FAR 3 Flashcards
The composite depreciation method
A. Is applied to a group of homogeneous assets.
B. Is an accelerated method of depreciation.
C. Does not recognize gain or loss on the retirement of single assets in the group.
D. Does not subtract salvage value from the base of the depreciation calculation.
C. Does not recognize gain or loss on the retirement of single assets in the group.
This answer is correct because under the composite and group methods, if an individual asset is retired before the average life of the group is reached, the resulting gain or loss is buried in the accumulated depreciation account. The composite and group depreciation are processes of averaging the service lives of a number of assets and taking depreciation on the entire group as if it were an operating unit.
On December 31, year 1, Marsh Company entered into a debt restructuring agreement with Saxe Company, which was experiencing financial difficulties. Marsh restructured a $100,000 note receivable as follows:
Reduced the principal obligation to $70,000.
Forgave $12,000 of accrued interest.
Extended the maturity date from December 31, year 1 to December 31, year 3.
Reduced the interest rate from 12% to 8%. Interest is payable annually on December 31, year 2 and year 3.
Present value factors:
Single sum, two years @ 8% .85734
Single sum, two years @ 12% .79719
Ordinary annuity, two years @ 8% 1.78326
Ordinary annuity, two years @ 12% 1.69006
In accordance with the agreement, Saxe made payments to Marsh on December 31, year 2 and year 3. Marsh does not elect the fair value option for reporting the modification of debt. How much interest income should Marsh report for the year ended December 31, year 3?
A. $0
B. $5,600
C. $8,100
D. $11,200
C. $8,100
The requirement is to determine the amount of interest revenue to be recorded by Marsh, after a modification of terms type of troubled debt restructure on December 31, year 1.
When a modification of terms results in the present value of future cash flows being less than the carrying amount, then the interest revenue is calculated by using the effective interest method. In this problem the expected future cash flows is determined by discounting the principal and interest at the original effective rate of 12%.
70,000
.79719 = 55,803
5,600
1.69005 = 9,464
Present value of future cash flows 65,267
The interest revenue to be recognized can then be determined using the effective interest method.
PV at 12/31/Y1
$65,267
Interest income at 12/31/Y1 ($65,267 @
12%) $7,832
Interest receivable at 12/31/Y2 (70,000 @
8%) 5,600
Increase in carrying value of loan
2,232
PV at 12/31/Y2
67,499
Interest revenue at 12/31/Y3 (67,499 @
12%) $8,100
Which of the following is not a profitability ratio?
A. Price/earnings ratio.
B. Return on assets.
C. Gross margin.
D. Operating profit margin.
A. Price/earnings ratio.
This answer is correct. The price/earnings ratio is a market ratio. It is calculated by dividing the price of a share of stock by earnings per share.
On January 1, Year 2, Ball, Inc. had 100,000 shares of $1 par common stock outstanding and $900,000 of APIC. Retained earnings had a balance of $250,000. Ball declared two stock dividends during the year: a 100% stock dividend and a 5% stock dividend. The fair value of the stock on the date of declaration was $3 for both dividends.
How would the 5% stock dividend affect the APIC and retained earnings amounts reported in Ball’s Year 2 statement of stockholders’ equity?
APIC Retained Earnings
A. Increase Decrease
B. Increase Increase
C. No change Decrease
D. No change Increase
A. Increase Decrease
Small stock dividends (ie, less than 20–25% of the outstanding shares) are recorded at FV on the date of declaration. The dividend decreases retained earnings by the total amount of the dividend, increases common stock by par or stated value, and increases APIC by the excess of FV over par.
Sylvester Co. borrowed a $900,000 at 12% on December 3, Year 4, to finance construction of a building for the company’s use. Construction in progress has a $536,000 beginning balance on January 1, Year 5. During Year 5, $240,000 in construction costs were incurred on March 1 and $100,000 on December 31. Construction was completed on December 31, Year 5. Actual interest paid on the debt in Year 5 was $108,000. How much interest should Sylvester capitalize in Year 5?
