FAR 6 Flashcards
A company whose stock is trading at $10 per share has 1,000 shares of $1 par common stock outstanding when the board of directors declares a 30% common stock dividend. Which of the following adjustments should be made when recording the stock dividend?
This is a large stock dividend (> 25%); therefore retained earnings is debited for par value. The amount is the par value of the shares distributed in the dividend, or 1,000(.30)($1) = $300. The credit is to common stock for the shares issued.
Zinc Co.’s adjusted trial balance at December 31, 2005 includes the following account balances:
Common stock, $3 par $600,000
Additional paid-in capital 800,000
Treasury stock, at cost 50,000
Net unrealized loss on non-current marketable equity securities 20,000
Retained earnings: appropriated for uninsured earthquake losses 150,000
Retained earnings: unappropriated 200,000
What amount should Zinc report as total stockholders’ equity in its December 31, 2005 balance sheet?
Each item listed belongs in owners’ equity. The treasury stock and net unrealized loss are negative items (debits), but the rest are positive items (credits).
Therefore, total owners’ equity is $1.68mn = $600,000 + $800,000 - $50,000 - $20,000 + $150,000 + $200,000.
Hoyt Corp.’s current balance sheet reports the following stockholders’ equity:
5% cumulative preferred stock, par value $100 per share; 2,500 shares issued and outstanding $250,000
Common stock, par value $3.50 per share; 100,000 shares issued and outstanding 350,000
Additional paid-in capital in excess of par value of common stock 125,000
Retained earnings 300,000
Dividends in arrears on the preferred stock amount to $25,000. If Hoyt were to be liquidated, the preferred stockholders would receive par value plus a premium of $50,000. The book value of common stock is
Book value per share of common stock is the portion of owners’ equity that would remain for common shareholders after the preferred claim was paid, divided by the number of common shares outstanding.
The preferred dividend claim includes the liquidation preference ($50,000 premium above par, plus par value) and the $25,000 dividends in arrears. All preferred stock dividends in arrears must be paid on liquidation before common shareholders receive any cash.
Total owners’ equity is $1.025mn, the sum of the four items taken from the owners’ equity section of the balance sheet ($250,000 + $350,000 + $125,000 + $300,000).
Book value per share of common stock = $7.00 = ($1.025 - $250,000 - $50,000 premium - $25,000 dividends in arrears)/100,000.
Entor Co. sold equipment to Pane Co. for $50,000. The equipment had a net book amount of $30,000. The collections were $20,000 in the first year, $15,000 in the next year, and $15,000 in the last year. What is the amount of gross profit for the third year if Entor used the installment-sales accounting method for the transaction?
The total gross profit to be recognized is $20,000 ($50,000-$30,000). This is recognized over the length of the transaction at a rate of $20,000/$50,000 = 40%. The amount collected in year three multiplied by the gross profit rate is $15,000 X 40% = $6,000
On January 1, 2005, Rex Co. sold a used machine to Lake, Inc. for $525,000. On this date, the machine had a depreciated cost of $367,500
Lake paid $75,000 cash on January 1, 2005 and signed a $450,000 note, bearing interest at 10%.
The note was payable in three annual installments of $150,000 beginning January 1, 2006. Rex appropriately accounted for the sale under the installment method. Lake made a timely payment of the first installment on January 1, 2006 of $195,000, which included interest of $45,000 to date of payment.
At December 31, 2006, Rex has deferred gross profit of
The gross profit percentage on the machine is 30% [($525,000 - $367,500)/$525,000]. Total gross profit is $157,500 ($525,000 - $367,500). This amount is deferred until cash is collected.
Under the installment method, 30% of each cash receipt is recognized gross profit. The $150,000 installments must be principal amounts, because they sum to the face value of the note. Interest is paid in addition to the installment amounts. As of December 31, 2006, only one $150,000 installment was collected.
Total gross profit on sale
$157,500
Less gross profit recognized on cash collections:
($75,000 + $150,000).30
(67,500)
Equals deferred gross profit at 31 December 2006
$90,000
North Co. entered into a franchise agreement with South Co. for an initial fee of $50,000. North received $10,000 at the agreement’s signing. The remaining balance was to be paid at a rate of $10,000 per year, beginning the following year. North’s services per the agreement were not complete in the current year. Operating activities will commence next year.
What amount should North report as franchise revenue in the current year?
FAS 45 requires that before the franchisor (North) can recognize revenue, its activities pertaining to the franchise must be substantially complete. The earliest point at which substantial completion occurs is the commencement of operations by the franchisee. Operating activities will not begin until next year - therefore, North recognizes no fee revenue in the current year.
The $10,000 received is recorded in a liability account.
Mill Construction Co. uses the percentage-of-completion method of accounting. During 2005, Mill contracts to build an apartment complex for Drew for $20mn. Mill estimates that total costs would amount to $16mn over the period of construction.
In connection with this contract, Mill incurs $2mn of construction costs during 2005. Mill bills and collects $3mn from Drew in 2005.
What amount should Mill recognize as gross profit for 2005?
The project is 12.5% complete at the end of 2005 ($2mn/$16mn). Total gross profit through the end of 2005 is therefore $500,000 [= .125($20mn - $16mn)].
The $500,000 amount is the proportion of completion applied to the total contract profit of $4mn. 2005 is the first year of construction; therefore no gross profit from previous years is subtracted. The entire $500,000 gross profit is recognized in 2005.
