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ACC 401 Advanced Accounting Week 7 Quiz – Strayer

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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.

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.

10-5 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.

10-6 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?