Accounting 381 Midterm Exam 2 Fall 2008 Solution Professor Kathy Rupley Name _____________________________________ Section ____________________________________ General

l Instructions: 1. Please observe the PSU Code of Conduct. 2. 3. This exam packet should have 15 pages. Please confirm that you have all the pages. Present Value Tables are provided for you on page 15. 4. Review the complete exam in order to allocate your time appropriately. 5. In fairness to all students, questions will not be answered during the exam, except to explain words or phrases. If a question is ambiguous, write your assumptions on the exam along with your answer. You will receive credit provided your assumptions are necessary and reasonable. 6. Write your answers neatly in the space provided. 7. Monitor your time and good luck! Points Available Question I Question II Question III TOTAL 25 37 38 100 Points Received

Question I: Revenue 1. (17 points) G2 Contractors uses the percentage-of-completion method to recognize revenue on its long-term construction contracts. During 2004, G2 Contractors started work on a $340,000 construction contract, which it plans to complete in 2006. The following information was taken from G2 Contractors accounting records: Contract costs incurred during the year Estimated costs to complete at year-end Cumulative progress billings as of year-end Cumulative collections as of year-end 2004 80,000 240,000 90,000 90,000 2005 160,000 160,000 270,000 250,000

a. What amount of revenue, expense, and gross profit should G2 Contractors have recognized on this contract for the year ended 12/31/04? 2004 Revenue: _______850K__________________ 2004 Expense: ___________80K_______________ 2004 Gross Profit: _____________5K____________

Construction Expense (A) CIP (DR or CR) Revenue (D/E * Tot Rev) Cost to Date (D) Total Estimated costs (E) Contract Revenue Total Previous Revenue Recognized Current Revenue Recognized

80,000 5,000 85,000 80,000 320,000 25.0000% 340,000 85,000 0 85,000

b. Prepare the December 31, 2004 balance sheet disclosure of construction in process and related billings. Be sure to indicate whether the amount is an asset or a liability. 85K CIP 90K billings = 5 Billings in excess of CIP (liability) $5,000

Question I, continued c. Calculate the amount of revenue, expense, and gross profit that G2 Contractors will report in 2005.

2005 Revenue: _______119,000__________________ 2005 Expense: ___________184,000______________ 2005 Gross Profit (Loss): ______(65,000)___________________

184,000 65,000 119,000 240,000 400,000 60.000% 340,000 204,000 85,000 119,000

d. Would net income be affected for 2005 if G2 Contractors used the Completed Contract Method to account for its long-term construction contracts instead of the Percent Completion Method? If so, what would be the journal entry that affects net income in 2005? Construction expense 60,000 CIP 60,000

Question I, continued 2. (8 points) The following information is provided for Wheatland Combines Inc. in 2007: Wheatland Combines Inc. concluded its first year of operations in which it made sales of $500,000, all on installment. Purchases for the year totaled $420,000; the cost of merchandise on hand at the end of the year was $30,000. Collections during the year from down payments and installments totaled $400,000. Instructions i) Under the installment-sales method, how much Realized Gross Profit is recognized during the year? 500,000 (sales) 390,000 (COGS) = 110,000 110,000/500,000 = 22% GP% X 400,000 collections =88,000 BI + purch EI = COGS 0 + 420k 30K = 390k ii) Under the installment sales method, what is the balance in the Unrealized Gross Profit account at the end of the year? 110,000 88,000 = 22,000

iii)

Under the cost recovery method, how much Realized Gross Profit is recognized during the year? 400,000 390,000 = ( $10,000 recognized gross profit Cash collected - costs

iv)

Under the cost recovery method, what is the balance in the Unrealized Gross Profit account at the end of the year? 110,000 10,000 = 100,000

Question II: Accounts Receivable and Notes Receivable 1. (3 points): Hoonah Hardware sold supplies of $1000 on credit to Dan Inc. on June 1, 2008 with credit terms 4/10, n/30. Hoonah Hardware. uses the gross method of accounting for cash discounts. What journal entry would Hoonah Hardware make on June 6, 2008 to record the cash receipt from Dan Inc., assuming that Dan Inc. made the correct payment on that date? Cash Sales Discounts AR 960 40 1000

