ACCT 6422 TEST II

November 12, 1990

Open book 2 hours

JUSTIFY ALL YOUR ANSWERS

F90F2.1 ASSET REPAIRS (King Company)

1. During 1985 King Company made the following expenditures relating to its plant building:

Continuing and frequent repairs $30,000

Repainted the plant building 10,000
Major improvements to the electrical
wiring system 32,000
Partial replacement of roof tiles 14,000

How much should be charged to repair and maintenance expense in 1985?

a. $86,000
b. 72,000
c. 44,000
d. 54,000

(c) Ordinary repairs are expensed. Painting and electrical are “major” repairs. I would also
take answer (d).

F90F2.2 DEPRECIATION EXPENSE

2. Graf Company purchased a machine that was installed and placed in service on January 2, 1984, at a
total cost of $120,000. Residual value was estimated at $20,000. The machine is being depreciated
over ten years by the double-declining balance method. For the year 1985, Graf should record
depreciation expense of

a. $10,800 c. $19,200
b. $16,000 d. $24,000

(c) Depreciation in year one = 120,000 x 2/10 = 24,000 => net book value = 96,000
Depreciation in year two = 96,000 x 2/10 = 19,200
F90F2.3 CAPITALIZATION OF COSTS
3. Theoretically, which of the following costs incurred in connection with a machine purchased for use in
a company's manufacturing operations would be capitalized?

Insurance on machine Testing and preparation of

in transit machine for use

a. No No
b. No Yes
c. Yes No
d. Yes Yes

(d) Both costs are incurred in getting the machine ready for use. Only costs to the point of use
are capitalized; hence (C) as well.

F90F2.4 VALUATION ALLOWANCE

4. Alto Corporation has a portfolio of equity securities which is held as a temporary investment. At the
end of the second quarter of 1989, the cost of the portfolio was $84,000, and its market value was
$77,000. At the end of the first quarter of 1989, the portfolio's valuation allowance account had a
credit balance of $6,500 i.e., the portfolio's net book value was $77,500. Based on the information
given, what accounting action is needed at the end of the second quarter?

a. the valuation allowance account should be credited for $7,000

b. the valuation allowance should be credited for $500
c. a $500 recovery of losses previously recognized should be recorded
d. the valuation allowance account should be debited for $500

(b) This question is based on the old rules for marketable securities. It needs to be revised to
read trading securities which are simply kept at market. They would have been written down to
$77,500 and should be written down a further $500 to $77,000. If you want to use valuation
accounts, it must go up (ie credited) by $500.

F90F2.5 CAPITALIZED INTEREST

5. Clay Company started construction of a new office building on January 1, 1984, and moved into the
finished building on July 1, 1985. Of the building's $2,500,000 total cost, $2,000,000 was incurred in
1984 evenly throughout the year. Clay's incremental borrowing rate was 12% throughout 1984, and
the total amount of interest incurred by Clay during 1984 was $102,000. What amount should Clay
report as capitalized interest at December 31, 1984?
 a. $240,000 c. $150,000
b. $120,000 d. $102,000

(d) Average cost during the year is $1.5 million. Rules allow capitalization up to 12% or cost
subject to a ceiling of actual interest cost ie $180,000 subject to a ceiling of $102,000.

F90F2.6 CAPITALIZED COSTS

6. On March 1, 1987 Kay Company purchased for $450,000 a tract of land as a factory site. An
existing building on the property was razed and construction was begun on a new factory building in
April 1987. Additional data are available as follows:

Cost of razing old building $60,000

Title insurance and legal fees to purchase land 30,000
Architect's fees 75,000
New building construction cost 1,850,000

The capitalized cost of the completed factory building should be

a. $2,005,000 c. $1,925,000
b. $1,975,000 d. $1,910,000

(c) Cost of land includes razing and insurance. Architect’s fees go to the building.

