AMIS 6201 Mini-Case 1 to 5 PDF

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2nd group essay for mini cases (1 to 5) (this is different from big comprehensive case submitted along with this one)....

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AMIS 6201 MINI-CASES Mini-Case #1 J&B Drilling completed construction of an offshore oil platform on January 1, 2015 at a cost of $100 million. J&B is legally required to dismantle and remove the platform at the end of its useful life (estimated to be 10 years). The Company initially estimated the present value of the future cash flows associated with dismantlement and removal to be $5 million (using a 7% discount rate – the credit-adjusted risk-free rate). There have been no changes to those initial estimates. What journal entries would the company be required to record during 2015? Include the initial accounting entries required when the asset first went in service and any other entries that would subsequently be required to be recorded during the remainder of the year 2015. To answer this question there is no need to get into industry-specific literature (eg: oil and gas and extractive industries). Cite and interpret the appropriate sections of the authoritative literature supporting your conclusion and show your proposed journal entries. According to FASB ASC 360-10-30-1, “historical cost of acquiring an asset includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use”. Moreover, for a tangible long lived asset with existing asset retirement obligation, the asset retirement cost shall be capitalized into the long-lived asset at the asset’s acquisition date as if that obligation was incurred on that date (FASB ASC 410-20-25-5, 410-20-25-16). Following the mentioned concepts, on January 1 2015, the entity should debit 100,000,000 in Long-lived Asset and credit either cash or payable account of 100,000,000. Moreover, since there was asset retirement obligation, entity would debit present value of 5,000,000 in the Long-lived Asset and recognize the obligation in that date by crediting the same amount in asset retirement obligation account. January 1, 2015: Long-lived Asset Cash/Payable/Construction WIP

Debit $100,000,000

Long-lived Asset $5,000,000 Asset retirement obligation liability

Credit $100,000,000

$5,000,000

By the end of the year, there would be the adjustment for the depreciation in both the longlived asset and asset retirement cost. In the case of long-lived asset, this cost would be spread 1

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over useful economic life in the most reasonable way. In this case, since we expect that oil platform would generate the constant outputs throughout the periods, straight line method would be appropriate (FASB ASC 360-10-35-3, 360-10-35-4). In the case of asset retirement obligation, straight line method could be also considered as a rational method (FASB ASC 410-20-35-2). Last but not least, for asset retirement obligation, “an entity shall measure changes in the liability for an asset retirement obligation due to passage of time by applying an interest method of allocation to the amount of the liability at the beginning of the period. The interest rate used to measure that change shall be the credit-adjusted risk-free rate” (FASB ASC 410-20-35-5). The increase in liability would be classified as an operating item, which was called accretion expense (FASB ASC 410-20-55-18). Following those standards, by the end of the year, J&B Drilling debited and credited 10,000,000 in depreciation expense and accumulated depreciation account respectively. Similarly, in the case of asset retirement cost, J&B Drilling debited and credited 500,000 in depreciation expense and accumulated depreciation account respectively. The change in asset retirement obligation due to the passage of time would be recorded by debiting accretion expense of 350,000 (7% x 5,000,000) and crediting asset retirement obligation liability of 350,000. December 31, 2015: Depreciation Expense Accumulated Depreciation

DR $10,000,000

CR $10,000,000

Depreciation Expenses (asset retirement cost) $500,000 Accumulated Depreciation

$500,000

Accretion Expense $350,000 Asset retirement obligation liability

$350,000

FASB ASC 360-10-30-1 Paragraph 835-20-05-1 states that the historical cost of acquiring an asset includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use. As indicated in that paragraph, if an asset requires a period of time in which to carry out the activities necessary to bring it to that condition and location, the interest cost incurred during that period as a result of expenditures for the asset is a part of the historical cost of acquiring the asset. FASB ASC 360-10-35-3 Depreciation expense in financial statements for an asset shall be determined based on the asset's useful life. FASB ASC 360-10-35-4 The cost of a productive facility is one of the costs of the services it renders during its useful economic life. Generally accepted accounting principles (GAAP) require that this cost be spread over the expected useful life of the facility in such a way as to allocate it as equitably as possible to the periods during which services are obtained from the use of the facility. 2

