Exam #_______

Start time: _________Stop time: _________

Name: ____________________________________

Exam 2Acct 414 – Corporate Accounting & Reporting II

Fall 2007

Show any necessary computations if you want to be eligible for partial credit. Present your work in a neat, well-organized manner. If you are using a PV calculator, spell out what you put in for n, i, PMT, FV, PV, etc. Follow the instructions and answer all parts of the question as directed.

1. Pension Work Paper {FASB No. 158} (50 points)

2. Deferred Income Taxes (60 points)

3. Earnings per share (60 points)

4-6. Other Short Problems – pick 2 of 4 (30 points total)

4. Employee stock options __________

5. Prior service cost allocation __________

6. Present value (pensions) __________

7. Present value (pensions) __________

8. Extra credit – deferred taxes matching (10 points max)and other (if any)

Total points earned (max = 200)

If you tear off the working papers, be sure your name is on the top AND that you staple the exam back together in page number order.

Do not attempt extra credit section until all other sections of the exam have been completed.

After Exam 2 - Course GradeTotal Points = __________/__________ = _________%

Quiz and HW percentage = ___________%

Projects percentage = ___________%

Exam 2 – Acct 414 – Fall 2007 Page 2

1. Pension Accounting (50 points). The Plymouth Plows Corporation initiated a noncontributory defined benefit pension plan on January 1, 1980 and applied the provisions of FASB Statement 87 as of January 1, 1987. FASB Statement No. 158 was implemented as of January 1, 2006. Plymouth Plows uses the straight-line method, based on average remaining service period of employees, to amortize prior service costs.

2007

BALANCES AS OF JANUARY 1, 2007

Projected Benefit Obligation 200,000

Plan Assets at market 230,000

Funded status 30,000

Unrecognized transition cost/(gain) 0

Straight-line amortization at $0 per year

Unrecognized Prior Service Cost 180,000

Straight-line amortization at $20,000 per year

Unrecognized (gains)/losses 130,000

OTHER INFORMATION:

Service cost for year 29,000

Discount rate for year 6.00%

Expected rate of return on plan assets 9.00%

Actual return on plan assets: gain/(loss) 12,000

Pension plan contribution 50,000

Retirement benefits paid during year 42,000

Accumulated Benefit Obligation, Dec. 31, 2005 198,000

Average remaining service years related to active employees 15

Increase/(decrease) in PBO during year due to revised actuarial assumptions 18,000

REQUIRED:a. Compute net periodic pension expense for 2007. (Be sure to show all of the components of

pension expense.) Prepare the journal entry needed to record pension expense and funding of pension plan.

b. Compute the balances in accumulated other comprehensive income, projected benefit obligation, and plan assets at 1/1/08

c. Explain (or show) how the net pension obligation or net pension asset will be displayed on the balance sheet at 12/31/07. Will there be other pension related accounts on the balance sheet? If so, explain where and how they are presented. Provide amounts.

Note: Completing the worksheet provided will be an acceptable answer for a and b.

Exam 2 – Acct 414 – Fall 2007 Page 3

2. Deferred tax asset (60 points)

Yarman Inc. began business on January 1, 2007. Its pretax financial income for the first 3 years was as follows:

2007 $240,0002008 560,0002009 725,000

The following items caused the only differences between pretax financial income and taxable income.

1. On January 2, 2007, heavy equipment costing $500,000 was purchased. The equipment had a life of 5 years and no salvage value. The straight-line method of depreciation is used for book purposes and the MACRS tax deduction taken each year is shown in the table below:

2007 2008 2009 2010 2011 TotalFor tax $120,000 $200,000 $150,000 $30,000 0 $500,000For accounting 100,000 100,000 100,000 100,000 100,000 500,000

2. In 2007, the company collected $180,000 of rent; of this amount, $60,000 was earned in 2007; the other $120,000 will be earned equally over the 2008-2009 period. The full $180,000 was included in taxable income in 2007.

3. The company pays $10,000 a year for life insurance on officers.

4. In 2008, the company had a long-term construction contract on which it recognized a gross profit of $90,000 on the income statement. For tax purposes, the company uses the completed contract method. The total estimated gross profit is $270,000 and the remaining 180,000 is expected to be realized equally in 2009 and 2010.

The enacted tax rates existing at December 31, 2007 are:

2007 35% 2009 40%2008 40% 2010 40%

Instructions(a) Compute taxable income and income tax payable/receivable for the 2007 and 2008.(b) Prepare an inventory of the deferred tax (asset) and liability and determine the net deferred

tax asset or liability as of 12/31/07 and 12/31/08. (c) Prepare the journal entry to record income tax expense, deferred taxes, and the income

taxes payable for 2007.(d) What amounts will appear on the 2008 balance sheet related to the deferred taxes? Be

sure to tell me whether the amount is classified as current or noncurrent.(e) For up to 5 points extra credit – IF YOU HAVE TIME, you may also do 2009 journal entry.

