Final exam key in intermediate accounting 2 PDF

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INTERMEDIATE ACCOUNTING 2 FINAL GRADING EXAMINATION

Chapter 23 – Current Liabilities 1. Alhambra Company offers three payment plans on its 12-month contracts. Information on the three plans and the number of children enrolled in each plan for September 1, 2005 through August 31, 2006 contract year follows:

Plan #1 #2 #3

Initial payment per child P500 200

Monthly fees per child P0 30 50

Number of children 15 12 9 36

Alhambra received all initial payments on September 1, 2005, and P3,240 of monthly fees during the period September 1 through December 31, 2005. In its December 31, 2005 balance sheet, what amount should Alhambra report as deferred revenue? a. 9,900 b. 3,300 c. 6,600 d. 4,380 C = initial payments (500 x 15) + 200 x 12)= 9,900 x 8/12 = 6,600 2. The following are taken from the records of ABC Co. as of year-end. Accounts payable Utilities payable Accrued interest expense Advances from customers

Unearned rent Warranty obligations Income taxes payable Preference shares issued Constructive obligation Obligation to deliver a variable number of own shares worth a fixed amount of cash

2,000 7,000 6,000 1,000 9,000 5,000 2,000 10,000 11,000

SSS contributions payable

Cash dividends payable Property dividends payable

Share dividends payable Lease liability Bonds payable Discount on bonds payable

Security deposit Redeemable preferences shares issued Unearned interest on receivables

10,000

How much is the total financial liabilities to be disclosed in the notes?

6,000 4,000 7,000 3,000 35,000 120,000 (15,000) 2,000 14,000 3,000

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a. b. c. d.

172,000 185,000 192,000 225,000

Solution: Accounts payable Utilities payable Accrued interest expense Obligation to deliver a variable number of own shares worth a fixed amount of cash Cash dividends payable Finance lease liability Bonds payable Discount on bonds payable Security deposit Redeemable preference shares Total financial liabilities

2,000 7,000 6,000 10,000 4,000 35,000 120,000 (15,000) 2,000 14,000 185,000

Chapter 24 – Notes Payable 3. Entity A purchases a TV set on a 6-month installment basis. The installment price is ₱120,000. However, if the TV set is purchased outright in cash, the cash price would have been ₱100,000. The payable will be initially recognized at a. 100,000 b. 120,000 c. Present value of 120,000 discounted at the current market rate using 6 periods d. None of these 4. Entity A purchases goods for ₱250,000 under a special credit period of 1 year. The seller normally sells the goods for ₱220,000 with a credit period of one month or with a ₱5,000 discount for cash basis (i.e., outright payment in cash). The initial measurement of the payable is a. 250,000 b. 220,000 c. 215,000 d. 200,000 Normal purchase price with credit period of one month Discount for cash on delivery Cash price equivalent of the goods purchased

220,000 (5,000) 215,000

5. On January 1, 20x1, ABC Co. acquired transportation equipment in exchange for ₱100,000 cash and ₱1,000,000, noninterest-bearing note payable due in 4 equal annual installments. The first installment is due on January 1, 20x1. The succeeding installment payments are due every

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December 31. The prevailing rate of interest for this type of note is 12%. How much is the interest income in 20x1? a. 120,000 b. 102,055 c. 72,055 d. 50,702

Future cash flows – annual installments (₱1M ÷ 4) Multiply by: PV of an annuity due of ₱1 @12%, n=4 Present value of note payable - Jan. 1, 20x1

250,000 3.401830 850,458

Amortization table: (Installment) Date Jan. 1, 20x1 Jan. 1, 20x1 Dec. 31, 20x1 Dec. 31, 20x2 Dec. 31, 20x3

Payments

Interest expense

Amortization

250,000 250,000 250,000 250,000

72,055 50,702 26,786

250,000 177,945 199,298 223,214

Present value 850,458 600,458 422,513 223,214 0

6. On January 1, 20x1, ABC Co. acquired machinery by issuing a 3-year, ₱1,200,000 noninterestbearing note payable due as follows: Date Amount of installment December 31, 20x1 600,000 December 31, 20x2 400,000 December 31, 20x3 200,000 Total 1,200,000 The prevailing rate of interest for this type of note is 10%. How much is the carrying amount of the note on December 31, 20x1? a. 1,026,296 b. 867,312 c. 528,926 d. 489,762

Date Dec. 31, 20x1 Dec. 31, 20x2 Dec. 31, 20x3

Totals

Collections 600,000 400,000 200,000 1,200,000

PV of ₱1 @ 10%, n= 1 to 3* 0.90909 0.82645 0.75131

* PV of ₱1 @10%: n=1 is 0.90909; n=2 is 0.82645; and n=3 is 0.75131

Amortization table: (Installment)