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FASB ASC 410-20-35-2 An entity shall subsequently allocate that asset retirement cost to expense using a systematic and rational method over its useful life. Application of a systematic and rational allocation method does not preclude an entity from capitalizing an amount of asset retirement cost and allocating an equal amount to expense in the same accounting period. FASB ASC 410-20-35-5 An entity shall measure changes in the liability for an asset retirement obligation due to passage of time by applying an interest method of allocation to the amount of the liability at the beginning of the period. The interest rate used to measure that change shall be the credit-adjusted risk-free rate that existed when the liability, or portion thereof, was initially measured. That amount shall be recognized as an increase in the carrying amount of the liability and as an expense classified as accretion expense. Paragraph 835-20-15-7states that accretion expense related to exit costs and asset retirement obligations shall not be considered to be interest cost for purposes of applying Subtopic 835-20. FASB ASC 410-20-55-18 This implementation guidance illustrates paragraphs 410-20-35-1 through 35-6. In periods subsequent to initial measurement, an entity recognizes the effect of the passage of time on the amount of a liability for an asset retirement obligation. A periodto-period increase in the carrying amount of the liability shall be recognized as an operating item (accretion expense) in the statement of income. An equivalent amount is added to the carrying amount of the liability. To calculate accretion expense, an entity shall multiply the beginning of the period liability balance by the credit-adjusted risk-free rate that existed when the liability was initially measured. The liability shall be adjusted for accretion prior to adjusting for revisions in estimated cash flows. FASB ASC 410-20-25-16 If a tangible long-lived asset with an existing asset retirement obligation is acquired, a liability for that obligation shall be recognized at the asset’s acquisition date as if that obligation were incurred on that date. FASB ASC 410-20-25-5 Upon initial recognition of a liability for an asset retirement obligation, an entity shall capitalize an asset retirement cost by increasing the carrying amount of the related long-lived asset by the same amount as the liability. Paragraph 835-2030-5 explains that capitalized asset retirement costs do not qualify as expenditures for purposes of applying Subtopic 835-20.

Mini-Case #2 Rust Belt Manufacturing Corp. intends to undertake a capital project to construct pollution control facilities to reduce the emissions of pollutants from its manufacturing facility. The project qualifies under provisions of the Ohio Air Quality Development Authority to issue $100 million tax-exempt bonds to fund 100% of the project. All proceeds from the offering will be held in an interest-bearing escrow account. 3

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Disbursements from escrow will be made only for qualifying project expenditures. The proceeds from the offering were received on January 1, 2015 and construction commenced on April 1, 2015. Interest incurred relating to the debt offering was $1.125 million thru March 31, 2015 and an additional $3.375 million was incurred from April 1 thru December 31, 2015. Interest earned on funds in escrow was $1.9 million during the year ended December 31, 2015. Construction expenditures from April 1, 2015 thru December 31, 2015 averaged $10 million per month. How much interest should be capitalized on this construction project in 2015? Cite and interpret the appropriate sections of the authoritative accounting literature to support your conclusions. In this case, Rust Belt Manufacturing Corp’s capital project involves acquisition of qualifying assets financed with the proceeds of tax-exempt borrowings that are externally restricted (FASB ASC 835-20-30-11). The tax-exempt bonds the company issued qualifies the pollution control funds. In such situations, offsetting interest income againts interest cost is appropriate (FASB ASC 835-20-30-10). Thus, the amount of interest cost capitalized shall be all interest cost of the borrowing less any interest earned on related interest-bearing investments acquired with proceeds of the related tax-exempt borrowings from the date of the borrowing until the assets are ready for their intended use. Thus, $2.6 million (1.125+3.375-1.9) of interest should be capitalized on this construction project in 2015. FASB ASC 835-20-30-9 The timing and use of tax-exempt borrowings are generally an integral part of the decision to acquire the related asset, and the net interest cost from the date of borrowing to the time the acquired asset is substantially complete and ready for its intended use is an essential part of the cost of acquiring that asset. FASB ASC 835-20-30-10 Interest earned shall not be offset against interest cost in determining either capitalization rates or limitations on the amount of interest cost to be capitalized except in situations involving acquisition of qualifying assets financed with the proceeds of tax-exempt borrowings if those funds are externally restricted to finance acquisition of specified qualifying assets or to service the related debt. Those situations include many governmental borrowings and most governmentally sponsored borrowings (such as industrial revenue bonds and pollution control bonds). In such situations, interest earned generally is considered in and is significant to the initial decision to acquire the asset, and the capitalization of net interest cost provides a better measure of the entity's net investment in the qualifying assets. In those circumstances the association is direct and the funds flows from borrowing, temporary investment, and construction expenditures are so intertwined and restricted as to require accounting for the total net cost of financing as a cost of the qualifying assets. In all other situations, offsetting of interest income against interest cost is not appropriate. FASB ASC 835-20-30-11 The amount of interest cost capitalized on qualifying assets acquired with proceeds of tax-exempt borrowings that are externally restricted as specified in 4

