Solutions to Quiz3, ACCY 593 Doogar, FA04

Question 1: Multiple Choice (25 points)

1. At the date of declaration of a small common stock dividend, the entry should not
include
a. a credit to Common Stock Dividend Payable.
b. a credit to Paid-in Capital in Excess of Par.
c. a debit to Retained Earnings.
d. All of these are acceptable.

Answer: d

At the date of declaration of a small common stock dividend, the entry should be:

Dr. R/E
Cr. CS Dividend Distributable
APIC in excess of Par

We also accept answer a , if you argue that the account should be “CS Dividend
Distributable” but not “Common Stock Dividend Payable”.

2. On June 30, 2004, when Vietti Co.'s stock was selling at $65 per share, its capital
accounts were as follows:
Capital stock (par value $25; 40,000 shares issued) $1,000,000
Premium on capital stock 600,000
Retained earnings 4,200,000
If a 100% stock dividend were declared and distributed, capital stock would be
a. $1,000,000.
b. $2,600,000.
c. $2,000,000.
d. $3,200,000.

Answer: c (40,000 × $25) + $1,000,000 = $2,000,000.

3. Information concerning the capital structure of Regan Corporation is as follows:

December 31,
2004 2003
Common stock 150,000 shares 150,000 shares
Convertible preferred stock 15,000 shares 15,000 shares
9% convertible bonds $3,000,000 $3,000,000

During 2004, Regan paid dividends of $1.00 per share on its common stock and $2.50
per share on its preferred stock. The preferred stock is convertible into 30,000 shares of
common stock. The 9% convertible bonds are convertible into 75,000 shares of common
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stock. The net income for the year ended December 31, 2004, was $500,000. Assume that
the income tax rate was 30%.

1).What should be the basic earnings per share for the year ended December 31, 2004,
rounded to the nearest penny?
a. $2.22
b. $2.43
c. $3.17
d. $3.33

Answer:

$500,000 – (15,000 × $2.50)

————————————— = $3.083.
150,000

NI $500,000
Less: PS dividend requirement (37,500)
Income applicable to CS shareholders $462,500

Weighted average of CS outstanding $150,000

Basic EPS (462,500/150,000) $3.083

2).What should be the diluted earnings per share for the year ended December 31, 2004,
rounded to the nearest penny?
a. $2.67
b. $2.45
c. $2.36
d. $1.96

Answer:

$500,000 + ($3,000,000 × .09 × .7)

———————————————— = $2.70.
150,000 + 75,000 + 30,000

Step 1:
1) Preferred stock dividend 15,000*2.5=$37,500
Income tax effect none
Dividend requirement avoided $37,500

Number of CS issued assuming conversion of PS 30,000 shares

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Per share effect:

Incremental numerator effect

———————————————— = $37,500 = $1.25
Incremental denominator effect 30,000

2) Interest expense for year (9% * 3,000,000) $270,000

Income tax deduction due to interest (30%*270,000) (81,000)
Interest expense avoided (Net of tax) $189,000

Number of CS issued assuming conversion of bonds 75,000

Per share effect:

Incremental numerator effect

———————————————— = $189,000 = $2.52
Incremental denominator effect 75,000

Step 2: Ranking of per share effect:

1. Convertible PS $1.25
2. 9% convertible bonds $2.52

Step 3:
1) Convertible PS
NI applicable to CS shareholders $462,500
Add: dividend requirement avoided 37,500
Total $500,000

Weighted average number of CS outstanding 150,000 shares

Add: number of CS assumed issued upon conversion of PS 30,000
Total 180,000

Recomputed EPS (500,000/180,000) $2.78

2) 9% convertible bond
Numerator from previous calculation $500,000
Add: interest expense avoided (Net of tax) 189,000
Total 689,000

Denominator from previous calculation 180,000

Add: number of CS assumed issued upon conversion of bonds 75,000
Total 255,000

Recomputed EPS (689,000/255,000) $2.70

4. On June 30, 2004, Fred sold equipment to an unaffiliated company for $500,000.
The equipment had a book value of $450,000 and a remaining useful life of 10
years. That same day, Fred leased back the equipment at $5,000 per month for 5
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years with no option to renew the lease or repurchase the equipment. Fred's rent
expense for this equipment for the year ended December 31, 2004, should be
a. $60,000.
b. $30,000.
c. $25,000.
d. $20,000.

Answer:

$5,000 × 6 = $30,000.

Question 2 (25 points):

Vernon Co. as lessee records a capital lease of machinery on January 1, 2004. The seven
annual lease payments of $210,000 are made at the end of each year. The present value of
the lease payments at 10% is $1,022,400. Vernon uses the effective interest method of
amortization and sum-of-the-years'-digits depreciation (no residual value).

Instructions (Round to the nearest dollar.)

(a) Prepare an amortization table for 2004 and 2005.
(b) Prepare all of Vernon's journal entries for 2004.

Answer:

(a) Annual Reduction

Date Payments 10% Interest Of Liability Lease
Liability
1/1/04 $1,022,400
12/31/04 $210,000 $102,240 $107,760 914,640
12/31/05 210,000 91,464 118,536 796,104

(b) Leased Machinery .......................................................................... 1,022,400

Lease Liability....................................................................
1,022,400
Interest Expense ............................................................................. 102,240
Lease Liability................................................................................ 107,760
Cash ....................................................................................
210,000
Depreciation Expense (7/28 × $1,022,400).................................... 255,600
Accumulated Depreciation .................................................
255,600
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