AC 506 FINANCIAL ACCCOUNTING 2 MIDTERM EXAMINATION JANUARY 20, 2011

Multiple Choice Identify the letter of the choice that best completes the statement or answers the question.

Write your answer on the provided answer sheet. 1. Lease A does not contain a bargain purchase option, but the lease term is equal to 90
percent of the estimated economic life of the leased property. Lease B does not transfer ownership of the property to the lessee by the end of the lease term, but the lease term is equal to 75 percent of the estimated economic life of the leased property. How should the lessee classify these leases? Lease A Lease B Operating lease Capital lease Operating lease Operating lease Capital lease Capital lease Capital lease Operating lease

a. b. c. d.

2. What impact does a bargain purchase option have on the present value of the
minimum lease payments computed by the lessee? a. No impact as the option does not enter into the transaction until the end of the lease term. b. The lessee must increase the present value of the minimum lease payments by the present value of the option price. c. The lessee must decrease the present value of the minimum lease payments by the present value of the option price. d. The minimum lease payments would be increased by the present value of the option price if, at the time of the lease agreement, it appeared certain that the lessee would exercise the option at the end of the lease and purchase the asset at the option price.

3. The amount to be recorded as the cost of an asset under capital lease is equal to the
a. present value of the minimum lease payments. b. present value of the minimum lease payments or the fair value of the asset, whichever is lower. c. present value of the minimum lease payments plus the present value of any unguaranteed residual value. d. carrying value of the asset on the lessor's books.

4. The Lease Liability account should be disclosed as

a. b. c. d. all current liabilities. all noncurrent liabilities. current portions in current liabilities and the remainder in noncurrent liabilities. deferred credits.

5. Which of the following is not considered a part of the definition of a liability?

a. Unavoidable obligation. b. Transaction or other event creating the liability has already occurred. c. Present obligation that entails settlement by probable future transfer or use of cash, goods, or services. d. Liquidation is reasonably expected to require use of existing resources classified as current assets or create other current liabilities.

6. Why is the liability section of the balance sheet of primary importance to bankers?
a. b. c. d. To evaluate the entity's credit quality. To assist in understanding the entity's liquidity. To better understand sources of repayment. To evaluate operating efficiency.

7. The printing costs and legal fees associated with the issuance of bonds should
a. be expensed when incurred. b. be reported as a deduction from the face amount of bonds payable. c. be accumulated in a deferred charge account and amortized over the life of the bonds. d. not be reported as an expense until the period the bonds mature or are retired.

8. A debt instrument with no ready market is exchanged for property whose fair market
value is currently indeterminable. When such a transaction takes place a. the present value of the debt instrument must be approximated using an imputed interest rate. b. it should not be recorded on the books of either party until the fair market value of the property becomes evident. c. the directors of both entities involved in the transaction should negotiate a value to be assigned to the property. d. the board of directors of the entity receiving the property should estimate a value for the property that will serve as a basis for the transaction.

9. Note disclosures for long-term debt generally include all of the following except
a. b. c. d. assets pledged as security. call provisions and conversion privileges. restrictions imposed by the creditor. names of specific creditors.

10. A troubled debt restructuring will generally result in a. a. b. c. d. loss by the debtor and a gain by the creditor. loss by both the debtor and the creditor. gain by both the debtor and the creditor. gain by the debtor and a loss by the creditor.

11. Under a debt restructuring involving substantial modification of terms, the future cash flows under the new terms should be discounted using a. original effective interest rate c. market rate of interest b. interest rate under the new termsd. prime interest rate 12. There is substantial modification of terms of an old financial liabiity of the gain or loss on extinguishment is a. at least 10% of the old liability c. at least 10% of the new liability b. less than 10% of the old liabilityd. less than 10% of the new liability 13. When should a lessor recognize in income a nonrefundable lease bonus paid by lessee on signing an operating lease? a. when received c. at the lease expiration b. at the inception of the lease d. over the lease term 14. Which statement characteristics an operating lease? a. the lessee records depreciation and interest b. the lessee records the lease obligation related to the leased asset c. the lessor transfers title of the leased property to the lessee for the duration of the lease term d. the lessor records depreciation and lease revenue 15. A twenty-year lease provides for 10% increase in annual payments every five years. In the sixth year compared to the fifth year, what could be the effect on the entitys expenses? a. rent and interest expense will both increase b. interest expense will increase but not rent expense c. rent expense will increase but not interest expense d. no increase in both rent and interest expense

