Exam #_______

Start time: _________Stop time: _________

Name: ____________________________________

Exam 2
Acct 414 Corporate Accounting & Reporting II

Fall 2007
Show any necessary computations if you want to be eligible for partial credit. Present your work in a
neat, well-organized manner. If you are using a PV calculator, spell out what you put in for n, i, PMT, FV,
PV, etc. Follow the instructions and answer all parts of the question as directed.
1.

Pension Work Paper {FASB No. 158} (50 points)

2.

Deferred Income Taxes (60 points)

3.

Earnings per share (60 points)

4-6.

Other Short Problems pick 2 of 4 (30 points total)

8.

4. Employee stock options

__________

5. Prior service cost allocation

__________

6. Present value (pensions)

__________

7. Present value (pensions)

__________

Extra credit deferred taxes matching (10 points max)

and other (if any)
Total points earned (max = 200)

If you tear off the working papers, be sure your name is on the top AND that you staple the exam back
together in page number order.
Do not attempt extra credit section until all other sections of the exam have been completed.

After Exam 2 - Course Grade

Total Points = __________/__________ = _________%
Quiz and HW percentage =
Projects percentage =

___________%
___________%

Exam 2 Acct 414 Fall 2007

Page 2

1.
Pension Accounting (50 points). The Plymouth Plows Corporation initiated a
noncontributory defined benefit pension plan on January 1, 1980 and applied the provisions of
FASB Statement 87 as of January 1, 1987. FASB Statement No. 158 was implemented as of
January 1, 2006. Plymouth Plows uses the straight-line method, based on average remaining
service period of employees, to amortize prior service costs.
2007
BALANCES AS OF JANUARY 1, 2007
Projected Benefit Obligation
Plan Assets at market
Funded status
Unrecognized transition cost/(gain)
Straight-line amortization at $0 per year
Unrecognized Prior Service Cost
Straight-line amortization at $20,000 per year
Unrecognized (gains)/losses
OTHER INFORMATION:
Service cost for year
Discount rate for year
Expected rate of return on plan assets
Actual return on plan assets: gain/(loss)
Pension plan contribution
Retirement benefits paid during year
Accumulated Benefit Obligation, Dec. 31, 2005
Average remaining service years related to active employees
Increase/(decrease) in PBO during year due to revised actuarial assumptions

200,000
230,000
30,000
0
180,000
130,000

29,000
6.00%
9.00%
12,000
50,000
42,000
198,000
15
18,000

REQUIRED:
a.
Compute net periodic pension expense for 2007. (Be sure to show all of the components of
pension expense.) Prepare the journal entry needed to record pension expense and funding of
pension plan.
b.
Compute the balances in accumulated other comprehensive income, projected benefit obligation,
and plan assets at 1/1/08
c.
Explain (or show) how the net pension obligation or net pension asset will be displayed on the
balance sheet at 12/31/07. Will there be other pension related accounts on the balance sheet? If
so, explain where and how they are presented. Provide amounts.
Note:

Completing the worksheet provided will be an acceptable answer for a and b.

Exam 2 Acct 414 Fall 2007

2.

Page 3

Deferred tax asset (60 points)

Yarman Inc. began business on January 1, 2007. Its pretax financial income for the first 3 years
was as follows:
2007
2008
2009

$240,000
560,000
725,000

The following items caused the only differences between pretax financial income and taxable
income.
1. On January 2, 2007, heavy equipment costing $500,000 was purchased. The equipment
had a life of 5 years and no salvage value. The straight-line method of depreciation is used
for book purposes and the MACRS tax deduction taken each year is shown in the table
below:
2007
2008
2009
2010
2011
Total
For tax
$120,000 $200,000 $150,000 $30,000
0
$500,000
For accounting
100,000
100,000
100,000
100,000
100,000
500,000
2. In 2007, the company collected $180,000 of rent; of this amount, $60,000 was earned in
2007; the other $120,000 will be earned equally over the 2008-2009 period. The full
$180,000 was included in taxable income in 2007.
3. The company pays $10,000 a year for life insurance on officers.
4. In 2008, the company had a long-term construction contract on which it recognized a gross
profit of $90,000 on the income statement. For tax purposes, the company uses the
completed contract method. The total estimated gross profit is $270,000 and the remaining
180,000 is expected to be realized equally in 2009 and 2010.
The enacted tax rates existing at December 31, 2007 are:
2007
2008

35%
40%

2009
2010

40%
40%

Instructions
(a) Compute taxable income and income tax payable/receivable for the 2007 and 2008.
(b) Prepare an inventory of the deferred tax (asset) and liability and determine the net deferred
tax asset or liability as of 12/31/07 and 12/31/08.
(c) Prepare the journal entry to record income tax expense, deferred taxes, and the income
taxes payable for 2007.
(d) What amounts will appear on the 2008 balance sheet related to the deferred taxes? Be
sure to tell me whether the amount is classified as current or noncurrent.
(e) For up to 5 points extra credit IF YOU HAVE TIME, you may also do 2009 journal entry.
Show your computations and answers as instructed on the next page.
Answers for Problem 2

Exam 2 Acct 414 Fall 2007

Page 4

(a)

Compute taxable income and income tax payable/receivable for the 2007 and 2008.
I can grade from workpaper if used

(b)

Prepare an inventory of the deferred tax (asset) and liability and determine the net deferred
tax asset or liability as of 12/31/07 and 12/31/08.
I can grade from workpaper if used

(c)

Prepare the journal entry to record income tax expense, deferred taxes, and the income
taxes payable for 2007. (Workpaper answer is NOT sufficient for this one!)

