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ACC 401 Week 11 Quiz Final Exam Strayer

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Quiz (Chapter 15 16) Final Exam (Chapter 5, 8, and 10 16)
Chapter 5
Allocation and Depreciation of Differences Between Implied and Book Value
Multiple Choice
1.

When the implied value exceeds the aggregate fair values of identifiable net
assets, the residual difference is accounted for as
a. excess of implied over fair value.
b. a deferred credit.
c. difference between implied and fair value.
d. goodwill.

2.

Long-term debt and other obligations of an acquired company should be


valued for consolidation purposes at their
a. book value.
b. carrying value.
c. fair value.
d. face value.

3.

On January 1, 2010, Lester Company purchased 70% of Stork Corporation's


$5 par common stock for $600,000. The book value of Stork net assets was
$640,000 at that time. The fair value of Stork's identifiable net assets were the
same as their book value except for equipment that was $40,000 in excess of
the book value. In the January 1, 2010, consolidated balance sheet, goodwill
would be reported at
a. $152,000.
b. $177,143.
c. $80,000.
d. $0.

4.

When the value implied by the purchase price of a subsidiary is in excess of


the fair value of identifiable net assets, the workpaper entry to allocate the
difference between implied and book value includes a
1. debit to Difference Between Implied and Book Value.
2. credit to Excess of Implied over Fair Value.
3. credit to Difference Between Implied and Book Value.
a. 1
b. 2
c. 3
d. Both 1 and 2

5.

If the fair value of the subsidiary's identifiable net assets exceeds both the
book value and the value implied by the purchase price, the workpaper entry
to eliminate the investment account
a. debits Excess of Fair Value over Implied Value.
b. debits Difference Between Implied and Fair Value.
c. debits Difference Between Implied and Book Value.
d. credits Difference Between Implied and Book Value.

6.

The entry to amortize the amount of difference between implied and book
value allocated to an unspecified intangible is recorded
1. on the subsidiary's books.
2. on the parent's books.
3. on the consolidated statements workpaper.
a. 1
b. 2
c. 3
d. Both 2 and 3

7.

The excess of fair value over implied value must be allocated to reduce
proportionally the fair values initially assigned to
a. current assets.
b. noncurrent assets.
c. both current and noncurrent assets.
d. none of the above.

8.

The SEC requires the use of push down accounting when the ownership
change is greater than
a. 50%
b. 80%
c. 90%
d. 95%

9.

Under push down accounting, the workpaper entry to eliminate the investment
account includes a
a. debit to Goodwill.
b. debit to Revaluation Capital.
c. credit to Revaluation Capital.
d. debit to Revaluation Assets.

10.

In a business combination accounted for as an acquisition, how should the


excess of fair value of identifiable net assets acquired over implied value be
treated?
a. Amortized as a credit to income over a period not to exceed forty years.
b. Amortized as a charge to expense over a period not to exceed forty years.
c. Amortized directly to retained earnings over a period not to exceed forty
years.
d. Recognized as an ordinary gain in the year of acquisition.

11.

On November 30, 2010, Pulse Incorporated purchased for cash of $25 per
share all 400,000 shares of the outstanding common stock of Surge Company.

Surge 's balance sheet at November 30, 2010, showed a book value of
$8,000,000. Additionally, the fair value of Surge's property, plant, and
equipment on November 30, 2010, was $1,200,000 in excess of its book value.
What amount, if any, will be shown in the balance sheet caption "Goodwill" in
the November 30, 2010, consolidated balance sheet of Pulse Incorporated, and
its wholly owned subsidiary, Surge Company?
a. $0.
b. $800,000.
c. $1,200,000.
d. $2,000,000.
12.

Goodwill represents the excess of the implied value of an acquired company


over the
a. aggregate fair values of identifiable assets less liabilities assumed.
b. aggregate fair values of tangible assets less liabilities assumed.
c. aggregate fair values of intangible assets less liabilities assumed.
d. book value of an acquired company.

13.

Scooter Company, a 70%-owned subsidiary of Pusher Corporation, reported


net income of $240,000 and paid dividends totaling $90,000 during Year 3.
Year 3 amortization of differences between current fair values and carrying
amounts of Scooter's identifiable net assets at the date of the business
combination was $45,000. The noncontrolling interest in net income of
Scooter for Year 3 was
a. $58,500.
b. $13,500.
c. $27,000.
d. $72,000.

14.

Porter Company acquired an 80% interest in Strumble Company on January 1,


2010, for $270,000 cash when Strumble Company had common stock of
$150,000 and retained earnings of $150,000. All excess was attributable to
plant assets with a 10-year life. Strumble Company made $30,000 in 2010 and
paid no dividends. Porter Companys separate income in 2010 was $375,000.
Controlling interest in consolidated net income for 2010 is:
a. $405,000.
b. $399,000.
c. $396,000.
d. $375,000.

15.

In preparing consolidated working papers, beginning retained earnings of the


parent company will be adjusted in years subsequent to acquisition with an
elimination entry whenever:
a. a noncontrolling interest exists.
b. it does not reflect the equity method.
c. the cost method has been used only.
d. the complete equity method is in use.

16.

Dividends declared by a subsidiary are eliminated against dividend income


recorded by the parent under the

a.
b.
c.
d.

partial equity method.


equity method.
cost method.
equity and partial equity methods.

Use the following information to answer questions 17 through 20.


On January 1, 2010, Pandora Company purchased 75% of the common stock of
Saturn Company. Separate balance sheet data for the companies at the combination
date are given below:
Pandora Co.

Saturn Co.Saturn Co.


Book Values
Fair

Values
Cash
Accounts receivable
Inventory
Land
Plant assets
Acc. depreciation
Investment in Saturn Co.
Total assets

$ 18,000
108,000
99,000
60,000
525,000
(180,000)
330,000
$960,000

$155,000
20,000
26,000
24,000
225,000
(45,000)

$155,000

$405,000

$565,000

Accounts payable
Capital stock
Retained earnings
Total liabilities & equities

$156,000
600,000
204,000
$960,000

$105,000
225,000
75,000
$405,000

$105,000

Determine below what the consolidated balance would be for each of the requested
accounts on January 2, 2010.
17.

What amount of inventory will be reported?


a. $125,000
b. $132,750
c. $139,250
d. $144,000

18.

What amount of goodwill will be reported?


a. ($20,000)
b. ($25,000)
c. $25,000
d. $0

19.

What is the amount of consolidated retained earnings?


a. $204,000
b. $209,250
c. $260,250
d. $279,000

20.

What is the amount of total assets?


a. $921,000
b. $1,185,000
c. $1,525,000
d. $1,195,000

21.

Sensible Company, a 70%-owned subsidiary of Proper Corporation, reported


net income of $600,000 and paid dividends totaling $225,000 during Year 3.
Year 3 amortization of differences between current fair values and carrying
amounts of Sensible's identifiable net assets at the date of the business
combination was $112,500. The noncontrolling interest in consolidated net
income of Sensible for Year 3 was
a. $146,250.
b. $33,750.
c. $67,500.
d. $180,000.

22.

Primer Company acquired an 80% interest in SealCoat Company on January


1, 2010, for $450,000 cash when SealCoat Company had common stock of
$250,000 and retained earnings of $250,000. All excess was attributable to
plant assets with a 10-year life. SealCoat Company made $50,000 in 2010 and
paid no dividends. Primer Companys separate income in 2010 was $625,000.
The controlling interest in consolidated net income for 2010 is:
a. $675,000.
b. $665,000.
c. $660,000.
d. $625,000.

Use the following information to answer questions 23 through 25.


On January 1, 2010, Poole Company purchased 75% of the common stock of
Swimmer Company. Separate balance sheet data for the companies at the combination
date are given below:
Swimmer Co.
Swimmer Co.
Poole Co.

Book Values

Fair

Values
Cash
Accounts receivable
Inventory
Land
Plant assets
Acc. depreciation
Investment in Swimmer Co.
Total assets
Accounts payable
Capital stock
Retained earnings

$ 24,000
144,000
132,000
78,000
700,000
(240,000)
440,000
$1,278,000

$206,000
26,000
38,000
32,000
300,000
(60,000)

$206,000

$542,000

$702,000

$206,000
800,000
272,000

$142,000
300,000
100,000

$142,000

Total liabilities & equities

$1,278,000

$542,000

Determine below what the consolidated balance would be for each of the requested
accounts on January 2, 2010.
23.

What amount of inventory will be reported?


a. $170,000.
b. $177,000.
c. $186,500.
d. $192,000.

24.

What amount of goodwill will be reported?


a. $26,667.
b. $20,000.
c. $42,000.
d. $86,667.

25.

What is the amount of total assets?


a. $1,626,667.
b. $1,566,667
c. $1,980,000.
d. $2,006,667.

Problems
5-1

Phillips Company purchased a 90% interest in Standards Corporation for


$2,340,000 on January 1, 2010. Standards Corporation had $1,650,000 of
common stock and $1,050,000 of retained earnings on that date.
The following values were determined for Standards Corporation on the date
of purchase:
Inventory
Land
Equipment

Book Value
$240,000
2,400,000
1,620,000

Fair Value
$300,000
2,700,000
1,800,000

Required:
A. Prepare a computation and allocation schedule for the difference between
the implied and book value in the consolidated statements workpaper.
B. Prepare the January 1, 2010, workpaper entries to eliminate the investment
account and allocate the difference between implied and book value.
5-2

Pullman Corporation acquired a 90% interest in Sleeper Company for


$6,500,000 on January 1 2010. At that time Sleeper Company had common
stock of $4,500,000 and retained earnings of $1,800,000. The balance sheet
information available for Sleeper Company on January 1, 2010, showed the
following:

Inventory (FIFO)
Equipment (net)
Land

Book Value
$1,300,000
1,500,000
3,000,000

Fair Value
$1,500,000
1,900,000
3,000,000

The equipment had a remaining useful life of ten years. Sleeper Company
reported $240,000 of net income in 2010 and declared $60,000 of dividends
during the year.
Required:
Prepare the workpaper entries assuming the cost method is used, to eliminate
dividends, eliminate the investment account, and to allocate and depreciate the
difference between implied and book value for 2010.
5-3

On January 1, 2010, Preston Corporation acquired an 80% interest in Spiegel


Company for $2,400,000. At that time Spiegel Company had common stock of
$1,800,000 and retained earnings of $800,000. The book values of Spiegel
Company's assets and liabilities were equal to their fair values except for land
and bonds payable. The land's fair value was $120,000 and its book value was
$100,000. The outstanding bonds were issued on January 1, 2005, at 9% and
mature on January 1, 2015. The bond principal is $600,000 and the current
yield rate on similar bonds is 8%.
Required:
Prepare the workpaper entries necessary on December 31, 2010, to allocate,
amortize, and depreciate the difference between implied and book value.

9%, 5 periods
8%, 5 periods
5-4

Present Value
Present value of 1 of Annuity of 1
.64993
3.88965
.68058
3.99271

Pennington Corporation purchased 80% of the voting common stock of


Stafford Corporation for $3,200,000 cash on January 1, 2010. On this date the
book values and fair values of Stafford Corporation's assets and liabilities
were as follows:
Book Value
Fair Value
Cash
$ 70,000
$ 70,000
Receivables
240,000
240,000
Inventories
600,000
700,000
Other Current Assets
340,000
405,000
Land
600,000
720,000
Buildings net
1,050,000
1,920,000
Equipment net
850,000
750,000
$3,750,000
$4,805,000
Accounts Payable
Other Liabilities
Capital Stock
Retained Earnings

$ 250,000
740,000
2,400,000
360,000
$3,750,000

$250,000
670,000

Required:
Prepare a schedule showing how the difference between Stafford Corporation's
implied value and the book value of the net assets acquired should be
allocated.
5-5

Perez Corporation acquired a 75% interest in Schmidt Company on January 1,


2010, for $2,000,000. The book value and fair value of the assets and
liabilities of Schmidt Company on that date were as follows:
Book Value
Fair Value
Current Assets
$ 600,000
$ 600,000
Property & Equipment (net)1,400,000
1,800,000
Land
700,000
900,000
Deferred Charge
300,000
300,000
Total Assets
$3,000,000
$3,600,000
Less Liabilities
600,000
600,000
Net Assets
$2,400,000
$3,000,000
The property and equipment had a remaining life of 6 years on January 1,
2010, and the deferred charge was being amortized over a period of 5 years
from that date. Common stock was $1,500,000 and retained earnings was
$900,000 on January 1, 2010. Perez Company records its investment in
Schmidt Company using the cost method.

Required:
Prepare, in general journal form, the December 31, 2010, workpaper entries
necessary to:
A. Eliminate the investment account.
B. Allocate and amortize the difference between implied and book value.
5-6

On January 1, 2010, Page Company acquired an 80% interest in Schell


Company for $3,600,000. On that date, Schell Company had retained earnings
of $800,000 and common stock of $2,800,000. The book values of assets and
liabilities were equal to fair values except for the following:
Inventory
Equipment (net)
Land

Book Value
$ 50,000
540,000
300,000

Fair Value
$ 85,000
720,000
660,000

The equipment had an estimated remaining useful life of 8 years. One-half of


the inventory was sold in 2010 and the remaining half was sold in 2011. Schell
Company reported net income of $240,000 in 2010 and $300,000 in 2011. No
dividends were declared or paid in either year. Page Company uses the cost
method to record its investment in Schell Company.
Required:
Prepare, in general journal form, the workpaper eliminating entries necessary
in the consolidated statements workpaper for the year ending December 31,
2011.
5-7

Paddock Company acquired 90% of the stock of Spector Company for


$6,300,000 on January 1, 2010. On this date, the fair value of the assets and
liabilities of Spector Company was equal to their book value except for the
inventory and equipment accounts. The inventory had a fair value of
$2,300,000 and a book value of $1,900,000. The equipment had a fair value of
$3,300,000 and a book value of $2,800,000.
The balances in Spector Company's capital stock and retained earnings
accounts on the date of acquisition were $3,700,000 and $1,900,000,
respectively.
Required:
In general journal form, prepare the entries on Spector Company's books to
record the effect of the pushed down values implied by the acquisition of its
stock by Paddock Company assuming that:
A values are allocated on the basis of the fair value of Spector Company as a
whole imputed from the transaction.
B values are allocated on the basis of the proportional interest acquired by
Paddock Company.

5-8

Pruitt Corporation acquired all of the voting stock of Soto Corporation on


January 1, 2010, for $210,000 when Soto had common stock of $150,000 and
retained earnings of $24,000. The excess of implied over book value was
allocated $9,000 to inventories that were sold in 2010, $12,000 to equipment
with a 4-year remaining useful life under the straight-line method, and the
remainder to goodwill.
Financial statements for Pruitt and Soto Corporations at the end of the fiscal
year ended December 31, 2011 (two years after acquisition), appear in the first
two columns of the partially completed consolidated statements workpaper.
Pruitt Corp. has accounted for its investment in Soto using the partial equity
method of accounting.
Required:
Complete the consolidated statements workpaper for Pruitt Corporation and
Soto Corporation for December 31, 2011.
Pruitt Corporation and Soto Corporation
Consolidated Statements Workpaper
at December 31, 2011
Eliminations
Pruitt
Corp.
INCOME
STATEMENT
Sales
Equity from
Subsidiary
Income
Cost of Sales
Other Expenses
Net Income to Ret.

Soto
Corp.

618,000

180,000

36,000
(450,000)
(114,000)

(90,000)
(54,000)

Earn.
Pruitt Retained

90,000

36,000

Earnings 1/1
Soto Retained

72,000

Earnings 1/1
Add: Net Income
Less: Dividends
Retained Earnings
12/31
BALANCE SHEET
Cash
Inventories

90,000
(60,000)

3,000
36,000
(12,000)

102,000

54,000

42,000
63,000

21,000
45,000

Debit

Credit

Consolidated
Balances

Land
Equipment and
Buildings-net
Investment in Soto
Corp.
Total Assets
LIA & EQUITIES
Liabilities
Common Stock
Retained Earnings
Total Equities

33,000

18,000

192,000

165,000

240,000
570,000

249,000

168,000
300,000
102,000
570,000

45,000
150,000
54,000
249,000

5-9 On January 1, 2010, Prescott Company acquired 80% of the outstanding capital
stock of Sherlock Company for $570,000. On that date, the capital stock of
Sherlock Company was $150,000 and its retained earnings were $450,000.
On the date of acquisition, the assets of Sherlock Company had the following
values:
Book Value
Inventories................................................................$ 90,000
Plant and equipment.....................................................150,000

Fair Market
Value
$165,000
180,000

All other assets and liabilities had book values approximately equal to their respective
fair market values. The plant and equipment had a remaining useful life of 10
years from January 1, 2010, and Sherlock Company uses the FIFO inventory
cost flow assumption.
Sherlock Company earned $180,000 in 2010 and paid dividends in that year of
$90,000.
Prescott Company uses the complete equity method to account for its
investment in S Company.
Required:
A. Prepare a computation and allocation schedule.
B. Prepare the balance sheet elimination entries as of December 31, 2010.
C. Compute the amount of equity in subsidiary income recorded on the books
of Prescott Company on December 31, 2010.
D. Compute the balance in the investment account on December 31, 2010.
Short Answer
1.

When the value implied by the acquisition price is below the fair value of the
identifiable net assets the residual amount will be negative (bargain
acquisition). Explain the difference in accounting for bargain acquisition
between past accounting and proposed accounting requirements.

2.

Push down accounting is an accounting method required for the subsidiary in


some instances such as the banking industry. Briefly explain the concept of
push down accounting.

Questions from the Textbook


1. Distinguish among the following concepts:(a)Difference between book value
and the value implied by the purchase price.(b)Excess of implied value over
fair value.(c)Excess of fair value over implied value.(d)Excess of book value
over fair value.
2. In what account is the difference between book value and the value implied by
the purchase
price recorded on the books of the investor? In what account is the excess of
implied over fair value recorded?
3. How do you determine the amount of the difference between book value and
the value implied by the purchase price to be allocated to a specific asset of a
less than wholly owned subsidiary?
4. The parent companys share of the fair value of the net assets of a subsidiary
may exceed acquisition cost. How must this excess be treated in the
preparation of consolidated financial statements?
5. What are the arguments for and against the alternatives for the handling of
bargain acquisitions? Why are such acquisitions unlikely to occur with great
frequency?
6. P Company acquired a 100% interest in S Company. On the date of acquisition
the fair value of the assets and liabilities of S Company was equal to their
book value except for land that had a fair value of $1,500,000 and a book
value of $300,000.
At what amount should the land of S Company be included in the consolidated
balance sheet?
At what amount should the land of S Company be included in the consolidated
balance sheet if P Company acquired an80% interest in S Company rather than
a 100%interest?
Business Ethics Question from the Textbook
Consider the following: Many years ago, a student in a consolidated financial
statements class came to me and said that Grand Central (a multi-store grocery and
variety chain in Salt Lake City and surrounding towns and cities) was going to be
acquired and that I should try to buy the stock and make lots of money. I asked him
how he knew and he told me that he worked part-time for Grand Central and heard
that Fred Meyer was going to acquire it. I did not know whether the student worked in
the accounting department at Grand Central or was a custodian at one of the stores. I
thanked him for the information but did not buy the stock. Within a few weeks, the

announcement was made that Fred Meyer was acquiring Grand Central and the stock
price shot up, almost doubling. It was clear that I had missed an opportunity to make a
lot of money ... I dont know to this day whether or not that would have been insider
trading. How-ever, I have never gone home at night and asked my wife if the SEC
called. From Dont go to jail and other good advice for accountants, by Ron Mano,
Accounting Today, October 25, 1999.
Question: Do you think this individual would have been guilty of insider trading if he
had purchased the stock in Grand Central based on this advice? Why or why not? Are
there ever instances where you think it would be wise to miss out on an opportunity to
reap benefits simply because the behavior necessitated would have been in a gray
ethical area, though not strictly illegal? Defend your position.
Chapter 8
Changes in Ownership Interest
Multiple Choice
1.

When the parent company sells a portion of its investment in a subsidiary, the
workpaper entry to adjust for the current years income sold to noncontrolling
stockholders includes a
a. debit to Subsidiary Income Sold.
b. debit to Equity in Subsidiary Income.
c. credit to Equity in Subsidiary Income.
d. credit to Subsidiary Income Sold.

2.

A parent company may increase its ownership interest in a subsidiary by


a. buying additional subsidiary shares from third parties.
b. buying additional subsidiary shares from the subsidiary.
c. having the subsidiary purchase its shares from third parties.
d. all of these.

3.

If a portion of an investment is sold, the value of the shares sold is determined


by using the:
1. first-in, first-out method.
2. average cost method.
3. specific identification method.
a. 1
b. 2
c. 3
d. 1 and 3

4.

If a parent company acquires additional shares of its subsidiarys stock directly


from the subsidiary for a price less than their book value:
1. total noncontrolling book value interest increases.
2. the controlling book value interest increases.
3. the controlling book value interest decreases.
a. 1
b. 2

c. 3
d. 1 and 3
5.

If a subsidiary issues new shares of its stock to noncontrolling stockholders,


the book value of the parents interest in the subsidiary may
a. increase.
b. decrease.
c. remain the same.
d. increase, decrease, or remain the same.

