Beruflich Dokumente
Kultur Dokumente
$ 6,250,000
Cost of sales
(3,750,000)
Gross profit
2,500,000
(1,260,500)
[A]
1,239,500
(122,500)
(225,000)
130,000
[B]
1,022,000
(306,600) [$1,022,000 x .30%]
715,400
(87,500)
[C]
(490,000)
[D]
Net income
$ 137,900
$1,212,500
48,000
$1,260,500
$ (25,000)
(100,000)
(125,000)
37,500
$ (87,500)
Note: The losses anticipated for future periods are not recognized until they occur.
[D] Extraordinary gain (loss): ($490,000)
As indicated in note [B], the gain on extinguishment of debt is not an extraordinary item; however, the loss
incurred due to the earthquake (which is a rare occurrence in the location of the plant) is considered an
extraordinary item and is reported net of tax.
Loss from earthquake
$ (700,000)
210,000
$ (490,000)
items. The gain or loss would be reported in the income from continuing operations section of the income
statement.
12. Extraordinary items
The occurrence of an earthquake in Wisconsin in an unusual and infrequent event (as this state rarely
experiences earthquakes); therefore, the loss from destruction of a warehouse (likely material) is reported in
the extraordinary items section of the income statement (not permitted under IFRS).
13. Income from continuing operations
A material write-down of inventory, while likely infrequent, is not considered unusual in nature for a
business; therefore, the loss cannot be reported in the extraordinary items section of the income
statement. The loss would be reported in the income from continuing operations section of the income
statement.
14. Discontinued operations
The results of operations of a component of an entity will be reported in the discontinued operations section
of the income statement if the component is a subsidiary that has already been sold.
Year 1
Year 2
Impairment Gain/(Loss)
(500,000)
Operating Gain/(Loss)
(700,000)
(200,000)
380,000
360,000
(54,000)
(840,000)
126,000
Gain/(Loss) on Disposal
Income/loss from an operating segment of a company that is held for sale or sold during the current period must
be reported, net of tax, in the period incurred. An operating segment is considered to be a component of an entity.
At December 31, Year 1, the segment has not been sold, but will still be accounted for as a discontinued
operation because it meets the held for sale requirement.
Impairment Loss
The impairment loss for Year 1 is $500,000 and represents the difference between the book value and fair value of
the segment at December 31, Year 1. Even though the division sold for a higher price in Year 2, the $2,500,000
represents the best available information as of December 31, Year 1.
There is no impairment loss at December 31, Year 2 because the segment was sold in Year 2.
Operating Loss
Operating losses are recognized in full in the period incurred. In Year 1, the operating loss for the entire year is
included in discontinued operations, even though the decision to dispose was not made until July 1.
Gain from Disposal
There is no gain or loss on disposal in Year 1 because the segment was not sold until Year 2.
The gain on disposal in Year 2 is $380,000 ($3,200,000 sales price - $320,000 brokers fee - $2,500,000 book
value of segment).
Income Tax Benefit (Expense)
In Year 1, the company records income tax benefit of $360,000 ($1,200,000 net loss from discontinued operations
x 30%). In Year 2, the company records income tax expense of $54,000 ($180,000 net gain from discontinued
operations x 30%).
Axl, Bruce, Diddy, and Elvis are reportable segments because they each have 10% of at least one of the
following criteria:
10% of Revenue Test Diddy, Elvis
An operating segment meets the size test if its reported revenue, including both sales to outsiders and
intersegment sales is 10% or more of the combined revenue, internal and external, of all reporting segments.
Combined revenue is $165,000 ($105,000 external + $60,000 intersegment). Diddy and Elvis have revenues in
excess of $16,500 ($165,000 x 10%).
10% of Reported Profit or Loss Test Axl, Elvis
An operating segment meets the size test if the absolute amount of its reported profit or loss is 10% or more of
the greater, in absolute amount, of
1. The combined reported profit of all operating segments that did not report a loss
2. The combined reported loss of all reporting segments that did report a loss.
The combined profit of all reporting segments that did not report a loss is $58,000 ($0 + $5,000 + $3,000 +
$50,000). The combined loss of all reporting segments that reported a loss is $9,000. $58,000 is greater than
$9,000, so a segment is deemed reportable if the absolute amount of its profit or loss exceeds $5,800 ($58,000 x
10%). Axl, with a loss of $9,000, and Elvis, with income of $50,000, meet this criteria.
10% of Reported Assets Test Bruce, Elvis
A segment meets the size test if its assets are 10% or more of the combined assets of all reporting segments.
Combined assets are $87,000. Bruce and Elvis have assets in excess of $8,700 ($87,000 x 10%).
75% Reporting Sufficiency Test
The total external revenue of operating segments, as determined above, must constitute 75% of total external
revenue. Total external revenue is $105,000. Reportable segments have external revenue of $90,000 (10,000 +
10,000 + 70,000), which is 86% of the total external sales.
1. Correct
No adjustment is necessary. Under both IFRS and U.S. GAAP, available for sale marketable securities are
marked-to-market at period end with the unrealized gain or loss recorded in the other comprehensive income
account. In the scenario above, the reclassified marketable securities would have generated an unrealized gain of
$750,000 in OCI.
3. Correct
No adjustment is necessary. Under IFRS, the company can choose to use the cost or revaluation model. RC
selected the revaluation model and properly reported the $895,000 excess of fair value over carrying value as a
revaluation surplus in other comprehensive income.
6. Correct
No adjustment is necessary. RC completed an effective foreign currency hedge in the third quarter of the fiscal
year properly reflecting the $65,000 translation gain in other comprehensive income. Because the foreign
currency transaction was liquidated in the following quarter, it is proper to remove the prior translation gain
reported in other comprehensive income in the fourth quarter when the investment was terminated.
The idea behind this type of question is to correct net income for Year 1, Year 2, and Year 3 and to correct the
balance sheet at December 31, Year 3. Individual corrections may affect only the three years of the income
statement, or they may go beyond that, in which case they affect the balance sheet. The keys to this kind of
question are: (1) to determine what should have been done for a fact situation; (2) to determine what was done
(and it was probably done wrong or there would not be much of a question); and then (3) to figure what has to be
done to correct or adjust what was done to what should have been done. The answers to these questions refer
to them as the "Correct Accounting" and the "Original Accounting."
Further, please note that this simulation in total is much longer than you should see on the CPA exam. It
would be difficult, if not impossible, to work a simulation this long in the "allotted" time on the exam. This
simulation is meant as a learning tool.
For each item, the original accounting and the correct accounting are provided. The question asks you to
"Identify the correction to net income in each of the years presented and to the balance sheet in the final year
by entering the appropriate amount in the shaded cell." The adjustments/corrections are provided for you in the
"correction" line of the explanations.
QUESTION 1
This question deals with the incorrect recording of a sale. The company incorrectly accounted for the
transaction on the cash basis, overstating sales and income in Year 3, the year of receipt, and understating
sales and income in Year 2, the year of the proper accrual. As the receivable was collected prior to the Year 3
balance sheet date, there is no impact on the balance sheet.
To correct the error, sales are increased (credited) in Year 2 when the sales should have been recorded and
decreased (debited) in Year 3 when the sales were actually (incorrectly) recorded.
INCOM E ST AT EM ENT
Year 1
Year 2
Year 3
(2,000)
C O R R EC T I O N
(2,000)
2,000
--
--
(2,000)
--
--
--
QUESTION 2
This question deals with the incorrect capitalizing of freight-out (covered in lecture F4). The company
inappropriately accounted for freight-out as an inventory item. Freight-out is a selling expense that should be
accounted for as a period cost at the time incurred. [Note that freight-in is a proper inventory cost.] The
company uses the FIFO method of inventory and maintains a safety stock equal to 50% of the current year
purchases. What this means is that only half of the current year purchases is sold each year; the other half of
the purchases carries over to the next year and is sold first (and shipped) in that year. For example, freight-out
for Year 1 was $50,000. The full $50,000 should have been expensed in Year 1, but it was not; only $25,000
was expensed (from the goods that were actually sold).
Although the company overstates its inventory, it does expense (and thereby reduce) net income for the cost of
goods sold that is recognized. The adjustment to each year's net income is the difference between the
accounting that should have occurred (expensing the entire amount) and the amount that had already been
recorded as cost of goods sold expense.
Year 1
INCOM E ST AT EM ENT
Year 2
Year 3
Items to note:
Freight-out capitalized as
inventory
50,000
150,000
300,000
25,000
75,000
150,000
25,000
75,000
Original Accounting
Cost of goods sold, current
year
Cost of goods sold, prior year
150,000
C O R R EC T I O N
25,000
50,000
75,000
--
150,000
50,000
150,000
300,000
--
150,000
Correct Accounting
Expense freight-out (period
expense)
The correction is to add $25,000 of expense to Year 1. [Note that the "freight-out capitalized" line is just
information and is not part of the "footing" of the column.] The total correction is the additional $25,000.
The "Original Accounting" plus the "Correction" equals the "Correct Accounting" for Year 1.
In Year 2, $150,000 should have been expensed, but only $75,000 of the $150,000 was. In addition, the
$25,000 from Year 1 was expensed in Year 2 when it should have been expensed in Year 1. That means
that $100,000 was expensed when $150,000 should have been. The correction is to add $50,000 of
expense to Year 2.
In Year 3, $300,000 should have been expensed, but only $150,000 of the $300,000 was. In addition, the
$75,000 from Year 2 was expensed in Year 3 when it should have been expensed in Year 2. That means
that $225,000 was expensed when $300,000 should have been. The correction is to add $75,000 of
expense to Year 3.
At December 31, Year 3, there was $150,000 still in inventory that should have been expensed and not
capitalized. Inventory is adjusted by that amount (as a credit).
QUESTION 3
This question deals with discontinued operations (covered in F1). Losses associated with discontinued
operations should be accounted for in the years in which they occur. Components that are held for sale or that
have already been sold (or otherwise disposed of) would be charged with an impairment loss that would be
recognized once the conditions for disposal or held for sale status are met. Operating losses related to the
component are recognized in the year in which they occur. Estimated losses related to subsequent periods are
not accrued. All that has to be done here is to move the $150,000 of Year 3 operating loss from Year 2 to Year
3. The correction is the difference between the amount recognized and what should have been recognized.
Because the asset was disposed of before 12/31/Year 3, there is no effect on the balance sheet.
