Exam 3 Review o 30 questions total o 47 math 14 questions o 53 conceptual 16 questions o Chapters 11 12 15 16 Chapter 11 1 Understand the difference between a bond sold at par a premium and a discount Slide 7 Bond Sold at Par Receive the same price as the face value of the bond Premium Receive more than the face value of the bond Discount Receive less than the face value of the bond 2 Know the journal entries for a bond issued at par Slide 8 Entry to record the bonds DR Cash CR Bonds Payable Entry to record interest accrual DR Interest Expense xxx xxx xxx xxx xxx CR Accrued Interest Payable Entry to record annual interest payment at year end DR Accrued Interest Payable CR Cash xxx 3 Know how to compute the bond carrying amount for a bond sold at a discount or premium Slides 12 and 15 4 Know how to compute the bond interest expense for a bond sold at a discount or premium Slides 12 and 15 6 7 Understand the difference between forwards futures swaps and options Slides 25 30 5 Know how to compute the bond cash interest paid for a bond sold at a discount or premium Slides 12 and 15 Cash Interest Payment Interest Expense Amortization Amount Forwards two parties agree to sale on future settlement date at price specified today o Three elements of the contract are key The agreed upon price to be paid in the future The delivery date The buyer will actually take delivery Futures two parties agree to the sale of some asset on some indefinite future date a price specified today o Futures contracts are like forward contracts except that They do NOT have a predetermined settlement date They are actively traded on financial exchange Swaps one stream of future interest payments swapped with another by creating a synthetic floating rate debt Options gives holder the right but not obligation to do something 8 Know the requirements for a loss contingency to be accrued Slide 38 A loss contingency should be accrued by a charge to income if BOTH 1 It is probable that an asset has been impaired of a liability incurred at the financial statement date 2 The amount of the loss can be reasonably estimated Chapter 12 9 10 Know the major differences between operating and capital leases Slide 5 11 Understand what executory costs are Slide 14 Executory Costs the costs of using an asset such as maintenance taxes and insurance o Omitted when determining minimum lease payments and the capitalized amount shown for the leased asset 12 Understand how to calculate a lessor s manufacturing profit Slide 21 Sales Type Lease Example ABC Company manufactures tractors Each tractor has a total production cost of 36 000 and a cash sales price of 50 000 ABC Company sells some of these tractors under five year sales type leases which call for annual lease payments of 15 000 At the end of the fifth year legal ownership of the tractor transfers to the lessee ABC Company s total profit over the five years of the lease is 39 000 that is the lessee s payments of 75 000 15 000 per year times five years minus the production cost of 36 000 Manufacturer s Profit Cash Sales Price Production Cost Manufacturer s Profit 50 000 36 000 14 000 13 Understand how to calculate a lessor s financing profit Slide 21 Sales Type Lease Example ABC Company manufactures tractors Each tractor has a total production cost of 36 000 and a cash sales price of 50 000 ABC Company sells some of these tractors under five year sales type leases which call for annual lease payments of 15 000 At the end of the fifth year legal ownership of the tractor transfers to the lessee ABC Company s total profit over the five years of the lease is 39 000 that is the lessee s payments of 75 000 15 000 per year times five years minus the production cost of 36 000 Finance Profit Gross Lease Inflows Cash Selling Price Finance Profit 75 000 50 000 25 000 14 Understand the differences between an operating lease direct financing capital lease and sales type capital lease Slide 21 Operating Lease Direct Financing Capital Lease Sales Type Capital Lease Asset remains on lessor s books Asset 15 Know how a gain on a sale and leaseback is recognized HW E12 13 Asset REMOVED from books added to lessee s books Liability Asset REMOVED from books added to lessee s books Liability Example First Company sells a manufacturing plant excluding land with a book value of 800 000 to Second Company for 1 000 000 First Company immediately leases the plant from Second Company for 20 years at an annual rental of 120 000 Sale transaction transfers title to asset Lease back allows use to be retained However First Company s gain cannot be recognized immediately 16 Know how to determine the balance of a lessee s lease liability HW E12 4 Operating Lease Amortized in proportion to rental payments Capital Lease Amortized using the same rate and life used for leased asset Chapter 15 17 Understand stock repurchases and earnings management Slide 10 Example Rocket Software just completed a successful third quarter with earnings of 220 000 and EPS of 1 00 The company s record for quarterly EPS growth is about to be broken because earnings for Q4 are predicted to be only 220 000 How can Rocket Software increase EPS for Q4 Answer Repurchase outstanding common shares so there are fewer reduce the denominator 18 Know how to calculate basic EPS Slide 21 19 Know how to calculate the weighted average number of shares Slide 22 Example 200 shares outstanding at 1 1 Issue convertible bonds that convert to 100 shares on 8 1 Issue 50 shares on 11 1 Repurchase 20 shares on 12 1 Time Span Shares Outstanding Portion of Year Weighted Shares Shares Outstanding x Portion of Year 1 1 7 1 8 1 10 1 11 1 12 1 12 1 1 1 200 200 100 300 300 50 350 350 20 330 7 12 3 12 1 12 1 12 TOTAL 20 Know how to calculate diluted EPS Slide 25 116 67 75 29 17 27 5 248 34 21 Understand the difference between a complex and simple capital structure as well as basic and diluted EPS Slide 24 22 Know the difference between the treasury stock and if converted methods Slide 27 Basic EPS used for simple capital structure Diluted EPS used for complex capital structure o Recognizes the dilutive potential securities Treasury Stock EPS figure understates likely dilution and overstates diluted EPS If Converted EPS figure overstates the likely dilution and understates the diluted EPS 23 Understand the extent to which EPS is a meaningful number Slide 28 Example Which firm performed the best Company A and Company B report identical basic EPS of 10 but Company B needed