Int act Unit 5-9

A company is leasing cars for four years at an agreed price of $500 per month, per car. The company provides the option to each lessee to lease each car for one additional year for an agreed upon price of $100 per month. The historical trend is that a lessee will take advantage of leasing the car for the one additional year due to this reduction in the monthly lease price. Each car has a useful life of six years. The company classifies the lease as a finance lease based on a specific test.

Which test did the company use for this purpose for classifying this lease based on the information provided?

Lease term

On January 1, Year 1, a corporation signed an agreement to lease a delivery truck for 36 months. The fair market value of the truck was $80,000 as of January 1, Year 1. The corporation estimates that the truck's fair market value will be $20,000 on December 31, Year 3. The corporation is reasonably certain it will exercise the lease option to purchase the delivery truck for $1,000 at the end of the lease.

How will the corporation report lease payments in its income statement?

Partially as amortization expense and partially as interest expense

Company A (lessee) has reached a lease agreement with Company B (lessor) to lease a new boom lift beginning January 1, Year 1. This is an operating lease with no renewal option and contains the following information:

• The lease is for three years, requiring annual payments at the beginning of the year of $10,213.

• The boom lift has a cost and fair value at the beginning of the lease of $40,000; an estimated economic life of five years; and a non-guaranteed residual value of $12,500.

• Present value of the residual value is $10,798.

• Company B depreciates assets like the boom lift using straight-line depreciation.

How should Company B record the lease payments received on January 1, Year 2?

Debit Cash for $10,213: Credit Unearned Lease Revenue for $10,213

A lessor incurs $10,000 of initial direct costs related to an operating lease.

How should the $10,000 cost be treated?

Defer the cost and allocate it over the term of the lease in proportion to the recognition of rental revenue.

Which two finance lease elements are a part of each lease payment?

A reduction of the lease liability and the recording of a financing cost (interest expense)

Company A agrees to lease racks to Company B for five years. The expected economic life of the racks are five years. At the end of the lease, Company B has the right to purchase the racks for $5,000, but the company is not certain it will exercise the right.

Which test must the lease pass to be classified as a finance lease?

Lease term

Company A has agreed to lease a full body scanner to Company B. The lease has the following information:

• The lease is for three years, requiring annual payments at the beginning of the year of $6,352.

• At the end of the lease, Company B may purchase the scanner for $5,000, and the company feels certain it will exercise this right.

• The scanner has a fair value at the beginning of the lease of $25,000; an estimated economic life of five years; and a guaranteed residual value of $7,800.

• Present value of the scanner is $18,333.

Which test does the lease pass in order to be classified as a finance lease?

Purchase option

A start-up company is trying to decide if it should purchase or lease cellular phones for its 2,500 new employees.

Which decision should the company make?

Lease, because leasing can pass the risk of residual value to the lessor

Company A leases cars from Company B for their salespeople. The leases are for three years. Company A paid a commission to a third party for helping to negotiate the leases from Company B.

How should Company A account for this commission?

Include the commission in the amount for the right-of-use asset but not in the lease liability

Which two finance lease elements are a part of each lease payment?

A reduction of the lease liability and recording the financing cost (interest expense)

Company A agrees to lease racks to Company B for five years. The expected economic life of the racks are five years. At the end of the lease, Company B has the right to purchase the racks for $5,000, but the company is not certain it will exercise the right.

Which test does the lease pass to be classified as a finance lease?

Lease term

A company wishes to avoid classifying a lease as a finance lease.

Which criterion will prevent the company from reaching this goal?

There is a bargain price option.

A company is looking for additional guidance on which equipment to lease. The company is using a lessor that has knowledge about the parent's product that can be passed on to the company.

Which lessor is being used by the lessee?

Captive leasing companies

A company needs to update one of its accounting estimates and report this update in the financial statements.

How should this change be reported?

By prospectively applying the change to current and future periods

A company did not accrue annual insurance expense in the prior year’s financial statements. The error resulted in a material overstatement of last year’s net income, and the books are closed for last year.