INCOM E ST A T EM ENT
Year 1
Year 2
Year 3
Original Accounting
Discontinued operations
losses & disposal:
Impairment loss
Year 2 operating loss
Year 3 estimated operating
loss
C O R R EC T I O N
100,000
75,000
150,000
(150,000)
150,000
--
--
150,000
--
--
Correct Accounting
Impairment loss
Year 2 operating loss
Year 3 operating loss
100,000
75,000
QUESTION 4
This question deals with a change in accounting principle inseparable from a change in accounting estimate
(covered in F1). A change in accounting principle inseparable from a change in accounting estimate should be
accounted for as a change in accounting estimate. The change should be handled prospectively in income.
The company changed to the cost recovery method of recognizing revenue, which means that it will only
recognize profit after all the costs have been recovered. Recall that with a profit margin of 50%, this means that
there is $300,000 in profit and $300,000 in costs. The company expects to collect $200,000 per year beginning
in Year 1. Therefore, with the cost recovery method, the company would recognize $0 profit in Year 1 (i.e., the
entire collection of $200,000 would go against the cost recovery), $100,000 profit in Year 2 ($100,000 of the
$200,000 collected would go against the cost recovery), and $200,000 profit in Year 3 (as the costs were
recovered 100% in Year 2, all of the collections in Year 3 would be revenue).
Note that the facts tell us that the company did not account for the change in accounting principle that was
inseparable from a change in estimate; therefore, the original accounting as installment sales still exists on the
books of the company.
Let's look at the details of the transaction. The original sale was $600,000, with $200,000 scheduled to be
collected each year. With a 50% profit margin and the installment method, $100,000 of profit would have been
recognized each year. This was part of the original accounting. Note that the receivable was collected before
12/31/Year 3, so there is no impact on the balance sheet.
INCOM E ST A T EM ENT
Year 1
Year 2
Year 3
Original Accounting
Installment sale accounting:
Year 1 profit recognition
(100,000)
(100,000)
(100,000)
100,000
(100,000)
--
--
(200,000)
--
--
Correct Accounting
Account for prospectively:
Year 1 profit recognition
--
(100,000)
QUESTION 5
This question deals with amortization of software costs (covered in F2). The question states two things: (1) the
useful life of the software is 4 years and (2) the amount of sales is realized at 10% of expected lifetime sales
each year. The question appears to contradict itself because if the software has a useful life of 4 years, then it
is expected that 25% of the sales would occur in each year. The question goes on to say, however, that 10%
of expected lifetime sales is expected to be realized each year, which would seem to indicate the company
believes the sales to exist over 10 years. For these purposes, we are going to assume that the company's
accounting estimates are correct (for whatever reason).
Software costs are capitalized once technological feasibility is established and are then amortized using the
greater of the straight-line amortization over the useful life of the software or the percentage of estimated sales
achieved. The useful life of four years requires amortization of one-quarter (or 25%) of the cost, while sales are
realized at only 10% of total projected sales. The company's method of amortization understated the
amortization by $30,000 per year and overstated the capitalized software by $90,000.
Year 1
INCOM E ST AT EM ENT
Year 2
Year 3
Original Accounting
Amortize cost b ased on sales
Amortization of cost
20,000
20,000
20,000
140,000
- 60,000)
C O R R EC T I O N
30,000
30,000
30,000
--
90,000
Correct Accounting
Account for software development costs and amortize on a straight-line b asis or percentage of sales,
whichever is greater.
Amortization of cost
50,000
50,000
50,000
(200,000
Remaining book value
50,000
- 150,000)
The $30,000 Debit in Year 1, Year 2, and Year 3 adjusts the amortization to the correct amounts, and the
$90,000 Credit for the Year 3 balance sheet adjusts the $140,000 that was originally recorded to its correct
$50,000 amount.
QUESTION 6
This question deals with revenue recognition (covered in F2). To properly match earnings with the period
benefited, revenues should be recognized when earned, not when received. Subscription revenues that
represent an advance payment over a three-year period should be recognized to the extent that obligations have
been fulfilled in the year of receipt, with the remainder recorded as deferred revenue. The company's accounting
overstated revenue in the year of receipt, and did not properly establish a liability.
Year 1
INCOM E ST AT EM ENT
Year 2
Year 3
Original Accounting
Recognize revenue when
received
Subscription revenues
(150,000)
C O R R EC T I O N
100,000
100,000
(50,000)
100,000
Correct Accounting
Recognition of revenue when
earned
Subscription revenue
Deferred revenue (150,000 $50,000)
QUESTION 7
This question deals with inventory (covered in F4). In this question, inventory sitting in a warehouse was
improperly included in cost of goods sold even though the goods had not been sold. Risks of ownership pass to
the buyer upon receipt when goods are shipped FOB destination. Risks of ownership pass to the buyer upon
delivery to a common carrier under FOB shipping point. In this case, since the goods were shipped FOB
destination, title had not passed to the buyer and the goods should properly have been included in inventory.
Restoration of inventory accounts and elimination of cost of goods sold are required adjustments.
Year 1
INCOM E ST AT EM ENT
Year 2
Year 3
Original Accounting
Improperly excluded inventory
Cost of goods sold
50,000
C O R R EC T I O N
(50,000)
Correct Accounting
Account for costs of inventory for
which company still has title
Cost of goods sold
Inventory
50,000
-50,000
SUMMARY
A recap of the correction adjustments is as follows:
YEAR 3 BAL A NCE SHEET
Question
Book income
Year 1 Debits
(Credits)
Year 2 Debits
(Credits)
Year 3 Debits
(Credits)
($10,000)
$6,000
($85,000)
1
2
25,000
3
4
100,000
30,000
(2,000)
2,000
50,000
75,000
(150,000)
150,000
Debit
$0
Credit
$0
150,000
(100,000)
30,000
30,000
90,000
100,000
100,000
7
Corrected net
income
Balance Sheet
(50,000)
145,000
(66,000)
50,000
122,000
50,000
340,000
Adjustments
Note that each numbered line, including the total adjustments line, shows a net total of debits and credits equal
to zero. All that is being done in each year is that the numbers are moved around.
JE#1
Accounts receivable
$20,000
Sales
$20,000
To adjust to accrual basis sales revenue, the sales that were made in Year 1 but not yet collected at the end of
the year are added to the sales already booked for the year under the cash basis. The amount uncollected at
year-end is accounts receivable.
JE#2
Inventory
$12,000
Accounts payable
Cost of sales
$12,000
$2,000
Accounts payable
$2,000
Purchases made on the cash basis of accounting are not recorded until the invoice is paid. Since $12,000 of the
goods are still on hand, the amount is recorded under the accrual basis with inventory as a debit and accounts
payable as a credit.
The $2,000 of goods sold but not yet paid for is recorded under the accrual basis with a debit to cost of sales and
a credit to accounts payable.
JE#3
Factory equipment
$5,000
$5,000
$1,000
Accumulated depreciation
$1,000
The asset purchase of $5,000 was recorded as small tools expense under the cash basis. Under the accrual
basis, the tools need to be reported as fixed assets with a debit to the factory equipment account. Depreciation
is calculated on a straight line basis for one year and totals $1,000.
JE #4
Prepaid insurance
$1,200
Administrative expenses
$1,200
The insurance policy included as an administrative expense is for one year, from July 1, Year 1 to June 30, Year
2. Since six months are still to run on the policy, prepaid insurance of $1,200 ($2,400 x 6/12) should be reported
under the accrual basis.
JE #5
Accounts receivable
$500
Cash
$500
Under the accrual basis, the bad check would be reported as accounts receivable since it was not paid as of
December 31, Year 1.
JE #6
Bad debt expense
Allowance for uncollectible accounts
$900
$900
The bad debt expense account is calculated based on 1.5% of sales for the year. Sales revenue for the year is
$60,000, after including the sales in JE #1. Bad debt expense is $900 ($60,000 x 1.5%).
JE #7
Payroll expense
$1,300
Accrued payroll
$1,300
Since the company pays its employees seven days after the end of the pay period and the last pay date recorded
by the company was December 31st (for time worked through December 24th), under the accrual basis the
company has to record accrued payroll for the additional one week that was worked in Year 1 and will be paid on
January 7th, Year 2.
JE #8
Income tax expense
Income tax payable
$1,000
$1,000
On the accrual basis, the company will record the tax liability based on the income shown in the Year 1 accrual
basis income statement. The taxable income is calculated as follows:
Cash basis pretax income (from trial balance)
$ (1,000)
JE #1 - Sales
20,000
JE #2 - Cost of sales
(2,000)
JE #3 - Small tools
JE #3 - Depreciation expense
JE #4 - Administrative expenses
JE #6 - Bad debt expense
JE #7 - Payroll expense
Taxable Income
5,000
(1,000)
1,200
(900)
(1,300)
$20,000
Under the cost recovery method, no profit is recognized until all costs have been recovered. Cash collections are
first applied to the recovery of product costs. Collections after all costs have been recovered are recognized as
profit.
Gross profit on income statement - Year 1: $0
No gross profit is recognized in Year 1 because the Year 1 cost of sales of $60,000 is not recovered during Year
1.
Deferred gross profit - End of Year 1: $60,000
Total gross profit = $120,000 - $60,000 = $60,000
All gross profit is deferred at the end of Year 1 because the $60,000 cost of sales has not been recovered.
Gross profit on income statement - Year 2: $90,000
From the Year 1 sales, $60,000 was collected in Year 2, for cumulative cash collections of $100,000 ($40,000 in
Year 1 + $60,000 in Year 2).
Year 2 recognized gross profit on Year 1 sales = $100,000 cash collections - $60,000 cost of sales = $40,000
Year 2 costs of $80,000 are fully recovered since the company collected $130,000 of the Year 2 installment
sales.
Year 2 recognized gross profit on Year 2 sales = $130,000 cash collections - $80,000 cost of sales = $50,000
Total Gross Profit = $40,000 + $50,000 = $90,000
Deferred gross profit - End of Year 2: $90,000
Total gross profit on Year 1 sales = $120,000 - $60,000 = $60,000
Gross profit on Year 1 sales recognized in Year 2 = $40,000
Deferred gross profit on Year 1 sales at the end of Year 2 = $60,000 - $40,000 = $20,000
Total gross profit on Year 2 sales = $200,000 - $80,000 = $120,000
Gross profit on Year 2 sales recognized in Year 2 = $50,000
Deferred gross profit on Year 2 sales at the end of Year 2 = $120,000 - $50,000 = $70,000
Total deferred gross profit - end of Year 2 = $20,000 + $70,000 = $90,000
1. $26,000,000
License Cost
Add: Legal Fee
$28,000,000
1,600,000
400,000
$30,000,000
Less: Y1 Amortization
(2,000,000)
$28,000,000
Less: Y2 Amortization
(2,000,000)
$26,000,000
2. $4,769,231
Carrying Value End Y2
$26,000,000
(3,000,000)
$23,000,000
Amortization Periods
Amortization Expense
13
$1,769,231
Impairment Charge
3,000,000
Total Expense in Y3
$4,769,231
3. $1,400,000
Initial Carrying Value
$30,000,000
Less: Y1 Amortization
(2,000,000)
$28,000,000
(26,600,000)
Revaluation Loss Y1
Carrying Value - Beg Y2
Remaining Periods
$1,400,000
$26,600,000
14
$1,900,000
$26,600,000
Less: Y2 Amortization
(1,900,000)
$24,700,000
$26,300,000
24,700,000
$1,600,000*
* The year 2 income statement recognizes a reversal of the $1,400,000 revaluation loss reported in year 1, with
the $200,000 remainder recognized on the balance sheet as a revaluation surplus in the other comprehensive
income account.
