Ecomprehensiveexam e

COMPREHENSIVE EXAMINATION E

PART 5

(Chapters 18-21)

Approximate

Problem Topic Time

E-I Long-Term Contracts. 15 min.

E-II Installment Sales Method. 20 min.

E-III Deferred Income Taxes. 25 min.

E-IV Pensions. 15 min.

E-V Leases. 25 min.

100 min.

Problem E-I — Long-Term Contracts.

Edwards Company contracted on 4/1/12 to construct a building for $2,300,000.

The project was completed in 2014. Additional data follow:

2012 2013 2014

Costs incurred to date $ 560,000$1,350,000$1,900,000

Estimated cost to complete 1,040,000 450,000 —

Billings to date 500,000 1,800,000 2,300,000

Collections to date 400,000 1,300,000 2,200,000

Instructions (a) Calculate the income recognized by Edwards under the percentage-of-

completion method of accounting in each of the years 2012, 2013, and

2014.

(b) Prepare all necessary entries for the year 2013.

(c) Present the balance sheet disclosures at December 31, 2013. Proper

headings or subheadings must be indicated.

Problem E-II — Installment Sales Method.

Garber, Inc. accounts for all sales of its merchandise on the installment basis.

Following is the unadjusted trial balance at 12/31/14:

Test Bank for Intermediate Accounting, Thirteenth Edition

E - 2

Cash $ 89,200

Installment Accounts Receivable—2012170,000



Inventory, 1/1/14 78,000

Repossessed Merchandise 22,000

Accounts Payable $ 136,000

Deferred Gross Profit—2012 84,000

Deferred Gross Profit—2013 175,000

Common Stock 600,000

Retained Earnings 406,200

Installment Sales 1,000,000

Purchases 738,000

Loss on Repossession 4,000

Operating Expenses 150,000

$2,401,200 $2,401,200

Additional Data: 2012 Gross Profit Rate = 32%; Inventory 12/31/14 =

$159,000; Repossessed merchandise 12/31/14 = $14,000;

Merchandise sold in 2013 was repossessed in 2014 and the

following entry was prepared (assume correctly):

Deferred Gross Profit—2013 ...... 14,000

Repossessed Merchandise ........... 22,000

Loss on Repossession ................ 4,000

Installment Accounts Receivable—2013 40,000

Problem E-II (cont.)

Instructions

(a) Determine collections during 2014 on Installment A/R for each of the years

2012, 2013, and 2014.

Comprehensive Examination E

E - 3

(b) Without prejudice to your answer in Part (a), assume that total collections

on Installment Accounts Receivable during 2014 were $1,060,000;

$220,000 from 2012, $300,000 from 2013, and $540,000 from 2014.

Prepare all necessary adjusting and closing entries at 12/31/14.

Problem E-III — Deferred Income Taxes.

In 2013, the initial year of its existence, Dexter Company's accountant, in

preparing both the income statement and the tax return, developed the

following list of items causing differences between accounting and taxable

income:

1. The company sells its merchandise on an installment contract basis. In 2013,

Dexter elected, for tax purposes, to report the gross profit from these sales in

the years the receivables are collected. However, for financial statement

purposes, the company recognized all the gross profit in 2013. These

procedures created a $500,000 difference between book and taxable

incomes. The future collection of the installment contracts receivables are

expected to result in taxable amounts of $250,000 in each of the next two

years. (Note: the company treats installment contracts receivable as a current

asset on its balance sheet.)

2. The company has also chosen to depreciate all of its depreciable assets on an

accelerated basis for tax purposes but on a straight-line basis for accounting

purposes. These procedures resulted in $60,000 excess depreciation for tax

purposes over accounting depreciation. The temporary difference due to

excess tax depreciation will reverse equally over the three year period from

2014-2016.

3. Dexter leased some of its property to Baker Company on July 1, 2013. The

lease was to expire on July 1, 2015 and the monthly rentals were to be

$60,000. Baker, however, paid the first year's rent in advance and Dexter

reported this entire amount on its tax return. These procedures resulted in a

$360,000 difference between book and taxable incomes. (Note: this lease


E - 4

was an operating lease and Dexter classified the unearned rent as a current

liability on its balance sheet.)

4. Dexter owns $200,000 of bonds issued by the State of Oregon upon which

5% interest is paid annually. In 2013, Dexter showed $10,000 of income

from the bonds on its income statement but did not show any of this amount

on its tax return. (Note: these bonds are classified as long-term investments

on Dexter's balance sheet.)

