Exam 1 Acct 414 – Corporate Accounting & Reporting II Fall 2010SOLUTIONSExam #__________ Name: __________________________________ Exam 1 Acct 414 – Corporate Accounting & Reporting II Fall 2010 Show any necessary computations if you want to be eligible for partial credit. Present your work in a neat, well-organized manner. When you are using a financial calculator, spell out what you put in for n, i, PMT, FV, PV, etc. You could also draw a time-line if that would explain your thinking to me. You may use abbreviations in your essay answers but I need complete thoughts. Follow the instructions and answer all parts of the question as directed. 1-3. Time Value of Money (45 points total) 4. Loan Impairment (30 points total) 5-6 Leases (70 points total) IFRS points________________ (5a & 5b) US GAAP points____________ (5c & 6) 7. Fair value & fair value option (30 points) 8. Serial Bonds (25 points) Total points earned (max = 200) To be completed by professor: After Exam 1 - Course Grade Total Points = __________/500 = _________% Quiz and HW percentage = ___________% Projects percentage = ___________%Exam 1 – Acct 414 – Fall 2010 Page 2 1. Deferred Compensation [15 points] Your client, Montana Missiles, has agreed to pay $50,000 per year for ten years to a retiring executive. The payments were in lieu of a year-end bonus which would have been taxed at a combined federal and state income tax rate of over 50%. The payments, which start five years from the end of the current year, have not yet been recorded in the accounting records. The company’s auditors believe that 7% per annum would be an appropriate discount rate. The company should record a liability in the amount of $____________________________ 2. Sinking Fund [15 points] Percy Corporation has signed a bond indenture that requires the establishment of a sinking fund in the amount of the face value of the bonds sold. Accordingly, the company needs to accumulate $5,000,000 by December 31, 2020. The company plans to deposit the premium received on the bonds in a savings account on January 1, 2011. The premium was $200,000. The account will earn interest at 8% compounded quarterly. Percy Corporation wants to know what additional amount it needs to deposit at the end of each quarter for 10 years to have $5,000,000 available at the end of 2020. The periodic deposits will also earn interest at 8% compounded quarterly. [15 points] REQUIRED: What is the amount of the quarterly deposit? $_____________________Exam 1 – Acct 414 – Fall 2010 Page 3 3. Lessor Computations [15 points] Assume that you are working for a leasing company. The original lease agreement specified a monthly payment of $6,500 over a six-year lease term. The first payment was to be made immediately and the asset was to be returned to the lessor at lease end. These terms gave a healthy return to the leasing company. However, the lessee wants to be able to buy the asset for $35,000 at the end of the lease (when the estimated fair value will be $70,000). Since the leasing company bought the asset for $370,000, the intended rate of return was about 12%. You boss wants you to compute the new rate of return to be sure it is adequate. Find the interest rate implicit in the lease assuming the terms are modified to include a purchase option for $35,000 at the end of 6 years. Carry computation to two decimal places. The implicit rate is _______________% per month and _____________% per annum Extra credit: If the lessor still wants to earn 12%, what lease payment would be needed (instead of the $6,500 in the proposed lease agreement)? (5 points) The payment should be $____________________ per monthExam 1 – Acct 414 – Fall 2010 Page 4 4. Troubled debt restructuring. [30 points] On October 1, 2010, a debtor owes $60,000 plus $6,000 in accrued interest on a note payable to Loans R Us Inc. The original interest rate on the loan was 10%. The debtor is in financial difficulties and might be forced into bankruptcy if the creditor is unwilling to renegotiate the loan. The Loans R Us Inc. agrees to modify the terms of the agreement as follows: (1) The debtor will pay $3,000 immediately. (2) The remaining amount due is reduced to $50,000. (3) The interest rate on the debt will be lowered to 6%. (3) The term of the restructured debt is five years with interest only due during the first four years. Principal and interest will be due at the end of the fifth year. Instructions Show any entries needed on the books of the creditor, Loans R Us Inc. at the following dates – note the variations in revenue recognition methods shown by each date. October 1, 2010, Date of restructuring (assuming the creditor uses the cost recovery method to recognize revenue) December 31, 2010, end of fiscal year (assuming the creditor uses the cost recovery method to recognize revenue) December 31, 2010, end of fiscal year (assuming the creditor uses the effective interest method to recognize revenue)Exam 1 – Acct 414 – Fall 2010 Page 5 5. Lease Classification under IFRS [30 points]. On May 1, 2010, London Hospital leased scientific equipment from Intuitive Diagnostics for use in the pathology department. The lease period is for 10 years and the estimated economic life of the leased property is 15 years. The lease does not contain automatic a title transfer or a bargain purchase option. Lease payments are $10,000 per year, to be made each May 1 beginning on May 1, 2010. London Hospital’ incremental borrowing rate is 12%. Intuitive Diagnostics generally requires a 10% return on leases. London Hospital (the lessee) is a financially stable company, and collectibility of the future lease payments is reasonably assured. The equipment contains many technologically advanced components, and Intuitive Diagnostics promises to upgrade the equipment for any subsequent improvements in software or hardware for the life of the lease without additional charge. This unusual guarantee was offered by Intuitive Diagnostics to gain experience with the new machine in an actual use situation. The cost of meeting the terms of this guarantee cannot be reasonably estimated. There is not yet a fixed selling price for this equipment but Intuitive Diagnostics’ construction cost was around $60,000 and since its usual markup on cost is 20 percent it has told London Hospital that