ACTG 3P33 Midterm Version A

ACTG 3P33 Midterm Version A - 33 JUNE 8, 2007 Page 1 of 14...

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Unformatted text preview: 33 JUNE 8, 2007 Page 1 of 14 pages THIS SCRIPT WILL NOT BE DEPOSITED IN THE LIBRARY BROCK UN 1 VERSITY Midterm Examination, Spring, 2007 COURSE: ACTG 3P33 DATE: June 8, 2007 TIME: noon. — 3:00 pm. Number of Pages: 14 Number of Students: l05 Number of Hours: 3 Instructor: S. F elton You may use only a nonprogrammable calculator and those interest tables that are provided by the instructor. No examination aids other than those specified are permitted. Use or possession of unauthorized materials will automatically result in the award of a zero grade for this examination. QUESTION 1. Multi 1e Choie 10 t 2. Discusson r 10 s. Investments -— 10 r 4. Investments det 7 _ m- — SECTION (please circle): (01) 9:00 -— 11:00 a.m. (02) 11:00 — 1:00 p.111. (03) 1:30 — 3:30 p.111. ACTG 3P33 Page 2 of 14 pages or; .srroN 1 {19 mar‘m‘ Indicate the ONE best answer for each of the following. Q1. use The rationale for comprehensive income tax allocation is to: a) follow the conservatism principle b) report income tax expense as the amount of income tax payable for the year c) recognize a tax asset or liability for the tax consequences of temporary differences that exist at the balance sheet date (1) reconcile the tax consequences of permanent and timing differences reported in the financial statements 6) report extraordinary items net of their tax effect . In the earlier years of a lease, from the lessee’s perspective a) use of the operating method will cause income to decrease, compared to the capital method b) the capital method will cause debt to increase, compared to the operating method c) the operating method will cause debt to increase, compared to the capital method d) the capital method will enable the lessee to report higher income, compared to the operating method e) both a) and b) If an investor owns 25% of the voting shares of an investee, the investor should: a) usually classify the investment as an available for sale b) produce consolidated financial statements 0) adjust the investment to fair market value at the end of each period and report any unrealized holding gains or losses in other comprehensive income d) always account for this investment using the equity method e) account for the investment using the equity method unless circumstances suggest that the investor cannot exercise significant influence over the investee Which of the following items would most likely be recorded by a lessor for an operating lease? a) rent expense and interest expense b) amortization expense and rent revenue 0) rent revenue and interest revenue d) interest revenue and amortization expense e) interest expense and amortization expense A material item of revenue is recognized on the income statement in the current period but will not be recognized in taxable income until a future period and future tax rates are expected to be higher than current rates. in this case, the method which would likely report the highest amount for current net income: a) is the taxes payable method b) is comprehensive tax allocation using the deferral method 0) is comprehensive tax allocation using the liability method d) is the partial tax allocation method e) cannot be determined from the information given. ACTG 3P33 a l W 6. 10. JUNE 8, 2007 Page 3 of 14 pages On January 1, 2006 Dov Co. sold for its fair value of $440,000 equipment that had a net book value of $400,000 and a remaining life of 20 years. That same day, the equipment was leased back at $24,000 per year for 8 years with no option to renew the lease or purchase the equipment. Lease payments are paid on the first of each year, beginning January 1, 2006. As a result of these transactions, Dov’s balance sheet at December 31, 2006 will include: a) $440,000 leased asset, $22,000 accumulated amortization and a deferred gain of $40,000 b) $400,000 leased asset, $20,000 accumulated amortization and a deferred gain of $40,000 0) $440,000 leased asset, $22,000 accumulated amortization and a deferred gain of $35,000 d) a deferred gain of $35,000 e) a deferred gain of $40,000 The factor which differentiates a sales—type lease from a direct financing lease is related to: a) whether or not the lease includes a bargain purchase option b) whether title of the property will transfer to the lessee at the end of the lease 0) whether the lease meets one of the three criteria for capitalization set out in the CICA Handbook d) whether the lessor can meet the two additional criteria necessary for revenue recognition e) whether the cost of the property to the lessor equals its fair market value at the inception of the lease On January 1, 2006 Albert Corp sold a property in exchange for a 5% $20,000 note receivable when the market rate was 10%. Interest payments are due on January 1 of each year, beginning January 1, 2007 with the principal due January 1, 2009. What should Albert record for interest revenue for its fiscal year ended December 31, 2006? a) $0 l9 V turf 3T” m 7333297“ 35/532462 b l 5 f' a : ' ' “E; '=-‘=~ "’8’; ,3 3:30;, i ‘30 V a aura am, 2.96%: at» Wires 9-3? ’7 d) $876 ‘ {75!