Which account should the company adjust in the books for the current year to correct this error?

Retained earnings

Company A acquires all shares of Company B on January 1 of Year 2. Both companies have conducted operations for the past 10 years. Company A presents two years of its financial position and results of operations when preparing financial statements.

What is the appropriate financial statement treatment for this situation?

Company A should report consolidated information for both Year 1 and Year 2 financial statements.

A manufacturing company measured its raw materials inventory using the LIFO method for all years prior to Year 2. Beginning with January 1, Year 2, the company elects to use the FIFO method and will present two years in the financial statements.

How should the company account for any additional changes?

By reporting inventory using FIFO on the December 31, Year 1 balance sheet and recording a one-time adjustment to retained earnings on January 1, Year 1

A company experiences a change in reporting entity.

Which event triggered this change?

Changing the companies included in the combined financial statements

A company purchases $1,000 of inventory that is subsequently sold. The company incorrectly records the purchase for $10,000.

Which entry should be used to correct this material error on the balance sheet?

Debit Retained Earnings for $9,000; Credit Inventory for $9,000

An accounting company identifies a material understatement of prior-year amortization expenses on a client's financial statement.

What is part of the current year's entry for the correction of the error?

Debit Retained Earnings

Which item is considered an accounting error in accrual accounting?

Recording the incorrect inventory value due to a mathematical mistake

A company purchases equipment costing $50,000 that is expected to have a useful life of five years with no salvage value. In Year 3, after two years of depreciation have been recorded, the company changes methods and decides the asset should be depreciated using a declining balance method.

Which disclosure completely illustrates the treatment required for this change?

Companies need to disclose the effect on income from operations, the related per share amounts for the current period, and why the new method is preferred.

Company A acquires all shares of Company B on January 1 of Year 2. Both companies have conducted operations for the last 10 years. Company A presents two years of its financial position and results of operations when preparing financial statements.

What is the appropriate financial statement disclosure for Company A in this situation?

Report the nature of and reason for the change in the disclosure notes for Year 2, with no requirement to repeat the disclosure for subsequent periods

A company that previously issued separate financial statements for several subsidiaries is now choosing to issue consolidated financial statements.

Which accounting change was made by this company?

Reporting entity

A company has elected to change from using the LIFO method for valuing its inventory from the previously reported FIFO method. As a result of the change, the prior year's net income increases, requiring the company to pay an additional profit-sharing bonus to its employees.

Which statement accurately depicts how this change should be accounted for as it relates to profit-sharing?

Recognize an indirect effect and record the change in expense in the current period

A company discovers an accounting error related to a prior period.

How should the correction of this material error be reported?

On the retained earnings statement as an adjustment to the opening balance

On December 31, Year 1, a company records revenue for $150,000 that applied to Year 2. The books have already been closed in Year 2.

Which action, if any, should the company take to address the error?

The company should take no action as the error is counterbalanced.

A company president is comparing the company's circumstances in the current period to that of the prior period and noticed several changes. The president has determined that the circumstances qualify as a change in the reporting entity.

Which change will require this treatment?

Changing the included companies in consolidated financial statements

Which plan involves an employer adding a certain sum to a pension trust each period, based on a formula?

Defined contribution plan

A company provides employees with a noncontributory defined benefit plan as part of the overall compensation package.

Which characteristic is associated with this type of plan?

The company is at risk for payments falling short of the future benefits.

A company has a pension plan where the employer agrees to fund a fixed amount to a pension trust each pay period. The payment is based on a formula that considers the employees’ age, length of service, salaries, and employer's profits.

What is the name for this type of pension plan?

Defined contribution

Which category is considered in a defined contribution plan?

Employer payments

Which type of U.S. pension plan has grown in the number of active participants over the past 40 years?

Defined contribution plans

Which factor is considered when calculating an employee's pension payment in a defined benefit plan?

Length of service

A company includes a pension plan as part of its overall compensation package. The employer bears the entire cost of the plan.

