Question & Answer

Explain the general difference in the composition of pension portfolios managed by trusts versus those managed by insurance companies. Why does this difference occur? (LO6)

Refer to the accounting change by Wertz Construction Company in BE22-1. Wertz has a profitsharing plan, which pays all employees a bonus at year-end based on 1% of pretax income. Compute the indirect effect of Wertz’s change in accounting principle that will be reported in the 2014 income statement, assuming that the profit-sharing contract explicitly requires adjustment for changes in income numbers.

You have completed the field work in connection with your audit of Alexander Corporation for the year ended December 31, 2014. The balance sheet accounts at the beginning and end of the year are shown below. Increase Dec. 31, Dec. 31, or 2014 2013 (Decrease) Cash $ 277,900 $ 298,000 ($20,100) Accounts receivable 469,424 353,000 116,424 Inventory 741,700 610,000 131,700 Prepaid expenses 12,000 8,000 4,000 Investment in subsidiary 110,500 –0– 110,500 Cash surrender value of life insurance 2,304 1,800 504 Machinery 207,000 190,000 17,000 Buildings 535,200 407,900 127,300 Land 52,500 52,500 –0– Patents 69,000 64,000 5,000 Copyrights 40,000 50,000 (10,000) Bond discount and issue costs 4,502 –0– 4,502 $2,522,030 $2,035,200 $486,830 Income taxes payable $ 90,250 $ 79,600 $ 10,650 Accounts payable 299,280 280,000 19,280 Dividends payable 70,000 –0– 70,000 Bonds payable—8% 125,000 –0– 125,000 Bonds payable—12% –0– 100,000 (100,000) Allowance for doubtful accounts 35,300 40,000 (4,700) Accumulated depreciation—buildings 424,000 400,000 24,000 Accumulated depreciation—machinery 173,000 130,000 43,000 Premium on bonds payable –0– 2,400 (2,400) Common stock—no par 1,176,200 1,453,200 (277,000) Paid-in capital in excess of par—common stock 109,000 –0– 109,000 Retained earnings—unappropriated 20,000 (450,000) 470,000 $2,522,030 $2,035,200 $486,830 STATEMENT OF RETAINED EARNINGS FOR THE YEAR ENDED DECEMBER 31, 2014 January 1, 2014 Balance (defi cit) $(450,000) March 31, 2014 Net income for fi rst quarter of 2014 25,000 April 1, 2014 Transfer from paid-in capital 425,000 Balance –0– December 31, 2014 Net income for last three quarters of 2014 90,000 Dividend declared—payable January 21, 2015 (70,000) Balance $ 20,000 Your working papers from the audit contain the following information: 1. On April 1, 2014, the existing deficit was written off against paid-in capital created by reducing the stated value of the no-par stock. 2. On November 1, 2014, 29,600 shares of no-par stock were sold for $257,000. The board of directors voted to regard $5 per share as stated capital. 3. A patent was purchased for $15,000. 4. During the year, machinery that had a cost basis of $16,400 and on which there was accumulated depreciation of $5,200 was sold for $9,000. No other plant assets were sold during the year. 5. The 12%, 20-year bonds were dated and issued on January 2, 2002. Interest was payable on June 30 and December 31. They were sold originally at 106. These bonds were redeemed at 100.9 plus accrued interest on March 31, 2014. 6. The 8%, 40-year bonds were dated January 1, 2014, and were sold on March 31 at 97 plus accrued interest. Interest is payable semiannually on June 30 and December 31. Expense of issuance was $839. 7. Alexander Corporation acquired 70% control in Crimson Company on January 2, 2014, for $100,000. The income statement of Crimson Company for 2014 shows a net income of $15,000. 8. Extraordinary repairs to buildings of $7,200 were charged to Accumulated Depreciation—Buildings. 9. Interest paid in 2014 was $10,500 and income taxes paid were $34,000. Instructions From the information given, prepare a statement of cash flows using the indirect method. A worksheet is not necessary, but the principal computations should be supported by schedules or general ledger accounts. The company uses straight-line amortization for bond interest.

Two positions have normally been taken with respect to the recording of fixed manufacturing overhead as an element of the cost of plant assets constructed by a company for its own use: (a) It should be excluded completely. (b) It should be included at the same rate as is charged to normal operations. What are the circumstances or rationale that support or deny the application of these methods?

For what reasons may the natural rate of unemployment increase?

Executive remuneration: two-strikes policy Investigate which companies have experienced either one-strike or two-strikes on their remuneration reports in the last year or two. Summarise your results and collect the specifics of one example. (LO4 and 5)

Compare and contrast the basis of property acquired via purchase, conversion from personal use to business or rental use, tax-deferred exchange, gift, and inheritance.

