FAR 10 Flashcards
Bigco, Inc. transferred long-term receivables with a carrying value of $500,000 and a fair value of $450,000 to Banco for $425,000 cash. Of the $450,000 fair value, $45,000 is attributable to collection of future fees and penalties, which Bigco will retain. The surrender of control requirements have been met, therefore the transfer qualifies as a sale. What amount of loss should Bigco recognize at the time of the transfer?
Bigco’s loss is the difference between the carrying value of the portion of the asset transferred and the cash received for the transferred portion. In this case, the total carrying value of $500,000 must be allocated between the portion of the asset surrendered and the portion retained, based on relative fair values. The relative fair values are:
Amount Percent
Asset retained $ 45,000 10%
Asset transferred 405,000 __90_
Total fair value $450,000 100%
Therefore, the carrying value of the asset transferred is .90 x $500,000 = $450,000. The resulting loss is carrying value transferred $450,000 - cash received $425,000 = $25,000 loss.
On January 2, 20X8, Fiserveco acquired a five-year right to service mortgage contracts for which it paid $120,000. Fiserveco estimated that servicing and other fees would generate $400,000 over the five-year period. During 20X8, the contract generated $100,000 in revenues. Which one of the following is the amount, if any, that Fiserveco should recognize as an asset on January 2, 20X8?
Since Fiserveco acquired the servicing rights asset in the market, it should recognize a servicing asset at its fair value, which is the cost to Fiserveco in the market. Therefore, it should recognize an asset of $120,000 on January 2, 20X8.
Hudson Corp. operates several factories that manufacture medical equipment. The factories have a historical cost of $200 million. Near the end of the company’s fiscal year, a change in business climate related to a competitor’s innovative products indicated to Hudson’s management that the $170 million carrying amount of the assets of one of Hudson’s factories may not be recoverable. Management identified cash flows from this factory and estimated that the undiscounted future cash flows over the remaining useful life of the factory would be $150 million. The fair value of the factory’s assets is reliably estimated to be $135 million. The change in business climate requires investigation of possible impairment. Which of the following amounts is the impairment loss?
Under U.S. GAAP, impairment testing is a two step process. The first step compares the assets’ carry value (CV) to its undiscounted cash flows (UCF). In this problem the CV > UCF; therefore the asset is potentially impaired and we must go to the second step. The second step compares the assets CV to its fair value (FV). In this problem the FV
Bell Co. is a defendant in a lawsuit that could result in a large payment to the plaintiff. Bell’s attorney believes that there is a 90% chance that Bell will lose the suit, and estimates that the loss will be anywhere from $5,000,000 to $20,000,000 and possibly as much as $30,000,000. None of the estimates is better than the others. What amount of liability should Bell report on its balance sheet related to the lawsuit?
Correct! When no amount within the range of estimated loss amounts is more probable than the others, the lowest amount in the range is recognized, provided that the loss is probable. A 90% probability is sufficient to meet the “probable and estimable” requirement of FAS 5 for recognizing contingent liabilities.
During 2004, Gum 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 the sale and 4% in the second 12 months following the sale.
Sales and actual warranty expenditures for the years ended December 31, 2004 and 2005 are as follows:
Sales Actual warranty expenditures 2004 $150,000 $2,250 2005 250,000 7,500 $400,000 $9,750 ========= ========= What amount should Gum report as estimated warranty liability in its December 31, 2005, balance sheet?
At Dec. 31, 2005, the total warranty liability accrued for the two years is 6% of sales (2% + 4%). This total is $24,000 (.06 x $400,000). Subtracting $9,750 of actual warranty expenditures to the end of 2005 yields the $14,250 ending warranty liability.
Martin Pharmaceutical Co. is currently involved in two lawsuits. One is a class-action suit in which consumers claim that one of Martin’s best selling drugs caused severe health problems. It is reasonably possible that Martin will lose the suit and have to pay $20 million in damages. Martin is suing another company for false advertising and false claims against Martin. It is probable that Martin will win the suit and be awarded $5 million in damages. What amount should Martin report on its financial statements as a result of these two lawsuits?
A contingent liability is recognized only when occurrence is probably and estimable. This class-action suit is reasonably possible (a 50/50 chance) but not probable (a higher threshold). Therefore, a liability for the class-action suit would not be accrued. Contingent assets are not recognized until the amount is actually received, even if the outcome is probable and estimable. Therefore, no asset is accrued for the suit where Martin may be awarded damages.
During 2004, a former employee of Dane Co. began a suit against Dane for wrongful termination in November 2003. After considering all of the facts, Dane’s legal counsel believes that the former employee will prevail and will probably receive damages between $1,000,000 and $1,500,000, with $1,300,000 being the most likely amount. Dane’s financial statements for the year ended December 31, 2003, will not be issued until February 2004. In its December 31, 2003, balance sheet, what amount should Dane report as a liability with respect to the suit?
When an estimate of the amount of a probable loss is more likely than others in the range, that amount is used for the accrual. If all amounts in the range are equally probable, then the lowest amount in the range is used for the accrual.
During the current year, Comma Co. had outstanding: 25,000 shares of common stock, 8,000 shares of $20 par, 10% cumulative preferred stock, and 3,000 bonds that are $1,000 par and 9% convertible. The bonds were originally issued at par, and each bond was convertible into 30 shares of common stock. During the year, net income was $200,000, no dividends were declared, and the tax rate was 30%.
What amount was Comma’s basic earnings per share for the current year?