} e) None of the above 5 { ’7}; i A corporation reports income before income taxes of $250,000 in its income statement, but because of timing differences, taxable income is only $125,000. If the tax rate is 45%, the firm should report net income of: a) $68,750 b) $1 12,500 c) $137,500 d) $193,750 e) some other amount A “1530, we 537;, 3% On January 1, 2007 Allen Co. (lessee) signed an agreement to lease land and a building for 15 years. At the end of the lease the property will be returned to the lessor. The building has a useful life of 15 years and the value of the land to the lessee is approximately 30% of the value of the leased property. The present value of the total payments that Allen must pay over the life of the lease is $5 00,000. In accounting for this lease, Allen should: a) record a lease liability of $350,000 at the inception of the lease b) account for this as an operating lease since the property will be returned to the lessor c) record a leased asset for $500,000 at the inception of the lease and amortize this over 15 years d) capitalize the land and building separately at the inception of the lease e) record a liability of $5 00,000 at the inception of the lease ACTG 3P33 JUNE 8, 2007 Page 5 of 14 pages a) (5 marks) When a firm acquires an equity investment, it classifies it as held for trading, available for sale, or an investment to be accounted for using the equity method. Do the CICA Handbook Recommendations permit the firm to transfer the investment to a different classification in future years? Explain when these transfers are allowed and what would be the justification for them. Where transfers are not allowed, explain why not. Investments CANNOT be reclassified out of HF T or into HF T. (I mark) The reason for this is to prevent management from manipulating net income. (I mark) Since only HF T investments must include all UH G & UHL in net income, management might be tempted to move other investments into this category when FM V > carrying value or out of this category when the reverse was the case. (I mark) A firm could reclassify an investment-from AFS to an equity method investment if circumstances changed so that the investor gained significant influence over an investee (perhaps the in vestor purchased more shares of the investee this period). (I mark) Conversely, a firm could reclassify an investment from an equity method investment to AFS if circumstances changed so that the investor lost significant influence over an investee (perhaps the investor some of its shares of the investee this period). (I mark) ACTG 3P33 JUNE 8i 2007 Page 6 of 14 pages Q'ESTION 2 continued ‘9) (5 marks) Explain the nature of a future tax liability. What is the justification for setting up such a liability? Why have some critics complained that the future tax liabilities reported by many companies are not “real” liabilities? F T L = Tax payable in future years as a result of a taxable temporary difference existing at end of current year (I mark) This is a liability because it represents ( I ) a future cash outflow (economic sacrifice) (2) owed by the firm (3) due to a past transaction (ie. Accounting income already recognized). (3 marks) Many of these F TL will not reverse in the foreseeable future, as long as the firm maintains its current level of operations (and will grow if thefirm ’s operations expand). (I mark) For example, F T L due to an excess of CCA charged over amortization to date often does not reverse because the firm replaces its operating assets, so that UCC does not decrease and amortization is never higher than C CA. OR ANY OTHER RELEVANT EXAMPLE (I mark) (I over mark possible) ACTG 3P33 JUNE 8, 2007 Page 7 of 14 pages QUE STION 3 (10 marks) On January 1, 2007 Fanika Co. paid $1,600,000 to acquire 6,000 of the 30,000 common shares of Zelka Inc. as a long-term investment. On January 1, 2006 Zelka’s balance sheet indicated total shareholders equity of $6,000,000. At that date Zelka reported $400,000 for land which had a fair value of $600,000 and amortiziable assets (20 year usefial life) with a camiing value of $2,000,000 and market value of $2,800,000. During the year ended December 31, 2007 Zelka sold half of the land and reported: Income before extraordinary items 75 0,000 Extraordinary loss due to tornado 50,000 Cash dividends declared and paid 100,000 REQUIRED: Prepare all journal entries on Fanika’s books for 2007 assuming that its investment in Zelka should be accounted for using the equity method. ACTG 3P33 JUNE 8, 2007 Page 9 of 14 pages QUESTION 4 continued b) (9 marks) Assume that the investment was classified as “available for sale” when it was acquired. Prepare the journal entries that would be required in 2006 if all of the bonds were sold on March 31, 2006 for l 10 plus accrued interest. Assun e that all entries were made correctly in 2005. Phantom uses an allowance account and held no other “available for sale” investments during 2006. ACTG 3P33 JUNE 8, 2007 Page 8 of 14 pages QUESTION 4 (1 6 marks) On April 1, 2005 Phantom purchased $150,000 12% bonds for $161,372 when the