A. $88,320
B. $93,120
C. $100,320
D. $108,000
A. $88,320
In this scenario, the beginning construction in progress costs must be considered and these costs are treated as outstanding for the entire year. The WAAE is $736,000, calculated as follows.
Date Expenditure
Weighted
period
Weighted
expenditures
Jan. 1 CIP $536,000 × 12/12 = $536,000
March 1 $240,000 × 10/12 = $200,000
Dec. 31 $100,000 × 0/12* = $0
Total WAAE $736,000
*if incurred on Dec. 31, outstanding for zero days.
The capitalized interest is $88,320 ($736,000 WAAE × 12%), which is lower than the $108,000 in actual interest.
A debtor and a creditor have negotiated new terms on a note. How can you determine whether the restructuring is a troubled debt restructure?
A. If the interest rate as stated in the restructuring agreement has been reduced relative to the original loan agreement
B. If the present value of the restructured flows using the original interest rate is less than the book value of the debt at the date of the restructure.
C. If the interest rate that equates (1) the book value of the debt at the date of the restructure and (2) the present value of restructured cash flows, exceeds the original interest rate
D. If the present value of the restructured flows using the original interest rate is less than the market value of the original debt at the date of the restructure
B. If the present value of the restructured flows using the original interest rate is less than the book value of the debt at the date of the restructure.
This is one of the ways to determine if a restructuring is troubled. Under the terms of this answer, the creditor is receiving a stream of cash flows with a present value less than what is currently owed and is making a concession.
Dannon Co. mistakenly reported its expenses of $35,200 on the cash basis. Corporate records revealed the following information:
Beginning prepaid expense $1,300
Beginning accrued expense 1,650
Ending prepaid expense 1,800
Ending accrued expense 1,200
What amount of expense should the Dannon report on its books under the accrual basis?
A. $34,250
B. $35,150
C. $35,300
D. $36,150
A. $34,250
In this scenario, Dannon Co. must adjust the $35,200 cash payments for the net increase in prepaids and the net decrease payables. Setting up the journal entry shows the accrual-based expenses are $34,250.
Accrual based expense (plug) 34,250
Prepaid accounts ($1,300 − $1,800) ↑ 500
Payable accounts ($1,650 − $1,200) ↓ 450
Cash (amount paid)
35,200
Things to remember:
When converting cash payments to an accrual-based expense, the cash paid is adjusted for net changes in the related payables and prepaid accounts. Both a net decrease in a payable (ie, debit) and a net increase in a prepaid (ie, debit) are deducted from the payments to arrive at the expense.
Werth Company’s outstanding capital stock at March 31, Year 2, consisted of the following:
10,000 shares of 4% cumulative preferred stock, par value $10 per share, fully participating as to dividends. Dividends are in arrears from Year 1.
150,000 shares of common stock, par value $2 per share.
On March 31, Year 2, Werth declared dividends of $50,000. What was the amount of dividends payable to Werth’s common shareholders?
A. $27,000
B. $34,500
C. $37,500
D. $42,000
B. $34,500
A dividend must be declared to be paid. However, if preferred stock is cumulative, any undeclared annual dividend not paid in the previous year(s) accumulates (dividends in arrears) and is paid in the future when declared. Preferred stock has a stated annualdividend preference (eg, 4%), which is paid before the common shareholders.
Preferred stock also may be participating, meaning once the common shareholders are paid an equivalent percentage of par value dividend (eg, 4%), any excess dividend declared is allocated between the two classes of stock. The allocation is based on relative par value.
In this case, the preferred shareholders are entitled to an annual dividend of $4,000 (10,000×$10par×4%)
10,000×$10par4%
. An equivalent percentage dividend for common shareholders would be $12,000 (150,000×$2par×4%)
150,000×$2par×4%
. The total dividends payable to preferred and common shareholders are $15,500 and $34,500, respectively, and are calculated as follows:
On January 1, Year 1, Grout Co. entered into a 5-year finance lease for a new truck with annual payments of $20,000 beginning January 1, Year 1. Based on an implicit interest rate of 6%, the five lease payments have a present value of $89,300 at lease inception. What amount should Grout report as interest expense for the year ended December 31, Year 1?