6.

The purchase by a subsidiary of some of its shares from noncontrolling


stockholders results in the parent companys share of the subsidiarys net
assets
a. increasing.
b. decreasing.
c. remaining unchanged.
d. increasing, decreasing, or remaining unchanged.

7.

The computation of noncontrolling interest in net assets is made by


multiplying the noncontrolling interest percentage at the
a. beginning of the year times subsidiary stockholders equity amounts.
b. beginning of the year times consolidated stockholders equity amounts.
c. end of the year times subsidiary stockholders equity amounts.
d. end of the year times consolidated stockholders equity amounts.

8.

Under the partial equity method, the workpaper entry that reverses the effect
of subsidiary income for the year includes a:
1. credit to Equity in Subsidiary Income.
2. debit to Subsidiary Income Sold.
3. debit to Equity in Subsidiary Income.
a. 1
b. 2
c. 3
d. both 1 and 2

9.

Polk Company owned 24,000 of the 30,000 outstanding common shares of


Sloan Company on January 1, 2010. Polks shares were purchased at book
value when the fair values of Sloans assets and liabilities were equal to their
book values. The stockholders equity of Sloan Company on January 1, 2010,
consisted of the following:
Common stock, $15 par value$ 450,000
Other contributed capital
337,500
Retained earnings
712,500
Total
$1,500,000
Sloan Company sold 7,500 additional shares of common stock for $90 per
share on January 2, 2010. If Polk Company purchased all 7,500 shares, the
book entry to record the purchase should increase the Investment in Sloan
Company account by
a. $562,500.

b.
c.
d.
e.

$590,625.
$675,000.
$150,000.
Some other account.

10.

Polk Company owned 24,000 of the 30,000 outstanding common shares of


Sloan Company on January 1, 2010. Polks shares were purchased at book
value when the fair values of Sloans assets and liabilities were equal to their
book values. The stockholders equity of Sloan Company on January 1, 2010,
consisted of the following:
Common stock, $15 par value$ 450,000
Other contributed capital
337,500
Retained earnings
712,500
Total
$1,500,000
Sloan Company sold 7,500 additional shares of common stock for $90 per
share on January 2, 2010. If all 7,500 shares were sold to noncontrolling
stockholders, the workpaper adjustment needed each time a workpaper is
prepared should increase (decrease) the Investment in Sloan Company by
a. ($140,625).
b. $140,625.
c. ($112,500).
d. $192,000.
e. None of these.

11.

On January 1, 2006, Parent Company purchased 32,000 of the 40,000


outstanding common shares of Sims Company for $1,520,000. On January 1,
2010, Parent Company sold 4,000 of its shares of Sims Company on the open
market for $90 per share. Sims Companys stockholders equity on January 1,
2006, and January 1, 2010, was as follows:
1/1/06
1/1/10
Common stock, $10 par value $400,000
$ 400,000
Other contributed capital
400,000
400,000
Retained earnings
800,000
1,400,000
$1,600,000
$2,200,000
The difference between implied and book value is assigned to Sims
Companys land. The amount of the gain on sale of the 4,000 shares that
should be recorded on the books of Parent Company is
a. $68,000.
b. $170,000.
c. $96,000.
d. $200,000.
e. None of these.

12.

On January 1, 2006, Patterson Corporation purchased 24,000 of the 30,000


outstanding common shares of Stewart Company for $1,140,000. On January
1, 2010, Patterson Corporation sold 3,000 of its shares of Stewart Company on
the open market for $90 per share. Stewart Companys stockholders equity on
January 1, 2006, and January 1, 2010, was as follows:
1/1/06
1/1/10
Common stock, $10 par value $ 300,000
$ 300,000
Other contributed capital
300,000
300,000
Retained earnings
600,000
1,050,000
$1,200,000
$1,650,000
The difference between implied and book value is assigned to Stewart
Companys land. As a result of the sale, Patterson Corporations Investment in
Stewart account should be credited for
a. $165,000.
b. $206,250.
c. $120,000.
d. $142,500.
e. None of these.

13.

On January 1, 2006, Peterson Company purchased 16,000 of the 20,000


outstanding common shares of Swift Company for $760,000. On January 1,
2010, Peterson Company sold 2,000 of its shares of Swift Company on the
open market for $90 per share. Swift Companys stockholders equity on
January 1, 2006, and January 1, 2010, was as follows:
1/1/06
1/1/10
Common stock, $10 par value $200,000
$ 200,000
Other contributed capital
200,000
200,000
Retained earnings
400,000
700,000
$800,000
$1,100,000
The difference between implied and book value is assigned to Swift
Companys land. Assuming no other equity transactions, the amount of the
difference between implied and book value that would be added to land on a
workpaper for the preparation of consolidated statements on December 31,
2010, would be
a. $120,000.
b. $115,000.
c. $105,000.
d. $84,000.
e. None of these.

14.

On January 1 2010, Paulson Company purchased 75% of Shields Corporation


for $500,000. Shields stockholders equity on that date was equal to $600,000
and Shields had 60,000 shares issued and outstanding on that date. Shields
Corporation sold an additional 15,000 shares of previously unissued stock on
December 31, 2010.
Assume that Paulson Company purchased the additional shares what would be
their current percentage ownership on December 31, 2010?

a.
b.
c.
d.
15.

92%
87%
80%
100%

On January 1 2010, Powder Mill Company purchased 75% of Selfine


Company for $500,000. Selfine Companys stockholders equity on that date
was equal to $600,000 and Selfine Company had 60,000 shares issued and
outstanding on that date. Selfine Company Corporation sold an additional
15,000 shares of previously unissued stock on December 31, 2010.
Assume Selfine Company sold the 15,000 shares to outside interests, Powder
Mill Companys percent ownership would be:
a. 33 1/3%
b. 60%
c. 75%
d. 80%

16.

P Corporation purchased an 80% interest in S Corporation on January 1, 2010,


at book value for $300,000. Ss net income for 2010 was $90,000 and no
dividends were declared. On May 1, 2010, P reduced its interest in S by selling
a 20% interest, or one-fourth of its investment for $90,000. What will be the
Consolidated Gain on Sale and Subsidiary Income Sold for 2010?
Consolidated Gain on Sale
Subsidiary Income Sold
a.
$9,000
$6,000
b.
$9,000
$15,000
c.
$15,000
$6,000
d.
$15,000
$15,000

17.

P Corporation purchased an 80% interest in S Corporation on January 1, 2010,


at book value for $300,000. Ss net income for 2010 was $90,000 and no
dividends were declared. On May 1, 2010, P reduced its interest in S by selling
a 20% interest, or one-fourth of its investment for $90,000. What would be the
balance in the Investment of S Corporation account on December 31, 2010?
a. $300,000.
b. $225,000.
c. $279,000.
d. $261,000.

18.

The purchase by a subsidiary of some of its shares from the noncontrolling


stockholders results in an increase in the parents percentage interest in the
subsidiary. The parent companys share of the subsidiarys net assets will
increase if the shares are purchased:
a. at a price equal to book value.
b. at a price below book value.
c. at a price above book value.
d. will not show an increase.

Use the following information for Questions 19-21.

On January 1, 2006, Perk Company purchased 16,000 of the 20,000 outstanding


common shares of Self Company for $760,000. On January 1, 2010, Perk Company
sold 2,000 of its shares of Self Company on the open market for $90 per share. Self
Companys stockholders equity on January 1, 2006, and January 1, 2010, was as
follows:
1/1/06
1/1/10
Common stock, $10 par value $ 200,000
$ 200,000
Other contributed capital
200,000
200,000
Retained earnings
400,000
700,000
$800,000
$1,100,000
The difference between implied and book value is assigned to Self Companys land.
19.

The amount of the gain on sale of the 2,000 shares that should be recorded on
the books of Perk Company is
a. $34,000.
b. $85,000.
c. $48,000.
d. $100,000.
e. None of these.

20.

As a result of the sale, Perk Companys Investment in Self account should be


credited for
a. $110,000.
b. $137,500.
c. $80,000.
d. $95,000.
e. None of these.

21.

Assuming no other equity transactions, the amount of the difference between


implied and book value that would be added to land on a work paper for the
preparation of consolidated statements on December 31, 2010 would be
a.
$120,000.
b.
$115,000.
c.
$105,000.
d.
$84,000.

22.

On January 1, 2010, P Corporation purchased 75% of S Corporation for


$500,000. Ss stockholders equity on that date was equal to $600,000 and S
had 40,000 shares issued and outstanding on that date. S Corporation sold an
additional 8,000 shares of previously unissued stock on December 31, 2010.
Assume that P Corporation purchased the additional shares what would be
their current percentage ownership on December 31, 2010?
a.
62 1/2%.
b.
75%
c.
79 1/6%
d.
100%

23.

On January 1, 2010, P Corporation purchased 75% of S Corporation for


$500,000. Ss stockholders equity on that date was equal to $600,000 and S
had 40,000 shares issued and outstanding on that date. S Corporation sold an
additional 8,000 shares of previously unissued stock on December 31, 2010.
Assume S sold the 8,000 shares to outside interests, Ps percent ownership
would be:
a.
56 1/4%
b.
62 1/2%
c.
75%
d.
79 1/6%

Problems
8-1

Piper Company purchased Snead Company common stock through openmarket purchases as follows:
Acquired
Date
Shares
Cost
1/1/09
1,500
$ 50,000
1/1/10
3,300
$ 90,000
1/1/11
6,600
$250,000
Snead Company had 12,000 shares of $20 par value common stock
outstanding during the entire period. Snead had the following retained
earnings balances on the relevant dates:
January 1, 2009
January 1, 2010
January 1, 2011
December 31, 2011

$ 90,000
30,000
150,000
300,000

Snead Company declared no dividends in 2009 or 2010 but did declare


$60,000 of dividends in 2011. Any difference between cost and book value is
assigned to subsidiary land. Piper uses the equity method to account for its
investment in Snead.
Required:
A. Prepare the journal entries Piper Company will make during 2010 and
2011 to account for its investment in Snead Company.
B. Prepare workpaper eliminating entries necessary to prepare a consolidated
statements workpaper on December 31, 2011.
8-2

On January 1, 2008, Patel Company acquired 90% of the common stock of


Seng Company for $650,000. At that time, Seng had common stock ($5 par) of
$500,000 and retained earnings of $200,000.
On January 1, 2010, Seng issued 20,000 shares of its unissued common stock,
with a market value of $7 per share, to noncontrolling stockholders. Sengs
retained earnings balance on this date was $300,000. Any difference between

cost and book value relates to Sengs land. No dividends were declared in
2010.
Required:
A. Prepare the entry on Patels books to record the effect of the issuance
assuming the cost method.
B. Prepare the elimination entries for the preparation of a consolidated
statements workpaper on December 31, 2010 assuming the cost method.
8-3 Pratt Company purchased 40,000 shares of Silas Companys common
stock for $860,000 on January 1, 2010. At that time Silas Company had
$500,000 of $10 par value common stock and $300,000 of retained
earnings. Silas Companys income earned and increase in retained earnings
during 2010 and 2011 were:
2010
Income earned
$260,000
Increase in Retained Earnings200,000

2011
$360,000
300,000

Silas Company income is earned evenly throughout the year.


On September 1, 2011, Pratt Company sold on the open market, 12,000 shares
of its Silas Company stock for $460,000. Any difference between cost and
book value relates to Silas Company land. Pratt Company uses the cost
method to account for its investment in Silas Company.
Required:
A. Compute Pratt Companys reported gain (loss) on the sale.
B. Prepare all consolidated statements workpaper eliminating entries for a
workpaper on December 31, 2011.
8.4

Pelky made the following purchases of Stark Company common stock:


Date
1/1/10
1/1/11

Shares
70,000 (70%)
10,000 (10%)

Cost
$1,000,000
160,000

Stockholders equity information for Stark Company for 2010 and 2011
follows:
2010
Common stock, $10 par value $1,000,000

2011
$1,000,000

1/1 Retained earnings


300,000
Net income
110,000
Dividends declared, 12/15
(30,000)
Retained earnings, 12/31
380,000
Total stockholders equity, 12/31$1,380,000

380,000
140,000
(40,000)
480,000
$1,480,000

On July 1, 2011, Pelky sold 14,000 shares of Stark Company common stock
on the open market for $22 per share. The shares sold were purchased on
January 1, 2010. Stark notified Pelky that its net income for the first six
months was $70,000. Any difference between cost and book value relates to
subsidiary land. Pelky uses the cost method to account for its investment in
Stark Company.
Required:
A. Prepare the journal entry made by Pelky to record the sale of the 14,000
shares on July 1, 2011.
B. Prepare the workpaper eliminating entries needed for a consolidated
statements workpaper on December 31, 2011.
C. Compute the amount of noncontrolling interest that would be reported
on the consolidated balance sheet on December 31, 2011.
8-5

P Company purchased 96,000 shares of the common stock of S Company for


$1,200,000 on January 1, 2007, when Ss stockholders equity consisted of $5
par value, Common Stock at $600,000 and Retained Earnings of $800,000.
The difference between cost and book value relates to goodwill.
On January 2, 2010, S Company purchased 20,000 of its own shares from
noncontrolling interests for cash of $300,000 to be held as treasury stock. S
Companys retained earnings had increased to $1,000,000 by January 2, 2010.
S Company uses the cost method in regards to its treasury stock and P
Company uses the equity method to account for its investment in S Company.
Required:
Prepare all determinable workpaper entries for the preparation of consolidated
statements on December 31, 2010.

8-6

Penner Company acquired 80% of the outstanding common stock of Solk


Company on January 1, 2008, for $396,000. At the date of purchase, Solk
Company had a balance in its $2 par value common stock account of $360,000
and retained earnings of $90,000. On January 1, 2010, Solk Company issued
45,000 shares of its previously unissued stock to noncontrolling stockholders
for $3 per share. On this date, Solk Company had a retained earnings balance
of $152,000. The difference between cost and book value relates to subsidiary
land. No dividends were paid in 2010. Solk Company reported income of
$30,000 in 2010.
Required:
A. Prepare the journal entry on Penners books to record the effect of the
issuance assuming the equity method.
B. Prepare the eliminating entries needed for the preparation of a
consolidated statements workpaper on December 31, 2010, assuming the
equity method.

8-7

Petty Company acquired 85% of the common stock of Selmon Company in


two separate cash transactions. The first purchase of 108,000 shares (60%) on
January 1, 2009, cost $735,000. The second purchase, one year later, of 45,000
shares (25%) cost $330,000. Selmon Companys stockholders equity was as
follows:
December 31
2009
Common Stock, $5 par
Retained Earnings, 1/1
Net Income
Dividends Declared, 9/30
Retained Earnings, 12/31
Total Stockholders Equity, 12/31

900,000
262,000
69,000
(30,000)
301,000
$1,201,000

December 31
2010
$ 900,000
302,000
90,000
(38,000)
354,000
$1,254,000

On April 1, 2010, after a significant rise in the market price of Selmon


Companys stock, Petty Company sold 32,400 of its Selmon Company shares
for $390,000. Selmon Company notified Petty Company that its net income
for the first three months was $22,000. The shares sold were identified as
those obtained in the first purchase. Any difference between cost and book
value relates to goodwill. Petty uses the partial equity method to account for
its investment in Selmon Company.
Required:
A. Prepare the journal entries Petty Company will make on its books during
2009 and 2010 to account for its investment in Selmon Company.
B. Prepare the workpaper eliminating entries needed for a consolidated
statements workpaper on December 31, 2010.
Short Answer
1.
A parents ownership percentage in a subsidiary may change for several
reasons. Identify three reasons the ownership percentage may change.
2.

A parent companys equity interest in a subsidiary may change as the


result of the issuance of additional shares of stock by the subsidiary.
Describe the affect on the parents investment account when the new
shares are (a) purchased ratably by the parent and noncontrolling
shareholders or (b) entirely by the noncontrolling shareholders.

Short Answer Question from the Textbook


1. Identify three types of transactions that result in a change in a parent companys
ownership interest in its subsidiary.
2. Why is the date of acquisition of subsidiary stock important under the purchase
method?

3. When a parent company has obtained control of a subsidiary through several


purchases and subsequently sells a portion of its shares in the subsidiary, how is
the carrying value of the shares sold determined?
4. When a parent company that records its investment using the cost method during a
fiscal year sells a portion of its investment, explain the correct accounting for any
differences between selling price and recorded values.
5. ABC Corporation purchased 10,000 shares(80%) of EZ Company at $35 per share
and sold them several years later for $35 per share. The consolidated income
statement reports a loss on the sale of this investment. Explain.
6. Explain how a parent company that owns less than100% of a subsidiary can
purchase an entire new is-sue of common stock directly from the subsidiary.
7. When a subsidiary issues additional shares of stock to noncontrolling stockholders
and such issuance results in an increase in the book value of the parents share of
the subsidiarys equity, how should the increase be reflected in the financial
statements? What if it results in a decrease?
8. P Company holds an 80% interest in S Company. Determine the effect (that is,
increase, decrease, no change, not determinable) on both the total book value of
the noncontrolling interest and the noncontrolling interests percentage of
ownership in the net assets of S Company for each of the following situations:
a. P Company acquires additional shares directly from S Company at a price
equal to the book value per share of the S Company stock immediately
prior to the issuance.
b. S Company acquires its own shares on the open market. The cost of these
shares is less than their book value.
c. Assume the same situation as in (b) except that the cost of the shares is
greater than their book value.
d. P Company and a noncontrolling stockholder each acquire 100 shares
directly from S Com-pany at a price below the book value per share.
Business Ethics Question from Textbook
During a recent review of the quarterly financial statements and supporting ledgers,
you noticed several un-usual journal entries. While the dollar amounts of the journal
entries were not large, there did not appear to be supporting documentation. You
decide to bring the matter to the attention of your immediate supervisor. After you
mentioned the issue, the supervisor calmly stated that the matter would be looked into
and that you should not worry about it.1.You feel a bit uncomfortable about the
situation. What is your responsibility and what action, if any, should you take?
Chapter 10
Insolvency Liquidation and Reorganization
Multiple Choice

1.

A corporation that is unable to pay its debts as they become due is:
a. bankrupt.
b. overdrawn.
c. insolvent.
d. liquidating.

2.

When a business becomes insolvent, it generally has three possible courses of


action. Which of the following is not one of the three possible courses of
action?
a. The debtor and its creditors may enter into a contractual agreement,
outside of formal bankruptcy proceedings.
b. The debtor continues operating the business in the normal course of the
day-to-day operations.
c. The debtor or its creditors may file a bankruptcy petition, after which the
debtor is liquidated under Chapter 7.
d. The debtor or its creditors may file a petition for reorganization under
Chapter 11.

3.

Assets transferred by the debtor to a creditor to settle a debt are transferred at:
a. book value of the debt.
b. book value of the transferred assets.
c. fair market value of the debt.
d. fair market value of the transferred assets.

4.

A composition agreement is an agreement between the debtor and its creditors


whereby the creditors agree to:
a. accept less than the full amount of their claims.
b. delay settlement of the claim until a latter date.
c. force the debtor into a liquidation.
d. accrue interest at a higher rate.

5.
In a troubled debt restructuring involving a modification of terms, the debtors
gain on restructuring:
a. will equal the creditors gain on restructuring.
b. will equal the creditors loss on restructuring.
c. may not equal the creditors gain on restructuring.
d. may not equal the creditors loss on restructuring.
6.

A bankruptcy petition filed by a firm is a:


a. chapter petition.
b. involuntary petition.
c. voluntary petition.
d. chapter 11 petition.

7.

When a bankruptcy court enters an order for relief it has:


a. accepted the petition.
b. dismissed the petition.
c. appointed a trustee.
d. started legal action against the debtor by its creditors.

8.

An involuntary petition filed by a firms creditors whereby there are twelve or


more creditors must be signed by at least:
a. two creditors.
b. three creditors.
c. five creditors.
d. six creditors.

9.

The duties of the trustee include:


a. appointing creditors committees in liquidation cases.
b. approving all payments for debts incurred before the bankruptcy filing.
c. examining claims and disallowing any that are improper.
d. calling a meeting of the debtors creditors.

10.

Which of the following items is not a specified priority for unsecured creditors
in a bankruptcy petition?
a. Administration fees incurred in administering the bankrupts estate.
b. Unsecured claims for wages earned within 90 days and are less than
$4,650 per employee.
c. Unsecured claims of governmental units for unpaid taxes.
d. Unsecured claims on credit card charges that do not exceed $3,000.

11.
Which statement with respect to gains and losses on troubled debt
restructuring is correct?
a. Creditors losses on restructuring are extraordinary.
b. Debtors gains and losses on asset transfers and debtors gains on
restructuring are combined and treated as extraordinary.
c. Debtor gains and creditor losses on restructuring are extraordinary, if
material in amount.
d. Debtor losses on asset transfers and debtor gains on restructuring are
reported as a component of net income.
12.

When fresh-start reporting is used according to Statement of Position (SOP)


90-7, the implication is that a new firm exists. Which of the following
statements is not correct about fresh-start accounting?
a. Assets are reported at fair values.
b. Beginning retained earnings is reported at zero.
c. The fair value of the assets must be less than the post liabilities and
allowed claims.
d. The original owners must own less than 50% of the voting stock after
reorganization.