(d) What amounts will appear on the 2008 balance sheet related to the deferred taxes? Be sure
to tell me whether the amount is classified as current or noncurrent. (Workpaper answer
is NOT sufficient for this one!)
Amounts on 12/31/08 balance sheet related to deferred income taxes:

Exam 2 Acct 414 Fall 2007

3.

Page 5

Earnings per share (60 points).

Net income for Adcock Corp. was $500,000 for 2007. Its tax rate was 40%.
On January 1, 2007 there were 200,000 shares of common stock outstanding. On April 1,
20,000 shares were issued. On July 31, 2007 Adcock issued a 2-for-1 stock split effected in the
form of a stock dividend. On September 1, Adcock bought 30,000 shares of treasury stock for
$45 per share.
There are 30,000 options to buy common stock at $40 a share outstanding. The market price of
the common stock averaged $50 during 2007 (both market price and option price have already
been adjusted for the stock split).
During 2007, there were 40,000 shares of convertible preferred stock outstanding. The
preferred is $100 par, pays $3.50 a year dividend, and is convertible into six shares of common
stock after the stock split.
Adcock issued $2,000,000 of 8% convertible bonds at face value during 2006. Each $1,000
bond is convertible into 30 shares of common stock after the stock split.
Instructions
(a) Compute the weighted average number of common shares outstanding.
Dates
Outstanding
Adjustment
Months

Weighted average = ____________________________ shares

Weighted

Exam 2 Acct 414 Fall 2007

Page 6

Problem 3 (continued)
Regardless of your answer to (a), assume that the weight average number of common shares
outstanding is 400,000 for parts (b) and (c). You may use the work paper provided below or
formulas but please write your answers in the space provided:
(b) Compute the basic earnings per share for 2007.

$_________________________

(c) Compute the diluted earnings per share for 2007. $___________________________

Net income

Numerator
$500,000

Denominator
400,000

Per Share

Exam 2 Acct 414 Fall 2007

Page 7

Other Short Problems pick 2 of 4 (15 points each)

4

Employee Stock Options (15 points)

On January 1, 2007, Doane Corp. granted an employee an option to purchase 6,000

shares of Doane's $5 par value common stock at $20 per share. The Black-Scholes
option pricing model determines total compensation expense to be $23 per share. The
options became exercisable on December 31, 2008, after the employee completed two
years of service. The market prices of Doane's stock were as follows:
January 1, 2007
December 31, 2008

$30
50

(a) Prepare the journal entry needed at December 31, 2007 to recognize the
compensation expense.

(b) Prepare the journal entry to record the exercise all 6,000 options on January 2, 2009
when the stock price was $51.

Exam 2 Acct 414 Fall 2007

5.

Page 8

Amortization of prior service cost using years-of-service method. (15 points)

On January 1, 2007, Portlands Porcelain Inc. amended its pension plan which caused
an increase of $10,500,000 in its projected benefit obligation. The company has 500
employees who are expected to receive benefits under the company's defined benefit
pension plan. The personnel department provided the following information regarding
expected employee retirements:
Number of
Employees
100
100
100
200
500

Expected Retirements
Remaining Years
On December 31 _ of Employment
2011
5 years
2016
10 years
2021
15 years
2026
20 years

Instructions
(a) What is the average remaining service life?

(b) Using the straight-line method, what would amortization of prior service costs be for
2007?

(c) Using the years-of-service method, what would amortization of prior services costs be
for 2012 through 2016?

Exam 2 Acct 414 Fall 2007

6.

Page 9

Pension Present Value Computations (15 points).

Freedonias Finest Furs Inc. has a defined benefit pension plan. The formula is the final
years annual salary times 2% times years of service. Consider one employee in the plan -Fred Flintstone. Fred is expected to be making $80,000 when he retires 10 years from
now. He already has 15 years of prior service and he is expected to live 20 years after he
retires. You may assume ordinary annuities and end-of-year annual payments upon
retirement and a 6% per annum discount rate.

What is the service cost for Fred Flintstone the year just ended?

7.

Pension Present Value Computations (15 points)

The actuary reports that the Freedonias Finest Furs will need a total of $15,000,000 in ten
years to cover the obligations promised to all of its employees. The president of
Freedonias Finest Furs, Inc. wants you to compute the annual contribution that the
company needs to make to the pension plan to achieve fully funded status in 10 years. The
current balance in plan assets is $5,000,000. The first payment would be at the end of this
year and at the end of each of the next 9 years. The plan assets are invested so that the
expected rate of return is 10% per year.