Part 1:
1. $98,500. Money market instruments are considered cash equivalents, as they are easily converted into
cash and represent short-term instruments that are very low risk in terms of potential loss of principal.
Cash and money market instruments should be included in this total.
2. $39,000. The current value of the TBR stock (3,000 shares at $13 per share) should be included. The
original purchase price is relevant in terms of calculating the unrealized gain or loss (which will be reflected
on the Statement of Changes in Net Worth), but will not be presented on the Statement of Financial
Condition. In addition, HYL stock will not be included here because the stock was sold and no longer
represents an asset in Tames portfolio.
3. $9,150. Bond investments are monetary assets and should be valued based on the present value of
projected cash receipts. Each bond is currently worth $915 and he has purchased 10 bonds. So the total
value should be $9,150 (bonds payable of $10,000 less $850 bond discount.
4. $225,000. The original purchase price and original mortgage are not relevant for the current years
Statement of Financial Condition. The current value of $225,000 is what will be listed as an asset. The
current value of the mortgage of $190,000 will be listed as a liability.
5. $50,000. The current value of $50,000 is all that is relevant for the Assets section of this statement. The
outstanding principal owed of $35,000 will be listed as a liability.
6. $35,000. Life insurance should be listed at its cash surrender value of $40,000 less the $5,000 loan that is
outstanding on the policy. The fair value and face value are not included here.
7. $300,000. When a business interest is deemed to be large, ($300,000 relative to his overall asset
portfolio would be considered large/significant) the interest should be presented on a net basis. The value
of the business is $1.5 million ($4 million in assets - $2.5 million in liabilities). Tames holds a 20% interest
valued at $300,000 ( $1,500,000 X 20%).
8. $275,000. Only the pension plan benefits that are vested should be included as an asset.
Part 2:
1. Current values for stock investments are listed as assets on the Statement of Financial Condition. Original
cost data is used to determine unrealized and realized gains or losses, but it is not listed specifically under
either statement and is not required to be disclosed.
2. Realized and unrealized gains and losses on investments will appear on the Statement of Changes in Net
Worth.
3. Estimated taxes owed (based on when the stock currently held is actually sold) will appear as a liability on
the Statement of Financial Condition.
4. Realized gains and losses on the sale of property will appear on the Statement of Changes in Net Worth.
5. Interest rate details on an outstanding mortgage will be listed as a Disclosure.
6. Principal outstanding on student loans will be listed as a liability on the Statement of Financial Condition.
7. While a pay down of principal will reflect as a decrease in the liability itself, interest paid on principal owed
will be reflected on the Statement of Changes in Net Worth.
8. Nonvested pension plan benefits may be listed as a Disclosure, but will not be included on either
statement. Vested pension plan benefits will be listed as an asset on the Statement of Financial
Condition.
9. The face amount on a life insurance policy will be included in a Disclosures area. The cash surrender value
(less any loans payable) will be included on the Statement of Financial Condition.
AJE#1
Dr. Prepaid expenses
$5,000
$5,000
The rent expense attributable to year 3 that has been paid in year 2 is a prepaid item as of December 31, year 2.
AJE#2
Dr.
Depreciation expense
$1,500
$1,500
Depreciation is calculated on the original cost of $20,000, less salvage value of $5,000 over a 10 year useful life.
AJE#3
Dr.
Bad debt expense
$750
$750
AJE#4
Dr.
Allowance for doubtful accounts
$855
$855
When a specific account is written off, the allowance account is reduced (debit) and the receivable is removed from
Accounts receivable (credit).
AJE#5
Dr.
Insurance expense
$650
$650
Insurance expense for the year ended December 31, year 2 that has been posted to Prepaid expenses needs to be
adjusted to an expense account.
AJE#6
Dr.
Interest receivable
$300
$300
Interest income that has been earned in Year 2 is shown as income even though it has not as yet been received
(accrual concept).
AJE#7
Dr.
Tax expense
Cr. Taxes payable
$2,000
$2,000
Income tax expense for the year of $3,000 for Year 2 is shown as an expense for the year. Since the amount in the
expense and payable account is $1,000, an additional $2,000 is needed to adjust the amount to the balance at year
end. It would appear that JRM Co. made a tax accrual of $1,000 earlier in the year.
April 1, year 1
Dr.
Patents
$50,000
Cr. Cash
$50,000
The cost of purchasing a patent from an outside source for $50,000 is capitalized as an intangible asset. The
$35,000 in development costs incurred by DD Co. is research and development which is a direct charge to
expense.
July 1, year 1
Dr.
Equipment
$79,000
Cr. Cash
$79,000
Research and development costs are a direct charge to income EXCEPT for materials or equipment that have
alternate future uses. Because the equipment qualifies under this rule, the amount capitalized is the original cost
plus any expenditure directly related to the acquisition of the asset.
October 1, year 1
Dr.
Legal Expense
$25,000
Cr. Cash
$25,000
Legal fees for an unsuccessful defense of a trademark are an expense. Legal fees for a successful defense of the
trademark are added to the asset value of the trademark.
Amortization Expenses
$3,750
$3,750
A patent is amortized over the shorter of its estimated useful life or its remaining useful life. Amortization is on a
straight line basis: $50,000/10 years x 9/12.
$7,900
$7,900
Depreciation expense is calculated on the capitalized amount of $79,000. Depreciation is on the straight line
basis: 79,000/5 year x 6/12. Because the equipment is currently used for research and development, the
depreciation is charged to research and development expense.
impairment is recognized.
Solution:
1) DR
CR
2) DR
CR
3) DR
CR
4) DR
CR
$10,000
$10,000
$15,000
$15,000
$25,000
$25,000
$15,000
$15,000
CR
6) DR
CR
7) DR
$ 5,000
$ 5,000
$10,000
Cash
$10,000
$255,000
DR
25,000
DR
15,000
CR
CR
8) DR
CR
9) DR
CR
10) DR
CR
Impairment Loss
Held to maturity security, Martin Co.
25,000
270,000
$30,000
$30,000
$1,400,000
$1,400,000
$ 150,000
$ 150,000
Solution
1. Cost Method
The investor (Big) accounts for the investment using the cost method if the investor does not have the ability to
exercise significant influence over the investee. Even though Big owns over 20% of Small, the remaining stock is
owned by one individual and control would be retained by the majority shareholder and his family who controls the
Board.
2. Consolidation
The partnership is a variable interest entity for the following reasons:
1. The activities of the partnership are conducted on behalf of Big
2. Big's voting rights are small in proportion to the focus of the partnership on Big, and
3. Big's voting rights (20%) are out of line with Big's variable interest in the partnership ($20,000,000 /
$25,000,000 = 80%).
Big is the primary beneficiary of the partnership/VIE and must consolidate the partnership/VIE.
3. Equity Method
The equity method is used if the investor can exercise significant influence over the investee and holds 50% or
less of the voting stock. At December 31, Year 1, Big is the largest shareholder of Little Ladies and controls the
Board of Directors. The stock ownership percentage, which is now 28%, is a guideline that would reinforce the
correct answer; however, the control supersedes the ownership percentage.
4. Consolidation
The investor should prepare consolidated financial statements whenever the investor has control (over 50%
ownership) of the subsidiary. Big would consolidate the operations of Shared into their consolidated financial
statements. Even though Big consults with and gets input from the 49% shareholder, there is nothing in the facts
of the question that would imply that Big does not have control.
5. Consolidation
Because Big owns over 50% of the stock of Petite, it has control of Petite and should consolidate Petites
operations into its consolidated financial statements. A different location, different industry, different year end,
and no daily business relationship would not change the control as a result of majority investment.
1. $369,000; $39,000
Under the equity method, the investment is originally recorded at the price paid to acquire the investment.
DR
Investment in Rhodes
CR
$330,000
Cash
$330,000
The investment is subsequently adjusted as the net assets of the investee change through the earning of
income and payment of dividends. The investment account increases by the investor's share of the investee's
net income. Barnes' Year 1 share of Rhodes' income is calculated as follows:
Rhodes' net income
Percent owned by Barnes
Share of income before adjustment
$150,000
30%
$ 45,000
Investment in Rhodes
$ 39,000
$ 39,000
2. $6,600; $9,000
Barnes should record the 10% stock dividend received from Rhodes with a memorandum entry that reduces the
per share cost of the Rhodes stock owned. Barnes will still own 30% of Rhodes after the stock dividend.
Barnes' Year 2 share of Rhodes' income is calculated as follows:
Rhodes' net income
Percent owned by Barnes
Share of income before adjustment
$50,000
30%
$ 15,000
Investment in Rhodes
$ 9,000
$ 9,000
The distribution of dividends by Rhodes reduces the investment balance on Barnes' books by $2,400 ($8,000 x
30%).
DR
CR
Cash
Investment in Rhodes
$ 2,400
$ 2,400
Neither the earnings or dividends of Barnes affect the investment or income account.
$1,050,000
$1,500,000
$ 900,000
100,000
80,000
200,000
$1,280,000
$1,050,000
$ 900,000
100,000
80,000
200,000
$1,280,000
Explanation:
SITUATION 1
The gain or loss on the intercompany sale of a depreciable asset is unrealized from a consolidated financial
statement perspective until the asset is sold to an outsider. An elimination entry in the period of the sale
eliminates the intercompany gain/loss and adjusts the asset and accumulated depreciation to their original
balance on the date of sale:
DR
Gain on sale
40,000
CR
Accumulated depreciation
15,000
CR
Depreciation expense
5,000
CR
Equipment
20,000
Gain on Sale, $40,000 Debit
Since Peterson sold the equipment to Silver, a 100% subsidiary, the gain of $40,000 is eliminated. It was
originally entered in the books of Peterson as a credit and is calculated as the sales price of the asset of
$120,000, less the net book value of $80,000 ($100,000 cost less accumulated depreciation on 1/1/Y3 of
$20,000).