Show your computations and answers as instructed on the next page.Answers for Problem 2

Exam 2 – Acct 414 – Fall 2007 Page 4

(a) Compute taxable income and income tax payable/receivable for the 2007 and 2008. I can grade from workpaper if used

(b) Prepare an inventory of the deferred tax (asset) and liability and determine the net deferred tax asset or liability as of 12/31/07 and 12/31/08. I can grade from workpaper if used

(c) Prepare the journal entry to record income tax expense, deferred taxes, and the income taxes payable for 2007. (Workpaper answer is NOT sufficient for this one!)

(d) What amounts will appear on the 2008 balance sheet related to the deferred taxes? Be sure to tell me whether the amount is classified as current or noncurrent. (Workpaper answer is NOT sufficient for this one!)

Amounts on 12/31/08 balance sheet related to deferred income taxes:

Exam 2 – Acct 414 – Fall 2007 Page 5

3. Earnings per share (60 points).

Net income for Adcock Corp. was $500,000 for 2007. Its tax rate was 40%.

On January 1, 2007 there were 200,000 shares of common stock outstanding. On April 1, 20,000 shares were issued. On July 31, 2007 Adcock issued a 2-for-1 stock split effected in the form of a stock dividend. On September 1, Adcock bought 30,000 shares of treasury stock for $45 per share.

There are 30,000 options to buy common stock at $40 a share outstanding. The market price of the common stock averaged $50 during 2007 (both market price and option price have already been adjusted for the stock split).

During 2007, there were 40,000 shares of convertible preferred stock outstanding. The preferred is $100 par, pays $3.50 a year dividend, and is convertible into six shares of common stock after the stock split.

Adcock issued $2,000,000 of 8% convertible bonds at face value during 2006. Each $1,000 bond is convertible into 30 shares of common stock after the stock split.

Instructions(a) Compute the weighted average number of common shares outstanding.

Dates Outstanding Adjustment Months Weighted

Weighted average = ____________________________ shares

Exam 2 – Acct 414 – Fall 2007 Page 6

Problem 3 (continued)Regardless of your answer to (a), assume that the weight average number of common shares outstanding is 400,000 for parts (b) and (c). You may use the work paper provided below or formulas but please write your answers in the space provided:

(b) Compute the basic earnings per share for 2007. $_________________________

(c) Compute the diluted earnings per share for 2007. $___________________________

Numerator Denominator Per Share

Net income $500,000 400,000

Exam 2 – Acct 414 – Fall 2007 Page 7

Other Short Problems – pick 2 of 4 (15 points each)

4 Employee Stock Options (15 points) On January 1, 2007, Doane Corp. granted an employee an option to purchase 6,000 shares of Doane's $5 par value common stock at $20 per share. The Black-Scholes option pricing model determines total compensation expense to be $23 per share. The options became exercisable on December 31, 2008, after the employee completed two years of service. The market prices of Doane's stock were as follows:

January 1, 2007 $30December 31, 2008 50

(a) Prepare the journal entry needed at December 31, 2007 to recognize the compensation expense.

(b) Prepare the journal entry to record the exercise all 6,000 options on January 2, 2009 when the stock price was $51.

Exam 2 – Acct 414 – Fall 2007 Page 8

5. Amortization of prior service cost using years-of-service method. (15 points)

On January 1, 2007, Portland’s Porcelain Inc. amended its pension plan which caused an increase of $10,500,000 in its projected benefit obligation. The company has 500 employees who are expected to receive benefits under the company's defined benefit pension plan. The personnel department provided the following information regarding expected employee retirements:

Number of Expected Retirements Remaining YearsEmployees On December 31 _ of Employment

100 2011 5 years100 2016 10 years100 2021 15 years

200 2026 20 years500

Instructions(a) What is the average remaining service life?

(b) Using the straight-line method, what would amortization of prior service costs be for 2007?

(c) Using the years-of-service method, what would amortization of prior services costs be for 2012 through 2016?

Exam 2 – Acct 414 – Fall 2007 Page 9

6. Pension Present Value Computations (15 points).Freedonia’s Finest Furs Inc. has a defined benefit pension plan. The formula is the final year’s annual salary times 2% times years of service. Consider one employee in the plan -- Fred Flintstone. Fred is expected to be making $80,000 when he retires 10 years from now. He already has 15 years of prior service and he is expected to live 20 years after he retires. You may assume ordinary annuities and end-of-year annual payments upon retirement and a 6% per annum discount rate.

What is the service cost for Fred Flintstone the year just ended?

7. Pension Present Value Computations (15 points)The actuary reports that the Freedonia’s Finest Furs will need a total of $15,000,000 in ten years to cover the obligations promised to all of its employees. The president of Freedonia’s Finest Furs, Inc. wants you to compute the annual contribution that the company needs to make to the pension plan to achieve fully funded status in 10 years. The current balance in plan assets is $5,000,000. The first payment would be at the end of this year and at the end of each of the next 9 years. The plan assets are invested so that the expected rate of return is 10% per year.