Choose the correct statement regarding accounting methods for revenue recognition on long-term contracts, for international and US accounting standards.
Contrary to US GAAP, international standards require a modified version of completed contract—the cost recovery method, when the percentage of completion method is not allowed.
A contractor recognizes $42,000 of gross profit on a contract at the end of year one of the contract under the percentage-of-completion method. At the end of year two, the gross profit to be recognized for both years together is $34,000. The total anticipated gross profit on the project estimated at the end of year two is $78,000. What amount of gross profit is to be recognized for year two alone?
This is an example of a single-period loss on a profitable contract. The loss for year two is computed as: $34,000 gross profit through year two - $42,000 gross profit year one = - $8,000 single-period loss. The loss “reverses” $8,000 of the $42,000 gross profit recognized in year one.
On May 1, 2004, Marno County issued property tax assessments for the fiscal year ended June 30, 2005.
The first of two equal installments was due on November 1, 2004. On September 1, 2004, Dyur Co. purchased a 4-year old factory in Marno subject to an allowance for accrued taxes.
Dyur did not record the entire year’s property tax obligation, but instead records tax expenses at the end of each month by adjusting prepaid property taxes or property taxes payable, as appropriate.
The recording of the November 1, 2004 payment by Dyur should have been allocated between an increase in prepaid property taxes and a decrease in property taxes payable in which of the following percentages?
When the property was purchased on September 1 the firm received an allowance for property taxes for the period July 1 - September 1, a period of two months. This is the portion of the fiscal year the firm did not own the factory. However, the firm will be responsible for the taxes for these two months.
The allowance at purchase reduced the total amount paid for the property by the tax for these two months. The firm recorded property taxes payable for two months (equal to the allowance amount). Then at the end of September and October, the firm accrued another month of property taxes payable. Now the firm has recorded a total of 4 months of property taxes payable. When it pays the first installment on November 1 (for 6 months), the property taxes payable is decreased to zero and prepaid property taxes is debited for 2 months worth of property tax.
Thus, the payment increases prepaid property taxes 2 months, and decreases property taxes payable 4 months, or 1/3 and 2/3 of the payment amount, respectively.
Kent Co., a division of National Realty, Inc., maintains escrow accounts and pays real estate taxes for National’s mortgage customers. Escrow funds are kept in interest-bearing accounts. Interest, less a 10% service fee, is credited to the mortgagee’s account and used to reduce future escrow payments.
Additional information follows:
Escrow accounts liability, 1 January, 2004
$700,000
Escrow payments received during 2004
$1.58mn
Real estate taxes paid during
$1.72mn
Interest on escrow funds during 2004
50,000
What amount should Kent report as escrow accounts liability in its December 31, 2004 balance sheet?
The following equation is used to explain the changes in the escrow liability and the ending balance (31 December, 2004):
Beginning + Payments - Real estate + Interest - 10% (interest) = Ending
Balance Received Tax Payments Balance
$700,000 + $1.58mn - $1.72mn + $50,000 - $5,000 = $605,000
The interest increases the liability, because it is an amount owed to the mortgagee. This debt is extinguished by crediting the receivable from the mortgagee. The 10% fee reduces the portion of the liability owing to interest.
North Corp. has an employee benefit plan for compensated absences that gives employees ten paid vacation days and ten paid sick days per year.
Both vacation and sick days can be carried over indefinitely. Employees can elect to receive payment in lieu of vacation days; however, no payment is given for sick days not taken.
At December 31, 2004, North’s unadjusted balance of liability for compensated absences was $21,000. North estimated that there were 150 vacation days and 75 sick days available at December 31, 2004. North’s employees earn an average of $100 per day.
In its December 31, 2004 balance sheet, what amount of liability for compensated absences is North required to report?
The liability must be accrued only for the vacation pay, because it is probable that paid vacations will be taken. Therefore, the liability is $15,000 (150 days x $100 per day).
The firm may, but is not required to, accrue a liability for sick days. If the employees were routinely paid for sick days not taken, then sick days would be required to be accrued. For this firm, there is no payment for sick days not taken, therefore there is no requirement to accrue this cost.
It may be argued that illness is the condition that mandates payment of sick pay. Illness cannot be predicted and therefore is not required to be accrued.
A company has a defined benefit pension plan for its employees. On December 31, year one, the accumulated benefit obligation is $45,900, the projected benefit obligation is $68,100, and the fair value of the plan assets is $62,000. What amount, if any, related to the defined benefit plan should be recognized in the balance sheet at December 31, year one?
The reported pension liability for a defined benefit pension plan is the difference between projected benefit obligation ($68,100) and the fair value of plan assets ($62,000), or $6,100. The two underlying amounts are reported in the footnotes, but are not recognized in the balance sheet. Only their difference, which is also the underfunded amount, is reported in the balance sheet as a liability.
The funded status of a defined benefit pension plan for a company should be reported in
Funded status is the difference between projected benefit obligation and plan assets at fair value. Neither of these amounts is reported in the balance sheet (they appear in the notes only), but their difference is reported in the balance sheet as the reported pension liability for defined benefit plans. It is the amount the plan is “behind” in terms of having assets available for payment of benefits.
The journal entry to record a $5,000 actuarial gain at year-end includes:
When the actuarial gain is recognized, pension liability is debited, because PBO is reduced by the gain, and pension liability is the difference between PBO and assets. Pension gain/loss-OCI is credited, because the firm’s pension costs have decreased. The pension gain/loss-OCI account causes other comprehensive income to be credited (increased).
