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finwk99j - .1. .__,,Jr H. Sander {01/ n} Earl Econ Summer...

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Unformatted text preview: .1. .__,,Jr H. Sander {01/ n} Earl Econ Summer 1999 . , \ . /._/ , / , Final Exam KW 2 {3% _Q’/ / .1 Problem I (40 mins) Stratco computed a pretax financial income of S 140,000 for the first year of its operations ended December 31, 1993. Included in financial income was $200,000 of proceeds of a life insurance policy on one of its officers, $20,000 gross profit on installment sales that was deferred for tax purposes until the installments were collected, and $50,000 in warranties payable that had been recognized as expense on the books in 1993 when product sales were made. The installment sale and warranty payments are expected to reverse in the following pattern: Gross Profit on Warranty Xear Collectir‘ms Payments 1994 $ 5,000 3 9,000 1995 7,000 16,500 1996 2,000 ‘ 20,500 1997 6,000 4,000 2 0 ‘ M Assume Stratco is not assured of book income in 1993 or 1994 but is. assured of future income in 1995 and 1996. At Dec. 31, 1993, the enacted tax rates for this year and the next four years are as follows: 1993 40% 1994—1997 35% Instructions: 1. Prepare journal entries to record income taxes for 1993. 2. Prepare the balance sheet for Stratco at 12/31/93. 3. Record income tax entries for 94 & 95 assuming book income is $100,000 each year for 1994—1997 and no nontaxable revenue exists in this period. Also assume that on 7/1/94 Congress passes a law changing the tax rate from 35% to 42% for 1995 and thereafter and that in 1994 Stratco accrued a loss related to a lawsuit on its books for $30,000 which will not be deductible on its tax return until it is settled in 1997. 4. Comment theoretically on the amount of income tax-expense in 1993 and 1994. “I. V‘ . y, , ‘ I I {a a {mi l . V r . “I / ,. ‘fo ’ / . V. p . ' 'I/CC/r} {A ’ frmr, Problem, II (40 mm) A; C, C v 2' -, .1,/ Comparative statements of income and retained earnings of Bakker Construction CorporatiOn for the years ended December 31, 1994, and December 31, 1995, are as follows: 1995 Construction revenues $350,000 1994 $240,000 Construction ex enses (250,000) (195,000) Administrative & other ex enses — 150 ,000) (15,000) Income before taxes & extraordinar items 3 50,000 S 30,000 Income tax ex ense 3 15,000) (9,0001 Income before extraordinar item $ 35,000 Extraordina ain, net of $3,000 tax 7,000 Net income $ 42,000 $ 21,000 Retained eamins, Jan ar 1 ‘ 200,000 179,000 ,1 4 marm- as N 'o o o Retained earnin 3, December 31 ____ W a E The following three situations incorporate accounting changes, error correction, and classification. Each situation is based on Bakker’s comparative statements shown above and requires revisions in these statements. The income tax rate is 30 percent. M a) On January 1, 1993, Bakker purchased an office building at a cost of $30,000. Bakker adopted straight—line depreciation and estimated the building’s useful life to be 10 years with no l salvage value. At the beginning of 1995, Bakker decided to switch to the double-declining in 5, 3 “3 i «V . (a programming error, however, the straight-line method was used in 1995. Depreciation expense W is included in administrative and other expenses on the income statement. For tax purposes, / Bakker uses ACRS and has recorded depreciation totaling $20,000 through December 31, 1995. Prior to 191475, Bakker used the completed—contract method in accounting for construction { activities. During 1995, Bakker switched to the percgtage—oficficgnpilgign method for book (3/ Y M”, ptfi purposes, although the completed-contract method was continued for tax purposes. The 1995 financial statements are based on the new method. Construction revenues less construction expenses under the two methods for 1994 and prior years are as follows: balance method, with no change in the estimated useful life or salvage value. Due to a computer . 21; é“ U‘t. L" — 1994 PRIOR YEARs Competed-contract method: Revenues $240,000 $800 000 195 000 670 000 Percentage-of—completion method: 320,000 1 900,000 Revenues 260.000 740 000 c) The extraordinary gain for 1995 resulted from Bakker’s discovery, in 1995, that a plot of land purchased in 1992, was expensed for both book purposes and tax purposes. The $3,000 in effect represents theadditionaltaxes remitted in 1995 to the [RS because of the uncle gym;pr lWfierest and'p'e‘nalties should be ignored). Reg uired A) Prepare journal entries to adjust for each of the items above. Indicate the type of change each one is and the method you are using. B) Prepare revised comparative statements of income and retained earnings for the years ended December 31, 1995, and December 31, 1994. Ignore any pro forma calculation and presentations and show all work. 1 Problem III (40 mins) Wade Corporation Balance Sheets ' ‘ INCREASE 12/31/95 (DECREASE) Cash $ 521,000 ‘$ 308,000 $213,000 Accounts receivable, net 585,000 495,000 90,000 Tradin securities, at fair value Inventories Investment in Zee (at fair value) Leased roert -_ Plant & euiment Accumulated dereciation — @0401— (Ema-m Total assets v 3'“ Liabilities & stockholders’euit : — Current ortion of notes a able ’ m Accounts 21 able 800,000 (100,000) Dividends a able Lease liabilit m -0- 133,000 Notes a able, Ion-term 300,000 __ 300,000 Bonds a able, ar value $500,000 m- (5000) Common stock, $20 ar value 60,000 Retained eamins 203 000 Unrealized holdin ain/(loss) on Zee 30.000 10,000 20,000 Total liabilities & stockholders‘euit ' l» , , / l I J 1 v f r a rag! f/‘r ,«m v N. u I; "m h» V H WV, “7“ A > v'" ‘ - e— r- - ~- - " ' r ». e r _ 7. _,_ ,V“-‘____~,,- my ll Wade Corporation Income Statement For the Year Ended December 31, 1995 $ 2,038,000 6,000 7,000 20.000 3 2,071,000 (_._1107000 Lemma ‘ . ".9 Additional information: a) Wade declared a cash dividend on common stock of $30,000. b) Wade issued 2,000 shares of common stock for land with a fair value of $100,000. 0) Wade borrowed $450,000 from a savings and loan. Interest is payable monthly, and the principal is payable in three annual installments of $150,000. The first installment is due in February 1996. / d) Wade sold for cash equipment costing $52,000 with a book value of $28,000. Wade also purchased equipment during the year which makes up the rest of massage in plant & equipment. e) Wade paid, and recorded as a prior period adjustment in retained earnings, at $20,000 penalty to the [RS in connection with an error in a previous year’s tax return. t) On QecemberS 1, 1995, Wade entered into a capital lease for equipment. The present value of the minimum lease payments was $158,000. The annual lease payments are $25,000 and are due on December 31 each year, beginning December 31, 1995. The $25,000 lease payment due on December 31, 1996, will consist of $9,000 principal and $16,000 interest. g) Wade owns 10 percent of the common stock of Zee Corporation and report the investment at fair value. Wade classifies the investment as an available-for-sale security and the related unrealized holding gain is reported in the stockholder’s equity section. Wade also owns trading security investments which were sold during the year at a gain of $20,000. No trading securities were bought and the dividend revenue is from the trading securities. \ I: :7 "~ ~ 9/ ‘- r " - . F3011]. I MW? "Ev/£4" Pfl/ 6’" (‘7' 6’; a6 d Required \__ . p «a. O. _ [J // A/IV it; /\-J§5[/M/\. $( 1,385,000) (149,000) (67,000) (10,000) (100,000) l éfé” x‘f/ [L’AV/ ()9 [(0, Prepare Wade Corporation’s statement of cash flows on an indirect basis for the year ended December 31, 1995. Include all addditional disclosures necessary. Problem IV Short Answers (25 mins) 1. Jack Fields, the president of a company that is one of your clients, has confronted you with something in the company’s financial statements he does not understand. You have prepared the company’s income statement from materials provided by the company‘s accountant. That statement shows pretax income of $250,000 and income tax expense of only $34,000. The income tax payable is also $34,000, de5pite the fact that the statutory income tax rate is 34%. There are no other differences to explain these relationships. Field’s reaction is mixed. On one hand, he is glad that you have computed the income tax the company must pay at only $34,000 rather than 34% of $250,000. On the other hand, he is concerned whether you are correct and that users of the company’s financial statements may be confused by this unusual-looking relationship in the income statement. You are aware of the company’s large losses in the past and the fact that those losses have ‘ been available through carryforward provisions in the law to reduce income taxes of the current year. Assume assurance of use of the net operating loss did not exist in the past. (a) How would you explain to Fields the Operating loss carryforward provision in the tax law? (b) What amount of carryforward appears to have been recognized in the current year? (c) Can you think of anything that should relieve Field’s concern for users of the financial statements who might be confused by the unusual relationship between pretax financial income and income tax expense? Why do deferred tax assets seldom appear on many companies’ financial statements even though they have them? Indicate the proper disclosure of a deferred tax asset which is not reasonably assured. Explain why pro forma data is necessary when a change in accounting principle occurs and not necessary when an error occurs. 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This note was uploaded on 01/31/2010 for the course ECON 136C taught by Professor Anderson during the Fall '08 term at UCSB.

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finwk99j - .1. .__,,Jr H. Sander {01/ n} Earl Econ Summer...

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