13.

A Statement of Affairs is a report designed to show:


a. an estimated amount that would be received by each class of creditors
claims in the event of liquidation.
b. a balance sheet prepared on the going-concern assumption.
c. assets and liabilities classified as current and noncurrent.
d. assets and liabilities reported at their current book values.

14.

When a secured claim is not fully settled by the selling of the underlying
collateral, the remaining portion:
a. of the claim cannot be collected by the creditor.
b. remains as a secured claim.
c. is classified as an unsecured priority claim.
d. is classified as an unsecured nonpriority claim.

15.

Layne Corporation entered into a troubled debt restructuring agreement with


their local bank. The bank agreed to accept land with a carrying amount of
$360,000 and a fair value of $540,000 in exchange for a note with a carrying
amount of $765,000. Ignoring income taxes, what amount should Layne report
as a gain on its income statement?
a. $0.
b. $180,000.
c. $225,000.
d. $405,000.

16.

The following information pertains to the transfer of real estate in regards to a


troubled debt restructuring by Nen Co. to Baker Co. in full settlement of Nens
liability to Baker:
Carrying amount of liability settled
Carrying amount of real estate transferred
Fair value of real estate transferred

$450,000
$300,000
$330,000

What amount should Nen report as ordinary gain (loss) on transfer of real
estate?
a. $(30,000).
b. $30,000.
c. $120,000.
d. $150,000.
17.

The following information pertains to the transfer of real estate in regards to a


troubled debt restructuring by Nen Co. to Baker Co. in full settlement of Nens
liability to Baker:
Carrying amount of liability settled
Carrying amount of real estate transferred
Fair value of real estate transferred
a.
b.
c.
d.

18.

$450,000
$300,000
$330,000

What amount should Baker report as a gain or (loss) on restructuring?


$120,000 ordinary loss.
$120,000 extraordinary loss.
$150,000 ordinary loss.
$150,000 extraordinary loss.
Dobler Corporation was forced into bankruptcy and is in the process of
liquidating assets and paying claims. Unsecured claims will be paid at the rate
of thirty cents on the dollar. Carson holds a note receivable from Dobler for
$75,000 collateralized by an asset with a book value of $50,000 and a

a.
b.
c.
d.

liquidation value of $25,000. The amount to be realized by Carson on this note


is:
$25,000.
$40,000.
$50,000.
$75,000.

19.
Bad Company filed a voluntary bankruptcy petition, and the statement of
affairs reflected the following amounts:
Estimated
Assets
Book Value
Current Value
Assets pledged with fully secured creditors $ 900,000
$ 1,110,000
Assets pledged partially secured creditors
540,000
360,000
Free assets
1,260,000
960,000
$2,700,000
$2,430,000
Liabilities
Liabilities with priority
$ 210,000
Fully secured creditors
780,000
Partially secured creditors
600,000
Unsecured creditors
1,620,000
$3,210,000
Assume the assets are converted to cash at their estimated current values.
What amount of cash will be available to pay unsecured nonpriority claims?
a.
b.
c.
d.

$720,000.
$840,000.
$960,000.
$1,080,000.

20.

The final settlement with unsecured creditors is computed by dividing:


a. total net realizable value by total unsecured creditor claims.
b. net free assets by total secured creditor claims.
c. total net realizable value by total secured creditor claims.
d. net free assets by total unsecured creditor claims.

21.

Dodge Corporation entered into a troubled debt restructuring agreement with


their local bank. The bank agreed to accept land with a carrying value of
$200,000 and a fair value of $300,000 in exchange for a note with a carrying
amount of $425,000. Ignoring income taxes, what amount should Dodge
report as a gain on its income statement?
a. $0.
b. $100,000.
c. $125,000.
d. $225,000.

22.

The following information pertains to the transfer of real estate in regards to a


troubled debt restructuring by Drier Co. to Cole Co. in full settlement of
Driers liability to Cole:

Carrying amount of liability settled


Carrying amount of real estate transferred
Fair value of real estate transferred

$375,000
$250,000
$275,000

What amount should Drier report as ordinary gain (loss) on transfer of real
estate?
a. $(25,000).
b. $25,000.
c. $100,000.
d. $125,000.
23.

The following information pertains to the transfer of real estate in regards to a


troubled debt restructuring by Drier Co. to Cole Co. in full settlement of
Driers liability to Cole:
Carrying amount of liability settled
Carrying amount of real estate transferred
Fair value of real estate transferred

$375,000
$250,000
$275,000

What amount should Cole report as a gain or (loss) on restructuring?


a. $100,000 ordinary loss.
b. $100,000 extraordinary loss.
c. $125,000 ordinary loss.
d. $125,000 extraordinary loss.
24.

Poor Company filed a voluntary bankruptcy petition, and the settlement of


affairs reflected the following amounts:
Assets
Book Value
Assets pledged with fully secured creditors $ 450,000
Assets pledged partially secured creditors
270,000
Free assets
630,000
$1,350,000
Liabilities
Liabilities with priority
Fully secured creditors
Partially secured creditors
Unsecured creditors

Estimated
Current Value
$ 555,000
180,000
480,000
$1,215,000

$ 105,000
390,000
300,000
810,000
$1,605,000

Assume the assets are converted to cash to their estimated current values.
What amount of cash will be available to pay unsecured nonpriority claims?
a. $360,000.
b. $420,000.
c. $480,000.
d. $540,000.

25.

Dooley Corporation was forced into bankruptcy and is in the process of


liquidating assets and paying claims. Unsecured claims will be paid at the rate
of thirty cents on the dollar. Cerner holds a note receivable from Dooley for
$90,000 collateralized by an asset with a book value of $60,000 and a
liquidation value of $30,000. The amount to be realized by Cerner on this note
is:
a. $30,000.
b. $48,000.
c. $60,000.
d. $90,000.

Problems
10.1

On January 1, 2011, Bargain Mart owed City Bank $1,600,000, under an 8%


note with three years remaining to maturity. Due to financial difficulties,
Bargain Mart was unable to pay the previous years interest. City Bank agreed
to settle Bargain Marts debt in exchange for land having a fair market value
of $1,310,000. Bargain Mart purchased the land in 2003 for $1,000,000.

Required:
Prepare the journal entries to record the restructuring of the debt by Bargain Mart.
10.2

On January 1, 2010, Gannon, Inc. owed BancCorp $12 million on a 10% note
due December 31, 2011. Interest was last paid on December 31, 2008. Gannon
was experiencing severe financial difficulties and asked BancCorp to modify
the terms of the debt agreement. After negotiation BancCorp agreed to:
- Forgive the interest accrued for the year just ended,
- Reduce the remaining two years interest payments to $900,000 each and
delay the first payment until December 31, 2011, and
- Reduce the unpaid principal amount to $9,600,000.

Required:
Prepare the journal entries for Gannon, Inc. necessitated by the restructuring of the
debt at (1) January 1, 2010, (2) December 31, 2011, and (3) December 31, 2012.
10.3

On January 2, 2011 Stevens, Inc. was indebted to First Bank under a $12
million, 10% unsecured note. The note was signed January 2, 2005, and was
due December 31, 2014. Annual interest was last paid on December 31, 2009.
Stevens negotiated a restructuring of the terms of the debt agreement due to
financial difficulties.

Required:
Prepare all journal entries for Stevens, Inc. to record the restructuring and any
remaining transactions relating to the debt under each independent assumption.
A.
First Bank agreed to settle the debt in exchange for land which cost
Stevens $8,500,000 and has a fair market value of $10,000,000.
B.
First Bank agreed to (1) forgive the accrued interest from last year
(2) reduce the remaining four interest payments to $600,000 each, and (3)
reduce the principal to $9,000,000.

10.4

On December 31, 2011, Community Bank agreed to restructure a $900,000,


8% loan receivable from Neer Corporation because of Neers financial
problems. At December 31 there was $36,000 of accrued interest for a sixmonth period. Terms of the restructuring agreement are as follows:
- Reduce the loan from $900,000 to $600,000;
- Extend the maturity date by 2 years from December 31, 2011 to
December 31, 2013;
- Reduce the interest rate on the loan from 8% to 6%.
Present value assumptions:
Present value of $1 for 2 years at 6% =
Present value of $1 for 2 years at 8% =
Present value of an ordinary annuity of $1 for 2 years at 6% =
Present value of an ordinary annuity of $1 for 2 years at 8% =

Required:
Compute the gain or loss that will be reported by Community Bank.

0.8900
0.8573
1.8334
1.7833

10.5

Donnelly Corporation incurred major losses in 2010 and entered into


voluntary Chapter 7 bankruptcy in the early part of 2011. By June 1, all assets
were converted into cash, the secured creditors were paid, and $150,000 in
cash was left to pay the remaining claims as follows.
Accounts payable
$ 48,000
Claims prior to the trustees appointment
21,000
Property taxes payable
18,000
Wages payable (all under $4,650 per employee)
54,000
Unsecured note payable
60,000
Accrued interest on the note payable
6,000
Administrative expenses of the trustee
30,000
Total
$237,000

Required:
Classify the claims by their Chapter 7 priority ranking, and analyze which amounts
will be paid and which amounts will be written off.
10.6

Davis Corporation filed a petition under Chapter 7 of the U.S. Bankruptcy Act
on June 30, 2011. Data relevant to its financial position as of this date are:
Estimated Net
Book Value
Realizable Values
Cash
$ 3,000
$ 3,000
Accounts receivable-net
72,000
48,000
Inventories
60,000
72,000
Equipment-net
165,000
87,000
Total assets
$300,000
$210,000
Accounts payable
Rent payable
Wages payable
Note payable plus accrued interest
Capital stock
Retained earnings (deficit)
Total liabilities and equity

$ 72,000
21,000
45,000
96,000
180,000
(120,000)
$300,000

Required:
A.
Prepare a statement of affairs assuming that the note payable
and interest are secured by
a mortgage on the equipment and that wages are less than $4,650 per
employee.
B.
Estimate the amount that will be paid to each class of claims if
priority liquidation expenses including trustee fees are $24,000 and estimated
net realizable values are actually realized.

10.7

The following data are taken from the statement of affairs of Mitchell
Company.
Assets pledged with fully secured creditors
(Realizable value, $635,000)
$800,000
Assets pledged with partially secured creditors
(realizable value, $300,000)
365,000
Free assets (Realizable value, $340,000)
535,000
Fully secured creditor claims
316,000
Partially secured creditor claims
400,000
Unsecured creditor claims with priority
100,000
General unsecured creditor claims
1,165,000

Required:
Compute the amount that will be paid to each class of creditor.
10-8

On February 1, 2011, Hilton Company filed a petition for reorganization under


the bankruptcy statutes. The court approved the plan on September 1, 2011,
including the following provisions:
1.
2.

3.
4.

Accrued expenses of $21,930, representing priority items, are to be


paid in full.
Hilton Company is to exchange accounts receivable in the face amount
of $138,000 and an allowance for uncollectible accounts of $29,200 for
the full settlement of $198,600 owed on open account to one of its
major unsecured creditors. The estimated fair value of the receivables
is $104,000.
Unsecured creditors of open accounts amounting to $91,600 and paid
40 cents on the dollar in full settlement.
Hilton Companys only other major unsecured creditor agreed to a
five-year extension of the $500,000 principal owed him on a 10% note
payable. Accrued interest on the note on September 1, 2011, amounts
to $45,000, one-third of which is to be paid in cash and the remainder
canceled. In addition, no interest is to be charged during the remaining
five years to maturity of the note.

Required:
Prepare journal entries on the books of Hilton Company to give effect to the
preceding provisions.
Short Answer
1.

The Bankruptcy Reform Act assigns priorities to certain unsecured claims, and
each rank must be satisfied in full before the nextlower rank is paid. Identify
the five categories of unsecured creditor claims.

2.

Creditors are classified by law as either secured or unsecured. Distinguish


among fully secured, partially secured, and unsecured creditors.

Short Answer Questions from the Textbook

3.

1.

List the primary types of contractual agreements between a debtor company


and its creditors and briefly explain what is involved in each of them.

2.

Distinguish between a voluntary and involuntary bankruptcy petition.

Distinguish among fully secured, partially se-cured, and unsecured claims


of creditors.
4.

Five priority categories of unsecured claims must be paid before general


unsecured creditors are paid. Briefly describe what makes up each category.

5.

What are dividends in a bankruptcy proceeding?

6.

For each of the following debt restructurings, indicate whether a gain is


recognized and, if so, how the gain is measured and reported. (a)Transfer of
assets by the debtor to the creditor.(b)Grant of an equity interest by the debtor
to the creditor.(c)Modification of the terms of the payable.

7.

What is the purpose of a Statement of Affairs?

8.

One of the officers of a corporation that had just received a discharge in


bankruptcy said, Good, now we dont owe anyone. Is he correct?

9.

What are the duties of a trustee in a liquidation proceeding?

10.

What is the purpose of a combining work paper prepared by a trustee?

11.

What is the purpose of a realization and liquidation account?

Business Ethics Question from Textbook


From an ethical perspective, some believe that it is never justifiable for an individual
or business to declare bankruptcy. Others believe that some actions are appropriate
only in extreme circumstances. Without question, as stated in the Journal of
Accountancy, November 2005,page 51, the ease with which debtors have been able
to walk away from debt has frustrated creditors for years.
1.
Describe the differences between Chapter 7 (liquidations) and Chapter 11
(reorganizations)from an ethical standpoint. Who is most likely to be hurt by a
Chapter 7 bankruptcy?
2.
Discuss the Bankruptcy Abuse Prevention and Consumer Protection Act of
2005. Do you believe the changes wrought by this act will serve to protect
creditors?
3.
The Protection Act of 2005 requires individuals, but not businesses, to
undergo a means test before they can seek Chapter 7 relief. Do you believe
this change should be applied to businesses as well? Why or why not?
4.
Do you think that you would ever resort to filing for bankruptcy relief
yourself? Why or why not?

Chapter 11
International Financial Reporting Standards
Multiple ChoiceConceptual
1.

The goals of the International Accounting Standards Committee include all of


the following except
a. To improve international accounting.
b. To formulate a single set of auditing standards to be applied in all
countries.
c. To promote global acceptance of its standards.
d. To harmonize accounting practices between countries.

2.

Which of the following is true about the FASB after the mandatory adoption
of IFRS by US companies?
a. The FASB will serve in an advisory capacity to the IASB.
b. The FASB will remain the designated standard-setter for US companies,
but incorporate IFRS into US GAAP.
c. The role of the FASB post-IFRS adoption has not been determined.
d. The FASB will cease to exist.

3.

Milestones in the transition plan for mandatory adoption of IFRS by US


companies include all of the following except:
a. Improvements in accounting standards.
b. Limited early adoption of IFRS in an effort to enhance comparability for
US investors
c. Mandatory use of IFRS by US entities.
d. All of the above are milestones in the transition plan for mandatory
adoption of IFRS by US companies.

4.

The roles of the IASC Foundation include


a. establishing global standards for financial reporting.
b. coordinating the filing requirements of stock exchange regulatory
agencies.
c. financing IASB operations.
d. all of the above are roles of the IASC Foundation.

5.

Which of the following statements is true regarding the IASC?


a. The IASC is a public-sector, not-for-profit organization.
b. The IASC is accountable to an international securities regulator.
c. The IASC is a stand-alone, private-sector organization.
d. The IASC funds the operations of the IASB through filing fees paid to
national securities regulators.

6. .

Concerns of the SEC with regard to the mandatory adoption of IFRS by US


entities include all of the following except:
a. the extent to which the standard-setting process addresses emerging issues
in a timely manner.
b. the security and stability of IASC funding.

c. the enhancement of IASB independence through a system of voluntary


contributions from firms in the accounting profession.
d. the degree to which due process is integrated into the standard-setting
process .
7. .

8.

Under the staged transition to mandatory adoption of IFRS being considered


by the SEC,
a. large, accelerated filers would begin IFRS filings for fiscal years
beginning on or after December 31, 2011.
b. non-accelerated filers would begin IFRS filings for fiscal years beginning
on or after December 31, 2015.
c. large non-accelerated filers would have until fiscal years beginning on or
after December 15, 2017 to adopt IFRS.
d. smaller reporting companies would begin IFRS filings for fiscal years
beginning on or after December 15, 2016.
.
In order to complete its first IFRS filing, including three years of audited
financial statements, according to the staged transition to mandatory adoption
of IFRS considered by the SEC, a large accelerated filer would need to adopt
IFRS beginning in fiscal year
a. 2011.
b. 2012.
c. 2013.
d. 2014.

9.

Benefits of the FASB Accounting Standards Codification (ASC) include all of


the following except
a. increases the independence of the FASB.
b. aids in the convergence of US GAAP with IFRS.
c. reduces time and effort required to research accounting issues.
d. clearly distinguishes between authoritative and non-authoritative guidance.

10.

SFAS No.162, the Accounting Standards Codification, is directed to


a. auditors.
b. Boards of Directors.
c. securities regulators.
d. entities.

11.

IFRS and US GAAP differ with regard to financial statement presentation in


all of the following except
a. IFRS generally requires that assets be listed in order of increasing liquidity
while US GAAP requires that assets be listed in order of decreasing
liquidity.
b. US GAAP requires expenses to be listed by function while IFRS requires
expenses to be listed by nature.
c. IFRS prohibits extraordinary items which are allowed by US GAAP.
d. IFRS requires two years of comparative income statements while under
US GAAP, three years of income statements are required.

12.

The major difference between IFRS and US GAAP in accounting for


inventories is that
a. US GAAP prohibits the use of specific identification.
b. IFRS requires the use of the LIFO cost flow assumption.
c. US GAAP prohibits the use of the LIFO cost flow assumption
d. US GAAP allows the use of the LIFO cost flow assumption.

13.

One difference between IFRS and GAAP in valuing inventories is that


a. IFRS, but not GAAP, allows reversals so that inventories written down
under lower-of-cost-or-market can be written back up to the original cost .
b. GAAP defines market value as replacement cost where IFRS defines
market as the selling price.
c. GAAP strictly adheres to the historical cost concept and does not allow for
write-downs of inventory values while IFRS embraces fair value.
d. IFRS, but not GAAP, requires that inventories be valued at the lower of
cost or market.

14.

In accounting for research and development costs.


a. the general rule under both US GAAP and IFRS is that research and
development costs should be expensed as incurred .
b. IFRS generally expenses all research and development costs while US
GAAP expenses research costs as incurred but capitalizes development
costs once technological and economic feasibility has been demonstrated.
c. US GAAP generally expenses all research and development costs while
IFRS expenses research costs as incurred but capitalizes development
costs once technological and economic feasibility has been demonstrated.
d. both US GAAP and IFRS expense research costs as incurred but capitalize
development costs once technological and economic feasibility has been
demonstrated.
.
Property, plant and equipment are valued at
a. historical cost under both IFRS and US GAAP.
b. historical cost or revalued amounts under both IFRS and US GAAP.
c. revalued amounts under IFRS.
d. historical cost under US GAAP while IFRS allows the assets to be valued
at either historical cost or revalued amounts.

15.

16.

The amount of a long-lived asset impairment loss is generally determined by


comparing
a. the assets carrying amount and its fair value under US GAAP.
b. the assets carrying amount and its discounted future cash flows less cost
to sell under IFRS.
c. the assets carrying amount and its undiscounted future cash flows under
US GAAP.
d. the assets carrying amount and its undiscounted future cash flows less
disposal cost under IFRS.

17.

In accounting for liabilities, IFRS interprets probable as


a. likely.
b. more likely than not.
c. somewhat possible.
d. possible and not remote.

18.

Accounting under IFRS and US GAAP is similar for all of the following
topics except
a. changes in estimates.
b. related party transactions.
c. research and development costs.
d. changes in methods.
Use the following information to answer the next three questions.
On January 1, 2010, AirFrance purchases an airplane for 14,400,000. The
components of the airplane and their useful lives are as follows:
Component
Frame
Engine
Other

Cost
7,200,000
4,800,000
2,400,000

Useful life
24 years
20 years
10 years

AirFrance uses the straight-line method of depreciation. The asset is assumed


to have no salvage value.
19.

Under IFRS, the entry to record the acquisition of the airplane would include
a. a debit to Asset/ Airplane of 14,400,000.
b. a debit to Asset/ Airplane frame of 14,400,000.
c. a debit to Asset/ Airplane engine of 4,800,000.
d. cannot be determined from the information given.

20.

Under US GAAP, the entry to record depreciation expense on the asset at


December 31, 2011 will include
a. a credit to accumulated depreciation of 1,200,000.
b. a debit to depreciation expense of 1,440,000
c. a debit to depreciation expense of 800,000.
d. a credit to accumulated depreciation of 600,000.

21.

Under IFRS, the entry to record depreciation expense on the asset at


December 31, 2011 will include a credit to accumulated depreciation of
a. 1,440,000.
b. 1,200,000
c. 800,000.
d. 600,000.

22.

Accounting terminology that differs between IFRS and US GAAP include all
of the following except
a. the use by IFRS of turnover for revenue.

b. the use by IFRS of share premium for additional paid-in-capital.


c. the use by IFRS of other capital reserves for retained earnings.
d. the use by IFRS of issued capital for common stock.
23.