Present value 545,455 330,579 150,263 1,026,296

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Date

Payments

Interest expense

Amortization

600,000 400,000 200,000

102,630 52,893 18,182

497,370 347,107 181,818

Jan. 1, 20x1 Dec. 31, 20x1 Dec. 31, 20x2 Dec. 31, 20x3

Present value 1,026,296 528,926 181,818 0

7. On January 1, 20x1, ABC Co. issued a ₱1,200,000 noninterest-bearing note due on December 31, 20x1 in exchange for inventory with a list price of ₱1,100,000 and a cash price of ₱1,000,000. How much is the carrying amount of the note on December 31, 20x1? a. 987,234 b. 1,000,000 c. 1,062,695 d. 1,129,321 First trial: (at 10%) Future cash flows x PV factor at x% = PV of note  1,200,000 X PV of ₱1 @ 10%, n=3 = 1,000,000  (1,200,000 x 0.751315) = 901,578 is not equal to 1,000,000 We need a substantially higher amount of present value. Therefore, we need to decrease substantially the interest rate. Let’s try 6%. Second trial: (at 6%) Future cash flows x PV factor at x% = PV of note  1,200,000 X PV factor at 6%, n=3 = 1,000,000  (1,200,000 x 0.839619) = 1,007,543 is not equal to 1,000,000 We need a slightly lower amount of present value. Therefore, we need to increase slightly the interest rate. Let’s try 7%. Third trial: (at 7%) Future cash flows x PV factor at x% = PV of note  1,200,000 X PV factor at 7%, n=3 = 1,000,000  (1,200,000 x 0.816298) = 979,558 is not equal to 1,000,000 In here, we need to perform interpolation. Looking at the values derived above, we can reasonably expect that the effective interest rate is a rate between 6% and 7%. To perform the interpolation, we will use the following formula: x% 6% 7% 6% Where: x% again is the effective interest rate.

1,000,000 979,558

-

1,007,543 1,007,543

=

(7,543) (27,985)

=

0.269 5

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The amount computed is added to 6% to derive the effective interest rate. The effective interest rate is 6.2695% (6% + .2695%).

Date Jan. 1, 20x1 Dec. 31, 20x1 Dec. 31, 20x2 Dec. 31, 20x3

Interest income 62,695 66,626 70,803

Unearned interest 200,000 137,305 70,679 (124)

Present value 1,000,000 1,062,695 1,129,321 1,200,124

8. On January 1, 20x1, ABC Co. issued a 3-year, ₱1,000,000 noninterest-bearing note payable to XYZ, Inc., a related party. The prevailing interest for similar type of obligation is 12%.The proceeds received from the note is ₱1,000,000, equal to the face amount. How much is the “Day 1” difference? Gain (Loss) a. 288,220 b. (288,220) c. 222,880 d. (222,880) Future cash flow Multiply by: PV of ₱1, @12%, n=3 Present value

1,000,000 0.71178 711,780

The entry to record the note is as follows: Jan. 1, Cash 20x1 Discount on note payable (1M – 711,780) Note payable

1,000,000 288,220 1,000,000 288,220

Unrealized gain – “Day 1” Difference

9. On January 1, 20x1, ABC Co. issued a 3-year, 3%, ₱1,000,000 note payable in exchange for a machine. Principal is due on January 1, 20x4 but interest is due annually every January 1. The prevailing interest rate for this type of note is 12%. How much is the carrying amount of the note on December 31, 20x1? a. 783,835 b. 883,664 c. 847,895 d. 919,643 Future cash flows Principal Annual interest (1M x 3%) Total a

b

(PV of ₱1 @12%, n=3) (PV of ordinary annuity of ₱1 @12%, n=3

Amortization table: (Installment)

1,000,000 30,000

Present value factors @12%, n=3 0.71178 a 2.40183 b

Present value 711,780 72,055 783,835

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Date Jan. 1, 20x1 Jan. 1, 20x2 Jan. 1, 20x3 Jan. 1, 20x4

Payments for interests

Interest expense

Amortization

30,000 30,000 30,000

94,060 101,747 110,357

64,060 71,747 80,357

Present value 783,835 847,895 919,643 1,000,000

10. On December 1 a company borrowed ₱100,000 at 12% per year. The interest will be paid quarterly, with the first payment due on March 1. What should the company report on its income statement for December? a. Interest expense of ₱12,000 b. Interest expense of ₱10,000 c. Interest expense of ₱1,000 d. Nothing Solution: 100,000 x 12% x 1 month/12 = 1,000 11. On May 1, year 1, a company borrowed ₱3,000 cash and signed a 13 percent note payable due April 30, year 3. Interest is paid each April 30. The accounting period ends December 31.the adjusting entry at December 31,year 1 would include: a. debit notes payable,₱390 b. credit interest payable ₱130 c. debit interest expense ₱390 d. credit interest payable ₱260