A. $4,158
B. $4,800
C. $5,358
D. $6,000
A. $4,158
In a finance lease, the lessee recognizes a right-of-use asset and a lease liability at the present value (PV) of lease payments. The PV of payments and interest expense are calculated using the lease’s implicit rate, if known. Otherwise, the lessee’s incremental borrowing rate is used.
If the first payment in a finance lease is made at lease inception, no timehas passed for interest to accrue. Therefore, the payment consists entirely of a reduction in the lease liability. Interest expense equals: Liability balance × Interest rate × (Months outstanding / 12 months).
In this scenario, Grout Co. signed a 5-year finance lease with an implicit rate of 6%. The PV of lease payments (ie, lease liability) is given as $89,300. After the first payment at lease inception, the liability balance equals $69,300: $89,300 PV of lease payments − $20,000 annual payment. Interest expense for Year 1 is $4,158: $69,300 liability balance × 6% interest rate × (12 months outstanding / 12 months).
A corporation issued debt to purchase 10 acres of land for development purposes. Expenditures related to this purchase are as follows:
Description Amount
Purchase price $1,000,000
Real estate taxes in arrears 15,000
Debt issuance costs 2,000
Attorney fee – title search on land 5,000
The company should record its acquisition of the land in its financial statements at a value of
A. $1,000,000
B. $1,015,000
C. $1,020,000
D. $1,022,000
C. $1,020,000
The cost of an asset includes any expenditures to make it ready for use. For land, this includes its purchase price and any closing costs (eg, taxes, fees, title costs). Debt issuance costs are treated as a reduction of cash received from the debt, regardless of the purpose for which this cash is used.
What method does a company use to determine the transaction price for a contract that includes variable consideration when the company has numerous other contracts with similar characteristics and there are more than two possible results?
A. Expected outcome method
B. Expected value method
C. Most likely value method
D. Most likely amount method
B. Expected value method
A company should use the expected value method when there are more than two possible outcomes and the company has experience with contracts with similar characteristics. The company can use its experience to appropriately weight the probability of each outcome to calculate the expected value of the variable consideration.
Dalton Company adopted the dollar-value LIFO inventory method on January 1, year 2. In applying the LIFO method Dalton uses internal price indexes and the multiple-pools approach. The following data were available for Inventory Pool No. 1 for the 2 years following the adoption of LIFO:
Current inventory
At current year cost At base year cost Internal price index
1/1/Y2 $100,000 $100,000 1.00
12/31/Y2 126,000 120,000 1.05
12/31/Y3 140,800 128,000 1.10
Under the dollar-value LIFO method the inventory at December 31, year 3, should be
A. $128,000
B. $129,800
C. $130,800
D. $140,800
B. $129,800
This answer is correct. When using DV LIFO, ending inventory at current year cost is converted to base-year cost. Then, the LIFO layers are determined at base-year cost and restated using the price index in effect at the time each layer was added. Using this approach, the 12/31/Y3 inventory is $129,800:
Base cost
Ending inventory at DV LIFO cost
1/1/Y2 layer $100,000 × 1.00 = $100,000
Y2 layer 20,000 × 1.05 = 21,000
Y3 layer 8,000 × 1.10 = 8,800
$128,000
$129,800
During year 4, the management of West Inc. decided to dispose of some of its older equipment and machinery. By year-end, December 31, year 4, these assets had not been sold, although the company was negotiating their sale to another company. On the December 31, year 4 balance sheet of West Inc., this equipment and machinery should be reported at
A. Fair value.
B. Carrying amount.
C. The lower of carrying amount or fair value.
D. The lower of carrying amount or fair value less cost to sell.
D. The lower of carrying amount or fair value less cost to sell.
When management plans to dispose of long-lived assets and limited-lived intangibles, the assets shall be reported at the lower of carrying amount or fair value less cost to sell.
Arena Corp. leased equipment from Bolton Corp. and correctly classified the lease as a finance lease. The present value of the annual lease payments at lease inception was $1,000,000. The present value of the maintenance and service obligations to be paid by Bolton was $50,000, and the fair value of the equipment at lease inception was $900,000. What amount should Arena report as the finance lease obligation at the lease’s inception?
