This is “End-of-Chapter Exercises”, section 15.5 from the book Business Accounting (v. 2.0).
This book is licensed under a Creative Commons by-nc-sa 3.0 license. See the license for more details, but that basically means you can share this book as long as you credit the author (but see below), don't make money from it, and do make it available to everyone else under the same terms.
This content was accessible as of December 29, 2012, and it was downloaded then by Andy Schmitz in an effort to preserve the availability of this book.
Normally, the author and publisher would be credited here. However, the publisher has asked for the customary Creative Commons attribution to the original publisher, authors, title, and book URI to be removed. Additionally, per the publisher's request, their name has been removed in some passages. More information is available on this project's attribution page.
For more information on the source of this book, or why it is available for free, please see the project's home page. You can browse or download additional books there. You may also download a PDF copy of this book (20 MB) or just this chapter (1 MB), suitable for printing or most e-readers, or a .zip file containing this book's HTML files (for use in a web browser offline).
Wichita Corporation leases a large machine with a life of twenty years. Which of the following does not necessitate reporting this contract as a capital lease?
Sizemore Corporation leases a building to use for the next twenty years. Which of the following is true about Sizemore’s reporting?
Albemarle Corporation leases a truck for six years and is trying to determine whether the contract qualifies as an operating lease or a capital lease. Which of the following is true?
Myers Company leases a boat on January 1, Year One. The lease does qualify as a capital lease. The lease covers four years, with payments of $20,000 annually, beginning on January 1, Year One. The expected life of the boat is six years. Myers annual incremental borrowing rate is 5 percent. The present value of an ordinary annuity for four years at a 5 percent rate is $3.54595. The present value of an annuity due for four years at a 5 percent rate is $3.72325. What amount of depreciation (rounded) should Myers recognize on the boat for Year One if Myers chooses to use the straight-line method?
Charlotte Company leases a piece of equipment on February 1. The lease covers two years although the life of the equipment is four years. The contract contains no bargain purchase option, the equipment does not transfer to Charlotte at the end of the lease, and the payments do not approximate the fair value of the equipment. The annual payments are $4,000 due each February 1, starting with the current one. Charlotte’s incremental borrow rate is 5 percent. The present value of an annuity due of $1 at a 5 percent interest rate for two years is $1.95238. What journal entry or entries should Charlotte make on February 1?
On December 31, Year One, the Brangdon Corporation leases a truck to use in its operations. The truck has a life of ten years, although the lease is only for six years. Payments are $10,000 per year with the first payment made immediately. No interest payments are made but Brangsdon has an incremental borrowing rate of 9 percent. The present value of an annuity due at a 9 percent rate for six periods is $4.88965. The present value of an ordinary annuity at a 9 percent rate for six periods is $4.48592. If this is an operating lease, what figure is recorded initially as the capitalized cost of the truck?
On December 31, Year One, the Sliyvoid Corporation leases a large machine for five years, its entire expected life. Depreciation is recorded using the straight-line method. Payments are $12,000 per year starting on December 31, Year One, and every December 31 thereafter. The incremental borrowing rate is 10 percent per year. The present value of an annuity due at a 10 percent rate for five periods is $4.16987. The present value of an ordinary annuity at a 10 percent rate for five periods is $3.79079. What is the net book value of the leased asset on December 31, Year Two?
Use the same information as in problem 7. Determine the interest expense to be recognized in Year Two.
Use the same information as in problem 7. Determine the lease liability to be reported on the company’s balance sheet at the end of Year Two.
On December 31, Year One, Company A leases a car for four years and pays $10,000 per year with the first payment made immediately. Company A believes the asset has a life of six years and records it as an operating lease. On December 31, Year One, Company B leases an identical car for four years and pays $10,000 per year with the first payment made immediately. Company B believes the asset has a life of five years and records it as a capital lease. The straight-line method of depreciation is used. Both companies have an annual incremental borrowing rate of 5 percent. The present value of an annuity due of $1 over four years at a 5 percent interest rate is $3.7232. Which of the following is true?
Potslitini Corporation has a large amount of income that is earned in Year One but will not be subject to income taxes until Year Three. Which of the following statements is true for financial reporting purposes?
Fargo Corporation earns revenue in Year One that will be reported on its Year One income statement but will not be reported on its tax return until Year Three. This revenue amounts to $800,000, and Fargo’s tax rate is 40 percent. Which of the following statements is true?
The Sinson Company buys land in Year One for $90,000 and then sells it in Year Two for $200,000. The company will collect this money in Year Four. For income tax purposes, Sinson will use the installment sales method. Sinson has a tax rate of 40 percent. Which of the following statements is true?
Which of the following is not a true statement about postretirement benefits?
At the start of Year One, the Arkansas Company promises all employees that it will pay their medical insurance after they retire. As a result, company officials realize that a liability will have to be reported. This promise is expected to cost the company a total cash amount of $3.3 million over the next 30 years. Who most likely determined this figure?
Use the information in problem 15. What liability does Arkansas have to report at the end of Year One?
On its latest balance sheet, the Sellers Corporation reports assets of $450,000 and liabilities of $200,000. What is Sellers’ debt-to-equity ratio?
The Xi Company is started at the beginning of Year One when its owners contribute $120,000 in cash. The company reports net income of $70,000 and pays cash dividends of $10,000 every year thereafter. At the end of Year Three, the company reports total assets of $900,000. On that date, what is the debt-to-equity ratio?
A company has a debt-to-equity ratio of 3.00 to 1.00. The company pays a cash dividend of $62,000. What is the impact on the debt-to-equity ratio?