Accumulated Depreciation, $15,000 Credit
The accumulated depreciation for the consolidated group at December 31, Yr 3 is based on the original cost of
$100,000. Three years of accumulated straight line depreciation is $30,000.
The accumulated depreciation shown by the separate companies is as follows:
$0 for Peterson since the accumulated depreciation was removed as part of the journal entry recorded at
the time of the sale.
$15,000 for Silver Corp., based on one year of straight-line depreciation ($120,000/8 years).
The eliminating journal entry raises the accumulated depreciation from $15,000 to the correct amount of $30,000.
Depreciation Expense, $5,000 Credit
The correct amount of depreciation expense for Year 3 is $10,000 based on the original purchase of the asset by
Peterson ($100,000 cost to Peterson / 10 years = $10,000). Silver Corp. recorded depreciation of $15,000 based
on their purchase of the asset at the beginning of Year3 ($120,000 cost to Silver / 8 years = $15,000).
The eliminating journal entry reduces the depreciation from $15,000 to the correct amount of $10,000.
Equipment, $20,000 Credit
The original cost of the equipment to Peterson is $100,000. The $120,000 cost of the asset to Silver must be
reduced to the original amount paid by Peterson.
SITUATION 2
When affiliated companies sell inventory to one another, the total amount of the intercompany sale and cost of
goods sold is eliminated when preparing consolidated financial statements. In addition, the intercompany profit
must be eliminated from the ending inventory and cost of goods sold of the group.
DR
Sales
50,000
CR
Inventory
8,000
CR
Cost of goods sold
42,000
Sales, $50,000 Debit
The gross sale amount of Peterson's sale to Silver is eliminated.
Common stock
DR
DR
Retained earnings
CR
$600,000
100,000
50,000
Investment in subsidiary
DR
DR
Goodwill
$1,760,000
$950,000
60,000
Remember to use the CARINBIG mnemonic to ensure that you eliminate all the appropriate accounts:
Common stock Eliminate the par value of the common stock of the subsidiary at the date of the acquisition;
the par value of the common stock is taken directly from the trial balance.
Additional paid-in capital Eliminate the additional paid-in capital of the subsidiary at the date of acquisition;
the additional paid-in capital is taken directly from the trial balance.
Retained earnings Eliminate the retained earnings of the subsidiary at the date of acquisition; amount is
taken directly from the trial balance.
Investment Eliminate the Parent Company's investment in Subsidiary.
Noncontrolling Interest In this instance, it is not applicable as it was a 100% acquisition.
Balance sheet adjusted to fair value Increase or decrease the book value of the subsidiary's plant and
equipment to equal its FV.
Identifiable intangible assets recorded at fair value No identifiable intangibles are identified in this problem.
Goodwill Establish a goodwill account as necessary.
Depreciation expense
CR
$316,667
Accumulated depreciation
$316,667
$950,000
3
$316,667
Impairment expense
CR
$2,000
Goodwill
$2,000
The goodwill suffered a $2,000 impairment according to the situation tab. Goodwill is not amortized.
4. Eliminate intercompany transactions associated with the income statement
Journal entry:
DR
CR
$10,000
$10,000
Eliminate intercompany transactions associated with the income statement. The only income statement
Intercompany payable
Intercompany receivable
$30,000
$30,000
Eliminate intercompany transactions on the balance sheet. The only intercompany transaction is the
payable and receivable as identified in the facts.
Solution
Adjustments
Amounts
$9,225
8,400
(11,550)
(450)
$5,625
$3,640
(265)
(30)
(1,240)
20
3,500
$5,625
Bad check
NSF check fee
Credit card processing fee
Fee rebate
April rent check
Actual Cash Balance - March 31
Deposit in transit - 8,400: The deposit of $8,400 made on March 31st was correctly posted to the accounting records in
March and is processed and recognized by the bank in April.
Outstanding checks - (11,550): Check #21063 is correctly shown as a disbursement by the company in March and should
clear in April. If the check has still not cleared by the end of April, the company may want to consider further investigation.
Incorrect check amount - (450): The check to the farmers market was correctly recorded by the company. The bank
cashed the check for the incorrect amount and will remit the $450 shortfall to the payee in April. This amount reduces the
actual cash balance in the bank reconciliation.
Bad check - (265): The bad check of $265 deposited by the company has not been recorded and should be adjusted on the
books in March.
NSF fee - (30): The NSF fee of $30 has not been recorded and should be adjusted on Gemini s books in March.
Payroll withdrawal: The payroll withdrawal was made by the payroll service in March. The company also properly
recorded the withdrawal in March, so no adjustment is necessary.
Credit card processing fee - (1,240): The credit card processing fee is $1,240 ($62,000x2%). The amount was deducted by
the bank as the deposits were being made. Because it has not yet been recorded on the books of the company, Gemini
needs to reduce the cash balance by $1,240.
Fee rebate - 20: The fee rebate of $20 is an addition to the books of the company on March 31st.
April rent check - 3,500: Since the rent check is still in the possession of Gemini Markets as of March 31st, the company
has incorrectly shown this amount as a reduction of the bank balance. The check amount should be added back to cash.
The rent check is not an outstanding check at March 31st since it was not sent or delivered in March.
$1,570,000
The purchase price of the inventory is reduced by the $30,000 discount that the company received. The freight in
on the shipment of $100,000 is added to the cost of the inventory purchased.
B)
$750,000
Since the goods were shipped FOB shipping point, title passes to the buyer when the common carrier picks up
the goods to be shipped. The goods are included in Party Supply s inventory until they are in the possession of
the common carrier.
C)
($3,500,000)
The average cost of sales is 70% (one minus the gross margin, ie 30%) of the sales price. Since sales for
December were $5,000,000, the cost of sales would be $3,500,000.
D)
$210,000
Since the inventory was in the possession of Party Supply at December 31 and not transferred to the shipper, the
goods are still part of the inventory of the company.
The sale of $300,000 needs to be removed from the accounting records and the $210,000 cost of the sale (70% x
$300,000) is reversed and the goods restored to inventory.
E)
($25,000)
In a consignment arrangement, Party Supply includes the goods in their inventory until such time that the goods
are sold to a third party. When the original shipment was made, there was no change in the company s
inventory. Since 25% of the goods were sold before the end of the year, inventory is reduced by $25,000.
F)
$20,000
The amount of goods stored in the public warehouse is already included in the inventory total. Shipping costs
between the warehouses is considered to be an inventory cost. The rent on the warehouse is a period expense
and is not part of inventory.
G)
($46,000)
Inventory is reduced to the lower of cost or market and any probable loss sustained is recorded in the period in
which the loss occurred. The amount of the loss is measured as the difference between the cost of $50,000 and
the realizable value net of selling costs of $4,000.
Solution
Part 1:
Amount
190,000
36,000
16,000
54,000
(40,000)
256,000
The opening balance consists of $150,000 for the precision tooling machine and $40,000 for the drill press, for a total of
$190,000.
The molding machine is recorded at the cost of $36,000.
The replacement motor for $12,000 and the installation of $4,000 are added as fixed assets since the motor significantly
increases the usefulness of the machine, for a total of $16,000. The maintenance agreement is not considered to be a fixed
asset. The payment at the front end of the agreement would be a prepaid expense, not a fixed asset.
The Super DP is recorded at the cost of $54,000.
The old drill press is removed from the fixed asset schedule at the asset s original cost of $40,000.
Part 2:
Asset
Description
Tooling Machine
Drill Press
Molding Machine
Replacement motor
Maintenance Agreement
Super DP
Depreciation
Base
$120,000
40,000
36,000
16,000
0
54,000
Useful
Life
Annual
Depreciation
5
5
9
4
Depreciation
Year 2
$24,000
8,000
4,000
4,000
$24,000
6,000
3,000
2,000
4
13,500
Total Depreciation Expense
3,375
$38,375
The tooling machine has a depreciation base of $120,000 (the cost of $150,000 less the salvage value of $30,000). The asset
has a useful life of 5 years, so the depreciation for the entire year is $24,000 ($120,000/5).
The drill press has a depreciation base of $40,000 and a useful life of 5 years, so the annual depreciation is $8,000
($40,000/5). Since the asset was sold in September, 9 months of depreciation are taken. The amount of depreciation is
$6,000 ($8,000 x 9/12).
The molding machine has a depreciation base of $36,000 and a useful life of 9 years, so the annual depreciation is $4,000
($36,000/9). The amount of depreciation from April through December is $3,000 ($4000 x 9/12).
The replacement motor has a depreciation base of $16,000 and a useful life of 4 years, which is the remaining life of the
tooling machine on which the motor was installed. The annual depreciation is $4,000 ($16,000/4) and the depreciation from
July through December is $2,000 ($4,000 x 6/12).
There is no depreciation on the maintenance agreement because it is not a fixed asset.
The Super DP has a depreciation base of $54,000 and a useful life of 4 years, so the annual depreciation is $13,500 and the
depreciation from October through December is $3,375 ($13,500 x 3/12). The change in the estimated useful life of the asset
was determined in Year 2 and should be used to calculate the depreciation for Year 2.
Tax depreciation is not considered when calculating depreciation on the books of the company.
Part 3:
42,375
The opening balance consists of $10,000 on the precision tooling machine and $6,000 on the drill press, for a total of
$16,000.
The depreciation expense of $38,375 is the calculated total from the previous schedule.
The old drill press is removed from the accumulated depreciation account at the cumulative amount of depreciation taken
on the asset when it was sold. The accumulated depreciation is $6,000 through Year 1 and an additional $6,000 for Year 2,
for a total of $12,000.
Explanation:
Construction period interest should be capitalized (based on the weighted average of accumulated expenditures)
as part of the cost of producing fixed assets.
Weighted average of accumulated expenditures for year 2: $360,000
The weighted average amount of accumulated expenditures (WAAE) for year 2 is calculated as follows:
$130,000
1/1-3/31/Y2
3 months
$ 390,000
$370,000
4/1-9/30/Y2
6
2,220,000
$570,000
10/1-12/31/Y2 3
1,710,000
$4,320,000/12 months
Weighted average of accumulated expenditures
$360,000
$67,000
1. $600,000
Cash paid
$ 800,000
Mortgage assumed
200,000
1,000,000
Allocation to building
60%
Cost of building
$ 600,000
Note: Although the valuation on the realty tax bill is not used for financial statement purposes, the realty
tax bill is often the best evidence available for obtaining the allocation percentages for land and building.