market rate was 10%. The bonds pay interest every March 31 and mature in 5 years. At December 31, 2005 these bonds were trading at 109 plus accrued interest. REQUIRED: a) (7 marks) Assume that Phantom has no other investments. Complete the table below to show the impact (dollar amounts) of these bonds on Phantom’s net income and on its other comprehensive income (0C1) for the fiscal year ended December 31, 2005 under each of the following independent assumptions: i) the bond investment is classified as “held for trading” ii) the bond investment is classified as “held to maturity” iii) the bond investment is classified as “available for sale” Journal entries are not required, but SHOW ALL CALCULATIONS. Bond Investment Amounts Reported in Net Income Amounts Reported in QC! Classification for 2005 for 2005 i) Held for Trading Pei V- p, 1 5;; C??? “is daisiwé“ A fl‘ZJ'Zilg we; ($15165mmrfieiéigfiqfléwi ii) Held to Maturity ‘W%_ (fig; é ; 503 :y L ' . , "x , (L; y I {leg/“751x iflflbx ’42:} iii) Available for Sale Mai 5 grab; K E 2/} 55;?) 317/ Li «3i 5 i 5 . (mama-wt; WE”) (g m v ...- awtéifiti 2651? mg My}; 37$ 32;) “a l 3.. ACTG 3P33 JUNE 8, 2007 Page 10 of 14 pages QUESTION 5 (29 marks) On January 1, 2005 Zane (lessor) signed an non—cancellable agreement to lease a machine to Bentley (lessee). The following information relates to this agreement: Inception of lease January 1, 2005 Lease term 6 years Economic life of asset 8 years Fair value of asset at inception of lease $100,000 Carrying value (NBV) of asset on lessor’s books January 1, 2005 $75,000 Annual lease payment made December 31 of each year $19,905 Annual insurance costs paid by lessor & included in $19,905 payment $1,000 Date first lease payment is due December 31, 2005 Unguaranteed residual at end of lease term $20,001 Legal fees paid by lessor on January 1, 2005 to negotiate lease $2,000 Rate implicit in lease and lessee’s incremental borrowing rate 8% Assume that it is appropriate for both lessee and lessor to account for this as a capital lease. REQURED: a) (18 marks) Assume that Zane (lessor) has a December 31 fiscal year end and keeps unearned revenue in an account separate from its gross receivable. Prepare all journal entries made by Zane in regards to this leased property for its fiscal year endedDecember 31, 2005. SHOW ALL CALCULATIONS. T he next page is blank .... .. QUESTION 5 continued ACTG 3P33 (1) JUNE 8, 2007 Page 11 of 14 pages mfg/LL51; OQAI: Swag?) {(76156 «2526;19de (:1 i 3 Effibg § Y( lg; L \ any" a" (f ([755 9ffo ’“' ll éfl‘fi . N . _, m CO l j if; 1/,2. 0v be ~» / tom MM (MM@,) (7 gm) ACTG 3P33 (1) JUNE 8, 2007 Page 12 of 14 pages QUESTION 5 continued b) (11 marks) Assume that Bentley (the lessee) has a September 30 fiscal year end. Show all the amounts and classification of all balance sheet and income statement items that would be included in Bentley’s financial statements for the fiscal year ended September 30, 2005 in regards to this lease. Journal entries are NOT required. SHOW ALL CALCULATIONS. t 0%; 815 (\JQ/vxwrwzwl’ / , I I s r / '75 L/ law/1W WM“ (‘W@* 6%?) O l/ ‘V “159 I ~ ’3” W’ewfl' Cl 45 ACTG- 3P33 JUNE 8, 2007 Page 13 of 14 pages QUESTION 6 (25 marks) On its December 31, 2005 balance sheet Rendalle Co. reported a future tax liability of $14,000 due to a $40,000 excess of the net book value of capital assets over their undepreciated capital cost (UCC). The following data pertain to Rendalle’s operations for 2006: > Income before tax and extraordinary items is $900,000. Already included in calculating this amount were the following items: $50,000 nontaxable dividend revenue; $10,000 tax penalty which is not deductible for tax purposes; $100,000 amortization expense; $30,000 warranty expense. On its 2006 tax return Rendalle claimed as tax deductions $140,000 capital cost allowance (CCA) and $18,000 of warranty costs actually incurred during 2006. in 2006 Rendalle recorded an extraordinary gain of $100,000, which is being collected in installments. $50,000 was collected in 2006 and $50,000 will be collected in 2007. Only 75% of this gain will ever be taxable and this must be included in taxable income when collections are made. The tax rate for all years prior 2006 was 35%. In 2006 the tax rate changed to 40%; this change was not enacted or known prior to 2006. By December 31, 2006 Rendalle had paid all taxes owing for prior years and had made installment payments of $200,000 on its 2006 income taxes. REQUIRED: 3) Prepare all journal entries related to income taxes for 2006. Show all calculations. (13 marks) T he next page is blank .... .. Page 13 of 18 pages 2007 JUNE 8, ACTG 3P33 ACTG 3P33 JUNE 8, 2007 Page 14 of 18 pages QUESTION 4 continued b) Prepare a partial income statement for 2006 beginning with income before tax and extraordinary items. c) Show the balance sheet presentation for 2006 for ALL items related to tax. Indicate whether each asset or liability listed is classified as current or noncurrent. (5 marks) ...
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ACTG 3P33 Midterm Version A - 33 JUNE 8, 2007 Page 1 of 14...

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