Hyde Corporation has long-term liabilities, such as bonds, notes and leases, for which interest expense must be accrued. During Year One, Hyde reported net income of $65,000 after income taxes of $15,000 and interest expense of $10,000. Which of the following is Hyde’s times interest earned?
Professor Joe Hoyle discusses the answers to these two problems at the links that are indicated. After formulating your answers, watch each video to see how Professor Hoyle answers these questions.
Your roommate is an English major. The roommate’s parents own a chain of ice cream shops located throughout Florida. One day, while walking over to the computer lab your roommate poses this question: “My parents just signed a contract to lease a new shop in Tampa. It is in a great location so they are going to pay $120,000 each year to lease this facility for 10 years. That’s $1.2 million. However, they were telling me that they will not have to report this liability on their financial statements. That makes no sense to me. They have a contract that requires them to pay over $1 million in the future. How could they possibly not have to report that as a liability?” How would you respond?
Your uncle and two friends started a small office supply store several years ago. The company has grown and now has several large locations. Your uncle knows that you are taking a financial accounting class and asks you the following question: “We always want to make sure that our financial statements and our tax returns are done properly. Several years ago we bought some land and built a store on it. However, we didn’t use all the land, so this year we sold several extra acres. The land had really appreciated in value, and we made a very large gain. We made the sale this year, but the payments will not start for a couple of years. Our accountant tells us that we have to report the related income tax expense this year, but we don’t have to pay the government anything until we start getting the money. That doesn’t sound right. It seems to me that the expense and the payment should be at the same time. Can you explain what is going on here because I really don’t want to get into any trouble?” How would you respond?
On October 1, Year One, United Company leases an office space in a downtown building. This contract qualifies as an operating lease. United pays $30,000 in advance for rent every year. Record journal entries and adjusting entries for United for the following dates in connection with this property.
Ralph Corporation agreed to lease a piece of equipment to Amy Company on January 1, Year One. The following information relates to this lease:
Amy’s incremental borrowing rate is 8 percent. The present value of a single payment of $1 in five years at an annual interest rate of 8 percent is $0.68058. The present value of an ordinary annuity of $1 for five years at an annual interest rate of 8 percent is $3.99271. The present value of an annuity due of $1 for five years at an annual interest rate of 8 percent is $4.31213.
Prepare the following journal entries for Amy.
On January 1, Year One, Landon Corporation decides to lease a truck for $20,000 per year for three years. The annual incremental borrowing rate for Landon is 10 percent. The truck has a life of five years. Landon cannot buy or obtain title to the truck. The present value of an annuity due of $1 for three years at an annual interest rate of 10 percent is $2.73554. At the last moment, Landon changes the contract to four years instead of three. No other changes are made. The present value of an annuity due of $1 for four years at an annual interest rate of 10 percent is $3.48685.
On December 31, Year One, the Abertion Company decides to lease a piece of equipment rather than buy it. The lease is for 10 years. Payments are $22,000 each December 31 beginning on December 31, Year One. Abertion has an annual incremental borrowing rate of 9 percent. The present value of an annuity due of $1 at 9 percent for 10 periods is $6.99525.
The Addams Corporation is preparing to lease several large pieces of equipment. The president has asked the company’s accountant to respond to the following questions about lease accounting.
On January 1, Year One, Lori Inc. signed a five-year capital lease for the use of an asset. Payments are $5,000 on each January 1, beginning with Year One. Lori’s incremental borrowing rate is 6 percent. The present value of an annuity due of $1 at 6 percent for 5 periods is $4.46511.
At December 30, Year One, the Eighorn Corporation has net income (and taxable income) of $400,000. The company has an effective tax rate of 30 percent. Taxes have not yet been recorded. Then, on the last day of the year, the company sells land that it bought several years ago for $70,000. The sales price is $300,000. The money will be collected in Year Three. The company opts to use the installment sales method to report this transaction for tax purposes.
The Yellow Corporation reports a deferred income tax liability of $732,000 in its December 31, Year One, balance sheet.
The Greene Company has net income before income tax expense of $300,000 in Year One. However, because of differences between U.S. GAAP and the tax laws, only 60 percent of this income is taxed in Year One (to be paid on March 15, Year Two). Another 30 percent will be taxed in Year Two and the final 10 percent will be taxed in Year Nine. Assume the effective tax rate is 25 percent.
The Bleu Company reports a liability for “postretirement benefits” of $14 million on its December 31, Year One, balance sheet.
Myrtle Inc. begins Year One with liabilities of $456,000 and stockholders’ equity of $320,000. On the first day of Year One, the following occur:
In several past chapters, we met Heather Miller, who started her own business, Sew Cool. The following are the financial statements for December.
Figure 15.18 Sew Cool Financial Statements
Based on the financial statements determine the following:
This problem will carry through several chapters, building in difficulty. It allows students to continually practice skills and knowledge learned in previous chapters.
In Chapter 14 "In a Set of Financial Statements, What Information Is Conveyed about Noncurrent Liabilities Such as Bonds?", financial statements for February were prepared for Webworks, They are included here as a starting point for the required recording for March.
Figure 15.21 Webworks Financial Statements
The following events occur during March:
Webworks pays taxes of $580 in cash.
Record cost of goods sold.
Assume that you take a job as a summer employee for an investment advisory service. One of the partners for that firm is currently looking at the possibility of investing in SuperValu Inc. The partner is aware that SuperValu uses a lot of stores and, therefore, probably has to lease many of those sites. The partner is curious as to whether these leases are mostly capital leases or operating leases. The partner asks you to look at the 2011 financial statements for SuperValu by following this path: