Intermediate Accounting II ACCTG 302 Section D Winter 2005 Instructor J.B.

Paperman Midterm Exam 2 February 16, 2005 Name: ____________________________ INSTRUCTIONS:

a) This exam is closed book. You may use one double-sided sheet of notes. You may use a calculator to assist in computations. b) You must complete this exam on your own. No assistance is allowed except that provided by the instructor. c) If you feel there is ambiguity in a problem, state your assumptions clearly. d) The last page of the exam is a PV table, you may remove this page if you desire. e) The exam has 9 pages in total and 14 questions with 100 points.

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Multiple Choice (3pts each) Circle the MOST correct answer 1. Riser Corporation was granted a patent on a product on January 1, 1995. To protect its patent, the corporation purchased on January 1, 2004 a patent on a competing product, which was originally issued on January 10, 2000. Because of its unique plant, Riser Corporation does not feel the competing patent can be used in producing a product. The cost of the competing patent should be A. amortized over a maximum period of 11 years. B. expensed in 2004. C. amortized over a maximum period of 16 years. D. amortized over a maximum period of 20 years. A The useful life is that of the patent it is protecting which will expire 10 years after issued in 1995 or 11 years from now. 2. Purchased goodwill should A. be written off by systematic charges as a regular operating expense over the period benefited. B. not be amortized. C. be written off as soon as possible as an extraordinary item. D. be written off as soon as possible against retained earnings. B Goodwill is no longer amortized, only impaired 3. How should research and development costs be accounted for, according to a Financial Accounting Standards Board Statement? A. May be either capitalized or expensed when incurred, depending upon the materiality of the amounts involved. B. Must be expensed in the period incurred unless it can be clearly demonstrated that the expenditure will have alternative future uses or unless contractually reimbursable. C. Must be expensed in the period incurred. D. Must be capitalized when incurred and then amortized over their estimated useful lives. B expense immediately, unless it is a long lived asset (such as a building) which can be used for other projects or it is contract research that has already been resold. 4. Which of the following is NOT true about the discount on short-term notes payable? A. When there is a discount on a note payable, the effective interest rate is higher than the stated discount rate. B. All of these are true. C. The Discount on Notes Payable account should be reported as an asset on the balance sheet. D. The Discount on Notes Payable account has a debit balance. C discount is a contra to the note, not an asset. Which of the following sets of conditions would give rise to the accrual of a contingency under current generally accepted accounting principles? A. Event is unusual in nature and occurrence of event is probable. B. Event is unusual in nature and event occurs infrequently. C. Amount of loss is reasonably estimable and occurrence of event is probable. D. Amount of loss is reasonably estimable and event occurs infrequently. C if either of these conditions arent met it does not need to be accrued.

5.

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Ritter Company has 35 employees who work 8-hour days and are paid hourly. On January 1, 2003, the company began a program of granting its employees 10 days' paid vacation each year. Vacation days earned in 2003 may first be taken on January 1, 2004. Information relative to these employees is as follows: Year 2003 2004 2005 Hourly Vacation Days Earned Wages by Each Employee $17.20 18.00 19.00 10 10 10 Vacation Days Used by Each Employee 0 8 10

Ritter has chosen to accrue the liability for compensated absences at the current rates of pay in effect when the compensated time is earned. What is the amount of expense relative to compensated absences that should be reported on Ritter's income statement for 2003? A. $50,400. B. $48,160. C. $45,920. D. $0. B 10 days * 8 hours/day * $17.20/hour * 35 employees 7. Stone, Inc. issued bonds with a maturity amount of $200,000 and a maturity ten years from date of issue. If the bonds were issued at a premium, this indicates that A. the nominal rate of interest exceeded the market rate. B. no necessary relationship exists between the two rates. C. the market and nominal rates coincided. D. the effective yield or market rate of interest exceeded the (stated) nominal rate. A premium means the effective rate was less than the contract rate 8. When the interest payment dates of a bond are May 1 and November 1, and a bond issue is sold on June 1, the amount of cash received by the issuer will be A. decreased by accrued interest from May 1 to June 1. B. increased by accrued interest from May 1 to June 1. C. increased by accrued interest from June 1 to November 1. D. decreased by accrued interest from June 1 to November 1. B the buyer pays the accrued interest to date so increase by the may-june accrual

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(15 points) Fowler Manufacturing Company decided to expand further by purchasing Blye Company. The balance sheet of Blye Company as of December 31, 2004 was as follows: Blye Company Balance Sheet December 31, 2004 Assets Cash Receivables Inventory Plant assets (net) Total assets $ 210,000 450,000 275,000 1,025,000 Equities Accounts payable Common stock Retained earnings $ 325,000 800,000 835,000

$1,960,000

Total equities

$1,960,000

An appraisal, agreed to by the parties, indicated that the fair market value of the inventory was $320,000 and that the fair market value of the plant assets was $1,425,000. The fair market value of the receivables is equal to the amount reported on the balance sheet. The agreed purchase price was $2,300,000, and this amount was paid in cash to the previous owners of Blye Company. INSTRUCTIONS a) Prepare the Balance Sheet for the new division after the acquisition is completed (assume stock is nopar). b) On 1/1/2005 Fowler hears of a legal ruling that will reduce the likely sales of Blye resulting in a decrease in the fair value of the division to $2,000,000. Total future cash flow the division is expected to generate is $4.500,000. The Inventory now has a fair value of $300,000 and the equipment has a fair value of $1,300,000. Prepare the required journal entry for this event. a) Assets Cash Receivables Inventory Plant assets (net) Goodwill $ Equities 210,000 Accounts payable 450,000 Common stock 320,000 1,425,000 220,000 (plug) $ 325,000 2,300,000

Total assets $2,625,000 Total equities $2,625,000 b) because the new fair value of the division is lower than the carrying value (2,000,000<2,300,000) the goodwill is impaired. New net identified asset value = 210+450+300+1,300-325 = 1,935,000 New goodwill = 2,000,000-1,935,000 = 65,000 Impairment = 220,000 65,000 = 155,000 Impairment Expense 155,000 Goodwill 155,000 4 Acctg 302D

10. (15 points) Risen, Incorporated sold its 8% bonds with a maturity value of $2,000,000 on August 1, 2002 for $1,964,000. At the time of the sale the bonds had 5 years until they reached maturity. Interest on the bonds is payable semiannually on August 1 and February 1. The bonds are callable at 104 at any time after August 1, 2004. By October 1,2004, the market rate of interest has declined and the market price of Risen's bonds has risen to a price of 102. The firm decides to refund the bonds by selling a new 6% bond issue to mature in 5years. Risen begins to reacquire its 8% bonds in the market and is able to purchase $300,000 worth at 102 (plus accrued interest). The remainder of the outstanding bonds is reacquired by exercising the bonds' call feature. Prepare the required journal entries for the repurchase and call of the bonds (Assume the firm used straightline amortization of premium or discount.) Show calculations. First amortize the interest through the date of retirement Discount originally was $36,000 on 60 month bonds so amortization is $600 per month. Interest payment is 8% of 2,000,000 or $160,000 annually Since August 1 payment was made we just need to recognize the 8/1 10/1 interest or 2 months Interest Expense 27,867 Discount on Bonds Payable (2*$600) Cash ($160,000 * 2/12) 1,200 26,667

To remove the bonds we need to determine the unamortized discount. From 8/1/02 10/1/04 is 26 months, so 34 months remain unamortized. From above $600 * 34 $20,400 Cash received is: 1.02* 300,000 = 1.04*1,700,000 = total cash 306,000 1,768,000 2,074,000 2,000,000 94,400 20,400 2,074,000

Bonds Payable Loss on Bond Retirement Discount on Bonds Payable Cash

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(8 points) Radio One Inc. purchased a broadcasting license in Philadelphia for $500,000 on January 1, 2001. The license is renewable every 3 years for a fee of $1,500 and Radio One pays their first fee to the FCC on January 1, 2003. Due to changes in demographics during 2004 on December 31, 2004 Radio One reevaluates their expected future cash flows and determines the license is expected to produce cash flows of $100,000 per year indefinitely. Appraisers also determine that the license could be sold for $1,300,000. Required

a) Prepare the journal entries required for the acquisition of the license and payment of the fee. b) Prepare any journal entries required for 12/31/04 (dont forget that fee). a) 1/1/01 Intangible Assets (License) 500,000 Cash 500,000 1/1/03 Intangible Asset (License renewal) 1,500 Cash 1,500 (this will get expensed over the 3 year renewal period) b) First amortize another year of the fee Licensing expense Intangible Asset (renewal)

500 500

For an intangible asset that has a limited life but fairly low cost renewals the life is considered indefinite. For and indefinite life asset the impairment check is a comparison of carrying value to fair value (cash flows is not considered as is the case with limited life intangibles). Because the fair value is greater than the carrying value no impairment is needed (okay so I typod, it was supposed to be a fair value of $300,000).

