Old Exam 1 with Solutions - Intermediate Financial Accounting II | ACCT 414, Exams of Accounting

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Exam 1

Acct 490 – Fall 2002

Time Value of Money – problems 1 through 4 (5 points each = 20 points total)

1. Assume that you are working for a leasing company. The boss asks you to compute the annual lease payment that the company should charge to earn a 12% return on the following lease: Fair market value of leased asset $100,000. First payment on lease to be made immediately. Lease term to run 5 years. The property should be worth 30,000 at the end of the lease but the lessee can buy it for $15,000.
2. Find the present value of the following lease: Term of lease is 4 years. First payment to be made at the inception of the lease. The monthly payment is $4,000. The incremental borrowing rate of lessee is 12%. Bargain purchase option at end of the 4-year lease is $15,000.
3. Troubled debt restructuring: The debtor owes $30,000 plus $3,000 in accrued interest on a note payable. The creditor agrees to modify the terms of the agreement such that the debtor will pay interest at a 9% annual rate for 5 years on a reduced principal balance of $28,000. For the debtor, what is the actual interest rate implied by the modification of terms?
4. Seattle’s Worst Inc. is establishing a pension plan for its sole employee. He will receive credit for 10 years of prior service and is expected to work 20 years until retirement. After retirement, he should collect pension payments for another 20 years. His current salary is $50,000 with estimated future pay increases to average 5% per year. What will be the initial amount of projected benefit obligation (i.e., prior service cost) at the inception of the plan if the benefit formula is final year’s annual salary times years of service times 2%? You may assume ordinary annuities and end-of-year annual payments upon retirement and a 10% per annum discount rate.

Exam 1 – Acct 490 – Fall 2002 Page 1

5. Troubled debt restructuring (20 points). Brakes R Us Inc., is one of Pete’s Auto Manufacturing Company major creditors. Pete’s Auto Manufacturing Company is experiencing substantial financial difficulties. Its original note with Brakes R Us, Inc. was dated May 1, 2002 and has a face value of $40,000 and specifies a 10% interest rate. The interest for the period ending May 1, 2003 has not been paid. On May 1, 2003, the automaker persuaded Brakes R Us to reduce the principal from $40,000 to $30,000 and to reduce interest payments to $1,500 per year for the remaining 4-year life of the debt. The modified terms also waive payment of the accrued interest currently due.

To save time, you may use the following present values to work this problem:

The PV of $30,000 (n=4, i= 5%) = 24,681 The PVA ord of 1,500 (n=4, i= 5%) = 5, The PV of $30,000 (n=4, i=10%) = 20,490 The PVA ord of 1,500 (n=4, i=10%) = 4, The PV of $40,000 (n=4, i= 5%) = 32,908 The PVA due of 1,500 (n=4, i= 5%) = 5, The PV of $40,000 (n=4, i=10%) = 27,321 The PVA due of 1,500 (n=4, i=10%) = 5, Instructions Show entries on the books of both the creditor , Brakes R Us, Inc., and the debtor , Pete’s Auto Manufacturing, at the following dates: (1) May 1, 2003 (2) End of fiscal year (12-31-03) (3) First interest payment date (5-1-04)

Exam 1 – Acct 490 – Fall 2002 Page 1

6. Serial Bonds (20 points). On April 1, 2003, Falstaff Corporation issued $2,000,000 in serial

bonds. The bond principal will be repaid in $500,000 increments beginning on April 1, 2004 with the final payment to be made on April 1, 2007. The bonds pay interest semi-annually on Oct. 1 and April 1. The coupon rate is 10% per annum. An investment banker handled the transaction and you have just received a check for $1,840,669. (Hint: The effective simple interest rate per year is 14%.) a. Using the effective interest method of amortizing bond discounts/premiums, prepare all the bond issuer's necessary journal entries for Oct 1, 2003 and Dec. 31, 2003 (end of fiscal year). b. Using the bonds outstanding method of amortizing bond discounts/premiums, prepare all the bond issuer's necessary journal entries for Oct 1, 2003 and Dec. 31, 2003 (end of fiscal year).

Exam 1 – Acct 490 – Fall 2002 Page 1

7. Minimum Liability (15 points). Information about PMM's pension plan is provided in the table

below. Prepare any necessary journal entries for 2003, 2004 and 2005 to record any necessary minimum liability related to pensions. You may assume that the company was not required to record a minimum liability adjustment at the end of 2002. (Accrued)/Prepaid Pension Cost Projected Benefit Obligation Plan Assets Prior Service Costs Unrecognized (gains)/losses Accumulated Benefit Oblation 12/31/03 (35,000) (925,000) 760,000 150,000 (20,000) 799, 12/31/04 30,000 (995,000) 855,000 120,000 50,000 879, 12/31/05 7,000 (1,049,000) 975,000 90,000 (9,000) 998,

Exam 1 – Acct 490 – Fall 2002 Page 1

8. Pension Accounting (25 points). The Tree Corporation initiated a noncontributory

defined benefit pension plan on January 1, 1980 and applied the provisions of

FASB Statement 87 as of January 1, 1987. Tree uses the straight-line method,

based on average remaining service period of employees, to amortize prior service

costs.