Grant Wood Corporation’s balance sheet at the end of 2013 included the following items. Current assets $235,000 Current liabilities $150,000 Land 30,000 Bonds payable 100,000 Buildings 120,000 Common stock 180,000 Equipment 90,000 Retained earnings 44,000 Accum. depr.—buildings (30,000) Total $474,000 Accum. depr.—equipment (11,000) Patents 40,000 Total $474,000 The following information is available for 2014. 1. Net income was $55,000. 2. Equipment (cost $20,000 and accumulated depreciation $8,000) was sold for $10,000. 3. Depreciation expense was $4,000 on the building and $9,000 on equipment. 4. Patent amortization was $2,500. 5. Current assets other than cash increased by $29,000. Current liabilities increased by $13,000. 6. An addition to the building was completed at a cost of $27,000. 7. A long-term investment in stock was purchased for $16,000. 8. Bonds payable of $50,000 were issued. 9. Cash dividends of $30,000 were declared and paid. 10. Treasury stock was purchased at a cost of $11,000. Instructions (Show only totals for current assets and current liabilities.) (a) Prepare a statement of cash flows for 2014. (b) Prepare a balance sheet at December 31, 2014.

Presented below are a number of business transactions that occurred during the current year for Gonzales, Inc. Instructions In each of the situations, discuss the appropriateness of the journal entries in terms of generally accepted accounting principles. (a) The president of Gonzales, Inc. used his expense account to purchase a new Suburban solely for personal use. The following journal entry was made. Miscellaneous Expense 29,000 Cash 29,000 (b) Merchandise inventory that cost $620,000 is reported on the balance sheet at $690,000, the expected selling price less estimated selling costs. The following entry was made to record this increase in value. Inventory 70,000 Sales Revenue 70,000 (c) The company is being sued for $500,000 by a customer who claims damages for personal injury apparently caused by a defective product. Company attorneys feel extremely confident that the company will have no liability for damages resulting from the situation. Nevertheless, the company decides to make the following entry. Loss from Lawsuit 500,000 Liability for Lawsuit 500,000 (d) Because the general level of prices increased during the current year, Gonzales, Inc. determined that there was a $16,000 understatement of depreciation expense on its equipment and decided to record it in its accounts. The following entry was made. Depreciation Expense 16,000 Accumulated Depreciation—Equipment 16,000 (e) Gonzales, Inc. has been concerned about whether intangible assets could generate cash in case of liquidation. As a consequence, goodwill arising from a purchase transaction during the current year and recorded at $800,000 was written off as follows. Retained Earnings 800,000 Goodwill 800,000 (f) Because of a “fire sale,” equipment obviously worth $200,000 was acquired at a cost of $155,000. The following entry was made. Equipment 200,000 Cash 155,000 Sales Revenue 45,000

Explain how gains or losses on impaired assets should be reported in income.

resented below are a number of balance sheet items for Montoya, Inc., for the current year, 2014. Goodwill $ 125,000 Accumulated depreciation—equipment $ 292,000 Payroll taxes payable 177,591 Inventory 239,800 Bonds payable 300,000 Rent payable (short-term) 45,000 Discount on bonds payable 15,000 Income taxes payable 98,362 Cash 360,000 Rent payable (long-term) 480,000 Land 480,000 Common stock, $1 par value 200,000 Notes receivable 445,700 Preferred stock, $10 par value 150,000 Notes payable (to banks) 265,000 Prepaid expenses 87,920 Accounts payable 490,000 Equipment 1,470,000 Retained earnings ? Equity investments (trading) 121,000 Income taxes receivable 97,630 Accumulated depreciation—buildings 270,200 Notes payable (long-term) 1,600,000 Buildings 1,640,000 Instructions Prepare a classified balance sheet in good form. Common stock authorized was 400,000 shares, and preferred stock authorized was 20,000 shares. Assume that notes receivable and notes payable are short-term, unless stated otherwise. Cost and fair value of equity investments (trading) are the same.

Tweedie Company issues 10,000 shares of restricted stock to its CFO, Mary Tokar, on January 1, 2014. The stock has a fair value of $500,000 on this date. The service period related to this restricted stock is 5 years. Vesting occurs if Tokar stays with the company until December 31, 2018. The par value of the stock is $10. At December 31, 2014, the fair value of the stock is $450,000. Instructions (a) Prepare the journal entries to record the restricted stock on January 1, 2014 (the date of grant), and December 31, 2015. (b) On July 25, 2018, Tokar leaves the company. Prepare the journal entry (if any) to account for this forfeiture.

