Version B 1 ACCT 304 Contemporary Issues in Intermediate Accounting Midterm Exam Name_____________________________ Instructions: 1. This exam consists of six sections; Section 1 is required to be completed, select any four of the remaining five sections to complete a total of five sections. Do not answer more than five sections in total as no extra-credits will be awarded. 2. Put all your answers in the blue book provided. Start each new section on a fresh page and put the numbers of the sections you have answered on the cover of the blue book before you hand in your answers. If you choose to answer Sections 5 and/or 6, Multiple-Choice Questions, circle your answer and transfer the question number and your answer selection to the blue book. Do not leave any answers in the question paper as these will not be graded. 3. This exam is a closed books, closed notes and individual effort test. Submit both the question paper and your blue book on completion of the exam. Budget a maximum of 30 minutes per section. Section 1 (Required Section) 1. Bonds issued with non-detachable stock warrants are treated as debt on issuance while bonds issued with detachable stock warrants have the proceeds allocated to both securities. Discuss the arguments for and against accounting for the bonds with non-detachable warrants the same way as the bonds with detachable stock warrants. 2. What effect do stock dividends or stock splits have on the computation of the weighted average number of shares outstanding? 3. When does a company entering into a leasing arrangement classify it as a capital lease? Section 2 This section has two parts ? answer both for full credit Part 1 On January 1, 2007, Yarrow Corporation had 1,000,000 shares of common stock outstanding. On March 1, the corporation issued 150,000 new shares to raise additional capital. On July 1, the corporation declared and issued a 2-for-1 stock split. On October 1, the corporation purchased on the market 600,000 of its own outstanding shares and retired them. Required: Compute the weighted average number of shares to be used in computing earnings per share for 2007. Part 2 The following information was taken from the books and records of Simonic, Inc.: 1. Net income $ 560,000 2. Capital structure: a. Convertible 6% bonds. Each of the 600, $1,000 bonds is convertible into 50 shares of common stock at the present date 600,000 b. $10 par common stock, 400,000 shares issued and outstanding during the entire year. 4,000,000 c. Stock warrants outstanding to buy 32,000 shares of common stock at $20 per share. 3. Other information: a. No bonds were converted during the year and the debt was outstanding the entire year b. Income tax rate 30% c. Average market price per share of common stock during the year $32 d. Warrants were outstanding the entire year and no warrants were exercised during the year Required: Compute basic and diluted earnings per share. Version B 2 Section 3 This section has two parts ? answer both for full credit Part 1 Describe deferred tax liabilities and assets. Which one may need a valuation allowance and why? Part 2 For each of the unrelated transactions described below, present the entry(ies) required to record the bond transactions. 1. On August 1, 2007, Ryan Corporation?s bondholders converted 40% of the outstanding $8,000,000 10% convertible bonds into 128,000 shares of $20 par common stock. On August 1, there was $700,000 of unamortized premium applicable to the bonds. The fair market value of the common stock was $20 per share. Ignore all interest payments. 2. Garnett, Inc. decides to issue convertible bonds instead of common stock. The company issues 10% convertible bonds, par $3,000,000, at 97. The investment banker indicates that if the bonds had not been convertible they would have sold at 94. 3. Lopez Company issues $10,000,000 of bonds with a coupon rate of 8%. To help the sale, detachable stock warrants are issued at the rate of ten warrants for each $1,000 bond sold. It is estimated that the value of the bonds without the warrants is $9,870,000 and the value of the warrants is $630,000. The bonds with the warrants sold at 101. Section 4 The following information is available for the first three years of operations for Taylor Company: 1. Year Taxable Income 2006 $500,000 2007 330,000 2008 400,000 2. On January 2, 2006, heavy equipment costing $300,000 was purchased. The equipment had a life of 5 years and no salvage value. The straight-line method of depreciation is used for book purposes and the tax depreciation taken each year is listed below: Tax Depreciation 2006 2007 2008 2009 Total $99,000 $135,000 $45,000 $21,000 $300,000 3. On January 2, 2007, $240,000 was collected in advance for rental of a building for a three-year period. The entire $240,000 was reported as taxable income in 2007, but $160,000 of the $240,000 was reported as unearned revenue at December 31, 2007 for book purposes. 4. The enacted tax rates are 30% for all years. Required: (a) Prepare a schedule comparing depreciation for financial reporting and tax purposes. (b) Determine the deferred tax (asset) or liability at the end of 2006. (c) Prepare a schedule of future taxable and (deductible) amounts at the end of 2007. (d) Prepare a schedule of the deferred tax (asset) and liability at the end of 2007. (e) Prepare the journal entries to record income tax expense, deferred income taxes, and income tax payable for 2006 and 2007. Version B 3 Section 5 Multiple-Choice Questions 1. Which of the following is not a characteristic of a noncompensatory stock option plan? a. Substantially all full-time employees may participate on an equitable basis. b. The plan offers no substantive option feature. c. Unlimited time period permitted for exercise of an option as long as the holder is still employed by the company. d. Discount from the market price of the stock no greater than would be reasonable in an offer of stock to stockholders or others. 