F90F2.7 BAD DEBT ALLOWANCE/RECEIVABLE TURNOVER

7. Jay Corporation sets aside 2 percent of its revenues each year as a bad debt allowance. Revenues
in 1989 were $50 million -- all on credit. The allowance for bad debt at the start of the year was $1
million and the accounts receivable, excluding the bad debt allowance, at the start of the year was $18
million. If $40 million of the revenues are collected, and $500,000 of the accounts receivable are
written off at the end of the year, what is the receivable turnover using year end balances.

a. 2 c. 2.04
b. 2.94 d. Other -- please specify.

(d) This was a very, very messy question which I will not phrase the same way again. Basically,
I was trying to see whether the class knew how to do bad debt accounting. There are a variety
of ways of reading the problem, but the essence of it is that accounts receivable go up by $50
million and down by $40 million and another $500,000. If you start at $18 million, then
accounts receivable at the end is $27.5. Sales for the year is $50 million. (Bad debt expense is $1
million. The bad debt allowance goes up by $1 million and down by $500,000.)

F90F2.8 NOTE PAYABLE ON NON-INTEREST BEARING NOTE

8. On December 30, 1986, Case Company purchased a machine from Pitt in exchange for a
noninterest-bearing note requiring ten payments of $10,000. The first payment was made on December
30, 1986, and the others are due annually on December 30. The prevailing rate of interest for this type
of note at date of issuance was 10%.

Present value of Present value of

ordinary annuity annuity in advance
of 1 at 10% of 1 at 10%
Period
9 years 5.759 6.335
10 years 6.145 6.759

At December 30, 1986, the total note payable to Pitt was

a. $63,350 c. $57,590
b. $67,590 d. $61,450

(b) Present value of note at start = 10,000 x 5.759 for the next 9 payments and $10,000 for the
one due immediately. The fact that it paid no “interest” is irrelevant. One discounts at the
market rate regardless of stated rates.

F90F2.9B LEASE LIABILITY

9. On January 31, 1988, Clay Company leased a new machine from Saxe Corporation. The following
data relate to the lease transaction at the inception of the lease.

Lease term 10 years

Annual rental payable at beginning
of each lease year $50,000
Useful life of machine 15 years
Implicit interest rate 10%

Present value of an annuity of 1

in advance for 10 periods at 10% 6.76
Present value of annuity of 1
in arrears for 10 periods at 10% 6.15
Fair value of the machine $400,000
The lease has no renewal option, and the possession of the machine reverts to Saxe when the lease
terminates. At the inception of the lease, Clay should record a lease liability of

a. $400,000 c. $307,500
b. $338,000 d. $0

(d) Do not capitalize. The lease term is less than 75% of the useful life. The PV is less than 90%
of the fair value and there is no bargain purchase option.
PV = 50,000 x 6.76 < 400,000

F90F2.10 LIFO INVENTORY

10. Marsh Company had 150 units or product on hand at January 1, 1985, costing $21 each.
Purchases of product A during the month of January were as follows:

Units Unit cost

Jan. 10 200 $22
18 250 $23
28 100 $24

A physical count on January 31, 1985, shows 250 units of product A on hand. The cost of the
inventory at January 31, 1985, under the LIFO method is

a. $5,850 c. $5,350
b. $5,550 d. $5,250

(b) Ending inventory is 200 x $22 + 50 x $23 = $5,550

F90F2.11 FINANCIAL STATEMENT ANALYSIS

11. Below are extracts from ARCO's financial statements:

Revenue $14,993
Cost of goods sold 9,495
Selling and admin. expenses
Depreciation 1,646
Provision for taxes on income 688
Net income $615
 Preferred stock dividends 5
Common stock dividends 701

Changes in working capital items for the year were:

Accounts receivable (153)

Notes receivable 212
Refundable income taxes 764
Inventories (64)
Deferred income taxes (268)
Other current assets 81
Accounts payable 674
Taxes payable 18
Other current liabilities 489
Total $1,753

Cash (56)
Short-term investments 1,370
Notes payable (639)
Debt due within a year (543)
Advances due within a year 780
Total increase (decrease)
in working capital $2,665

The cash flow statement read as follows:

Income from continuing operations 615

Depreciation 1,646
Deferred income taxes 1,096
Dry-hole costs charged to income 193
Other (494)
(Increase) decrease in
working capital items (1,753)
Cash from continuing operations 1,303