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12. (15 points) Hannas Hot Dogs issues new 8% debt on January 1, 2005 with a face value of $100,000. Interest payments are made semi-annually on June 30th and December 31st of each year. Issue costs for the bonds total $3,500. The bonds will mature on December 31, 2014. Investors in the market are requiring a 10% return on similar bonds. Prepare all the necessary journal entries for transactions related to the bonds that occur in 2005 and 2006 (Hanna uses the effective interest rate method). First determine issue price: Interest payments are $100,000*8%/2 = $4,000 twice annually for 10 years PV of annuity(20,5%) *$4,000= 12.46221*4000 = 49,849 PV of maturity (10,5%) * 100,000 = .37689*100,000 = 37,689 Issue price = 49,880+37689 = 87,538 We did know that since the effective rate was higher than the stated rate it would be at a discount so this seems reasonable. 1/1/2005 issue with costs of issue Cash 84,038 Bond Issue Costs 3,500 Discount on Bonds 12,462 Bonds Payable 100,000 6/30/05 interest payment Interest Expense 4,377 Discount on Bonds Payable Cash 12/31/05 interest payment Interest Expense 4,396 Discount on Bonds Payable Cash Interest Expense Bond Issue Costs 350 350 (5% * bv of bonds 88,311) 416 (plug, new Bv of bonds = 88,311+416 = 88,727) 4,000 (5% * bv of bonds 88,727) 436 (5% * bv of bonds 87,538) 377 (plug, new Bv of bonds = 87,538+377 = 87,915) 4,000 (5% * bv of bonds 87,915) 396 (plug, new Bv of bonds = 87,915+396 = 88,311) 4,000 (cold also put into bond issue expense)

6/30/06 interest payment Interest Expense 4,416 Discount on Bonds Payable Cash 12/31/06 interest payment Interest Expense 4,436 Discount on Bonds Payable

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Cash Interest Expense Bond Issue Costs 350

4,000 (cold also put into bond issue expense) 350

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13. (8 points) Kenji and Sons Inc. sells 8,000 automobiles in 2004 for an average price of $25,000. Each automobile is sold with a 3-year warranty covering various parts. The average cost of repairing warranted parts during the 3-year period is $400 per automobile. During 2004 $750,000 of repairs are made under the warranties and half of the remaining average amount is performed in each of 2005 and 2006. Prepare the necessary journal entries to record the sale and repair work performed. 2004 First record sale Sales (8,000 *$25,000) Cash Warranty Expense Warranty Liability Warranty paid in 2004 Warranty Liability Cash Warranty paid in 2005 Warranty Liability Cash Warranty paid in 2006 Warranty Liability Cash

200,000,000 200,000,000 3,200,000 3,200,000 750,000 750,000 1,225,000 1,225,000 1,225,000 1,225,000

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14. (15 points) Shores Corporation is reviewing three situations to determine the proper accounting treatment for their December 31, 2004 financial statements. Details for each situation follow: a) Two customers slipped and fell at different retail locations owned by Shores and have sued the company. One case is for $150,000 and Shores attorneys believe it is unlikely the case will be lost. If it is lost the settlement will most likely be for $90,000. The second case involved a more severe injury and the lawsuit is for $4,500,000. Shores attorneys believe it is probable that the company will lose this case and the likely settlement would be between $2,000,000 and $2,750,000 based on previous history. Shores Corporation does not have any insurance coverage that would pay either judgment. b) DuCharme Inc. released a new product in 2004 that was a blatant copy of Shores most popular selling product. Shores has filed a $50,000,000 suit against DuCharme for copyright infringement. Shores lawyers are extremely confident that Shores will win the lawsuit and receive a settlement in the full amount of the case. The attorneys for DuCharme have already contacted Shores Corporation to make multiple offers for settlement with the most recent offer at $30,000,000. c) Due to an unexpected problem with a product Shores was the defendant in a class action lawsuit during 2004. Shores quickly settled the lawsuit by issuing $500,000 of discount coupons to the plaintiffs in November of 2004. Shores has never issued coupons of this type before and is unsure how many will be used by customers. During December of 2004 $25,000 worth of coupons were redeemed on gross sales of $1,250,000. Describe the required accounting treatment for each of these situations along with any required journal entries (dont forget the sales in c). Give a very brief reason for the required treatment. a) Because the 150,000 suit is remote it is completely ignored no accrual and no disclosure.(if you interpret unlikely as reasonably possible then disclosure needed). The second suit is probable and estimable so we must accrue. Given a range with no point more likely than another we use the lower end of $2,000,000. Litigation Loss2,000,000 Litigation Liability 2,000,000 Also disclose information about the case in the footnotes. b) This is a gain contingency and thus no accrual is made no matter how likely the positive outcome. We would probably disclose information about the litigation in the financial statements but usually in a muted way to avoid the appearance that management is promising a favorable ruling. c) In this case the contingent loss is probable since coupons have been issued and some have even already been used. However the amount of the loss is not estimable so the amounts are expensed as incurred. Accounts Receivable (or cash) 1,225,000 Loss on Settlement 25,000 Sales 1,250,000

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