(6 points) The following information is taken from Armadillo Co.s accounting records at December 31, 2005, 2006 and 2007: Dec. 31, 2005 Dec. 31, 2006 Dec. 31, 2007 Accounts Receivable $1,120,000 $1,200,000 $1,600,000 Allowance for doubtful accounts 220,000 CR. 214,000 CR. ? Write-offs of A/R during the year 210,000 310,000 100,000 Recoveries of amounts written off 50,000 during year Sales (all on credit) 15,800,000 15,200,000 18,000,000 Armadillo Co. estimates bad debt expense using the percentage of sales method. Based on historical data, it is estimated that 1% of all credit sales will be uncollectible. What amount of net accounts receivable should Armadillo Co. report on its Balance Sheet at 12/31/07? Allowance at 12/31/07 = Beg. Bal. + 07 Bad Debt Exp. - 07 W/o + 07 recov = 299k Allowance at 12/31/07 = 214,000 + 180,000* - 100,000 + 50,000= 344,000 *18,000,000 x 1% = 180,000

2.

Net A/R at 12/31/07 = 1,600,000 - 344,000 = 1,256,000

Question II (continued) 3. (11 points) On December 31, 2007, Roethlisberger, Inc. finished consultation services and accepted in exchange a promissory note with a face value of $500,000, a due date of December 31, 2010, and a stated rate of 9%, with interest receivable at the end of each year. The note is considered to have a market rate of interest of 6%. Table 6-2 (PV of single sum) Periods (n) 3 3% 0.91514 2 6% 0.8396 8 9% 0.7721

Table 6-4 (PV of an ordinary annuity) Periods (n) 3 3% 2.82861 1 6% 2.6730 0 9% 2.5313

(a) Prepare the journal entry made by Roethlisberger, Inc. on 12/31/07 to record this transaction.
500,00 NR Premium Sales Rev 0 40,09 5 540,09 5

(b) Prepare relevant journal entry by Stork, Inc. to record interest for the year ended 12/31/08.
Cash Premium Int Rev 45,000 12,594 32,406

Question II (continued) (c) Prepare the relevant journal entries by Roethlisberger, Inc. to record interest and repayment for the note in 2010 (assume that the note was repaid on 12/31/10).
Cash NR 500,000 500,000

Cash Premium Int Rev

45,000 14,150 30,850

Question II (continued) 4. (9 points) On January 1, 2006, Mittys Inc. factored $400,000 of accounts receivable with Polamalu Finance Co. on a with recourse basis. Under the arrangement, Polamalu Finance Co. was to make the collections, handle the sales discounts, and absorb the credit losses. Mittys Inc. estimates its recourse liability would be $60,000. Polamalu Finance Co. assessed a finance charge of $25,000. On February 10, 2006, Polamalu Finance Co. informed Mittys Inc. that $80,000 of the total accounts receivable were uncollectible, and Mittys Inc. sent Polamalu Finance Co. the appropriate recourse payment. a. Prepare the journal entry required on Mittys Inc.s books on January 1, 2006.

Cash (AR - withheld - finance charge) Loss on Sale of Receivables (50+30) Accounts Receivable Recourse Liability

375,00 0 85,000 400,00 0 60,000

b. Prepare the journal entry required on Mittys Inc.s books on February 10, 2006. Dr. Liability Recourse 0 20,00 Dr. Loss on sale Cash 0 80,00 0 60,00

Question II (continued) 5. (8 points) Indicate the effect (increase (I), decrease (D) or no effect (NE)) on total assets and net income for each of the following independent transactions. Use the table provided for your answers. 1. Writing off an account as uncollectible. 2. Recovery of an account previously written off as uncollectible. 3. Recording an adjusting entry to record estimated bad debts.+ 4. Factoring receivables without recourse at 99% of gross amount. Total Assets NE NE NE D D D D Net Income NE

1. 2. 3. 4.