A. $900,000
B. $950,000
C. $1,000,000
D. $1,050,000
C. $1,000,000
When the present value (PV) of lease payments is substantially all of the leased item’s fair value, it is a finance lease. The lease obligation is recorded at the PV of the lease payments. Leases can also include nonlease components (eg, maintenance service obligations) that are separated from the lease components and expensed as incurred.
On January 1, Year 1, Alpha Co. signed an annual cloud computing arrangement with a software provider for $15,000. The arrangement did not include a software license, and the maintenance period begins on March 1, Year 1. Alpha also incurred $5,000 of costs on January 1, Year 1, related to software modification requests that will increase the functionality of the software. Alpha depreciates and amortizes its computer and software assets over 5 years using the straight-line method. What amount is the total expense that Alpha should recognize related to the cloud computing arrangement and the software modifications for the year ended December 31, Year 1?
A. $5,000
B. $13,500
C. $16,000
D. $20,000
B. $13,500
If the CCA includes a software license, the entire cost is capitalized as an intangible asset. However, if the CCA does not include a software license, the entire amount is treated as a service contract, with the expense recognized over the life of the contract (ie, as benefit is derived). Implementation costs on such CCAs are separatelycapitalized as a software asset and amortized over its useful life.
Alpha’s CCA does not include a software license, so its cost is amortized over the 12-month life of the service contract, with 10 months (March 1 through December 31) occurring in Year 1 (Choices C and D). The modification requests are implementation costs that are amortized evenly over the 5-year life of the software asset. Alpha’s total expense relating to the CCA is $13,500:
CCA service contract ($15,000 ×
×
10 months/12 months) $12,500
Implementation costs ($5,000 /
/
5-year life) 1,000
Total Year 1 expense recognized $13,500
On January 1, Year 1, a company’s new CEO was awarded a $200,000 bonus that would be paid out in two $100,000 installments in Years 3 and 4 of employment, contingent on employment through the year ended December 31, Year 2. What amount should the company expense for this bonus for Years 2 and 3?
Year 2 Year 3
A. $0 $100,000
B. $100,000 $0
C. $100,000 $100,000
D. $200,000 $0
B. $100,000 $0
In this scenario, the bonus is contingent upon the CEO’s employment through the end of Year 2. Therefore, the $200,000 compensation expense is allocated evenly across Years 1 and 2, with $100,000 (ie, 1/2) recognized each of those years (as the requirement is met). The bonus recognition is as follows:
Year Compensation
expense recognized
1 $100,000
2 100,000
3 0
4 0
$200,000
The following information applies to Laverin Corp. for Year 3:
Net income $240,000
Dividends paid on common stock $120,000
Common stock outstanding 300,000 shares
The market price per share of the common stock on December 31 is $12. What is Laverin’s December 31, Year 3 price-to-earnings ratio?
A. 9.6 to 1
B. 10.0 to 1
C. 15.0 to 1
D. 30.0 to 1
C. 15.0 to 1
price per share/EPS
Which of the following statements is a primary objective of accounting for income taxes?
A. To compare an enterprise’s federal tax liability to its state tax liability
B. To identify all of the permanent and temporary differences of an enterprise
C. To estimate the effect of the tax consequences of future events
D. To recognize the amount of deferred tax liabilities and deferred tax assets reported for future tax consequences
D. To recognize the amount of deferred tax liabilities and deferred tax assets reported for future tax consequences
The two primary objectives of accounting for income taxes under GAAP are: (1) to recognize the current-year amount of taxes payable or refundable, and (2) to recognize the amount of deferred tax liabilities and deferred tax assets reported for future tax consequences.
On July 1, Year 1, Glen Corp. leased a new machine from Ryan Corp. The lease contains the following information:
Lease term 10 years
Useful life of the machine 12 years
Present value of the lease payments $120,000
Fair value of the machine $200,000
Taxes and insurance included in lease payments $3,000
No purchase option is provided, and the machine reverts to Ryan when the lease expires. What amount should Glen record as a right-of-use asset at inception of the lease?