Which type of plan is described in this scenario?

Noncontributory plan

A company includes a pension plan as part of its overall compensation package. Employees may voluntarily make payments to increase benefits, and they assume part of the cost of the benefits.

Which type of plan is described in this scenario?

Contributory plan

Which factor is a function of the defined benefit plan funding model for each employee's benefit?

Employee's compensation level

A company provides a pension plan to eligible new hires. Pension payments are typically based on the employee’s years of service and the compensation level as the employee approaches retirement. It is the responsibility of the employer to pay any shortfall in the accumulated assets held by the trust.

Which type of plan is described in the scenario?

Defined benefit plan

Which plan involves an employer adding a certain sum to a pension trust each period, based on a formula?

Defined contribution plan

Which amount does a defined contribution plan specify?

The required payment amount by the employer

Which calculation is used to measure the funding needed for projected benefit obligations of a defined benefit plan?

Present value

Which statement accurately describes an employer's accounting when making a required contribution to a defined contribution pension plan?

The employer pays an amount each year to the plan based on a formula calculated by the plan.

How is a noncontributory pension plan funded?

The employer makes payments to the funding agency.

In substance, who do the trust assets and liabilities belong to under a defined benefit plan?

Employer

Which type of plan is a 401(k)?

Defined contribution

Which type of pension plan allows employees to deduct contributions from their personal taxable income?

Qualified

Which plan outlines the payments that employees will receive when they retire?

Defined benefit plan

Which factor is a function of the defined benefit plan funding model for each employee's benefit?

Employee's compensation level

A company needs to determine the order to use when presenting information in the statement of cash flows.

Which section should be presented third?

Financing activities

An individual is reading a company's statement of cash flows in order to better understand the company.

Which question is able to be answered from this information?

Where does the company generate cash inflows?

A company has decided to use the indirect cash flow method to reconcile the differences between accrual accounting net income and cash from operating activities. The company is making a deduction from net income when calculating cash flow from operating activities.

Which deduction is possible under this method?

Increase in prepaid expense

A company is preparing a statement of cash flows and needs to know the order to use to present information.

Which section should be presented second?

Cash flow from investing activities

Which kind of activity will be included in the operating activities section of the statement of cash flows?

Cash payments to a supplier

An accountant is gathering the information necessary to prepare the statement of cash flows. The first section in the statement of cash flows necessitates the use of information from a comparative financial statement.

Which comparative financial statement is used for this purpose?

Balance sheet

A company has determined it is easier to use the indirect method of accounting for cash flows. The company wishes to increase net cash flows from operating activities.

Which transaction is relevant when this method is used?

Depreciation expense

A company wishes to prepare its statement of cash flows and wants to know which transaction to include in the operating activities section.

Which type of transaction should be included?

Depreciation

How does the direct method compare to the indirect method in preparing the statement of cash flows?

Cash flow from operations is presented differently using the direct method.

What is the primary purpose of the statement of cash flows?

To provide information about cash inflows and outflows for a period of time

A company wants to prepare its statement of cash flows.

Which type of transaction should be included in the financing activities section?

Issuance of common stock

A company has decided to use the indirect method for its statement of cash flows and needs to determine which items are subtracted from net income in the operating section.

Which item will be subtracted?

Increase in receivables

The company is creating a Year 3 statement of cash flows using the indirect method. The company's information is as follows:
 

Comparative Balance Sheets
Assets	Year 3	Year 2	Year 1
Cash	$ 35,000	$  30,000	$ 25,000
Accounts receivable	45,000	40,000	50,000
Prepaid expenses	20,000	30,000	25,000
Equipment	70,000	80,000	100,000
Accumulated depreciation - equipment	(35,000)	(40,000)	(50,000)
Total assets	$135,000	$140,000	$150,000
Liabilities and stockholders equity
Accounts payable	$100,000	$110,000	$115,000
Common stock ($5 par)	25,000	20,000	20,000
Retained earnings	10,000	10,000	15,000
Total liabilities and stockholders equity	$135,000	$140,000	$150,000

 

How does the change in prepaid expenses affect the statement of cash flows?