New terminology introduced under the joint IFRS- US GAAP Customer


Consideration (Allocation) Model includes all of the following except
a. revenue recognition voids.
b. contract rights.
c. net contract asset/ liability.
d. performance obligations.

24.

Under IFRS, the criteria to determine whether a lease should be capitalized


include
a. the present value of the minimum lease payments is 90% or more of the
fair value of the asset at the inception of the lease.
b. the term of the lease is 75% or more of the economic life of the asset.
c. the term of the lease is equal to substantially all of the economic life of the
asset.
d. the present value of the minimum lease payments is equal to substantially
all of the fair value of the asset at the inception of the lease.
Use the following information to answer the next three questions.
Bellingham Electronics Inc. offers one model of laptop computer for 1000
and a two-year warranty for 250. The retailer, as part of a Boxing Day
promotion, offers a limited-time offer for the laptop, including delivery and
the two-year warranty for 1,180. The cost of the computer to Bellingham is
700. Any warranty repairs are assumed to be done ratably over time.
Bellingham accounts for transactions using the customer consideration model.
In the first twelve months following the sale, Bellingham incurred 980 of
costs servicing the computers under warranty.

25.

Bellingham sells ten laptops to Bertram Inc. under the limited-time promotion.
Upon delivery of the laptops to Bertram, Bellingham will recognize revenue of
a. 9,300.
b. 9,440
c. 10,000.
d. 11,800.

26.

In the first twelve months following the sale, Bellingham would reduce the
Contract liability warranty account by
a. 784.
b. 980
c. 1,180.
d. 1,380.

27.

In the first twelve months, Bellingham would record warranty expense of


a. 784.
b. 980
c. 1,180.
d. 1,380.

28.

Significant differences between IFRS and Chinese GAAP include all of the
following except
a. Chinese GAAP allows the use of LIFO while IFRS prohibits it.
b. Chinese GAAP has different related party disclosure requirements.
c. Chinese GAAP follows the cost principle while IFRS allows for
revaluations and recoveries of impairment losses.
d. Chinese GAAP uses the equity method of accounting for jointly controlled
entities while IFRS also allows proportionate consolidation.

29.

All of the following are options for non-US companies who wish to list
securities on a US exchange except
a. The company can use either IFRS or their local GAAP.
b. If a company uses their local GAAP they must reconcile net income and
shareholders equity or fully disclose all financial information required of
US companies.
c. If a company uses their local GAAP they must reconcile net income and
shareholders equity and fully disclose all financial information required of
US companies
d. The company must file a form 20-F with the SEC.

30.

All of the following are true regarding American Depository Receipts (ADRs)
except
a. Most ADRs are unsponsored, meaning that the DR bank creates a DR
program without a formal agreement with the issuing non-US company.
b. An ADR is a derivative instrument traded in the US that usually represents
a fixed number of publicly traded shares of a non-US company.
c. ADRs are denominated in US dollars.
d. A Level 1 sponsored ADR is the easiest way for a non-US company to
access US markets.

Exercise from the Textbook


Exercise 11-1
Component Depreciation SMC Company purchases a building for $100,000.
Included in this cost are $12,000 for electrical systems and $15,000 for the roof. The
building is expected to have a 40 year useful life, but the electrical system will last
for 20 years and the roof will last 15 years.
Required: Part A: Assuming that straight-line depreciation is used, compute
depreciation expense assuming that U.S. GAAP is used.

Part B: Assuming that straight line depreciation is used, compute depreciation


expense for year one assuming IFRS is used (assume component depreciation).

Problem from the Textbook


Problem 11-4

Prepare a statement of financial position using the proposed new format as described
in the chapter.
Questions from the Textbook
1. As mentioned in Chapter 1, the project on business combinations was the first
of several joint projects undertaken by the FASB and the IASB in their move
to converge standards globally. Nonetheless, complete convergence has not yet
occurred, and there are those who believe it to be a poor idea. Discuss the
reasons for and against global convergence.

2. In recent months, virtually every topic that has come to the attention of the
standard setters has been undertaken as a joint effort of the FASB and the
IASB rather than as an individual effort by one of the two boards. List and
discuss some of the joint projects that fall into this category.
3. What is the rationale for the harmonization of international accounting
standards?
4. Why is the SEC, once so reluctant to accept IAS, now very willing to allow
firms using IFRS to is-sue securities in the U.S. stock market without
reconciling to U.S. GAAP?
5. Discuss the types of ADRs that non-U.S. companies might use to access the
U.S. markets.
6. Describe the attitude of the FASB toward the IASB (International Accounting
Standards Board).
7. How does the FASB view its role in the development of an international
accounting system? Currently, two members of the IASB board were affiliated
with the FASB. Comment on what effect this might have on the likelihood that
the U.S. standard setters will accept the new IASB statements, if any?
8. List some of the major differences in accounting between IFRS and U.S.
GAAP.
Business Ethics Question from the Textbook
A vice president of marketing for your company has been charged with
embezzling nearly $100,000 from the company. The vice president allegedly
submitted fraudulent vendor invoices in order to receive payments. As the vice
president of marketing for the company, the vice president is authorized to
approve the payment of invoices submitted by third-party vendors who did work
for the company. After the activities were uncovered, the company responded by
stating: All employees are accountable to our ethics guidelines and procedures.
We do not tolerate violations of our ethics policy and will consistently enforce
these policies and procedures.
1. How would you evaluate the internal controls of the company?
2. Do you think there are companies that develop comprehensive ethics and
compliance pro-grams for mid- and lower-level employees and ignore upperlevel executives and managers?
3. Is it an ethical issue if companies are not forth-coming concerning fraudulent
activities of top executives in an effort to minimize negative publicity?
Chapter 12

Accounting for Foreign Currency Transactions And Hedging Foreign Exchange


Risk
Multiple Choice
1.

A discount or premium on a forward contract is deferred and included in the


measurement of the related foreign currency transaction if the contract is
classified as a:
a. hedge of a net investment in a foreign entity.
b. hedge of an exposed asset or liability position.
c. hedge of an identifiable foreign currency commitment.
d. contract acquired to speculate in the movement of exchange rates.

2.

The discount or premium on a forward contract entered into as a hedge of an


exposed asset or liability position should be:
a. included as a separate component of stockholders equity.
b. amortized over the life of the forward contract.
c. deferred and included in the measurement of related foreign currency
transaction.
d. none of these.

3.
An indirect exchange rate quotation is one in which the exchange rate is
quoted:
a. in terms of how many units of the domestic currency can be converted into
one unit of foreign currency.
b. for the immediate delivery of currencies exchanged.
c. in terms of how many units of the foreign currency can be converted into
one unit of domestic currency.
d. for the future delivery of currencies exchanged.
4.

A transaction gain is recorded when there is an:


a. importing transaction and the exchange rate increases.
b. exporting transaction and the exchange rate increases.
c. exporting transaction and the exchange rate decreases.
d. none of these.

5.

During 2011, a U.S. company purchased inventory from a foreign supplier.


The transaction was denominated in the local currency of the seller. The direct
exchange rate increased from the date of the transaction to the balance sheet
date. The exchange rate decreased from the balance sheet date to the
settlement date in 2012. For the years 2011 and 2012, transaction gains or
losses should be recognized as:
2011
2012
a.
gain
gain
b.
gain
loss
c.
loss
loss
d.
loss
gain

6.

A transaction gain or loss is reported currently in the determination of income


if the purpose of the forward contract is to:
a. hedge a net investment in a foreign entity.
b. hedge an identifiable foreign currency commitment.
c. speculate in foreign currency.
d. none of these.

7.

On November 1, 2011, American Company sold inventory to a foreign


customer. The account will be settled on March 1 with the receipt of $500,000
foreign currency units (FCU). On November 1, American also entered into a
forward contract to hedge the exposed asset. The forward rate is $0.70 per unit
of foreign currency. American has a December 31 fiscal year-end. Spot rates
on relevant dates were:
Date
November 1
December 31
March 1

8.

Per Unit of
Foreign Currency
$0.73
0.71
0.74

The entry to record the forward contract is


a. FCU Receivable
350,000
Premium on Forward Contract
15,000
Dollars Payable

365,000

b. Dollars Receivable
365,000
Discount on Forward Contract
FCU Payable

15,000
350,000

c. FCU Receivable
365,000
Discount on Forward Contract
Dollars Payable

15,000
350,000

d. Dollars Receivable
Discount on Forward Contract
FCU Payable

365,000

350,000
15,000

On November 1, 2011, American Company sold inventory to a foreign


customer. The account will be settled on March 1 with the receipt of $450,000
foreign currency units (FCU). On November 1, American also entered into a
forward contract to hedge the exposed asset. The forward rate is $0.70 per unit
of foreign currency. American has a December 31 fiscal year-end. Spot rates
on relevant dates were:
Date
November 1
December 31
March 1

Per Unit of
Foreign Currency
$0.73
0.71
0.74

What will be the adjusted balance in the Accounts Receivable account on


December 31, and how much gain or loss was recorded as a result of the
adjustment?
Receivable Balance
a.
$319,500
b.
$319,500
c.
$333,000
d.
$333,000
9.

Gain/Loss Recorded
$9,000 gain
$9,000 loss
$4,500 gain
$18,000 gain

A transaction gain or loss at the settlement date is:


a. a change in the exchange rate quoted by a foreign exchange trader.
b. synonymous with the translation of foreign currency financial statements
into dollars.
c. the difference between the recorded dollar amount of an account
receivable denominated in a foreign currency and the amount of dollars
received.
d. the difference between the buying and selling rate quoted by a foreign
exchange trader at the settlement date.
10.

From the viewpoint of a U.S. company, a foreign currency transaction is a


transaction:
a. measured in a foreign currency.
b. denominated in a foreign currency.
c. measured in U.S. currency.
d. denominated in U.S. currency.

11.
The exchange rate quoted for future delivery of foreign currency is the
definition of a(n):
a. direct exchange rate.
b. indirect exchange rate.
c. spot rate.
d. forward exchange rate.
12.

A transaction loss would result from:


a. an increase in the exchange rate applicable to an asset denominated in a
foreign currency.
b. a decrease in the exchange rate applicable to a liability denominated in a
foreign currency.
c. the import of merchandise when the transaction is denominated in a
foreign currency.
d. a decrease in the exchange rate applicable to an asset denominated in a
foreign currency.

13.

The forward exchange rate quoted for the remaining term of a forward
contract is used to account for the contract when the forward contract:
a. extends beyond one year or the current operating cycle.
b. is a hedge of an identifiable foreign currency commitment.
c. is a hedge of an exposed net liability position.
d. was acquired to speculate in foreign currency.

14.

A transaction gain or loss on a forward contract entered into as a hedge of an


identifiable foreign currency commitment may be:
a. included as a separate item in the stockholders equity section of the
balance sheet.
b. recognized currently in the determination of net income.
c. deferred and included in the measurement of the related foreign currency
transaction.
d. none of these.

15.

Craiger, Inc. a U.S. corporation, bought machine parts from Reinsch Company
of Germany on March 1, 2011, for 70,000 marks, when the spot rate for marks
was $0.5395. Craigers year-end was March 31, 2011, when the spot rate for
marks was $0.5445. Craiger bought 70,000 marks and paid the invoice on
April 20, 2011, when the spot rate was $0.5495. How much should be shown
in Craigers income statements as foreign exchange (transaction) gain or loss
for the years ended March 31, 2011 and 2012?
a.
b.
c.
d.

2011
$0
$0
$350 loss
$350 loss

2012
$0
$350 loss
$0
$350 loss

16.

A forward exchange contract is transacted at a discount if the current forward


rate is:
a. less than the expected spot rate.
b. more than the expected spot rate.
c. less than the current spot rate.
d. more than the current spot rate.

17.

Stuart Corporation a U.S. company, contracted to purchase foreign goods.


Payment in foreign currency was due one month after delivery. Between the
delivery date and the time of payment, the exchange rate changed in Stuarts
favor. The resulting gain should be reported in the financial statements as a(n):
a. component of other comprehensive income.
b. component of income from continuing operations.
c. extraordinary income.
d. deferred income.

18.

Jackson Paving Company purchased equipment for 350,000 British pounds


from a supplier in London on July 7, 2011. Payment in British pounds is due
on Sept. 7, 2011. The exchange rates to purchase one pound is as follows:
July 7
August 31, (year end)
September 7
Spot-rate
2.08
2.05
2.04
30-day rate
2.07
2.03
-60-day rate
2.06
1.99
-On its August 31, 2011 income statement, what amount should Jackson Paving
report as a foreign exchange transaction gain:
a. $14,000.
b. $7,000.
c. $10,500.
d. $0.

19.

On September 1, 2011, Swash Plating Company entered into two forward


exchange contracts to purchase 250,000 euros each in 90 days. The relevant
exchange rates are as follows:

September 1, 2011
September 30, 2011 (year-end)

Spot rate
1.46
1.50

Forward Rate
For Dec. 1, 2011
1.47
1.48

The first forward contract was to hedge a purchase of inventory on September


1, payable on December 1. On September 30, what amount of foreign
currency transaction loss should Swash Plating report in income?
a. $0.
b. $2,500.
c. $5,000.
d. $10,000.
20.

On September 1, 2011, Swash Plating Company entered into two forward


exchange contracts to purchase 250,000 euros each in 90 days. The relevant
exchange rates are as follows:
Spot rate
September 1, 2011
1.46
September 30, 2011 (year-end)
1.50

Forward Rate
For Dec. 1, 2011
1.47
1.48

The second forward contract was strictly for speculation. On September 30,
2011, what amount of foreign currency transaction gain should Swash Plating
report in income?
a. $0.
b. $2,500.
c. $5,000.
d. $10,000.

21.

On November 1, 2011, Prism Company sold inventory to a foreign customer.


The account will be settled on March 1 with the receipt of 250,000 foreign
currency units (FCU). On November 1, Prism also entered into a forward
contract to hedge the exposed asset. The forward rate is $0.90 per unit of
foreign currency. Prism has a December 31 fiscal year-end. Spot rates on
relevant dates were:
Date
November 1
December 31
March 1

Per Unit of
Foreign Currency
$0.93
0.91
0.94

The entry to record the forward contract is


a. FCU Receivable
225,000
Premium on Forward Contract
7,500
Dollars Payable

232,500

b. Dollars Receivable
232,500
Discount on Forward Contract
FCU Payable

7,500
225,000

c.

FCU Receivable
232,500
Discount on Forward Contract
Dollars Payable

d. Dollars Receivable
Discount on Forward Contract
FCU Payable
22.

7,500
225,000

225,000
7,500
232,500

On November 1, 2011, National Company sold inventory to a foreign


customer. The account will be settled on March 1 with the receipt of 200,000
foreign currency units (FCU). On November 1, National also entered into a
forward contract to hedge the exposed asset. The forward rate is $0.80 per unit
of foreign currency. National has a December 31 fiscal year-end. Spot rates on
relevant dates were:
Date
November 1
December 31
March 1

Per Unit of
Foreign Currency
$0.83
0.81
0.84

What will be the adjusted balance in the Accounts Receivable account on


December 31, and how much gain or loss was recorded as a result of the
adjustment?
Receivable Balance
a.
$170,000
b.
$162,000

Gain/Loss Recorded
$4,000 gain
$4,000 loss

c.
d.
23.

$168,000
$164,000

$2,000 gain
$2,000 loss

Caldron Company purchased equipment for 375,000 British pounds from a


supplier in London on July 3, 2011. Payment in British pounds is due on Sept.
3, 2011. The exchange rates to purchase one pound is as follows:
July 3
August 31, (year end)
September 3
Spot-rate
1.58
1.55
1.54
30-day rate
1.57
1.53
-60-day rate
1.56
1.49
-On its August 31, 2011, income statement, what amount should Caldron report
as a foreign exchange transaction gain:
a. $18,750.
b. $3,750.
c. $11,250.
d. $0.

24.

On April 1, 2011, Trent Company entered into two forward exchange contracts
to purchase 300,000 euros each in 90 days. The relevant exchange rates are as
follows:

April 1, 2011
April 30, 2011 (year-end)

Spot rate
1.16
1.20

Forward Rate
For Aug. 1, 2011
1.17
1.18

The first forward contract was to hedge a purchase of inventory on April 1,


payable on December 1. On April 30, what amount of foreign currency
transaction loss should Trent report in income?
a. $0.
b. $3,000.
c. $9,000.
d. $12,000.
25.

On April 1, 2011, Trent Company entered into two forward exchange contracts
to purchase 300,000 euros each in 90 days. The relevant exchange rates are as
follows:

April 1, 2011
April 30, 2011 (year-end)

Spot rate
1.16
1.20

Forward Rate
For Aug. 1, 2011
1.17
1.18

The second forward contract was strictly for speculation. On April 30, 2011,
what amount of foreign currency transaction gain should Trent report in
income.
a. $0.
b. $3,000.
c. $9,000.

d. $12,000.
Problems
12-1

On November 1, 2010, Dorsey Company sold inventory to a company in


England. The sale was for 600,000 British pounds and payment will be
received on February 1, 2011. On November 1, Dorsey entered into a forward
contract to sell 600,000 British pounds on February 1 at the forward rate of
$1.65. Spot rates for the British pound are as follows:
November 1
$1.61
December 31
1.67
February 1
1.62
Dorsey has a December 31 fiscal year-end.

Required:
Compute each of the following:
1.

The dollars to be received on February 1, 2011, from selling the 600,000


pounds to the exchange dealer.

2.

The dollars that would have been received from the account receivable if
Dorsey had not hedged the sale contract with the forward contract.

3.

The discount or premium on the forward contract.

4.

The transaction gain or loss on the exposed asset related to the sale in 2010
and 2011.

5.

The transaction gain or loss on the forward contract in 2010 and 2011.

6.

The amount of the discount or premium on the forward contract amortized in


2010 and 2011.

12-2

On December 1, 2010, Derrick Corporation agreed to purchase a machine to


be manufactured by a company in Brazil. The purchase price is 1,150,000
Brazilian reals. To hedge against fluctuations in the exchange rate, Derrick
entered into a forward contract on December 1 to buy 1,150,000 reals on April
1, the agreed date of machine delivery, for $0.375 per real. The following
exchange rates were quoted:
Forward Rate
Date
Spot Rate
(Delivery on 4/1)
December 1
0.390
0.375
December 31
0.370
0.373
April 1
0.385
--

Required:
Prepare journal entries necessary for Derrick during 2010 and 2011 to account for the
transactions described above.

12-3

Colony Corp., a U.S. corporation, entered into a contract on November 1,


2010, to sell two machines to Crown Company, for 95,000 foreign currency
units (FCU). The machines were to be delivered and the amount collected on
March 1, 2011.
In order to hedge its commitment, Colony entered into a forward contract for
95,000 FCU delivery on March 1, 2011. The forward contract met all
conditions for hedging an identifiable foreign currency commitment.
Selected exchange rates for FCU at various dates were as follows:
November 1, 2010 Spot rate
Forward rate for delivery on March 1, 2011
December 31, 2010 Spot rate
Forward rate for delivery on March 1, 2011
March 1, 2011 Spot rate

$1.3076
1.2980
1.3060
1.3150
1.2972

Required:
Prepare all journal entries relative to the above on the books of Colony Corp. on the
following dates:
1.
November 1, 2010.
2.
Year-end adjustments on December 31, 2010.
3.
March 1, 2011. (Include all adjustments related to the forward contract.)
12.4 On October 1, 2010, Nance Company purchased inventory from a foreign
customer for 750,000 units of foreign currency (FCU) due on January 31, 2011.
Simultaneously, Nance entered into a forward contract for 750,000 units of FC
for delivery on January 31, 2011, at the forward rate of $0.75. Payment was
made to the foreign customer on January 31, 2011. Spot rates on October 1,
December 31, and January 31, were $0.72, $0.73, and $0.76, respectively.
Nance amortizes all premiums and discounts on forward contracts and closes
its books on December 31.
Required:
A.
B.
C.

Prepare all journal entries relative to the above to be made by Nance on


October 1, 2010.
Prepare all journal entries relative to the above to be made by Nance on
December 31, 2010.
Compute the transaction gain or loss on the forward contract that would be
recorded in 2011. Indicate clearly whether the amount is a gain or loss.

12.5 On October 1, 2010, Kline Company shipped equipment to a foreign customer


for a foreign currency (FC) price of FC 3,000,000 due on January 31, 2011. All
revenue realization criteria were satisfied and accordingly the sale was recorded
by Kline Company on October 1. Simultaneously, Kline entered into a forward
contract to sell 3,000,000 FCU on January 31, 2011 for $1,200,000. Payment
was received from the foreign customer on January 31, 2011. Spot rates on

October 1, December 31, and January 31 were $0.42, $0.425, and $0.435,
respectively. Kline amortizes all premiums and discounts on forward contracts
and closes its books on December 31.
Required:
Prepare all journal entries relative to the above to be made by Kline during 2010 and
2011.
12-6

On July 15, Worth, Inc. purchased 88,500,000 yen worth of parts from a
Tokyo company paying 20% down, and the balance is due in 90 days. Interest
is payable at a rate of 8% on the unpaid balance. The exchange rate on July
15, was $1.00 = 118 Japanese yen. On October 13, the exchange rate was
$1.00 = 114 Japanese yen.

