Sample/practice exam 2015, questions and answers PDF

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ACCT 352 Intermediate Financial Accounting II Practice Final Examination with Solutions Instructions: 1. This practice exam is intended to provide a sample of various learning concepts covered after the midterm exam. The practice examination questions may not be the same as the actual examination questions. The actual final exam can include concepts from the ENTIRE course material, so students may want to review the ACCT 352 practice midterm exam as well. 2. This practice exam should be written as a closed-book examination without the use of books, tapes, or notes, in order to provide the best feedback on areas that require additional study. 3. This is a comprehensive exam so it will take longer to complete than the actual final exam. As a result you can allow yourself unlimited time to complete this examination. 4. This examination contributes 0% to your grade in this course. It is a practice exam with a comprehensive format for study purposes only. 5. The breakdown for this examination is as follows:

Part 1 2 3 4 5

Description Theory Pensions Leases Accounting Changes and Error Analysis Statement of Cash Flows

Note: For all journal entries, explanations are not required. SHOW CALCULATIONS WHEREVER POSSIBLE.

-1-

ACCT 352 Intermediate Financial Accounting II Practice Final Examination with Solutions Part 1: Theory Note: The questions in Part 1 are examples only. Any of the learning objectives in the textbook that deal with accounting theory may be examined in the actual examination, so it is important to review and understand all the objectives. The Summary of Learning Objectives and the Key Terms at the end of each chapter and appendix are a good place to start this type of review. When you are answering written response questions worth several marks, think about what, why, when, and how to answer the question fully. 1.

Discuss the advantages of leasing instead of purchasing assets.

Solution: Leases usually require no down payment and interest rates are fixed. This can help preserve scarce cash and protect against unexpected changes in interest rates. The ability to return equipment at the end of the term and lease new equipment can help protect against obsolescence—the lessee can always obtain the latest technology. Leases allow for more flexibility than conventional loans. The covenants/provisions are usually less restrictive, and can be tailored to the individual needs of the lessee. In some cases, leasing can be cheaper than other forms of financing. Investment tax credits and CCA deductions are of little use to the lessee if the business is not currently generating income. The lessor, however, can claim these tax benefits and possibly lower the rental payments. If leases are structured as operating leases, then these obligations do not show up on the balance sheet, which may improve the lessee’s financial ratios and compliance with other debt covenants.

2.

Discuss the factors that may motivate managers to choose certain accounting policies, other than purely conceptual reasons such as relevance and reliability.

Solution: Political costs: Companies that are large and highly visible to the public may be subject to additional taxation, anti-competition laws, and other restrictions on their business activities. In order to avoid these problems, the companies may choose conservative accounting policies that deliberately defer income to future periods. Capital structure: Companies that are highly leveraged may also be subject to the conditions of debt covenants. In order to avoid violating these covenants, these companies may choose aggressive accounting policies that maximize current net income, and thus, current equity. Bonus payments: Managers whose compensation is tied to profitability measures will likely choose accounting policies that maximize current income. Earnings smoothing: Companies that report rapid growth in earnings may attract unwanted attention of regulators, and may set unreasonable baselines for future performance evaluation. On the other hand, a decline in earnings may signal difficulties in the company which may weaken investor confidence. Accordingly, managers may make use of accounting policies and discretionary accruals to “manage” the growth of earnings to a reasonable, persistent, and steady amount.

Part 2: Pensions 1.

Kyle Corp. reports the following information about its defined benefit pension plan for 2015: ($000’s) ABO, opening balance 260 Plan assets, opening balance 273 Accrued pension asset 13 Discount rate and expected return 9% Service Cost 29 Contributions (from employer) 28 Actual return on plan assets 26 Benefits paid to retirees 20 Past service cost (plan amendment January 2), net present value 50 The compan y uses the immediate recognition approach under ASPE. a. b.

Provide a continuity schedule for the ABO and a continuity schedule for the plan assets for the year. Explain whether or not the plan is overfunded or underfunded. Calculate the pension expense for 2015 assuming that the company uses the immediate recognition approach.

