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finwkf98 - Economics 136B Fall 1998 Final Problem I (20...

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Unformatted text preview: Economics 136B Fall 1998 Final Problem I (20 mins.) Peterson, Inc. purchased 15% of the outstanding common stock of Sunspot Co. on January 1, 1993, when Sunspot's net assets had a book value and fair value of $400,000. Assume Peterson can exercise significant influence over Sunspot Co. Peterson Inc. paid $77,000 for the investment. The excess of fair value over book value is partiallyt attributable to machinery with a 10 year life. Assume the machinery has an excess of fair value over book value of $50,000 in total and the remainder of the excess is attributable to goodwill. Goodwill, when amortized, is amortized over a 40-year period. Sunspot's reported income and dividends for 1993 and 1994 are given below. 1994 1993 Net income $50,000 <$30,000> Dividends 40,000 30,000 A. Indicate whihc mthod of accounting is more approrpriate and indicate why, if 1) it’s a short term investment or 2) it’s a short term investment. B. Indicate the balance sheet and income statement results at year end for 1993 and 1994 related to its investment in Sunspot Co. assuming the market value of the stock has increased to $80,000 at 12/31/93 and then decreased to $70,000 at 12/31/94, using 1) the market to market method 2) the equity method. C. In general how would your results change if the consolidation method of accounting for investments was used. Problem II (20 mins.) Tucker Corporation sells a long-term bond of $1,000,000 face value, less a discount of $60,000 at April 1, 1988 plus accrued interest of $25,000. While the bonds bear a stated interest rate of 10%, they were issued at an effective yield of 12%. Interest is payable on January 1 of each year. On June 30, 1990, Tucker retires'the bonds for 103 plus accrued interest of $50,000. Tucker amortizes bond discount by the effective interest method. Instructions: A. Record the sale of the bond on 4/1/88. B. Record an entry for the retirement of the bond on 6/3 0/90. C. How much interest expense should be reported in 1988, 1989 and 1990? g D. Assuming that Tucker Corporation needs to borrow money and 103 is the market value, do you agree with the decision to reacquire the bonds economically? Why? Assuming no great changes have taken place related to the risk level of the bonds, has the interest rate increased or decreased during this period of time in the bond market? F” Problem III (20 mins.) On 10/1/1 Bud Lumber Co. acquires land with timber under the following terms: $ 1000 down and 53.000 every other month for 3 years and $5000 at the end of the 3 years. Payments are to be made at the beginning of every other month beginning with 1 1/1/1. Notes related to [and normally carry an annual interest rate of 12%x’year. Assume the land has 10000 board feet of timber and 2.000 board feet have been extracted in November of which 1.000 board feet have been sold by December 31, 1. a. Record the acquisition of the land and any adjusting entries necessary. Assume the land will have a salvage value ofSS.000 but will cost $3,000 to restore to salable condition. b. Record the first 3 payments on the land and any adjusting entries necessary at 1231/1. Show the balance sheet presentation ofthe liability at 12/31/1. (Show all work.) d. Indicate the 3 main attributes the readers of these financial statements receive from your accounting method employed for the liability. 0 Problem IV (15 mins.) Assume the following facts about an investment made by A Company which is not a trading security. 1. Cost paid for security $10,000 2. Commission paid on purchase of security $200 3. Dividend or interest paid $1,000 4. Market value at year end $9,000 Uu Our share oftheir earnings <$500> loss 1. Determine the income statement and balance sheet results if the type of investment is A. preferred stock short term B. preferred stock long term C. common stock short term - significant influence D. common stock long term - no significant influence E. bond‘investment — intend to hold to maturity [J Theoretically justify the carrying value ofthe investment in each of A-E. (1f samejust say so.) 3. Assume on the lst day ofthe following year the preferred stock in Part B is sold for $9.500. Record the transaction. Problem V (20 mins.) Northeastern Banking Group follows the policy of borrowing money for relatively long periods of time and lending the money to newly formed companies on a medium-term basis. At December 3 l. 1993. Northeastern has several loans outstanding. and all but one are current in their interest payments and are living up to the covenant agreements made in conjunction with the loan. However. one loan to Digital Corporation for 310.000.000 made at 14% interest is of much concern to Northeastern. Digital has not been successful in generating a steady cash flow and thus has fallen 2 years behind in its interest payments. The current position of the company is also far below the amount specified in the loan agreement. The president of Digital has asked Northeastern for help and suggests forgiving interest due now followed by a new rate of 4% on the debt and a term of4 years. The owners of Northeastern initially refuse. saying that for the risk now involved. the going interest rate might even be higher. After a somewhat bitter discussion. the president of Digital says that Northeastern leaves them no alternative: they must declare bankruptcy. After renewed discussion. the new terms requested are agreed upon. Reguired: Indicate how Northeastern & Digital should account for this asjustment in debt term and interest and theoretically justify each company’s results. Which represent the economics best? Show the interest results of the first two years for each and include it in your discussion of the economics. Problem VI Short Answers (40 mins.) 1. Explain how one decides if an investment is a trading security or an available for sale security. Also indicate how the results on the income statement and balance sheet will vary according to this distinction and whether transfers from one category to another are typical. lJ If a company decides to build an asset internally describe in general terms how one decides the correct amount of interest and other costs to capitalize and why are they capitalized. (No details necessary.) Exp ain why or why not interest is capitalized for an asset that is acquired externally. Why are patents commonly undervalued and what accounting method used by accountants causes this understatement. Theoretically justify this accounting method. L1) 4. Explain why a company would use dollar value retail LIFO inventory accounting. Explain each item separately 1) dollar value 2) retail 3) LIFO. UI Theoretically justify the most theoretically sound methods of depreciation to use 1) land 2) computer 3) an oil rig that can’t be used elsewhere. 6. Indicate the issues one should consider in deciding whether to capitalize on expense a replacement ofa part of an asset which is slightly better than the old one. 7. List several liabilities that result from payroll and indicate who actually funds the liability. Problem VII (10 ~mins.) Nance Equipment Company sells small business computers for $3000 each and also gives each customer a 4-year warranty that requires the company to perform periodic services and to replace defective parts. During‘1998, the company sold 500 computers, Based on past experience. the company has estimated that 80% of the computers need repair and that the total retail value of the 4-year warranty costs as $50 for parts and $120 for labor. (Assume sales all occur at December 51. 1998.) Assumecosts are 50% of retail value and are assumed to happen equally in end of the the 4 years of the warranty period. In 1999. Nance incurred actual warranty costs relative to 1998 computer sales ofSBJSO for parts and $8,750 for labor. Required a) Under the expense warranty treatment, give the balance sheet and income statement results for 1998 and 1999 to reflect the above transactions (accrual method). b) Under the cash basis method, what are the balance sheet and income statement results for balances for 1998 and 1999? 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finwkf98 - Economics 136B Fall 1998 Final Problem I (20...

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