BALANCES AS OF JANUARY 1, 2002

Projected Benefit Obligation $825, Plan Assets at market $625, Prepaid/(accrued) pension cost $4, Additional Liability $10, Unrecognized transition cost (gain) ($60,000) Amortization amount $5,000 per year Unrecognized Prior Service Cost $351, Amortization amount $15,300 per year Unrecognized (gains)/losses ($87,000) OTHER INFORMATION: Service cost for year $42, Discount rate for year 8.00% Expected rate of return on plan assets 12.00% Actual return on plan assets: gain/(loss) $80, Pension plan contribution $75, Retirement benefits paid during year $15, Accumulated Benefit Obligation, Dec. 31, 2002 $760, Average remaining service years related to active employees 23 Increase/(decrease) in PBO during year due to revised actuarial assumptions ($15,000) REQUIRED: a. Compute net periodic pension expense for 2002. (Be sure to show all of the components of pension expense.) Prepare the journal entry needed to record pension expense and funding of pension plan. b. Compute the balance in unrecognized gains and losses, projected benefit obligation, and plan assets, prior service costs and transition gain/loss at 1/1/03. c. List the amounts that will be found on the balance sheet indicating whether the balances are debits or credits and in what section (current assets, owners' equity, etc.) of the balance sheet they should appear. Note: Completing a worksheet will be an acceptable answer for (a) the components of pension expense (but make the actual journal entry below) and (b) the ending balances as long as the answers are easy to find, read, and understand. You need to answer part (c) specifically – the work paper alone is not sufficient. You do NOT need to compute any minimum liability that might be required.

Exam 1 – Acct 490 – Fall 2002 SOLUTION Page 1

Problem 1 - find lease payment n= 5 Problem 4 - PBO related to prior service cost at adoption of plan i= 12.00% pmt=? Current salary $ 50,000 =PV Step 1 pv= -100,000 (^) Salary inereases 5% =INT RATE fv= 15,000 Years until 65 20 =N ordinary annuity = 0; annuity due = 1 1 Future salary $132,664.89 at retirement =PMT 22,660.56 (^) Benefit formula 2% per year of service Benefit per yr $2,653. Problem 2 - find PVMLP for a lease Life expectancy 20 years after retirement n= (^48) Credited for PS 10 years credited for prior service i= 1.00% Benefit for PSC $26,532. pmt= 4,000 Step 2 pv=? PMT = $26,532.98 benefit related to prior service fv= 15,000 (^) N = 20 life expectancy after retirement ordinary annuity = 0; annuity due = 1 1 FV = $0. =PV 162,718.70 INT RATE = 10% discount rate PV = $225,890.19 Needed at retirement for PSC Problem 3 - troubled debt Step 3 n= 5 PMT = 0 i=? N = 20 years until retirement pmt= 2,520.00 INT RATE = 10% discount rate pv= -33,000.00 FV = $225,890.19 Needed at retirement for PSC fv= 28,000.00 PV = $33,577.14 needed at plan amendment ordinary annuity = 0; annuity due = 1 0 =rate 4.88819%

Exam 1 – Acct 490 – Fall 2002 SOLUTION Page 1

5. Troubled debt restructuring Under new terms, total cash flows = $36,000 [30,000 + (1,500 * 4 years)] so the debtor recognizes a gain on restructuring Debtor journal entries Debit Credit 5/1/03 Accrued interest payable 4, Note payable (old) 40, Gain on troubled debt restructuring 8, Note payable (new) 36, 12/31/03 Interest expense 0 Note payable - No entry at year end since interest rate Has been effectively set at ZERO 5/1/04 Interest expense 0 Notes payable 1, Cash 1,

Creditor finds present value of expected future cash flows using original effective interest

rate of 10% (see table which follows journal entries)

Creditor journal entries Debit Credit 5/1/03 Accrued interest receivable 4, Note receivable (old) 40, Loss on loan impairment 18, Restructured note receivable 25, 12/31/03 Interest revenue 1, Restructured note receivable 683 Interest receivable 1, 8 Months to accrue at year end 5/1/04 Interest receivable 1, Interest revenue 842 Restructured note receivable 342 - Cash 1,

• 47,525 47, Cash Received Interest Revenue Amortization^ Balance 10% $25, 1,500 $2,525 1,025 26, 1,500 $2,627 1,127 27, 1,500 $2,740 1,240 28, 31,500 $2,864 (28,636) -

