1 ACCT 304 Contemporary Issues in Intermediate Accounting Midterm Exam Name_____________________________ Instructions: 1. This exam consists of seven sections; Section 1 is required to be completed, select any four of the remaining six 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 Section 7, 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. How should a company account for the conversion of bonds into common stock on the date of conversion? Discuss the rationale for this method. 2. When a company issues convertible bonds and stock warrants, describe how these securities impact the computation of the diluted earnings per share. 3. Define permanent differences, temporary differences, future taxable amounts, and future deductible amounts. Section 2 This section has two parts ? answer both for full credit Part 1 Prepare the necessary entries from 1/1/07-2/1/09 for the following events using the fair value method. If no entry is needed, write "No Entry Necessary." 1. On 1/1/07, the stockholders adopted a stock option plan for top executives whereby each might receive rights to purchase up to 12,000 shares of common stock at $40 per share. The par value is $10 per share. 2. On 2/1/07, options were granted to each of five executives to purchase 12,000 shares. The options were non-transferable and the executive had to remain an employee of the company to exercise the option. The options expire on 2/1/09. It is assumed that the options were for services performed equally in 2007 and 2008. The Black-Scholes option pricing model determines total compensation expense to be $1,300,000. 3. At 2/1/09, four executives exercised their options. The fifth executive chose not to exercise his options, which therefore were forfeited. 2 Part 2 Dahl Co. issued $5,000,000 of 12%, 5-year convertible bonds on December 1, 2006 for $5,020,800 plus accrued interest. The bonds were dated April 1, 2006 with interest payable April 1 and October 1. Bond premium is amortized each interest period on a straight-line basis. Dahl Co. has a fiscal year end of September 30. On October 1, 2007, $2,500,000 of these bonds were converted into 35,000 shares of $15 par common stock. Accrued interest was paid in cash at the time of conversion. Required: (a) Prepare the entry to record the interest expense at April 1, 2007. Assume that interest payable was credited when the bonds were issued (round to nearest dollar). (b) Prepare the entry to record the conversion on October 1, 2007. Assume that the entry to record amortization of the bond premium and interest payment has been made. Section 3 This section has two parts ? answer both for full credit Part 1 Define Basic earnings per share and Diluted earnings per share. Part 2 Assume that the following data relative to Eddy Company for 2007 is available: Net Income $2,100,000 Transactions in Common Shares Change Cumulative Jan. 1, 2007, Beginning number 700,000 Mar. 1, 2007, Purchase of treasury shares (60,000) 640,000 June 1, 2007, Stock split 2-for-1 640,000 1,280,000 Nov. 1, 2007, Issuance of shares 120,000 1,400,000 8% Cumulative Convertible Preferred Stock Sold at par, convertible into 200,000 shares of common (adjusted for split). $1,000,000 Stock Options Exercisable at the option price of $25 per share. Average market price in 2007, $30 (market price and option price adjusted for split). 60,000 shares Required: (a) Compute the basic earnings per share for 2007. (Round to the nearest penny.) (b) Compute the diluted earnings per share for 2007. (Round to the nearest penny.) 3 Section 4 This section has two parts ? answer both for full credit Part 1 Earl Co. at the end of 2007, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 750,000 Estimated expenses deductible for taxes when paid 1,200,000 Extra depreciation (1,350,000) Taxable income $ 600,000 Estimated warranty expense of $800,000 will be deductible in 2008, $300,000 in 2009, and $100,000 in 2010. The use of the depreciable assets will result in taxable amounts of $450,000 in each of the next three years. Required: (a) Prepare a table of future taxable and deductible amounts. (b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2007, assuming an income tax rate of 40% for all years. Part 2 In 2007, its first year of operations, Penner Corp. has a $900,000 net operating loss when the tax rate is 30%. In 2008, Penner has $360,000 taxable income and the tax rate remains 30%. Required: (a) Assume the management of Penner Corp. in 2007 thinks that it is more likely than not that the loss carryforward will not be realized in the near future because it is a new company (this is before results of 2008 operations are known), what are the entries in 2007 to record the tax loss carryforward? (b) What entries would be made in 2008 to record the current and deferred income taxes and to recognize the loss carryforward? (Assume that at the end of 2008 it is more likely than not that the deferred tax asset will be realized.) Section 5 Yarman Inc. began business on January 1, 2007. Its pretax financial income for the first 2 years was as follows: 2007 $240,000 2008 560,000 The following items caused the only differences between pretax financial income and taxable income: 1. In 2007, the company collected $180,000 of rent; of this amount, $60,000 was earned in 2007; the other $120,000 will be earned equally over the 2008-2009 period. The full $180,000 was included in taxable income in 2007. 