ACC 401 Week 11 Quiz 10 Chapters 15 – 16 and Final Exam – Strayer

ACC 401 Advanced Accounting Week 11 Quiz Final Exam chapters 5,8 and 10 Through 16 – Strayer (All Possible Questions With Answers)

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Quiz (Chapter 15 – 16) Final Exam (Chapter 5, 8, and 10 – 16)

Chapter 5

Allocation and Depreciation of Differences Between Implied and Book Value

Multiple Choice

1. When the implied value exceeds the aggregate fair values of identifiable net assets, the residual difference is accounted for as
a. excess of implied over fair value.
b. a deferred credit.
c. difference between implied and fair value.
d. goodwill.

2. Long-term debt and other obligations of an acquired company should be valued for consolidation purposes at their
a. book value.
b. carrying value.
c. fair value.
d. face value.

3. On January 1, 2010, Lester Company purchased 70% of Stork Corporation’s $5 par common stock for $600,000. The book value of Stork net assets was $640,000 at that time. The fair value of Stork’s identifiable net assets were the same as their book value except for equipment that was $40,000 in excess of the book value. In the January 1, 2010, consolidated balance sheet, goodwill would be reported at
a. $152,000.
b. $177,143.
c. $80,000.
d. $0.

4. When the value implied by the purchase price of a subsidiary is in excess of the fair value of identifiable net assets, the workpaper entry to allocate the difference between implied and book value includes a
1. debit to Difference Between Implied and Book Value.
2. credit to Excess of Implied over Fair Value.
3. credit to Difference Between Implied and Book Value.
a. 1
b. 2
c. 3
d. Both 1 and 2

5. If the fair value of the subsidiary’s identifiable net assets exceeds both the book value and the value implied by the purchase price, the workpaper entry to eliminate the investment account
a. debits Excess of Fair Value over Implied Value.
b. debits Difference Between Implied and Fair Value.
c. debits Difference Between Implied and Book Value.
d. credits Difference Between Implied and Book Value.

6. The entry to amortize the amount of difference between implied and book value allocated to an unspecified intangible is recorded
1. on the subsidiary’s books.
2. on the parent’s books.
3. on the consolidated statements workpaper.
a. 1
b. 2
c. 3
d. Both 2 and 3

7. The excess of fair value over implied value must be allocated to reduce proportionally the fair values initially assigned to
a. current assets.
b. noncurrent assets.
c. both current and noncurrent assets.
d. none of the above.

8. The SEC requires the use of push down accounting when the ownership change is greater than
a. 50%
b. 80%
c. 90%
d. 95%

9. Under push down accounting, the workpaper entry to eliminate the investment account includes a
a. debit to Goodwill.
b. debit to Revaluation Capital.
c. credit to Revaluation Capital.
d. debit to Revaluation Assets.

10. In a business combination accounted for as an acquisition, how should the excess of fair value of identifiable net assets acquired over implied value be treated?
a. Amortized as a credit to income over a period not to exceed forty years.
b. Amortized as a charge to expense over a period not to exceed forty years.
c. Amortized directly to retained earnings over a period not to exceed forty years.
d. Recognized as an ordinary gain in the year of acquisition.

11. On November 30, 2010, Pulse Incorporated purchased for cash of $25 per share all 400,000 shares of the outstanding common stock of Surge Company. Surge ‘s balance sheet at November 30, 2010, showed a book value of $8,000,000. Additionally, the fair value of Surge’s property, plant, and equipment on November 30, 2010, was $1,200,000 in excess of its book value. What amount, if any, will be shown in the balance sheet caption “Goodwill” in the November 30, 2010, consolidated balance sheet of Pulse Incorporated, and its wholly owned subsidiary, Surge Company?
a. $0.
b. $800,000.
c. $1,200,000.
d. $2,000,000.

12. Goodwill represents the excess of the implied value of an acquired company over the
a. aggregate fair values of identifiable assets less liabilities assumed.
b. aggregate fair values of tangible assets less liabilities assumed.
c. aggregate fair values of intangible assets less liabilities assumed.
d. book value of an acquired company.

13. Scooter Company, a 70%-owned subsidiary of Pusher Corporation, reported net income of $240,000 and paid dividends totaling $90,000 during Year 3. Year 3 amortization of differences between current fair values and carrying amounts of Scooter’s identifiable net assets at the date of the business combination was $45,000. The noncontrolling interest in net income of Scooter for Year 3 was
a. $58,500.
b. $13,500.
c. $27,000.
d. $72,000.

14. Porter Company acquired an 80% interest in Strumble Company on January 1, 2010, for $270,000 cash when Strumble Company had common stock of $150,000 and retained earnings of $150,000. All excess was attributable to plant assets with a 10-year life. Strumble Company made $30,000 in 2010 and paid no dividends. Porter Company’s separate income in 2010 was $375,000. Controlling interest in consolidated net income for 2010 is:
a. $405,000.
b. $399,000.
c. $396,000.
d. $375,000.

15. In preparing consolidated working papers, beginning retained earnings of the parent company will be adjusted in years subsequent to acquisition with an elimination entry whenever:
a. a noncontrolling interest exists.
b. it does not reflect the equity method.
c. the cost method has been used only.
d. the complete equity method is in use.

16. Dividends declared by a subsidiary are eliminated against dividend income recorded by the parent under the
a. partial equity method.
b. equity method.
c. cost method.
d. equity and partial equity methods.

Use the following information to answer questions 17 through 20.

On January 1, 2010, Pandora Company purchased 75% of the common stock of Saturn Company. Separate balance sheet data for the companies at the combination date are given below:

Saturn Co. Saturn Co.
Pandora Co. Book Values Fair Values

Cash $ 18,000 $155,000 $155,000
Accounts receivable 108,000 20,000 20,000
Inventory 99,000 26,000 45,000
Land 60,000 24,000 45,000
Plant assets 525,000 225,000 300,000
Acc. depreciation (180,000) (45,000)
Investment in Saturn Co. 330,000
Total assets $960,000 $405,000 $565,000

Accounts payable $156,000 $105,000 $105,000
Capital stock 600,000 225,000
Retained earnings 204,000 75,000
Total liabilities & equities $960,000 $405,000

Determine below what the consolidated balance would be for each of the requested accounts on January 2, 2010.

17. What amount of inventory will be reported?
a. $125,000
b. $132,750
c. $139,250
d. $144,000

18. What amount of goodwill will be reported?
a. ($20,000)
b. ($25,000)
c. $25,000
d. $0

19. What is the amount of consolidated retained earnings?
a. $204,000
b. $209,250
c. $260,250
d. $279,000

20. What is the amount of total assets?
a. $921,000
b. $1,185,000
c. $1,525,000
d. $1,195,000

21. Sensible Company, a 70%-owned subsidiary of Proper Corporation, reported net income of $600,000 and paid dividends totaling $225,000 during Year 3. Year 3 amortization of differences between current fair values and carrying amounts of Sensible’s identifiable net assets at the date of the business combination was $112,500. The noncontrolling interest in consolidated net income of Sensible for Year 3 was
a. $146,250.
b. $33,750.
c. $67,500.
d. $180,000.

22. Primer Company acquired an 80% interest in SealCoat Company on January 1, 2010, for $450,000 cash when SealCoat Company had common stock of $250,000 and retained earnings of $250,000. All excess was attributable to plant assets with a 10-year life. SealCoat Company made $50,000 in 2010 and paid no dividends. Primer Company’s separate income in 2010 was $625,000. The controlling interest in consolidated net income for 2010 is:
a. $675,000.
b. $665,000.
c. $660,000.
d. $625,000.

Use the following information to answer questions 23 through 25.

On January 1, 2010, Poole Company purchased 75% of the common stock of Swimmer Company. Separate balance sheet data for the companies at the combination date are given below:

Swimmer Co. Swimmer Co.
Poole Co. Book Values Fair Values
Cash $ 24,000 $206,000 $206,000
Accounts receivable 144,000 26,000 26,000
Inventory 132,000 38,000 60,000
Land 78,000 32,000 60,000
Plant assets 700,000 300,000 350,000
Acc. depreciation (240,000) (60,000)
Investment in Swimmer Co. 440,000
Total assets $1,278,000 $542,000 $702,000

Accounts payable $206,000 $142,000 $142,000
Capital stock 800,000 300,000
Retained earnings 272,000 100,000
Total liabilities & equities $1,278,000 $542,000

Determine below what the consolidated balance would be for each of the requested accounts on January 2, 2010.

23. What amount of inventory will be reported?
a. $170,000.
b. $177,000.
c. $186,500.
d. $192,000.

24. What amount of goodwill will be reported?
a. $26,667.
b. $20,000.
c. $42,000.
d. $86,667.

25. What is the amount of total assets?
a. $1,626,667.
b. $1,566,667
c. $1,980,000.
d. $2,006,667.

Problems

5-1 Phillips Company purchased a 90% interest in Standards Corporation for $2,340,000 on January 1, 2010. Standards Corporation had $1,650,000 of common stock and $1,050,000 of retained earnings on that date.

The following values were determined for Standards Corporation on the date of purchase:

Book Value Fair Value
Inventory $240,000 $300,000
Land 2,400,000 2,700,000
Equipment 1,620,000 1,800,000

Required:
A. Prepare a computation and allocation schedule for the difference between the implied and book value in the consolidated statements workpaper.

B. Prepare the January 1, 2010, workpaper entries to eliminate the investment account and allocate the difference between implied and book value.

5-2 Pullman Corporation acquired a 90% interest in Sleeper Company for $6,500,000 on January 1 2010. At that time Sleeper Company had common stock of $4,500,000 and retained earnings of $1,800,000. The balance sheet information available for Sleeper Company on January 1, 2010, showed the following:

Book Value Fair Value
Inventory (FIFO) $1,300,000 $1,500,000
Equipment (net) 1,500,000 1,900,000
Land 3,000,000 3,000,000

The equipment had a remaining useful life of ten years. Sleeper Company reported $240,000 of net income in 2010 and declared $60,000 of dividends during the year.

Required:
Prepare the workpaper entries assuming the cost method is used, to eliminate dividends, eliminate the investment account, and to allocate and depreciate the difference between implied and book value for 2010.

5-3 On January 1, 2010, Preston Corporation acquired an 80% interest in Spiegel Company for $2,400,000. At that time Spiegel Company had common stock of $1,800,000 and retained earnings of $800,000. The book values of Spiegel Company’s assets and liabilities were equal to their fair values except for land and bonds payable. The land’s fair value was $120,000 and its book value was $100,000. The outstanding bonds were issued on January 1, 2005, at 9% and mature on January 1, 2015. The bond principal is $600,000 and the current yield rate on similar bonds is 8%.

Required:
Prepare the workpaper entries necessary on December 31, 2010, to allocate, amortize, and depreciate the difference between implied and book value.

Present Value
Present value of 1 of Annuity of 1
9%, 5 periods .64993 3.88965
8%, 5 periods .68058 3.99271

5-4 Pennington Corporation purchased 80% of the voting common stock of Stafford Corporation for $3,200,000 cash on January 1, 2010. On this date the book values and fair values of Stafford Corporation’s assets and liabilities were as follows:
Book Value Fair Value
Cash $ 70,000 $ 70,000
Receivables 240,000 240,000
Inventories 600,000 700,000
Other Current Assets 340,000 405,000
Land 600,000 720,000
Buildings – net 1,050,000 1,920,000
Equipment – net 850,000 750,000
$3,750,000 $4,805,000

Accounts Payable $ 250,000 $250,000
Other Liabilities 740,000 670,000
Capital Stock 2,400,000
Retained Earnings 360,000
$3,750,000

Required:
Prepare a schedule showing how the difference between Stafford Corporation’s implied value and the book value of the net assets acquired should be allocated.

5-5 Perez Corporation acquired a 75% interest in Schmidt Company on January 1, 2010, for $2,000,000. The book value and fair value of the assets and liabilities of Schmidt Company on that date were as follows:
Book Value Fair Value
Current Assets $ 600,000 $ 600,000
Property & Equipment (net) 1,400,000 1,800,000
Land 700,000 900,000
Deferred Charge 300,000 300,000
Total Assets $3,000,000 $3,600,000
Less Liabilities 600,000 600,000
Net Assets $2,400,000 $3,000,000

The property and equipment had a remaining life of 6 years on January 1, 2010, and the deferred charge was being amortized over a period of 5 years from that date. Common stock was $1,500,000 and retained earnings was $900,000 on January 1, 2010. Perez Company records its investment in Schmidt Company using the cost method.

Required:
Prepare, in general journal form, the December 31, 2010, workpaper entries necessary to:

A. Eliminate the investment account.
B. Allocate and amortize the difference between implied and book value.

5-6 On January 1, 2010, Page Company acquired an 80% interest in Schell Company for $3,600,000. On that date, Schell Company had retained earnings of $800,000 and common stock of $2,800,000. The book values of assets and liabilities were equal to fair values except for the following:

Book Value Fair Value
Inventory $ 50,000 $ 85,000
Equipment (net) 540,000 720,000
Land 300,000 660,000

The equipment had an estimated remaining useful life of 8 years. One-half of the inventory was sold in 2010 and the remaining half was sold in 2011. Schell Company reported net income of $240,000 in 2010 and $300,000 in 2011. No dividends were declared or paid in either year. Page Company uses the cost method to record its investment in Schell Company.

Required:
Prepare, in general journal form, the workpaper eliminating entries necessary in the consolidated statements workpaper for the year ending December 31, 2011.

5-7 Paddock Company acquired 90% of the stock of Spector Company for $6,300,000 on January 1, 2010. On this date, the fair value of the assets and liabilities of Spector Company was equal to their book value except for the inventory and equipment accounts. The inventory had a fair value of $2,300,000 and a book value of $1,900,000. The equipment had a fair value of $3,300,000 and a book value of $2,800,000.

The balances in Spector Company’s capital stock and retained earnings accounts on the date of acquisition were $3,700,000 and $1,900,000, respectively.

Required:
In general journal form, prepare the entries on Spector Company’s books to record the effect of the pushed down values implied by the acquisition of its stock by Paddock Company assuming that:

A values are allocated on the basis of the fair value of Spector Company as a whole imputed from the transaction.

B values are allocated on the basis of the proportional interest acquired by Paddock Company.

5-8 Pruitt Corporation acquired all of the voting stock of Soto Corporation on January 1, 2010, for $210,000 when Soto had common stock of $150,000 and retained earnings of $24,000. The excess of implied over book value was allocated $9,000 to inventories that were sold in 2010, $12,000 to equipment with a 4-year remaining useful life under the straight-line method, and the remainder to goodwill.

Financial statements for Pruitt and Soto Corporations at the end of the fiscal year ended December 31, 2011 (two years after acquisition), appear in the first two columns of the partially completed consolidated statements workpaper. Pruitt Corp. has accounted for its investment in Soto using the partial equity method of accounting.

Required:
Complete the consolidated statements workpaper for Pruitt Corporation and Soto Corporation for December 31, 2011.
Pruitt Corporation and Soto Corporation
Consolidated Statements Workpaper
at December 31, 2011

Eliminations
Pruitt Corp. Soto Corp. Debit Credit Consolidated Balances
INCOME STATEMENT
Sales 618,000 180,000
Equity from Subsidiary Income 36,000
Cost of Sales (450,000) (90,000)
Other Expenses (114,000) (54,000)
Net Income to Ret. Earn. 90,000 36,000
Pruitt Retained Earnings 1/1 72,000
Soto Retained Earnings 1/1 3,000
Add: Net Income 90,000 36,000
Less: Dividends (60,000) (12,000)
Retained Earnings 12/31 102,000 54,000
BALANCE SHEET
Cash 42,000 21,000
Inventories 63,000 45,000
Land 33,000 18,000
Equipment and Buildings-net 192,000 165,000
Investment in Soto Corp. 240,000

Total Assets 570,000 249,000
LIA & EQUITIES Liabilities 168,000 45,000
Common Stock 300,000 150,000
Retained Earnings 102,000 54,000
Total Equities 570,000 249,000

5-9 On January 1, 2010, Prescott Company acquired 80% of the outstanding capital stock of Sherlock Company for $570,000. On that date, the capital stock of Sherlock Company was $150,000 and its retained earnings were $450,000.

On the date of acquisition, the assets of Sherlock Company had the following values:

Fair Market
Book Value Value
Inventories $ 90,000 $165,000
Plant and equipment 150,000 180,000

All other assets and liabilities had book values approximately equal to their respective fair market values. The plant and equipment had a remaining useful life of 10 years from January 1, 2010, and Sherlock Company uses the FIFO inventory cost flow assumption.

Sherlock Company earned $180,000 in 2010 and paid dividends in that year of $90,000.
Prescott Company uses the complete equity method to account for its investment in S Company.

Required:

A. Prepare a computation and allocation schedule.
B. Prepare the balance sheet elimination entries as of December 31, 2010.
C. Compute the amount of equity in subsidiary income recorded on the books of Prescott Company on December 31, 2010.
D. Compute the balance in the investment account on December 31, 2010.

Short Answer

1. When the value implied by the acquisition price is below the fair value of the identifiable net assets the residual amount will be negative (bargain acquisition). Explain the difference in accounting for bargain acquisition between past accounting and proposed accounting requirements.

2. Push down accounting is an accounting method required for the subsidiary in some instances such as the banking industry. Briefly explain the concept of push down accounting.

Questions from the Textbook

1. Distinguish among the following concepts:(a)Difference between book value and the value implied by the purchase price.(b)Excess of implied value over fair value.(c)Excess of fair value over implied value.(d)Excess of book value over fair value.

2. In what account is the difference between book value and the value implied by the purchase
price recorded on the books of the investor? In what account is the “excess of implied over fair value” recorded?

3. How do you determine the amount of “the difference between book value and the value implied by the purchase price” to be allocated to a specific asset of a less than wholly owned subsidiary?

4. The parent company’s share of the fair value of the net assets of a subsidiary may exceed acquisition cost. How must this excess be treated in the preparation of consolidated financial statements?

5. What are the arguments for and against the alternatives for the handling of bargain acquisitions? Why are such acquisitions unlikely to occur with great frequency?

6. P Company acquired a 100% interest in S Company. On the date of acquisition the fair value of the assets and liabilities of S Company was equal to their book value except for land that had a fair value of $1,500,000 and a book value of $300,000.
At what amount should the land of S Company be included in the consolidated balance sheet?
At what amount should the land of S Company be included in the consolidated balance sheet if P Company acquired an80% interest in S Company rather than a 100%interest?

Business Ethics Question from the Textbook

Consider the following: Many years ago, a student in a consolidated financial statements class came to me and said that Grand Central (a multi-store grocery and variety chain in Salt Lake City and surrounding towns and cities) was going to be acquired and that I should try to buy the stock and make lots of money. I asked him how he knew and he told me that he worked part-time for Grand Central and heard that Fred Meyer was going to acquire it. I did not know whether the student worked in the accounting department at Grand Central or was a custodian at one of the stores. I thanked him for the information but did not buy the stock. Within a few weeks, the announcement was made that Fred Meyer was acquiring Grand Central and the stock price shot up, almost doubling. It was clear that I had missed an opportunity to make a lot of money … I don’t know to this day whether or not that would have been insider trading. How-ever, I have never gone home at night and asked my wife if the SEC called. From “Don’t go to jail and other good advice for accountants,” by Ron Mano, Accounting Today, October 25, 1999.
Question: Do you think this individual would have been guilty of insider trading if he had purchased the stock in Grand Central based on this advice? Why or why not? Are there ever instances where you think it would be wise to miss out on an opportunity to reap benefits simply because the behavior necessitated would have been in a gray ethical area, though not strictly illegal? Defend your position.

Chapter 8

Changes in Ownership Interest

Multiple Choice

1. When the parent company sells a portion of its investment in a subsidiary, the workpaper entry to adjust for the current year’s income sold to noncontrolling stockholders includes a
a. debit to Subsidiary Income Sold.
b. debit to Equity in Subsidiary Income.
c. credit to Equity in Subsidiary Income.
d. credit to Subsidiary Income Sold.

2. A parent company may increase its ownership interest in a subsidiary by
a. buying additional subsidiary shares from third parties.
b. buying additional subsidiary shares from the subsidiary.
c. having the subsidiary purchase its shares from third parties.
d. all of these.

3. If a portion of an investment is sold, the value of the shares sold is determined by using the:
1. first-in, first-out method.
2. average cost method.
3. specific identification method.
a. 1
b. 2
c. 3
d. 1 and 3

4. If a parent company acquires additional shares of its subsidiary’s stock directly from the subsidiary for a price less than their book value:
1. total noncontrolling book value interest increases.
2. the controlling book value interest increases.
3. the controlling book value interest decreases.
a. 1
b. 2
c. 3
d. 1 and 3

5. If a subsidiary issues new shares of its stock to noncontrolling stockholders, the book value of the parent’s interest in the subsidiary may
a. increase.
b. decrease.
c. remain the same.
d. increase, decrease, or remain the same.

6. The purchase by a subsidiary of some of its shares from noncontrolling stockholders results in the parent company’s share of the subsidiary’s net assets
a. increasing.
b. decreasing.
c. remaining unchanged.
d. increasing, decreasing, or remaining unchanged.

7. The computation of noncontrolling interest in net assets is made by multiplying the noncontrolling interest percentage at the
a. beginning of the year times subsidiary stockholders’ equity amounts.
b. beginning of the year times consolidated stockholders’ equity amounts.
c. end of the year times subsidiary stockholders’ equity amounts.
d. end of the year times consolidated stockholders’ equity amounts.

8. Under the partial equity method, the workpaper entry that reverses the effect of subsidiary income for the year includes a:
1. credit to Equity in Subsidiary Income.
2. debit to Subsidiary Income Sold.
3. debit to Equity in Subsidiary Income.
a. 1
b. 2
c. 3
d. both 1 and 2

9. Polk Company owned 24,000 of the 30,000 outstanding common shares of Sloan Company on January 1, 2010. Polk’s shares were purchased at book value when the fair values of Sloan’s assets and liabilities were equal to their book values. The stockholders’ equity of Sloan Company on January 1, 2010, consisted of the following:
Common stock, $15 par value $ 450,000
Other contributed capital 337,500
Retained earnings 712,500
Total $1,500,000

Sloan Company sold 7,500 additional shares of common stock for $90 per share on January 2, 2010. If Polk Company purchased all 7,500 shares, the book entry to record the purchase should increase the Investment in Sloan Company account by
a. $562,500.
b. $590,625.
c. $675,000.
d. $150,000.
e. Some other account.

10. Polk Company owned 24,000 of the 30,000 outstanding common shares of Sloan Company on January 1, 2010. Polk’s shares were purchased at book value when the fair values of Sloan’s assets and liabilities were equal to their book values. The stockholders’ equity of Sloan Company on January 1, 2010, consisted of the following:
Common stock, $15 par value $ 450,000
Other contributed capital 337,500
Retained earnings 712,500
Total $1,500,000
Sloan Company sold 7,500 additional shares of common stock for $90 per share on January 2, 2010. If all 7,500 shares were sold to noncontrolling stockholders, the workpaper adjustment needed each time a workpaper is prepared should increase (decrease) the Investment in Sloan Company by
a. ($140,625).
b. $140,625.
c. ($112,500).
d. $192,000.
e. None of these.

11. On January 1, 2006, Parent Company purchased 32,000 of the 40,000 outstanding common shares of Sims Company for $1,520,000. On January 1, 2010, Parent Company sold 4,000 of its shares of Sims Company on the open market for $90 per share. Sims Company’s stockholders’ equity on January 1, 2006, and January 1, 2010, was as follows:
1/1/06 1/1/10
Common stock, $10 par value $400,000 $ 400,000
Other contributed capital 400,000 400,000
Retained earnings 800,000 1,400,000
$1,600,000 $2,200,000

The difference between implied and book value is assigned to Sims Company’s land. The amount of the gain on sale of the 4,000 shares that should be recorded on the books of Parent Company is
a. $68,000.
b. $170,000.
c. $96,000.
d. $200,000.
e. None of these.

12. On January 1, 2006, Patterson Corporation purchased 24,000 of the 30,000 outstanding common shares of Stewart Company for $1,140,000. On January 1, 2010, Patterson Corporation sold 3,000 of its shares of Stewart Company on the open market for $90 per share. Stewart Company’s stockholders’ equity on January 1, 2006, and January 1, 2010, was as follows:
1/1/06 1/1/10
Common stock, $10 par value $ 300,000 $ 300,000
Other contributed capital 300,000 300,000
Retained earnings 600,000 1,050,000
$1,200,000 $1,650,000

The difference between implied and book value is assigned to Stewart Company’s land. As a result of the sale, Patterson Corporation’s Investment in Stewart account should be credited for
a. $165,000.
b. $206,250.
c. $120,000.
d. $142,500.
e. None of these.

13. On January 1, 2006, Peterson Company purchased 16,000 of the 20,000 outstanding common shares of Swift Company for $760,000. On January 1, 2010, Peterson Company sold 2,000 of its shares of Swift Company on the open market for $90 per share. Swift Company’s stockholders’ equity on January 1, 2006, and January 1, 2010, was as follows:
1/1/06 1/1/10
Common stock, $10 par value $200,000 $ 200,000
Other contributed capital 200,000 200,000
Retained earnings 400,000 700,000
$800,000 $1,100,000

The difference between implied and book value is assigned to Swift Company’s land. Assuming no other equity transactions, the amount of the difference between implied and book value that would be added to land on a workpaper for the preparation of consolidated statements on December 31, 2010, would be
a. $120,000.
b. $115,000.
c. $105,000.
d. $84,000.
e. None of these.

14. On January 1 2010, Paulson Company purchased 75% of Shields Corporation for $500,000. Shields’ stockholders’ equity on that date was equal to $600,000 and Shields had 60,000 shares issued and outstanding on that date. Shields Corporation sold an additional 15,000 shares of previously unissued stock on December 31, 2010.

Assume that Paulson Company purchased the additional shares what would be their current percentage ownership on December 31, 2010?
a. 92%
b. 87%
c. 80%
d. 100%

15. On January 1 2010, Powder Mill Company purchased 75% of Selfine Company for $500,000. Selfine Company’s stockholders’ equity on that date was equal to $600,000 and Selfine Company had 60,000 shares issued and outstanding on that date. Selfine Company Corporation sold an additional 15,000 shares of previously unissued stock on December 31, 2010.

Assume Selfine Company sold the 15,000 shares to outside interests, Powder Mill Company’s percent ownership would be:
a. 33 1/3%
b. 60%
c. 75%
d. 80%

16. P Corporation purchased an 80% interest in S Corporation on January 1, 2010, at book value for $300,000. S’s net income for 2010 was $90,000 and no dividends were declared. On May 1, 2010, P reduced its interest in S by selling a 20% interest, or one-fourth of its investment for $90,000. What will be the Consolidated Gain on Sale and Subsidiary Income Sold for 2010?
Consolidated Gain on Sale Subsidiary Income Sold
a. $9,000 $6,000
b. $9,000 $15,000
c. $15,000 $6,000
d. $15,000 $15,000

17. P Corporation purchased an 80% interest in S Corporation on January 1, 2010, at book value for $300,000. S’s net income for 2010 was $90,000 and no dividends were declared. On May 1, 2010, P reduced its interest in S by selling a 20% interest, or one-fourth of its investment for $90,000. What would be the balance in the Investment of S Corporation account on December 31, 2010?
a. $300,000.
b. $225,000.
c. $279,000.
d. $261,000.

18. The purchase by a subsidiary of some of its shares from the noncontrolling stockholders results in an increase in the parent’s percentage interest in the subsidiary. The parent company’s share of the subsidiary’s net assets will increase if the shares are purchased:
a. at a price equal to book value.
b. at a price below book value.
c. at a price above book value.
d. will not show an increase.

Use the following information for Questions 19-21.

On January 1, 2006, Perk Company purchased 16,000 of the 20,000 outstanding common shares of Self Company for $760,000. On January 1, 2010, Perk Company sold 2,000 of its shares of Self Company on the open market for $90 per share. Self Company’s stockholders’ equity on January 1, 2006, and January 1, 2010, was as follows:
1/1/06 1/1/10
Common stock, $10 par value $ 200,000 $ 200,000
Other contributed capital 200,000 200,000
Retained earnings 400,000 700,000
$800,000 $1,100,000

The difference between implied and book value is assigned to Self Company’s land.

19. The amount of the gain on sale of the 2,000 shares that should be recorded on the books of Perk Company is
a. $34,000.
b. $85,000.
c. $48,000.
d. $100,000.
e. None of these.

20. As a result of the sale, Perk Company’s Investment in Self account should be credited for
a. $110,000.
b. $137,500.
c. $80,000.
d. $95,000.
e. None of these.

21. Assuming no other equity transactions, the amount of the difference between implied and book value that would be added to land on a work paper for the preparation of consolidated statements on December 31, 2010 would be
a. $120,000.
b. $115,000.
c. $105,000.
d. $84,000.

22. On January 1, 2010, P Corporation purchased 75% of S Corporation for $500,000. S’s stockholders’ equity on that date was equal to $600,000 and S had 40,000 shares issued and outstanding on that date. S Corporation sold an additional 8,000 shares of previously unissued stock on December 31, 2010.

Assume that P Corporation purchased the additional shares what would be their current percentage ownership on December 31, 2010?
a. 62 1/2%.
b. 75%
c. 79 1/6%
d. 100%

23. On January 1, 2010, P Corporation purchased 75% of S Corporation for $500,000. S’s stockholders’ equity on that date was equal to $600,000 and S had 40,000 shares issued and outstanding on that date. S Corporation sold an additional 8,000 shares of previously unissued stock on December 31, 2010.

Assume S sold the 8,000 shares to outside interests, P’s percent ownership would be:
a. 56 1/4%
b. 62 1/2%
c. 75%
d. 79 1/6%

Problems

8-1 Piper Company purchased Snead Company common stock through open-market purchases as follows:
Acquired
Date Shares Cost
1/1/09 1,500 $ 50,000
1/1/10 3,300 $ 90,000
1/1/11 6,600 $250,000

Snead Company had 12,000 shares of $20 par value common stock outstanding during the entire period. Snead had the following retained earnings balances on the relevant dates:

January 1, 2009 $ 90,000
January 1, 2010 30,000
January 1, 2011 150,000
December 31, 2011 300,000

Snead Company declared no dividends in 2009 or 2010 but did declare $60,000 of dividends in 2011. Any difference between cost and book value is assigned to subsidiary land. Piper uses the equity method to account for its investment in Snead.

Required:
A. Prepare the journal entries Piper Company will make during 2010 and 2011 to account for its investment in Snead Company.
B. Prepare workpaper eliminating entries necessary to prepare a consolidated statements workpaper on December 31, 2011.

8-2 On January 1, 2008, Patel Company acquired 90% of the common stock of Seng Company for $650,000. At that time, Seng had common stock ($5 par) of $500,000 and retained earnings of $200,000.

On January 1, 2010, Seng issued 20,000 shares of its unissued common stock, with a market value of $7 per share, to noncontrolling stockholders. Seng’s retained earnings balance on this date was $300,000. Any difference between cost and book value relates to Seng’s land. No dividends were declared in 2010.

Required:
A. Prepare the entry on Patel’s books to record the effect of the issuance assuming the cost method.
B. Prepare the elimination entries for the preparation of a consolidated statements workpaper on December 31, 2010 assuming the cost method.

8-3 Pratt Company purchased 40,000 shares of Silas Company’s common stock for $860,000 on January 1, 2010. At that time Silas Company had $500,000 of $10 par value common stock and $300,000 of retained earnings. Silas Company’s income earned and increase in retained earnings during 2010 and 2011 were:

2010 2011
Income earned $260,000 $360,000
Increase in Retained Earnings 200,000 300,000

Silas Company income is earned evenly throughout the year.

On September 1, 2011, Pratt Company sold on the open market, 12,000 shares of its Silas Company stock for $460,000. Any difference between cost and book value relates to Silas Company land. Pratt Company uses the cost method to account for its investment in Silas Company.

Required:
A. Compute Pratt Company’s reported gain (loss) on the sale.
B. Prepare all consolidated statements workpaper eliminating entries for a workpaper on December 31, 2011.

8-4 Pelky made the following purchases of Stark Company common stock:

Date Shares Cost
1/1/10 70,000 (70%) $1,000,000
1/1/11 10,000 (10%) 160,000

Stockholders’ equity information for Stark Company for 2010 and 2011 follows:

2010 2011
Common stock, $10 par value $1,000,000 $1,000,000

1/1 Retained earnings 300,000 380,000
Net income 110,000 140,000
Dividends declared, 12/15 (30,000) (40,000)
Retained earnings, 12/31 380,000 480,000
Total stockholders’ equity, 12/31 $1,380,000 $1,480,000

On July 1, 2011, Pelky sold 14,000 shares of Stark Company common stock on the open market for $22 per share. The shares sold were purchased on January 1, 2010. Stark notified Pelky that its net income for the first six months was $70,000. Any difference between cost and book value relates to subsidiary land. Pelky uses the cost method to account for its investment in Stark Company.

Required:
A. Prepare the journal entry made by Pelky to record the sale of the 14,000 shares on July 1, 2011.
B. Prepare the workpaper eliminating entries needed for a consolidated statements workpaper on December 31, 2011.
C. Compute the amount of noncontrolling interest that would be reported on the consolidated balance sheet on December 31, 2011.

8-5 P Company purchased 96,000 shares of the common stock of S Company for $1,200,000 on January 1, 2007, when S’s stockholders’ equity consisted of $5 par value, Common Stock at $600,000 and Retained Earnings of $800,000. The difference between cost and book value relates to goodwill.

On January 2, 2010, S Company purchased 20,000 of its own shares from noncontrolling interests for cash of $300,000 to be held as treasury stock. S Company’s retained earnings had increased to $1,000,000 by January 2, 2010. S Company uses the cost method in regards to its treasury stock and P Company uses the equity method to account for its investment in S Company.

Required:
Prepare all determinable workpaper entries for the preparation of consolidated statements on December 31, 2010.

8-6 Penner Company acquired 80% of the outstanding common stock of Solk Company on January 1, 2008, for $396,000. At the date of purchase, Solk Company had a balance in its $2 par value common stock account of $360,000 and retained earnings of $90,000. On January 1, 2010, Solk Company issued 45,000 shares of its previously unissued stock to noncontrolling stockholders for $3 per share. On this date, Solk Company had a retained earnings balance of $152,000. The difference between cost and book value relates to subsidiary land. No dividends were paid in 2010. Solk Company reported income of $30,000 in 2010.

Required:
A. Prepare the journal entry on Penner’s books to record the effect of the issuance assuming the equity method.
B. Prepare the eliminating entries needed for the preparation of a consolidated statements workpaper on December 31, 2010, assuming the equity method.

8-7 Petty Company acquired 85% of the common stock of Selmon Company in two separate cash transactions. The first purchase of 108,000 shares (60%) on January 1, 2009, cost $735,000. The second purchase, one year later, of 45,000 shares (25%) cost $330,000. Selmon Company’s stockholders’ equity was as follows:

December 31 December 31
2009 2010

Common Stock, $5 par $ 900,000 $ 900,000
Retained Earnings, 1/1 262,000 302,000
Net Income 69,000 90,000
Dividends Declared, 9/30 (30,000) (38,000)
Retained Earnings, 12/31 301,000 354,000
Total Stockholders’ Equity, 12/31 $1,201,000 $1,254,000

On April 1, 2010, after a significant rise in the market price of Selmon Company’s stock, Petty Company sold 32,400 of its Selmon Company shares for $390,000. Selmon Company notified Petty Company that its net income for the first three months was $22,000. The shares sold were identified as those obtained in the first purchase. Any difference between cost and book value relates to goodwill. Petty uses the partial equity method to account for its investment in Selmon Company.

Required:
A. Prepare the journal entries Petty Company will make on its books during 2009 and 2010 to account for its investment in Selmon Company.
B. Prepare the workpaper eliminating entries needed for a consolidated statements workpaper on December 31, 2010.

Short Answer
1. A parent’s ownership percentage in a subsidiary may change for several reasons. Identify three reasons the ownership percentage may change.

2. A parent company’s equity interest in a subsidiary may change as the result of the issuance of additional shares of stock by the subsidiary. Describe the affect on the parent’s investment account when the new shares are (a) purchased ratably by the parent and noncontrolling shareholders or (b) entirely by the noncontrolling shareholders.

Short Answer Question from the Textbook

1. Identify three types of transactions that result in a change in a parent company’s ownership interest in its subsidiary.

2. Why is the date of acquisition of subsidiary stock important under the purchase method?

3. When a parent company has obtained control of a subsidiary through several purchases and subsequently sells a portion of its shares in the subsidiary, how is the carrying value of the shares sold determined?

4. When a parent company that records its investment using the cost method during a fiscal year sells a portion of its investment, explain the correct accounting for any differences between selling price and recorded values.

5. ABC Corporation purchased 10,000 shares(80%) of EZ Company at $35 per share and sold them several years later for $35 per share. The consolidated income statement reports a loss on the sale of this investment. Explain.

6. Explain how a parent company that owns less than100% of a subsidiary can purchase an entire new is-sue of common stock directly from the subsidiary.

7. When a subsidiary issues additional shares of stock to noncontrolling stockholders and such issuance results in an increase in the book value of the parent’s share of the subsidiary’s equity, how should the increase be reflected in the financial statements? What if it results in a decrease?

8. P Company holds an 80% interest in S Company. Determine the effect (that is, increase, decrease, no change, not determinable) on both the total book value of the noncontrolling interest and the noncontrolling interest’s percentage of ownership in the net assets of S Company for each of the following situations:
a. P Company acquires additional shares directly from S Company at a price equal to the book value per share of the S Company stock immediately prior to the issuance.
b. S Company acquires its own shares on the open market. The cost of these shares is less than their book value.
c. Assume the same situation as in (b) except that the cost of the shares is greater than their book value.
d. P Company and a noncontrolling stockholder each acquire 100 shares directly from S Com-pany at a price below the book value per share.

Business Ethics Question from Textbook

During a recent review of the quarterly financial statements and supporting ledgers, you noticed several un-usual journal entries. While the dollar amounts of the journal entries were not large, there did not appear to be supporting documentation. You decide to bring the matter to the attention of your immediate supervisor. After you mentioned the issue, the supervisor calmly stated that the matter would be looked into and that you should not worry about it.1.You feel a bit uncomfortable about the situation. What is your responsibility and what action, if any, should you take?

Chapter 10

Insolvency – Liquidation and Reorganization

Multiple Choice

1. A corporation that is unable to pay its debts as they become due is:
a. bankrupt.
b. overdrawn.
c. insolvent.
d. liquidating.

2. When a business becomes insolvent, it generally has three possible courses of action. Which of the following is not one of the three possible courses of action?
a. The debtor and its creditors may enter into a contractual agreement, outside of formal bankruptcy proceedings.
b. The debtor continues operating the business in the normal course of the day-to-day operations.
c. The debtor or its creditors may file a bankruptcy petition, after which the debtor is liquidated under Chapter 7.
d. The debtor or its creditors may file a petition for reorganization under Chapter 11.

3. Assets transferred by the debtor to a creditor to settle a debt are transferred at:
a. book value of the debt.
b. book value of the transferred assets.
c. fair market value of the debt.
d. fair market value of the transferred assets.

4. A composition agreement is an agreement between the debtor and its creditors whereby the creditors agree to:
a. accept less than the full amount of their claims.
b. delay settlement of the claim until a latter date.
c. force the debtor into a liquidation.
d. accrue interest at a higher rate.

5. In a troubled debt restructuring involving a modification of terms, the debtor’s gain on restructuring:
a. will equal the creditor’s gain on restructuring.
b. will equal the creditor’s loss on restructuring.
c. may not equal the creditor’s gain on restructuring.
d. may not equal the creditor’s loss on restructuring.

6. A bankruptcy petition filed by a firm is a:
a. chapter petition.
b. involuntary petition.
c. voluntary petition.
d. chapter 11 petition.

7. When a bankruptcy court enters an “order for relief” it has:
a. accepted the petition.
b. dismissed the petition.
c. appointed a trustee.
d. started legal action against the debtor by its creditors.

8. An involuntary petition filed by a firm’s creditors whereby there are twelve or more creditors must be signed by at least:
a. two creditors.
b. three creditors.
c. five creditors.
d. six creditors.

9. The duties of the trustee include:
a. appointing creditors’ committees in liquidation cases.
b. approving all payments for debts incurred before the bankruptcy filing.
c. examining claims and disallowing any that are improper.
d. calling a meeting of the debtor’s creditors.

10. Which of the following items is not a specified priority for unsecured creditors in a bankruptcy petition?
a. Administration fees incurred in administering the bankrupt’s estate.
b. Unsecured claims for wages earned within 90 days and are less than $4,650 per employee.
c. Unsecured claims of governmental units for unpaid taxes.
d. Unsecured claims on credit card charges that do not exceed $3,000.

11. Which statement with respect to gains and losses on troubled debt restructuring is correct?
a. Creditors losses on restructuring are extraordinary.
b. Debtor’s gains and losses on asset transfers and debtor’s gains on restructuring are combined and treated as extraordinary.
c. Debtor gains and creditor losses on restructuring are extraordinary, if material in amount.
d. Debtor losses on asset transfers and debtor gains on restructuring are reported as a component of net income.