Exam 1 – Acct 490 – Fall 2002 SOLUTION Page 1

6. Serial bonds (a) – Effective Interest Method Solution (table not required)

5.00% 7.000% Face Value: 2,000, Period Date Interest Principal Interest Amorti- Carrying BALANCE Paid Payment Expense zation Value DISCOUNT 0 04/01/02 0 0 0 1,840,669 (159,331) 1 10/01/02 100,000 128,847 (28,847) 1,869,516 (130,484) 2 04/01/03 100,000 500,000 130,866 (30,866) 1,400,382 (99,618) 3 10/01/03 75,000 98,027 (23,027) 1,423,409 (76,591) 4 04/01/04 75,000 500,000 99,639 (24,639) 948,047 (51,953) 5 10/01/04 50,000 66,363 (16,363) 964,411 (35,589) 6 04/01/05 50,000 500,000 67,509 (17,509) 481,919 (18,081) 7 10/01/05 25,000 33,734 (8,734) 490,654 (9,346) 8 04/01/06 25,000 500,000 34,346 (9,346) (1) (1) Debit Credit 10/01/02 Interest expense 128, Discount on Bonds Payable 28, Cash 100, 12/31/02 Interest Expense 65, Interest Payable 50, Discount on Bonds Payable 15, 2,194,280 2,194, FRACTION OF YEAR FOR ENTRY ABOVE = 3/6 = 50%: 6-b – Bonds outstanding method (table not required – but it helps to schedule out the total face values and fractions – see below) Period Date Interest Principal Interest Amorti- Carrying BALANCE Paid Payment Expense zation Value DISCOUNT 0 04/01/02 - - - 1,840,669 (159,331) 1 10/01/02 100,000 - 131,866 (31,866) 1,872,535 (127,465) 2 04/01/03 100,000 500,000 131,866 (31,866) 1,404,401 (95,599) 3 10/01/03 75,000 - 98,900 (23,900) 1,428,301 (71,699) 4 04/01/04 75,000 500,000 98,900 (23,900) 952,201 (47,799) 5 10/01/04 50,000 - 65,933 (15,933) 968,134 (31,866) 6 04/01/05 50,000 500,000 65,933 (15,933) 484,067 (15,933) 7 10/01/05 25,000 - 32,967 (7,967) 492,033 (7,967) 8 04/01/06 25,000 500,000 32,967 (7,967) 0 - FACE Amortization Fraction VALUE percent 2,000,000 0.20000 20/ 2,000,000 0.20000 20/ 1,500,000 0.15000 15/ 1,500,000 0.15000 15/ 1,000,000 0.10000 10/ 1,000,000 0.10000 10/ 500,000 0.05000 5/ 500,000 0.05000 5/ 10,000,000 1.00000 100/ Debit Credit 10/01/02 Interest expense 131, Discount on Bonds Payable 31, Cash 100, 12/31/02 Interest Expense 65, Interest Payable 50, Discount on Bonds Payable 15, 2,197,799 2,197,

Exam 1 – Acct 490 – Fall 2002 SOLUTION Page 1

Problem 7 – minimum liability

Plan Assets Accumulated Benefit Obligation Minimum Liability Needed (Accrued)/ Prepaid Pension Cost Additional liability Needed (min adjusted for what’s already on books) 12/31/03 760,000 799,000 39,000 (35,000) 4, 12/31/04 855,000 879,000 24,000 30,000 54, 12/31/05 975,000 998,000 23,000 7,000 30, 12/31/03 Debit Credit Intangible Asset (Pension cost) 4, Additional minimum pension liability 4, 12/31/ Intangible Asset (pension cost) 50, Additional minimum pension liability 50, 12/31/05| Additional minimum pension liability 24, Intangible Asset (pension cost) 24,

Additional Pension

Liability

4,000 12/31/

50,

54,000 12/31/

24,

30,000 12/31/

Exam 1 – Acct 490 – Fall 2002 SOLUTION Page 1

Pension Worksheet 1 2 3 4 5 6 7 8 Accounts on Employer's Books Memorandum Amounts Exam F02 Problem 8 Pension Expense Cash Prepaid/ (Accrued) Pension Cost Projected Benefit Obligation Plan Assets Unrecognized (gain)/loss Prior Serivce Cost Transition (Gain)/ loss BALANCE FORWARD 4,900 -825,000 625,000 -87,000 351,900 -60, Service Cost 42,000 -42, 8% Interest Cost 66,000 -66, 12% Expected return on plan assets -75,000 75, 82,500 Corridor Amount -4,500 Excess AMORTIZATIONS: 23 Unrecognized gain/loss -196 196 Prior Service Cost 15,300 -15, Transition Amount -5,000 5, Contributions to Pension Plan -75,000 75, Retirement Benefits Paid by Plan 15,000 -15, Actual Return on Plan Assets 80,702 -80, Actuarial Adjustments to PBO 15,000 -15, Amounts for journal entry: 43,104 -75,000 31, BALANCES AT YEAR END 36,796 -903,000 765,702 -107,506 336,600 -55, Computation of Minimum Liability 760,000 Accumulated benefit obligation at year end Accounts on Books - Minimum Liability Requirement Intangible Asset Additional Pension Liability Other Comprehensive Income 765,702 Plan Assets at end of year 0 Minimum liability needed Balances forward 10,000 -10, Accrued/Prepaid Pension Cost at year end Correct amounts need EOY 0 0 0 0 Minimum liability to record (if any) Amounts for adjusting journal entry -10,000 10,000 0 a. Journal Entry debit credit Pension cost 43, Cash 75, Prepaid pension cost 31, c. Prepaid pension cost will appear on balance sheet under noncurrent assets: $36,796 debit No other accounts will appear since there is no minimum liability requirement