11.14.18 Flashcards
On January 1, Year 4, Day Corp. entered into a 10-year lease agreement with Ward, Inc., for industrial equipment. Annual lease payments of $10,000 are payable at the end of each year. Day knows that the lessor expects a 10% return on the lease. Day has a 12% incremental borrowing rate. The equipment is expected to have an estimated useful life of 10 years. In addition, a third party has guaranteed to pay Ward a residual value of $5,000 at the end of the lease.
The present value of an ordinary annuity of $1 at
12% for 10 years is 5.6502
10% for 10 years is 6.1446
The present value of $1 at
12% for 10 years is .3220
10% for 10 years is .3855
In Day’s October 31, Year 4, balance sheet, the principal amount of the lease obligation was
$61,446.
This lease qualifies as a capital lease because the 10-year lease term is greater than 75% of the 10-year estimated useful life of the equipment. The lessee should record the present value of the minimum lease payments at the lower of the lessee’s incremental borrowing rate or the lessor’s implicit rate if known to the lessee. Because the 10% implicit rate (the lessor’s expected return on the lease) is less than the 12% incremental borrowing rate, the lease obligation should be recorded on 1/1/Year 4 at $61,446 ($10,000 periodic payment × 6.1446). The end of the fiscal year (10/31/Year 4) is 10 months after the inception of the lease, but the annual lease payments are payable at the end of the calendar year. Hence, the lease obligation recorded at the inception of the lease has not yet been reduced by the first payment. Moreover, given that the residual value of $5,000 is guaranteed by a third party, it is not included in the minimum lease payments by the lessee.
In a business combination, Major Corporation issued nonvoting, nonconvertible preferred stock with a fair value of $8 million in exchange for all of the outstanding common stock of Minor Corporation. On the acquisition date, Minor had identifiable net assets with a carrying amount of $4 million and a fair value of $5 million. In addition, Major issued preferred stock with a fair value of $800,000 to an individual as a finder’s fee in arranging the transaction. As a result of this transaction, Major should record an increase in net assets of
$8,000,000.
Based on fair value, goodwill is the excess of (1) the sum of (a) the consideration transferred ($8,000,000), (b) any noncontrolling interest in the acquiree ($0), and (c) the acquirer’s previously held equity interest in the acquiree ($0) over (2) the net of the identifiable assets acquired and liabilities assumed ($5,000,000). Thus, goodwill is $3,000,000, and the increase in net assets is $8,000,000. The acquisition-related cost (the finder’s fee) is expensed.
Flac City recorded a 20-year building rental agreement as a capital lease. The building lease asset was reported as a noncurrent asset in Flac’s government-wide financial statements. How should the lease liability be reported?
Capital Lease Obligation.
If a capital lease results from acquiring or constructing a capital asset, that is, a capital asset not reported in the fund financial statements, the transaction is recognized by debiting expenditures and crediting other financing sources in the general fund. Furthermore, the accounting and reporting should be consistent with that for general obligation bonded debt. Consequently, the related liability is a noncurrent liability. It should be reported only in the governmental activities column of the government-wide statement of net position as a capital lease obligation in the noncurrent liabilities section.
If a long-lived asset satisfies the criteria for classification as held for sale,
It is not depreciated.
A long-lived asset is not depreciated (amortized) while it is classified as held for sale and measured at the lower of carrying amount or fair value minus cost to sell. The reason is that depreciation (amortization) would reduce the carrying amount below fair value minus cost to sell. Furthermore, fair value minus cost to sell must be evaluated each period, so any future decline will be recognized in the period of decline.
Each of the following is a component of the changes in the net assets available for benefits of a defined benefit pension plan trust except
The net change in the actuarial present value of accumulated plan benefits.
Plan assets change as a result of the actual return on investments, benefit payments, and contributions. Changes in the actuarial present value of accumulated plan benefits do not affect the changes in the net assets available for benefits of a defined benefit pension plan trust.
Birdlovers, a nongovernmental not-for-profit entity, incurred $5,000 in management and general expenses during the year. In Birdlovers’ statement of activities for the year ended December 31, the $5,000 should be reported as
Part of supporting services.
The major functional expenses of NFPs are incurred for either program services or supporting activities. An analysis also must be presented that disaggregates functional expense classifications by natural expense classifications (e.g., salaries, interest, rent, and depreciation). Program expenses relate directly to the primary mission of the entity. Expenses of supporting activities, i.e., general administration, membership development, and fundraising, do not. The $5,000 in management and general expenses incurred therefore should be reported as part of supporting activities.
Dunn Trading Stamp Company records stamp service revenue and provides for the cost of redemptions in the year stamps are sold to licensees. Dunn’s past experience indicates that only 80% of the stamps sold to licensees will be redeemed. Dunn’s liability for stamp redemptions was $6 million at December 31, Year 3. Additional information for Year 4 is as follows:
Stamp service revenue from
stamps sold to licensees: $4,000,000
Cost of redemption (stamps sold prior to 1/1/Yr 4): 2,750,000
If all the stamps sold in Year 4 were presented for redemption in Year 5, the redemption cost would be $2,250,000. What amount should Dunn report as a liability for stamp redemptions at December 31, Year 4?
$5,050,000.