They showed the overall change in cash as:

Increase (decrease) in cash 675

This was made up as follows:

Cash (56)
Short-term investments 1,370
 Notes payable (639)
Total $675

Use these numbers to establish:

(a) Receipts from sales

$15,146

(b) Payments made on goods sold

$10,105

(c) Taxes paid to the IRS

$1,202

(d) Pure cash from operations

$572

(e) Pure cash available for common shareholders

$563

F90F2.12 BOND LIFE/BOUND PAYABLE

12. Bonds with a par value of $6 million are issued on January 1, 1989. Assume that they have a life of
ten years and that the coupon rate is 6 percent. They were issued at a time when the market rate was 8
percent.

Coupon = 6% x $6 million = $360,000 (Ignore the stated rate from here on!)

Purchase price = 6 million x 0.463 (Table A) + 360,000 x 6.710 (Table B)

= $5,193,000

(a) What was the issue price of the bonds?

5,193,000
Bond table:
 Bond Interest at market Coupon = Closing bond
5,193,000 + 415,488 - 360,000 = 5,249,088
5,249,088 + 419,927 - 360,000 = 5,309,015

(b) What will the interest expense be in the second year of the bonds life?

$419,927

(c) What will the change in the bond payable (net) account be in that second year?

$59,927 = 419,927 - 360,000

(d) If the market rate rises to 10 percent, what amount of money would need to be set aside to refund
the bond?

$4,719,617

(e) If the company decided to replace the old bond with a new one and gives the new one a face value
equal to the old, and a term equal to 10 years, what would the new coupon rate have to be?

6.53

F90F2.13 INVENTORY TURNOVER

13. The Leno Corporation recognized all its revenues on the delivery basis. Because of difficulties that
it was having in collecting its receivables, it decided to move certain of its goods onto the collection
method. The revenue affect this past year is 20 percent of the total of $60 million. Their gross margin is
25 percent. What effect would this have had on inventory turnover? Currently this is 9:1.

a. It will have no effect on inventory turnover.

b. It will increase inventory turnover.
c. It will decrease inventory turnover by 20 percent.
d. It will decrease inventory turnover by more than 20 percent.
e. Other - specify.

(d)
F90F2.14 DEFERRED INCOME TAX
14. Bee Corp prepared the following reconciliation between book and taxable income for the year
ended December 31, 1988:

Pretax accounting income $500,000

Taxable income 300,000
Difference $200,000

The difference was due to interest on tax-free municipal bonds of $ 50,000 and lower depreciation on
the financial statements of $150,000. Bee's effective income tax rate for 1988 is 30%. The enacted tax
rate for 1989 and beyond is 25%.

In Bee's 1988 income statement, the deferred portion of its provision for income taxes (i.e., its deferred
tax) should be

a. $60,000 c. 45,000
b. 50,000 d. 37,500

(c)/(d)

F90F2.15 RETAINED EARNINGS AND OWNERS' EQUITY

15. How would the declaration of a 10% stock dividend by a corporation affect each of the following
on its books?

Retained earnings Total stockholders' equity

a. Decrease No effect
b. Decrease Decrease
c. No effect Decrease
d. No effect No effect

(a) dr Retained earnings cr Capital; RE decreases; (RE + CAP) remains unchanged

F90F2.16 DILUTED EARNINGS PER SHARE

16. Information relating to the capital structure of Parke Corporation is as follows:
 Outstanding shares of:
Common stock 90,000
Preferred stock convertible
into 30,000 common shares 30,000
10% convertible bonds, convertible
into 20,000 shares of common $1,000,000

Parke paid $45,000 of dividends on the preferred stock which is considered a common stock
equivalent. The convertible bonds are not considered common stock equivalents. Parke's net income
was $980,000 and the income tax rate was 40%.

For the year ended December 31, 1984, fully diluted earnings per share is

a. $9.82 c. $7.71
b. $8.29 d. $7.43

(d) [980,000 + 100,000 x 0.6] / [90,000 + 30,000 + 20,000]