2. $370,000
In an exchange that lacks commercial substance, record the asset received on the balance sheet as the
net book value (NBV) of the asset surrendered, minus any boot received (or plus any boot paid) in the
transaction, plus any gain recognized (or minus any loss recognized) on the transaction. In this case, a
realized gain of $130,000 exists [$450,000 - $320,000], but it is not reported (recognized) because cash
was paid in an exchange that lacks commercial substance (i.e., the gain is deferred).
NBV of asset surrendered
$320,000
Boot paid
50,000
Journal entry:
DR
CR
CR
New Land
Cash
NBV of old land
$370,000
$ 50,000
320,000
3. $315,000
Exchanges of nonmonetary assets should be categorized into one of two groups: those which have
"commercial substance" and those which lack "commercial substance." If the exchange lacks commercial
substance, boot is received and a gain is realized, a portion or all of the gain will be reported (recognized).
In this case, boot received is less than 25% of the total consideration received, so a proportional gain is
recorded, as follows:
$50,000 / $500,000 = 10%
Journal entry:
DR
DR
CR
CR
Cash
New land
NBV of old land
Gain on exchange
$ 50,000
315,000
$350,000
15,000
Balance sheet:
NBV of asset surrendered
$350,000
(50,000)
15,000
$315,000
1. $90,000
Rule: Salvage value is subtracted from cost under the straight-line method to arrive at depreciable base.
Cost of machine
$864,000
(144,000)
Depreciable base
$720,000
$ 90,000
2. $162,000
Rule: Double declining balance method is at twice the straight-line rate (in this case twice 12.5% or 25%). However,
DDB does not subtract salvage value to arrive at depreciable base. Thus, cost is the depreciable base.
Cost of machine
$864,000
(216,000)
$648,000
$162,000
3. $140,000
Rule: Salvage value is subtracted from cost under the sum-of-the-years'-digits method to arrive at depreciable base.
The denominator for the SYD fraction is 36 (1 + 2 + 3 + 4 + 5 + 6 + 7 + 8).
Cost of machine
$864,000
(144,000)
Depreciable base
$720,000
Year 2 fraction
Depreciation expense for Year 2
(7/36)
$140,000
4. $120,000
Rule: Salvage value is subtracted from cost under the units of production method to arrive at depreciable base.
Cost of machine
$864,000
(144,000)
Depreciable base
$720,000
Year 2 fraction
Depreciation expense for Year 2
x (300,000/1,800,000)
$120,000
The $12,000 receivable deemed uncollectible because the customer declared bankruptcy should be written-off
(debit the allowance and credit AR) and the $5,000 receivable collected but not removed from AR should be
recognized as a cash receipt (debit cash and credit AR). This will reduce the AR balance in the "over 90 days"
aging category due to the ages of these balances. After these adjustments, the allowance for doubtful
accounts can be calculated using the new aging percentages, as follows:
AR
Adjustments
Adjusted AR
Estimated %
Allowance
Total
677,000
(17,000)
0-30 days
225,000
0
31-60 days
240,000
0
61-90 days
127,000
0
660,000
225,000
3%
6,750
240,000
11%
26,400
127,000
25%
31,750
107,060
Over 90
85,000
(17,000)
68,000
62%
42,160
$62,000
- Write-offs
(31,000)
+ Recoveries
Allowance before adjustment
Bad debt expense
Ending allowance
4,000
$35,000
72,060
$107,060
72,060
72,060
$325,000
120,000
(65,000)
24,000
$404,000
$ 11,000
305,000
$316,000
$36,000
2,100
3,700
$41,800
Year
Doub le SL%
NBV
Depreciation
Expense
Year 1
Year 2
25%
$47,000
$11,750
75%
25%
25%
$35,250
$8,813
75%
$13,000
(11,500)
$ 1,500
Sale price
Less NBV
Loss on sale
$ 1,200
(1,500)
($300)
Pickup truck exchange gain or loss recognized: $-0In an exchange of received non-monetary assets lacking commercial substance, gains are not recognized if no
boot (cash) is received.
Equipment destroyed gain or loss recognized: $1,000
The calculation to determine the gain or loss is a two step calculation. First calculate the NBV by taking the
original cost less accumulated depreciation. Then subtract the NBV from the insurance proceeds received to
get the gain or loss.
Original cost of the equipment
Accumulated depreciation
Net book value
$17,500
(3,500)
$14,000
Insurance proceeds
Less NBV
Gain on sale
$15,000
(14,000)
$ 1,000
I = Increase
D = Decrease
N = No Effect
Bond
discount
Bond
premium
Bonds
payable
Common
stock
Additional
paid-in
capital
Retained
earnings
1. Cash
Discount
Bonds payable
2. Cash
Bonds payable
Premium
3. Bonds payable
Premium
Common stock
Additional paid-in
capital
4. Cash
Discount
Bonds payable
APIC (stock
warrants)
Transaction Journal
Entries
5. Retained earnings
Common stock
Additional paid-in
capital
1. Because the nominal interest rate is below market, the bonds will sell at a discount.
2. The amount in excess of face is recorded as a premium. Under U.S. GAAP, no separate entry is made for
the convertibility feature because it is not separable from the bonds.
3. Under the book value method (which is GAAP), the stock issued is valued at the book value of the bonds
being converted. There is no gain or loss recognized.
4. The value of the warrants is credited to Additional paid-in-capital. Because the combination of bonds and
warrants were issued for an amount equal to the face amount of the bonds, the bonds without the warrants
must be valued at a discount.
5. A stock dividend merely reclassifies amounts from Retained earnings to Common stock and APIC at the fair
value on the declaration date.
Answers:
1. Record the journal entry for the issuance of the convertible bonds on January 1,
Year 1. Select no entry if no journal entry is required on this date.
Account
Debit
$ 825,500
50,000
Cash
Bond Issue Cost
Bonds Payable
Premium on Bonds Payable
Credit
$ 800,000
75,500
Explanation:
Cash is debited for $825,500 calculated as follows:
Bonds
Bond Premium
Bond Issue Costs
Cash
$800,000
75,500
(50,000)
$825,500
Bond issue cost is an asset amortized over the life of the bond. The premium is
also amortized over the life of the bond.
2. Record the journal entries on June 30, Year 1 to recognize interest expense and
the amortization of the bond issue cost for the first six months of Year 1.
Account
Interest Expense
Premium on Bonds Payable
Cash
Account
Bond Issuance Expense
Bond Issue Cost
Debit
$ 13,133
2,867
Debit
$ 2,500
Credit
$ 16,000
Credit
$ 2,500
Explanation:
Bond interest paid (credit to cash) = $800,000 X .02 = $ 16,000.
Bond interest expense = $875,500 X 1.5% = $13,133.
Bond premium amortization = $16,000 - $ 13,133 = $2,867.
Record six months of bond issuance expense amortization = $50,000/20 periods =
$2,500.
Debit
$ 13,090
2,910
Account
Bond Issuance Expense
Bond Issue Cost
Debit
$ 2,500
Credit
$ 16,000
Credit
$ 2,500
Explanation:
Bond interest paid (credit to cash) = $800,000 X .02 = $ 16,000.
Bond interest expense = ($875,500 - $ 2,867) X 1.5% = $ 13,090.
Bond premium amortization = $16,000 - $ 13,090 = $2,910.
Record six months of bond issuance expense amortization = $50,000/20 periods =
$2,500.
4. Assume that the bonds are converted on January 1, Year 2 and Acorn uses the
book value method to account for the conversion of bonds into common stock.
Record the journal entry for the conversion.
Account
Bonds Payable
Unamortized Premium on Bonds
Payable
Common Stock
Unamortized Bond Issue Costs
Additional Paid In Capital
Debit
$ 800,000
69,723
Credit
$ 80,000
45,000
744,723
Explanation:
Bonds payable = $800,000 face value
Unamortized premium on bonds payable = $75,500 - $2,867 - $2,910 = $69,723
Unamortized bond issue costs = $50,000 - $2,500 - $2,500 = $45,000
Common stock at par value = 800 bonds x 5 shares/bond x $20.00 par value =
$80,000
Additional paid in capital = $744,723 (squeeze)
5. Assume that the bonds are converted on January 1, Year 2 and Acorn uses the
market value method to account for the conversion of bonds into common stock.
Assume the market price of the common stock on the date of conversion was $
250.00 per share. Record the journal entry for the conversion.
Account
Bonds Payable
Unamortized Premium on Bonds
Payable
Loss on bond conversion
Common Stock
Unamortized Bond Issue
Costs
Additional Paid In Capital
Debit
$ 800,000
69,723
Credit
175,277
$ 80,000
45,000
920,000
Explanation:
Bonds payable = $800,000 face value
Unamortized premium on bonds payable = $75,500 - $2,867 - $2,910 = $69,723
Unamortized bond issue costs = $50,000 - $2,500 - $2,500 = $45,000
Common stock at par value = 800 bonds x 5 shares/bond x $20.00 par value =
$80,000
Common stock at market value = 800 bonds X 5 shares/bond X $250.00 market
value = $1,000,000
Additional paid in capital = $1,000,000 - $80,000 = $920,000
Loss on bond conversion is calculated as follows:
Market price of stock
$1,000,000
45,000
($869,723)
Loss
$175,277
PART 1:
Amount
Over(under)funded
($225,000)
Underfunded
$550,000
Overfunded
($450,000)
Underfunded
$0
$550,000
$25,000
$650,000
For balance sheet reporting purposes under U.S. GAAP, all overfunded pension plans are aggregated and
reported in total as a noncurrent asset. Because Plan B is SuretoPass' only overfunded pension plan, the
company will report a noncurrent pension benefit asset of $550,000. No current assets are reported under defined
benefit pension plan accounting rules.
Under U.S. GAAP, all underfunded pension plans are also aggregrated and reported as a current liability (to the
extent that the expected benefits payable in the next 12 months exceed the fair value of the plan's assets), a
noncurrent liability or both. SuretoPass has two underfunded pension plans: Plan A and Plan C. The total funded
status of these underfunded pension plans is $675,000 ($225,000 + $450,000). Because Plan C has plan assets
totaling $125,000, but expects to pay benefits of $150,000 in Year 2, SuretoPass must report a current pension
benefit liability of $25,000 ($125,000 $150,000) at 12/31/Year 1. The remaining $650,000 is reported as a
noncurrent liability.
Solution:
1. $941,000
Service Cost-Year 5
Interest Cost
Return on Plan Assets
Amortization of Prior Service Cost
Amortization of (Gain)/Loss:
Pension expense
$920,000
Given
189,300
3,155,000 x 6%
(182,050)
3,310,000 x 5.5%
13,750
275,000/20
$941,000
Note: There are two components of the amortization of gains/losses. The first component is the difference
between actual versus expected returns (if expected returns are used to calculate pension expense). The
second component relates to any actuarial changes that result in gains or losses for the company.