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the preceding paragraph shall be all interest cost of the borrowing less any interest earned on related interest-bearing investments acquired with proceeds of the related tax-exempt borrowings from the date of the borrowing until the assets are ready for their intended use. The interest cost and interest earned on any portion of the proceeds of the tax-exempt borrowings that are not designated for the acquisition of specified qualifying assets and servicing the related debt are excluded. Mini-Case #3 Flip-Flop Corp. generated $1 million of net income in 2014 and incurred a net loss of $1 million in 2015. In both years, the weighted-average number of common shares outstanding was 500,000. The company also has warrants outstanding that are “in the money.” After applying the Treasury Stock Method and the assumed conversion of the warrants, the company determined the additional dilutive potential common shares in each year to be 100,000 shares. Assume there is no preferred stock outstanding. Calculate the Basic EPS and diluted EPS for both years. Cite and interpret the appropriate sections of the accounting literature to support your conclusions. Year 2014: Basic EPS = $1 million net income/0.5 million shares outstanding = $2.0 EPS Diluted EPS = $1 million net income/(0.5+0.1) million shares outstanding = $1.67 EPS In this case, Flip-Flop Corp. applies the Treasury Stock Method and has warrants outstanding that are “in the money”. “In the money” means “these options and warrants will have a dilutive effect under the treasury method” (FASB ASC 260-10-45-25). In Year 2014, the company generated $1 million of net income. According to FASB ASC 260-10-55-3B, “when there is a year-to-date income, if in-the-money options or warrants were excluded from one or more quarterly diluted EPS computations, those options or warrants should be included in the diluted EPS denominator (on a weighted-average basis) in the year-to-date computation as long as the effect is not antidilutive.” Thus, when calculated the diluted EPS for Year 2014, the denominator should include the additional 0.1 million dilutive potential common shares. Year 2015: Basic EPS =$ 1million net loss/0.5 million shares outstanding = $ (2.0) EPS Diluted EPS =$ 1million net loss/0.5 million shares outstanding = $ (2.0) EPS In Year 2015, Flip-Flop Corp. incurred a net loss of $1 million. According to FASB ASC 26010-55-3B, “when there is a year-to-date loss, potential common shares should never be included in the computation of diluted EPS, because to do so would be antidilutive.” Thus, the addtional 0.1 million dilutive potential common shares should not be included in the Year 2015 diluted EPS calculation. 5