Solution: a)

Accrued benefit obligation, 1/1/15 Past service cost Interest cost ($310,000 x 9%) rounded Service cost Benefits paid out

$260 50 310 28 29 (20)

ABO, 12/31/15

$347

Plan assets, 1/1/15 Actual return on assets Contributions Benefits paid out

$273 26 28 (20)

Plan assets, 12/31/15

$307

Plan’s Funded Status on the balance sheet ABO, 12/31/15

$347

Plan assets, 12/31/15

307

Pension Liability

$40

Since the accrued benefit obligation exceeds the plan assets, the plan is underfunded.

b)

Pension expense 2015 (immediate recognition): Service cost Interest on accrued benefit obligation Actual return on plan assets Past service cost

$ 29 28 (26) 50 $ 81

Part 3: Leases 1.

On January 1, 2015, Narnia Corp. leased a building to Smithens Ltd. Information about the lease is below: • • • • •

• •

The lease is for 10 years. The leased building cost $4.75 million and was purchased by the Narnia for cash on January 1, 2015. The building is depreciated on a straight-line basis. Its estimated economic life is 50 years and will have a residual value of $500,000. Lease payments are $320,000 per year and are made at the end of the year. Property tax expense of $53,000 and insurance expense of $20,000 on the building were incurred by Narnia in the first year. Payment on these two items was made at the end of the year. Lessee’s interest rate is 10%. The market interest rate is 8%. Both the lessor and the lessee have their fiscal years on a calendar-year basis and both use ASPE.

Required: a. Is this lease capital or operating? Why? b. Prepare the journal entries for both the lessee and lessor for 2015 assuming the payments are paid in cash when due. c. Would your answer change if the companies used IFRS instead? Solution: a) This is an operating lease. There is no transfer of ownership or bargain purchase option. The economic life 10/50 = 20% which is less than 75%. Present value is $2,147,226 which is less than 90% of fair value of $4.75 million.

Solution (cont’d) b) Entries for Narnia: 1/1/15 12/31/15

Building (Leased) ..................................... Cash ...................................................

4,750,000

Cash............................................................ Rental Income..................................... Depreciation Expense ............................. Accumulated Depreciation —Building .......................................... [($4,750,000 – 500,000) ÷ 50] Property Tax Expense ........................... Insurance Expense ................................. Cash ...................................................

320,000

4,750,000 320,000 85,000 85,000 53,000 20,000 73,000

b) Entries for Smithens: 12/31/15

Rent Expense ............................................. Cash ......................................................

320,000 320,000

c) Both ASPE and IFRS entries above would be the same for operating leases.

2.

On January 1, 2015, Pelletier Corp. leased equipment to Beemac Corp. The following information relates to the lease: •

• • • • • •

The lease term is 6 years and is non-cancellable with no renewal option. The equipment reverts to the lessor at the end of the lease, with an expected residual value (not guaranteed) of $10,000. Beemac depreciates all its equipment on a straight-line basis. Equal rental payments are due on January 1 of each year, beginning in 2015. The equipment’s fair value on January 1, 2015 is $148,000 and its cost to Pelletier is $120,000. The equipment has an economic life of 8 years. Pelletier set the annual rent to ensure an 11% rate of return. Beemac’s incremental borrowing rate is 12% and the lessor’s implicit rate is not known to the lessee. Collectibility of lease payments is reasonably predictable and there are no important uncertainties about any costs that have not yet been incurred by the lessor. Both companies use ASPE.