Journal entries that would be recorded: 1. Allowance A/R A decrease and an increase in total assets for the same amount no effect on total assets. No revenue or expense accounts involved no effect on net income. 2. A/R Allowance Cash A/R A decrease and an increase in total assets for the same amount no effect on total assets. No revenue or expense accounts involved no effect on net income. 3. Bad Debt Expense Allowance An increase in an expense a decrease to net income. A decrease in assets a decrease in total assets. 4. Decrease in A/R more than cash cash received = Decrease in Assets Cash Received below A/R value = loss: Decrease in NI

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Question III: Inventory 1. (7 points) Ibiza, Inc. sells beach towels. On January 1, 2004, Ibiza, Inc. had 1000 units in inventory. Ibiza, Inc. has a December 31, 2004 year-end. If Ibiza, Inc. reported inventory on a LIFO basis, its beginning inventory balance would include the following: Year units were purchased 1995 1996 2002 Number of units 730 220 50 Cost per unit $5 $8 $12

If Ibiza, Inc. reported inventory on a FIFO basis, its beginning inventory balance would include the following: Number of units 1000 Cost per unit $15

Year units were purchased 2003

During 2004, Ibiza, Inc. purchased 1200 units at a cost of $20 per unit and sold 1250 units at a price of $30 each. Ibiza, Inc. uses a periodic inventory system. a. Calculate Gross Margin for 2004 if Ibiza, Inc. uses LIFO to value inventory. COGS: (1200 X 20) + (50*12) = 24,600 24000+600 = 24,600 Sales = 1250 X 30 = 37,500 GM =37,500 24,600= 12,900

b. Calculate Gross Margin for 2004 if Ibiza, Inc. uses FIFO to value inventory. COGS: 1000X 15 + 250 X 20 = 15,000+ 5000 = 20,000 Sales = 1250 X 30 = 37,500 GM = 37,500 - 20,000 = 17,500

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Question III, continued 2. (12 points) Lower-of-cost-or-market Whitsunday, Inc. is a manufacturer of building products. The Company sells its finished products to large retail chains (Wholesale Products) and through its own retail stores (Retail Products). The following table gives data pertinent to items included in Whitsunday Inc.s inventory at December 31, 2007. Wholesale Products Units in ending inventory Cost Selling price Replacement cost Estimated cost to sell Normal Profit Margin Ceiling Floor Unit inventory value under LCM rule 100 $145 $160 $150 $20 $25 140 115 140 Retail Products 1,000 $80 $130 $75 $15 $30 115 85 80

a. Using the given information, calculate ceiling values, floor values and the unit inventory value under the lower-of-cost-or-market rule for each of the product types in Whitsunday, Inc.s inventory. Please write your answers in the space provided in the table above. b. Assuming that Whitsunday, Inc. applies the Lower of Cost or Market Rule on a product basis, calculate the amount of inventory write-down, if any, that Whitsunday, Inc. will report on its Income Statement for the year ended December 31, 2007. If there is an inventory writedown, prepare the journal entry to reflect this. ($145-140) X 100 units = $500 writedown for wholesale; no writedown for retail because designated market (85) is greater than cost COGS (or Loss) 500 Inventory (or Inventory Allowance) 500

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Question III, cont. 3. (9 points) Dollar-value LIFO Gallatin Outfitters manufactures one product. On December 31, 2005, Gallatin Outfitters adopted the dollar-value LIFO inventory method. The inventory on that date (the base year) using the dollar-value LIFO inventory method was $180,000. Inventory data are as follows: Year 2006 2007 2008 Inventory at year-end prices $252,000 368,000 387,500 Price index (base year 2005) 1.05 1.15 1.25

Instructions Compute the inventory for Nevis Outfitters at December 31, 2006, 2007, and 2008, using the dollar-value LIFO method for each year.

III-3

Base Yr 2005
13

Am 18

Question III, cont. 4. (6 points) Inventory estimation techniques Toto, Inc., incurred a catastrophic tornado loss. Fortunately, Totos accounting records were kept off-site. Using the gross profit method, compute the amount of the tornado loss so that Toto, Inc. can file an insurance claim. The following information is available: Gross profit on sales Sales Beginning inventory Allowance for bad debts Purchases Purchase discounts
BI + net purch COGA Est. COGS: Net Sales 2,200,000 l 40% GM 880,000 Est. COGS Est. EI less: good not destroyed Goods destroyed 800,000 1,055,000 1,855,000

40% 2,200,000 800,000 25,000 1,100,000 45,000

1,320,000 535,000 535,000

5.

(4 points) Relative Sales Value Jermaine Dye Corporation acquired two inventory items at a lump-sum cost of $50,000. The acquisition included 3,000 units of product A, and 7,000 units of product B. Product A normally sells for $15 per unit, and product B for $5 per unit. If Dye sells 1,000 units of product A, what amount of gross profit should it recognize? a. b. c. d. $1,875 $5,625. $10,000. $11,875.

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