12. When fresh-start reporting is used according to Statement of Position (SOP) 90-7, the implication is that a new firm exists. Which of the following statements is not correct about fresh-start accounting?
a. Assets are reported at fair values.
b. Beginning retained earnings is reported at zero.
c. The fair value of the assets must be less than the post liabilities and allowed claims.
d. The original owners must own less than 50% of the voting stock after reorganization.

13. A Statement of Affairs is a report designed to show:
a. an estimated amount that would be received by each class of creditor’s claims in the event of liquidation.
b. a balance sheet prepared on the going-concern assumption.
c. assets and liabilities classified as current and noncurrent.
d. assets and liabilities reported at their current book values.

14. When a secured claim is not fully settled by the selling of the underlying collateral, the remaining portion:
a. of the claim cannot be collected by the creditor.
b. remains as a secured claim.
c. is classified as an unsecured priority claim.
d. is classified as an unsecured nonpriority claim.

15. Layne Corporation entered into a troubled debt restructuring agreement with their local bank. The bank agreed to accept land with a carrying amount of $360,000 and a fair value of $540,000 in exchange for a note with a carrying amount of $765,000. Ignoring income taxes, what amount should Layne report as a gain on its income statement?
a. $0.
b. $180,000.
c. $225,000.
d. $405,000.

16. The following information pertains to the transfer of real estate in regards to a troubled debt restructuring by Nen Co. to Baker Co. in full settlement of Nen’s liability to Baker:

Carrying amount of liability settled $450,000
Carrying amount of real estate transferred $300,000
Fair value of real estate transferred $330,000

What amount should Nen report as ordinary gain (loss) on transfer of real estate?
a. $(30,000).
b. $30,000.
c. $120,000.
d. $150,000.

17. The following information pertains to the transfer of real estate in regards to a troubled debt restructuring by Nen Co. to Baker Co. in full settlement of Nen’s liability to Baker:

Carrying amount of liability settled $450,000
Carrying amount of real estate transferred $300,000
Fair value of real estate transferred $330,000

What amount should Baker report as a gain or (loss) on restructuring?
a. $120,000 ordinary loss.
b. $120,000 extraordinary loss.
c. $150,000 ordinary loss.
d. $150,000 extraordinary loss.

18. Dobler Corporation was forced into bankruptcy and is in the process of liquidating assets and paying claims. Unsecured claims will be paid at the rate of thirty cents on the dollar. Carson holds a note receivable from Dobler for $75,000 collateralized by an asset with a book value of $50,000 and a liquidation value of $25,000. The amount to be realized by Carson on this note is:
a. $25,000.
b. $40,000.
c. $50,000.
d. $75,000.

19. Bad Company filed a voluntary bankruptcy petition, and the statement of affairs reflected the following amounts:
Estimated
Assets Book Value Current Value
Assets pledged with fully secured creditors $ 900,000 $ 1,110,000
Assets pledged partially secured creditors 540,000 360,000
Free assets 1,260,000 960,000
$2,700,000 $2,430,000
Liabilities
Liabilities with priority $ 210,000
Fully secured creditors 780,000
Partially secured creditors 600,000
Unsecured creditors 1,620,000
$3,210,000

Assume the assets are converted to cash at their estimated current values. What amount of cash will be available to pay unsecured nonpriority claims?

a. $720,000.
b. $840,000.
c. $960,000.
d. $1,080,000.

20. The final settlement with unsecured creditors is computed by dividing:
a. total net realizable value by total unsecured creditor claims.
b. net free assets by total secured creditor claims.
c. total net realizable value by total secured creditor claims.
d. net free assets by total unsecured creditor claims.

21. Dodge Corporation entered into a troubled debt restructuring agreement with their local bank. The bank agreed to accept land with a carrying value of $200,000 and a fair value of $300,000 in exchange for a note with a carrying amount of $425,000. Ignoring income taxes, what amount should Dodge report as a gain on its income statement?
a. $0.
b. $100,000.
c. $125,000.
d. $225,000.

22. The following information pertains to the transfer of real estate in regards to a troubled debt restructuring by Drier Co. to Cole Co. in full settlement of Drier’s liability to Cole:

Carrying amount of liability settled $375,000
Carrying amount of real estate transferred $250,000
Fair value of real estate transferred $275,000

What amount should Drier report as ordinary gain (loss) on transfer of real estate?
a. $(25,000).
b. $25,000.
c. $100,000.
d. $125,000.

23. The following information pertains to the transfer of real estate in regards to a troubled debt restructuring by Drier Co. to Cole Co. in full settlement of Drier’s liability to Cole:

Carrying amount of liability settled $375,000
Carrying amount of real estate transferred $250,000
Fair value of real estate transferred $275,000

What amount should Cole report as a gain or (loss) on restructuring?
a. $100,000 ordinary loss.
b. $100,000 extraordinary loss.
c. $125,000 ordinary loss.
d. $125,000 extraordinary loss.

24. Poor Company filed a voluntary bankruptcy petition, and the settlement of affairs reflected the following amounts:

Estimated
Assets Book Value Current Value
Assets pledged with fully secured creditors $ 450,000 $ 555,000
Assets pledged partially secured creditors 270,000 180,000
Free assets 630,000 480,000
$1,350,000 $1,215,000

Liabilities
Liabilities with priority $ 105,000
Fully secured creditors 390,000
Partially secured creditors 300,000
Unsecured creditors 810,000
$1,605,000

Assume the assets are converted to cash to their estimated current values. What amount of cash will be available to pay unsecured nonpriority claims?
a. $360,000.
b. $420,000.
c. $480,000.
d. $540,000.

25. Dooley Corporation was forced into bankruptcy and is in the process of liquidating assets and paying claims. Unsecured claims will be paid at the rate of thirty cents on the dollar. Cerner holds a note receivable from Dooley for $90,000 collateralized by an asset with a book value of $60,000 and a liquidation value of $30,000. The amount to be realized by Cerner on this note is:
a. $30,000.
b. $48,000.
c. $60,000.
d. $90,000.

Problems

10-1 On January 1, 2011, Bargain Mart owed City Bank $1,600,000, under an 8% note with three years remaining to maturity. Due to financial difficulties, Bargain Mart was unable to pay the previous year’s interest. City Bank agreed to settle Bargain Mart’s debt in exchange for land having a fair market value of $1,310,000. Bargain Mart purchased the land in 2003 for $1,000,000.

Required:
Prepare the journal entries to record the restructuring of the debt by Bargain Mart.

10-2 On January 1, 2010, Gannon, Inc. owed BancCorp $12 million on a 10% note due December 31, 2011. Interest was last paid on December 31, 2008. Gannon was experiencing severe financial difficulties and asked BancCorp to modify the terms of the debt agreement. After negotiation BancCorp agreed to:
– Forgive the interest accrued for the year just ended,
– Reduce the remaining two years interest payments to $900,000 each and delay the first payment until December 31, 2011, and
– Reduce the unpaid principal amount to $9,600,000.

Required:
Prepare the journal entries for Gannon, Inc. necessitated by the restructuring of the debt at (1) January 1, 2010, (2) December 31, 2011, and (3) December 31, 2012.

10-3 On January 2, 2011 Stevens, Inc. was indebted to First Bank under a $12 million, 10% unsecured note. The note was signed January 2, 2005, and was due December 31, 2014. Annual interest was last paid on December 31, 2009. Stevens negotiated a restructuring of the terms of the debt agreement due to financial difficulties.

Required:
Prepare all journal entries for Stevens, Inc. to record the restructuring and any remaining transactions relating to the debt under each independent assumption.
A. First Bank agreed to settle the debt in exchange for land which cost Stevens $8,500,000 and has a fair market value of $10,000,000.
B. First Bank agreed to (1) forgive the accrued interest from last year (2) reduce the remaining four interest payments to $600,000 each, and (3) reduce the principal to $9,000,000.

10-4 On December 31, 2011, Community Bank agreed to restructure a $900,000, 8% loan receivable from Neer Corporation because of Neer’s financial problems. At December 31 there was $36,000 of accrued interest for a six-month period. Terms of the restructuring agreement are as follows:
– Reduce the loan from $900,000 to $600,000;
– Extend the maturity date by 2 years from December 31, 2011 to December 31, 2013;
– Reduce the interest rate on the loan from 8% to 6%.

Present value assumptions:
Present value of $1 for 2 years at 6% = 0.8900
Present value of $1 for 2 years at 8% = 0.8573
Present value of an ordinary annuity of $1 for 2 years at 6% = 1.8334
Present value of an ordinary annuity of $1 for 2 years at 8% = 1.7833

Required:
Compute the gain or loss that will be reported by Community Bank.

10-5 Donnelly Corporation incurred major losses in 2010 and entered into voluntary Chapter 7 bankruptcy in the early part of 2011. By June 1, all assets were converted into cash, the secured creditors were paid, and $150,000 in cash was left to pay the remaining claims as follows.

Accounts payable $ 48,000
Claims prior to the trustee’s appointment 21,000
Property taxes payable 18,000
Wages payable (all under $4,650 per employee) 54,000
Unsecured note payable 60,000
Accrued interest on the note payable 6,000
Administrative expenses of the trustee 30,000
Total $237,000

Required:
Classify the claims by their Chapter 7 priority ranking, and analyze which amounts will be paid and which amounts will be written off.

10-6 Davis Corporation filed a petition under Chapter 7 of the U.S. Bankruptcy Act on June 30, 2011. Data relevant to its financial position as of this date are:
Estimated Net
Book Value Realizable Values
Cash $ 3,000 $ 3,000
Accounts receivable-net 72,000 48,000
Inventories 60,000 72,000
Equipment-net 165,000 87,000
Total assets $300,000 $210,000

Accounts payable $ 72,000
Rent payable 21,000
Wages payable 45,000
Note payable plus accrued interest 96,000
Capital stock 180,000
Retained earnings (deficit) (120,000)
Total liabilities and equity $300,000

Required:
A. Prepare a statement of affairs assuming that the note payable and interest are secured by
a mortgage on the equipment and that wages are less than $4,650 per employee.
B. Estimate the amount that will be paid to each class of claims if priority liquidation expenses including trustee fees are $24,000 and estimated net realizable values are actually realized.

10-7 The following data are taken from the statement of affairs of Mitchell Company.

Assets pledged with fully secured creditors
(Realizable value, $635,000) $800,000
Assets pledged with partially secured creditors
(realizable value, $300,000) 365,000
Free assets (Realizable value, $340,000) 535,000
Fully secured creditor claims 316,000
Partially secured creditor claims 400,000
Unsecured creditor claims with priority 100,000
General unsecured creditor claims 1,165,000

Required:
Compute the amount that will be paid to each class of creditor.

10-8 On February 1, 2011, Hilton Company filed a petition for reorganization under the bankruptcy statutes. The court approved the plan on September 1, 2011, including the following provisions:

1. Accrued expenses of $21,930, representing priority items, are to be paid in full.
2. Hilton Company is to exchange accounts receivable in the face amount of $138,000 and an allowance for uncollectible accounts of $29,200 for the full settlement of $198,600 owed on open account to one of its major unsecured creditors. The estimated fair value of the receivables is $104,000.
3. Unsecured creditors of open accounts amounting to $91,600 and paid 40 cents on the dollar in full settlement.
4. Hilton Company’s only other major unsecured creditor agreed to a five-year extension of the $500,000 principal owed him on a 10% note payable. Accrued interest on the note on September 1, 2011, amounts to $45,000, one-third of which is to be paid in cash and the remainder canceled. In addition, no interest is to be charged during the remaining five years to maturity of the note.

Required:
Prepare journal entries on the books of Hilton Company to give effect to the preceding provisions.

Short Answer

1. The Bankruptcy Reform Act assigns priorities to certain unsecured claims, and each rank must be satisfied in full before the next–lower rank is paid. Identify the five categories of unsecured creditor claims.

2. Creditors are classified by law as either secured or unsecured. Distinguish among fully secured, partially secured, and unsecured creditors.

Short Answer Questions from the Textbook

1. List the primary types of contractual agreements between a debtor company and its creditors and briefly explain what is involved in each of them.

2. Distinguish between a voluntary and involuntary bankruptcy petition.

3. Distinguish among fully secured, partially se-cured, and unsecured claims of creditors.

4. Five priority categories of unsecured claims must be paid before general unsecured creditors are paid. Briefly describe what makes up each category.

5. What are “dividends” in a bankruptcy proceeding?

6. For each of the following debt restructurings, indicate whether a gain is recognized and, if so, how the gain is measured and reported. (a)Transfer of assets by the debtor to the creditor.(b)Grant of an equity interest by the debtor to the creditor.(c)Modification of the terms of the payable.

7. What is the purpose of a Statement of Affairs?

8. One of the officers of a corporation that had just received a discharge in bankruptcy said, “Good, now we don’t owe anyone.” Is he correct?

9. What are the duties of a trustee in a liquidation proceeding?

10. What is the purpose of a combining work paper prepared by a trustee?

11. What is the purpose of a realization and liquidation account?

Business Ethics Question from Textbook

From an ethical perspective, some believe that it is never justifiable for an individual or business to declare bankruptcy. Others believe that some actions are appropriate only in extreme circumstances. Without question, as stated in the Journal of Accountancy, November 2005,page 51, “the ease with which debtors have been able to walk away from debt has frustrated creditors for years.”
1. Describe the differences between Chapter 7 (liquidations) and Chapter 11 (reorganizations)from an ethical standpoint. Who is most likely to be hurt by a Chapter 7 bankruptcy?
2. Discuss the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Do you believe the changes wrought by this act will serve to protect creditors?
3. The Protection Act of 2005 requires individuals, but not businesses, to undergo a “means” test before they can seek Chapter 7 relief. Do you believe this change should be applied to businesses as well? Why or why not?
4. Do you think that you would ever resort to filing for bankruptcy relief yourself? Why or why not?
Chapter 11

International Financial Reporting Standards

Multiple Choice—Conceptual

1. The goals of the International Accounting Standards Committee include all of the following except
a. To improve international accounting.
b. To formulate a single set of auditing standards to be applied in all countries.
c. To promote global acceptance of its standards.
d. To harmonize accounting practices between countries.

2. Which of the following is true about the FASB after the mandatory adoption of IFRS by US companies?
a. The FASB will serve in an advisory capacity to the IASB.
b. The FASB will remain the designated standard-setter for US companies, but incorporate IFRS into US GAAP.
c. The role of the FASB post-IFRS adoption has not been determined.
d. The FASB will cease to exist.

3. Milestones in the transition plan for mandatory adoption of IFRS by US companies include all of the following except:
a. Improvements in accounting standards.
b. Limited early adoption of IFRS in an effort to enhance comparability for US investors
c. Mandatory use of IFRS by US entities.
d. All of the above are milestones in the transition plan for mandatory adoption of IFRS by US companies.

4. The roles of the IASC Foundation include
a. establishing global standards for financial reporting.
b. coordinating the filing requirements of stock exchange regulatory agencies.
c. financing IASB operations.
d. all of the above are roles of the IASC Foundation.

5. Which of the following statements is true regarding the IASC?
a. The IASC is a public-sector, not-for-profit organization.
b. The IASC is accountable to an international securities regulator.
c. The IASC is a stand-alone, private-sector organization.
d. The IASC funds the operations of the IASB through filing fees paid to national securities regulators.

6. . Concerns of the SEC with regard to the mandatory adoption of IFRS by US entities include all of the following except:
a. the extent to which the standard-setting process addresses emerging issues in a timely manner.
b. the security and stability of IASC funding.
c. the enhancement of IASB independence through a system of voluntary contributions from firms in the accounting profession.
d. the degree to which due process is integrated into the standard-setting process .

7. . Under the staged transition to mandatory adoption of IFRS being considered by the SEC,
a. large, accelerated filers would begin IFRS filings for fiscal years beginning on or after December 31, 2011.
b. non-accelerated filers would begin IFRS filings for fiscal years beginning on or after December 31, 2015.
c. large non-accelerated filers would have until fiscal years beginning on or after December 15, 2017 to adopt IFRS.
d. smaller reporting companies would begin IFRS filings for fiscal years beginning on or after December 15, 2016.
.
8. In order to complete its first IFRS filing, including three years of audited financial statements, according to the staged transition to mandatory adoption of IFRS considered by the SEC, a large accelerated filer would need to adopt IFRS beginning in fiscal year
a. 2011.
b. 2012.
c. 2013.
d. 2014.

9. Benefits of the FASB Accounting Standards Codification (ASC) include all of the following except
a. increases the independence of the FASB.
b. aids in the convergence of US GAAP with IFRS.
c. reduces time and effort required to research accounting issues.
d. clearly distinguishes between authoritative and non-authoritative guidance.

10. SFAS No.162, the Accounting Standards Codification, is directed to
a. auditors.
b. Boards of Directors.
c. securities regulators.
d. entities.

11. IFRS and US GAAP differ with regard to financial statement presentation in all of the following except
a. IFRS generally requires that assets be listed in order of increasing liquidity while US GAAP requires that assets be listed in order of decreasing liquidity.
b. US GAAP requires expenses to be listed by function while IFRS requires expenses to be listed by nature.
c. IFRS prohibits extraordinary items which are allowed by US GAAP.
d. IFRS requires two years of comparative income statements while under US GAAP, three years of income statements are required.

12. The major difference between IFRS and US GAAP in accounting for inventories is that
a. US GAAP prohibits the use of specific identification.
b. IFRS requires the use of the LIFO cost flow assumption.
c. US GAAP prohibits the use of the LIFO cost flow assumption
d. US GAAP allows the use of the LIFO cost flow assumption.

13. One difference between IFRS and GAAP in valuing inventories is that
a. IFRS, but not GAAP, allows reversals so that inventories written down under lower-of-cost-or-market can be written back up to the original cost .
b. GAAP defines market value as replacement cost where IFRS defines market as the selling price.
c. GAAP strictly adheres to the historical cost concept and does not allow for write-downs of inventory values while IFRS embraces fair value.
d. IFRS, but not GAAP, requires that inventories be valued at the lower of cost or market.

14. In accounting for research and development costs.
a. the general rule under both US GAAP and IFRS is that research and development costs should be expensed as incurred .
b. IFRS generally expenses all research and development costs while US GAAP expenses research costs as incurred but capitalizes development costs once technological and economic feasibility has been demonstrated.
c. US GAAP generally expenses all research and development costs while IFRS expenses research costs as incurred but capitalizes development costs once technological and economic feasibility has been demonstrated.
d. both US GAAP and IFRS expense research costs as incurred but capitalize development costs once technological and economic feasibility has been demonstrated.
.
15. Property, plant and equipment are valued at
a. historical cost under both IFRS and US GAAP.
b. historical cost or revalued amounts under both IFRS and US GAAP.
c. revalued amounts under IFRS.
d. historical cost under US GAAP while IFRS allows the assets to be valued at either historical cost or revalued amounts.

16. The amount of a long-lived asset impairment loss is generally determined by comparing
a. the asset’s carrying amount and its fair value under US GAAP.
b. the asset’s carrying amount and its discounted future cash flows less cost to sell under IFRS.
c. the asset’s carrying amount and its undiscounted future cash flows under US GAAP.
d. the asset’s carrying amount and its undiscounted future cash flows less disposal cost under IFRS.

17. In accounting for liabilities, IFRS interprets “probable” as
a. likely.
b. more likely than not.
c. somewhat possible.
d. possible and not remote.

18. Accounting under IFRS and US GAAP is similar for all of the following topics except
a. changes in estimates.
b. related party transactions.
c. research and development costs.
d. changes in methods.

Use the following information to answer the next three questions.

On January 1, 2010, AirFrance purchases an airplane for €14,400,000. The components of the airplane and their useful lives are as follows:

Component Cost Useful life
Frame €7,200,000 24 years
Engine 4,800,000 20 years
Other 2,400,000 10 years

AirFrance uses the straight-line method of depreciation. The asset is assumed to have no salvage value.

19. Under IFRS, the entry to record the acquisition of the airplane would include
a. a debit to Asset/ Airplane of €14,400,000.
b. a debit to Asset/ Airplane frame of €14,400,000.
c. a debit to Asset/ Airplane engine of €4,800,000.
d. cannot be determined from the information given.

20. Under US GAAP, the entry to record depreciation expense on the asset at December 31, 2011 will include
a. a credit to accumulated depreciation of €1,200,000.
b. a debit to depreciation expense of €1,440,000
c. a debit to depreciation expense of €800,000.
d. a credit to accumulated depreciation of €600,000.

21. Under IFRS, the entry to record depreciation expense on the asset at December 31, 2011 will include a credit to accumulated depreciation of
a. €1,440,000.
b. €1,200,000
c. €800,000.
d. €600,000.