16. In a lease that is recorded as an operating lease by the lessee, the equal monthly rental payments should be a. allocated between a reduction in the liability for leased asset and depreciation expense b. allocated between a reduction in the liability for leased asset and interest expense c. recorded as a reduction in the liability for leased asset d. recorded as a rental expense 17. When equipment held under operating lease is subleased by the original lessee, the original lessee would account for the sublease as a. operating lease c. direct financing lease b. sales-type lease d. finance lease 18. Rent received in advance by the lessor for an operating lease should be recognized as revenue a. when received c. at the lease expiration b. at the lease inception d. in the period specified by the lease 19. Major reasons why a company may become involved in leasing to other companies is (are) a. b. interest revenue. c. high residual values. d. tax incentives. all of these.

20. The amount to be recorded as the cost of an asset under capital lease is equal to the a. present value of the minimum lease payments. b. present value of the minimum lease payments or the fair value of the asset, whichever is lower. c. present value of the minimum lease payments plus the present value of any unguaranteed residual value. d. carrying value of the asset on the lessor's books.

PROBLEM SOLVING: CURRENT LIABILITIES Select the answer of the choice that best completes the statement or answers the question on the choices provided below. Write your answer and show your solution on the answer sheet provided. (all in Philippine pesos)
151,470175,000 and 3,000 150,735180,000 and 3,000 600,000 and 390,000 210,000 and 390,000 700,00084,000 and 120,000 784,00084,000 and 108,000 108,000 and 66,000 42,000 and 66, 000 850,000 950,000

Debit Litigation expense P500,000 and Credit litigation liability P500,000 No journal entry 500,000 300,000 21. Glaus Corp. signed a three-month, zero-interest-bearing note on November 1, 2010 for the purchase of $150,000 of inventory. The face value of the note was $152,205. Assuming Glaus used a Discount on Note Payable account to initially record the note and that the discount will be amortized equally over the 3-month period, What is the carrying value of the note payable in the balance sheet at December 31, 2010? 22. Collier borrowed P 175,000 on October 1 and is required to pay P180,000 on March What amount is the note payable recorded at on October 1 and how much interest is recognized from October 1 to December 31?

23. Vopat, Inc., is a retail store operating in a state with a 12% VAT. The state law provides that the retail sales tax collected during the month must be remitted to the state during the following month. If the amount collected is remitted to the state on or before the twentieth of the following month, the retailer may keep 3% of the VAT collected. On April 10, 2010, Vopat remitted P81,480 tax to the BIR for March 2010 retail sales. What was Vopat 's March 2010 retail sales subject to VAT? 24. A company gives each of its 50 employees (assume they were all employed continuously through 2010 and 2011) 12 days of vacation a year if they are employed at the end of the year. The vacation accumulates and may be taken starting January 1 of the next year. The employees work 8 hours per day. In 2010, they made P 17.50 per hour and in 2011 they made P 20 per hour. During 2011, they took an average of 9 days of vacation each. The companys policy is to record the liability existing at the end of each year at the wage rate for that year. What amount of vacation liability would be reflected on the 2010 and 2011 balance sheets, respectively? 25. A company offers a cash rebate of P1 on each P4 package of batteries sold during 2010. Historically, 10% of customers mail in the rebate form. During 2010, 6,000,000 packages of batteries are sold, and 210,000 P1 rebates are mailed to customers. What is the rebate expense and liability, respectively, shown on the 2010 financial statements dated December 31? 26. During 2010, Eaton Co. introduced a new product carrying a two-year warranty against defects. The estimated warranty costs related to dollar sales are 2% within 12 months following sale and 4% in the second 12 months following sale. Sales and actual warranty expenditures for the years ended December 31, 2010 and 2011 are as follows: Sales $ 800,000 1,000,000 $1,800,000 Actual Warranty Expenditures $12,000 30,000 $42,000