Required:
Prepare journal entries to record the purchase and payment of this foreign currency
transaction in U.S. dollars.
12-7

On November 1, 2010, Bisk Corporation, a calendar-year U.S. Corporation,


invested in a speculative contract to purchase 700,000 euros on January 31,
2011, from a German brokerage firm. Bisk agreed to buy 700,000 euros at a
fixed price of $1.46 per euro. The brokerage firm agreed to send 700,000
euros to Bisk on January 31, 2011. The spot rates for euros are:
November 1, 2010
December 31, 2010
January 31, 2011

1 euro = 1.45
1 euro = 1.43
1 euro = 1.44

Required:
Prepare the journal entries that Bisk would record on November 1, December 31, and
January 31.
12.8

Consider the following information:


1.

On November 1, 2011, a U.S. firm contracts to sell equipment (with an


asking price of 500,000 pesos) in Mexico. The firm will take delivery and
will pay for the equipment on February 1, 2012.

2.

On November 1, 2011, the company enters into a forward contract to sell


500,000 pesos for $0.0948 on February 1, 2012.

3.

Spot rates and the forward rates for February 1, 2012, settlement were as
follows (dollars per peso):

November 1, 2011
Balance sheet date (12/31/11)
February 1, 2012

Spot Rate
$0.0954
0.0949
0.0947

Forward Rate
for 2/1/12
$0.0948
0.0944

4.

On February 1, the equipment was sold for 500,000 pesos. The cost of the
equipment was $20,000.

Required:
Prepare all journal entries needed on November 1, December 31, and February 1 to
account for the forward contract, the firm commitment, and the transaction to sell the
equipment.
Short Answer
1.
2.

Accounting for a foreign currency transaction involves the terms measured and
denominated. Describe a foreign currency transaction and distinguish between
the terms measured and denominated.
There are a number of business situations in which a firm may acquire a forward
exchange contract. Identify three common situations in which a forward
exchange contract can be used as a hedge.

Short Answer Questions from the Textbook


1.

Define currency exchange rates and distinguish between direct and indirect
quotations.

2.

Explain why a firm is exposed to an added risk when it enters into a transaction that is
to be settled in a foreign currency.

3.

Name the three stages of concern to the accountant in accounting for importexport
transactions. Briefly explain the accounting for each stage.

4.

How should a transaction gain or loss be reported that is related to an unsettled


receivable recorded when the firms inventory was exported?

5.

A U.S. firm carried a receivable for 100,000 yen. Assuming that the direct exchange
rate declined from $.009 at the date of the transaction to $.006at the balance sheet
date, compute the transaction gain or loss. What balance would be reported for the
receivable in the firms balance sheet?

6.

Explain what is meant by the two-transaction method in recording exporting or


importing trans-actions. What support is given for this method?

7.

Describe a forward exchange contract.

8.

Explain the effects on income from hedging a foreign currency exposed net asset
position or net liability position.

9.

What criteria must be satisfied for a foreign currency transaction to be considered a


hedge of an identifiable foreign currency commitment?

10.

The FASB classifies forward contracts as those acquired for the purpose of hedging
and those acquired for the purpose of speculation. What main differences are there in
accounting for these two classifications?

11.

How are foreign currency exchange gains and losses from hedging a forecasted
transaction handled?

12.

What is a put option, and how might it be used to hedge a forecasted transaction?

13.

Define a derivative instrument, and describe the keystones identified by the FASB for
the ac-counting for such instruments.

14.

Differentiate between forward-based derivatives and option-based derivatives.

15.

List some of the criteria laid out by the FASB that are required for a gain or loss on
forecasted trans-actions (a cash flow hedge) to be excluded from the income
statement. If these criteria are satisfied, where are the gains or losses reported, and
when (if ever) are they shown in the income statement? What is the rationale for this
treatment?

Business Ethics Question from Textbook


Executive stock options (ESOs) are used to provide incentives for executives to
improve company performance. ESOs are usually granted at-the-money, meaning
that the exercise price of the options is set to equal the market price of the underlying
stock on the grant date. Clearly, executives would prefer to be granted options when
the stock price (and thus the exercise price) is at its lowest. Backdating options is the
practice of choosing a past date when the market price was particularly low.
Backdating has not, in the past, been illegal if no documents are forged, if
communicated to the shareholders, and if properly reflected in earnings and in taxes.
1. Since backdating gives the executive an instant profit, why wouldnt the
firm simply grant an option with the exercise price lower than the cur-rent
market price?
2. Suppose the executive was not involved in back-dating the ESOs. Does the
executive face any ethical issues?

Chapter 13
Translation of Financial Statements of Foreign Affiliates
Multiple Choice

1.

When translating foreign currency financial statements for a company whose


functional currency is the U.S. dollar, which of the following accounts is
translated using historical exchange rates?
a.
b.
c.
d.

Notes Payable
Yes
Yes
No
No

Equipment
Yes
No
No
Yes

2.

Under the temporal method, monetary assets and liabilities are translated by
using the exchange rate existing at the:
a. beginning of the current year.
b. date the transaction occurred.
c. balance sheet date.
d. None of these.

3.

The process of translating the accounts of a foreign entity into its functional
currency when they are stated in another currency is called:
a. verification.
b. translation.
c. remeasurement.
d. None of these.

4.

Which of the following would be restated using the average exchange rate
under the temporal method?
a. cost of goods sold
b. depreciation expense
c. amortization expense
d. None of these

5.

Paid-in capital accounts are translated using the historical exchange rate under:
a. the current rate method only.
b. the temporal method only.
c. both the current rate and temporal methods.
d. neither the current rate nor temporal methods.

6.

Which of the following would be restated using the current exchange rate
under the temporal method?
a. Marketable securities carried at cost.
b. Inventory carried at market.
c. Common stock.
d. None of these.

7.

The translation adjustment that results from translating the financial


statements of a foreign subsidiary using the current rate method should be:
a. included as a separate item in the stockholders' equity section of the
balance sheet.
b. included in the determination of net income for the period it occurs.
c. deferred and amortized over a period not to exceed forty years.

d. deferred until a subsequent year when a loss occurs and offset against that
loss.
8.

Average exchange rates are used to translate certain items from foreign
financial statements into U.S. dollars. Such averages are used in order to:
a. smooth out large translation gains and losses.
b. eliminate temporary fluctuation in exchange rates that may be reversed in
the next fiscal period.
c. avoid using different exchange rates for some revenue and expense
accounts.
d. approximate the exchange rate in effect when the items were recognized.

9.

When the functional currency is identified as the U.S. dollar, land purchased
by a foreign subsidiary after the controlling interest was acquired by the parent
company should be translated using the:
a. historical rate in effect when the land was purchased.
b. current rate in effect at the balance sheet date.
c. forward rate.
d. average exchange rate for the current period.

10.

The appropriate exchange rate for translating a plant asset in the balance sheet
of a foreign subsidiary in which the functional currency is the U.S. dollar is
the:
a. current exchange rate.
b. average exchange rate for the current year.
c. historical exchange rate in effect when the plant asset was acquired or the
date of acquisition, whichever is later.
d. forward rate.

11.

The following balance sheet accounts of a foreign subsidiary at December 31,


2011, have been translated into U.S. dollars as follows:
Translated at
Current Rates Historical Rates
Accounts receivable, current
$ 600,000
$ 660,000
Accounts receivable, long-term
300,000
324,000
Inventories carried at market
180,000
198,000
Goodwill
190,000
220,000
$1,270,000
$1,402,000
What total should be included in the translated balance sheet at December 31,
2011, for the above items? Assume the U.S. dollar is the functional currency.
a. $1,270,000
b. $1,288,000
c. $1,300,000
d. $1,354,000

12.

A foreign subsidiary's functional currency is its local currency which has not
experienced significant inflation. The weighted average exchange rate for the
current year would be the appropriate exchange rate for translating

a.
b.
c.
d.
13.

Wages expense
Yes
Yes
No
No

Sales to customers
Yes
No
No
Yes

A wholly owned subsidiary of a U.S. parent company has certain expense


accounts for the year ended December 31, 2011, stated in local currency units
(LCU) as follows:
LCU
Depreciation of equipment (related assets
were purchased January 1, 2009)
375,000
Provision for doubtful accounts
250,000
Rent
625,000
The exchange rates at various dates are as follows:
Dollar equivalent
of 1 LCU
December 31, 2011
$0.50
Average for year ended December 31, 2011
0.55
January 1, 2009
0.40
Assume that the LCU is the subsidiary's functional currency and that the
charges to the expense accounts occurred approximately evenly during the
year. What total dollar amount should be included in the translated income
statement to reflect these expenses?
a.
b.
c.
d.

$687,500
$625,000
$550,000
$500,000

14.

If the functional currency is determined to be the U.S. dollar and its financial
statements are prepared in the local currency, SFAS 52, requires which of the
following procedures to be followed?
a. Translate the financial statements into U.S. dollars using the current rate
method.
b. Remeasure the financial statements into U.S. dollars using the temporal
method.
c. Translate the financial statements into U.S. dollars using the temporal
method.
d. Remeasure the financial statements into U.S. dollars using the current rate
method.

15.

P Company acquired 90% of the outstanding common stock of S Company


which is a foreign company. The acquisition was accounted for using the
purchase method. In preparing consolidated statements, the paid-in capital of S
Company should be converted at the:
a. exchange rate effective when S Company was organized.

b. exchange rate effective on the date of purchase of the stock of S Company


by P Company.
c. average exchange rate for the period S Company stock has been upheld by
P Company.
d. current exchange rate.
16.

In preparing consolidated financial statements of a U.S. parent company and a


foreign subsidiary, the foreign subsidiarys functional currency is the currency:
a. of the country the parent is located.
b. of the country the subsidiary is located.
c. in which the subsidiary primarily generates and spends cash.
d. in which the subsidiary maintains its accounting records.

17.

Gains from remeasuring a foreign subsidiarys financial statements from the


local currency, which is not the functional currency, into the parent companys
currency should be reported as a(n):
a. other comprehensive income item.
b. extraordinary item (net of tax).
c. part of continuing operations.
d. deferred credit.

18.

Assuming no significant inflation, gains resulting from the process of


translating a foreign entitys financial statements from the functional currency
to U.S. dollars should be included as a(n):
a. other comprehensive income item.
b. extraordinary item (net of tax).
c. part of continuing operations.
d. deferred credit.

19.

A foreign subsidiarys functional currency is its local currency and inflation of


over 100 percent has been experienced over a three-year period. For
consolidation purposes, SFAS No. 52 requires the use of:
the current rate method only.
the temporal method only
both the current rate and temporal methods.
neither the current rate or the temporal method.

a.
b.
c.
d.
20.

The objective of remeasurement is to:


a.
produce the same results as if the books were maintained in the
currency of the foreign entitys
largest customer.
b.
produce the same results as if the books were maintained solely in the
local currency.
c.
produce the same results as if the books were maintained solely in the
functional currency.
d.
None of the above.

Problems
13-1

Ramsey, Inc. owns a company that operates in France. Account balances in


francs for the subsidiary are shown below:

Cash and Receivables


Supplies
Property, Plant, and Equipment
Accounts Payable
Long-term Notes Payable
Common Stock
Retained Earnings
Dividends-Declared & Paid on Dec 31
Revenues
Operating Expenses
Totals

January 1
24,000
1,000
52,500
(11,500)
(19,000)
(30,000)
(17,000)
----------0-

2011
December 31
26,000
500
49,000
(5,500)
(11,000)
(30,000)
(17,000)
3,000
(30,000)
15,000
-0

Exchange rates for 2011 were as follows:


January 1
$0.22
Average for the year
0.19
December 31
0.18
Revenues were earned and operating expenses, except for depreciation and
supplies used, were incurred evenly throughout the year. No purchases of
supplies or plant assets were made during the year.
Required:
A.
Prepare a schedule to compute the translation adjustment for the year,
assuming the subsidiary's functional currency is the franc.
B.

Prepare a schedule to compute the translation gain or loss, assuming the


subsidiary's functional currency is the U.S. dollar.

13-2

Sloop Sails Corporation, a U.S. company, operates a 100%-owned British


subsidiary, Sewart Corporation. The U.S. dollar is the functional currency of
the subsidiary. Financial statements for the subsidiary for the fiscal year-end
December 31, 2011, are as follows:
Sewart Corporation
Income Statement
Sales
Cost of Goods Sold
Beginning Inventory
Purchases
Goods Available For Sale
Less: Ending Inventory
Cost of Goods Sold
Depreciation
Selling and Admin. Expenses
Income Taxes

Pounds
650,000
310,000
265,000
575,000
285,000
290,000
79,000
155,000
32,000

556,000

Net Income

94,000
Sewart Corporation
Partial Balance Sheet

Current Assets
Cash
Accts. Rec.
Inventories

155,000
171,000
285,000
611,000

Current Liabilities
Notes Payable
Accts. Payable
Other Current Liab.
Long-term Liab.
(issued July 1, 2009)

78,000
165,000
51,000
294,000
250,000

Other Information:
1. Equipment costing 340,000 pounds was acquired July 1, 2009, and 38,000
was acquired June 30, 2011. Depreciation for the period was as follows:
Equipment 2009 acquisitions
66,000
2011 acquisitions
6,000
2. The beginning inventory was acquired when the exchange rate was $1.77.
The inventory is valued on a FIFO basis. Purchases and the ending
inventory were acquired evenly throughout the period.
3. Dividends were paid by the subsidiary on June 30 amounting to 156,000
pounds.
4. Sales were made and all expenses were incurred uniformly throughout the
year.
5. Exchange rates for the pound on various dates were:
July 1, 2009
Jan. 1, 2011
June 30, 2011
Dec. 31, 2011
Average for 2011

$1.79
1.75
1.74
1.71
1.73

13-2 (Continued)
Required:
A.
Prepare a schedule to determine the translation gain or loss for 2010, assuming
the net monetary liability position on January 1, 2011, was 180,000 pounds.
B.

Compute the dollar amount that each of the following would be reported at in
the 2011 financial statements:
1. Cost of Goods Sold.
2. Depreciation Expense.
3. Equipment.

13-3

Accounts are listed below for a foreign subsidiary that maintains its books in
its local currency. The equity interest in the subsidiary was acquired in a
purchase transaction. In the space provided, indicate the exchange rate that

would be used to translate the accounts into dollars assuming the functional
currency was identified (a) as the U.S. dollar and (b) as the foreign entity's
local currency. Use the following letters to identify the exchange rate:
H Historical exchange rate
C Current exchange rate
A Average exchange rate for the current period
Exchange rate if the
functional currency is:
U.S. Dollar
Local currency

Account
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.

Bonds Payable (issued 01/01/08)


Office Supplies
Dividends Declared
Common Stock
Additional Paid-In Capital
Inventory Carried at Cost
Short-term Notes Payable
Accumulated Depreciation
Cash
Marketable Securities (carried
at market)
Cost of Goods Sold
Sales
Accounts Receivable
Depreciation Expense
Income Tax Expense

___________
___________
___________
___________
___________
___________
___________
___________
___________

______________
______________
______________
______________
______________
______________
______________
______________
______________

___________
___________
___________
___________
___________
___________

______________
______________
______________
______________
______________
______________

Use the following information to answer Problems 13-4 and 13-5.


On January 2, 2011, Promo Inc., a U.S. parent company, purchased a 100%
interest in Spot Company, a subdivision located in Switzerland. The purchase
method of accounting was used to account for the acquisition. The 2011
financial statements for Spot Company, the subsidiary, in Swiss francs were as
follows:
Comparative Balance Sheets
Cash
Accounts receivable
Plant and equipment (net) (purchased 6/30/08)
Land (purchased 6/30/08)
Total

Jan. 2
15,000
45,000
75,000
45,000
180,000

Dec. 31
33,000
49,500
67,500
45,000
195,000

Accounts payable
Long-term notes payable (issued 6/30/08)
Common stock (issued 6/30/08)
Retained earnings
Total

13,500
31,500
90,000
45,000
180,000

18,000
27,000
90,000
60,000
195,000

Income Statement
Revenues
Operating expenses including depreciation
of 7,500 francs
Net income
Beginning retained earnings
Dividends declared and paid
Ending retained earnings

180,000
135,000
45,000
45,000
90,000
30,000
60,000

Sales were earned and operating expenses were incurred evenly during the
year.
Exchange rates for the franc at various dates are:
January 2, 2011
December 31, 2011
Average for 2011
December 10, 2011, dividend payment date
June 30, 2008
13-4

0.8600
0.8830
0.8715
0.8810
0.8316

Use the above information to answer the following question:

Required:
Translate the year-end financial statements of Spot Company, the foreign subsidiary,
using the temporal method. Round numbers to the nearest dollar.
13-5

Use the above information to answer the following question:

Required:
Prepare a schedule to compute the translation gain or loss for Spot Company,
assuming the temporal method of translation. Round numbers to the nearest dollar.

13.6

Bass Corporation, a U.S. Company, formed a subsidiary with a new company


in London on January 1, 2011, by investing 500,000 British pounds in
exchange for all of the subsidiarys common stock. The subsidiary purchased
land for 100,000 pounds and a building for 300,000 pounds on July 1, 2011.
The building is being depreciated over a 40-year life by the straight-line
method. The inventory is valued on an average cost basis. The British pound is
the subsidiarys functional currency and its reporting currency and has not
experienced any abnormal inflation. Exchange rates for the pound on various
dates were:
January 1, 2011
July 1, 2011
December 31, 2011
2011 average rate

1 pound = 1.81
1 pound = 1.86
1 pound = 1.83
1 pound = 1.82

The subsidiarys adjusted trial balance is presented below for the year ended
December 31, 2011.
Debits
Cash
Accounts receivable
Inventory
Land
Building
Depreciation expense
Cost of goods sold
Other expenses
Total debits

In Pounds
200,000
60,000
80,000
100,000
300,000
3,750
213,750
90,000
1,047,500

Credits
Accumulated depreciation
Accounts payable
Accrued liabilities
Common stock
Retained earnings
Sales revenue
Total credits

3,750
84,000
16,750
500,000
- 0 443,000
1,047,500

Required: Prepare the subsidiarys:


A.
Translated workpapers (round to the nearest dollar)
B.
Translated income statement
C.
Translated balance sheet
13.7

Using the information provided in Problem 13-6, use the temporal method
instead of the current rate method.
Required: Prepare the subsidiarys:
A.
Translated workpapers (round to the nearest dollar)
B.
Translated income statement
C.
Translated balance sheet

13-8
On January 1, 2011, Roswell Systems, a U.S.-based company, purchased a controlling
interest in Swiss Management Consultants located in Zurich, Switzerland. The
acquisition was treated as a purchase transaction. The 2011 financial statements stated
in Swiss francs are given below.
SWISS MANAGEMENT CONSULTANTS
Comparative Balance Sheets
January 1 and December 31, 2011
Jan. 1
Dec. 31
Cash and Receivables
Net Property, Plant, and Equipment
Totals

30,000
60,000
90,000

84,000
56,000
140,000

Accounts and Notes Payable


Common Stock
Retained Earnings
Totals

45,000
30,000
15,000
90,000

50,000
30,000
60,000
140,000

SWISS MANAGEMENT CONSULTANTS


Consolidated Income and Retained Earnings Statement
For the Year Ended December 31, 2011
Revenues
Operating Expenses including depreciation of 5,000 francs
Net income
Dividends Declared and Paid
Increase in Retained Earnings

112,000
45,000
67,000
22,000
45,000

Direct exchange rates for Swiss franc are:


January 1, 2011
December 31, 2011
Average for 2011
Dividend declaration and payment date

U.S. Dollars per Franc


$0.9987
0.9321
0.9654
0.9810

Required:
A. Translate the year-end balance sheet and income statement of the foreign
subsidiary using the current rate method of translation.
B. Prepare a schedule to verify the translation adjustment.
Short Answer

1.

To accomplish the objectives of translation, two translation methods are used


depending on the functional currency of the foreign entity. Describe the two
translation methods.

2.

The translation process can be done using either the current rate method or the
temporal method. Explain under what circumstances each of the methods is
appropriate.

Short Answer Questions from the Textbook


1.

What requirements must be satisfied if a foreign subsidiary is to be


consolidated?

2.

What is meant by an entitys functional currency and what are the economic
indicators identified by the FASB to provide guidance in selecting the
functional currency?

3.

The __________is the functional currency of a foreign subsidiary with


operations that are relatively self-contained and integrated within the country
in which it is located. In such cases, the__________ method of translation
would be used to translate the accounts into dollars.

4.

The __________is the functional currency of a foreign subsidiary that is a


direct and integral component or extension of a U.S. parent company. In such
cases, the __________method of translation is used to translate (remeasure)
the accounts into dollars.

5.

Which method of translation is used to convert the financial statements when a


foreign subsidiary operates in a highly inflationary economy?

6.

Define remeasurement.

7.

Under the current rate method, how are assets and liabilities that are stated in a
foreign currency translated?

8.

Under the current rate method, describe how the various balance sheet
accounts are translated (including the equity accounts) and how this translation
affects the computation of various ratios (such as debt to equity or the current
ratio). In particular, discuss whether or not the ratios will change when
computed in local currencies and compared to their calculations (after
translation) using the parents currency.

9.

What is the objective of the temporal method of translation?

10.