Exam 2 Acct 414 Fall 2007

Page 10

8. EXTRA CREDIT: Permanent and temporary differences (10 points maximum)

Listed below are items that are treated differently for accounting purposes than they are for tax purposes.
Indicate whether the items are permanent differences or temporary differences. For temporary
differences, indicate whether they will create deferred tax assets or deferred tax liabilities.
A
B
C
D

______
______
______
______
______
______
______
______
______
______

Temporary difference deferred tax liability

Temporary difference deferred tax asset
Permanent difference
None of the above

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Advance rental receipts.

Fine for polluting.
Estimated future warranty costs.
Excess of pension expense over deductible contribution to plan assets.
Expenses incurred in obtaining tax-exempt revenue.
Installment sales.
Profitable investments accounted for by the equity method.
Excess tax depreciation over accounting depreciation.
Long-term construction contracts.
Premiums paid on life insurance of officers (company is the beneficiary).

Exam 2 Acct 414 Fall 2007

For Problem 1

Page 11
Name:

Exam 2 Acct 414 Fall 2007

For Problem 2

Page 12
Name:______________________________

Exam 2 Acct 414 Fall 2007

Page 13
SOLUTIONS

Problem 1

4. Employee stock options

(a) 12/31/07
Compensation expense (6,000 * $23 * 50% earned)........................69,000
APIC stock options........................................................................................69,000
Same entry would be made at 12/31/08 because the service period is two years and the
compensation expense would be recognized equally in each of the 2 years.
(b) 1/2/09
Cash (6,000 * $20 each)................................................................120,000
APIC stock options (6,000 * 23 each)..........................................138,000
Common stock (6,000 * $5 par value)..............................................................30,000
APIC common stock (what it takes to balance)...........................................228,000

Exam 2 Acct 414 Fall 2007

Page 14

Problem 2

(a), (b) and (d) on working paper above

(c)
Income Tax Expense ($122,500 $70,000)............................................
82,500
Deferred Tax Asset..................................................................................
40,000
Income Tax Payable ($350,000 35%)......................................
122,500
Comments:
The tricky item is the $120,000 in unearned rent revenue because only half is current and
the other half will not be on tax return for 2 years. We present deferred taxes on the balance sheet as two
amounts by netting the current items and then netting the noncurrent items. For 2007 (not required) we
have a current deferred tax asset of $24,000 (120,000/2 * 40%) and a noncurrent deferred tax asset
of $16,000 {computation = [(20,000) + 60,000] * 40%}. For 2008, it is easier since the $60,000 of rent will
be deductible in one year (60,000 * 40%) and gives us a current deferred tax asset. Both the
depreciation is noncurrent because it is related to noncurrent assets and the construction accounting
deferral is long-term because the taxes will not be due on the contract for 2 more years. Thus the
noncurrent deferred tax liability is $84,000 {(120,000 + 90,000)* 40%}. We use 40% for all deferred tax
amounts because the enacted law contains the 40% tax rate in 2007.

Exam 2 Acct 414 Fall 2007

Problem 3a

For Problem 3b & 3c

Page 15

Exam 2 Acct 414 Fall 2007

Page 16

5. Years of service method

Number of expected
retirements

Years of Work
Remaining

Year of retirement (on Dec 31)

100
100
100
200
500

2011
2016
2021
2026

TOTAL
500
1,000
1,500
4,000

5 years
10 years
15 years
20 years

7,000

a. Average remaining service life = 7,000/500 employees = 14 years

b. For SL, divide total by average remaining service life: $10,500,000/14 years = $750,000
c. For the first five years, there are 500 employees so 500/7000 * $10,500,000 = $750,000 (same as
straight-line method). However, for the next 5 years, there are only 400 employees left so 400/7000 *
10,500,000 = $600,000 per year.
Here is an alternate format that some students attempted but tended to leave out some of the years that
are essential to include! Note the other way (multiply years by employees on each row and total to get
the denominator) is considerably easier.
2007
100
100
100
200
500

2008
100
100
100
200
500

2009
100
100
100
200
500

2010
100
100
100
200
500

2011
100
100
100
200
500

2012
0
100
100
200
400

2013
0
100
100
200
400

2014
0
100
100
200
400

2015
0
100
100
200
400

2016
0
100
100
200
400

2017
0
0
100
200
300

2018
0
0
100
200
300

2019
0
0
100
200
300

2020
0
0
100
200
300

2021
0
0
100
200
300

2022
0
0
0
200
200

2023
0
0
0
200
200

2024
0
0
0
200
200

For #6, I was trying to simplify the problem by giving you how many years remained before retirement at
the END of the year just worked. If you interpret the problem differently, youd use n-1 or 9 years to
compute service cost in the formulas above. Most students did it as I intended but I dont think I counted
anything off for the alternate assumption. This is an example of where a good EXPLANATION for your
work can prevent you from losing points over an interpretation of the problem!

8 Matching extra credit

1. B
2. C
6. A
7. B

3. B
8. A

4. B
9. A

5. C
10. C

2025
0
0
0
200
200

2026
0
0
0
200
200