22. Accounting terminology that differs between IFRS and US GAAP include all of the following except
a. the use by IFRS of “turnover” for revenue.
b. the use by IFRS of “share premium” for additional paid-in-capital.
c. the use by IFRS of “other capital reserves” for retained earnings.
d. the use by IFRS of “issued capital” for common stock.

23. New terminology introduced under the joint IFRS- US GAAP Customer Consideration (Allocation) Model includes all of the following except
a. revenue recognition voids.
b. contract rights.
c. net contract asset/ liability.
d. performance obligations.

24. Under IFRS, the criteria to determine whether a lease should be capitalized include
a. the present value of the minimum lease payments is 90% or more of the fair value of the asset at the inception of the lease.
b. the term of the lease is 75% or more of the economic life of the asset.
c. the term of the lease is equal to substantially all of the economic life of the asset.
d. the present value of the minimum lease payments is equal to substantially all of the fair value of the asset at the inception of the lease.

Use the following information to answer the next three questions.

Bellingham Electronics Inc. offers one model of laptop computer for £1000 and a two-year warranty for £250. The retailer, as part of a Boxing Day promotion, offers a limited-time offer for the laptop, including delivery and the two-year warranty for £1,180. The cost of the computer to Bellingham is £700. Any warranty repairs are assumed to be done ratably over time. Bellingham accounts for transactions using the customer consideration model.

In the first twelve months following the sale, Bellingham incurred £980 of costs servicing the computers under warranty.

25. Bellingham sells ten laptops to Bertram Inc. under the limited-time promotion. Upon delivery of the laptops to Bertram, Bellingham will recognize revenue of
a. £9,300.
b. £9,440
c. £10,000.
d. £11,800.

26. In the first twelve months following the sale, Bellingham would reduce the Contract liability – warranty account by
a. £784.
b. £980
c. £1,180.
d. £1,380.

27. In the first twelve months, Bellingham would record warranty expense of
a. £784.
b. £980
c. £1,180.
d. £1,380.

28. Significant differences between IFRS and Chinese GAAP include all of the following except
a. Chinese GAAP allows the use of LIFO while IFRS prohibits it.
b. Chinese GAAP has different related party disclosure requirements.
c. Chinese GAAP follows the cost principle while IFRS allows for revaluations and recoveries of impairment losses.
d. Chinese GAAP uses the equity method of accounting for jointly controlled entities while IFRS also allows proportionate consolidation.

29. All of the following are options for non-US companies who wish to list securities on a US exchange except
a. The company can use either IFRS or their local GAAP.
b. If a company uses their local GAAP they must reconcile net income and shareholders’ equity or fully disclose all financial information required of US companies.
c. If a company uses their local GAAP they must reconcile net income and shareholders’ equity and fully disclose all financial information required of US companies
d. The company must file a form 20-F with the SEC.

30. All of the following are true regarding American Depository Receipts (ADRs) except
a. Most ADRs are unsponsored, meaning that the DR bank creates a DR program without a formal agreement with the issuing non-US company.
b. An ADR is a derivative instrument traded in the US that usually represents a fixed number of publicly traded shares of a non-US company.
c. ADRs are denominated in US dollars.
d. A Level 1 sponsored ADR is the easiest way for a non-US company to access US markets.

Exercise from the Textbook

Exercise 11-1

Component Depreciation SMC Company purchases a building for $100,000. Included in this cost are $12,000 for electrical systems and $15,000 for the roof. The building is expected to have a 40 year useful life, but the electrical system will last for 20 years and the roof will last 15 years.

Required: Part A: Assuming that straight-line depreciation is used, compute depreciation expense assuming that U.S. GAAP is used.

Part B: Assuming that straight line depreciation is used, compute depreciation expense for year one assuming IFRS is used (assume component depreciation).

Problem from the Textbook

Problem 11-4

Prepare a statement of financial position using the proposed new format as described in the chapter.

Questions from the Textbook

1. As mentioned in Chapter 1, the project on business combinations was the first of several joint projects undertaken by the FASB and the IASB in their move to converge standards globally. Nonetheless, complete convergence has not yet occurred, and there are those who believe it to be a poor idea. Discuss the reasons for and against global convergence.

2. In recent months, virtually every topic that has come to the attention of the standard setters has been undertaken as a joint effort of the FASB and the IASB rather than as an individual effort by one of the two boards. List and discuss some of the joint projects that fall into this category.
3. What is the rationale for the harmonization of international accounting standards?

4. Why is the SEC, once so reluctant to accept IAS, now very willing to allow firms using IFRS to is-sue securities in the U.S. stock market without reconciling to U.S. GAAP?

5. Discuss the types of ADRs that non-U.S. companies might use to access the U.S. markets.

6. Describe the attitude of the FASB toward the IASB (International Accounting Standards Board).

7. How does the FASB view its role in the development of an international accounting system? Currently, two members of the IASB board were affiliated with the FASB. Comment on what effect this might have on the likelihood that the U.S. standard setters will accept the new IASB statements, if any?

8. List some of the major differences in accounting between IFRS and U.S. GAAP.

Business Ethics Question from the Textbook

A vice president of marketing for your company has been charged with embezzling nearly $100,000 from the company. The vice president allegedly submitted fraudulent vendor invoices in order to receive payments. As the vice president of marketing for the company, the vice president is authorized to approve the payment of invoices submitted by third-party vendors who did work for the company. After the activities were uncovered, the company responded by stating: “All employees are accountable to our ethics guidelines and procedures. We do not tolerate violations of our ethics policy and will consistently enforce these policies and procedures.”

1. How would you evaluate the internal controls of the company?

2. Do you think there are companies that develop comprehensive ethics and compliance pro-grams for mid- and lower-level employees and ignore upper-level executives and managers?

3. Is it an ethical issue if companies are not forth-coming concerning fraudulent activities of top executives in an effort to minimize negative publicity?

Chapter 12

Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk

Multiple Choice

1. A discount or premium on a forward contract is deferred and included in the measurement of the related foreign currency transaction if the contract is classified as a:
a. hedge of a net investment in a foreign entity.
b. hedge of an exposed asset or liability position.
c. hedge of an identifiable foreign currency commitment.
d. contract acquired to speculate in the movement of exchange rates.

2. The discount or premium on a forward contract entered into as a hedge of an exposed asset or liability position should be:
a. included as a separate component of stockholders’ equity.
b. amortized over the life of the forward contract.
c. deferred and included in the measurement of related foreign currency transaction.
d. none of these.

3. An indirect exchange rate quotation is one in which the exchange rate is quoted:
a. in terms of how many units of the domestic currency can be converted into one unit of foreign currency.
b. for the immediate delivery of currencies exchanged.
c. in terms of how many units of the foreign currency can be converted into one unit of domestic currency.
d. for the future delivery of currencies exchanged.

4. A transaction gain is recorded when there is an:
a. importing transaction and the exchange rate increases.
b. exporting transaction and the exchange rate increases.
c. exporting transaction and the exchange rate decreases.
d. none of these.

5. During 2011, a U.S. company purchased inventory from a foreign supplier. The transaction was denominated in the local currency of the seller. The direct exchange rate increased from the date of the transaction to the balance sheet date. The exchange rate decreased from the balance sheet date to the settlement date in 2012. For the years 2011 and 2012, transaction gains or losses should be recognized as:
2011 2012
a. gain gain
b. gain loss
c. loss loss
d. loss gain

6. A transaction gain or loss is reported currently in the determination of income if the purpose of the forward contract is to:
a. hedge a net investment in a foreign entity.
b. hedge an identifiable foreign currency commitment.
c. speculate in foreign currency.
d. none of these.

7. On November 1, 2011, American Company sold inventory to a foreign customer. The account will be settled on March 1 with the receipt of $500,000 foreign currency units (FCU). On November 1, American also entered into a forward contract to hedge the exposed asset. The forward rate is $0.70 per unit of foreign currency. American has a December 31 fiscal year-end. Spot rates on relevant dates were:

Per Unit of
Date Foreign Currency
November 1 $0.73
December 31 0.71
March 1 0.74

The entry to record the forward contract is
a. FCU Receivable 350,000
Premium on Forward Contract 15,000
Dollars Payable 365,000

b. Dollars Receivable 365,000
Discount on Forward Contract 15,000
FCU Payable 350,000

c. FCU Receivable 365,000
Discount on Forward Contract 15,000
Dollars Payable 350,000

d. Dollars Receivable 350,000
Discount on Forward Contract 15,000
FCU Payable 365,000

8. On November 1, 2011, American Company sold inventory to a foreign customer. The account will be settled on March 1 with the receipt of $450,000 foreign currency units (FCU). On November 1, American also entered into a forward contract to hedge the exposed asset. The forward rate is $0.70 per unit of foreign currency. American has a December 31 fiscal year-end. Spot rates on relevant dates were:

Per Unit of
Date Foreign Currency
November 1 $0.73
December 31 0.71
March 1 0.74

What will be the adjusted balance in the Accounts Receivable account on December 31, and how much gain or loss was recorded as a result of the adjustment?

Receivable Balance Gain/Loss Recorded
a. $319,500 $9,000 gain
b. $319,500 $9,000 loss
c. $333,000 $4,500 gain
d. $333,000 $18,000 gain

9. A transaction gain or loss at the settlement date is:
a. a change in the exchange rate quoted by a foreign exchange trader.
b. synonymous with the translation of foreign currency financial statements into dollars.
c. the difference between the recorded dollar amount of an account receivable denominated in a foreign currency and the amount of dollars received.
d. the difference between the buying and selling rate quoted by a foreign exchange trader at the settlement date.

10. From the viewpoint of a U.S. company, a foreign currency transaction is a transaction:
a. measured in a foreign currency.
b. denominated in a foreign currency.
c. measured in U.S. currency.
d. denominated in U.S. currency.

11. The exchange rate quoted for future delivery of foreign currency is the definition of a(n):
a. direct exchange rate.
b. indirect exchange rate.
c. spot rate.
d. forward exchange rate.

12. A transaction loss would result from:
a. an increase in the exchange rate applicable to an asset denominated in a foreign currency.
b. a decrease in the exchange rate applicable to a liability denominated in a foreign currency.
c. the import of merchandise when the transaction is denominated in a foreign currency.
d. a decrease in the exchange rate applicable to an asset denominated in a foreign currency.

13. The forward exchange rate quoted for the remaining term of a forward contract is used to account for the contract when the forward contract:
a. extends beyond one year or the current operating cycle.
b. is a hedge of an identifiable foreign currency commitment.
c. is a hedge of an exposed net liability position.
d. was acquired to speculate in foreign currency.

14. A transaction gain or loss on a forward contract entered into as a hedge of an identifiable foreign currency commitment may be:
a. included as a separate item in the stockholders’ equity section of the balance sheet.
b. recognized currently in the determination of net income.
c. deferred and included in the measurement of the related foreign currency transaction.
d. none of these.

15. Craiger, Inc. a U.S. corporation, bought machine parts from Reinsch Company of Germany on March 1, 2011, for 70,000 marks, when the spot rate for marks was $0.5395. Craiger’s year-end was March 31, 2011, when the spot rate for marks was $0.5445. Craiger bought 70,000 marks and paid the invoice on April 20, 2011, when the spot rate was $0.5495. How much should be shown in Craiger’s income statements as foreign exchange (transaction) gain or loss for the years ended March 31, 2011 and 2012?

2011 2012
a. $0 $0
b. $0 $350 loss
c. $350 loss $0
d. $350 loss $350 loss

16. A forward exchange contract is transacted at a discount if the current forward rate is:
a. less than the expected spot rate.
b. more than the expected spot rate.
c. less than the current spot rate.
d. more than the current spot rate.

17. Stuart Corporation a U.S. company, contracted to purchase foreign goods. Payment in foreign currency was due one month after delivery. Between the delivery date and the time of payment, the exchange rate changed in Stuart’s favor. The resulting gain should be reported in the financial statements as a(n):
a. component of other comprehensive income.
b. component of income from continuing operations.
c. extraordinary income.
d. deferred income.

18. Jackson Paving Company purchased equipment for 350,000 British pounds from a supplier in London on July 7, 2011. Payment in British pounds is due on Sept. 7, 2011. The exchange rates to purchase one pound is as follows:
July 7 August 31, (year end) September 7
Spot-rate 2.08 2.05 2.04
30-day rate 2.07 2.03 —
60-day rate 2.06 1.99 —

On its August 31, 2011 income statement, what amount should Jackson Paving report as a foreign exchange transaction gain:
a. $14,000.
b. $7,000.
c. $10,500.
d. $0.

19. On September 1, 2011, Swash Plating Company entered into two forward exchange contracts to purchase 250,000 euros each in 90 days. The relevant exchange rates are as follows:

Forward Rate
Spot rate For Dec. 1, 2011
September 1, 2011 1.46 1.47
September 30, 2011 (year-end) 1.50 1.48

The first forward contract was to hedge a purchase of inventory on September 1, payable on December 1. On September 30, what amount of foreign currency transaction loss should Swash Plating report in income?
a. $0.
b. $2,500.
c. $5,000.
d. $10,000.

20. On September 1, 2011, Swash Plating Company entered into two forward exchange contracts to purchase 250,000 euros each in 90 days. The relevant exchange rates are as follows:

Forward Rate
Spot rate For Dec. 1, 2011
September 1, 2011 1.46 1.47
September 30, 2011 (year-end) 1.50 1.48

The second forward contract was strictly for speculation. On September 30, 2011, what amount of foreign currency transaction gain should Swash Plating report in income?
a. $0.
b. $2,500.
c. $5,000.
d. $10,000.

21. On November 1, 2011, Prism Company sold inventory to a foreign customer. The account will be settled on March 1 with the receipt of 250,000 foreign currency units (FCU). On November 1, Prism also entered into a forward contract to hedge the exposed asset. The forward rate is $0.90 per unit of foreign currency. Prism has a December 31 fiscal year-end. Spot rates on relevant dates were:

Per Unit of
Date Foreign Currency
November 1 $0.93
December 31 0.91
March 1 0.94

The entry to record the forward contract is
a. FCU Receivable 225,000
Premium on Forward Contract 7,500
Dollars Payable 232,500

b. Dollars Receivable 232,500
Discount on Forward Contract 7,500
FCU Payable 225,000

c. FCU Receivable 232,500
Discount on Forward Contract 7,500
Dollars Payable 225,000

d. Dollars Receivable 225,000
Discount on Forward Contract 7,500
FCU Payable 232,500

22. On November 1, 2011, National Company sold inventory to a foreign customer. The account will be settled on March 1 with the receipt of 200,000 foreign currency units (FCU). On November 1, National also entered into a forward contract to hedge the exposed asset. The forward rate is $0.80 per unit of foreign currency. National has a December 31 fiscal year-end. Spot rates on relevant dates were:

Per Unit of
Date Foreign Currency
November 1 $0.83
December 31 0.81
March 1 0.84

What will be the adjusted balance in the Accounts Receivable account on December 31, and how much gain or loss was recorded as a result of the adjustment?

Receivable Balance Gain/Loss Recorded
a. $170,000 $4,000 gain
b. $162,000 $4,000 loss
c. $168,000 $2,000 gain
d. $164,000 $2,000 loss

23. Caldron Company purchased equipment for 375,000 British pounds from a supplier in London on July 3, 2011. Payment in British pounds is due on Sept. 3, 2011. The exchange rates to purchase one pound is as follows:
July 3 August 31, (year end) September 3
Spot-rate 1.58 1.55 1.54
30-day rate 1.57 1.53 —
60-day rate 1.56 1.49 —

On its August 31, 2011, income statement, what amount should Caldron report as a foreign exchange transaction gain:
a. $18,750.
b. $3,750.
c. $11,250.
d. $0.

24. On April 1, 2011, Trent Company entered into two forward exchange contracts to purchase 300,000 euros each in 90 days. The relevant exchange rates are as follows:

Forward Rate
Spot rate For Aug. 1, 2011
April 1, 2011 1.16 1.17
April 30, 2011 (year-end) 1.20 1.18

The first forward contract was to hedge a purchase of inventory on April 1, payable on December 1. On April 30, what amount of foreign currency transaction loss should Trent report in income?
a. $0.
b. $3,000.
c. $9,000.
d. $12,000.

25. On April 1, 2011, Trent Company entered into two forward exchange contracts to purchase 300,000 euros each in 90 days. The relevant exchange rates are as follows:

Forward Rate
Spot rate For Aug. 1, 2011
April 1, 2011 1.16 1.17
April 30, 2011 (year-end) 1.20 1.18

The second forward contract was strictly for speculation. On April 30, 2011, what amount of foreign currency transaction gain should Trent report in income.
a. $0.
b. $3,000.
c. $9,000.
d. $12,000.

Problems

12-1 On November 1, 2010, Dorsey Company sold inventory to a company in England. The sale was for 600,000 British pounds and payment will be received on February 1, 2011. On November 1, Dorsey entered into a forward contract to sell 600,000 British pounds on February 1 at the forward rate of $1.65. Spot rates for the British pound are as follows:
November 1 $1.61
December 31 1.67
February 1 1.62

Dorsey has a December 31 fiscal year-end.

Required:
Compute each of the following:

1. The dollars to be received on February 1, 2011, from selling the 600,000 pounds to the exchange dealer.

2. The dollars that would have been received from the account receivable if Dorsey had not hedged the sale contract with the forward contract.

3. The discount or premium on the forward contract.

4. The transaction gain or loss on the exposed asset related to the sale in 2010 and 2011.

5. The transaction gain or loss on the forward contract in 2010 and 2011.

6. The amount of the discount or premium on the forward contract amortized in 2010 and 2011.

12-2 On December 1, 2010, Derrick Corporation agreed to purchase a machine to be manufactured by a company in Brazil. The purchase price is 1,150,000 Brazilian reals. To hedge against fluctuations in the exchange rate, Derrick entered into a forward contract on December 1 to buy 1,150,000 reals on April 1, the agreed date of machine delivery, for $0.375 per real. The following exchange rates were quoted:
Forward Rate
Date Spot Rate (Delivery on 4/1)
December 1 0.390 0.375
December 31 0.370 0.373
April 1 0.385 —

Required:
Prepare journal entries necessary for Derrick during 2010 and 2011 to account for the transactions described above.

12-3 Colony Corp., a U.S. corporation, entered into a contract on November 1, 2010, to sell two machines to Crown Company, for 95,000 foreign currency units (FCU). The machines were to be delivered and the amount collected on March 1, 2011.

In order to hedge its commitment, Colony entered into a forward contract for 95,000 FCU delivery on March 1, 2011. The forward contract met all conditions for hedging an identifiable foreign currency commitment.

Selected exchange rates for FCU at various dates were as follows:

November 1, 2010 – Spot rate $1.3076
Forward rate for delivery on March 1, 2011 1.2980
December 31, 2010 – Spot rate 1.3060
Forward rate for delivery on March 1, 2011 1.3150
March 1, 2011 – Spot rate 1.2972

Required:
Prepare all journal entries relative to the above on the books of Colony Corp. on the following dates:
1. November 1, 2010.
2. Year-end adjustments on December 31, 2010.
3. March 1, 2011. (Include all adjustments related to the forward contract.)

12-4 On October 1, 2010, Nance Company purchased inventory from a foreign customer for 750,000 units of foreign currency (FCU) due on January 31, 2011. Simultaneously, Nance entered into a forward contract for 750,000 units of FC for delivery on January 31, 2011, at the forward rate of $0.75. Payment was made to the foreign customer on January 31, 2011. Spot rates on October 1, December 31, and January 31, were $0.72, $0.73, and $0.76, respectively. Nance amortizes all premiums and discounts on forward contracts and closes its books on December 31.

Required:

A. Prepare all journal entries relative to the above to be made by Nance on October 1, 2010.
B. Prepare all journal entries relative to the above to be made by Nance on December 31, 2010.
C. Compute the transaction gain or loss on the forward contract that would be recorded in 2011. Indicate clearly whether the amount is a gain or loss.

12-5 On October 1, 2010, Kline Company shipped equipment to a foreign customer for a foreign currency (FC) price of FC 3,000,000 due on January 31, 2011. All revenue realization criteria were satisfied and accordingly the sale was recorded by Kline Company on October 1. Simultaneously, Kline entered into a forward contract to sell 3,000,000 FCU on January 31, 2011 for $1,200,000. Payment was received from the foreign customer on January 31, 2011. Spot rates on October 1, December 31, and January 31 were $0.42, $0.425, and $0.435, respectively. Kline amortizes all premiums and discounts on forward contracts and closes its books on December 31.

Required:
Prepare all journal entries relative to the above to be made by Kline during 2010 and 2011.

12-6 On July 15, Worth, Inc. purchased 88,500,000 yen worth of parts from a Tokyo company paying 20% down, and the balance is due in 90 days. Interest is payable at a rate of 8% on the unpaid balance. The exchange rate on July 15, was $1.00 = 118 Japanese yen. On October 13, the exchange rate was $1.00 = 114 Japanese yen.