Exam 2 – Acct 414 – Fall 2007 Page 10

8. EXTRA CREDIT: Permanent and temporary differences (10 points maximum)

Listed below are items that are treated differently for accounting purposes than they are for tax purposes. Indicate whether the items are permanent differences or temporary differences. For temporary differences, indicate whether they will create deferred tax assets or deferred tax liabilities.

A Temporary difference – deferred tax liabilityB Temporary difference – deferred tax assetC Permanent differenceD None of the above

______ 1. Advance rental receipts.______ 2. Fine for polluting.______ 3. Estimated future warranty costs.______ 4. Excess of pension expense over deductible contribution to plan assets.______ 5. Expenses incurred in obtaining tax-exempt revenue.______ 6. Installment sales.______ 7. Profitable investments accounted for by the equity method.______ 8. Excess tax depreciation over accounting depreciation.______ 9. Long-term construction contracts.______ 10. Premiums paid on life insurance of officers (company is the beneficiary).

Exam 2 – Acct 414 – Fall 2007 Page 11

For Problem 1 Name:

Exam 2 – Acct 414 – Fall 2007 Page 12

For Problem 2 Name:______________________________

Exam 2 – Acct 414 – Fall 2007 Page 13

SOLUTIONS

Problem 1

4. Employee stock options(a) 12/31/07Compensation expense (6,000 * $23 * 50% earned)........................69,000

APIC – stock options.........................................................................................69,000

Same entry would be made at 12/31/08 because the service period is two years and the compensation expense would be recognized equally in each of the 2 years.

(b) 1/2/09Cash (6,000 * $20 each).................................................................120,000APIC – stock options (6,000 * 23 each)..........................................138,000

Common stock (6,000 * $5 par value)...............................................................30,000APIC – common stock (what it takes to balance)............................................228,000

Exam 2 – Acct 414 – Fall 2007 Page 14

Problem 2

(a), (b) and (d) on working paper above(c) Income Tax Expense ($122,500 – $70,000)........................................... 82,500

Deferred Tax Asset................................................................................. 40,000Income Tax Payable ($350,000 × 35%)..................................... 122,500

Comments: The tricky item is the $120,000 in unearned rent revenue because only half is current and the other half will not be on tax return for 2 years. We present deferred taxes on the balance sheet as two amounts by netting the current items and then netting the noncurrent items. For 2007 (not required) we have a current deferred tax asset of $24,000 (120,000/2 * 40%) and a noncurrent deferred tax asset of $16,000 {computation = [(20,000) + 60,000] * 40%}. For 2008, it is easier since the $60,000 of rent will be deductible in one year (60,000 * 40%) and gives us a current deferred tax asset. Both the depreciation is noncurrent because it is related to noncurrent assets and the construction accounting deferral is long-term because the taxes will not be due on the contract for 2 more years. Thus the noncurrent deferred tax liability is $84,000 {(120,000 + 90,000)* 40%}. We use 40% for all deferred tax amounts because the enacted law contains the 40% tax rate in 2007.

Exam 2 – Acct 414 – Fall 2007 Page 15

Problem 3a

For Problem 3b & 3c

Exam 2 – Acct 414 – Fall 2007 Page 16

5. Years of service methodNumber of expected

retirements Year of retirement (on Dec 31)Years of Work

Remaining TOTAL 100 2011 5 years 500 100 2016 10 years 1,000 100 2021 15 years 1,500 200 2026 20 years 4,000

500 7,000

a. Average remaining service life = 7,000/500 employees = 14 yearsb. For SL, divide total by average remaining service life: $10,500,000/14 years = $750,000c. For the first five years, there are 500 employees so 500/7000 * $10,500,000 = $750,000 (same as straight-line method). However, for the next 5 years, there are only 400 employees left so 400/7000 * 10,500,000 = $600,000 per year.

Here is an alternate format that some students attempted but tended to leave out some of the years that are essential to include! Note the other way (multiply years by employees on each row and total to get the denominator) is considerably easier. 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026

100 100 100 100 100 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0100 100 100 100 100 100 100 100 100 100 0 0 0 0 0 0 0 0 0 0100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 0 0 0 0 0200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200500 500 500 500 500 400 400 400 400 400 300 300 300 300 300 200 200 200 200 200

For #6, I was trying to simplify the problem by giving you how many years remained before retirement at the END of the year just worked. If you interpret the problem differently, you’d use n-1 or 9 years to compute service cost in the formulas above. Most students did it as I intended but I don’t think I counted anything off for the alternate assumption. This is an example of where a good EXPLANATION for your work can prevent you from losing points over an interpretation of the problem!

8 Matching – extra credit1. B 2. C 3. B 4. B 5. C6. A 7. B 8. A 9. A 10. C