2010 2011

At December 31, 2011, Eaton should report an warranty expense and estimated warranty liability of 27. Tender Foot Inc. is involved in litigation regarding a faulty product sold in a prior year. The company has consulted with its attorney and determined that it is probable that they may lose the case. The attorneys estimated that there is a 90% chance of losing. If this is the case, their attorney estimated that the amount of any payment would be $500,000. What is the required journal entry as a result of this litigation? 28. Cobb Department Store sells gift certificate redeemable only when merchandise is purchased. These gift certificates have an expiration date of two years after issuance date. Upon redemption or expiration, Cobb recognizes the unearned revenue as realized. Information for 2009 is as follows: Unearned revenue, 1/1 Gift certificate sold gift certificate redeemed expired gift certificate Cost of goods sold 650,000 2,250,000 1,950,000 100,000 60%

On December 31, 2009 what amount should Cobb report as unearned revenue?

29. On January 1, 2009, Roca Company began marketing a new soft drink. To help promote the soft drink, the management is offering a special gift, a T-short, to each customer who returns 10 bottles caps. Roca estimates that out of the 250,000 bottles sold in 2009, only 80% will be redeemed. On December 31, 2009, the following information was collected: T-shirt purchased T-shirt distributed Unit 18,000 15,000 Amount 1,800,000

What is the estimated premium liability on December 31, 2009? 30. On January 1, 2009, Roca Company began marketing a new soft drink. To help promote the soft drink, the management is offering a special gift, a T-short, to each customer who returns 10 bottles caps. Roca estimates that out of the 250,000 bottles sold in 2009, only 80% will be redeemed. On December 31, 2009, the following information was collected: T-shirt purchased T-shirt distributed Unit 18,000 15,000 Amount 1,800,000

What is the amount of premium inventory on December 31, 2009? 1,950,000 2,000,000 11,500 13,500 90,000 446,400 428,220 100,753 18,600 60,000 40,000 discount on Bonds Payable 40,000 premium on Bonds Payable 377,400 364,500 1,015,000

31. The adjusted trial balance for Lifesaver Corp. at the end of the current year, 2010, contained the following accounts. 5-year Bonds Payable 8% 1,500,000 Bond Interest Payable 50,000 Premium on Bonds Payable 100,000 Notes Payable (3 mo.) 40,000 Notes Payable (5 yr.P15,000 due currently) 200,000 Salaries Payable 18,000 Taxes Payable (due 3/15 of 2011) 25,000 The total long-term liabilities reported on the balance sheet are 32. On December 31, 2008, Nolte Co. is in financial difficulty and cannot pay a note due that day. It is a P600,000 note with P60,000 accrued interest payable to Piper, Inc. Piper agrees to accept from Nolte equipment that has a fair value of P290,000, an original cost of P480,000, and accumulated depreciation of P230,000. Piper also forgives the accrued interest, extends the maturity date to December 31, 2011, reduces the face amount of the note to P250,000, and reduces the interest rate to 6%, with interest payable at the end of each year. Nolte should recognize a gain or loss on the extinguishment of debt of: 33. On January 1, 2010, Crown Company sold property to Leary Company. There was no established exchange price for the property, and Leary gave Crown a P2,000,000 zero-interest-bearing note payable in 5 equal annual installments of P400,000, with the first payment due December 31, 2010. The prevailing rate of interest for a note of this type is 9%. The present value of the note at 9% was P1,442,000 at January 1, 2010. What should be the balance of the Discount on Notes Payable account on the books of Leary at December 31, 2010 after adjusting entries are made, assuming that the effective-interest method is used?

34. On October 1, 2010 Macklin Corporation issued 5%, 10-year bonds with a face value of P1,000,000 at 104. Interest is paid on October 1 and April 1, with any premiums or discounts amortized on a straight-line basis. The entry to record the issuance of the bonds would include a credit of 35. On October 1, 2010 Macklin Corporation issued 5%, 10-year bonds with a face value of P 1,000,000 at 104. Interest is paid on October 1 and April 1, with any premiums or discounts amortized on a straight-line basis. Bond interest expense reported on the December 31, 2010 income statement of Macklin Corporation would be 36. At the beginning of 2010, Wallace Corporation issued 10% bonds with a face value of P900,000. These bonds mature in the five years, and interest is paid semiannually on June 30 and December 31. The bonds were sold for P 833,760 to yield 12%. Wallace uses a calendar-year reporting period. Using the effectiveinterest method of amortization, what amount of interest expense should be reported for 2010? (Round your answer to the nearest dollar.) 37. The December 31, 2010, balance sheet of Hess Corporation includes the following items: 9% bonds payable due December 31, 2019 Unamortized premium on bonds payable P1,000,000 27,000