Required:
Prepare journal entries to record the purchase and payment of this foreign currency transaction in U.S. dollars.

12-7 On November 1, 2010, Bisk Corporation, a calendar-year U.S. Corporation, invested in a speculative contract to purchase 700,000 euros on January 31, 2011, from a German brokerage firm. Bisk agreed to buy 700,000 euros at a fixed price of $1.46 per euro. The brokerage firm agreed to send 700,000 euros to Bisk on January 31, 2011. The spot rates for euros are:

November 1, 2010 1 euro = 1.45
December 31, 2010 1 euro = 1.43
January 31, 2011 1 euro = 1.44
Required:
Prepare the journal entries that Bisk would record on November 1, December 31, and January 31.

12-8 Consider the following information:

1. On November 1, 2011, a U.S. firm contracts to sell equipment (with an asking price of 500,000 pesos) in Mexico. The firm will take delivery and will pay for the equipment on February 1, 2012.

2. On November 1, 2011, the company enters into a forward contract to sell 500,000 pesos for $0.0948 on February 1, 2012.

3. Spot rates and the forward rates for February 1, 2012, settlement were as follows (dollars per peso):

Forward Rate
Spot Rate for 2/1/12
November 1, 2011 $0.0954 $0.0948
Balance sheet date (12/31/11) 0.0949 0.0944
February 1, 2012 0.0947

4. On February 1, the equipment was sold for 500,000 pesos. The cost of the equipment was $20,000.

Required:
Prepare all journal entries needed on November 1, December 31, and February 1 to account for the forward contract, the firm commitment, and the transaction to sell the equipment.

Short Answer

1. Accounting for a foreign currency transaction involves the terms measured and denominated. Describe a foreign currency transaction and distinguish between the terms measured and denominated.
2. There are a number of business situations in which a firm may acquire a forward exchange contract. Identify three common situations in which a forward exchange contract can be used as a hedge.

Short Answer Questions from the Textbook

1. Define currency exchange rates and distinguish between “direct” and “indirect” quotations.

2. Explain why a firm is exposed to an added risk when it enters into a transaction that is to be settled in a foreign currency.

3. Name the three stages of concern to the accountant in accounting for import–export transactions. Briefly explain the accounting for each stage.

4. How should a transaction gain or loss be reported that is related to an unsettled receivable recorded when the firm’s inventory was exported?

5. A U.S. firm carried a receivable for 100,000 yen. Assuming that the direct exchange rate declined from $.009 at the date of the transaction to $.006at the balance sheet date, compute the transaction gain or loss. What balance would be reported for the receivable in the firm’s balance sheet?

6. Explain what is meant by the “two-transaction method” in recording exporting or importing trans-actions. What support is given for this method?

7. Describe a forward exchange contract.

8. Explain the effects on income from hedging a foreign currency exposed net asset position or net liability position.

9. What criteria must be satisfied for a foreign currency transaction to be considered a hedge of an identifiable foreign currency commitment?

10. The FASB classifies forward contracts as those acquired for the purpose of hedging and those acquired for the purpose of speculation. What main differences are there in accounting for these two classifications?

11. How are foreign currency exchange gains and losses from hedging a forecasted transaction handled?

12. What is a put option, and how might it be used to hedge a forecasted transaction?

13. Define a derivative instrument, and describe the keystones identified by the FASB for the ac-counting for such instruments.

14. Differentiate between forward-based derivatives and option-based derivatives.

15. List some of the criteria laid out by the FASB that are required for a gain or loss on forecasted trans-actions (a cash flow hedge) to be excluded from the income statement. If these criteria are satisfied, where are the gains or losses reported, and when (if ever) are they shown in the income statement? What is the rationale for this treatment?

Business Ethics Question from Textbook

Executive stock options (ESOs) are used to provide incentives for executives to improve company performance. ESOs are usually granted “at-the-money,” meaning that the exercise price of the options is set to equal the market price of the underlying stock on the grant date. Clearly, executives would prefer to be granted options when the stock price (and thus the exercise price) is at its lowest. Backdating options is the practice of choosing a past date when the market price was particularly low. Backdating has not, in the past, been illegal if no documents are forged, if communicated to the shareholders, and if properly reflected in earnings and in taxes.

1. Since backdating gives the executive an “instant” profit, why wouldn’t the firm simply grant an option with the exercise price lower than the cur-rent market price?

2. Suppose the executive was not involved in back-dating the ESOs. Does the executive face any ethical issues?

Chapter 13

Translation of Financial Statements of Foreign Affiliates

Multiple Choice

1. When translating foreign currency financial statements for a company whose functional currency is the U.S. dollar, which of the following accounts is translated using historical exchange rates?

Notes Payable Equipment
a. Yes Yes
b. Yes No
c. No No
d. No Yes

2. Under the temporal method, monetary assets and liabilities are translated by using the exchange rate existing at the:
a. beginning of the current year.
b. date the transaction occurred.
c. balance sheet date.
d. None of these.

3. The process of translating the accounts of a foreign entity into its functional currency when they are stated in another currency is called:
a. verification.
b. translation.
c. remeasurement.
d. None of these.

4. Which of the following would be restated using the average exchange rate under the temporal method?
a. cost of goods sold
b. depreciation expense
c. amortization expense
d. None of these

5. Paid-in capital accounts are translated using the historical exchange rate under:
a. the current rate method only.
b. the temporal method only.
c. both the current rate and temporal methods.
d. neither the current rate nor temporal methods.

6. Which of the following would be restated using the current exchange rate under the temporal method?
a. Marketable securities carried at cost.
b. Inventory carried at market.
c. Common stock.
d. None of these.

7. The translation adjustment that results from translating the financial statements of a foreign subsidiary using the current rate method should be:
a. included as a separate item in the stockholders’ equity section of the balance sheet.
b. included in the determination of net income for the period it occurs.
c. deferred and amortized over a period not to exceed forty years.
d. deferred until a subsequent year when a loss occurs and offset against that loss.

8. Average exchange rates are used to translate certain items from foreign financial statements into U.S. dollars. Such averages are used in order to:
a. smooth out large translation gains and losses.
b. eliminate temporary fluctuation in exchange rates that may be reversed in the next fiscal period.
c. avoid using different exchange rates for some revenue and expense accounts.
d. approximate the exchange rate in effect when the items were recognized.

9. When the functional currency is identified as the U.S. dollar, land purchased by a foreign subsidiary after the controlling interest was acquired by the parent company should be translated using the:
a. historical rate in effect when the land was purchased.
b. current rate in effect at the balance sheet date.
c. forward rate.
d. average exchange rate for the current period.

10. The appropriate exchange rate for translating a plant asset in the balance sheet of a foreign subsidiary in which the functional currency is the U.S. dollar is the:
a. current exchange rate.
b. average exchange rate for the current year.
c. historical exchange rate in effect when the plant asset was acquired or the date of acquisition, whichever is later.
d. forward rate.

11. The following balance sheet accounts of a foreign subsidiary at December 31, 2011, have been translated into U.S. dollars as follows:
Translated at
Current Rates Historical Rates
Accounts receivable, current $ 600,000 $ 660,000
Accounts receivable, long-term 300,000 324,000
Inventories carried at market 180,000 198,000
Goodwill 190,000 220,000
$1,270,000 $1,402,000

What total should be included in the translated balance sheet at December 31, 2011, for the above items? Assume the U.S. dollar is the functional currency.
a. $1,270,000
b. $1,288,000
c. $1,300,000
d. $1,354,000

12. A foreign subsidiary’s functional currency is its local currency which has not experienced significant inflation. The weighted average exchange rate for the current year would be the appropriate exchange rate for translating

Wages expense Sales to customers
a. Yes Yes
b. Yes No
c. No No
d. No Yes

13. A wholly owned subsidiary of a U.S. parent company has certain expense accounts for the year ended December 31, 2011, stated in local currency units (LCU) as follows:
LCU
Depreciation of equipment (related assets
were purchased January 1, 2009) 375,000
Provision for doubtful accounts 250,000
Rent 625,000

The exchange rates at various dates are as follows:
Dollar equivalent
of 1 LCU
December 31, 2011 $0.50
Average for year ended December 31, 2011 0.55
January 1, 2009 0.40

Assume that the LCU is the subsidiary’s functional currency and that the charges to the expense accounts occurred approximately evenly during the year. What total dollar amount should be included in the translated income statement to reflect these expenses?

a. $687,500
b. $625,000
c. $550,000
d. $500,000

14. If the functional currency is determined to be the U.S. dollar and its financial statements are prepared in the local currency, SFAS 52, requires which of the following procedures to be followed?
a. Translate the financial statements into U.S. dollars using the current rate method.
b. Remeasure the financial statements into U.S. dollars using the temporal method.
c. Translate the financial statements into U.S. dollars using the temporal method.
d. Remeasure the financial statements into U.S. dollars using the current rate method.

15. P Company acquired 90% of the outstanding common stock of S Company which is a foreign company. The acquisition was accounted for using the purchase method. In preparing consolidated statements, the paid-in capital of S Company should be converted at the:
a. exchange rate effective when S Company was organized.
b. exchange rate effective on the date of purchase of the stock of S Company by P Company.
c. average exchange rate for the period S Company stock has been upheld by P Company.
d. current exchange rate.

16. In preparing consolidated financial statements of a U.S. parent company and a foreign subsidiary, the foreign subsidiary’s functional currency is the currency:
a. of the country the parent is located.
b. of the country the subsidiary is located.
c. in which the subsidiary primarily generates and spends cash.
d. in which the subsidiary maintains its accounting records.

17. Gains from remeasuring a foreign subsidiary’s financial statements from the local currency, which is not the functional currency, into the parent company’s currency should be reported as a(n):
a. other comprehensive income item.
b. extraordinary item (net of tax).
c. part of continuing operations.
d. deferred credit.

18. Assuming no significant inflation, gains resulting from the process of translating a foreign entity’s financial statements from the functional currency to U.S. dollars should be included as a(n):
a. other comprehensive income item.
b. extraordinary item (net of tax).
c. part of continuing operations.
d. deferred credit.

19. A foreign subsidiary’s functional currency is its local currency and inflation of over 100 percent has been experienced over a three-year period. For consolidation purposes, SFAS No. 52 requires the use of:
a. the current rate method only.
b. the temporal method only
c. both the current rate and temporal methods.
d. neither the current rate or the temporal method.

20. The objective of remeasurement is to:
a. produce the same results as if the books were maintained in the currency of the foreign entity’s largest customer.
b. produce the same results as if the books were maintained solely in the local currency.
c. produce the same results as if the books were maintained solely in the functional currency.
d. None of the above.

Problems

13-1 Ramsey, Inc. owns a company that operates in France. Account balances in francs for the subsidiary are shown below:

2011
January 1 December 31
Cash and Receivables 24,000 26,000
Supplies 1,000 500
Property, Plant, and Equipment 52,500 49,000
Accounts Payable (11,500) (5,500)
Long-term Notes Payable (19,000) (11,000)
Common Stock (30,000) (30,000)
Retained Earnings (17,000) (17,000)
Dividends-Declared & Paid on Dec 31 —- 3,000
Revenues —- (30,000)
Operating Expenses —- 15,000
Totals -0- -0

Exchange rates for 2011 were as follows:
January 1 $0.22
Average for the year 0.19
December 31 0.18

Revenues were earned and operating expenses, except for depreciation and supplies used, were incurred evenly throughout the year. No purchases of supplies or plant assets were made during the year.

Required:
A. Prepare a schedule to compute the translation adjustment for the year, assuming the subsidiary’s functional currency is the franc.

B. Prepare a schedule to compute the translation gain or loss, assuming the subsidiary’s functional currency is the U.S. dollar.

13-2 Sloop Sails Corporation, a U.S. company, operates a 100%-owned British subsidiary, Sewart Corporation. The U.S. dollar is the functional currency of the subsidiary. Financial statements for the subsidiary for the fiscal year-end December 31, 2011, are as follows:

Sewart Corporation
Income Statement
Pounds
Sales 650,000
Cost of Goods Sold
Beginning Inventory 310,000
Purchases 265,000
Goods Available For Sale 575,000
Less: Ending Inventory 285,000
Cost of Goods Sold 290,000
Depreciation 79,000
Selling and Admin. Expenses 155,000
Income Taxes 32,000 556,000
Net Income 94,000

Sewart Corporation
Partial Balance Sheet

Current Assets Current Liabilities
Cash 155,000 Notes Payable 78,000
Accts. Rec. 171,000 Accts. Payable 165,000
Inventories 285,000 Other Current Liab. 51,000
611,000 294,000
Long-term Liab. 250,000
(issued July 1, 2009)

Other Information:
1. Equipment costing 340,000 pounds was acquired July 1, 2009, and 38,000 was acquired June 30, 2011. Depreciation for the period was as follows:
Equipment – 2009 acquisitions 66,000
– 2011 acquisitions 6,000

2. The beginning inventory was acquired when the exchange rate was $1.77. The inventory is valued on a FIFO basis. Purchases and the ending inventory were acquired evenly throughout the period.

3. Dividends were paid by the subsidiary on June 30 amounting to 156,000 pounds.

4. Sales were made and all expenses were incurred uniformly throughout the year.

5. Exchange rates for the pound on various dates were:

July 1, 2009 $1.79
Jan. 1, 2011 1.75
June 30, 2011 1.74
Dec. 31, 2011 1.71
Average for 2011 1.73
13-2 (Continued)
Required:
A. Prepare a schedule to determine the translation gain or loss for 2010, assuming the net monetary liability position on January 1, 2011, was 180,000 pounds.

B. Compute the dollar amount that each of the following would be reported at in the 2011 financial statements:
1. Cost of Goods Sold.
2. Depreciation Expense.
3. Equipment.

13-3 Accounts are listed below for a foreign subsidiary that maintains its books in its local currency. The equity interest in the subsidiary was acquired in a purchase transaction. In the space provided, indicate the exchange rate that would be used to translate the accounts into dollars assuming the functional currency was identified (a) as the U.S. dollar and (b) as the foreign entity’s local currency. Use the following letters to identify the exchange rate:
H – Historical exchange rate
C – Current exchange rate
A – Average exchange rate for the current period

Exchange rate if the
functional currency is:
Account U.S. Dollar Local currency

1. Bonds Payable (issued 01/01/08) ___________ ______________
2. Office Supplies ___________ ______________
3. Dividends Declared ___________ ______________
4. Common Stock ___________ ______________
5. Additional Paid-In Capital ___________ ______________
6. Inventory Carried at Cost ___________ ______________
7. Short-term Notes Payable ___________ ______________
8. Accumulated Depreciation ___________ ______________
9. Cash ___________ ______________
10. Marketable Securities (carried
at market) ___________ ______________
11. Cost of Goods Sold ___________ ______________
12. Sales ___________ ______________
13. Accounts Receivable ___________ ______________
14. Depreciation Expense ___________ ______________
15. Income Tax Expense ___________ ______________

Use the following information to answer Problems 13-4 and 13-5.

On January 2, 2011, Promo Inc., a U.S. parent company, purchased a 100% interest in Spot Company, a subdivision located in Switzerland. The purchase method of accounting was used to account for the acquisition. The 2011 financial statements for Spot Company, the subsidiary, in Swiss francs were as follows:

Comparative Balance Sheets
Jan. 2 Dec. 31
Cash 15,000 33,000
Accounts receivable 45,000 49,500
Plant and equipment (net) (purchased 6/30/08) 75,000 67,500
Land (purchased 6/30/08) 45,000 45,000
Total 180,000 195,000

Accounts payable 13,500 18,000
Long-term notes payable (issued 6/30/08) 31,500 27,000
Common stock (issued 6/30/08) 90,000 90,000
Retained earnings 45,000 60,000
Total 180,000 195,000

Income Statement
Revenues 180,000
Operating expenses including depreciation
of 7,500 francs 135,000
Net income 45,000
Beginning retained earnings 45,000
90,000
Dividends declared and paid 30,000
Ending retained earnings 60,000

Sales were earned and operating expenses were incurred evenly during the year.

Exchange rates for the franc at various dates are:
January 2, 2011 0.8600
December 31, 2011 0.8830
Average for 2011 0.8715
December 10, 2011, dividend payment date 0.8810
June 30, 2008 0.8316

13-4 Use the above information to answer the following question:

Required:
Translate the year-end financial statements of Spot Company, the foreign subsidiary, using the temporal method. Round numbers to the nearest dollar.

13-5 Use the above information to answer the following question:

Required:
Prepare a schedule to compute the translation gain or loss for Spot Company, assuming the temporal method of translation. Round numbers to the nearest dollar.

13-6 Bass Corporation, a U.S. Company, formed a subsidiary with a new company in London on January 1, 2011, by investing 500,000 British pounds in exchange for all of the subsidiary’s common stock. The subsidiary purchased land for 100,000 pounds and a building for 300,000 pounds on July 1, 2011. The building is being depreciated over a 40-year life by the straight-line method. The inventory is valued on an average cost basis. The British pound is the subsidiary’s functional currency and its reporting currency and has not experienced any abnormal inflation. Exchange rates for the pound on various dates were:

January 1, 2011 1 pound = 1.81
July 1, 2011 1 pound = 1.86
December 31, 2011 1 pound = 1.83
2011 average rate 1 pound = 1.82

The subsidiary’s adjusted trial balance is presented below for the year ended December 31, 2011.

Debits In Pounds
Cash 200,000
Accounts receivable 60,000
Inventory 80,000
Land 100,000
Building 300,000
Depreciation expense 3,750
Cost of goods sold 213,750
Other expenses 90,000
Total debits 1,047,500

Credits
Accumulated depreciation 3,750
Accounts payable 84,000
Accrued liabilities 16,750
Common stock 500,000
Retained earnings – 0 –
Sales revenue 443,000
Total credits 1,047,500

Required: Prepare the subsidiary’s:
A. Translated workpapers (round to the nearest dollar)
B. Translated income statement
C. Translated balance sheet

13-7 Using the information provided in Problem 13-6, use the temporal method instead of the current rate method.

Required: Prepare the subsidiary’s:
A. Translated workpapers (round to the nearest dollar)
B. Translated income statement
C. Translated balance sheet

13-8

On January 1, 2011, Roswell Systems, a U.S.-based company, purchased a controlling interest in Swiss Management Consultants located in Zurich, Switzerland. The acquisition was treated as a purchase transaction. The 2011 financial statements stated in Swiss francs are given below.

SWISS MANAGEMENT CONSULTANTS
Comparative Balance Sheets
January 1 and December 31, 2011
Jan. 1 Dec. 31

Cash and Receivables 30,000 84,000
Net Property, Plant, and Equipment 60,000 56,000
Totals 90,000 140,000

Accounts and Notes Payable 45,000 50,000
Common Stock 30,000 30,000
Retained Earnings 15,000 60,000
Totals 90,000 140,000

SWISS MANAGEMENT CONSULTANTS
Consolidated Income and Retained Earnings Statement
For the Year Ended December 31, 2011

Revenues 112,000
Operating Expenses including depreciation of 5,000 francs 45,000
Net income 67,000
Dividends Declared and Paid 22,000
Increase in Retained Earnings 45,000

Direct exchange rates for Swiss franc are:

U.S. Dollars per Franc
January 1, 2011 $0.9987
December 31, 2011 0.9321
Average for 2011 0.9654
Dividend declaration and payment date 0.9810

Required:
A. Translate the year-end balance sheet and income statement of the foreign subsidiary using the current rate method of translation.
B. Prepare a schedule to verify the translation adjustment.

Short Answer
1. To accomplish the objectives of translation, two translation methods are used depending on the functional currency of the foreign entity. Describe the two translation methods.

2. The translation process can be done using either the current rate method or the temporal method. Explain under what circumstances each of the methods is appropriate.

Short Answer Questions from the Textbook

1. What requirements must be satisfied if a foreign subsidiary is to be consolidated?

2. What is meant by an entity’s functional currency and what are the economic indicators identified by the FASB to provide guidance in selecting the functional currency?

3. The __________is the functional currency of a foreign subsidiary with operations that are relatively self-contained and integrated within the country in which it is located. In such cases, the__________ method of translation would be used to translate the accounts into dollars.

4. The __________is the functional currency of a foreign subsidiary that is a direct and integral component or extension of a U.S. parent company. In such cases, the __________method of translation is used to translate (remeasure) the accounts into dollars.

5. Which method of translation is used to convert the financial statements when a foreign subsidiary operates in a highly inflationary economy?

6. Define remeasurement.

7. Under the current rate method, how are assets and liabilities that are stated in a foreign currency translated?

8. Under the current rate method, describe how the various balance sheet accounts are translated (including the equity accounts) and how this translation affects the computation of various ratios (such as debt to equity or the current ratio). In particular, discuss whether or not the ratios will change when computed in local currencies and compared to their calculations (after translation) using the parent’s currency.