What type of lease is this for Pelletier? For Beemac? What is the amount of the rental payment? Prepare all journal entries for the lessee and lessor for 2015. Solution: Lessee - this is a capital lease since the lease term is 75% (6 ÷ 8) of the asset’s economic life. In addition, the present value of the minimum lease payments is more than 90% of the fair value of the asset. Lessor - this is a sales-type lease since the lease is a capital lease to the lessee, and because the collectibility of the lease payments is reasonably predictable, there are no important uncertainties surrounding the costs yet to be incurred by the les sor. Moreover, the fair value of the equipment ($148,000) exceeds the lessor’s cost ($120,000), therefore is a salestype lease. (If the lessor’s cost equalled fair value then it would be classified as a direct financing lease.) Calculation of annual rental payment: PA/D (use BGN/END) = (+/- 148000 PV, 11 I/Y, 6 N, 10000 FV) COMP PMT = $30,378

Lessee entries: 1/1/15 Equipment Under Capital Leases......................... 139,884 Obligations Under Capital Leases ............................................. 139,884 (30378 PA/D (use BGN/END), 12 I/Y, 6 N) COMP PV = $139,884 Obligations Under Capital Leases ........................ 30,378 Cash ......................................................... 30,378 12/31/15 Depreciation Expense ................................................ 23,314 Accumulated Depreciation ..................... 23,314 ($139,884 ÷ 6 years) Interest Expense .................................................... 13,141 Interest Payable ....................................... 13,141 [($139,884 – $30,378) X 12%] Lessor entries: 1/1/15 Lease Payments Receivable............................. 192,268* Cost of Goods Sold ........................................... 114,654 Sales ..................................................... 142,654 Inventory ............................................. 120,000 Unearned Interest Income— Leases .................................... 44,268** *[($30,378 X 6) + $10,000] **($192,268 – $148000) Since the residual value is not guaranteed, the present value of the residual value of $10,000 is withheld from both sales and cost of goods sold. Sales

$148,000

Less present value of residual value (10000 FV, 11 I/Y, 6 N) = 5,346

5,346 $142,654

Cost of Goods Sold Less present value of residual value

Cash

12/31/15

............................................................. Lease Payments Receivable ..............

Unearned Interest Income—Leases............... Interest Income—Leases.................... [($148,000 – $30,378) X .11]

$120,000 5,346* $114,654 30,378 30,378 12,938 12,938

3.

On January 1, 2015, Hyoto Corp., which uses IFRS, sold a Bobcat to ABC Finance for $70,000 and immediately leased it back. The Bobcat was carried on Hyoto’s books at $55,000, net of $16,000 of accumulated depreciation. The term of the lease is 5 years, and title transfers to Hyoto at the end of the lease. The lease requires five equal payments of $17,300, with each payment made at year end. The appropriate rate of interest is 8% and the Bobcat has a useful life of 5 years with no residual value. Prepare the lessee’s 2015 journal entries.

Solution: Jan 1/15 Cash 70,000 Accumulated Depreciation - Bobcat .............................16,000 Bobcat................................................................................ Deferred Profit on Sale-Leaseback.................................

71,000 15,000

Bobcat Under Capital Leases.................................................... 69,074 Lease Obligation............................................................... (PV= 17300 PMT, 8 I/Y, 5 N COMP PV = 69,074 rounded)

Dec 31/15 Depreciation Expense .................................................. 13,815 Accumulated Depreciation ($69,074 X 1/5) ................... Deferred Profit on Sale-Leaseback........................................... Depreciation Expense ($15,000 X 1/5)............................

3,000

Interest Expense ($69,074 X 8%) ............................................. Obligations Under Capital Leases ............................................ Cash ...................................................................................

5,526 11,774

69,074

13,815

3,000

17,300

Part 4: Accounting Changes and Error Analysis 1.