The bonds were issued on December 31, 2009, at 103, with interest payable on July 1 and December 31 of each year. Hess uses straight-line amortization. On March 1, 2011, Hess retired P400,000 of these bonds at 98 plus accrued interest. What should Hess record as a gain on retirement of these bonds? Ignore taxes. 38. On January 1, 2010, Solis Co. issued its 10% bonds in the face amount of P3,000,000, which mature on January 1, 2020. The bonds were issued for P3,405,000 to yield 8%, resulting in bond premium of P405,000. Solis uses the effective-interest method of amortizing bond premium. Interest is payable annually on December 31. At December 31, 2010, Solis's adjusted unamortized bond premium should be 39. On January 1, 2011, Doty Co. redeemed its 15-year bonds of $2,500,000 par value for 102. They were originally issued on January 1, 1999 at 98 with a maturity date of January 1, 2014. The bond issue costs relating to this transaction were $150,000. Doty amortizes discounts, premiums, and bond issue costs using the straight-line method. What amount of loss should Doty recognize on the redemption of these bonds (ignore taxes)? 40. On July 1, 2010, Spear Co. issued 1,000 of its 10%, P1,000 bonds at 99 plus accrued interest. The bonds are dated April 1, 2010 and mature on April 1, 2020. Interest is payable semiannually on April 1 and October 1. What amount did Spear receive from the bond issuance? 1,000,000 990,000 4,425,000 4,125,000 400,000 375,000 426,160 421,867 850,000 950,000 767,088 759,360 495,000 395,000 232,912 240,640

41. Rapp Company leased a new machine to Lake Company on January 1, 2009. The lease expires on January 1, 2014. The annual rental is P900,000. Additionally, on January 1, 2009, Lake paid P500,000 to Rapp as a lease bonus and P250,000 as a security deposit to be refunded upon expiration of the lease. In Rapps, 2009 income statement, the amount of rental revenue should be

Condor Company purchased a new machine for P4,800,000 on January 1, 2009 and leased it to East Company the same day. The machine has an estimated useful life of 12 years and will be depreciated by the straight line method. the estimated residual value of the machine is P300,000. The lease is for a three-year period expiring January 1, 2012 at an annual rental of P850,000. Additionally, East Company paid P300,000 to Condor as a lease bonus to obtain the three-year lease. During 2009, Condor Company paid insurance of P80,000 for the leased machine. 42. What is the Codor depreciation expense on DEcember 31, 2009? 43. What is the lessors rent income on December 31, 2009? 44. What is the balance of prepaid rent expense of East on December 31, 2009? 45..What is the lessors net income for the lease contract on December 31, 2009? 46. What is the book value of the lease machine on December 31,2009? Letty Company leased a machine on January 1, 2009 with the following provisions. Annual rental payable in advance at the beginning of each year, starting January 1, 2009 Lease term useful life of machine implicit interest rate in the lease incremental borrowing rate 1,000,000 10 years 15 years 12% 11%

Letty Company has the option to purchase the machine on January 1, 2009 by paying P200,000 which is sufficiently lower than the expected fair value of the machine on January 1, 2019. At the inception of the lease, it is reasonably certain that the option will be exercised. Present value factor is at 3 decimal places. 47. What is the minimum lease payment on January 1, 2009? 48. What is the depreciation expense on December 31, 2009? 49. What is the interest expense on December 31, 2009? 50. What is the amount debited to lease liability upon payment of the rental on January 1, 2010?