While there is a difference between actual return versus expected return in Year 5, the actual difference will be
booked to other comprehensive income (OCI) at the end of Year 5 and subsequently amortized beginning in
Year 6. Pension expense will not be impacted until amortization begins.
In terms of actuarial gains/losses, Look Ahead Co. has a balance in OCI for the unrecognized actuarial loss of
$220,000 at the end of Year 4. This amount will be amortized using the corridor approach, which entails
comparing the unrecognized balance to a threshold equal to 10% of the greater of the fair value of plan assets
or the pension benefit obligation at the end of Year 4. For Look Ahead Co., the fair value of plan assets of
$3,310,000 is greater than the pension benefit obligation of $3,155,000. 10% of $3,310,000 is $331,000, which is
greater than the unrecognized balance of $220,000. If the unrecognized balance is less than this 10%
corridor (as it is here in Year 5), there will be no amortization.
2. $(33,100)
When a company uses the expected return on plan assets in calculating pension expense, a gain/loss will
occur if there is a difference between the actual return and the expected return. The company can choose to
either book this difference directly to the income statement in the period incurred or book it to other
comprehensive income and amortize it as part of pension expense.
For Look Ahead Co., the actual return of 4.5% is less than the expected return of 5.5%. As a result, Look
Ahead has a loss of $33,100 [$3,310,000 x (4.5% - 5.5%) = $(33,100)]. The company has chosen to recognize
this loss in the current period.
3. Decrease
Interest cost will decrease due to the decrease in the discount rate, resulting in pension expense decreasing.
4. Decrease
The increase in the average remaining service life will decrease the annual amortization of prior service cost,
which will decrease pension expense.
expense in Year 5.
Solutions:
Part 1: Funded Status
Classification: Noncurrent Asset
Amount: $105,000
Fair value of plan assets, 12/31/Y4
PBO 12/31/Y4
Funded Status
$975,000
($870,000)
$105,000
Under U.S. GAAP, all positive funded status pension plans are reported as noncurrent assets.
Account
Pension Benefit Asset
Cash
Debit
175,000
Credit
175,000
2. Service/Interest Cost
Account
Net Periodic Pension Cost
Pension Benefit Asset
Deferred Tax Asset
Deferred Tax Benefit Income Statement
Calculations:
Debit
158,600
Credit
158,600
63,440
63,440
Account
Pension Benefit Asset
Net Periodic Pension Cost
Deferred Tax Expense Income Statement
Deferred Tax Liability
Calculations:
Debit
41,400
Credit
41,400
16,560
16,560
Account
Net Periodic Pension Cost
Debit
19,000
Credit
19,000
7,600
7,600
Account
Pension Benefit Asset
Other Comprehensive Income
Deferred Tax Expense OCI
Deferred Tax Liability
Debit
4,600
Credit
$4,600
1,840
1,840
A gain is recognized in OCI because the actual return on plan assets exceeds the expected return.
Calculations:
Organizational expenses are immediately recognized for purposes of financial statement presentation but
are amortized for tax purposes over multiple years. The existence of expenses recognized on the
financial statements for which there will only be a later tax benefit (when amortized) generates a deferred
tax asset. Since the organizational expense will be fully amortized at some point, the difference will
ultimately reverse and is considered temporary.
If applicable, deferred tax assets and liabilities are generally classified the same as the related asset or
liability. Organizational costs amortize over multiple years and are, therefore, noncurrent. Accordingly,
the deferred tax asset identified for this transaction is also noncurrent.
8. Permanent difference, no financial statement presentation
Key man life insurance premiums are never recognized for tax purposes so the difference will never
reverse. The difference is considered permanent and receives no deferred tax treatment.
Permanent differences do not receive deferred tax treatment. The inclusions of noncurrent asset and
noncurrent liability selections in the popup window represent nonsense distracters.
PART 1
Row 5: Allowance for doubtful accounts
$21,000 | $6,930 |
For GAAP purposes, Stanhope accounts for bad debts using the allowance method and has an Allowance for
Doubtful Accounts of $21,000. For tax purposes, the direct write-off method is used and no allowance is
recorded. Therefore, there is a $21,000 ($21,000 GAAP allowance - $0 tax allowance) temporary difference
between GAAP accounting and tax accounting. This $21,000 temporary difference represents future write-offs
that will be deducted for tax purposes when the write-offs actually occur. Future tax deductions result in deferred
tax assets.
The deferred tax asset to be reported is equal to the total temporary difference times the enacted future tax rate,
which is the company's effective tax rate of 33%:
Deferred tax asset = $21,000 x 33% = $6,930
Row 6: Accumulated depreciation, excess of tax over GAAP
$767,000 | | $253,110
A temporary difference exists because Stanhope is using the straight-line method for GAAP purposes and
accelerated methods for tax purposes. Because tax depreciation exceeds GAAP depreciation, this temporary
difference results in a deferred tax liability. The total temporary difference of $767,000 is equal to the difference
between the GAAP accelerated depreciation of $1,510,000 and the tax accelerated depreciation of $2,277,000.
The deferred tax liability is equal to the total temporary difference times the company's effective tax rate of 33%:
Deferred tax liability = $767,000 x 33% = $253,110
Row 7: Unrealized gain (loss) on trading securities
$8,000 | | $2,640
A temporary difference exists because unrealized gains of $8,000 have been recognized in net income for GAAP
purposes, but for tax purposes, the gains will not be recognized as taxable income until the securities are sold.
Because the gains represent future taxable income, the $8,000 temporary difference results in a deferred tax
liability.
The deferred tax liability is equal to the total temporary difference times the company's effective tax rate of 33%:
Deferred tax liability = $8,000 x 33% = $2,640
PART 2
Under U.S. GAAP, deferred tax assets and deferred tax liabilities are classified as current or noncurrent based on
the following criteria:
1. Deferred tax items should be classified as current or noncurrent based on the classification of the related
asset or liability for financial reporting purposes.
2. Deferred tax items not related to an asset or liability should be classified as current or noncurrent based on
the expected reversal date of the temporary difference.
Deferred taxes, current asset: $4,290
The $6,930 deferred tax asset related to the allowance for doubtful accounts is classified as current because
accounts receivable is a current asset. The $2,640 deferred tax liability related to the unrealized gain on trading
securities is classified as current because trading securities are (generally) classified as current. GAAP requires
that current deferred tax assets be offset against current deferred tax liabilities and presented as one amount.
Therefore, a net current deferred tax asset is reported on the balance sheet:
$6,930 current DTA - $2,640 current DTL = $4,290 current DTA
Deferred taxes, noncurrent liability: $253,110
The $253,110 deferred tax liability related to tax accumulated depreciation in excess of GAAP accumulated
depreciation is classified as a noncurrent deferred tax liability because fixed assets as classified as noncurrent.
Land
$169,000
Com m on s tock
Additional paid in capital
$13,000
156,000
$252,000
Retained earnings
Los s on inventory
Inventory
$55,000
10,000
$65,000
Retained earnings
Com m on s tock
$126,300
Retained earnings
Dividend payable
$968,300
$95,000
$95,000
Cash
$24,000
CR
Treasury stock
CR
$20,000
4,000
Cash
DR
4,000
DR
Retained earnings
2,000
CR
$14,000
Treasury stock
$20,000
$ 2,000
$14,000
Elimination of previous treasury stock transaction "gains" accounted for through additional paid-in capital
scheduled from the previous entry:
APIC, treasury stock
$ 4,000
Accounting for any unabsorbed treasury stock loss through retained earnings after elimination of additional
paid-in capital, treasury stock:
Treasury stock cost
$ 20,000
Cash received
(14,000)
Preliminary loss
6,000
(4,000)
$ 2,000
$ 2,000
Cost of reacquisition
Credit to treasury stock
10
$20,000
Common stock
DR
CR
Treasury stock
CR
$ 5,000
10,000
$10,000
5,000
$1,000
x
$5,000
$ 15
Par value
(5)
x 10
Debit to APIC
$10,000
$ 1,000
x
10
$10,000
5
10
$
15
(10)
5
x 1,000
$ 5,000
Additional paid-in capital from retirement may be computed on a per share basis, as per above, or simply
plugged to bring the journal entry into balance.
1,772,000
447,700
(1,463,000)
Increase/decrease in inventory
(594,000)
(18,000)
(18,000)
475,800
602,500
(400,000)
58,500
(341,500)
18,000
(27,000)
Dividends paid
(180,000)
(189,000)
72,000
Supplemental disclosures:
Interest paid
250,000
700,000
1. An indirect method statement of cash flows always starts with net income/loss. For this question, net
income is obtained from the statement of income and retained earnings. For other questions, it might have
to be calculated from an analysis of the retained earnings account, but that is not necessary for this
question because the amount is given.
2. Almost all indirect method statements of cash flow have a depreciation and amortization "add-back."
Depreciation (and amortization) is sometimes given; for this question, it must be calculated, and it is
calculated from the accumulated depreciation from the balance sheets, the disposal of the equipment from
the other information, and the information about amortization. The starting point is an Account Analysis
Format of the accumulated depreciation account, as follows:
Beginning balance = $455,000 (from the Year 1 balance sheet)
Add: Depreciation expense = plug (works out to be $440,500)
Subtract: Disposal of building = (319,500) (from the additional information)
Ending balance =$576,000 (from the Year 2 balance sheet)
For this question, the statement requires both depreciation and amortization. Amortization can be
determined from the accumulated amortization balances from the balance sheets as $7,200 ($28,800 $21,600). The total depreciation and amortization add back is thus $447,700 [$440,500 + $7,200].
Remember that depreciation and amortization are always add-backs under the indirect method because
they were subtracted to get to net income in the first place. Now that we are working backwards from net
income for the statement of cash flows, they are added.
3. The next few line items on this indirect method statement of cash flows are differences in current assets
and liabilities. For this question, we can start with the change in accounts receivable, which is an increase
of $1,463,000 (identified directly from the given balance sheets). The next question is whether an increase
in accounts receivable should be added or subtracted, and there are many different ways to remember
whether to add or subtract. The one we will use for this question relates back to depreciation. Depreciation
is a decrease in the balance of an asset. Depreciation is added back. A decrease in accounts receivable
would thus also be added back. An increase in accounts receivable, like the $1,463,000 in this question,
would be subtracted from net income to arrive at net cash provided by operations. Other increases and
decreases in current assets would work the same way.
Think about it this way: Cash is a debit balance account generally, correct? And, the balance sheet always
balances (at least it should, and it always will on the CPA exam!). Therefore:
If an account that generally has a debit balance is increased, then the net balance sheet effect on
cash must be a decrease.
