70-458-30 ADVANCED ACCOUNTING II

June 19, 2007 Midterm Examination - Solution

Professor Petro

1. (8 Points) Cash flows, interest rate, states, and probabilities not known

2. a. (5 Points)
Actual EPS<Expected EPS. Flat earnings forecast. Concerns about new product introduction. Beta may have increased.
b. (2 Points)
The market expects the "paper" losses to be realized
c. (6 Points)
Investors tend to underweight high probabilities or good news and overweight low probabilities or bad news.
They are risk averse and overreact to small losses. They hold losers and sell winners.
d. (3 Points)
All three explanations are reasonable.

3. a. (3 Points)
Present value basis. Net Income = the present value of future cash flows adjusted for capital transactions.
b. (4 Points)
Market or present values for assets and liabilities do not exist. Cash flows and the interest rate are not known.
c. ( 4 Points)
Unbiased verifiable numbers traded against the ability to predict future cash flows.
d. (4 Points)
Any two of the following: Amortization of assets, deferred taxes, successful efforts versus full costs, A/R valuation,
inventory valuation, pension accounting, OPEB accounting.
or
Fair values not used throughout and cannot predict cash flows.

4. a. (4 Points)
The present value at t=0 is 6,421. At t=1 it is 4,545
b. (3 Points)
Revenue 5,000
Amortization 1,876
Interest 300 2,176
Net Income 2,824
 c. (7 Points)
Cash 3,288 B/P 3,000
Asset 4,545 C/S 3,421
7,833 RE 1,412
7,833

5. Note: Graded as 10 points, not 5.

a. (4 Points)
Market or present value.
b. (6 Points)
Conditions are not ideal. Present values do not equal market values and are not reliable.
Historical cost is not completely reliable due to different methods allowed and LCM estimates.

6. a.(7 Points)
E(a) = 20.29; E(b) = 32.62; Buy Canada Savings Bonds
b. (15 Points)
P(NB/LO) = .94; P(B/LO) = .06
E(a/LO) = 31.79; E(b/LO) = 32.62, Buy Canada Savings Bonds

7. a. (4 Points)
It is a probable, measurable sacrifice based upon a past event.
b. (3 Points)
OPEB Expense 100,000,000
OPEB Liability 100,000,000
c. (4 Points)
To reduce liabilities which would reduce expenses, raise net income and increase the stock price.
d. (3 Points)
The market expects the benefits to decrease and cash flows to increase.
The market expected a larger liability.