The liability for stamp redemptions at the beginning of Year 4 is given as $6 million. This liability would be increased in Year 4 by $2,250,000 if all stamps sold in Year 4 were presented for redemption. However, because only 80% are expected to be redeemed, the liability should be increased by $1,800,000 ($2,250,000 × 80%). The liability was decreased by the $2,750,000 attributable to the costs of redemptions. Thus, the liability for stamp redemptions at December 31, Year 4, is $5,050,000 ($6,000,000 + $1,800,000 – $2,750,000).
On February 5, Year 2, an employee filed a $2 million lawsuit against Steel Co. for damages suffered when one of Steel’s plants exploded on December 29, Year 1. Steel’s legal counsel expects the company will lose the lawsuit and estimates the loss to be between $500,000 and $1 million. The employee has offered to settle the lawsuit out of court for $900,000, but Steel will not agree to the settlement. In its December 31, Year 1, balance sheet, what amount should Steel report as liability from lawsuit?
$500,000.
Because the loss is probable and can be reasonably estimated, it should be accrued if the amount is material. If the estimate is stated within a given range, and no amount within that range appears to be a better estimate than any other, the minimum of the range should be accrued. Thus, Steel should report a $500,000 contingent liability.
Day Co. received dividends from its common stock investments during the year ended December 31 as follows:
- A stock dividend of 400 shares from Parr Corp. on July 25 when the market price of Parr’s shares was $20 per share. Day owns less than 1% of Parr’s stock.
- A cash dividend of $15,000 from Lark Corp. in which Day owns a 25% interest. Day did not elect the fair value option to account for its investment in Lark.
What amount of dividend revenue should Day report in its income statement?
$0.
Day Co. owns a 25% interest in Lark. Because the fair value option was not elected, the investment in Lark should be accounted for in accordance with the equity method. A stock dividend is not reported as dividend revenue under (1) the fair value method, or (2) the equity method. A cash dividend is not reported as dividend revenue under the equity method. Consequently, the amount of dividend revenue to be reported in the income statement is $0.
General revenues reported in the government-wide statement of activities
Include all taxes.
General revenues are revenues not required to be reported as program revenues. They are reported separately after total net (expense) revenue for all functions in the government-wide statement of activities. All taxes, including those levied for a special purpose, are general revenues.
During the year ended December 31, Year 1, the city of Todd received a state grant to buy a bus and an additional grant for bus operation in Year 1. In Year 1, only 90% of the capital grant was used for the bus purchase, but 100% of the operating grant was disbursed. Todd accounts for its bus operations in an enterprise fund. In reporting the state grants for the bus purchase and operation, what should Todd include as grant revenues for the year ended December 31, Year 1?
90% of the capital Grant:
100% of the capital grant:
Operating grant:
No
Yes
Yes
Because the bus operation is accounted for in an enterprise fund, the accrual basis of accounting is used. Thus, the purpose restriction has no bearing on revenue recognition. The recipient classifies the unused resources as restricted. Consequently, 100% of both grants should be recognized as revenues because all eligibility requirements apparently have been met given that 90% of the capital grant and 100% of the operating grant have been spent.
Government-wide financial statements
Use separate columns to distinguish between governmental and business-type activities.
The basic financial statements include government-wide statements, fund statements, and the notes to the statements. Government-wide statements do not display funds or fund types but instead report information about the overall government. They distinguish between the primary government and its discretely presented component units and between the governmental activities and business-type activities of the primary government.
On June 18, Dell Printing Co. incurred the following costs for one of its printing presses:
Purchase of collating and stapling attachment: $84,000
Installation of attachment: 36,000
Replacement parts for overhaul of press: 26,000
Labor and overhead in connection with overhaul: 14,000
The overhaul resulted in a significant increase in production. Neither the attachment nor the overhaul increased the estimated useful life of the press. What amount of the above costs should be capitalized?
$160,000.
Expenditures that increase the quality or quantity of a machine’s output should be capitalized whether or not its useful life is extended. Thus, the amount of the cost to be capitalized equals $160,000 ($84,000 + $36,000 + $26,000 + $14,000).
Freya Co. has two patents that have allegedly been infringed by competitors. After investigation, legal counsel informed Freya that it had a weak case for Patent A34 and a strong case in regard to Patent B19. Freya incurred additional legal fees to stop infringement on Patent B19. Both patents have a remaining legal life of 8 years. How should Freya account for these legal costs incurred relating to the two patents?
Expense costs for Patent A34 and capitalize costs for Patent B19.
Legal fees incurred in a successful defense of a patent should be capitalized and amortized. Legal fees incurred in an unsuccessful defense should be expensed as incurred. Hence, Freya should expense costs for Patent A34 and capitalize costs for Patent B19.
How should a nongovernmental not-for-profit organization report investments in its financial statements?
Fair value with gains and losses reported in the statement of activities.
An NFP measures (1) equity securities with readily determinable fair values and (2) all debt securities at fair value in the statement of financial position. Purchased investments initially are recorded at acquisition cost. Those received as contributions or through agency transactions are recorded at fair value. Unrealized gains and losses are reported when they occur. Unless they are donor-restricted (or subject to a law that extends donor restrictions), they are included in the statement of activities as changes in net assets without donor restrictions.