John and Tara Smith are married and have lived in the same home for over 20 years.John’s uncle Tim, who is 64 years old, has lived with the Smiths since March of this year. Tim is searching for employment but has been unable to find any—his gross income for the year is $2,000.Tim used all $2,000 toward his own support.The Smiths provided the rest of Tim’s support by providing him with lodging valued at $5,000 and food valued at $2,200. a. Are the Smiths able to claim a dependency exemption for Tim?

Dagwood Inc. recently noted that its 4% preferred stock and 4% participating preferred stock, which are both cumulative, have priority as to dividends up to 4% of their par value. Its participating preferred stock participates equally with the common stock in any dividends in excess of 4%. What is meant by the term participating? Cumulative?

Green Day Hardware Company’s payroll for November 2014 is summarized below. Amount Subject to Payroll Taxes Unemployment Tax Payroll Wages Due FICA Federal State Factory $120,000 $120,000 $40,000 $40,000 Sales 32,000 32,000 4,000 4,000 Administrative 36,000 36,000 — — Total $188,000 $188,000 $44,000 $44,000 At this point in the year, some employees have already received wages in excess of those to which payroll taxes apply. Assume that the state unemployment tax is 2.5%. The FICA rate is 7.65% on an employee’s wages to $113,700 and 1.45% in excess of $113,700. Of the $188,000 wages subject to FICA tax, $20,000 of the sales wages is in excess of $113,700. Federal unemployment tax rate is 0.8% after credits. Income tax withheld amounts to $16,000 for factory, $7,000 for sales, and $6,000 for administrative. Instructions (a) Prepare a schedule showing the employer’s total cost of wages for November by function. (Round allcomputations to nearest dollar.) (b) Prepare the journal entries to record the factory, sales, and administrative payrolls including the employer’s payroll taxes.

Sustainability and classification Using the following table, classify each sustainability cost according to their appropriate category (level 1–5).         (LO3 and 4)

If the regulator imposed such rules, would they cause the firm to make a loss if it faced a downward-sloping LRMSC curve? (Clues: Where would the LRAC curve be relative to the LRMC curve? What would be the effect of externalities and the addition of the Z factor on the price?)

Ace Inc. produces electronic components for sale to manufacturers of radios, television sets, and digital sound systems. In connection with her examination of Ace’s financial statements for the year ended December 31, 2015, Gloria Rodd, CPA, completed field work 2 weeks ago. Ms. Rodd now is evaluating the significance of the following items prior to preparing her auditor’s report. Except as noted, none of these items have been disclosed in the financial statements or notes. Item 1: A 10-year loan agreement, which the company entered into 3 years ago, provides that dividend payments may not exceed net income earned after taxes subsequent to the date of the agreement. The balance of retained earnings at the date of the loan agreement was $420,000. From that date through December 31, 2015, net income after taxes has totaled $570,000 and cash dividends have totaled $320,000. On the basis of these data, the staff auditor assigned to this review concluded that there was no retained earnings restriction at December 31, 2015. Item 2: Recently Ace interrupted its policy of paying cash dividends quarterly to its stockholders. Dividends were paid regularly through 2014, discontinued for all of 2015 to finance purchase of equipment for the company’s new plant, and resumed in the first quarter of 2016. In the annual report, dividend policy is to be discussed in the president’s letter to stockholders. Item 3: A major electronics firm has introduced a line of products that will compete directly with Ace’s primary line, now being produced in the specially designed new plant. Because of manufacturing innovations, the competitor’s line will be of comparable quality but priced 50% below Ace’s line. The competitor announced its new line during the week following completion of field work. Ms. Rodd read the announcement in the newspaper and discussed the situation by telephone with Ace executives. Ace will meet the lower prices that are high enough to cover variable manufacturing and selling expenses but will permit recovery of only a portion of fixed costs. Item 4: The company’s new manufacturing plant building, which cost $2,400,000 and has an estimated life of 25 years, is leased from Wichita National Bank at an annual rental of $600,000. The company is obligated to pay property taxes, insurance, and maintenance. At the conclusion of its 10-year noncancelable lease, the company has the option of purchasing the property for $1. In Ace’s income statement, the rental payment is reported on a separate line. Instructions For each of the above items, discuss any additional disclosures in the financial statements and notes that the auditor should recommend to her client. (The cumulative effect of the four items should not be considered.)

Risk classification Regal Foods is a multi-divisional company operating in a range of locations around the globe. Its product-based divisions are: Ice Cream and Associated Dairy Products, Confectionery, Nutrition, and Prepared Food. Regal has total sales in excess of $10 billion. The CEO, Ruby Day, recently undertook a company review, which identified the following strategies and objectives: • optimising product performance through strong research and development, product innovation and market share growth • enhancing financial performance through financial discipline and targeted capital expenditure.   Divisional managers have traditionally been allowed significant autonomy in line with the decentralised divisional structure. CFO Paul Falkenberg has recently introduced relative performance evaluation (RPE) at the divisional level to promote competitiveness, with the objective of growing the company.   Ice Cream and Associated Dairy Products Division The Ice Cream and Associated Dairy Products Division focuses on such products as ice cream, yoghurt, milk and cheeses. The current divisional manager is Alette Rennie, who has been in the position for the past three years. In that time, Alette has achieved average annual divisional revenue growth of 6 per cent. However, there are concerns about some of the exposures the division has. For example in a recent email to the CFO and CEO, Alette expressed concerns about some of the division’s exposures to the agricultural industry, the increasing global competition in dairy products, and the lack of bargaining power of the company in the local milk price wars.   Nutrition Division The Nutrition Division focuses on health-related products. Historically, the Nutrition Division has been an excellent contributor to group performance, with annual growth rates of up to 12 per cent for the period 2006 to 2012, and revenues exceeding $2 billion. However, divisional manager Bruce Buncle has found it increasingly difficult to maintain growth. An increasingly crowded market for health and nutritional products seems to be the main driver of these difficulties. As a consequence, debt levels of the division seem to be rising. However, Buncle is conscious that he needs to develop new products and markets in line with company objectives.   Buncle and his management team have been considering a range of investment opportunities and have decided on a major investment in the bottled water industry. While the industry has its challenges (for example, environmental opposition to the use of plastic bottles, tightening environmental regulations and the expectation of reduced carbon emissions), Buncle and his management team see a lot of potential with such a strategic move. However, where significant capital expenditure is required, Buncle finds the company investment decision-making processes frustrating.   The management team within the Nutrition Division has identified a new spring water source in a regional area. The local authorities are in favour of the springs being used to supply the Nutrition Division with spring water for a new water bottling plant to be built in the region. In fact, the local authorities are willing to forgo local taxes and provide subsidies to Regal to ensure the plant is built. The region has experienced relatively high levels of unemployment in recent years and the new plant will generate some 100 local new jobs. While there is some local opposition to the new facility on environmental grounds, Buncle considers these to be manageable. While he knows the project’s financial benefit is mainly after the third year, he knows that the investment is a good strategic move for his division.   Required Using the risk classification framework (strategic, operational, legal and regulatory, and financial) identify the key risks to which Regal and its divisions are exposed. (LO6)

How can the market distortions argument be used to justify putting excise duties on specific goods such as petrol, alcohol and tobacco? Is this the only reason why excise duties are put on these particular products?

Alvarado Company sells a machine for $7,400 with a 12-month warranty agreement that requires the company to replace all defective parts and to provide the repair labor at no cost to the customers. With sales being made evenly throughout the year, the company sells 600 machines in 2014 (warranty expense is incurred half in 2014 and half in 2015). As a result of product testing, the company estimates that the warranty cost is $390 per machine ($170 parts and $220 labor). Instructions Assuming that actual warranty costs are incurred exactly as estimated, what journal entries would be made relative to the following facts? (a) Under application of the expense warranty accrual method for: (1) Sale of machinery in 2014. (2) Warranty costs incurred in 2014. (3) Warranty expense charged against 2014 revenues. (4) Warranty costs incurred in 2015. (b) Under application of the cash-basis method for: (1) Sale of machinery in 2014. (2) Warranty costs incurred in 2014. (3) Warranty expense charged against 2014 revenues. (4) Warranty costs incurred in 2015. (c) What amount, if any, is disclosed in the balance sheet as a liability for future warranty costs as of December 31, 2014, under each method? (d) Which method best reflects the income in 2014 and 2015 of Alvarado Company? Why?

The assets of Fonzarelli Corporation are presented below (000s omitted).   Instructions Indicate the deficiencies, if any, in the foregoing presentation of Fonzarelli Corporation’s assets.

What key measures should be included in a sustainability balanced       scorecard?

In a surface grinding operation performed on hardened plain carbon steel, the grinding wheel has a diameter = 200 mm and width = 25 mm. The wheel rotates at 2400 rev/min, with a depth of cut (infeed) = 0.05 mm/pass and a crossfeed = 3.50 mm. The reciprocating speed of the work is 6 m/min, and the operation is performed dry. Determine (a) length of contact between the wheel and the work and (b) volume rate of metal removed. (c) If there are 64 active grits/cm2 of wheel surface, estimate the number of chips formed per unit time. (d) What is the average volume per chip? (e) If the tangential cutting force on the work = 25 N, compute the specific energy in this operation?

What is meant by the terms elements and items as they relate to the income statement? Why might items have to be disclosed in the income statement?