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FASB ASC 260-10-45-10 Basic EPS shall be computed by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Shares issued during the period and shares reacquired during the period shall be weighted for the portion of the period that they were outstanding. See Example 1 (paragraph 260-10-55-38) for an illustration of this guidance. FASB ASC 260-10-45-16 The computation of diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. In addition, in computing the dilutive effect of convertible securities, the numerator is adjusted to add back any convertible preferred dividends and the after-tax amount of interest recognized in the period associated with any convertible debt. The numerator also is adjusted for any other changes in income or loss that would result from the assumed conversion of those potential common shares, such as profit-sharing expenses. Similar adjustments also may be necessary for certain contracts that provide the issuer or holder with a choice between settlement methods. See Example 1 (paragraph 260-10-55-38) for an illustration of this guidance. FASB ASC 260-10-45-23 Under the treasury stock method: a. Exercise of options and warrants shall be assumed at the beginning of the period (or at time of issuance, if later) and common shares shall be assumed to be issued. b. The proceeds from exercise shall be assumed to be used to purchase common stock at the average market price during the period. (See paragraphs 260-10-45-29 and 260-10-55-4 through 55-5.) c. The incremental shares (the difference between the number of shares assumed issued and the number of shares assumed purchased) shall be included in the denominator of the diluted EPS computation. FASB ASC 260-10-45-25 Options and warrants will have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options or warrants (they are in the money). Previously reported EPS data shall not be retroactively adjusted as a result of changes in market prices of common stock. FASB ASC 260-10-55-3 The number of incremental shares included in quarterly diluted EPS shall be computed using the average market prices during the three months included in the reporting period. For year-to-date diluted EPS, the number of incremental shares to be included in the denominator shall be determined by computing a year-to-date weighted average of the number of incremental shares included in each quarterly diluted EPS

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computation. Example 1 (see paragraph 260-10-55-38) provides an illustration of that provision. FASB ASC 260-10-55-3A Computation of year-to-date diluted EPS when an entity has a year-to-date loss from continuing operations including one or more quarters with income from continuing operations and when in-the-money options or warrants were not included in one or more quarterly diluted EPS computations because there was a loss from continuing operations in those quarters is as follows. In computing year-to-date diluted EPS, year-to-date income (or loss) from continuing operations shall be the basis for determining whether or not dilutive potential common shares not included in one or more quarterly computations of diluted EPS shall be included in the year-to-date computation. FASB ASC 260-10-55-3B Therefore: a. When there is a year-to-date loss, potential common shares should never be included in the computation of diluted EPS, because to do so would be antidilutive. b. When there is year-to-date income, if in-the-money options or warrants were excluded from one or more quarterly diluted EPS computations because the effect was antidilutive (there was a loss from continuing operations in those periods), then those options or warrants should be included in the diluted EPS denominator (on a weighted-average basis) in the yearto-date computation as long as the effect is not antidilutive. Similarly, contingent shares that were excluded from a quarterly computation solely because there was a loss from continuing operations should be included in the year-to-date computation unless the effect is antidilutive.

Mini Case #4 Ajax Company sold a parcel of land to an unaffiliated company, Comet Company, on January 3, 2013 and accepted a note for payment due January 31, 2015. The terms of the note call for full repayment (lump sum amount) on the due date. The note does not state an interest rate or specifically require the payment of interest. You have determined that, in light of the facts and circumstances, the fair value of the note is more clearly determinable than the fair value of the land. How should Ajax record the note receivable (show the journal entry that would be required)? How should the note be presented on the balance sheet? Describe the additional entries that would be required during the periods that they hold the note (don’t have to show dollar amounts). Cite and interpret the sections of the authoritative accounting literature that support your conclusions.

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Additional Case Facts: Carrying value of the land Principal amount of note Fair Value of the note

$ 105,000 $ 110,000 $ 100,000

According to the FASB ASC 835-30-25-10 and 310-10-30-5, in the case where there is no stated interest, “the note, the sales price, and the cost of the property, goods, or service exchanged for the note shall be recorded at the fair value of the property, goods, or service or at an amount that reasonably approximates the fair value of the note, whichever is the more clearly determinable”. That amount might be different from the face amount the note, and thus any discount or premium resulting from that difference would be recorded as the interest ele...