9. What is the objective of the temporal method of translation?

10. Assuming that the temporal method is used, how are revenue and expense items in foreign currency financial statements converted?

11. A translation adjustment results from the process of translating financial statements of a foreign subsidiary from its functional currency into dollars. Where is the translation adjustment reported in the financial statements if the current rate method is used to translate the accounts?

Business Ethics Question from the Textbook

The Shady Tree Company is preparing to announce their quarterly earnings numbers. The company expectsto beat the analysts’ forecast of earnings by at least5cents a share. In anticipation of the increase instockvalue and before the release of the earnings numbers, the company issued stock options to the top executives in the firm, with the option price equal to today’s market price.
1. This type of executive stock option is often re-ferred to as “spring-loading.” Do you think this practice should be allowed? Does it provide in-formation about the integrity of the firm or is this just good business practice?
2. Do you think this practice violates the insider trading rules?

Chapter 14

Reporting for Segments and for Interim Financial Periods

1. A component of an enterprise that may earn revenues and incur expenses, and about which management evaluates separate financial information in deciding how to allocate resources and assess performance is a(n)
a. identifiable segment.
b. operating segment.
c. reportable segment.
d. industry segment.

2. An entity is permitted to aggregate operating segments if the segments are similar regarding the
a. nature of the production processes.
b. types or class of customers.
c. methods used to distribute products or provide services.
d. all of these.

3. Which of the following is not a segment asset of an operating segment?
a. Assets used jointly by more than one segment.
b. Assets directly associated with a segment.
c. Assets maintained for general corporate purposes.
d. Assets used exclusively by a segment.

4. SFAS No. 131 requires the disclosure of information on an enterprise’s operations in different industries for
1. each annual period presented.
2. each interim period presented.
3. the current period only.
a. 1
b. 2
c. 3
d. both 1 and 2

5. Which of the following is not required to be disclosed by SFAS No. 131?
a. Information concerning the enterprise’s products.
b. Information related to an enterprise’s foreign operations.
c. Information related to an enterprise’s major suppliers.
d. All of the above are required disclosures.

6. To determine whether a substantial portion of a firm’s operations are explained by its segment information, the combined revenue from sales to unaffiliated customers of all reportable segments must constitute at least
a. 10% of the combined revenue of all operating segments.
b. 75% of the combined revenue of all operating segments.
c. 10% of the combined revenue from sales to unaffiliated customers of all operating segments.
d. 75% of the combined revenue from sales to unaffiliated customers of all operating segments.

7. A segment is considered to be significant if its
1. reported profit is at least 10% of the combined profit of all operating segments.
2. reported profit (loss) is at least 10% of the combined reported profit of all operating segments not reporting a loss.
3. reported profit (loss) is at least 10% of the combined reported loss of all operating segments that reported a loss.
a. 1
b. 2
c. 3
d. both 2 and 3

8. Which of the following disclosures is not required to be presented for a firm’s reportable segments?
a. Information about segment assets
b. Information about the bases for measurement
c. Reconciliation of segment amounts and consolidated amounts for revenue, profit or loss, assets, and other significant items.
d. All of these must be presented.

9. Current authoritative pronouncements require the disclosure of segment information when certain criteria are met. Which of the following reflects the type of firm and type of financial statement for which this disclosure is required?
a. Annual financial statements for publicly held companies.
b. Annual financial statements for both publicly held and nonpublicly held companies.
c. Annual and interim financial statements for publicly held companies.
d. Annual and interim financial statements for both publicly held and nonpublicly held companies.

10. An enterprise determines that it must report segment data in annual reports for the year ended December 31, 2011. Which of the following would not be an acceptable way of reporting segment information?
a. Within the body of the financial statements, with appropriate explanatory disclosures in the footnotes
b. Entirely in the footnotes to the financial statements.
c. As a special report issued separately from the financial statements.
d. In a separate schedule that is included as an integral part of the financial statements.

11. Selected data for a segment of a business enterprise are to be separately reported in accordance with SFAS No. 131 when the revenues of the segment is 10% or more of the combined
a. net income of all segments reporting profits.
b. external and internal revenue of all reportable segments.
c. external revenue of all reportable segments.
d. revenues of all segments reporting profits.

12. Long Corporation’s revenues for the year ended December 31, 2011, were as follows
Consolidated revenue per income statement $800,000
Intersegment sales 105,000
Intersegment transfers 35,000
Combined revenues of all operating segments $940,000

Long has a reportable segment if that segment’s revenues exceed
a. $80,000.
b. $90,500.
c. $94,000.
d. $14,000.

13. Revenue test
(dollars in thousands)
Wholesale Retail Finance
Segment Segment Segment
Sales to unaffiliated customers $3,600 $1,500 $-0-
Sales – intersegment 400 240 -0-
Loan interest income – intersegment -0- 120 900
Loan interest income – unaffiliated -0- 240 80
Income from equity method investees -0- 280 -0-

Determine the amount of revenue for each of the three segments that would be used to identify the reportable industry segments in accordance with the revenues test specified by SFAS 131.

Wholesale Retail Finance
a. $3,600 $1,500 $ -0-
b. 4,000 1,740 -0-
c. 4,000 1,980 980
d. 4,000 2,380 980

14. Which of the following is not part of the information about foreign operations that is required to be disclosed?
a. Revenues from external customers
b. Operating profit or loss, net income, or some other common measure of profitability
c. Capital expenditures
d. Long-lived assets

15. Eaton, Inc., discloses supplemental industry segment information. The following data are available for 2011.
Traceable
Segment Sales operating expenses
A $420,000 $255,000
B 480,000 300,000
C 300,000 165,000
$1,200,000 $720,000

Additional 2011 expenses, not included above, are as follows:

Indirect operating expenses $240,000
General corporate expenses 180,000

Appropriate common expenses are allocated to segments based on the ratio of a segment’s sales to total sales. What should be the operating profit for Segment C for 2011?
a. $135,000
b. $ 75,000
c. $ 105,000
d. $ 30,000

16. Gant Company has four manufacturing divisions, each of which has been determined to be a reportable segment. Common operating costs are appropriately allocated on the basis of each division’s sales in relation to Gant’s aggregate sales. Gant’s Delta division accounted for 40% of Gant’s total sales in 2011. For the year ended December 31, 2011, Delta had sales of $5,000,000 and traceable costs of $3,600,000. In 2011, Gant incurred operating costs of $350,000 that were not directly traceable to any of the divisions. In addition, Gant incurred interest expense of $360,000 in 2011. In reporting supplementary segment information, how much should be shown as Delta’s operating profit for 2011?
a. $1,400,000
b. $1,256,000
c. $1,260,000
d. $1,116,000

17. For external reporting purposes, it is appropriate to use estimated gross profit rates to determine the ending inventory value for

Interim Annual
Reporting Reporting
a. No No
b. No Yes
c. Yes No
d. Yes Yes

18. Inventory losses from market declines that are expected to be temporary
a. should be recognized in the interim period in which the decline occurs.
b. should be recognized in the last (fourth) quarter of the year in which the decline occurs.
c. should not be recognized.
d. none of these.

19. Gains and losses that arise in an interim period should be
a. recognized in the interim period in which they arise.
b. recognized in the last quarter of the year in which they arise.
c. allocated equally among the remaining interim periods.
d. deferred and included only in the annual income statement.

20. If a cumulative effect type accounting change is made during the first interim period of a year
a. no cumulative effect of the change should be included in net income of the period of change.
b. the cumulative effect of the change on retained earnings at the beginning of the year should be included in net income of the first interim period.
c. the cumulative effect of the change should be allocated to the current and remaining interim periods of the year.
d. none of these.

21. Which of the following does not have to be disclosed in interim reports?
a. Seasonal costs or expenses.
b. Significant changes in estimates.
c. Disposal of a segment of a business.
d. All of these must be disclosed.

22. For interim financial reporting, the effective tax rate should reflect

Anticipated Extraordinary
Tax Credits Items
a. Yes Yes
b. Yes No
c. No Yes
d. No No

23. Companies using the LIFO method may encounter a liquidation of base period inventories at an interim date that is expected to be replaced by the end of the year. In these cases, cost of goods sold should be charged with the
a. cost of the most recent purchases.
b. average cost of the liquidated LIFO base.
c. expected replacement cost of the liquidated LIFO base.
d. none of these.

24. In considering interim financial reporting, how did the Accounting Principles Board conclude that each reporting should be viewed?
a. As a “special” type of reporting that need not follow generally accepted accounting principles.
b. As useful only if activity is evenly spread throughout the year so that estimates are unnecessary.
c. As reporting for a basic accounting period.
d. As reporting for an integral part of an annual period.

25. When a company issues interim financial statements, extraordinary items should be
a. allocated to the current and remaining interim periods of the current year on a pro rata basis.
b. deferred and included only in the annual income statement.
c. included in the determination of net income in the interim period in which they occur.
d. charged or credited directly to retained earnings so that comparisons of interim results of operations will not be distorted.

26. If annual major repairs made in the first quarter and paid for in the second quarter clearly benefit the entire year, when should they be expensed?
a. An allocated portion in each of the last three quarters
b. An allocated portion in each quarter of the year
c. In full in the first quarter
d. In full in the second quarter

27. During the second quarter of 2011, Dodge Company sold a piece of equipment at a gain of $90,000. What portion of the gain should Dodge report in its income statement for the second quarter of 2011?
a. $90,000
b. $45,000
c. $30,000
d. $ -0-

28. In January 2011, Abel Company paid $200,000 in property taxes on its plant for the calendar year 2011. Also in January 2011, Abel estimated that its year-end bonuses to executives for 2011 would be $800,000. What is the amount of expenses related to these two items that should be reflected in Abel’s quarterly income statement for the three months ended June 30, 2011 (second quarter)?
a. $ -0-
b. $250,000
c. $ 50,000
d. $200,000

29. For interim financial reporting, a company’s income tax provision for the second quarter of 2011 should be determined using the
a. statutory tax rate for 2011.
b. effective tax rate expected to be applicable for the full year of 2011 as estimated at the end of the first quarter of 2011.
c. effective tax rate expected to be applicable for the full year of 2011 as estimated at the end of the second quarter of 2011.
d. effective tax rate expected to be applicable for the second quarter of 2011.

30. Which of the following reporting practices is permissible for interim financial reporting?
a. Use of the gross profit method for interim inventory pricing.
b. Use of the direct costing method for determining manufacturing inventories.
c. Deferral of unplanned variances under a standard cost system until year-end.
d. Deferral of inventory market declines until year-end.

31. Which of the following statements most accurately describes interim period tax expense?
a. The best estimate of the annual tax rate times the ordinary income (loss) for the quarter.
b. The best estimate of the annual tax rate times income (loss) for the year to date less tax expense (benefit) recognized in previous interim periods.
c. Average tax rate for each quarter, including the current quarter, times the current income (loss).
d. The previous year’s actual effective tax rate times the current quarter’s income.

32. The computation of a company’s third quarter provision for income taxes should be based upon earnings
a. for the quarter at an expected annual effective income tax rate.
b. for the quarter at the statutory rate.
c. to date at an expected annual effective income tax rate less prior quarters’ provisions.
d. to date at the statutory rate less prior quarters’ provisions.

33. Finney, a calendar year company, has the following income before income tax provision and estimated effective annual income tax rates for the first three quarters of 2011:

Income Before Estimated Effective
Income Tax Annual Tax Rate
Quarter Provision at the End of Quarter
First $120,000 25%
Second 160,000 25%
Third 200,000 30%

Finney’s income tax provision in its interim income statement for the third quarter should be
a. $74,000.
b. $60,000.
c. $50,000.
d. $144,000.

34. An inventory loss from a market price decline occurred in the first quarter. The loss was not expected to be restored in the fiscal year. However, in the third quarter the inventory had a market price recovery that exceeded the market decline that occurred in the first quarter. For interim reporting, the dollar amount of net inventory should
a. decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the market price recovery.
b. decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the decrease in the first quarter.
c. not be affected in the first quarter and increase in the third quarter by the amount of the market price recovery that exceeded the amount of the market price decline.
d. not be affected in either the first quarter or the third quarter.

35. Advertising costs may be accrued or deferred to provide an appropriate expense in each period for
Interim Annual
Reporting Reporting
a. Yes No
b. Yes Yes
c. No No
d. No Yes

Problems

14-1 The following information is available for Torrey Company for 2011:

a. In early April Torrey made major repairs to its equipment at a cost of $90,000. These repairs will benefit the remainder of 2011 operations.

b. At the end of May, Torrey sold machinery with a book value of $35,000 for $45,000.

c. An inventory loss of $60,000 from market decline occurred in July. In the fourth quarter the inventory had a market value recovery that exceeded the market decline by $30,000.

Required:
Compute the amount of expense/loss that would appear in Torrey Company’s June 30, September 30, and December 31, 2011, quarterly financial statements.

14-2 Stein Corporation’s operations involve three industry segments, X, Y, and Z. During 2011, the operating profit (loss) of each segment was:
Operating
Segment Profit (Loss)
X $ 600
Y 8,100
Z (6,300)

Required:
Determine which of the segments are reportable segments.

14-3 Bass Industries operates in four different industries. Information concerning the operations of these industries for the year 2011 is:

Revenue
Industry Operating Segment
Segment Total Intersegment Profit (Loss) Assets
A $ 24,000 $4,200 $ 2,700 $ 22,400
B 18,000 2,200 (2,000) 25,200
C 90,000 14,000 3,600 70,000
D 168,000 -0- 23,700 162,400
$300,000 $28,000 $280,000

Required:
Complete the following schedule to determine which of the above segments must be treated as reportable segments.
10% Test For
Segment Revenue Op. Profit (Loss) Segment Assets Reportable?
A

B

C

D

14-4 Logan Company prepares quarterly financial statements. The following information is available concerning calendar year 2011:

Estimated full-year earnings $3,000,000
Full-year permanent differences:
Penalty for pollution 150,000
Estimated dividend income exclusion 60,000
Actual pretax earnings, 1/1/11 to 3/31/11 480,000
Nominal income tax rate 40%

Required:
Compute the income tax provision for the first quarter of 2011.

14-5 XYZ Corporation has eight industry segments with sales, operating profit and loss, and identifiable assets at and for the year ended December 31, 2011, as follows:

Sales to Unaffiliated Customers Sales to Affiliated Customers Profit or (Loss) Segment
Assets
Steel $1,350,000 $150,000 $265,000 $2,250,000
Auto Parts 1,200,000 — 450,000 1,430,000
Coal Mine 600,000 450,000 (300,000) 1,200,000
Textiles 530,000 220,000 150,000 750,000
Paint 1,120,000 380,000 300,000 1,050,000
Lumber 710,000 — (75,000) 600,000
Leisure Time 690,000 — 110,000 450,000
Electronics 600,000 — 300,000 670,000
Total $6,800,000 $1,200,000 $1,200,000 $8,400,000

Required:
A. Identify the segments, which are reportable segments under one or more of the 10 percent revenue, operating profit, or assets tests.
B. After reportable segments are determined under the 10 percent tests, they must be reevaluated under a 75 percent revenue test before a final determination of reportable segments can be made. Under this 75 percent test, identify if any other segments may have to be reported.

14-6 Ace Company, which uses the FIFO inventory method, had 508,000 units in inventory at the beginning of the year at a FIFO cost per unit of $20. No purchases were made during the year. Quarterly sales information and end-of-quarter replacement cost figures follow:

End-of- Quarter
Quarter Unit Sales Replacement Cost
1 200,000 $17
2 60,000 18
3 85,000 13
4 61,000 18
The market decline in the first quarter was expected to be nontemporary. Declines in other quarters were expected to be permanent.

Required:
Determine cost of goods sold for the four quarters and verify the amounts by computing cost of goods sold using the lower-of-cost-or-market method applied on an annual basis.

14-7 Barr Company’s actual earnings for the first two quarters of 2011 and its estimate during each quarter of its annual earnings are:

Actual first-quarter earnings $ 800,000
Actual second-quarter earnings 1,020,000
First-quarter estimate of annual earnings 2,700,000
Second-quarter estimate of annual earnings 2,830,000

Barr Company estimated its permanent differences between accounting income and taxable income for 2011 as:

Environmental violation penalties $ 45,000
Dividend income exclusion 320,000

These estimates did not change during the second quarter. The combined state and federal tax rate for Barr Company for 2011 is 40%.

Required:
Prepare journal entries to record Barr Company’s provisions for income taxes for each of the first two quarters of 2011.

Short Answer
1. In SFAS No. 131, the FASB requires all public companies to report a variety of information for reportable segments. Define a reportable segment and identify the information to be reported for each reportable segment.

2. Publicly owned companies are usually required to file some type of quarterly (interim) report as part of the agreement with the stock exchanges that list their stock. Indicate two problems with interim reporting and GAAP’s position on this reporting.

Short Answer Questions from the Textbook

1. For what types of companies would segmented financial reports have the most significance? Why?

2. Why do financial statement users (financial analysts, for example) need information about seg- ments of a firm?

3. Define the following: (a)Operating segment.(b)Reportable segment.

4. Describe the guidelines to be used in determining (a) what constitutes an operating segment, and (b) whether a specific operating segment is a significant segment.

5. List the three major types of enterprise wide information disclosures required by SFAS No. 131[ASC 280], and explain how the firm’s designation of reportable segments affects these disclosures.

6. What segmental disclosures are required, if any, for interim reports?

7. What type of disclosure is required of a firm when the major portion of its operations takes place within a single reportable segment?

8. List the types of information that must be presented for each reportable segment of a com-pany under the rules of SFAS No. 131 [ASC 280].

9. Describe the methods that might be used to disclose reportable segment information.

10. What types of information must be disclosed about foreign operations under SFAS No. 131[ASC 280–10–50–40]?

11. How are foreign operations defined under SFASNo. 131 [ASC 280]?

12. If the operations of a firm in some foreign countries are grouped into geographic areas, what factors should be considered in forming the groups?

13. When must a firm present segmental disclosures for major customers? What is the reason for this requirement?

14. How are common costs distinguished from general corporate expenses for segmental purposes?

15. What is the purpose of interim financial reporting?

16. Some accountants hold the view that each interim period should stand alone as a basic ac-counting period, whereas others view each interim period as essentially an integral part of the annual period. Distinguish between these views.

17.Describe the basic procedure for computing in-come tax provisions for interim financial state-ments.

18.Describe how changes in estimates should be treated in interim financial statements.

19.What are the minimum disclosure requirements established ASC 270 for interim financial reports?

20.What is the general rule regarding the treatment of costs and expenses associated directly with revenues for interim reporting purposes?

Business Ethics Question from Textbook
SMC Inc. operates restaurants based on various themes, such as Mex-delight, Chinese for the Buffet, and Steak-it and Eat-it. The Steak-it and Eat-it restaurants have not been performing well recently, but SMC prefers not to disclose these details for fear that competitors might use the information to the detriment of SMC. The restaurants are located in various geographical locations, and management currently measures profits and losses and asset allocation by restaurant concept. How-ever, when preparing the segmental disclosures under SFAS No. 131 [ASC 280], the company reports the segment information by geographical location only. The company recently hired you to review the financial statements.
1.What disclosures should the company report for segment purposes?
2.The company’s CEO believed that the rules in SFAS No. 131 [ASC 280] are vague and that the company could easily support its decision to dis-close the segment data by geographic regions. What would you recommend to the CEO and how would you approach the issues?

Chapter 15

Partnerships: Formation, Operation, and Ownership Changes

Multiple Choice

1. When a partner retires and withdraws assets in excess of his book value, the remaining partners absorb the excess
a. equally.
b. in their profit-sharing ratio.
c. based on their average capital balances.
d. based on their ending capital balances.

2. In a partnership, interest on capital investment is accounted for as a(n)
a. return on investment.
b. expense.
c. allocation of net income.
d. reduction of capital.

3. A partnership in which one or more of the partners are general partners and one or more are not is called a(n)
a. joint venture.
b. general partnership.
c. limited partnership.
d. unlimited partnership.

4. Which of the following is an advantage of a partnership?
a. mutual agency
b. limited life
c. unlimited liability
d. none of these

5. Bob and Fred form a partnership and agree to share profits in a 2 to 1 ratio. During the first year of operation, the partnership incurs a $20,000 loss. The partners should share the losses
a. based on their average capital balances.
b. in a 2 to 1 ratio.
c. equally.
d. based on their ending capital balances.

6. When the goodwill method is used to record the admission of a new partner, total partnership capital increases by an amount
a. equal to the new partner’s investment.
b. greater than the new partner’s investment.
c. less than the new partner’s investment.
d. that may be more or less than the new partner’s investment.