If an account that generally has a debit balance is decreased, then the net balance sheet effect on
cash must be an increase.
If an account that generally has a credit balance is increased, then the net balance sheet effect on
cash must be an increase.
If an account that generally has a credit balance is decreased, then the net balance sheet effect on
cash must be a decrease.
In short,
A change in a debit balance account has the OPPOSITE effect on the net balance of cash.
A change in a credit balance account has the SAME effect on the net balance of cash.
If you use another method to remember whether to add or subtract, use it. But you do need some method
so that these types of questions are easily answered by you on the CPA exam. The Becker Financial text
discusses other methods in lecture F7.
4. The next line item is the change in inventory, which is an increase of $594,000 from the balance sheet. An
increase in inventory (an asset and generally a debit balance account) would be subtracted, just like the
increase in accounts receivable.
5. The next line item is the change in prepaid expenses, which is an increase of $18,000 from the balance
sheets. An increase in prepaid expenses (an asset generally a debit balance account) would be
subtracted, just like the increases in accounts receivable and inventory.
6. The next line item is the gain or loss on disposal of property and equipment. For this question, the $18,000
amount can be obtained from the income statement. For other questions, it might have to be calculated
(original cost of $360,000 less accumulated depreciation of $319,500 = net book value of $40,500; the gain
is the proceeds of $58,500 less net book value of $40,500 = $18,000). For this question, we verified the
amount (and there was only one such disposal). Note that we really did not have to verify (as it was given
to us), but we have done this for illustrative purposes.
Gains on disposals are subtracted because they were added to get to net income in the first place. Losses
are added because they were subtracted to get to net income in the first place. (It is a coincidence that the
$18,000 for this line item is the same as the $18,000 for line item 10 and also, as will be discussed later,
the $18,000 from the line of credit.)
Note: You have likely memorized that, for the indirect method, gains and losses are adjustments to net
income to arrive at net cash provided by operations, but they did enter into the net income calculation and
they may also have been a 100% cash transaction (i.e., a cash gain or loss). So, why are they adjusted
out? Well, they are NOT from operations, right? And, the statement of cash flows also presents a section
on investing activities. The total proceeds from the disposal of the asset must be shown in the investing
activities section. If the gain (or loss) were not adjusted out of the operating section, then the statement
would not balance if the entire proceeds were used in the investing section.
7. The next line item is the change in accounts payable and accrued expenses. These accounts are typically
credit balance accounts. As discussed above in item (8), a change in a credit balance account has the
same net effect on the balance of cash. For this question, there is an increase of $475,800 from the
balance sheets. Therefore, the adjustment to net income to arrive at net cash provided by operations is to
add the increase (again, with assets, an increase is subtracted; with liabilities, an increase is added). That
is the end of the operating activities section.
8/9. Not used.
10/11.
The next section is the investing activities section. Investing activities include buying something or
investing in something. For this question, property and equipment was purchased, and property and
equipment was sold. Purchases and sales must be reported separately (not netted). The calculation
requires another Account Analysis Format, this time, of the property and equipment account, as follows:
Beginning balance = $7,740,000 (from the Year 1 balance sheet)
Nothing else has to be done, except to realize that the cash flow from the disposal of the equipment is the
$58,500 proceeds (obtained from the additional information). That is the end of the investing activities
section.
12. Not used.
13. The next section is the financing activities section. Financing activities include borrowing, paying back,
and buying/selling the company's own equity (and other equity transactions). For example, they include
obtaining financing, either from inside investors (stockholders) or from outside investors (creditors, etc.).
For this question, there is an increase in the line of credit (which is short-term debt). More money was
borrowed, and it brought in $18,000 of cash flows to the company from financing activities (a positive
number on the statement of cash flows).
14. Financing activities include borrowing, paying back, and buying/selling the company's own equity (and
other equity transactions). For example, they include obtaining financing, either from inside investors
(stockholders) or from outside investors (creditors, etc.). For this question, there is a $2,000 increase in
the current portion of long-term debt and a $29,000 decrease in long-term debt. The net decrease is a
$27,000 decrease, so it is $27,000 of cash flows used for financing activities to pay down the debt (a
negative number on the statement of cash flows).
15. Financing activities include borrowing, paying back, and buying/selling the company's own equity (and
other equity transactions). For this question, there is no change in common stock or additional paid-in
capital, so no stock was issued. However, there were dividends paid (information obtained from the
statement of income and retained earnings). The $180,000 dividends are cash flows out of the company
from financing activities, or paying the dividends to those who have invested in the company (a negative
number on the statement of cash flows). That is the end of the financing activities section.
16. Not used.
17. For an indirect method statement of cash flows, there is always a supplemental disclosure of interest paid.
(Note: interest paid is an amount that most readers of financial statements want to know. In the direct
method of the statement of cash flows, this amount is disclosed in the operations section as a separate
line item; however, this is not the case on the indirect method, so a supplemental disclosure is required.)
The interest expense from the income statement is $252,000, but it is the interest "paid" that is disclosed
on the statement of cash flows. Often, it has to be calculated, but in this question, the $250,000 was given
in the additional information.
18. For an indirect method statement of cash flows, there is always a supplemental disclosure of income taxes
paid. (Note: income taxes paid is an amount that most readers of financial statements want to know. In
the direct method of the statement of cash flows, this amount is disclosed in the operations section as a
separate line item; however, this is not the case on the indirect method, so a supplemental disclosure is
required.) The provision for income taxes from the income statement is $759,700, but it is the income
taxes "paid" that are disclosed on the statement of cash flows. Often, it has to be calculated, but in this
question, the $700,000 was given in the additional information.
The list was explained in the order in which the examiners provided the answers. There is no necessary order
to the items within each of the sections (operating, investing, and financing). The items have to be within the
correct section, however.
The statement of cash flows is divided into three categories that display the sources and uses of cash and cash
equivalents:
Operating This section displays the cash effects of the line items that make up the calculation of net
income.
Investing This section displays the cash effects of non-current asset transactions, such as purchases
and sales of fixed assets and investments and lending activities.
Financing This section displays the cash effects of borrowing, or paying back debt, and buying or selling
the equity of the company.
Solutions:
1. Operating activity
2. Investing activity
3. Investing activity
4. Financing activity
5. Financing activity
6. Operating activity
7. Financing activity
8. Operating activity
9. Operating activity
10. Financing activity
1.
No Effect. Depreciation is an expense that does not require any outlay of cash. Depreciation expense for a
given year is added to net income under the indirect method. Under the direct method, the amount itself
(and the change from one year to the next) is not a component of cash flow from operating activities.
2.
Decrease. Taxes paid, whether current or deferred, are a cash flow from operations (CFO) outflow under
the direct method.
3.
Increase. A decrease in accounts receivable implies that overall the company collected cash on its
outstanding credit sales, which will be an increase in cash flow from operating activities.
4.
No effect. Gains are subtracted from net income under the indirect method. Under the direct method,
gains are not included in the calculation of operating cash flow.
5.
Decrease. This is a CFO outflow. A decrease in accounts payable implies that the company made cash
payments on amounts owed to vendors during the period.
6.
No effect. The sale of an AFS security (assuming it is a non-current asset) produces a cash flow from
investing (CFI) inflow. Note that the loss itself would be an addition to net income under the indirect
method. However, the loss is not a component of the direct method calculation of operating cash flow.
7.
Decrease. An increase in a prepaid expense is a cash outflow which would decrease CFO under the direct
method. Cash is paid in advance for rent prior to the warehouse being occupied or used by the company.
8.
No effect. This is a cash flow from financing (CFF) outflow, regardless of whether the call price is above,
below, or at par.
9.
10. Increase. Under U.S. GAAP, interest received on an investment is a CFO inflow, regardless of the
classification of the investment.
11. Increase. Cash received that is not earned is a CFO inflow. It will be booked as a liability until it is earned.
12. Decrease. $40,000 of cash refunded to customers for returned goods will be an actual cash outflow.
1,939,100
(1,302,600)
(459,200)
1,700
1,600
(7,900)
(26,200)
(10,200)
(94,600)
41,700
Additional detail:
Cash received from customers:
Sales
1,950,000
(4,700)
(6,200)
1,939,100
1,295,000
21,700
(14,100)
1,302,600
460,400
(1,200)
459,200
Interest paid is equal to interest expense because all bonds outstanding were issued at par.
Operating cash paid is the combination of prepaid rent of 49,000 and administrative expenses of 45,600.
Additional Information for the candidate:
Net cash provided by operating activities under the indirect
method:
Net Income
58,900
Plus Depreciation
53,800
(4,700)
(21,700)
(10,200)
(49,000)
14,100
(6,200)
1,200
3,000
2,500
41,700
Net cash used by investing activities under the direct and indirect method:
Increase in Gross PP&E
(92,000)
(92,000)
Net cash provided by financing activities under the direct and indirect method:
Proceeds of Bond Issue
30,000
50,400
(10,600)
69,800
19,500
37,300
56,800
Record the journal entry and affected financial statements on the grant date, January 1, Year 1.
Account
Debit
Credit
No entry required
Explanation: No entry is required when stock options are granted. There is no effect on shareholders equity at
the time of issuance and compensation expense is not recorded because the right to use the options has not yet
been earned.
Record the journal entries to recognize compensation expense for Year 1, Year 2 and Year 3.
December 31, Year 1:
Debit
Account
Compensation expense Stock options
Additional paid-in capital Stock options
Credit
50,000
50,000
Credit
50,000
50,000
Credit
50,000
50,000
Explanation: As time passes, compensation expense is recorded. One third of the total value of the options on
the grant date is recognized each year as compensation expense based on the three year vesting period for the
options. Additional paid in capital is credited for the same amount as the compensation expense.
Record the journal entry and affected financial statements assuming one half of the options were exercised
January 1, Year 4
Debit
Account
Cash (25,000 X $30)
Additional Paid in Capitalstock options
Common stock (25,000 X $1.00)
Additional Paid in Capital
Credit
750,000
75,000
25,000
800,000
Explanation: The debit to cash is based on the number of options exercised times the exercise price. Previously
recorded additional paid in capital (refer to question #2) is reversed (debited). Common stock is credited based on
the number of shares purchased (25,000) times par value. The remainder is credited to additional paid in capital.
Assume the options not exercised on January 1, Year 4 expired on March 31, Year 4. Record the journal entry
needed on March 31, Year 4 to record expiration of the stock options. Select no entry if no journal entry is
required on this date.
Debit
Account
Additional Paid in Capital stock options
Additional Paid in Capital expired stock
options
Credit
$ 75,000
$75,000
Explanation: The entry reflects reclassification of the capital from additional paid in capital stock options to
additional paid in capital expired stock options because the stock options have expired.