A. $0
B. $120,000
C. $123,000
D. $200,000
B. $120,000
In this scenario, Glen Corp. has a finance lease because the lease term is a major part (ie, ≥ 75%) of the machine’s useful life (10/12 years ≈ 83%). The PV of lease payments (ie, lease liability, ROU asset) is given as $120,000 and includes taxes and insurance of $3,000
Lessee Company enters into a lease on December 31, Year 1, that is accounted for as a finance lease. The lease requires quarterly payments of $15,000, beginning on December 31, Year 1, and continuing for 5 years. The lease has an implicit annual interest rate of 8%, which is known to Lessee. The present value of an annuity due at:
8% per period for 5 periods is 4.312.
2% per period for 20 periods is 16.678.
What amount will Lessee report as a lease liability on its financial statements dated December 31, Year 1?
A. $235,170
B. $243,720
C. $250,170
D. $258,720
A. $235,170
In this scenario, Lessee Company enters into a 5-year finance lease with an 8% annual implicit rate. Because the payments are quarterly, the 2% (8% / 4) PV factor for 20 periods (5 years × 4) is used to determine the $250,170 initial lease liability (Choice C). After the first payment, the lease liability is $235,170 on December 31, Year 1.
Initial lease liability ($15,000 payment × 16.678) $250,170
Less: payment made at lease inception (15,000)
December 31, Year 1, lease liability $235,170
Zarek Co. adopted the dollar-value LIFO inventory method as of January 1, Year 2. A single inventory pool and an internally calculated price index are used to calculate Zarek’s LIFO inventory layers. Information about Zarek’s dollar-value inventory follows:
Inventory
Date Current-year cost Base-year cost Dollar-value LIFO
1/1/YR 2 $120,000 $120,000 $120,000
12/31/YR 2 160,000 128,000 130,000
12/31/YR 3 201,000 134,000
What is Zarek’s dollar value LIFO inventory on December 31, Year 3?
A. $132,000
B. $132,500
C. $139,000
D. $140,050
C. $139,000
In this scenario, the starting point for DVL is to determine the new LIFO layer (Step 2), which is $6,000 ($134,000 − $128,000) or the difference in Year 3 and Year 2’s inventory in base-year costs. The new layer is restated in current-year costs by using the current-year index (Step 3). Although the price index is not provided, it can be calculated as (Current EI / Current EI in base-year dollars), or [($201,000 / $134,000) = 1.5]. DVL is $139,000, the sum of all the restated layers (Step 4).
DVL
Step 2: Year 3 layer in base-year costs ($134,000 − $128,000) = $6,000
DVL at end of Year 2 (given) $130,000
Step 3: Year 3 layer, restated in current costs ($6,000 × 1.50*) 9,000
Step 4: Year 3 DVL $139,000
*1.50 = ($201,000 / $134,000)
On January 1, Year 1, Stockman Co. issued a $100,000, 5-year, noninterest-bearing note to Trolley Co. in exchange for machinery. Based on the value of the machinery, the imputed interest rate is 10%. The present value of the note on January 1, Year 1, is $62,092. What amount, if any, should Trolley record as interest expense for the year ended December 31, Year 1?
A.$0
B.$2,000
C.$6,209
D.$10,000
C.$6,209
Under the effective interest method, interest expense equals NP’s carrying value (CV × Effective interest rate (ie, imputed, yield, or market rate) × Portion of year outstanding. Each period, the borrower expenses a portion of the implicit interest (ie, the discount).