Chapter 25 – Bonds Payable & Other Concepts 12. Unamortized bond discount should be reported on the financial statements of the issuer as a a. Direct deduction from the face amount of the bond b. Direct deduction from the present value of the bond c. Deferred charge d. Part of the issue costs 13. For a bond issue which sells for less than its face amount, the market rate of interest is a. Dependent on the rate stated on the bond. b. Equal to rate stated on the bond. c. Less than rate stated on the bond. d. Higher than rate stated on the bond. 14. The market price of a bond issued at a discount is the present value of its principal amount at the market (effective) rate of interest a. Less the present value of all future interest payments at the market (effective) rate of interest. b. Less the present value of all future interest payments at the rate of interest stated on the bond. c. Plus the present value of all future interest payments at the market (effective) rate of interest. d. Plus the present value of all future interest payments at the rate of interest stated on the bond.

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15. Which of the following is not a relevant consideration when evaluating whether to derecognize a financial liability? a. Whether the obligation has been discharged. b. Whether the obligation has been canceled. c. Whether the obligation has expired. d. Whether substantially all the risks and rewards of the obligation have been transferred. 16. What is the effective interest rate of a bond or other debt instrument measured at amortized cost? a. The stated coupon rate of the debt instrument. b. The interest rate currently charged by the entity or by others for similar debt instruments (i.e., similar remaining maturity, cash flow pattern, currency, credit risk, collateral, and interest basis). c. The interest rate that exactly discounts estimated future cash payments or receipts through the expected life of the debt instrument or, when appropriate, a shorter period to the net carrying amount of the instrument. d. The basic, risk-free interest rate that is derived from observable government bond prices. 17. Which of the following statements is false? a. Bonds carry no corporate ownership privileges. b. A bond is a financial contract. c. Bond prices remain fixed over time. d. A bond issuer must pay periodic interest. 18. Most bonds: a. are money market securities. b. are floating-rate securities. c. give bondholders a voice in the affairs of the corporation. d. are interest-bearing obligations of governments or corporations. 19. In an “asset swap,” where a liability is settled through the transfer of noncash asset, a. the gain or loss on settlement is computed as the difference between the carrying amount of the liability extinguished and the fair value of the noncash asset transferred. b. the gain or loss on settlement is computed as the difference between the carrying amount of the liability extinguished and the carrying amount of the noncash asset transferred. c. the gain or loss on settlement is computed as the difference between the carrying amount of the liability extinguished and the more clearly determinable between the fair value of the liability extinguished and the carrying amount of the noncash asset transferred. d. no gain or loss is recognized 20. Entity A issues convertible bonds with face amount of ₱2,000,000 for ₱2,600,000. Each ₱1,000 bond is convertible into 10 shares with par value of ₱60 per share. On issuance date, the bonds are selling at 102 without the conversion option. What is value allocated to the equity component on initial recognition? a. 2,040,000 b. 540,000

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c. 560,000 d. 460,000 Solution: Issue price Fair value of debt instrument without equity feature (2M x 102%)

Equity component

2,600,000 (2,040,000) 560,000

Chapter 26 – Provisions, Contingent liabilities and Contingent assets 21. An entity is the defendant in a patent infringement lawsuit. The entity’s lawyers believe there is a 30% chance that the court will dismiss the case and the entity will incur no outflow of economic benefits. However, if the court rules in favor of the claimant, the lawyers believe that there is a 20% chance that the entity will be required to pay damages of ₱800,000 (the amount sought by the claimant) and an 80% chance that the entity will be required to pay damages of ₱400,000 (the amount that was recently awarded by the same judge in a similar case). Other outcomes are unlikely. The court is expected to rule in late December 20x2. There is no indication that the claimant will settle out of court. A 7% risk adjustment factor to the probability-weighted expected cash flows is considered appropriate to reflect the uncertainties in the cash flow estimates. An appropriate discount rate is 10% per year. How much is the provision for lawsuit at December 31, 20x1? a. 436,360 b. 446,908 c. 326,836 d. 0 C Solution: At twenty per cent chance: (800K x 20%) At eighty per cent chance: (400K x 80%) Total Multiply by: PV of P1 @10%, n=1 Total Multiply by: Risk adjustment (100% + 7%) Total Multiply by: Probability of settlement (100% - 30%) Provision for lawsuit – Dec. 31, 20x1