Cash
CR
Encumbrance control
CR
Budgetary control
Budgetary control
CR
DR
Encumbrance control
Expenditures control
CR
Vouchers payable
Expenditures control
CR
Vouchers payable
CR
Interfund revenues
CR
Grant revenues
Cash
CR
Estimated revenues
CR
Appropriation control
Cash
Tax anticipation notes payable
Estimated revenues
CR
Appropriations
CR
Budgetary control
1. Special revenue
Special revenue funds are set up to account for revenues from specific taxes or other earmarked sources
that are restricted or committed to finance particular activities for a government.
2. Permanent
Permanent funds are used to report resources that are legally restricted to the extent that income, and not
principal, may be used for purposes that support the reporting government's programs.
3. Enterprise
Enterprise funds are set up to account for the acquisition and operation of governmental facilities and
services that are intended to be primarily self- supported by user charges.
4. Capital project
Capital projects funds are set up to account for resources used for the acquisition or construction of major
capital assets by a governmental unit, except those financed by proprietary or fiduciary funds.
5. Internal service
Internal service funds are set up to account for goods and services provided by designated departments on
a fee basis to other departments and agencies within a single governmental unit or to other governmental
units.
6. Agency
Agency trust funds account for resources in the temporary custody of a governmental unit. Fees are
accounted for as a liability to another fund.
1. Non-reciprocal | Transfer
The monies transferred by the Tourist Development fund to meet debt service requirements that are fully
anticipated by the budget represent a non-reciprocal transaction (the Tourist Development fund will never get
the money back) and would be accounted for as a transfer in the fund financial statements.
2. Non-reciprocal | Eliminated
The monies transferred between governmental funds (the Tourist Development Fund and Debt Service Fund)
would be within the same category (governmental activities) in the government-wide financial statements. The
transaction is still non-reciprocal, but it would be eliminated in the government-wide financial statements to
avoid grossing up activity.
3. Reciprocal | Revenue
Charges made by an internal service fund are reciprocal (the internal service fund expects to be paid in
exchange for services) and would be accounted for as revenue in the fund financial statements.
4. Non-Reciprocal | Eliminated
The General Fund paid costs on behalf of another fund and was reimbursed. The expenditures should have
been accounted for in the capital projects fund. The reimbursement transaction is non-reciprocal (the general
fund expects the money back) but the reimbursement will net to zero. It will be eliminated and not be
displayed on the financial statements.
Fund b alance
5,000,000
2,375,000
(425,000)
(3,700,000)
375,000
-0-
-0-
3,625,000
To reconcile the Fund Balance of Governmental Funds to the Net Position of Governmental Activities on the
government-wide financial statements, follow the GALS BARE mnemonic.
For differences between fund financial statement fund balances and government wide financial statement net
position related to measurement focus:
For differences between fund financial statement fund balances and government-wide financial statement net
position related to basis of accounting:
Add additional accounts receivable associated with revenue recognized under accrual vs. modified
accrual basis.
Subtract additional accounts payable associated with expenses recognized under accrual vs. modified
accrual basis.
750,000
350,000
80,000
-0(1,250,000)
-015,000
-0-
(175,000)
(230,000)
To reconcile the change in Fund Balance of Governmental Funds to the change in Net Position of Governmental
Activities on the government-wide financial statements, follow the GOES BARE mnemonic.
For differences between changes in fund balance per fund financial statements and changes in net position per
governmental activities on government-wide financial statements related to measurement focus:
Subtract other financing sources associated with new debt proceeds or capital leases.
Add expenditures related to capital outlay in excess of depreciation and add expenditures related to
debt service principal.
For differences between changes in fund balance per fund financial statements and changes in net position per
governmental activities on government-wide financial statements related to basis of accounting
Add additional accrued revenue associated with earnings recognized under accrual vs. modified accrual
basis.
Subtract additional accrued expenses recognized under accrual vs. modified accrual basis.
45,000
Revenues
95,000
(75,000)
65,000
Payments to Suppliers:
Inventory Beginning
21,000
(10,000)
Inventory -Ending
(35,000)
(24,000)
Payments to Employees:
Accounts Payable Beginning
17,250
60,000
(29,000)
Payments to Employees>/td>
48,250
1. $89,000
Contribution revenue is equal to the FMV of the gift at the time of the contribution. The fair value at the time
of receipt is correct.
2. $6,500
Investment income represents a combination of both interest received as well as changes in market value.
Earned
FMV/receipt
FMV/year end
Earnings less change in value
$ 9,500
(89,000)
86,000
$ 6,500
3. $115,000
Community Service, Inc. will classify expenses as program expenses and supporting expenses. Support
will be further analyzed as either administration or fund-raising. The candidate is required to classify various
expenses given in the problem and to arrive at program expense as follows:
Donated reading material
Instructor salaries
Director of Community Activities
Subtotal
Building rental - Amount allocable to programs
($30,000 x 75%)
Total
$ 7,500
25,000
60,000
92,500
22,500
$115,000
In arriving at this answer, candidates are required to ignore the value of volunteer services, properly classify
the expenses associated with specific fund raising appeals as general administration (in keeping with the
policy described in the situation), distinguish between administrative and fund-raising expenses listed as
Other cash operating expenses, properly classify interest expenses as administrative expense and
recognize that principal liquidations are irrelevant to expense classifications for purposes of not-for-profit
financial statements.
4. $2,750
General fund-raising expenses. Community services will classify expenses associated with printing and
mailing pledge cards as general fund-raising expense.
5. $-0Income on long-term investments - unrestricted. Community Services has no long-term investments unrestricted according to the situation. No income would be recognized.
6. $-0Community Services received donated hours from concerned citizens to serve meals to the homeless. The
skill levels required for this task failed to meet revenue recognition criteria (SOME). Community Services
need not recognize any revenue for contributed voluntary services of the type described.
1.
2.
Cash
Cr.
3.
$200,000
Refundable advance (liability)
$200,000
Refundable advance
Dr.
Pledge receivable
Cr.
4.
$200,000
300,000
$500,000
Asset | No classification
The receivable becomes cash but it is still temporarily restricted until the building is built. The asset box is
checked because the pledge receivable decreases and cash increases (assets are impacted), but there is
no change in total assets.
Dr.
Cash
Cr.
5.
$300,000
Pledge receivable
$300,000
Cr.
$150,000
$150,000
Unrestricted
Dr.
Cr.
Unrestricted cash
$150,000
Dr.
Construction in progress
Cr.
Unrestricted cash
$150,000
$150,000
$150,000
1. $30,000
The legal services pass the SOME test. The attorney has a specialized skill, otherwise needed, that can be
valued. Barter will recognize revenue (and expense) in the full amount of $30,000.
2. $0
The volunteer services that provide companionship fail the SOME test. No specialized skills are required for
the work and, if not provided by volunteers, it would likely not be provided at all. Barter will not recognize any
revenue or expense.
3. $25,000
Barter's revenues would include the value of the skilled carpenter since it passes the SOME test and the
carpenter "enhanced a physical asset." It would also include the unskilled labor associated with the project
since the labor "enhanced a physical asset." Barter would recognize $25,000 in revenue ($13,000 +
$12,000).
4. $100,000
The medical services pass the SOME test. They are partially defrayed ($20,000) so the revenue from
contributed services would be $100,000 ($120,000 - $20,000).
1. November 1, Year 1
No journal entry.
2. December 31, Year 1
DR
CR
$60,000
$60,000
CR
$80,000
$80,000
Cash
CR
$140,000
Cash flow hedge
$140,000
XYZ records the cash received from the net settlement of the cash flow hedge:
($71/barrel - $85/barrel) x 10,000 barrels = $140,000
4. February 1, Year 2
DR
CR
Accounts receivable
$710,000
Sales revenue
$710,000
$140,000
$140,000
When the oil is sold, XYZ reclassifies the gain on the hedge from OCI to earnings. The net impact on
earnings from the sales revenue plus the gain equals $850,000 ($710,000 + $140,000). The forward contract
allowed XYZ to "lock in" the selling price of $85/barrel.
1. The asset (Asset Retirement Cost, ARC) is debited for $530,555, which is calculated as the
estimated cost of $710,000 multiplied by the PV Factor of 0.74726 in order to discount it to
todays dollars. The liability (Asset Retirement Obligation, ARO) is credited for the same
$530,555.
DR
Asset Retirement Cost (ARC)
530,555
CR
Asset Retirement Obligation (ARO)
530,555
2. Accretion expense is calculated as the balance in the liability account multiplied by the
accretion rate. The beginning balance in the liability account is $530,555. Multiplying that by
6% results in a Year 1 expense of $31,833 (rounded to the nearest dollar).
Year 1 Accretion Expense 31,833
179,445
4. Increase: The liability that is currently reflected at present value ($530,555) will be increased
every year such that in 5 years, it will reflect the estimated asset retirement obligation of
$710,000. The accretion rate of 6% is assessed every year on the liability that year, which is
always increasing.
5. Depreciation expense of $ 106,111 ($530,555 depreciated straight- line over 5 years) will
be booked, with an offsetting entry of $106,111 to accumulated depreciation. Accretion
expense of $31,833 (calculated earlier) will also be booked, with an offsetting increase to the
ARO liability account.
DR
DR
CR
Depreciation Expense
Accretion Expense
ARO
106,111
31,833
31,833
CR
Accumulated Depreciation
106,111
106,111
424,444
562,388
($530,555/5)
($530,555 $106,111)
($530,555 + $31,833)
1. H - $2,250,000
H Profit Distribution
Total Profit Y1
Total Partnership
$4,000,000
Guaranteed Bonus
$400,000
(400,000)
10% X $4,000,000
Interest on H Capital
600,000
(600,000)
Interest on J Capital
(240,000)
$12,000,000 X 2% = $240,000
Interest on S Capital
(360,000)
$18,000,000 X 2% = $360,000
Annual Salary to H
100,000
(100,000)
Balance
$1,100,000
$2,300,000
$1,150,000
Total Distribution to H
$2,250,000
$80,000,000
($60,000,000 + $20,000,000)
16,000,000
Amount Overpaid
4,000,000
($20,000,000 - $16,000,000)
$800,000
H:(50% X $4,000,000)
$2,000,000
$1,200,000
$100,000,000
($20,000,000 X 5 = $100,000,000)
80,000,000
Goodwill
$20,000,000
$ 4,000,000
10,000,000
6,000,000
4. S - $26,500,000
Original S Capital Balance
$18,000,000
6,000,000
2,500,000
Payoff to S Partner
$26,500,000