One year of preferred stock dividends is subtracted from income in the numerator of EPS because the stock is cumulative. The amount of dividends declared does not affect the calculation. The bonds are not relevant because basic EPS does not assume conversion of the bonds. The calculation is: Basic EPS = [$200,000 - (8,000 x $20 x .10)]/25,000 = ($200,000 - $16,000)/25,000 = $7.36.
Wood Co.’s dividends on noncumulative preferred stock have been declared but not paid. Wood has not declared or paid dividends on its cumulative preferred stock in the current or the prior year and has reported a net loss in the current year. For the purpose of computing basic earnings per share, how should the income available to common stockholders be calculated?
In general, the dividends subtracted in computing basic EPS are (1) the annual dividend commitment on cumulative preferred whether or not declared or paid, and (2) declared dividends on noncumulative preferred whether paid or not. The firm has negative income. This answer means that the dividends reduce the numerator further - beyond the loss. The final numerator amount is less than (more negative than) the loss. Also, arrear dividends are never included in EPS because they were subtracted in computing EPS in a previous year.
A company had the following outstanding shares as of January 1, year 2:
Preferred stock, $60 par, 4%, cumulative 10,000 shares
Common stock, $3 par 50,000 shares
On April 1, year 2, the company sold 8,000 shares of previously unissued common stock. No dividends were in arrears on January 1, year 2, and no dividends were declared or paid during year 2. Net income for year 2 totaled $236,000. What amount is basic earnings per share for the year ended December 31, year 2?
Basic EPS = Net Income - Preferred Dividends / Weighted shares outstanding. The numerator is $236,000 - preferred dividends [($60 x 10,000) x .04 = 24,000] = $212,000. The denominator is 50,000 (12/12) + 8,000 (9/12) = 56,000 shares. $212,000 / 56,000 = $3.786 or $3.79.
On January 31, 2004, Pack, Inc. split its common stock 2 for 1, and Young, Inc. issued a 5% stock dividend. Both companies issued their December 31, 2003, financial statements on March 1, 2004.
Should Pack’s 2003 earnings per share (EPS) take into consideration the stock split, and should Young’s 2003 EPS take into consideration the stock dividend?
EPS is used primarily as an input to predictions of future earnings. The stock split and dividend cause the number of shares outstanding to increase, and thus affect the future earnings prospects on a per share basis. These events should be included in the computation of EPS even though they did not occur as of the balance sheet date. Financial statement users view the information as if it were current as of the date of publication.
Ian Co. is calculating earnings per share amounts for inclusion in the Ian’s annual report to shareholders. Ian has obtained the following information from the controller’s office as well as shareholder services:
Net income from January 1 to December 31 $125,000
Number of outstanding shares:
January 1 to March 31 15,000
April 1 to May 31 12,500
June 1 to December 31 17,000
In addition, Ian has issued 10,000 incentive stock options with an exercise price of $30 to its employees and a year-end market price of $25 per share. What amount is Ian’s diluted earnings per share for the year ended December 31?
Weighted average shares outstanding for basic EPS = 15,000(3/12) + 12,500(2/12) + 17,000(7/12) = 15,750. Basic EPS = $125,000/15,750 = $7.94. The stock options are antidilutive because the exercise price exceeds the average market price of the stock. Such options would not be assumed exercised. Under the treasury stock method, assuming exercise would result in more shares being purchased for the treasury than issued upon assumed exercised. The result is a decrease in the denominator of diluted EPS causing diluted EPS to exceed basic EPS. Therefore, in this case, diluted and basic EPS are equal.
A firm has basic earnings per share of $1.29. If the tax rate is 30%, which of the following securities would be dilutive?
This security is dilutive. The numerator effect is $49 saving in interest ($1,000 x .07 x (1-.3)), and the denominator effect is 40 more shares outstanding. 49 / 40 = $1.225, which is less than the BEPS of $1.29, so the security is dilutive.
On May 15, 2003, Munn, Inc. approved a plan to dispose of a segment of its business. It is expected that the sale will occur on February 1, 2004, at a selling price of $500,000. The segment reported $195,000 in operating losses for 2003. The segment is expected to lose $30,000 from operations in 2004. The carrying amount of the segment at the date of sale was expected to be $850,000. Before income taxes, what amount should Munn report as a loss from discontinued operations in its 2003 income statement?
There are two components for discontinued operations: (1) the operating income or loss for the period in which the decision is made to dispose, and (2) the disposal loss. Only actual operating income (or loss) is recognized, but estimated as well as actual disposal losses are recognized. The $350,000 estimated disposal loss is the difference between the $850,000 carrying value of the segment, and its $500,000 estimated selling price. The operating loss for the period ($195,000) plus the estimated disposal loss ($350,000) equals the $545,000 total loss to be recognized for discontinued operations for 2003.
RWB Co., a U.S. entity, purchased goods for resale from a Thai manufacturer. The purchase agreement provided that the U.S. entity would pay the Thai entity 500,000 baht, the Thai currency. The goods were delivered on July 1, 2008, with payment due August 29, 2008. The following exchange rates were determined for the number of baht to the dollar (i.e., B/$):
Spot Rate 60-day Forward Rate
July 1, 2008 35.0B/$ 36.5B/$
August 29, 2008 37.0B/$ 38.0B/$
At which one of the following amounts (rounded) would RWB Co. record the goods purchased from the Thai manufacturer?
The goods should be measured and recorded in dollars based on the exchange rate in effect (spot rate) at the date of the purchase, July 1. Thus, the correct amount would be 500,000B/35.0B per $ = $14,286.