Assuming that the temporal method is used, how are revenue and expense
items in foreign currency financial statements converted?

11.

A translation adjustment results from the process of translating financial


statements of a foreign subsidiary from its functional currency into dollars.

Where is the translation adjustment reported in the financial statements if the


current rate method is used to translate the accounts?
Business Ethics Question from the Textbook
The Shady Tree Company is preparing to announce their quarterly earnings numbers.
The company expectsto beat the analysts forecast of earnings by at least5cents a
share. In anticipation of the increase instockvalue and before the release of the
earnings numbers, the company issued stock options to the top executives in the firm,
with the option price equal to todays market price.
1.
This type of executive stock option is often re-ferred to as spring-loading.
Do you think this practice should be allowed? Does it provide in-formation
about the integrity of the firm or is this just good business practice?
2.
Do you think this practice violates the insider trading rules?

Chapter 14
Reporting for Segments and for Interim Financial Periods
1.

A component of an enterprise that may earn revenues and incur expenses, and
about which management evaluates separate financial information in deciding
how to allocate resources and assess performance is a(n)
a. identifiable segment.
b. operating segment.
c. reportable segment.
d. industry segment.

2.

An entity is permitted to aggregate operating segments if the segments are


similar regarding the
a. nature of the production processes.
b. types or class of customers.
c. methods used to distribute products or provide services.
d. all of these.

3.

Which of the following is not a segment asset of an operating segment?


a. Assets used jointly by more than one segment.
b. Assets directly associated with a segment.
c. Assets maintained for general corporate purposes.
d. Assets used exclusively by a segment.

4.

SFAS No. 131 requires the disclosure of information on an enterprise's


operations in different industries for
1. each annual period presented.
2. each interim period presented.
3. the current period only.
a. 1
b. 2

c. 3
d. both 1 and 2
5.

Which of the following is not required to be disclosed by SFAS No. 131?


a. Information concerning the enterprise's products.
b. Information related to an enterprise's foreign operations.
c. Information related to an enterprise's major suppliers.
d. All of the above are required disclosures.

6.

To determine whether a substantial portion of a firm's operations are explained


by its segment information, the combined revenue from sales to unaffiliated
customers of all reportable segments must constitute at least
a. 10% of the combined revenue of all operating segments.
b. 75% of the combined revenue of all operating segments.
c. 10% of the combined revenue from sales to unaffiliated customers of all
operating segments.
d. 75% of the combined revenue from sales to unaffiliated customers of all
operating segments.

7.

A segment is considered to be significant if its


1. reported profit is at least 10% of the combined profit of all operating
segments.
2. reported profit (loss) is at least 10% of the combined reported profit of
all operating segments not reporting a loss.
3. reported profit (loss) is at least 10% of the combined reported loss of
all operating segments that reported a loss.
a. 1
b. 2
c. 3
d. both 2 and 3

8.

Which of the following disclosures is not required to be presented for a firm's


reportable segments?
a. Information about segment assets
b. Information about the bases for measurement
c. Reconciliation of segment amounts and consolidated amounts for revenue,
profit or loss, assets, and other significant items.
d. All of these must be presented.

9.

Current authoritative pronouncements require the disclosure of segment


information when certain criteria are met. Which of the following reflects the
type of firm and type of financial statement for which this disclosure is
required?
a. Annual financial statements for publicly held companies.
b. Annual financial statements for both publicly held and nonpublicly held
companies.
c. Annual and interim financial statements for publicly held companies.
d. Annual and interim financial statements for both publicly held and
nonpublicly held companies.

10.

An enterprise determines that it must report segment data in annual reports for
the year ended December 31, 2011. Which of the following would not be an
acceptable way of reporting segment information?
a. Within the body of the financial statements, with appropriate explanatory
disclosures in the footnotes
b. Entirely in the footnotes to the financial statements.
c. As a special report issued separately from the financial statements.
d. In a separate schedule that is included as an integral part of the financial
statements.

11.

Selected data for a segment of a business enterprise are to be separately


reported in accordance with SFAS No. 131 when the revenues of the segment
is 10% or more of the combined
a. net income of all segments reporting profits.
b. external and internal revenue of all reportable segments.
c. external revenue of all reportable segments.
d. revenues of all segments reporting profits.

12.

Long Corporation's revenues for the year ended December 31, 2011, were as
follows
Consolidated revenue per income statement $800,000
Intersegment sales
105,000
Intersegment transfers
35,000
Combined revenues of all operating segments $940,000
Long has a reportable segment if that segment's revenues exceed
a. $80,000.
b. $90,500.
c. $94,000.
d. $14,000.

13.

Revenue test
(dollars in thousands)
Wholesale
Retail
Finance
Segment
Segment
Segment
Sales to unaffiliated customers
$3,600
$1,500
$-0Sales intersegment
400
240
-0Loan interest income intersegment
-0120
900
Loan interest income unaffiliated
-0240
80
Income from equity method investees
-0280
-0Determine the amount of revenue for each of the three segments that would be
used to identify the reportable industry segments in accordance with the
revenues test specified by SFAS 131.
a.
b.
c.

Wholesale Retail
$3,600
$1,500
4,000
1,740
4,000
1,980

Finance
$ -0-0980

d.

4,000

2,380

980

14.

Which of the following is not part of the information about foreign operations
that is required to be disclosed?
a. Revenues from external customers
b. Operating profit or loss, net income, or some other common measure of
profitability
c. Capital expenditures
d. Long-lived assets

15.

Eaton, Inc., discloses supplemental industry segment information. The


following data are available for 2011.
Traceable
Segment
Sales
operating expenses
A
$420,000
$255,000
B
480,000
300,000
C
300,000
165,000
$1,200,000
$720,000
Additional 2011 expenses, not included above, are as follows:
Indirect operating expenses
General corporate expenses

$240,000
180,000

Appropriate common expenses are allocated to segments based on the ratio of


a segment's sales to total sales. What should be the operating profit for
Segment C for 2011?
a. $135,000
b. $ 75,000
c. $ 105,000
d. $ 30,000
16.

Gant Company has four manufacturing divisions, each of which has been
determined to be a reportable segment. Common operating costs are
appropriately allocated on the basis of each division's sales in relation to
Gants aggregate sales. Gants Delta division accounted for 40% of Gant's
total sales in 2011. For the year ended December 31, 2011, Delta had sales of
$5,000,000 and traceable costs of $3,600,000. In 2011, Gant incurred
operating costs of $350,000 that were not directly traceable to any of the
divisions. In addition, Gant incurred interest expense of $360,000 in 2011. In
reporting supplementary segment information, how much should be shown as
Delta's operating profit for 2011?
a. $1,400,000
b. $1,256,000
c. $1,260,000
d. $1,116,000

17.

For external reporting purposes, it is appropriate to use estimated gross profit


rates to determine the ending inventory value for

a.
b.
c.
d.

Interim
Reporting
No
No
Yes
Yes

Annual
Reporting
No
Yes
No
Yes

18.

Inventory losses from market declines that are expected to be temporary


a. should be recognized in the interim period in which the decline occurs.
b. should be recognized in the last (fourth) quarter of the year in which the
decline occurs.
c. should not be recognized.
d. none of these.

19.

Gains and losses that arise in an interim period should be


a. recognized in the interim period in which they arise.
b. recognized in the last quarter of the year in which they arise.
c. allocated equally among the remaining interim periods.
d. deferred and included only in the annual income statement.

20.

If a cumulative effect type accounting change is made during the first interim
period of a year
a. no cumulative effect of the change should be included in net income of the
period of change.
b. the cumulative effect of the change on retained earnings at the beginning
of the year should be included in net income of the first interim period.
c. the cumulative effect of the change should be allocated to the current and
remaining interim periods of the year.
d. none of these.

21.

Which of the following does not have to be disclosed in interim reports?


a. Seasonal costs or expenses.
b. Significant changes in estimates.
c. Disposal of a segment of a business.
d. All of these must be disclosed.

22.

For interim financial reporting, the effective tax rate should reflect

a.
b.
c.
d.
23.

Anticipated Extraordinary
Tax Credits
Items
Yes
Yes
Yes
No
No
Yes
No
No

Companies using the LIFO method may encounter a liquidation of base period
inventories at an interim date that is expected to be replaced by the end of the
year. In these cases, cost of goods sold should be charged with the
a. cost of the most recent purchases.
b. average cost of the liquidated LIFO base.

c. expected replacement cost of the liquidated LIFO base.


d. none of these.
24.

In considering interim financial reporting, how did the Accounting Principles


Board conclude that each reporting should be viewed?
a. As a "special" type of reporting that need not follow generally accepted
accounting principles.
b. As useful only if activity is evenly spread throughout the year so that
estimates are unnecessary.
c. As reporting for a basic accounting period.
d. As reporting for an integral part of an annual period.

25.

When a company issues interim financial statements, extraordinary items


should be
a. allocated to the current and remaining interim periods of the current year
on a pro rata basis.
b. deferred and included only in the annual income statement.
c. included in the determination of net income in the interim period in which
they occur.
d. charged or credited directly to retained earnings so that comparisons of
interim results of operations will not be distorted.

26.

If annual major repairs made in the first quarter and paid for in the second
quarter clearly benefit the entire year, when should they be expensed?
a. An allocated portion in each of the last three quarters
b. An allocated portion in each quarter of the year
c. In full in the first quarter
d. In full in the second quarter

27.

During the second quarter of 2011, Dodge Company sold a piece of equipment
at a gain of $90,000. What portion of the gain should Dodge report in its
income statement for the second quarter of 2011?
a. $90,000
b. $45,000
c. $30,000
d. $ -0-

28.

In January 2011, Abel Company paid $200,000 in property taxes on its plant
for the calendar year 2011. Also in January 2011, Abel estimated that its yearend bonuses to executives for 2011 would be $800,000. What is the amount of
expenses related to these two items that should be reflected in Abel's quarterly
income statement for the three months ended June 30, 2011 (second quarter)?
a. $ -0b. $250,000
c. $ 50,000
d. $200,000

29.

For interim financial reporting, a company's income tax provision for the
second quarter of 2011 should be determined using the
a. statutory tax rate for 2011.

b. effective tax rate expected to be applicable for the full year of 2011 as
estimated at the end of the first quarter of 2011.
c. effective tax rate expected to be applicable for the full year of 2011 as
estimated at the end of the second quarter of 2011.
d. effective tax rate expected to be applicable for the second quarter of 2011.
30.

Which of the following reporting practices is permissible for interim financial


reporting?
a. Use of the gross profit method for interim inventory pricing.
b. Use of the direct costing method for determining manufacturing
inventories.
c. Deferral of unplanned variances under a standard cost system until yearend.
d. Deferral of inventory market declines until year-end.

31.

Which of the following statements most accurately describes interim period


tax expense?
a. The best estimate of the annual tax rate times the ordinary income (loss)
for the quarter.
b. The best estimate of the annual tax rate times income (loss) for the year to
date less tax expense (benefit) recognized in previous interim periods.
c. Average tax rate for each quarter, including the current quarter, times the
current income (loss).
d. The previous year's actual effective tax rate times the current quarter's
income.

32.

The computation of a company's third quarter provision for income taxes


should be based upon earnings
a. for the quarter at an expected annual effective income tax rate.
b. for the quarter at the statutory rate.
c. to date at an expected annual effective income tax rate less prior quarters'
provisions.
d. to date at the statutory rate less prior quarters' provisions.

33.

Finney, a calendar year company, has the following income before income tax
provision and estimated effective annual income tax rates for the first three
quarters of 2011:

Quarter
First
Second
Third

Income Before Estimated Effective


Income Tax
Annual Tax Rate
Provision at the End of Quarter
$120,000
25%
160,000
25%
200,000
30%

Finney's income tax provision in its interim income statement for the third
quarter should be
a. $74,000.
b. $60,000.
c. $50,000.

d. $144,000.
34.

An inventory loss from a market price decline occurred in the first quarter. The
loss was not expected to be restored in the fiscal year. However, in the third
quarter the inventory had a market price recovery that exceeded the market
decline that occurred in the first quarter. For interim reporting, the dollar
amount of net inventory should
a. decrease in the first quarter by the amount of the market price decline and
increase in the third quarter by the amount of the market price recovery.
b. decrease in the first quarter by the amount of the market price decline and
increase in the third quarter by the amount of the decrease in the first
quarter.
c. not be affected in the first quarter and increase in the third quarter by the
amount of the market price recovery that exceeded the amount of the
market price decline.
d. not be affected in either the first quarter or the third quarter.

35.
Advertising costs may be accrued or deferred to provide an appropriate
expense in each period for
Interim
Annual
Reporting
Reporting
a.
Yes
No
b.
Yes
Yes
c.
No
No
d.
No
Yes
Problems
14-1

The following information is available for Torrey Company for 2011:


a. In early April Torrey made major repairs to its equipment at a cost of
$90,000. These repairs will benefit the remainder of 2011 operations.
b. At the end of May, Torrey sold machinery with a book value of $35,000
for $45,000.
c. An inventory loss of $60,000 from market decline occurred in July. In the
fourth quarter the inventory had a market value recovery that exceeded the
market decline by $30,000.
Required:
Compute the amount of expense/loss that would appear in Torrey Company's
June 30, September 30, and December 31, 2011, quarterly financial
statements.

14-2

Stein Corporation's operations involve three industry segments, X, Y, and Z.


During 2011, the operating profit (loss) of each segment was:
Operating
Segment
Profit (Loss)
X
$ 600

Y
Z

8,100
(6,300)

Required:
Determine which of the segments are reportable segments.
14-3

Bass Industries operates in four different industries. Information concerning


the operations of these industries for the year 2011 is:
Revenue
Industry
Segment
A
B
C
D

Total
$ 24,000
18,000
90,000
168,000
$300,000

Operating
Segment
Intersegment Profit (Loss)
Assets
$4,200
$ 2,700
$ 22,400
2,200
(2,000)
25,200
14,000
3,600
70,000
-023,700
162,400
$28,000
$280,000

Required:
Complete the following schedule to determine which of the above segments
must be treated as reportable segments.
10% Test For
Segment
Revenue
Op. Profit (Loss)
Segment Assets
Reportable?
A
B
C
D
14-4

Logan Company prepares quarterly financial statements. The following


information is available concerning calendar year 2011:
Estimated full-year earnings
Full-year permanent differences:
Penalty for pollution
Estimated dividend income exclusion
Actual pretax earnings, 1/1/11 to 3/31/11
Nominal income tax rate

$3,000,000
150,000
60,000
480,000
40%

Required:
Compute the income tax provision for the first quarter of 2011.
14.5

XYZ Corporation has eight industry segments with sales, operating profit and
loss, and identifiable assets at and for the year ended December 31, 2011, as
follows:

Steel
Auto Parts
Coal Mine
Textiles
Paint
Lumber
Leisure Time
Electronics
Total

Sales to
Sales to
Unaffiliated Affiliated
Customers Customers
$1,350,000
$150,000
1,200,000
600,000
530,000
1,120,000
710,000
690,000
600,000
$6,800,000

--450,000
220,000
380,000
------$1,200,000

Profit or
(Loss)

Segment
Assets

$265,000

$2,250,00
0
1,430,000
1,200,000
750,000
1,050,000
600,000
450,000
670,000
$8,400,00
0

450,000
(300,000)
150,000
300,000
(75,000)
110,000
300,000
$1,200,000

Required:
A. Identify the segments, which are reportable segments under one or
more of the 10 percent revenue, operating profit, or assets tests.
B. After reportable segments are determined under the 10 percent tests,
they must be reevaluated under a 75 percent revenue test before a final
determination of reportable segments can be made. Under this 75
percent test, identify if any other segments may have to be reported.

14.6

Ace Company, which uses the FIFO inventory method, had 508,000 units in
inventory at the beginning of the year at a FIFO cost per unit of $20. No
purchases were made during the year. Quarterly sales information and end-ofquarter replacement cost figures follow:
End-of- Quarter
Quarter
Unit Sales
Replacement Cost
1
200,000
$17
2
60,000
18
3
85,000
13
4
61,000
18
The market decline in the first quarter was expected to be nontemporary.
Declines in other quarters were expected to be permanent.
Required:
Determine cost of goods sold for the four quarters and verify the amounts by
computing cost of goods sold using the lower-of-cost-or-market method
applied on an annual basis.

14-7

Barr Companys actual earnings for the first two quarters of 2011 and its
estimate during each quarter of its annual earnings are:
Actual first-quarter earnings
Actual second-quarter earnings
First-quarter estimate of annual earnings
Second-quarter estimate of annual earnings

$ 800,000
1,020,000
2,700,000
2,830,000

Barr Company estimated its permanent differences between accounting


income and taxable income for 2011 as:
Environmental violation penalties
Dividend income exclusion

$ 45,000
320,000

These estimates did not change during the second quarter. The combined state
and federal tax rate for Barr Company for 2011 is 40%.
Required:
Prepare journal entries to record Barr Companys provisions for income taxes
for each of the first two quarters of 2011.

Short Answer
1.
In SFAS No. 131, the FASB requires all public companies to report a variety
of information for reportable segments. Define a reportable segment and
identify the information to be reported for each reportable segment.
2.

Publicly owned companies are usually required to file some type of quarterly
(interim) report as part of the agreement with the stock exchanges that list
their stock. Indicate two problems with interim reporting and GAAPs position
on this reporting.

Short Answer Questions from the Textbook


1. For what types of companies would segmented financial reports have the most
significance? Why?
2. Why do financial statement users (financial analysts, for example) need
information about seg- ments of a firm?
3. Define the following: (a)Operating segment.(b)Reportable segment.
4. Describe the guidelines to be used in determining (a) what constitutes an operating
segment, and (b) whether a specific operating segment is a significant segment.
5. List the three major types of enterprise wide information disclosures required by
SFAS No. 131[ASC 280], and explain how the firms designation of reportable
segments affects these disclosures.
6. What segmental disclosures are required, if any, for interim reports?
7. What type of disclosure is required of a firm when the major portion of its
operations takes place within a single reportable segment?
8. List the types of information that must be presented for each reportable segment of
a com-pany under the rules of SFAS No. 131 [ASC 280].
9. Describe the methods that might be used to disclose reportable segment
information.
10. What types of information must be disclosed about foreign operations under SFAS
No. 131[ASC 280105040]?
11. How are foreign operations defined under SFASNo. 131 [ASC 280]?
12. If the operations of a firm in some foreign countries are grouped into geographic
areas, what factors should be considered in forming the groups?
13. When must a firm present segmental disclosures for major customers? What is the
reason for this requirement?

14. How are common costs distinguished from general corporate expenses for
segmental purposes?
15. What is the purpose of interim financial reporting?
16. Some accountants hold the view that each interim period should stand alone as a
basic ac-counting period, whereas others view each interim period as essentially
an integral part of the annual period. Distinguish between these views.
17.Describe the basic procedure for computing in-come tax provisions for interim
financial state-ments.
18.Describe how changes in estimates should be treated in interim financial
statements.
19.What are the minimum disclosure requirements established ASC 270 for interim
financial reports?
20.What is the general rule regarding the treatment of costs and expenses associated
directly with revenues for interim reporting purposes?
Business Ethics Question from Textbook
SMC Inc. operates restaurants based on various themes, such as Mex-delight, Chinese
for the Buffet, and Steak-it and Eat-it. The Steak-it and Eat-it restaurants have not
been performing well recently, but SMC prefers not to disclose these details for fear
that competitors might use the information to the detriment of SMC. The restaurants
are located in various geographical locations, and management currently measures
profits and losses and asset allocation by restaurant concept. How-ever, when
preparing the segmental disclosures under SFAS No. 131 [ASC 280], the company
reports the segment information by geographical location only. The company recently
hired you to review the financial statements.
1.What disclosures should the company report for segment purposes?
2.The companys CEO believed that the rules in SFAS No. 131 [ASC 280] are
vague and that the company could easily support its decision to dis-close the
segment data by geographic regions. What would you recommend to the
CEO and how would you approach the issues?
Chapter 15
Partnerships: Formation, Operation, and Ownership Changes
Multiple Choice
1.

When a partner retires and withdraws assets in excess of his book value, the
remaining partners absorb the excess
a. equally.
b. in their profit-sharing ratio.
c. based on their average capital balances.
d. based on their ending capital balances.

2.

In a partnership, interest on capital investment is accounted for as a(n)


a. return on investment.
b. expense.
c. allocation of net income.
d. reduction of capital.

3.

A partnership in which one or more of the partners are general partners and
one or more are not is called a(n)
a. joint venture.
b. general partnership.
c. limited partnership.
d. unlimited partnership.

4.

Which of the following is an advantage of a partnership?


a. mutual agency
b. limited life
c. unlimited liability
d. none of these

5.

Bob and Fred form a partnership and agree to share profits in a 2 to 1 ratio.
During the first year of operation, the partnership incurs a $20,000 loss. The
partners should share the losses
a. based on their average capital balances.
b. in a 2 to 1 ratio.
c. equally.
d. based on their ending capital balances.

6.

When the goodwill method is used to record the admission of a new partner,
total partnership capital increases by an amount
a. equal to the new partners investment.
b. greater than the new partners investment.
c. less than the new partners investment.
d. that may be more or less than the new partners investment.

7.