5. In 2013, Dexter insured the lives of its chief executives. The premiums paid

amounted to $12,000 and this amount was shown as an expense on the

income statement. However, this amount was not deducted on the tax return.

The company is the beneficiary.

Problem E-III (cont.)

Instructions

Assuming that the income statement of Dexter Company showed "Income

before income taxes" of $1,200,000; that the enacted tax rates are 40% for all

years; and that no other differences between book and taxable incomes existed,

except for those mentioned above:

(a) Compute the income tax payable.

(b) Prepare a schedule of future taxable and (deductible) amounts at the end of

2013.

(c) Prepare a schedule of deferred tax (asset) and liability at the end of 2013.

(d) Compute the net deferred tax expense (benefit) for 2013.

(e) Make the journal entry recording income tax expense, income tax payable,

and deferred income taxes for 2013.

(f) Indicate how income tax expense and any deferred income taxes should be

disclosed on the financial statements under generally accepted accounting

principles. Show the amounts for these items and indicate specifically

where they would be disclosed.


E - 5

Problem E-IV — Pensions.

Presented below is information related to Stage Department Stores, Inc.

pension plan for 2013.

Service cost $520,000

Funding contribution for 2013 500,000

Settlement rate used in actuarial computation 10%

Expected return on plan assets 9%

Amortization of PSC (due to benefit increase) 90,000

Amortization of unrecognized net gains 48,000

Projected benefit obligation (at beginning of period)540,000

Fair value of plan assts (at beginning of period)360,000

Instructions (a) Compute the amount of pension expense to be reported for 2013. (Show

computations.)

(b) Prepare the journal entry to record pension expense and the employer’s

contribution for 2013.

Problem E-V — Leases.

On January 1, 2013, Foley Company (as lessor) entered into a noncancelable

lease agreement with Pinkley Company for machinery which was carried on

the accounting records of Foley at $5,436,000 and had a market value of

$5,760,000. Minimum lease payments under the lease agreement which expires

on December 31, 2022, total $8,520,000. Payments of $852,000 are due each

January 1. The first payment was made on January 1, 2013 when the lease

agreement was finalized. The interest rate of 10% which was stipulated in the

lease agreement is the implicit rate set by the lessor. The effective interest

method of amortization is being used. Pinkley expects the machine to have a

ten-year life with no salvage value, and be depreciated on a straight-line basis.

Collectibility of the rentals is reasonably predictable, and there are no important

uncertainties surrounding the costs yet to be incurred by the lessor.


E - 6

Instructions

(a) From the lessee's viewpoint, what kind of lease is the above agreement?

From the lessor's viewpoint, what kind of lease is the above agreement?

(b) What should be the income before income taxes derived by Foley from the

lease for the year ended December 31, 2013?

(c) Ignoring income taxes, what should be the expenses incurred by Pinkley

from this lease for the year ended December 31, 2013?

(d) What journal entries should be recorded by Pinkley Company on January 1,

2013?

(e) What journal entries should be recorded by Foley Company on January 1,

2013?


E - 7

Solutions — Comprehensive Examination E

Problem E-I — Solution.

(a) 2012 income = ($560,000 ÷ $1,600,000) × $700,000 = $245,000

2013 income = ($1,350,000 ÷ $1,800,000) × $500,000 = $375,000 –

$245,000 = $130,000

2014 income = $400,000 – $375,000 = $25,000

(b) Construction in Process ............................. 790,000

Accounts Payable, Cash, Inventory, etc. 790,000

Accounts Receivable ................................. 1,300,000

Billings on Construction in Process ... 1,300,000

Cash ........................................................... 900,000

Accounts Receivable ......................... 900,000

Construction Expenses .............................. 790,000

Construction in Process ............................. 130,000

Revenue from Long-Term Contracts . 920,000

(c) Current assets:

Accounts receivable $1,000,000

Current liabilities:

Billings ($1,800,000) in excess of costs and

recognized profit ($1,725,000) $75,000

Problem E-II — Solution.

(a) Collections in 2014 on installment accounts receivable:


E - 8

2012 $84,000 ÷ ($170,000 + collections) = 32%

Collections equal $92,500

2013 $175,000 ÷ ($400,000 + collections) = 35% *

Collections equal $100,000

2014 Installment Sales – Installment Accounts Receivable = Collections

$1,000,000 – $750,000 = $250,000

*14,000 ÷ 40,000 = 35%

Problem E-II — Solution (cont.).

