital $2,586
    Net purchasing power loss(gain) 33 (goes to retained earnings)
    PLA Adjusted Equity $2,487
    The only monetary asset of WTC is cash arising from earnings that are not
    expended for operations or to pay dividends, i.e., cash on hand. The
    monetary loss is this case is the inflation loss of cash in the till at the
    beginning of the year.
    Recall that the $1,000 that Granny put under the bed in 1910 would have
    been enough to buy ten Ford cars. In the current year, this would not
    be enough to buy a new door for one Ford car. Granny’s cash on hand
    had severe purchasing power loss.
  2. Current Cost (Replacement Cost, Entry Value) accounting for booked items is supposed to indicate how much earnings should be retained for replacement of assets at their current costs. At the end of the third year, current cost accounting did not provide the amount needed for WTD to replace its only operating asset. Explain why this happened.

The major problem is that the total revenue of WTD is $3,000 and
the replacement cost moved up to $3,300. No accounting method
can make up for never earning enough cash for replacement. This
is now happening to most major airline companies and telecom
companies.
To add to the problem, entry value accounting allowed WTD to
pay $100 in cash dividends to in Year 1. This further reduced the
replacement fund to $2,900 instead of $3,000.

  1. Suppose a company borrowed $98,606,513 on 10,000 bonds on March 12, 1998. The bonds expire in 2,008. What are the main reasons why there may be a different exit value versus entry value of bonds on January 31, 2005? Note that exit value in this case should be the total cost to buy the existing bonds back on the open market. Entry value is to be based on the proceeds and issuance fees of a new bond issue used to call the bonds back under recall provisions in the original bond contracts.
    Begin with the Bacon Printing example where a new press costs
    $1,000,000 installed but is only worth $600,000 if immediately
    resold.
    Then explain how the market to buy back bonds differs from the
    market to float new bonds (with all the issuance and underwriting
    fees).
  2. Under what conditions might the bonds mentioned in the previous question have to be carried at exit value on January 31, 2005? In ACCT 5341 we’ve not yet discussed one of the major reasons, but I did point out two reasons in the first class meeting of ACCT 5341. Assume that the company in question is not deemed a securities “trader.”
    Non-going concern audit opinions
    Personal financial statements
    Available-for-Sale securities under FAS 133 (although no impact on
    current earnings due to OCI)
    FAS 133 adjustments for fair value hedging of booked item values
  3. After reading Chapter 2 of your Strong textbook, can you explain why an option having no intrinsic value might have time value? When might it have intrinsic value with zero time value?


Before expiration, options have time value unless they are hopelessly out-of-
the-money given the time remaining before expiration.
At the date of expiration they have no time value but have intrinsic value
if they expire in-the-money.