The bonus and goodwill methods of recording the admission of a new partner
will produce the same result if the:
1. new partners profit-sharing ratio equals his capital interest
2. old partners profit-sharing ratio in the new partnership is the same
relatively as it was in the old partnership.
a. 1
b. 2
c. both 1 and 2 are met.
d. none of these.

8.

When the goodwill method is used and the book value acquired is less than the
value of the assets invested, total implied capital is computed by
a. multiplying the new partners capital interest by the capital balances of
existing partners.
b. dividing the total capital balances of existing partners by their collective
capital interest.
c. dividing the new partners investment by his (her) capital interest.
d. dividing the new partners investment by the existing partners collective
capital interest.

9.

The partnership of Adams and Baker was formed on February 28, 2011. At
that date the following assets were invested:
Adams
Baker
Cash
$ 120,000
$200,000
Merchandise
-0320,000
Building
-0840,000
Furniture and equipment
200,000
-0The building is subject to a mortgage loan of $280,000, which is to be
assumed by the partnership. The partnership agreement provides that Adams
and Baker share profits or losses 30% and 70%, respectively. Bakers capital
account at February 28, 2011, should be
a. $1,080,000.
b. $1,360,000.
c. $1,176,000.
d. $952,000.

10.
The following balance sheet information is for the partnership of Abel, Ball,
and Catt:
Cash
Other assets

$ 210,000
1,500,000
$1,710,000

Liabilities
$ 510,000
Abel, Capital (40%) 300,000
Ball, Capital (40%)
480,000
Catt, Capital (20%)
420,000
$1,710,000

Figures shown parenthetically reflect agreed profit and loss sharing


percentages.

If the assets are fairly valued on the above balance sheet and the partnership
wishes to admit Dent as a new 1/5 partner without recording goodwill or
bonus, Dent should invest cash or other assets of
a. $427,500.
b. $240,000.
c. $300,000.
d. $342,000.
11.
The following balance sheet information is for the partnership of Abel, Ball,
and Catt:
Cash
Other assets

$ 210,000
1,500,000
$1,710,000

Liabilities
$ 510,000
Abel, Capital (40%) 300,000
Ball, Capital (40%)
480,000
Catt, Capital (20%)
420,000
$1,710,000

Figures shown parenthetically reflect agreed profit and loss sharing


percentages.
If assets on the initial balance sheet are fairly valued, Abel and Ball consent
and Dent pays Catt $225,000 for his interest; the revised capital balances of
the partners would be
a. Abel, $315,000; Ball, $495,000; Dent, $450,000.
b. Abel, $315,000; Ball, $495,000; Dent, $420,000.
c. Abel, $300,000; Ball, $570,000; Dent, $450,000.
d. Abel, $300,000; Ball, $480,000; Dent, $420,000.
12.

Linda desires to purchase a one-fourth capital and profit and loss interest in
the partnership of Hank, Greg, and Jim. The three partners agree to sell Linda
one-fourth of their respective capital and profit and loss interests in exchange
for a total payment of $100,000. The payment is made directly to the
individual partners. The capital accounts and the respective percentage
interests in profits and losses immediately before the sale to Linda follow

Hank
Greg
Jim
Total

Capital
Accounts
$168,000
104,000
48,000
$320,000

Percentage
Interests in
Profits and Losses
50%
35
15

All other assets and liabilities are fairly valued and implied goodwill is to be
recorded prior to the acquisition by Linda. Immediately after Lindas
acquisition, what should be the capital balances of Hank, Greg, and Jim,
respectively?
a. $126,000; $78,000; $36,000
b. $156,000; $99,000; $45,000
c. $178,000; $111,000; $51,000
d. $208,000; $132,000; $60,000

13.

At December 31, 2011, Barb and Kim are partners with capital balances of
$250,000 and $150,000, and they share profits and losses in the ratio of 2:1,
respectively. On this date, Jack invests $125,000 cash for a one-fifth interest in
the capital and profit of the new partnership. The partners agree that the
implied partnership goodwill is to be recorded simultaneously with the
admission of Jack. The total implied goodwill of the firm is
a. $25,000.
b. $20,000.
c. $45,000.
d. $100,000.

14.

Pete, Joe, and Ron are partners with capital balances of $135,000, $90,000,
and $60,000, respectively. The partners share profits and losses equally. For an
investment of $120,000 cash, Jerry is to be admitted as a partner with a onefourth interest in capital and profits. Based on this information, the amount of
Jerrys investment can best be justified by which of the following?
a. Jerry will receive a bonus from the other partners upon his admission to
the partnership.
b. Assets of the partnership were overvalued immediately prior to Jerrys
investment.
c. The book value of the partnerships net assets were less than their fair
value immediately prior to Jerrys investment.
d. Jerry is apparently bringing goodwill into the partnership and his capital
account will be credited for the appropriate amount.

15.

The partnership of Amos, Cole, and Eddy had total capital of $570,000 on
December 31, 2011 as follows:
Amos, Capital (30%)
Cole, Capital (45%)
Eddy, Capital (25%)
Total

$180,000
255,000
135,000
$570,000

Profit and loss sharing percentages are shown in parentheses. If Flynn


purchases a 25 percent interest from each of the old partners for a total
payment of $270,000 directly to the old partners
a. total partnership net assets can logically be revalued to $1,080,000 on the
basis of the price paid by Flynn.
b. the payment of Flynn does not constitute a basis for revaluation of
partnership net assets because the capital and income interests of the old
partnership were not aligned.
c. total capital of the new partnership should be $760,000.
d. total capital of the new partnership will be $840,000 assuming no
revaluation.
16.

The partnership of Amos, Cole, and Eddy had total capital of $570,000 on
December 31, 2011 as follows:
Amos, Capital (30%)

$180,000

Cole, Capital (45%)


Eddy, Capital (25%)
Total

255,000
135,000
$570,000

Profit and loss sharing percentages are shown in parentheses. Assume that
Flynn became a partner by investing $150,000 in the Amos, Cole, and Eddy
partnership for a 25 percent interest in capital and profits and that partnership
net assets are not revalued. Flynns capital credit should be
a. $180,000.
b. $142,500.
c. $150,000.
d. $190,000.
17.

The partnership of Amos, Cole, and Eddy had total capital of $570,000 on
December 31, 2011 as follows:
Amos, Capital (30%)
Cole, Capital (45%)
Eddy, Capital (25%)
Total

$180,000
255,000
135,000
$570,000

Profit and loss sharing percentages are shown in parentheses.


Assume that Flynn became a partner by investing $100,000 in the Amos, Cole,
and Eddy partnership for a 25 percent interest in the capital and profits, and
the partnership assets are revalued. Under this assumption
a. Flynns capital credit will be $150,000.
b. Amoss capital will be increased to $147,000.
c. total partnership capital after Flynns admission to the partnership will be
$600,000.
d. net assets of the partnership will increase by $190,000, including Flynns
interest.
18.

In the absence of an agreement among the partners


a. interest is allowed on capital investments.
b. interest is charged on partners drawings.
c. interest is allowed on advances to the firm made by partners beyond
agreed investments.
d. compensation is allowed partners for extra time devoted to the partnership.

19.

The profit and loss sharing ratio should be


a. in the same ratio as the percentage interest owned by each partner.
b. based on relative effort contributed to the firm by the partners.
c. a weighted average of capital and effort contributions.
d. based on any formula that the partners choose.

20.

The partnership agreement of Flynn, Gant, and Hill allows Gant a bonus of
10% of income after the bonus, salaries of $30,000 per partner and interest of
6% on average capital balances of $120,000, $150,000, and $180,000 for
Flynn, Gant, and Hill, respectively. The amount of Gants bonus, assuming
income before bonus, salaries, and interest of $315,000, is

a.
b.
c.
d.

$18,000.
$22,000.
$19,800.
$31,500.

21.

Steve and Robby are partners operating an electronics repair shop. For 2011,
net income was $50,000. Steve and Robby have salary allowances of $90,000
and $60,000, respectively, and remaining profits and losses are shared 4:6.
The division of profits would be:
a. $20,000 and $30,000
b. $50,000 and $-0c. $30,000 and $20,000
d. $25,000 and $25,000

22.

Steve and Robby are partners operating an electronics repair shop. For 2011,
net income was $50,000. Steve and Robby have salary allowances of $90,000
and $60,000, respectively, and remaining profits and losses are shared 4:6.
If their agreement specifies that salaries are allowed only to the extent of
income, based on a prorata share of their salary allowances, the division of
profits would be:
a. $20,000 and $30,000
b. $50,000 and $-0c. $30,000 and $20,000
d. $25,000 and $25,000

23.

Carter, Wynn, and Norton are partners in a janitorial service. The business
reported net income of $54,000 for 2011. The partnership agreement provides
that profits and losses are to be divided equally after Wynn receives a $60,000
salary, Norton receives a $24,000 salary, and each partner receives 10%
interest on his beginning capital balance. Beginning capital balances were
$40,000 for Carter, $48,000 for Wynn, and $32,000 for Norton. Nortons share
of partnership income for 2011 is:
e. $68,800
f. $36,000
g. $31,200
h. $27,200

24.

Bell and Carson are partners who share profits and losses 3:7. The capital
accounts on January 1, 2011, are $120,000 and $160,000, respectively. Elston
is to be admitted as a partner with a one-fourth interest in the capital and
profits and losses by investing $80,000. Goodwill is not to be recorded. The
capital balances after admission should be:
a. Bell, $117,000; Carson, $153,000; Elston, $90,000
b. Bell, $120,000; Carson, $160,000; Elston, $90,000
c. Bell, $123,000; Carson, $160,000; Elston, $80,000
i. Bell, $120,000; Carson, $167,000; Elston, $80,000

25. The balance sheet for the partnership of Nen, Pap, and Sup at January 1, 2011
follows. The partners share profits and losses in the ratio of 3:2:5, respectively.

Assets at cost

$480,000

Liabilities
Nen, capital
Pap, capital
Sup, capital

$135,000
75,000
120,000
150,000
$480,000

Nen is retiring from the partnership. By mutual agreement, the assets are to be
adjusted to their fair value of $540,000 at January 1, 2011. Pap and Sup agree
that the partnership will pay Nen $135,000 cash for his partnership interest.
NO goodwill is to be recorded. What is the balance of Paps capital account
after Nens retirement?
a. $138,000
b. $108,000
c. $120,000
d. $132,000
26.

The following balance sheet information is for the partnership of Axe, Barr, and
Cole:
Cash
Other assets

$ 210,000
1,500,000

Liabilities
Axe, Capital (40%)
Barr, Capital (40%)
Cole, Capital (20%)

510,000
300,000
480,000

420,000
$1,710,000

$1,710,000

Figures shown parenthetically reflect agreed profit and loss sharing percentages.
If the assets are fairly valued on the above balance sheet and the partnership
wishes to admit Dent as a new 1/5 partner without recording goodwill or bonus,
Dent should invest cash or other assets of
a.
$427,500.
b.
$240,000.
c.
$300,000.
d.
$342,000.
27.

Susan desires to purchase a one-fourth capital and profit and loss interest in the
partnership of Tony, Mary, and Ron. The three partners agree to sell Susan onefourth of their respective capital and profit and loss interests in exchange for a
total payment of $125,000. The payment is made directly to the individual
partners. The capital accounts and the respective percentage interests in profits
and losses immediately before the sale to Susan follow

Tony
Mary
Ron

Capital
Accounts
$210,000
130,000
60,000

Percentage
Interests in
Profits and Losses
50%
35
15

Total

$400,000

All other assets and liabilities are fairly valued and implied goodwill is to be
recorded prior to the acquisition by Susan. Immediately after Susans
acquisition, what should be the capital balances of Tony, Mary, and Ron,
respectively?
a.
$157,500; $97,500; $45,000
b.
$195,000; $123,750; $56,250
c.
$222,500; $138,750; $63,750
d.
$260,000; $165,000; $75,000
28.

The partnership of Carr, Eddy, and Howe had total capital of $1,140,000 on
December 31, 2011, as follows:
Carr, Capital (30%)
Eddy, Capital (45%)
Howe, Capital (25%)
Total

$360,000
510,000
270,000
$1,140,000

Profit and loss sharing percentages are shown in parentheses.


Assume that Klein became a partner by investing $300,000 in the Carr, Eddy,
and Howe partnership for a 25 percent interest in capital and profits and that
partnership net assets are not revalued. Kleins capital credit should be
a.
$360,000.
b.
$285,000.
c.
$300,000.
d.
$380,000.
29.

The partnership of Carr, Eddy, and Howe had total capital of $1,140,000 on
December 31, 2011, as follows:
Carr, Capital (30%)
Eddy, Capital (45%)
Howe, Capital (25%)
Total

$360,000
510,000
270,000
$1,140,000

Profit and loss sharing percentages are shown in parentheses.


Assume that Klein became a partner by investing $300,000 in the Carr, Eddy,
and Howe partnership for a 25 percent interest in the capital and profits, and the
partnership assets are revalued. Under this assumption
a.
Kleins capital credit will be $300,000.
b.
Carrs capital will be increased to $394,000.
c.
total partnership capital after Kleins admission to the partnership will be
$1,200,000.
d.
net assets of the partnership will increase by $380,000 including Klein
interest.
30.

Newlin, Vick, and Morton are partners in a plumbing service. The business
reported net income of $108,000 for 2011. The partnership agreement

provides that profits and losses are to be divided equally after Vick
receives a $60,000 salary, Morton receives a $24,000 salary, and each
partner receives 10% interest on his beginning capital balance. Beginning
capital balances were $40,000 for Newlin, $48,000 for Vick, and $32,000
for Morton. Vicks share of partnership income for 2011 is:
a. $68,800.
b. $36,000.
c. $31,200.
d. $27,200.
Problems
15-1

Unruh, Grey, and Carter are partners with capital balances of $80,000,
$200,000, and $120,000, respectively. Profits and losses are shared in a 3:2:1
ratio. Grey decided to withdraw and the partnership revalued its assets. The
value of inventory was decreased by $20,000 and the value of land was
increased by $50,000. Unruh and Carter then agreed to pay Grey $230,000 for
his withdrawal from the partnership.
Required:
Prepare the journal entry to record Greys withdrawal under the
A.
bonus method.
B.
full goodwill method.

15-2

Dell and Gore are partners in an automobile repair business. Their respective
capital balances are $425,000 and $275,000, and they share profits in a 3:2
ratio. Because of growth in their repair business, they decide to admit a new
partner. Mann is admitted to the partnership, after which Dell, Gore, and Mann
agree to share profits in a 3:2:1 ratio.
Required:
Prepare the necessary journal entries to record the admission of Mann in each
of the following independent situations:

15-3

A.

Mann invests $300,000 for a one-fourth capital interest, but will not
accept a capital balance of less than his investment.

B.

Mann invests $150,000 for a one-fifth capital interest. The partners


agree that assets and the firm as a whole should be revalued.

C.

Mann purchases a 20% capital interest from each partner. Dell receives
$100,000 and Gore receives $50,000 directly from Mann.

Bryant, Milton, and Pine formed a partnership and agreed to share profits in a
3:1:2 ratio after recognition of 5% interest on average capital balances and
monthly salary allowances of $3,750 to Milton and $3,000 to Pine. Average
capital balances were as follows:
Bryant
Milton

300,000
240,000

Pine

180,000

Required:
Compute the net income (loss) allocated to each partner assuming the
partnership incurred a $27,000 net loss.
15-4

Rice and Thome formed a partnership on January 2, 2011. Thome invested


$120,000 in cash. Rice invested land valued at $30,000, which he had
purchased for $20,000 in 2005. In addition, Rice possessed superior
managerial skills and agreed to manage the firm. The partners agreed to the
following profit and loss allocation formula:
a. Interest 8% on original capital investments.
b. Salary $5,000 a month to Rice.
c. Bonus Rice is to be allocated a bonus of 20% of net income after
subtracting the bonus, interest, and salary.
d. Remaining profit is to be divided equally.
At the end of 2011 the partnership reported net income before interest,
salaries, and bonus of $168,000.
Required:
Calculate the amount of bonus to be allocated to Rice.

15-5

Wynn and Yates are partners whose capital balances are $400,000 and
$300,000 and who share profits 3:2. Due to a shortage of cash, Wynn and
Yates agree to admit Zaun to the firm.
Required:
Prepare the journal entries required to record Zauns admission under each of
the following assumptions:
(a)
Zaun invests $200,000 for a 1/4 interest. The total firm capital is to be
$900,000.
(b)
Zaun invests $300,000 for a 1/4 interest. Goodwill is to be recorded.
(c)
Zaun invests $150,000 for a 1/5 interest. Goodwill is to be recorded.
(d)
Zaun purchases a 1/4 interest in the firm, with 1/4 of the capital of each
old partner transferred to the account of the new partner. Zaun pays the
partners cash of $250,000, which they divide between themselves.

15-6

The partners in the ABC partnership have capital balances as follows:


A. $70,000;
B. $70,000
C. $105,000
Profits and losses are shared 30%, 20%, and 50%, respectively.

On this date, C withdraws and the partners agree to pay him $140,000 out of
partnership cash.
Required:
A.
Prepare journal entries to show three acceptable methods of recording
the withdrawal. (Tangible assets are already stated at values
approximating their fair market values.)

B.

15-7

Which alternative would you recommend if you determined that the


agreement to pay C $140,000 was not the result of arms length
bargaining between C and the other partners? Why?

Agler, Bates and Colter are partners who share income in a 5:3:2 ratio. Colter,
whose capital balance is $150,000, retires from the partnership.
Required:
Determine the amount paid to Colter under each of the following cases:
(1) $50,000 is debited to Agler capital account; the bonus approach is used.
(2) Goodwill of $60,000 is recorded; the partial goodwill approach is used.
(3) $66,000 is credited to Bates capital account; the total goodwill approach is
used.

15-8

The partnership agreement of Stone, Miles, and Kiney provides for annual
distribution of profit and loss in the following sequence:
Miles, the managing partner, receives a bonus of 10% of net income.
Each partner receives 5% interest on average capital investment.
Residual profit or loss is to be divided 4:2:4.
Average capital investments for 2011 were:
Stone
Miles
Kiney

$270,000
$180,000
$120,000

Required:
A.
Prepare a schedule to allocate net income, assuming operations for the
year resulted in:
1.
Net income of $75,000.
2.
Net income of $15,000.
3.
Net loss of $30,000.
B.

Prepare the journal entry to close the Income Summary account for
each situation above.

Short Answer
1. The principal types of partnerships are general partnerships, limited partnerships,
and joint ventures. Describe the characteristics of each type of partnership.
2. There are two methods of recording changes in the membership of a partnership
the bonus method and the goodwill method. Describe these two methods of
recording changes in partnership membership.
Short Answer from the Textbook
1. Describe the tax treatment of partnership income.

2. Distinguish between a partners interest in capital and his interest in the


partnerships income and losses. Also, make a general distinction between a
partners capital account and his drawing account.
3. Explain why a partnership is viewed in accounting as a separate economic entity.
4. What are some of the methods commonly used in allocating income and losses to
the partners?
5. Explain the distinction between the terms withdrawals and salaries.
6. List some of the alternative methods of calculating a bonus that may appear in a
partnership agreement.
7. What is meant by dissolution and what are its causes?
8. Discuss the methods used to record changes in partnership membership.
9. Differentiate between the admission of a new partner through assignment of an
interest andthrough investment in the partnership.
10.Under what two conditions will the bonus and goodwill methods of recording the
admission ofa partner yield the same result?
11.Describe the circumstances where neither the goodwill nor the bonus method
should be used to record the admission of a new partner.
12.How might a partner withdrawing in violation of the partnership agreement and
without the con-sent of the other partners be treated? What about a partner who is
forced to withdraw?
Business Ethics Question from Textbook
Many companies with defined benefit plans are curtailing or eliminating the plans
altogether. With a defined benefit plan, the company guarantees some set amount(or
formula-determined payment) when the employee retires. Because most pension
assets are invested in the stock market, whether a pension plan is fully funded of-ten
depends on the strength of the stock market. Be-cause of this volatility, companies
often find themselves unexpectedly in a position where they must either in-crease
funding or disclose significant underfunding. Because of this, many companies simply
reduce or eliminate the plan. Consider the pension plan of Golden Years Company
(GYC). Historically, GYC has been a great company to work for, with strong
employee benefits. GYCs pension liability is approximately $15 million. However,
recently the company has been experiencing minor financial troubles in a decreasing
stock market and, consequently, announced the termination of the pension plan in an
effort to save costs. However, the pension plan was fully funded by$9 million (the fair
value of assets exceeded the expected liability).
1.How does the firm reconcile the trade-off between financial performance and the
responsibility to its employees?

Chapter 16
Partnership Liquidation
Multiple Choice
1.

Which of the following statements is correct?


1. Personal creditors have first claim on partnership assets.
2. Partnership creditors have first claim on partnership assets.
3. Partnership creditors have first claim on personal assets.
a. 1
b. 2
c. 3
d. Both 2 and 3

2.

The first step in the liquidation process is to


a. convert noncash assets into cash.
b. pay partnership creditors
c. compute any net income (loss) up to the date of dissolution.
d. allocate any gains or losses to the partners.

3.