Trolley’s interest expense for the year ended December 31, Year 1, is $6,209, calculated as follows:
CV of note* × Effective interest rate × Portion of year outstanding = Interest expense
$62,092 *x 10% x 12/12 = $6,209
Each of the following transactions will cause a decrease in stockholders’ equity, except:
A. The sale of treasury stock at less than cost.
B. The declaration of a cash dividend.
C. A loss on the sale of a discontinued segment.
D. A loss from a foreign currency translation adjustment.
A. The sale of treasury stock at less than cost.
Because treasury stock is a contra account, reissuing (ie, selling) treasury stock would reduce its debit balance, thus increasing total stockholders’ equity. If accounted for under the cost method, the sale of treasury stock at less than cost will always result in an overall increase in stockholders’ equity. For example, if treasury stock with a cost of $100 is sold for $80, there is an $80 net increase in stockholders’ equity, as shown below:
Sale of treasury stock
Cash 80
APIC-treasury stock (decreases equity) 20
Treasury stock (increases equity)
100
A company with a June 30 fiscal year end entered a $3,000,000 construction project on April 1 to be completed on September 30. The cumulative construction-in-progress balances at April 30, May 31, and June 30 were $500,000, $800,000, and $1,500,000, respectively. The interest rate on company debt used to finance the construction project was 5% from April 1 through June 30 and 6% from July 1 through September 30. Assuming that the asset is placed into service on October 1, what amount of interest should be capitalized to the project on June 30?
A. $11,666
B. $18,750
C. $75,000
D. $90,000
A. $11,666
In this scenario, the cumulativeconstruction-in-progress (CIP) costs (not the expenditures) are provided at the end of April, May, and June. The 6% interest is not applicable until July, the next fiscal year. Using the CIP monthly balances, and the current interest rate of 5%, the calculated interest for the fiscal year ending June 30 is $11,666, as shown below.
500000.051/12 = 2083
800000.051/12 = 3333
1500000.051/12 = 6250
11,666
On January 1 of the current year, Tree Co. enters into a five-year lease agreement for production equipment. The lease requires Tree to pay $12,500 per year in lease payments. At the end of the five-year lease term, Tree can purchase the equipment for $30,000. The fair value of the equipment is $75,000. The estimated useful life of the equipment is 10 years. The present value of the lease payments is $50,000. The present value of the purchase option is $20,000. Tree’s controller believes the purchase option price is sufficiently below the expected fair value of the equipment at the date the option becomes exercisable to reasonably assure its exercise. Tree would normally depreciate equipment of this type using the straight-line method. What amount is the carrying value of the asset related to this lease at December 31, of the current year?
A. $40,000
B. $45,000
C. $56,000
D. $63,000
D. $63,000
Tree Co.’s lease meets the criteria for a finance lease because the controller believes Tree will likely exercise the purchase option. The ROU asset recognized is $70,000, and Tree will amortize the ROU asset by its useful life. The carrying value at the end of the first year of the lease is $63,000.
ROU asset ($50,000 PV lease payments + $20,000 PV purchase option) $70,000
(−) Annual depreciation ($70,000 ROU asset / 10 years useful life) (7,000)
Carrying value after first year $63,000
The balance in Kemp Corp.’s accounts payable account at December 31, 20X5 was $900,000 before any necessary year-end adjustment relating to the following:
Goods were in transit to Kemp from a vendor on December 31, 20X5. The invoice cost was $50,000. The goods were shipped F.O.B. shipping point on December 29, 20X5 and were received on January 4, 20X6.
Goods shipped F.O.B. destination on December 21, 20X5 from a vendor to Kemp were received on January 6, 20X6. The invoice cost was $25,000.
On December 27, 20X5, Kemp wrote and recorded checks to creditors totaling $40,000 that were mailed on January 10, 20X6.
In Kemp’s December 31, 20X5 balance sheet, the accounts payable should be
A. $940,000
B. $950,000
C. $975,000
D. $990,000
D. $990,000
The correct answer, $990,000, is the balance in the AP account at year-end, which equals: $900,000 (bal. before adjustment) + $50,000 (in transit, FOB shipping point) + $40,000 (checks not sent as of Dec. 31).
The $50,000 amount is included in AP at 12/31 because the title passed to Kemp at 12/29. The title to goods shipped FOB shipping point passes to the buyer when the goods reach the common carrier. Therefore, Kemp owned the goods and incurred a liability on 12/29.
The $25,000 amount is not included in AP at 12/31 because the title did not pass to Kemp until the goods reached the destination, which occurred after 12/31. The title of the goods shipped FOB destination passes to the buyer at the destination.
