11.14.18 Flashcards
Keller Corporation signed a 3-year lease for an automobile on December 1. The automobile had a list price of $17,000 and an estimated useful life of 8 years. The lease called for payments of $500 per month for 36 months. The present value of the $500 payments was $15,054 at Keller’s incremental borrowing rate and $15,496 at the lessor’s implicit rate, which is known to the lessee. Based on the above information, Keller should record the lease as a(n)
Capital Lease.
A lessee must report a lease as a capital lease if the present value of the minimum lease payments (MLP) is at least 90% of the fair value of the asset. If both the incremental borrowing rate and the implicit rate are known, the lesser of the two should be used to compute the PV. The lower interest rate is the one that will result in the highest PV. Dividing the present value of the MLP by the list price of the automobile yields a result > 90% ($15,496 ÷ $17,000 = 91.2%). Thus, this lease must be classified by Keller as a capital lease.
On October 1, Bordeaux, Inc., a calendar year-end firm, invested in a derivative designed to hedge the risk of changes in fair value of certain assets, currently valued at $1.5 million. The derivative is structured to result in an effective hedge. However, some ineffectiveness may result. On December 31, the fair value of the hedged assets has decreased by $350,000, and the fair value of the derivative has increased by $325,000. Bordeaux should recognize a net effect on earnings for the year of
$25,000.
A hedge of an exposure to changes in the fair value of a recognized asset or liability is classified as a fair value hedge. Gains and losses arising from changes in fair value of a derivative classified as a fair value hedge are included in the determination of earnings in the period of change. They are offset by losses or gains on the hedged item attributable to the risk being hedged. Thus, earnings of the period of change are affected only by the net gain or loss attributable to the ineffective aspect of the hedge. The ineffective portion is equal to $25,000 ($350,000 – $325,000).
The computations required to prepare the statement of cash flows include all of the following except
Equipment purchased with a note payable.
The acquisition of a long-lived asset in exchange for debt is a noncash investing transaction. It is therefore classified as a noncash financing and investing activity because it affects a recognized asset and a recognized liability but not cash flows. It is disclosed outside the statement of cash flows.
Burr Company had the following account balances at December 31, Year 1:
Cash in banks: $2,250,000
Cash on hand: 125,000
Cash legally restricted for additions to plant (expected to be disbursed in Year 2): 1,600,000
Cash in banks includes $600,000 of compensating balances related to short-term borrowing arrangements. The compensating balances are not legally restricted as to withdrawal by Burr. In the current assets section of Burr’s December 31, Year 1, balance sheet, total cash should be reported at
$2,375,000.
Legally restricted amounts related to long-term arrangements should be classified separately as noncurrent. Thus, the amount restricted for additions should be classified as noncurrent because it relates to a plant asset. Compensating balances against short-term borrowing arrangements that are legally restricted should be reported separately among the cash and cash equivalents in the current assets section. Total cash reported as current assets therefore equals $2,375,000 ($2,250,000 + $125,000).
On December 31, Year 4, Roth Co. issued a $10,000 note payable to Wake Co. in exchange for services rendered to Roth. The transaction was not in the normal course of business. The note, made at usual trade terms, is due in 9 months and bears interest, payable at maturity, at the annual rate of 3%, a rate that is unreasonable in the circumstances. The market interest rate is 8%, the prevailing rate for similar instruments of issuers with similar credit ratings. The compound interest factor of $1 due in 9 months at 8% is .944. At what amount should the note payable be credited in Roth’s December 31, Year 4, balance sheet?
$9,652.
The transaction was not in the ordinary course of business. Thus, the payable is measured at present value. Moreover, absent evidence of the market value of the note or an established exchange price for the services, the present value of a note with an interest rate that is clearly unreasonable is determined by discounting the payments at an imputed rate. The prevailing rate for issuers with similar credit ratings normally helps determine the appropriate rate. Assuming that 8% is the best approximation of the rate that would have resulted in a similar transaction between independent parties, the note payable should be credited at its present value of $9,652 {($10,000 × .944) + [$10,000 × 3% × .944 × (9 ÷ 12)]}.
Net income is understated if, in the first year, estimated salvage value is excluded from the depreciation computation when using the
Straight-line Method:
Units-of-Production Method:
Yes
Yes
Under the straight-line method, the depreciable base of an asset is allocated uniformly over the time periods of the estimated use of the asset. Under the production-or-use method, the depreciable base is allocated as a constant per-unit amount as goods are produced. For both methods, the depreciable base is equal to the original cost minus the salvage value. Thus, if the estimated salvage value is excluded from the depreciable base calculated using either method, the amount of depreciation will be overstated. The result will be an understatement of net income.
Which of the following resources increases the net assets with donor restrictions of a nongovernmental, not-for-profit voluntary health and welfare organization?
Donor contributions to fund a resident camp program.