A schedule prepared each time cash is to be distributed is called a(n)


a. advance cash distribution schedule.
b. marshaling of assets schedule.
c. loss absorption potential schedule.
d. safe payment schedule.

4.

An advance cash distribution plan is prepared


a. each time cash is distributed to partners in an installment liquidation.
b. each time a partnership asset is sold in an installment liquidation.
c. to determine the order and amount of cash each partner will receive as it
becomes available for distribution.
d. none of these.

5.

The first step in preparing an advance cash distribution plan is to


a. determine the order in which partners are to participate in cash
distributions.
b. compute the amount of cash each partner is to receive as it becomes
available for distribution.
c. allocate any gains (losses) to the partners in their profit-sharing ratio.
d. determine the net capital interest of each partner.

6.
Offsetting a partner's loan balance against his debit capital balance is referred
to as the
a. marshaling of assets.
b. right of offset.
c. allocation of assets.

d. liquidation of assets.
7.
If a partner with a debit capital balance during liquidation is personally
solvent, the
a. partner must invest additional assets in the partnership.
b. partner's debit balance will be allocated to the other partners.
c. other partners will give the partner enough cash to absorb the debit
balance.
d. partnership will loan the partner enough cash to absorb the debit balance.
8.

The following condensed balance sheet is presented for the partnership of Jim,
Bill, and Fred who share profits and losses in the ratio of 4:3:3, respectively:
Cash
Other assets
Jim, receivable

$ 180,000
1,940,000
60,000
$ 2,180,000

Accounts payable
Bill, loan
Jim, capital
Bill, capital
Fred, capital

$ 480,000
80,000
720,000
440,000
460,000
$2,180,000

Assume that the assets and liabilities are fairly valued on the balance sheet and
that the partnership decides to admit Tom as a new partner, with a 25%
interest. No goodwill or bonus is to be recorded. How much should Tom
contribute in cash or other assets?
a. $270,000
b. $405,000
c. $540,000
d. $520,000
9.

The partnership of Joe, Al, and Mike shares profits and losses 60%, 30%, and
10%, respectively. On January 1, 2011, the partners voted to dissolve the
partnership, at which time the assets, liabilities, and capital balances were as
follows:
Assets
Cash
Other Assets

Total assets

$1,600,000

400,000
1,200,000

All of the partners are personally insolvent.

Liabilities and Capital


Accounts Payable
Joe, Capital
Al, Capital
Mike, Capital
Total liabilities

580,000
440,000
380,000
200,000
$1,600,000

Assume that all noncash assets are sold for $840,000 and all available cash is
distributed in final liquidation of the partnership. Cash should be distributed to
the partners as follows
a. Joe, $744,000;
Al, $372,000;
Mike, $124,000.
b. Joe, $440,000;
Al, $380,000;
Mike, $200,000.
c. Joe, $224,000;
Al, $272,000;
Mike, $164,000.
d. Joe, $396,000;
Al, $198,000;
Mike, $66,000.
10.

The partnership of Pratt, Ellis, and Mack share profits and losses in the ratio of
4:4:2, respectively. The partners voted to dissolve the partnership when its
assets, liabilities, and capital were as follows:
Assets
Cash
$ 250,000
Other assets
1,000,000
$1,250,000
Liabilities and Capital
Liabilities
Pratt, Capital
Ellis, Capital
Mack, Capital

$ 200,000
300,000
350,000
400,000
$1,250,000

The partnership will be liquidated over a prolonged period of time. As cash is


available, it will be distributed to the partners. The first sale of noncash assets
having a book value of $600,000 realized $475,000. How much cash should
be distributed to each partner after this sale?
a. Pratt, $90,000;
Ellis, $140,000; Mack, $295,000
b. Pratt, $210,000; Ellis, $290,000; Mack, $145,000
c. Pratt, $290,000; Ellis, $210,000; Mack, $105,000
d. Pratt, $150,000; Ellis, $175,000; Mack, $200,000
11.

In a partnership liquidation, the final cash distribution to the partners should


be made in accordance with the:
a. partners' profit and loss sharing ratio.
b. balances of the partners' capital accounts.
c. ratio of the capital contributions by the partners.
d. ratio of capital contributions less withdrawals by the partners.

12.

In an advance plan for installment distributions of cash to partners of a


liquidating partnership, each partner's loss absorption potential is computed by
a. dividing each partner's capital account balance by the percentage of that
partner's capital account balance to total partners' capital.
b. multiplying each partner's capital account balance by the percentage of
that partner's capital account balance to total partners' capital.
c. dividing the total of each partner's capital account less receivables from the
partner plus payables to the partner by the partner's profit and loss
percentage.
d. some other method.

13.

Under the Uniform Partnership Act


a. partnership creditors have first claim (Rank I) against the assets of an
insolvent partnership.
b. personal creditors of an individual partner have first claim (Rank I) against
the personal assets of all partners.
c. partners with credit capital balances share (Rank I) the personal assets of
an insolvent partner that has a debit capital balance with personal creditors
of that partner.
d. personal creditors of the partners of an insolvent partnership share
partnership assets on a pro rata basis (Rank I) with partnership creditors.

14.

During the liquidation of the partnership of Karr, Rice, and Long. Karr
accepts, in partial settlement of his interest, a machine with a cost to the
partnership of $150,000, accumulated depreciation of $70,000, and a current
fair value of $110,000. The partners share net income and loss equally. The net
debit to Karr's account (including any gain or loss on disposal of the machine)
is
a. $90,000.
b. $100,000.
c. $110,000.
d. $150,000.

15.

X, Y, and Z have capital balances of $90,000, $60,000, and $30,000,


respectively. Profits are allocated 35% to X, 35% to Y, and 30% to Z. The
partners have decided to dissolve and liquidate the partnership. After paying
all creditors, the amount available for distribution is $60,000. X, Y, and Z are
all personally solvent. Under the circumstances, Z will
a. receive $18,000.
b. receive $30,000.
c. personally have to contribute an additional $6,000.
d. personally have to contribute an additional $36,000.

16.
The ABC partnership has the following capital accounts on its books at
December 31, 2011:
Credit
A, Capital
$400,000
B, Capital
240,000
C, Capital
80,000
All liabilities have been liquidated and the cash balance is zero. None of the
partners have personal assets in excess of his personal liabilities. The partners
share profits and losses in the ratio of 3:2:5. If the noncash assets are sold for
$400,000, the partners should receive as a final payment:
a. A, $304,000; B, $176,000; C, $80,000
b. A, $256,000; B, $144,000; C, $-0c. A, $304,000; B, $176,000; C, $-0d. A, $120,000; B, $80,000;
C, $200,000
17.

The summarized balances of the accounts of MNO partnership on December


31, 2011, are as follows:

Assets
Cash
Noncash

Liabilities and Capital


Liabilities
$ 15,000
M, Capital
45,000
N, Capital
30,000

$ 15,000
90,000

Total Assets

O, Capital
Total Equities

$105,000

15,000
$105,000

The agreed upon profit/loss ratio is 50:40:10, respectively. Using the


information given above, which one of the following amounts, if any, is the
loss absorption potential of partner N as of December 31, 2011?
a. $20,000
b. $35,000
c. $75,000
d. $120,000
18.

Adamle, Boyer, and Clay are partners with a profit and loss ratio of 4:3:3. The
partnership was liquidated and, prior to the liquidation process, the partnership
balance sheet was as follows:
ADAMLE, BOYER, AND CLAY
Balance Sheet
January 1, 2011
Assets
Cash
Other assets
Total Assets

$ 60,000
540,000
$600,000

Liabilities and Equity


Adamle, Capital
Boyer, Capital
Clay, Capital
Total Liabilities & Equities

$600,000
After the partnership was liquidated and the cash was distributed, Boyer
received $96,000 in cash in full settlement of his interest.
The liquidation loss must have been:
a. $360,000
b. $144,000
c. $504,000
d. $480,000
19.

The partnership of Hall, Jones, and Otto has been dissolved and is in the
process of liquidation. On July 1, 2011, just before the second cash
distribution, the assets and equities of the partnership along with residual
profit sharing ratios were as follows:
Assets
Cash
Receivables-net

$ 200,000
50,000

Liabilities & Equities


Liabilities
$ 150,000
Hall, Capital 50%
100,000

Inventories
Equipment-net
Total assets

150,000
100,000
$ 500,000

Jones, Capital 30%


Otto, Capital 20%
Total Lia & Equity

175,000
75,000
500,000

Assume that the available cash is distributed immediately, except for a $25,000
contingency fund that is withheld pending complete liquidation of the partnership.
How much cash should be paid to each of the partners?
Hall
a. $87,500
b. 12,500
c.
-0d.
-0-

20.

Jones
$52,500
7,500
25,000
15,000

Otto
$35,000
10,000
-010,000

The partnership of Hall, Jones, and Otto has been dissolved and is in the
process of liquidation. On July 1, 2011, just before the second cash
distribution, the assets and equities of the partnership along with residual
profit sharing ratios were as follows:
Assets
Cash
Receivables-net
Inventories
Equipment-net
Total assets

$ 200,000
50,000
150,000
100,000
$ 500,000

Liabilities & Equities


Liabilities
$
Hall, Capital 50%
Jones, Capital 30%
Otto, Capital 20%
Total Lia & Equity

150,000
100,000
175,000
75,000
500,000

Assume that Hall takes equipment with a fair value of $40,000 and a book value
of $50,000 in partial satisfaction of his equity in the partnership. If all the
$200,000 cash is then distributed, the partners should receive:
Hall
Jones
Otto
a.$100,000 $60,000 $40,000
b. 25,000
15,000
10,000
c.
-0
45,000
5,000
d.
-0
50,000
-0
21.

The partnership of Starr, Foley, and Pele share profits and losses in the ratio of
4:4:2, respectively. The partners voted to dissolve the partnership when its
assets,
liabilities,
and
capital
were
as
follows:
Assets
Cash
Other assets
Total assets

$150,000
600,000
$750,000

Liabilities and Equity


Liabilities
$120,000
Starr, Capital
180,000
Foley, Capital
210,000
Pele, Capital
240,000
Total Lia & Equity
$750,000

The partnership will be liquidated over a prolonged period of time. As cash is


available, it will be distributed to the partners. The first sale of noncash assets
having a book value of $360,000 realized $285,000. How much cash should
be distributed to each partner after this sale?
a. Starr, $54,000;
Foley, $84,000;
Pele, $177,000.
b. Starr, $174,000; Foley, $174,000;
Pele, $87,000.
c. Starr, $126,000; Foley, $126,000;
Pele, $63,000.
d. Starr, $90,000;
Foley, $105,000;
Pele, $120,000.
22.

A, B, and C have capital balances of $90,000, $60,000, and $30,000,


respectively. Profits are allocated 35% to A, 35% to B and 30% to C. The
partners have decided to dissolve and liquidate the partnership. After paying
all creditors the amount available for distribution is $60,000. A, B, and C are
all personally solvent. Under the circumstances, C will
a. receive $18,000.
b. receive $30,000.
c. personally have to contribute an additional $6,000.
d. personally have to contribute an additional $36,000.

23.

The ABC partnership has the following capital accounts on its books at
December 31, 2011:
Credit
$200,000
120,000
40,000

A, Capital
B, Capital
C, Capital

All liabilities have been liquidated and the cash balance is zero. None of the
partners have personal assets in excess of his personal liabilities. The partners
share profits and losses in the ratio of 3:2:5. If the noncash assets are sold for
$150,000, the partners should receive as a final payment:
a. A, $152,000; B, $88,000
C, $40,000
b. A, $128,000; B, $72,000; C, $ - 0 c. A, $152,000; B, $88,000; C, $ - 0 d. A, $60,000; B, $40,000; C, $100,000
24.

The summarized balances of the accounts of RST partnership on December


31, 2011, are as follows:
Assets
Liabilities and Equity
Cash
$ 30,000
Liabilities

30,000
Noncash
90,000

180,000

R, Capital
S, Capital

60,000
T, Capital
30,000
Total Assets
$210,000

$210,000

Total Lia & Equities

The agreed upon profit/loss ratio is 50:40:10, respectively. Using the


information given above, which one of the following amounts, if any, is the
loss absorption potential of partner S as of December 31, 2011?
a.
$60,000
b.
$70,000
c.
$150,000
d.
$240,000
25.

The partnership of Hill, Kiner, and Polk has been dissolved and is in the
process of liquidation. On July 1, 2011, just before the second cash
distribution, the assets and equities of the partnership along with residual
profit sharing ratios were as follows:
Assets
Liabilities and Equity
Cash
$ 80,000
Liabilities
$ 60,000
Receivables-net
20,000
Hill, Capital 50%
40,000
Inventories
60,000
Kiner, Capital 30%
70,000
Equipment-net
40,000
Polk, Capital 20%
30,000
Total assets
$200,000
Total Lia & Equity
$200,000
Assume that the available cash is distributed immediately, except for a
$10,000 contingency fund that is withheld pending complete liquidation of the
partnership. How much cash should be paid to each of the partners?
Hill
Kiner
Polk
a. $35,000
$21,000
$14,000
b.
$5,000
$3,000
$4,000
c.
$0
$10,000
$0
d.
$0
$6,000
$4,000

Problems
16-1

The NOR Partnership is being liquidated. A balance sheet prepared prior to


liquidation is presented below:
Assets
Cash
Other Assets

Total Assets

$240,000
300,000

$540,000

Liabilities & Equities


Liabilities
$ 160,000
Reese, Loan
60,000
Nen, Capital
180,000
Ott, Capital
60,000
Reese, Capital
80,000
Total Equities
$540,000

Nen, Ott, and Reese share profits and losses in a 40:40:20 ratio. All partners
are personally insolvent.
Required:
A.
Prepare the journal entries necessary to record the distribution of the
available cash.

B.
16-2

Prepare the journal entries necessary to record the completion of the


liquidation process, assuming the other assets are sold for $120,000.

The trial balance for the ABC Partnership is as follows just before liquidation:

OTHER
BALL
CARL
CASH
ASSETS RECEIVABLE = LIABILITIES
CAPITAL
180,000 625,000
90,000
150,000
180,000

ADLER

BALL

CAPITAL

CAPITAL

420,000

270,000

Partners share profits a 50:30:20 ratio.


Required:
Prepare an advance cash distribution plan showing how available cash would
be distributed.
16-3

Lewis, Nance, and Otis operate the LNO Partnership. The partnership
agreement provides that the partners share profits in the ratio of 40:40:20,
respectively. Unable to satisfy the firm's debts, the partners decide to liquidate.
Account balances just prior to the start of the liquidation process are as
follows:
Debit
Credit
Cash
$ 90,000
Other Assets
330,000
Liabilities
$165,000
Otis, Loan
36,000
Lewis, Capital
165,000
Nance, Capital
36,000
Otis, Capital
39,000
Otis, Drawing
21,000
_______
Totals
$441,000
$441,000
During the first month of liquidation, other assets with a book value of
$150,000 are sold for $165,000, and creditors are paid. In the following month
unrecorded liabilities of $12,000 are discovered and assets carried on the
books at a cost of $90,000 are sold for $36,000. During the third month the
remaining other assets are sold for $42,000 and all available cash is
distributed.
Required:
Prepare a schedule of partnership realization and liquidation. A safe
distribution of cash is to be made at the end of the second and third months.
The partners agreed to hold $30,000 in cash in reserve to provide for possible
liquidation expenses and/or unrecorded liabilities. All of the partners are
personally insolvent.

16-4

Due to the fact that the partnership had been unprofitable for the past several
years, A, B, C, and D decided to liquidate their partnership. The partners share

profits and losses in the ratio of 40:30:20:10, respectively. The following


balance sheet was prepared immediately before the liquidation process began:
A B C D Partnership
Balance Sheet
Cash
Other Assets

$ 100,000
350,000

Total Assets

Liabilities
A, Capital
B, Capital
C, Capital
D, Capital
Total Lia & Equities

$450,000

$250,000
55,000
60,000
50,000
35,000
$450,000

The personal status of each partner is as follows:


Personal
Personal
_Assets_
Liabilities
A
$165,000
$ 120,000
B
100,000
140,000
C
180,000
160,000
D
60,000
70,000
The partnership's other assets are sold for $100,000 cash. The partnership
operates in a state which has adopted the Uniform Partnership Act.
Required:
A. Complete the following schedule of partnership realization and liquidation.
Assume that a partner makes additional contributions to the partnership
when appropriate based on their individual status.
OTHER
ASSETS LIABILITIES

CASH
__D__
$100,000 $350,000
35,000

$250,000

__A__

CAPITAL
__B__
__C__

55,000

60,000

50,000

B. Complete the following schedule to show the total amount that will be paid
to the personal creditors.
From
Personal
_Assets_
A
B
C
D

Distribution
from
_Partnership_

Total Paid
to Personal
_Creditors_

16-5

A trial balance for the DEF partnership just prior to liquidation is given below:
Cash
Noncash Assets
Nonpartner Liabilities
Dugan, Loan
Dugan, Capital
Elston, Capital
Flynn, Capital
Totals

Debit
$ 75,000
750,000

Credit

$825,000

$240,000
75,000
225,000
153,000
132,000
$825,000

The partners share income and loss on the following basis:


Dugan
50%
Elston
30%
Flynn
20%
Required:
Prepare an advance cash distribution plan for the partners.
16-6

David, Paul, and Burt are partners in a CPA firm sharing profits and losses in a
ratio of 2:2:3, respectively. Immediately prior to liquidation, the following
balance sheet was prepared:
Assets
Cash
Noncash assets

$ 100,000
580,000

Total Assets

_______
$680,000

Liabilities & Equities


Liabilities
David, Capital
Paul, Capital
Burt, Capital
Total Liabilities & Equities

$680,000
Required:
Assuming the noncash assets are sold for $300,000, determine the amount of
cash to be distributed to each partner. Complete the worksheet and clearly
indicate the amount of cash to be distributed to each partner in the spaces
provided. No cash is available from any of the three partners.
A.

Beginning Bal.

Noncash
Burt
Cash
Capital
100,000
80,000

David

Paul

Assets

Liabilities

Capital Capital

580,000

280,000

160,000 160,000

16.7
Using the information from Problem 16-6, assume the noncash assets
are sold for $160,000. Determine the amount of cash to be distributed to each
partner assuming all partners are personally solvent.
16-8

The December 31, 2010, balance sheet of the Deng, Danielson, and Gibson
partnership, along with the partners residual profit and loss sharing ratios, is
summarized as follows:
Assets
Cash
Receivables
Inventories
Other Assets

$ 150,000
300,000
375,000
475,000

Liabilities & Equities


Accounts Payable
Loan from Danielson
Deng, Capital (20%)
Danielson, Capital (30%)
Gibson, Capital (50%)

375,000
Total Assets

$1,300,000

Total Lia & Equities

$1,300,000
The partners agree to liquidate their partnership as soon as possible after
January 1, 2011 and to distribute all cash as it becomes available.
Required:
Prepare an advance cash distribution plan to show how cash will be distributed
as it becomes available.

Short Answer
1.

The Uniform Partnership Act specifies specific steps in distributing available


partnership assets in liquidation. Describe the steps used to distribute
partnership assets during the liquidation process.

2.

An advance cash distribution plan specifies the order in which each partner
will receive cash and the dollar amount each will receive as it becomes
available for distribution. Identify the four steps in the preparation of an
advance cash distribution plan.

Short Answer Questions from the Textbook


1. Why are realization gains or losses allocated to partners in their profit and loss
ratios?
2. In what manner should the final cash distribution be made in partnership
liquidation?
3. Why does a debit balance in a partners capital account create problems in the
UPA order of payment for a partnership liquidation?

4. Is it important to maintain separate accounts for a partners outstanding loan and


capital ac-counts? Explain why or why not.
5. Discuss the possible outcomes in the situation where the equity interest of one
partner is inadequate to absorb realization losses.
6. During a liquidation, at which point may cash be distributed to any of the
partners?
7. What is marshaling of assets?
8. To what extent can personal creditors seek re-covery from partnership assets?
9. In an installment liquidation, why should the partners view each cash distribution
as if it were the final distribution?
10. Discuss the three basic assumptions necessary for calculating a safe cash
distribution. How is this safe cash distribution computed?
11. How are unexpected costs such as liquidation expenses, disposal costs, or
unrecorded liabilities covered in the safe distribution schedule?
12. What is the objective of the procedures used for the preparation of an advance
cash distribution plan?
13. What is the loss absorption potential?
14. In what order must partnership assets be distributed?
Business Ethics Question from the Textbook
You and two of your former college friends, Freeman and Oxyman, formed a
partnership called FOB, which builds and installs fabricated swimming pools. The
business has been operating for 15 years and has become one of the top swimming
pool companies in the area. Typically, you have been providing the on-site estimates
for the pools, while your partners do most of the onsite construction. While visiting
one of the sites, you hear a conversation between one of your partners and a customer.
Your partner is explaining that the cost will increase by $10,000 because of
unexpected rock removal. You are a bit surprised by this, since you had tested the area
for rocks. Later, back at the office, you review the core-sample results done on that
job, which did not reveal any rock. You decide to talk to the partner when he returns to
the office. When the partner returns to the office, he is arguing with someone from a
local bank concerning an outstanding personal loan.
1.What do you see as your duty with respect to the partnership?
2.What should you do? Explain your reasoning.