The change increases cash flows from operating activities.

In March, a company pays its vendors for inventory that was purchased in January. Accounts Payable is decreased by $500,000.

Where is this activity presented on the statement of cash flows?

Operating activities

A company has material related-party transactions.

Which disclosure note should be included in the financial statements?

The relationship between the transacting parties

A manufacturing company operates on a fiscal year. In the early spring of Year 2, a fire destroys the factory and its contents. Despite an anticipated work stoppage for six months and a net loss from operations for Year 2, the manufacturer assesses that it is still an ongoing concern. The manufacturer has not issued financial statements for Year 1.

Is the manufacturer required to adjust the financial statements related to the fire as a subsequent event?

No, because the condition of the loss did not exist at the balance sheet date

A company is noticing an increase in the number of disclosures in its annual report.

What would be a reason for this increase?

Complexity of the business environment

A business learns of a material financial event after the balance sheet date. The event existed prior to the balance sheet date and will provide evidence about the business's financial condition.

How should this event be reported?

As a recognized subsequent event

A supermarket is owned by a sibling of the owner of a major seafood distributor. The supermarket purchases all of its seafood from the distributor. 90% of its seafood orders are placed by a salesperson with half of the orders receiving a discount. 10% of the orders are placed directly through the siblings, all at a discount.

Which disclosure in the notes regarding seafood purchases should be made in the supermarket’s financial statements?

Disclosure of all dollar amounts of all transactions

A company agrees to a merger after the balance sheet date but before the issue date.

How should the merger be treated under these circumstances?

As a nonrecognized subsequent event that is disclosed in the financial statements

In Year 2, a company receives notice of a $1,200,000 lawsuit relating to a customer’s injury on company property in Year 1. The company decides to settle the lawsuit out of court before issuing financial statements for Year 1

Does the company need to adjust the financial statements for Year 1?

Yes, because the lawsuit was settled prior to issuing the financial statements for Year 1

A company is determining if a major disclosure must be made in the notes included with its financial statements.

Which tax item requires this treatment?

Deferred taxes

After a successful year, a company’s board of directors votes to expand operations. The company sells 40,000 shares of $1 par value common stock for $60 per share to fund the $2.4 million dollar project in January of Year 2, weeks before issuing the financial statements for Year 1. Which type of transaction has occurred in this company?

Nonrecognized subsequent event

A company has material related-party transactions. Which disclosure note should be included in the financial statements?

The relationship between the transacting parties

A company is trying to determine if a subsequent event should be disclosed in its financial statements. Management understands that the event must be disclosed if it happened before a key date. Which key date is being used for this decision?

Issue date

A company is considering changing from a public corporation to a private corporation but still wants to follow generally accepted accounting principles (GAAP).

Which reporting requirement, according to the Financial Accounting Standards Board (FASB), will no longer apply if this change is made?

Segment reporting for companies with multiple product lines

A merchandising business maintains a significant level of inventory for goods to be sold to the public.

Which financial statement disclosure is required?

The inventory value stated at the lower of cost or market (LCM)

A business learns of a material financial event after the balance sheet date. The event existed prior to the balance sheet date and will provide evidence about the business's financial condition.

How should this event be reported?

As a recognized subsequent event

The decision-making needs between large, public companies and small, private companies have resulted in variations in how generally accepted accounting principles (GAAP) are applied.

Which principle was modified by the Financial Accounting Standards Board (FASB) in response to this issue?

Differential disclosure

A company is trying to determine how many years that the aggregate amount of maturities for all long-term borrowing must be reported.

How many years should be disclosed?

5

A company is determining whether a disclosure to the financial statements must be included in a note.

Which of the following disclosures would be required?

Liens held against equipment

Regulations and professional accounting standards have resulted in an increased level of disclosures in financial reporting. Which reason supports this trend?

Increased complexity of the business environment