7. The bonus and goodwill methods of recording the admission of a new partner will produce the same result if the:
1. new partner’s profit-sharing ratio equals his capital interest
2. old partners’ profit-sharing ratio in the new partnership is the same relatively as it was in the old partnership.
a. 1
b. 2
c. both 1 and 2 are met.
d. none of these.

8. When the goodwill method is used and the book value acquired is less than the value of the assets invested, total implied capital is computed by
a. multiplying the new partner’s capital interest by the capital balances of existing partners.
b. dividing the total capital balances of existing partners by their collective capital interest.
c. dividing the new partner’s investment by his (her) capital interest.
d. dividing the new partner’s investment by the existing partners’ collective capital interest.

9. The partnership of Adams and Baker was formed on February 28, 2011. At that date the following assets were invested:
Adams Baker
Cash $ 120,000 $200,000
Merchandise -0- 320,000
Building -0- 840,000
Furniture and equipment 200,000 -0-

The building is subject to a mortgage loan of $280,000, which is to be assumed by the partnership. The partnership agreement provides that Adams and Baker share profits or losses 30% and 70%, respectively. Baker’s capital account at February 28, 2011, should be
a. $1,080,000.
b. $1,360,000.
c. $1,176,000.
d. $952,000.

10. The following balance sheet information is for the partnership of Abel, Ball, and Catt:

Cash $ 210,000 Liabilities $ 510,000
Other assets 1,500,000 Abel, Capital (40%) 300,000
Ball, Capital (40%) 480,000
Catt, Capital (20%) 420,000
$1,710,000 $1,710,000

Figures shown parenthetically reflect agreed profit and loss sharing percentages.
If the assets are fairly valued on the above balance sheet and the partnership wishes to admit Dent as a new 1/5 partner without recording goodwill or bonus, Dent should invest cash or other assets of
a. $427,500.
b. $240,000.
c. $300,000.
d. $342,000.

11. The following balance sheet information is for the partnership of Abel, Ball, and Catt:

Cash $ 210,000 Liabilities $ 510,000
Other assets 1,500,000 Abel, Capital (40%) 300,000
Ball, Capital (40%) 480,000
Catt, Capital (20%) 420,000
$1,710,000 $1,710,000

Figures shown parenthetically reflect agreed profit and loss sharing percentages.
If assets on the initial balance sheet are fairly valued, Abel and Ball consent and Dent pays Catt $225,000 for his interest; the revised capital balances of the partners would be
a. Abel, $315,000; Ball, $495,000; Dent, $450,000.
b. Abel, $315,000; Ball, $495,000; Dent, $420,000.
c. Abel, $300,000; Ball, $570,000; Dent, $450,000.
d. Abel, $300,000; Ball, $480,000; Dent, $420,000.

12. Linda desires to purchase a one-fourth capital and profit and loss interest in the partnership of Hank, Greg, and Jim. The three partners agree to sell Linda one-fourth of their respective capital and profit and loss interests in exchange for a total payment of $100,000. The payment is made directly to the individual partners. The capital accounts and the respective percentage interests in profits and losses immediately before the sale to Linda follow

Percentage
Capital Interests in
Accounts Profits and Losses
Hank $168,000 50%
Greg 104,000 35
Jim 48,000 15
Total $320,000

All other assets and liabilities are fairly valued and implied goodwill is to be recorded prior to the acquisition by Linda. Immediately after Linda’s acquisition, what should be the capital balances of Hank, Greg, and Jim, respectively?
a. $126,000; $78,000; $36,000
b. $156,000; $99,000; $45,000
c. $178,000; $111,000; $51,000
d. $208,000; $132,000; $60,000

13. At December 31, 2011, Barb and Kim are partners with capital balances of $250,000 and $150,000, and they share profits and losses in the ratio of 2:1, respectively. On this date, Jack invests $125,000 cash for a one-fifth interest in the capital and profit of the new partnership. The partners agree that the implied partnership goodwill is to be recorded simultaneously with the admission of Jack. The total implied goodwill of the firm is
a. $25,000.
b. $20,000.
c. $45,000.
d. $100,000.

14. Pete, Joe, and Ron are partners with capital balances of $135,000, $90,000, and $60,000, respectively. The partners share profits and losses equally. For an investment of $120,000 cash, Jerry is to be admitted as a partner with a one-fourth interest in capital and profits. Based on this information, the amount of Jerry’s investment can best be justified by which of the following?
a. Jerry will receive a bonus from the other partners upon his admission to the partnership.
b. Assets of the partnership were overvalued immediately prior to Jerry’s investment.
c. The book value of the partnership’s net assets were less than their fair value immediately prior to Jerry’s investment.
d. Jerry is apparently bringing goodwill into the partnership and his capital account will be credited for the appropriate amount.

15. The partnership of Amos, Cole, and Eddy had total capital of $570,000 on December 31, 2011 as follows:

Amos, Capital (30%) $180,000
Cole, Capital (45%) 255,000
Eddy, Capital (25%) 135,000
Total $570,000

Profit and loss sharing percentages are shown in parentheses. If Flynn purchases a 25 percent interest from each of the old partners for a total payment of $270,000 directly to the old partners
a. total partnership net assets can logically be revalued to $1,080,000 on the basis of the price paid by Flynn.
b. the payment of Flynn does not constitute a basis for revaluation of partnership net assets because the capital and income interests of the old partnership were not aligned.
c. total capital of the new partnership should be $760,000.
d. total capital of the new partnership will be $840,000 assuming no revaluation.

16. The partnership of Amos, Cole, and Eddy had total capital of $570,000 on December 31, 2011 as follows:

Amos, Capital (30%) $180,000
Cole, Capital (45%) 255,000
Eddy, Capital (25%) 135,000
Total $570,000

Profit and loss sharing percentages are shown in parentheses. Assume that Flynn became a partner by investing $150,000 in the Amos, Cole, and Eddy partnership for a 25 percent interest in capital and profits and that partnership net assets are not revalued. Flynn’s capital credit should be
a. $180,000.
b. $142,500.
c. $150,000.
d. $190,000.

17. The partnership of Amos, Cole, and Eddy had total capital of $570,000 on December 31, 2011 as follows:

Amos, Capital (30%) $180,000
Cole, Capital (45%) 255,000
Eddy, Capital (25%) 135,000
Total $570,000

Profit and loss sharing percentages are shown in parentheses.
Assume that Flynn became a partner by investing $100,000 in the Amos, Cole, and Eddy partnership for a 25 percent interest in the capital and profits, and the partnership assets are revalued. Under this assumption
a. Flynn’s capital credit will be $150,000.
b. Amos’s capital will be increased to $147,000.
c. total partnership capital after Flynn’s admission to the partnership will be $600,000.
d. net assets of the partnership will increase by $190,000, including Flynn’s interest.

18. In the absence of an agreement among the partners
a. interest is allowed on capital investments.
b. interest is charged on partners’ drawings.
c. interest is allowed on advances to the firm made by partners beyond agreed investments.
d. compensation is allowed partners for extra time devoted to the partnership.

19. The profit and loss sharing ratio should be
a. in the same ratio as the percentage interest owned by each partner.
b. based on relative effort contributed to the firm by the partners.
c. a weighted average of capital and effort contributions.
d. based on any formula that the partners choose.

20. The partnership agreement of Flynn, Gant, and Hill allows Gant a bonus of 10% of income after the bonus, salaries of $30,000 per partner and interest of 6% on average capital balances of $120,000, $150,000, and $180,000 for Flynn, Gant, and Hill, respectively. The amount of Gant’s bonus, assuming income before bonus, salaries, and interest of $315,000, is
a. $18,000.
b. $22,000.
c. $19,800.
d. $31,500.

21. Steve and Robby are partners operating an electronics repair shop. For 2011, net income was $50,000. Steve and Robby have salary allowances of $90,000 and $60,000, respectively, and remaining profits and losses are shared 4:6.
The division of profits would be:
a. $20,000 and $30,000
b. $50,000 and $-0-
c. $30,000 and $20,000
d. $25,000 and $25,000

22. Steve and Robby are partners operating an electronics repair shop. For 2011, net income was $50,000. Steve and Robby have salary allowances of $90,000 and $60,000, respectively, and remaining profits and losses are shared 4:6.
If their agreement specifies that salaries are allowed only to the extent of income, based on a prorata share of their salary allowances, the division of profits would be:
a. $20,000 and $30,000
b. $50,000 and $-0-
c. $30,000 and $20,000
d. $25,000 and $25,000

23. Carter, Wynn, and Norton are partners in a janitorial service. The business reported net income of $54,000 for 2011. The partnership agreement provides that profits and losses are to be divided equally after Wynn receives a $60,000 salary, Norton receives a $24,000 salary, and each partner receives 10% interest on his beginning capital balance. Beginning capital balances were $40,000 for Carter, $48,000 for Wynn, and $32,000 for Norton. Norton’s share of partnership income for 2011 is:
e. $68,800
f. $36,000
g. $31,200
h. $27,200

24. Bell and Carson are partners who share profits and losses 3:7. The capital accounts on January 1, 2011, are $120,000 and $160,000, respectively. Elston is to be admitted as a partner with a one-fourth interest in the capital and profits and losses by investing $80,000. Goodwill is not to be recorded. The capital balances after admission should be:
a. Bell, $117,000; Carson, $153,000; Elston, $90,000
b. Bell, $120,000; Carson, $160,000; Elston, $90,000
c. Bell, $123,000; Carson, $160,000; Elston, $80,000
i. Bell, $120,000; Carson, $167,000; Elston, $80,000

25. The balance sheet for the partnership of Nen, Pap, and Sup at January 1, 2011 follows. The partners share profits and losses in the ratio of 3:2:5, respectively.

Assets at cost $480,000

Liabilities $135,000
Nen, capital 75,000
Pap, capital 120,000
Sup, capital 150,000
$480,000

Nen is retiring from the partnership. By mutual agreement, the assets are to be adjusted to their fair value of $540,000 at January 1, 2011. Pap and Sup agree that the partnership will pay Nen $135,000 cash for his partnership interest. NO goodwill is to be recorded. What is the balance of Pap’s capital account after Nen’s retirement?
a. $138,000
b. $108,000
c. $120,000
d. $132,000

26. The following balance sheet information is for the partnership of Axe, Barr, and Cole:

Cash $ 210,000 Liabilities $ 510,000
Other assets 1,500,000 Axe, Capital (40%) 300,000
Barr, Capital (40%) 480,000
Cole, Capital (20%) 420,000
$1,710,000 $1,710,000

Figures shown parenthetically reflect agreed profit and loss sharing percentages.
If the assets are fairly valued on the above balance sheet and the partnership wishes to admit Dent as a new 1/5 partner without recording goodwill or bonus, Dent should invest cash or other assets of
a. $427,500.
b. $240,000.
c. $300,000.
d. $342,000.

27. Susan desires to purchase a one-fourth capital and profit and loss interest in the partnership of Tony, Mary, and Ron. The three partners agree to sell Susan one-fourth of their respective capital and profit and loss interests in exchange for a total payment of $125,000. The payment is made directly to the individual partners. The capital accounts and the respective percentage interests in profits and losses immediately before the sale to Susan follow

Percentage
Capital Interests in
Accounts Profits and Losses
Tony $210,000 50%
Mary 130,000 35
Ron 60,000 15
Total $400,000

All other assets and liabilities are fairly valued and implied goodwill is to be recorded prior to the acquisition by Susan. Immediately after Susan’s acquisition, what should be the capital balances of Tony, Mary, and Ron, respectively?
a. $157,500; $97,500; $45,000
b. $195,000; $123,750; $56,250
c. $222,500; $138,750; $63,750
d. $260,000; $165,000; $75,000

28. The partnership of Carr, Eddy, and Howe had total capital of $1,140,000 on December 31, 2011, as follows:

Carr, Capital (30%) $360,000
Eddy, Capital (45%) 510,000
Howe, Capital (25%) 270,000
Total $1,140,000

Profit and loss sharing percentages are shown in parentheses.
Assume that Klein became a partner by investing $300,000 in the Carr, Eddy, and Howe partnership for a 25 percent interest in capital and profits and that partnership net assets are not revalued. Klein’s capital credit should be
a. $360,000.
b. $285,000.
c. $300,000.
d. $380,000.

29. The partnership of Carr, Eddy, and Howe had total capital of $1,140,000 on December 31, 2011, as follows:

Carr, Capital (30%) $360,000
Eddy, Capital (45%) 510,000
Howe, Capital (25%) 270,000
Total $1,140,000

Profit and loss sharing percentages are shown in parentheses.
Assume that Klein became a partner by investing $300,000 in the Carr, Eddy, and Howe partnership for a 25 percent interest in the capital and profits, and the partnership assets are revalued. Under this assumption
a. Klein’s capital credit will be $300,000.
b. Carr’s capital will be increased to $394,000.
c. total partnership capital after Klein’s admission to the partnership will be $1,200,000.
d. net assets of the partnership will increase by $380,000 including Klein interest.

30. Newlin, Vick, and Morton are partners in a plumbing service. The business reported net income of $108,000 for 2011. The partnership agreement provides that profits and losses are to be divided equally after Vick receives a $60,000 salary, Morton receives a $24,000 salary, and each partner receives 10% interest on his beginning capital balance. Beginning capital balances were $40,000 for Newlin, $48,000 for Vick, and $32,000 for Morton. Vick’s share of partnership income for 2011 is:
a. $68,800.
b. $36,000.
c. $31,200.
d. $27,200.

Problems

15-1 Unruh, Grey, and Carter are partners with capital balances of $80,000, $200,000, and $120,000, respectively. Profits and losses are shared in a 3:2:1 ratio. Grey decided to withdraw and the partnership revalued its assets. The value of inventory was decreased by $20,000 and the value of land was increased by $50,000. Unruh and Carter then agreed to pay Grey $230,000 for his withdrawal from the partnership.

Required:
Prepare the journal entry to record Grey’s withdrawal under the
A. bonus method.
B. full goodwill method.

15-2 Dell and Gore are partners in an automobile repair business. Their respective capital balances are $425,000 and $275,000, and they share profits in a 3:2 ratio. Because of growth in their repair business, they decide to admit a new partner. Mann is admitted to the partnership, after which Dell, Gore, and Mann agree to share profits in a 3:2:1 ratio.

Required:
Prepare the necessary journal entries to record the admission of Mann in each of the following independent situations:

A. Mann invests $300,000 for a one-fourth capital interest, but will not accept a capital balance of less than his investment.

B. Mann invests $150,000 for a one-fifth capital interest. The partners agree that assets and the firm as a whole should be revalued.

C. Mann purchases a 20% capital interest from each partner. Dell receives $100,000 and Gore receives $50,000 directly from Mann.

15-3 Bryant, Milton, and Pine formed a partnership and agreed to share profits in a 3:1:2 ratio after recognition of 5% interest on average capital balances and monthly salary allowances of $3,750 to Milton and $3,000 to Pine. Average capital balances were as follows:

Bryant 300,000
Milton 240,000
Pine 180,000

Required:
Compute the net income (loss) allocated to each partner assuming the partnership incurred a $27,000 net loss.

15-4 Rice and Thome formed a partnership on January 2, 2011. Thome invested $120,000 in cash. Rice invested land valued at $30,000, which he had purchased for $20,000 in 2005. In addition, Rice possessed superior managerial skills and agreed to manage the firm. The partners agreed to the following profit and loss allocation formula:
a. Interest —8% on original capital investments.
b. Salary — $5,000 a month to Rice.
c. Bonus — Rice is to be allocated a bonus of 20% of net income after subtracting the bonus, interest, and salary.
d. Remaining profit is to be divided equally.

At the end of 2011 the partnership reported net income before interest, salaries, and bonus of $168,000.

Required:
Calculate the amount of bonus to be allocated to Rice.

15-5 Wynn and Yates are partners whose capital balances are $400,000 and $300,000 and who share profits 3:2. Due to a shortage of cash, Wynn and Yates agree to admit Zaun to the firm.

Required:
Prepare the journal entries required to record Zaun’s admission under each of the following assumptions:
(a) Zaun invests $200,000 for a 1/4 interest. The total firm capital is to be $900,000.
(b) Zaun invests $300,000 for a 1/4 interest. Goodwill is to be recorded.
(c) Zaun invests $150,000 for a 1/5 interest. Goodwill is to be recorded.
(d) Zaun purchases a 1/4 interest in the firm, with 1/4 of the capital of each old partner transferred to the account of the new partner. Zaun pays the partners cash of $250,000, which they divide between themselves.

15-6 The partners in the ABC partnership have capital balances as follows:
A. $70,000; B. $70,000 C. $105,000

Profits and losses are shared 30%, 20%, and 50%, respectively.

On this date, C withdraws and the partners agree to pay him $140,000 out of partnership cash.

Required:
A. Prepare journal entries to show three acceptable methods of recording the withdrawal. (Tangible assets are already stated at values approximating their fair market values.)

B. Which alternative would you recommend if you determined that the agreement to pay C $140,000 was not the result of arms length bargaining between C and the other partners? Why?

15-7 Agler, Bates and Colter are partners who share income in a 5:3:2 ratio. Colter, whose capital balance is $150,000, retires from the partnership.

Required:
Determine the amount paid to Colter under each of the following cases:

(1) $50,000 is debited to Agler capital account; the bonus approach is used.
(2) Goodwill of $60,000 is recorded; the partial goodwill approach is used.
(3) $66,000 is credited to Bates’ capital account; the total goodwill approach is used.

15-8 The partnership agreement of Stone, Miles, and Kiney provides for annual distribution of profit and loss in the following sequence:
– Miles, the managing partner, receives a bonus of 10% of net income.
– Each partner receives 5% interest on average capital investment.
– Residual profit or loss is to be divided 4:2:4.

Average capital investments for 2011 were:

Stone $270,000
Miles $180,000
Kiney $120,000

Required:
A. Prepare a schedule to allocate net income, assuming operations for the year resulted in:
1. Net income of $75,000.
2. Net income of $15,000.
3. Net loss of $30,000.

B. Prepare the journal entry to close the Income Summary account for each situation above.

Short Answer
1. The principal types of partnerships are general partnerships, limited partnerships, and joint ventures. Describe the characteristics of each type of partnership.
2. There are two methods of recording changes in the membership of a partnership – the bonus method and the goodwill method. Describe these two methods of recording changes in partnership membership.

Short Answer from the Textbook
1. Describe the tax treatment of partnership income.

2. Distinguish between a partner’s interest in capital and his interest in the partnership’s income and losses. Also, make a general distinction between a partner’s capital account and his drawing account.

3. Explain why a partnership is viewed in accounting as a “separate economic entity.”

4. What are some of the methods commonly used in allocating income and losses to the partners?

5. Explain the distinction between the terms “withdrawals” and “salaries.”

6. List some of the alternative methods of calculating a bonus that may appear in a partnership agreement.

7. What is meant by dissolution and what are its causes?

8. Discuss the methods used to record changes in partnership membership.

9. Differentiate between the admission of a new partner through assignment of an interest andthrough investment in the partnership.

10.Under what two conditions will the bonus and goodwill methods of recording the admission ofa partner yield the same result?

11.Describe the circumstances where neither the goodwill nor the bonus method should be used to record the admission of a new partner.

12.How might a partner withdrawing in violation of the partnership agreement and without the con-sent of the other partners be treated? What about a partner who is forced to withdraw?

Business Ethics Question from Textbook
Many companies with defined benefit plans are curtailing or eliminating the plans altogether. With a defined benefit plan, the company guarantees some set amount(or formula-determined payment) when the employee retires. Because most pension assets are invested in the stock market, whether a pension plan is fully funded of-ten depends on the strength of the stock market. Be-cause of this volatility, companies often find themselves unexpectedly in a position where they must either in-crease funding or disclose significant underfunding. Because of this, many companies simply reduce or eliminate the plan. Consider the pension plan of Golden Years Company (GYC). Historically, GYC has been a great company to work for, with strong employee benefits. GYC’s pension liability is approximately $15 million. However, recently the company has been experiencing minor financial troubles in a decreasing stock market and, consequently, announced the termination of the pension plan in an effort to save costs. However, the pension plan was fully funded by$9 million (the fair value of assets exceeded the expected liability).

1.How does the firm reconcile the trade-off between financial performance and the responsibility to its employees?

Chapter 16

Partnership Liquidation

Multiple Choice

1. Which of the following statements is correct?
1. Personal creditors have first claim on partnership assets.
2. Partnership creditors have first claim on partnership assets.
3. Partnership creditors have first claim on personal assets.
a. 1
b. 2
c. 3
d. Both 2 and 3

2. The first step in the liquidation process is to
a. convert noncash assets into cash.
b. pay partnership creditors
c. compute any net income (loss) up to the date of dissolution.
d. allocate any gains or losses to the partners.