2. The company pays $10,000 a year for life insurance on officers. 3. In 2008, the company terminated a top executive and agreed to $90,000 of severance pay. The amount will be paid $30,000 per year for 2008-2010. The 2008 payment was made. The $90,000 was expensed in 2008. For tax purposes, the severance pay is deductible as it is paid. The enacted tax rates existing at December 31, 2007 are: 2007 30% 2009 40% 2008 35% 2010 40% 4 Required: (a) Determine taxable income for 2007 and 2008. (b) Determine the deferred income taxes at the end of 2007, and prepare the journal entry to record income taxes for 2007. (c) Prepare a schedule of future taxable and (deductible) amounts at the end of 2008. (d) Prepare a schedule of the deferred tax (asset) and liability at the end of 2008. (e) Compute the net deferred tax expense (benefit) for 2008. (f) Prepare the journal entry to record income taxes for 2008. (g) Show how the deferred income taxes should be reported on the balance sheet at December 31, 2008. Section 6 This section has two parts ? answer both for full credit Part 1 How does a lessee company distinguish between an operating lease and a capital lease? Part 2 Windom Co. as lessee records a capital lease of machinery on January 1, 2008. Eight annual lease payments of $350,000 are made at the start of each year beginning 2008. The present value of the lease payments at 10% is $2,054,000. Windom uses the effective-interest method of amortization. Required: (Round to the nearest dollar.) (a) Prepare an amortization table for 2008 and 2009. (b) Prepare all of Windom 's journal entries for 2008 for the lease. Section 7 1. When a bond issuer offers some form of additional consideration (a ?sweetener?) to induce conversion, the sweetener is accounted for as a(n) a. extraordinary item. b. expense. c. loss. d. none of these. 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. 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. 5 4. . Kiner, Inc. had 40,000 shares of treasury stock ($10 par value) at December 31, 2006, which it acquired at $11 per share. On June 4, 2007, Kiner issued 20,000 treasury shares to employees who exercised options under Kiner's employee stock option plan. The market value per share was $13 at December 31, 2006, $15 at June 4, 2007, and $18 at December 31, 2007. The stock options had been granted for $12 per share. The cost method is used. What is the balance of the treasury stock on Kiner's balance sheet at December 31, 2007? a. $140,000. b. $180,000. c. $220,000. d. $240,000. 5. Foley Company has 1,800,000 shares of common stock outstanding on December 31, 2006. An additional 150,000 shares of common stock were issued on July 1, 2007, and 300,000 more on October 1, 2007. On April 1, 2007, Foley issued 6,000, $1,000 face value, 8% convertible bonds. Each bond is convertible into 40 shares of common stock. No bonds were converted into common stock in 2007. What is the number of shares to be used in computing basic earnings per share and diluted earnings per share, respectively, for the year ended December 31, 2007? a. 1,950,000 and 2,130,000 b. 1,950,000 and 1,950,000 c. 1,950,000 and 2,190,000 d. 2,250,000 and 2,430,000 6. At the December 31, 2007 balance sheet date, Garth Brooks Corporation reports an accrued receivable for financial reporting purposes but not for tax purposes. When this asset is recovered in 2008, a future taxable amount will occur and a. pretax financial income will exceed taxable income in 2008. b. Garth will record a decrease in a deferred tax liability in 2008. c. total income tax expense for 2008 will exceed current tax expense for 2008. d. Garth will record an increase in a deferred tax asset in 2008. Use the following information for questions 7 through 9: Frizell Co. at the end of 2007, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 750,000 Estimated litigation expense 1,000,000 Extra depreciation for taxes (1,500,000) Taxable income $ 250,000 The estimated litigation expense of $1,000,000 will be deductible in 2008 when it is expected to be paid. Use of the depreciable assets will result in taxable amounts of $500,000 in each of the next three years. The income tax rate is 30% for all years. 7. Income tax payable is a. $0. b. $75,000. c. $150,000. d. $225,000. 8. The deferred tax asset to be recognized is a. $75,000 current. b. $150,000 current. c. $225,000 current. d. $300,000 current. 6 9. The deferred tax liability to be recognized is Current Noncurrent a. $150,000 $300,000 b. $150,000 $225,000 c. $0 $450,000 d. $0 $375,000 10. In computing the present value of the minimum lease payments, the lessee should a. use its incremental borrowing rate in all cases. b. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is higher, assuming that the implicit rate is known to the lessee. c. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee. d. none of these. narasimhanr
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