The $40,000 amount is included in AP at 12/31 because the checks were not sent as of 12/31. Kemp did not extinguish this amount of its debt as of 12/31 and should make an adjusting entry to increase both cash and AP at 12/31.
Choose the correct statement concerning the classification of a liability when a firm is subject to a debt covenant.
A. All liabilities callable on demand are classified as current in all circumstances.
B. If the liability is callable on demand and the covenant is violated, then the liability is classified as current if the violation is waived by the creditor.
C. If the covenant includes a subjective acceleration clause and there is only a remote chance that debt will be called, then the liability is classified as noncurrent.
D. If a covenant grants a grace period during which it is possible that the violation will be cured, then the liability is classified as noncurrent.
C. If the covenant includes a subjective acceleration clause and there is only a remote chance that debt will be called, then the liability is classified as noncurrent.
It must be at least possible that the liability will be called in order for the classification to be downgraded to current.
A six-year finance lease that specifies equal annual lease payments expires on December 31. The payments being made represent both interest and a reduction in the net lease liability. The portion of the lease payment in the fifth year applicable to the reduction of the net lease liability should be:
A. Less than in the fourth year.
B. More than in the fourth year.
C. The same as in the sixth year.
D. More than in the sixth year.
B. More than in the fourth year.
In a finance lease, lease payments include interest expense and a reduction in lease liability. The difference between the lease payment and the interest expense is the reduction in lease liability. When lease payments are equal, the interest calculated on a declining liability balance decreases over time while the liability reduction increases.
Elan Co. has two employees. Each employee receives two weeks of paid vacation each year. Vacation rights accumulate. One employee, whose weekly salary is $600, took a two-week vacation during the year, but the other employee, who earns $800 per week, took no vacation during the year. In its year-end financial statements, what amount should Elan report as vacation liability and expense?
Liability Expense
A. $1,600 $1,200
B. $1,600 $2,800
C.$0 $1,200
D.$0 $2,800
B. $1,600 $2,800
In addition to regular wages, employees may be entitled to compensated absences (eg, vacation, sick days). A company will report a liability for future vacation pay if all of the following conditions are met:
The employee’s services were already provided.
The right to compensation for future absences either vests or accumulates.
Payment is probable and can be reasonably estimated.
Based on the information provided, Elan Co.’s compensation plan should report a liability (ie, future economic obligation) after employees perform services to the company and earn vacation days. The entry is as follows:
Vacation expense [($600 × 2 weeks) + ($800 × 2 weeks)] 2,800
Accrued vacation
2,800
Once one employee has taken their vacation time, the liability will be reduced because the future obligation the company must pay is decreased. The entry is as follows:
Accrued vacation ($600 × 2 weeks) 1,200
Cash (or Salaries payable)
1,200
Elan will report a vacation liability of $1,600 ($2,800 − $1,200) and a vacation expense of $2,800.
Dunn and Grey are partners with capital account balances of $60,000 and $90,000, respectively. They agree to admit Zorn as a partner with a one-third interest in capital and profits, for an investment of $100,000, after revaluing the assets of Dunn and Grey. Goodwill to the original partners should be
A. $0
B. $33,333
C. $50,000
D. $66,667
C. $50,000
The goodwill method is based on the total value of the partnership implied by the new partner’s contribution. If the existing partners’ capital accounts do not equal their pro rata share of the implied BV, goodwill is recorded for the difference (Choice A). The old partners’ capital balances are increased by the goodwill according to their old profit ratios.
For example, if a new partner acquires a one-fourth interest for $25,000, the BV of the partnership is assumed to be $100,000. There is goodwill if the existing partners’ capital accounts do not equal $75,000 (ie, the remaining three-fourths).
In this scenario, Zorn is admitted as a one-third partner for a $100,000 contribution. This implies that the partnership’s BV is $300,000. The resulting goodwill is $50,000, as shown below:
Step 1: Implied BV of partnership $100,000 ÷ 1/3 = $300,000
Step 2: Old partners’ share of implied BV $300,000 × 2/3 = $200,000
Step 3: Goodwill $200,000 − ($60,000 + $90,000) = $50,000