3. A schedule prepared each time cash is to be distributed is called a(n)
a. advance cash distribution schedule.
b. marshaling of assets schedule.
c. loss absorption potential schedule.
d. safe payment schedule.

4. An advance cash distribution plan is prepared
a. each time cash is distributed to partners in an installment liquidation.
b. each time a partnership asset is sold in an installment liquidation.
c. to determine the order and amount of cash each partner will receive as it becomes available for distribution.
d. none of these.

5. The first step in preparing an advance cash distribution plan is to
a. determine the order in which partners are to participate in cash distributions.
b. compute the amount of cash each partner is to receive as it becomes available for distribution.
c. allocate any gains (losses) to the partners in their profit-sharing ratio.
d. determine the net capital interest of each partner.

6. Offsetting a partner’s loan balance against his debit capital balance is referred to as the
a. marshaling of assets.
b. right of offset.
c. allocation of assets.
d. liquidation of assets.

7. If a partner with a debit capital balance during liquidation is personally solvent, the
a. partner must invest additional assets in the partnership.
b. partner’s debit balance will be allocated to the other partners.
c. other partners will give the partner enough cash to absorb the debit balance.
d. partnership will loan the partner enough cash to absorb the debit balance.

8. The following condensed balance sheet is presented for the partnership of Jim, Bill, and Fred who share profits and losses in the ratio of 4:3:3, respectively:

Cash $ 180,000
Other assets 1,940,000
Jim, receivable 60,000
$ 2,180,000

Accounts payable $ 480,000
Bill, loan 80,000
Jim, capital 720,000
Bill, capital 440,000
Fred, capital 460,000
$2,180,000

Assume that the assets and liabilities are fairly valued on the balance sheet and that the partnership decides to admit Tom as a new partner, with a 25% interest. No goodwill or bonus is to be recorded. How much should Tom contribute in cash or other assets?
a. $270,000
b. $405,000
c. $540,000
d. $520,000

9. The partnership of Joe, Al, and Mike shares profits and losses 60%, 30%, and 10%, respectively. On January 1, 2011, the partners voted to dissolve the partnership, at which time the assets, liabilities, and capital balances were as follows:

Assets Liabilities and Capital
Cash $ 400,000 Accounts Payable $ 580,000
Other Assets 1,200,000 Joe, Capital 440,000
Al, Capital 380,000
Mike, Capital 200,000
Total assets $1,600,000 Total liabilities $1,600,000

All of the partners are personally insolvent.

Assume that all noncash assets are sold for $840,000 and all available cash is distributed in final liquidation of the partnership. Cash should be distributed to the partners as follows
a. Joe, $744,000; Al, $372,000; Mike, $124,000.
b. Joe, $440,000; Al, $380,000; Mike, $200,000.
c. Joe, $224,000; Al, $272,000; Mike, $164,000.
d. Joe, $396,000; Al, $198,000; Mike, $66,000.

10. The partnership of Pratt, Ellis, and Mack share profits and losses in the ratio of 4:4:2, respectively. The partners voted to dissolve the partnership when its assets, liabilities, and capital were as follows:
Assets
Cash $ 250,000
Other assets 1,000,000
$1,250,000

Liabilities and Capital
Liabilities $ 200,000
Pratt, Capital 300,000
Ellis, Capital 350,000
Mack, Capital 400,000
$1,250,000

The partnership will be liquidated over a prolonged period of time. As cash is available, it will be distributed to the partners. The first sale of noncash assets having a book value of $600,000 realized $475,000. How much cash should be distributed to each partner after this sale?
a. Pratt, $90,000; Ellis, $140,000; Mack, $295,000
b. Pratt, $210,000; Ellis, $290,000; Mack, $145,000
c. Pratt, $290,000; Ellis, $210,000; Mack, $105,000
d. Pratt, $150,000; Ellis, $175,000; Mack, $200,000

11. In a partnership liquidation, the final cash distribution to the partners should be made in accordance with the:
a. partners’ profit and loss sharing ratio.
b. balances of the partners’ capital accounts.
c. ratio of the capital contributions by the partners.
d. ratio of capital contributions less withdrawals by the partners.

12. In an advance plan for installment distributions of cash to partners of a liquidating partnership, each partner’s loss absorption potential is computed by
a. dividing each partner’s capital account balance by the percentage of that partner’s capital account balance to total partners’ capital.
b. multiplying each partner’s capital account balance by the percentage of that partner’s capital account balance to total partners’ capital.
c. dividing the total of each partner’s capital account less receivables from the partner plus payables to the partner by the partner’s profit and loss percentage.
d. some other method.

13. Under the Uniform Partnership Act
a. partnership creditors have first claim (Rank I) against the assets of an insolvent partnership.
b. personal creditors of an individual partner have first claim (Rank I) against the personal assets of all partners.
c. partners with credit capital balances share (Rank I) the personal assets of an insolvent partner that has a debit capital balance with personal creditors of that partner.
d. personal creditors of the partners of an insolvent partnership share partnership assets on a pro rata basis (Rank I) with partnership creditors.

14. During the liquidation of the partnership of Karr, Rice, and Long. Karr accepts, in partial settlement of his interest, a machine with a cost to the partnership of $150,000, accumulated depreciation of $70,000, and a current fair value of $110,000. The partners share net income and loss equally. The net debit to Karr’s account (including any gain or loss on disposal of the machine) is
a. $90,000.
b. $100,000.
c. $110,000.
d. $150,000.

15. X, Y, and Z have capital balances of $90,000, $60,000, and $30,000, respectively. Profits are allocated 35% to X, 35% to Y, and 30% to Z. The partners have decided to dissolve and liquidate the partnership. After paying all creditors, the amount available for distribution is $60,000. X, Y, and Z are all personally solvent. Under the circumstances, Z will
a. receive $18,000.
b. receive $30,000.
c. personally have to contribute an additional $6,000.
d. personally have to contribute an additional $36,000.

16. The ABC partnership has the following capital accounts on its books at December 31, 2011:
Credit
A, Capital $400,000
B, Capital 240,000
C, Capital 80,000
All liabilities have been liquidated and the cash balance is zero. None of the partners have personal assets in excess of his personal liabilities. The partners share profits and losses in the ratio of 3:2:5. If the noncash assets are sold for $400,000, the partners should receive as a final payment:
a. A, $304,000; B, $176,000; C, $80,000
b. A, $256,000; B, $144,000; C, $-0-
c. A, $304,000; B, $176,000; C, $-0-
d. A, $120,000; B, $80,000; C, $200,000

17. The summarized balances of the accounts of MNO partnership on December 31, 2011, are as follows:

Assets Liabilities and Capital
Cash $ 15,000 Liabilities $ 15,000
Noncash 90,000 M, Capital 45,000
N, Capital 30,000
O, Capital 15,000
Total Assets $105,000 Total Equities $105,000

The agreed upon profit/loss ratio is 50:40:10, respectively. Using the information given above, which one of the following amounts, if any, is the loss absorption potential of partner N as of December 31, 2011?
a. $20,000
b. $35,000
c. $75,000
d. $120,000

18. Adamle, Boyer, and Clay are partners with a profit and loss ratio of 4:3:3. The partnership was liquidated and, prior to the liquidation process, the partnership balance sheet was as follows:

ADAMLE, BOYER, AND CLAY
Balance Sheet
January 1, 2011

Assets Liabilities and Equity
Cash $ 60,000 Adamle, Capital $216,000
Other assets 540,000 Boyer, Capital 240,000
Clay, Capital 144,000
Total Assets $600,000 Total Liabilities & Equities $600,000

After the partnership was liquidated and the cash was distributed, Boyer received $96,000 in cash in full settlement of his interest.

The liquidation loss must have been:
a. $360,000
b. $144,000
c. $504,000
d. $480,000

19. The partnership of Hall, Jones, and Otto has been dissolved and is in the process of liquidation. On July 1, 2011, just before the second cash distribution, the assets and equities of the partnership along with residual profit sharing ratios were as follows:

Assets Liabilities & Equities
Cash $ 200,000 Liabilities $ 150,000
Receivables-net 50,000 Hall, Capital 50% 100,000
Inventories 150,000 Jones, Capital 30% 175,000
Equipment-net 100,000 Otto, Capital 20% 75,000
Total assets $ 500,000 Total Lia & Equity 500,000

Assume that the available cash is distributed immediately, except for a $25,000 contingency fund that is withheld pending complete liquidation of the partnership. How much cash should be paid to each of the partners?

Hall Jones Otto
a. $87,500 $52,500 $35,000
b. 12,500 7,500 10,000
c. – 0 – 25,000 – 0 –
d. – 0 – 15,000 10,000

20. The partnership of Hall, Jones, and Otto has been dissolved and is in the process of liquidation. On July 1, 2011, just before the second cash distribution, the assets and equities of the partnership along with residual profit sharing ratios were as follows:

Assets Liabilities & Equities
Cash $ 200,000 Liabilities $ 150,000
Receivables-net 50,000 Hall, Capital 50% 100,000
Inventories 150,000 Jones, Capital 30% 175,000
Equipment-net 100,000 Otto, Capital 20% 75,000
Total assets $ 500,000 Total Lia & Equity 500,000

Assume that Hall takes equipment with a fair value of $40,000 and a book value of $50,000 in partial satisfaction of his equity in the partnership. If all the $200,000 cash is then distributed, the partners should receive:
Hall Jones Otto
a. $100,000 $60,000 $40,000
b. 25,000 15,000 10,000
c. – 0 45,000 5,000
d. – 0 50,000 – 0

21. The partnership of Starr, Foley, and Pele share profits and losses in the ratio of 4:4:2, respectively. The partners voted to dissolve the partnership when its assets, liabilities, and capital were as follows:

Assets Liabilities and Equity
Cash $150,000 Liabilities $120,000
Other assets 600,000 Starr, Capital 180,000
Foley, Capital 210,000
Pele, Capital 240,000
Total assets $750,000 Total Lia & Equity $750,000

The partnership will be liquidated over a prolonged period of time. As cash is available, it will be distributed to the partners. The first sale of noncash assets having a book value of $360,000 realized $285,000. How much cash should be distributed to each partner after this sale?
a. Starr, $54,000; Foley, $84,000; Pele, $177,000.
b. Starr, $174,000; Foley, $174,000; Pele, $87,000.
c. Starr, $126,000; Foley, $126,000; Pele, $63,000.
d. Starr, $90,000; Foley, $105,000; Pele, $120,000.

22. A, B, and C have capital balances of $90,000, $60,000, and $30,000, respectively. Profits are allocated 35% to A, 35% to B and 30% to C. The partners have decided to dissolve and liquidate the partnership. After paying all creditors the amount available for distribution is $60,000. A, B, and C are all personally solvent. Under the circumstances, C will
a. receive $18,000.
b. receive $30,000.
c. personally have to contribute an additional $6,000.
d. personally have to contribute an additional $36,000.

23. The ABC partnership has the following capital accounts on its books at December 31, 2011:

Credit
A, Capital $200,000
B, Capital 120,000
C, Capital 40,000

All liabilities have been liquidated and the cash balance is zero. None of the partners have personal assets in excess of his personal liabilities. The partners share profits and losses in the ratio of 3:2:5. If the noncash assets are sold for $150,000, the partners should receive as a final payment:
a. A, $152,000; B, $88,000 C, $40,000
b. A, $128,000; B, $72,000; C, $ – 0 –
c. A, $152,000; B, $88,000; C, $ – 0 –
d. A, $60,000; B, $40,000; C, $100,000

24. The summarized balances of the accounts of RST partnership on December 31, 2011, are as follows:
Assets Liabilities and Equity
Cash $ 30,000 Liabilities $ 30,000
Noncash 180,000 R, Capital 90,000
S, Capital 60,000
T, Capital 30,000
Total Assets $210,000 Total Lia & Equities $210,000

The agreed upon profit/loss ratio is 50:40:10, respectively. Using the information given above, which one of the following amounts, if any, is the loss absorption potential of partner S as of December 31, 2011?
a. $60,000
b. $70,000
c. $150,000
d. $240,000

25. The partnership of Hill, Kiner, and Polk has been dissolved and is in the process of liquidation. On July 1, 2011, just before the second cash distribution, the assets and equities of the partnership along with residual profit sharing ratios were as follows:
Assets Liabilities and Equity
Cash $ 80,000 Liabilities $ 60,000
Receivables-net 20,000 Hill, Capital 50% 40,000
Inventories 60,000 Kiner, Capital 30% 70,000
Equipment-net 40,000 Polk, Capital 20% 30,000
Total assets $200,000 Total Lia & Equity $200,000

Assume that the available cash is distributed immediately, except for a $10,000 contingency fund that is withheld pending complete liquidation of the partnership. How much cash should be paid to each of the partners?
Hill Kiner Polk
a. $35,000 $21,000 $14,000
b. $5,000 $3,000 $4,000
c. $0 $10,000 $0
d. $0 $6,000 $4,000

Problems

16-1 The NOR Partnership is being liquidated. A balance sheet prepared prior to liquidation is presented below:

Assets Liabilities & Equities
Cash $240,000 Liabilities $ 160,000
Other Assets 300,000 Reese, Loan 60,000
Nen, Capital 180,000
Ott, Capital 60,000
Reese, Capital 80,000
Total Assets $540,000 Total Equities $540,000

Nen, Ott, and Reese share profits and losses in a 40:40:20 ratio. All partners are personally insolvent.

Required:
A. Prepare the journal entries necessary to record the distribution of the available cash.

B. Prepare the journal entries necessary to record the completion of the liquidation process, assuming the other assets are sold for $120,000.

16-2 The trial balance for the ABC Partnership is as follows just before liquidation:

OTHER BALL ADLER BALL CARL
CASH ASSETS RECEIVABLE = LIABILITIES CAPITAL CAPITAL CAPITAL
180,000 625,000 90,000 150,000 420,000 270,000 180,000

Partners share profits a 50:30:20 ratio.

Required:
Prepare an advance cash distribution plan showing how available cash would be distributed.

16-3 Lewis, Nance, and Otis operate the LNO Partnership. The partnership agreement provides that the partners share profits in the ratio of 40:40:20, respectively. Unable to satisfy the firm’s debts, the partners decide to liquidate. Account balances just prior to the start of the liquidation process are as follows:
Debit Credit
Cash $ 90,000
Other Assets 330,000
Liabilities $165,000
Otis, Loan 36,000
Lewis, Capital 165,000
Nance, Capital 36,000
Otis, Capital 39,000
Otis, Drawing 21,000 _______
Totals $441,000 $441,000

During the first month of liquidation, other assets with a book value of $150,000 are sold for $165,000, and creditors are paid. In the following month unrecorded liabilities of $12,000 are discovered and assets carried on the books at a cost of $90,000 are sold for $36,000. During the third month the remaining other assets are sold for $42,000 and all available cash is distributed.

Required:
Prepare a schedule of partnership realization and liquidation. A safe distribution of cash is to be made at the end of the second and third months. The partners agreed to hold $30,000 in cash in reserve to provide for possible liquidation expenses and/or unrecorded liabilities. All of the partners are personally insolvent.

16-4 Due to the fact that the partnership had been unprofitable for the past several years, A, B, C, and D decided to liquidate their partnership. The partners share profits and losses in the ratio of 40:30:20:10, respectively. The following balance sheet was prepared immediately before the liquidation process began:

A B C D Partnership
Balance Sheet

Cash $ 100,000 Liabilities $250,000
Other Assets 350,000 A, Capital 55,000
B, Capital 60,000
C, Capital 50,000
D, Capital 35,000
Total Assets $450,000 Total Lia & Equities $450,000

The personal status of each partner is as follows:
Personal Personal
_Assets_ Liabilities
A $165,000 $ 120,000
B 100,000 140,000
C 180,000 160,000
D 60,000 70,000

The partnership’s other assets are sold for $100,000 cash. The partnership operates in a state which has adopted the Uniform Partnership Act.

Required:
A. Complete the following schedule of partnership realization and liquidation. Assume that a partner makes additional contributions to the partnership when appropriate based on their individual status.

OTHER CAPITAL
CASH ASSETS LIABILITIES __A__ __B__ __C__ __D__
$100,000 $350,000 $250,000 55,000 60,000 50,000 35,000

B. Complete the following schedule to show the total amount that will be paid to the personal creditors.

From Distribution Total Paid
Personal from to Personal
_Assets_ _Partnership_ _Creditors_
A
B
C
D

16-5 A trial balance for the DEF partnership just prior to liquidation is given below:

Debit Credit
Cash $ 75,000
Noncash Assets 750,000
Nonpartner Liabilities $240,000
Dugan, Loan 75,000
Dugan, Capital 225,000
Elston, Capital 153,000
Flynn, Capital 132,000
Totals $825,000 $825,000

The partners share income and loss on the following basis:
Dugan 50%
Elston 30%
Flynn 20%

Required:
Prepare an advance cash distribution plan for the partners.

16-6 David, Paul, and Burt are partners in a CPA firm sharing profits and losses in a ratio of 2:2:3, respectively. Immediately prior to liquidation, the following balance sheet was prepared:

Assets Liabilities & Equities
Cash $ 100,000 Liabilities $280,000
Noncash assets 580,000 David, Capital 160,000
Paul, Capital 160,000
_______ Burt, Capital 80,000
Total Assets $680,000 Total Liabilities & Equities $680,000

Required:
Assuming the noncash assets are sold for $300,000, determine the amount of cash to be distributed to each partner. Complete the worksheet and clearly indicate the amount of cash to be distributed to each partner in the spaces provided. No cash is available from any of the three partners.

A. Noncash David Paul Burt
Cash Assets Liabilities Capital Capital Capital
Beginning Bal. 100,000 580,000 280,000 160,000 160,000 80,000

16-7 Using the information from Problem 16-6, assume the noncash assets are sold for $160,000. Determine the amount of cash to be distributed to each partner assuming all partners are personally solvent.

16-8 The December 31, 2010, balance sheet of the Deng, Danielson, and Gibson partnership, along with the partners’ residual profit and loss sharing ratios, is summarized as follows:

Assets Liabilities & Equities
Cash $ 150,000 Accounts Payable $ 225,000
Receivables 300,000 Loan from Danielson 50,000
Inventories 375,000 Deng, Capital (20%) 250,000
Other Assets 475,000 Danielson, Capital (30%) 400,000
Gibson, Capital (50%) 375,000
Total Assets $1,300,000 Total Lia & Equities $1,300,000

The partners agree to liquidate their partnership as soon as possible after January 1, 2011 and to distribute all cash as it becomes available.

Required:
Prepare an advance cash distribution plan to show how cash will be distributed as it becomes available.

Short Answer

1. The Uniform Partnership Act specifies specific steps in distributing available partnership assets in liquidation. Describe the steps used to distribute partnership assets during the liquidation process.

2. An advance cash distribution plan specifies the order in which each partner will receive cash and the dollar amount each will receive as it becomes available for distribution. Identify the four steps in the preparation of an advance cash distribution plan.

Short Answer Questions from the Textbook

1. Why are realization gains or losses allocated to partners in their profit and loss ratios?

2. In what manner should the final cash distribution be made in partnership liquidation?

3. Why does a debit balance in a partners’ capital account create problems in the UPA order of payment for a partnership liquidation?

4. Is it important to maintain separate accounts for a partner’s outstanding loan and capital ac-counts? Explain why or why not.

5. Discuss the possible outcomes in the situation where the equity interest of one partner is inadequate to absorb realization losses.

6. During a liquidation, at which point may cash be distributed to any of the partners?

7. What is “marshaling of assets”?

8. To what extent can personal creditors seek re-covery from partnership assets?

9. In an installment liquidation, why should the partners view each cash distribution as if it were the final distribution?

10. Discuss the three basic assumptions necessary for calculating a safe cash distribution. How is this safe cash distribution computed?

11. How are unexpected costs such as liquidation expenses, disposal costs, or unrecorded liabilities covered in the safe distribution schedule?

12. What is the objective of the procedures used for the preparation of an advance cash distribution plan?

13. What is the “loss absorption potential”?

14. In what order must partnership assets be distributed?

Business Ethics Question from the Textbook

You and two of your former college friends, Freeman and Oxyman, formed a partnership called FOB, which builds and installs fabricated swimming pools. The business has been operating for 15 years and has become one of the top swimming pool companies in the area. Typically, you have been providing the on-site estimates for the pools, while your partners do most of the onsite construction. While visiting one of the sites, you hear a conversation between one of your partners and a customer. Your partner is explaining that the cost will increase by $10,000 because of unexpected rock removal. You are a bit surprised by this, since you had tested the area for rocks. Later, back at the office, you review the core-sample results done on that job, which did not reveal any rock. You decide to talk to the partner when he returns to the office. When the partner returns to the office, he is arguing with someone from a local bank concerning an outstanding personal loan.

1.What do you see as your duty with respect to the partnership?

2.What should you do? Explain your reasoning.