160,000 320,000 480,000 0.90909 436,363 107% 466,909 70% 326,836

22. A manufacturer gives warranties at the time of sale to purchasers of its product. Under the terms of the contract of sale, the manufacturer undertakes to make good, by repair or replacement, manufacturing defects that become apparent within one year from the date of sale. On the basis of experience, it is probable (i.e., more likely than not) that there will be some claims under the warranties. Sales of ₱40 million were made evenly throughout 20X1. At December 31, 20x1 the expenditures for warranty repairs and replacements for the product sold in 20x1 are expected to be made 50% in 20x1 and 50% in 20x2. Assume for simplicity that all the 20x2

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outflows of economic benefits related to the warranty repairs and replacements take place on June 30, 20x2. Experience indicates that 95% of products sold require no warranty repairs; 3% of products sold require minor repairs costing 10% of the sale price; and 2% of products sold require major repairs or replacement costing 90% of sale price. The entity has no reason to believe future warranty claims will be different from its experience. At December 31, 20x1, the appropriate discount factor for cash flows expected to occur on June 30, 20x2 is 0.95238. Furthermore, an appropriate risk adjustment factor to reflect the uncertainties in the cash flow estimates is an increment of 6 per cent to the probability-weighted expected cash flows. How much is the warranty provision at December 31, 20x1? a. 424,000 b. 840,000 b. 800,000 d. 752,000 A Solution: The amount of the provision is estimated as follows: Minor repairs (40M x 3% x 10%) Major repairs (40M x 2% x 90%) Total Multiply by: Present value factor (given) Total Multiply by: Risk adjustment (100% + 6%) Total Multiply by: Amount to be settled in 20x2 Warranty provision – Dec. 31, 20x1

120,000 720,000 840,000 0.95238 800,000 106% 848,000 50% 424,000

23. As of December 31, 20x1, ROUSE AWAKEN Co. has adopted a detailed formal plan to close one of its toys divisions and put up a new division to manufacture warfare weapons. The plan was communicated through a public announcement and all of those affected by the closure were informed. ROUSE estimates the following costs in relation to the closure of the division: Termination benefits of employees terminated as a result of the closure Costs of retraining and relocating retained employees Payment for unpaid purchases made by the division New systems and distribution networks for the weapons division Marketing costs for the weapons to be manufactured by the new division Expected losses during the first year of operations of the weapons division How much is the provision to be recognized? a. 4,000,000 b. 12,000,000 c. 84,000,000 d. 20,000,000 A 4,000,000 – termination benefits of employees terminated as a result of the closure.

₱4,000,000 8,000,000 16,000,000 80,000,000 24,000,000 80,000,000

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Use the following information for the next two questions: RISIBLE FUNNY Co. provides 3-year warranty for the products it sells. RISIBLE estimates that warranty costs ₱400 per unit sold. As of January 1, 20x1, the liability for warranty has a balance of ₱800,000 for units sold in 20x0. During the year RISIBLE sold 5,000 units and actual warranty costs incurred were ₱1,240,000. 24. How much is the warranty expense to be recognized in 20x1? a. 2,000,000 b. 1,240,000 c. 3,240,000 d. 4,240,000 A (5,000 units sold x ₱400) = 2,000,000

25. How much is the balance of the warranty obligation as of December 31, 20x1? a. 1,560,000 b. 2,000,000 c. 3,560,000 d. 2,800,000 A Solution:

Actual warranty costs Dec. 31, 20x1

Estimated warranty liability 800,000 1,240,000 2,000,000 1,560,000

Jan. 1, 20x1 (given) Warranty expense

26. PROFUSE EXTRAVAGANT Co. launched a sales promotion in 20x1. For every ten empty packs returned to PROFUSE plus ₱200, customers will receive a set of kitchen knives. PROFUSE estimates that 40% of the packs sold will be redeemed. Information on transactions during the year is as follows: Units Amount Sales 500,000 3B Sets of kitchen knives purchased (₱800 per set) 300,000 240M Number of packs redeemed 45,000 How much is the premium expense in 20x1? a. 8,000,000 b. 12,000,000 c. 14,000,000

d. 16,000,000

B Solution: The premium expense is computed as follows: Sales in units Multiply by: Estimate of wrappers to be redeemed Estimated wrappers to be presented for redemption Divide by: Required number of wrappers for redemption Estimated number of premiums to be distributed Multiply by: Net cost of premium (₱800 purchase cost less ₱200 cash requirement from customer)

Premium expense

500,000 40% 200,000 10 20,000 600 12,000,000

27. On January 1, 20x1, CONFOUND Co. guaranteed a ₱4,000,000 loan obtained by CONFUSE, Inc. from a bank. On December 31, 20x1, CONFUSE defaulted on its loan and it became probable that CONFOUND will be held liable to the bank for the ₱4,000,000 loan taken by CONFUSE. How much is the provisi...