A temporary restriction is donor-imposed. It permits the donee to use up or expend the donation as specified. It is satisfied by the passage of time or by actions of the donee. Donor contributions subject to a purpose restriction are classified as net assets with donor restrictions.
General long-term liabilities of a state or local government
Are not limited to liabilities from debt issuances.
General long-term debt is not limited to liabilities from debt issuance. It also may include noncurrent liabilities on (1) capital and operating leases, (2) compensated absences, (3) claims and judgments, (4) pensions, (5) termination benefits, (6) landfill closure and postclosure care, (7) pollution remediation obligations, and (8) other commitments that are not current liabilities properly recorded in governmental funds.
Kingwood Town, at the beginning of the year, paid $22,000 cash for a flatbed trailer to be used in the general operations of the town. The expected useful life of the trailer is 6 years with an estimated $7,000 salvage value. Which of the following amounts should be reported?
$22,000 increase in general capital assets.
Capital assets related to proprietary funds are accounted for in the government-wide financial statements and in the fund financial statements. Capital assets related to fiduciary funds are reported only in the statement of fiduciary net position. All other capital assets are general capital assets reported only in the governmental activities column in the government-wide statement of net position. Capital assets are recorded at historical cost or at estimated fair value if donated. Thus, general capital assets should be debited for $22,000, the historical cost of the equipment.
Holly Company’s inventory is overstated at December 31 of this year. The result will be
Understated income next year.
Cost of goods sold equals beginning finished goods, plus cost of goods manufactured for a manufacturer or purchases for a retailer, minus ending finished goods. Overstated ending inventory therefore results in understated cost of goods sold, overstated net income, and overstated retained earnings in the period of the error. When these errors reverse in the following period, beginning inventory and cost of goods sold will be overstated, and net income will be understated. Retained earnings will be correct.
Fogg Co., a U.S. company, contracted to purchase foreign goods. Payment in foreign currency was due 1 month after the goods were received at Fogg’s warehouse. Between the receipt of goods and the time of payment, the exchange rates changed in Fogg’s favor. The resulting gain should be included in Fogg’s financial statements as a(n)
Component of income from continuing operations.
This foreign currency transaction resulted in a payable stated in a foreign currency. The favorable change in the exchange rate between the functional currency and the currency in which the transaction was stated should be included in determining net income for the period in which the exchange rate changed. It should be classified as a component of income from continuing operations.
Cook Co. had the following balances at December 31, Year 1:
Cash in checking account: $350,000
Cash in money-market account: 250,000
U.S. Treasury bill, purchased 12/1/Yr 1, maturing 2/28/Yr 2: 800,000
U.S. Treasury bond, purchased 3/1/Yr 1, maturing 2/28/Yr 2: 500,000
Cook’s policy is to treat as cash equivalents all highly liquid investments with a maturity of 3 months or less when purchased. What amount should Cook report as cash and cash equivalents in its December 31, Year 1, balance sheet?
$1,400,000.
Cash equivalents are short-term, highly liquid investments. As part of its cash management procedures, an entity makes such investments when cash held exceeds immediate needs. Cash equivalents should be readily convertible to known amounts of cash. They should also be so near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Normally, only investments with original maturities of 3 months or less qualify as cash equivalents. Accordingly, cash and cash equivalents equal $1,400,000 ($350,000 checking account + $250,000 money-market account + $800,000 Treasury bill).
With regard to the statement of cash flows for a governmental unit’s proprietary funds, items generally presented as cash equivalents are
2-month Treasury Bills:
3-month CDs:
Yes
Yes
Cash equivalents are highly liquid investments, readily convertible to known amounts of cash with an original time to maturity at acquisition of 3 months or less. The T-bills and CDs both meet these criteria and are presented as cash equivalents.
What is the primary purpose of the statement of activities of a nongovernmental not-for-profit organization?
To report the change in net assets for the period.
The general-purpose financial statements of a nongovernmental not-for-profit entity (NFP) are the statement of financial position, statement of activities, and statement of cash flows. A statement of financial position is equivalent to a for-profit entity’s balance sheet. It presents information about assets, liabilities, net assets, and their relationships at a moment in time. A statement of activities is an operating statement equivalent to a for-profit entity’s income statement. It presents changes during the reporting period in the classes of net assets, including reclassifications of net assets. It also includes information about how resources are used to provide programs and services. An NFP’s statement of cash flows is similar to the statement reported by for-profit entities.
An entity entered into a contract to construct a building. Based on the contract’s terms, the entity appropriately determined that the performance obligation in the contract will be satisfied over time. At an early stage of the contract, the entity cannot reasonably measure the outcome of the contract, but it expects to recover the costs incurred in the construction of the building. The revenue from the contract should be recognized
Only to the extent of the costs incurred.
When the outcome of the contract is not reasonably measurable but the costs incurred in satisfying the performance obligation are expected to be recovered, revenue must be recognized only to the extent of the costs incurred. Revenue recognized is based on a zero profit margin until the entity can reasonably measure the outcome of the performance obligation.