You have been assigned to examine the financial statements of Dutchie Co., a publicly traded company, for the year ended December 31, 2015. You discover the following situations: a. The physical inventory count on December 31, 2014 improperly excluded merchandise costing $18,000 that had been temporarily stored in a public warehouse. Dutchie uses a periodic inventory system. b. The physical inventory count on December 31, 2015 improperly included merchandise with a cost of $17,000 that had been recorded as a sale on December 27, 2015, and was being held for the customer to pick up on January 4, 2016. c. A collection of $4,000 on account from a customer received on December 31, 2015 was not recorded until January 2, 2016. d. Depreciation expense of $3,200 for 2015 on delivery vehicles was not recorded. e. In 2015, the company received $6,700 on a sale of fully depreciated equipment that originally cost $22,000. The company credited the proceeds from the sale to the Equipment account. f. During November 2015, a competitor company filed a patent infringement suit against Dutchie, claiming damages of $720,000. The company’s legal counsel has indicated that an unfavourable verdict is probable and a reasonable estimate of the court’s award to the competitor is $580,000. The company has not reflected or disclosed this situation in the financial statements. g. A large piece of equipment was purchased on January 3, 2015 for $40,000 and was charged in error to Repairs Expense. The equipment is estimated to have a service life of 8 years and no residual value. Dutchie normally uses the straight- line depreciation method for this type of equipment. h. Dutchie has a portfolio of temporary investments reported as trading investments at fair value. No adjusting entry has been made yet in 2015. Information on carrying amounts and fair value is as follows: Carrying Amount

Fair Value

December 31, 2014

$91,000

$91,000

December 31, 2015

90,000

87,000

i. At December 31, 2015, an analysis of payroll information showed accrued salaries of $10,500. The Accrued Salaries Payable account had a balance of $14,000 at December 31, 2015, which was unchanged from its balance at December 31, 2014. j. A $21,000 insurance premium paid on July 1, 2014, for a policy that expires on June 30, 2017, was charged to insurance expense. k. A trademark was acquired at the beginning of 2014 for $50,000. Through an oversight, no amortization has been recorded since its acquisition. Dutchie expected the trademark to benefit the company for a total of approximately 10 years. Required: Assume that all amounts are material, the trial balance has been prepared, the ending inventory has not yet been recorded, and the books have not been closed for 2015. Prepare the journal entries showing the adjustments that are required. Ignore income tax considerations.

Solution: (a) Inventory.............................................................................................. 18,000 Retained Earnings..................................................................... (b) No entry. Reduce the physical inventory count by $17,000. (c) Cash ..................................................................................................... 4,000 Accounts Receivable ................................................................. (d) Depreciation Expense ......................................................................... 3,200 Accumulated Depreciation —Delivery Vehicles ................................................................................. (e) Accumulated Depreciation—Equipment.......................................... 22,000 Equipment ................................................................................. Gain on Sale of Equipment ......................................................

18,000

4,000

3,200

15,300 6,700

(f) Estimated Litigation Loss................................................................... 580,000 Estimated Litigation Liability.................................................. 580,000 (g) Depreciation Expense ......................................................................... Equipment ........................................................................................... Repairs Expense ........................................................................ Accumulated Depreciation—Equipment................................ (h) Investment Income/Loss (FV-NI) ...................................................... Investments (FV-NI)........................................................... (i) Accrued Salaries Payable ($14,000 – $10,500) ................................. Salaries Expense........................................................................ (j) Insurance Expense ($21,000 ÷ 3) ....................................................... Prepaid Insurance ............................................................................... Retained Earnings..................................................................... (k) Amortization Expense ($50,000 ÷ 10)................................................ Retained Earnings............................................................................... Accumulated Amortization - Trademark ...............................

5,000 40,000 40,000 5,000 3,000 3,000 3,500 3,500 7,000 10,500 17,500 5,000 5,000 10,000

2.

Indicate the effect – Understated (U), Overstated (O), No Effect (NE) – that each of the errors for each independent situation has on 2015 net income and 2014 net income. 2014 a. Wages payable wer not recorded at Dec. 31, 2015. The wages were recorded when paid in 2015. b. Equipment purchased in 2013 was expensed c. Equipment purchased in 2014 was expensed d. Ending inventory at Dec. 31, 2014 was overstated e. Patent amortization was not recorded in 2015 f. Ending inventory not recorded Dec. 31, 2014 g. Merchandise purchased in 2014 not recorded or counted ending inventory in 2014 and remained unso...