(b) Inventory 12/31/14 ..................................... 159,000

Repossessed Merchandise 12/31/14 ........... 14,000

Cost of Goods Sold .................................... 665,000

Purchases ........................................... 738,000

Inventory 1/1/14 ................................. 78,000

Repossessed Merchandise ................. 22,000

Installment Sales ......................................... 1,000,000

Cost of Goods Sold ............................ 665,000

Deferred Gross Profit—2014 (33.5%) 335,000

Deferred Gross Profit—2012 (32% × $220,000) 70,400

Deferred Gross Profit—2013 (35% × $300,000) 105,000

Deferred Gross Profit—2014 (33.5% × $540,000) 180,900

Realized Gross Profit ......................... 356,300

Realized Gross Profit ................................. 356,300

Loss on Repossession ........................ 4,000

Operating Expenses ........................... 150,000


E - 9

Income Summary ............................... 202,300

Income Summary ...................................... 202,300

Retained Earnings .............................. 202,300

Problem E-III — Solution.

(a) The computation of income tax payable is as follows:

Pretax financial income $1,200,000

Permanent differences:

State of Oregon bonds (10,000)

Executive insurance premiums 12,000

Temporary differences:

Installment contracts (500,000)

Excess tax depreciation (60,000)

Lease rental 360,000

Taxable income 1,002,000

Tax rate 40%

Income tax payable $400,800

(b) 2014 2015 2016 Total

Future taxable (deductible) amounts:

Installment sales $250,000$250,000 $500,000

Depreciation 20,000 20,000$20,000 60,000

Unearned rent (360,000) (360,000)

Problem E-III — Solution (cont.).

(c) Future Taxable

(Deductible) Tax Deferred Tax

Temporary Differences Amounts Rate (Asset) Liability


E - 10

Installment Sales $500,000 40% $200,000

Depreciation 60,000 40 24,000

Rent (360,000) 40 $(144,000)

Totals $200,000 $(144,000)$224,000

(d) Deferred tax asset at end of 2013 $(144,000)

Deferred tax asset at beginning of 2013 -0-

Deferred tax (benefit) $(144,000)

Deferred tax liability at end of 2013 $224,000

Deferred tax liability at beginning of 2013 -0-

Deferred tax expense $224,000

Deferred tax expense $224,000

Deferred tax (benefit) (144,000)

Net deferred tax expense for 2013 $ 80,000

(e) Income Tax Expense ($400,800 + $80,000) 480,800

Deferred Tax Asset ..................................... 144,000

Deferred Tax Liability ....................... 224,000

Income Tax Payable .......................... 400,800

(f) Income statement

Income before income taxes $1,200,000

Income tax expense:

Current $400,800

Deferred 80,000 480,800

Net income $719,200

Balance sheet

Current liabilities:

Deferred tax liability ($200,000 – $144,000)$56,000


E - 11

Long-term liabilities:

Deferred tax liability $24,000

Problem E-IV — Solution.

(a) Service cost $520,000

Interest on projected benefit obligation ($540,000 10%) 54,000

Expected return on plan assets ($360,000 9%)(32,400)

Amortization of PSC 90,000

Amortization of net gains (48,000)

Pension expense—2013 $583,600

(b) Pension Expense ......................... 583,600

Other Comprehensive Income (G/L) 48,000

Cash .......................................... 500,000

Other Comprehensive Income (PSC). 90,000

Pension Asset/Liability ............. 41,600

Problem E-V — Solution.

(a) From the viewpoint of the lessee (Pinkley Company), the lease is a capital

lease because the present value of the minimum lease payments

($5,760,000) exceeds 90% of the fair market value of the leased property.

The lease term also is in excess of 75% of the property's estimated

economic life. For those same reasons and because of the predictable

collectibility, absence of uncertainties surrounding costs yet to be incurred

by the lessor, and presence of a dealer's profit, the lease is a sales-type lease

to the lessor, Foley Company.

(b) Profit on sale $564,000

Interest on outstanding balance

($5,760,000 – $852,000) × .10 490,800

Income of lessor in 2012 $1,054,800

(c) Interest on outstanding balance


E - 12

($5,760,000 – $852,000) × .10 $490,000

Depreciation ($5,760,000 ÷ 10) 576,000

Expenses incurred by lessee in 2012$1,066,800

(d) Leased Equipment .................................... 5,760,000

Lease Liability ................................... 5,760,000

Lease Liability ........................................... 852,000

Cash ................................................... 852,000

(e) Lease Receivable ...................................... 5,760,000

Cost of Goods Sold ................................... 5,436,000

Sales Revenue ................................... 5,760,000

Inventory .......................................... 5,436,000

Cash ........................................................... 852,000

Lease Receivable ............................... 852,000

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