2. Jenks Co.has $2,500,000 of 8% convertible bonds outstanding. Each $1,000 bond is convertible into 30 shares of $30 par value common stock. The bonds pay interest on January 31 and July 31. On July 31, 2007, the holders of $800,000 bonds exercised the conversion privilege. On that date the market price of the bonds was 105 and the market price of the common stock was $36. The total unamortized bond premium at the date of conversion was $175,000. Jenks should record, as a result of this conversion, a a. credit of $136,000 to Paid-in Capital in Excess of Par. b. credit of $120,000 to Paid-in Capital in Excess of Par. c. credit of $56,000 to Premium on Bonds Payable. d. loss of $8,000. 3. On March 1, 2007, Yang Corporation issued $800,000 of 8% nonconvertible bonds at 104, which are due on February 28, 2027. In addition, each $1,000 bond was issued with 25 detachable stock warrants, each of which entitled the bondholder to purchase for $50 one share of Yang common stock, par value $25. The bonds without the warrants would normally sell at 95. On March 1, 2007, the fair market value of Yang?s common stock was $40 per share and the fair market value of the warrants was $2.00. What amount should Yang record on March 1, 2007 as paid-in capital from stock warrants? a. $28,800 b. $33,600 c. $41,600 d. $40,000 4. On January 1, 2008, Downs Company granted Tim Wright, an employee, an option to buy 1,000 shares of Downs Co. stock for $25 per share, the option exercisable for 5 years from date of grant. Using a fair value option pricing model, total compensation expense is determined to be $7,500. Wright exercised his option on September 1, 2008, and sold his 1,000 shares on December 1, 2008. Quoted market prices of Downs Co. stock during 2008 were January 1 $25 per share September 1 $30 per share December 1 $34 per share The service period is for three years beginning January 1, 2008. As a result of the option granted to Wright, using the fair value method, Downs should recognize compensation expense for 2008 on its books in the amount of a. $9,000. b. $7,500. c. $2,500. d. $1,500. Version B 4 5. In computations of weighted average of shares outstanding, when a stock dividend or stock split occurs, the additional shares are a. weighted by the number of days outstanding. b. weighted by the number of months outstanding. c. considered outstanding at the beginning of the year. d. considered outstanding at the beginning of the earliest year reported. 6. On January 1, 2008, Dingler Corporation had 125,000 shares of its $2 par value common stock outstanding. On March 1, Dingler sold an additional 250,000 shares on the open market at $20 per share. Dingler issued a 20% stock dividend on May 1. On August 1, Dingler purchased 140,000 shares and immediately retired the stock. On November 1, 200,000 shares were sold for $25 per share. What is the weighted-average number of shares outstanding for 2008? a. 510,000 b. 375,000 c. 358,333 d. 258,333 7. Meyers Co. had a deferred tax liability balance due to a temporary difference at the beginning of 2007 related to $600,000 of excess depreciation. In December of 2007, a new income tax act is signed into law that lowers the corporate rate from 40% to 35%, effective January 1, 2009. If taxable amounts related to the temporary difference are scheduled to be reversed by $300,000 for both 2008 and 2009, Meyers should increase or decrease deferred tax liability by what amount? a. Decrease by $30,000 b. Decrease by $15,000 c. Increase by $15,000 d. Increase by $30,000 Use the following information for questions 8 and 9. Neasha Corporation reported the following results for its first three years of operation: 2006 income (before income taxes) $ 100,000 2007 loss (before income taxes) (900,000) 2008 income (before income taxes) 1,000,000 There were no permanent or temporary differences during these three years. Assume a corporate tax rate of 30% for 2006 and 2007, and 40% for 2008. 8. Assuming that Neasha elects to use the carryback provision, what income (loss) is reported in 2007? (Assume that any deferred tax asset recognized is more likely than not to be realized.) a. $(900,000) b. $ -0- c. $(870,000) d. $(550,000) 9. Assuming that Neasha elects to use the carryforward provision and not the carryback provision, what income (loss) is reported in 2007? a. $(900,000) b. $(540,000) c. $ -0- d. $(870,000) Version B 5 10. Huffman Company leases a machine from Lincoln Corp. under an agreement which meets the criteria to be a capital lease for Huffman. The six-year lease requires payment of $102,000 at the beginning of each year, including $15,000 per year for maintenance, insurance, and taxes. The incremental borrowing rate for the lessee is 10%; the lessor's implicit rate is 8% and is known by the lessee. The present value of an annuity due of 1 for six years at 10% is 4.79079. The present value of an annuity due of 1 for six years at 8% is 4.99271. Huffman should record the leased asset at a. $509,256. b. $488,661. c. $434,366. d. $416,799. Section 6 Multiple-Choice Questions 1. On July 1, 2007, an interest payment date, $60,000 of Risen Co. bonds were converted into 1,200 shares of Risen Co. common stock each having a par value of $45 and a market value of $54. There is $2,400 unamortized discount on the bonds. Using the book value method, Risen would record a. no change in paid-in capital in excess of par. b. a $3,600 increase in paid-in capital in excess of par. c. a $7,200 increase in paid-in capital in excess of par. d. a $4,800 increase in paid-in capital in excess of par. 2. When the cash proceeds from a bond issued with detachable stock warrants exceed the sum of the par value of the bonds and the fair market value of the warrants, the excess should be credited to a. additional paid-in capital from stock warrants. b. retained earnings. c. a liability account. d. premium on bonds payable. 3. In 2006, Berger, Inc., issued for $103 per share, 60,000 shares of $100 par value convertible preferred stock. One share of preferred stock can be converted into three shares of Berger's $25 par value common stock at the option of the preferred stockholder. In August 2007, all of the preferred stock was converted into common stock. The market value of the common stock at the date of the conversion was $30 per share. What total amount should be credited to additional paid-in capital from common stock as a result of the conversion of the preferred stock into common stock? a. $1,020,000. b. $780,000. c. $1,500,000. d. $1,680,000. 4. On January 1, 2008, Porter Company granted stock options to officers and key employees for the purchase of 10,000 shares of the company's $1 par common stock at $20 per share as additional compensation for services to be rendered over the next three years. The options are exercisable during a five-year period beginning January 1, 2011 by grantees still employed by Porter. The Black-Scholes option pricing model determines total compensation expense to be $90,000. The market price of common stock was $26 per share at the date of grant. The journal entry to record the compensation expense related to these options for 2008 would include a credit to the Paid-in Capital?Stock Options account for a. $0. b. $18,000. c. $20,000. d. $30,000. Version B 6 5. In the diluted earnings per share computation, the treasury stock method is used for options and warrants to reflect assumed reacquisition of common stock at the average market price during the period. If the exercise price of the options or warrants exceeds the average market price, the computation would a. fairly present diluted earnings per share on a prospective basis. b. fairly present the maximum potential dilution of diluted earnings per share on a prospective basis. c. reflect the excess of the number of shares assumed issued over the number of shares assumed reacquired as the potential dilution of earnings per share. d. be antidilutive. 6. At December 31, 2007, Norbett Company had 500,000 shares of common stock issued and outstanding, 400,000 of which had been issued and outstanding throughout the year and 100,000 of which were issued on October 1, 2007. Net income for the year ended December 31, 2007, was $1,020,000. What should be Norbett's 2007 earnings per common share, rounded to the nearest penny? a. $2.02 b. $2.55 c. $2.40 d. $2.27 7. A reconciliation of Reaker Company's pretax accounting income with its taxable income for 2008, its first year of operations, is as follows: Pretax accounting income $3,000,000 Excess tax depreciation (90,000) Taxable income $2,910,000 The excess tax depreciation will result in equal net taxable amounts in each of the next three years. Enacted tax rates are 40% in 2008, 35% in 2009 and 2010, and 30% in 2011. The total deferred tax liability to be reported on Reaker's balance sheet at December 31, 2008, is a. $36,000. b. $30,000. c. $31,500. d. $27,000. 8. Nevitt Co., organized on January 2, 2007, had pretax accounting income of $880,000 and taxable income of $1,600,000 for the year ended December 31, 2007. The only temporary difference is accrued product warranty costs which are expected to be paid as follows: 2008 $240,000 2009 120,000 2010 120,000 2011 240,000 The enacted income tax rates are 35% for 2007, 30% for 2008 through 2010, and 25% for 2011. If Nevitt expects taxable income in future years, the deferred tax asset in Nevitt's December 31, 2007 balance sheet should be a. $144,000. b. $168,000. c. $204,000. d. $252,000. Version B 7 9. Mast, Inc. reports a taxable and financial loss of $650,000 for 2008. Its pretax financial income for the last two years was as follows: 2006 $300,000 2007 400,000 The amount that Mast, Inc. reports as a net loss for financial reporting purposes in 2008, assuming that it uses the carryback provisions, and that the tax rate is 30% for all periods affected, is a. $650,000 loss. b. $ -0-. c. $195,000 loss. d. $455,000 loss. 10. On January 1, 2008, Penn Corporation signed a ten-year noncancelable lease for certain machinery. The terms of the lease called for Penn to make annual payments of $100,000 at the end of each year for ten years with title to pass to Penn at the end of this period. The machinery has an estimated useful life of 15 years and no salvage value. Penn uses the straight-line method of depreciation for all of its fixed assets. Penn accordingly accounted for this lease transaction as a capital lease. The lease payments were determined to have a present value of $671,008 at an effective interest rate of 8%. With respect to this capitalized lease, Penn should record for 2008 a. lease expense of $100,000. b. interest expense of $44,734 and depreciation expense of $38,068. c. interest expense of $53,681 and depreciation expense of $44,734. d. interest expense of $45,681 and depreciation expense of $67,101. End of Exam ? Have a nice Spring Break narasimhanr
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