ANSWERS: 1. C 2. B 3. B 4. C 5. D 6. B 7. C 8. A 9. D 10. D 11. A 12. A 13. D 14. D 15. D 16. D 17. A 18. D 19. D 20. B
21. face amount discount on notes payable ( 2,205/3) x 2/12 = 1470 carying value 152, 205 (735) -------151,470 ======

22. interest bearing note

175,000 and 3,000 cash 175,000 note payable 175,000

interest expense 3,000 accrued interest expense3,000 ( 5,000 x 3/5) = 3,000

23. 81,480 / 97% = 84,000

total VAt payable sales subject to VAT 84,000 / .12 700,000

24. 2010
2011

12 x 8 hours x 50 employees x P17.5 = 84,000 15 x 8 hours x 50 employees x 20 = 120,000

25. 6,000,000 x .10 = 600,000 x P1 = 600,000

600,000 - 210,000 = 390,000

26. 1800,000 x 6% = 108,000

108,000 - 42,000 = 66,000 108,000 and 66,000

27. debit litigation expense for P500,000 and credit litigation liability for P500,000, because the
contingent liability is probable.

28. unearned revenue, beg

gift cert sold gift cert redeemed expired gift cert

650,000 2250,000 (1950,000) (100,000) --------850,000

29. 250,000 x 80% = 200,000

200,000/10 = 20,000 20,000 - 15,000 = 5,000 5,000 x P100 cost of t-shirt = 500,000

30. 18,000 - 15,000 = 3,000

3,000 x 100 = 300,000

31. bonds payable

premium on bonds payable notes payable - 5 years mortgage payable (200,000 - 15,000) total long term liabilities 100,000 165,000 185,000 ---------

1,500,000

1,950,000 660,000 (250,000) (250,000) (45,000) ----------115,000 interest expense 129,780 amort 129,780 cv 1,442,000 1,571,780

32. old liability

equipment paid ( at book value) new principal obligation new interest

33.
jan 1, 2010 dec 31, 2010

interest paid ---

total discount on NP amortization

( 2,000,000 - 1,442,000) 558,000 129,780 -------------------428,220

34. 1,000,000 x 1.04 = 1,040,000

face value issue price premium on PB 1,000,000 1,040,000 ---------40,000 credit

35. interest expense

( 1,000,000 x 2.5% x 3/6) = 12,500 less amortization on premium in PB ( 40,000/10) 4,000 x 3/12 (1,000) -----------------interest expense dec 31, 2010 11,500

36. date
jan 1 jun 30 dec 31 45,000 45,000

interest paid

interest expense

50,025.6 50,327.16 ----------100,753

amortization carrying value 833,760 5,025.6 838,786 5,327.16 844,113

37. amortized premium on PB ( 30,000 x 14/120) = 3,500

less: premium on PB unamortized premium 30,000 ----------------26,500 x 400000/1000000 ---------------10,600 400,000 ------------------410,600 392,000 ----------18,600

add face value of bonds book value on the date of retirement less: retirement price ( 400,000 x .98) gain on bond redemption

38. interest expense

interest paid

3,405,000 x 8% 272,400 3,000,000 x 10% 300,000 ------------

amortization of premium premium unamortized premium

27,600 405,000 ----------377,400

39. amortized discount on bonds payable

50,000 x 12/15 = 40,000 unamortized discount on bonds payable (50,000 - 40,000) 10,000 amortized bond issue cost 150,000 x 12/15 = 120,000 unamortized bond issue cost ( 150,000 - 120,000 30,000 add: face value of bonds 2,500,000 ------------------------book value of bonds 2,460,000 retirement price(2,500,000 x 1.02) 2,550,000 ---------------------loss on bond redemption 90,000

40. issue price ( 1,000,000 x 99% )

accrued interest ( 1000,000 x 10% x 3/12) cash received

990,000 25,000 ----------------------------1,015,000 900,000

41. rental payment

realization of lease bonus ( 500,000/5) rental revenue

100,000 -------------------------1,000,000 ===============

42. 4,800,000 - 300,000 = 4,500,000 4,500,000 /12 = 375,000 43. rental payment realization of lease bonus (300,000/3) rent income 44. rent income depreciation expense insurance expense net income 45. 300,000 - 100,000 = 200,000 46. 4800,000 - 375,000 = 4,425,000 47. rental payment ( 1,000,000 x 6.328) BPO ( 200,000 x .322) MLP 48. 6,392,400 / 15 years = 426,160 49. 6,392,400 x .12 = 767,088 6,328,000 64,400 --------6392,400 ======= 850,000 100,000 ---------950,000 ======= 950,000 (375,000) (80,000) ----------495,000 ======

50. 1,000,000 - 767,088 = 232,912