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Ex. 13-152—Provisions

1. The following situations relate to Washburn Company Washburn provides a warranty with all its
products it sells. It estimates that it will sell 1,200,000 units of its product for the year ended December
31, 2022, and that its total revenue for the product will be €100,000,000. It also estimates that 60% of
the product will have no defects, 30% will have major defects, and 10% will have minor defects. The
cost of a minor defect is estimated to be $5 for each product repaired, and the cost for a major defect
cost is €15. The company also estimates that the minimum amount of warranty expense will be
€2,500,000 and the maximum will be €12,000,000.

Dr Warranty Expense 6,000,000 (1.200.000 x 10% x 5) + (1.200.000 x 30% x 15)

Cr Warranty Liability 6,000,000

2. Washburn is involved in a tax dispute with the tax authorities. The most likely outcome of this dispute
is that Washburn will lose and have to pay €500,000. The minimum it will lose is €25,000 and the
maximum is €3,000,000.

Dr Tax Dispute expense 500,000

Cr Provision for tax dispute 500,000

3. Washburn has a policy of refunding purchases to dissatisfied customers, even though it is under no
obligation to do so. However, it has created a valid expectation with its customers to continue this
practice. These refunds can range from 5% of sales to 9% of sales, with any amount in between a
reasonable possibility. In 2022, Washburn has €50,000,000 of sales subject to possible refund.

9 %+ 5 %
Dr Sales Return 3,500,000 (50,000,000 x ( ))
2
Cr Allowance for Sales Returns 3,500,000

Instructions

Prepare the journal entry to record provisions, if any, for Washburn at December 31, 2022
Pr. 14-131—Comprehensive bond problem

Titania Co. sells €600,000 of 12% bonds on June 1, 2021. The bonds pay interest on December 1 and June
1. The due date of the bonds ¡is June 1, 2026. The bonds yield 10%, selling for €638,780. On October 1,
2022, Titania bought back €300,000 worth of bonds for €315,000 (includes accrued interest)

Instructions

(Round to the nearest dollar.)

Prepare all relevant entries through October 1, 2022. Amortize premium or discount on interest dates and
at year-end. (Assume that reversing entries were made.)

Date Cash Paid Interest Expense Premium Carrying Amount of

Amortized Bonds

01/06/2 638,780
021

01/12/2 = 600,000 * 12% = 638,780 * 10% = 36,000 - = 638,780 - 4,061

021 * 6/12 * 6/12 31,939
634,719
36,000 31,939 4,061

01/06/2 36,000 31,736 4,264 630,455

022

01/12/2 36,000 31,523 4,477 625,978

022

July 1, 2021

Dr Cash 638,780

Cr Bonds Payable 638,780

December 1, 2021

Dr Interest Expense 31,939 (638,780 x (10% x 6/12))

Dr Bonds Payable 4,061

Cr Cash 36,000 (600,000 x (12% x 6/12))

December 31, 2021

Dr Interest Expense 5,289 ( 31,736 x 1/6 )

Dr Bonds Payable 711 ( 4,264 x 1/6 )

Cr Interest Payable 6,000 ( 36,000 x 1/6 )

June 1,2022

Dr Interest Expense 26,447 ( 31,736 x 5/6 )

Dr Interest Payable 6,000

Dr Bonds Payable 3,553 ( 4,264 x 5/6 )

Cr Cash 36,000
 October 1 2022

Dr Interest 1,050,767 ( 31,523 x 4/6 x 0.5*) *

300,000/600,000 = 0.5

Dr Bonds Payable 1,492 ( 4,477 x 4/6 x 0.5*)

Cr Cash 12,000

October 1 2022

Dr Bonds Payable 313,736

Cr Gain on Extinguishment of bonds 10,736

Cr Cash 303,000

 Reacquisition price = 315,000 – ( 300,000 x 12% x 4/12 ) = 303,000

 Net carrying amount of bonds redeemed = (( 638,780 – 4,061 – 4,264 ) x 50% ) – 1,492 = 313,736

Ex. 21-113—Lessor accounting—sales-type lease

Hayes Corp. is a manufacturer of truck trailers. On January 1, 2022, Hayes Corp. leases ten trailers to
Lester Company under a six-year noncancelable lease agreement. The following information about the
lease and the trailers is provided:

1. Equal annual payments that are due on January 1 each year provide Hayes Corp. with an 8% return on
net investment (present value factor for 6 periods at 8% is 4.99271)

2. Titles to the trailers pass to Lester at the end of the lease

3. The fair value of each trailer is €60,000. The cost of each trailer to Hayes Corp. is €54,000 Each trailer
has an expected useful life of nine years.

4. Collectibility of the lease payments is probable

Instructions

a) What type of lease is this for the lessor? Discuss.

This is a finance lease because Hayes Corp grants Lester to purchase the trailers at the end of the lease.

b) Calculate the annual lease payment. (Round to nearest dollar.)

PV ( total fair value) = 600,000

The annual lease payment ( PMT ) = 600,000 / 4.99271 = 120,175.22

c) Prepare a lease amortization schedule for Hayes Corp. for the first three years

Interest on
Annual lease lease Reduction of lease
Date Lease receivable
payment receivable receivable
(8%)

01/01/2022 600000

01/01/2022 120,175.22 0 120,175.22 = 600000 - 120,175.22

 479,824.78

01/01/2023 120,175.22 38,385.98 81,789.24 398,035.54

01/01/2024 120,175.22 31,842.84 88,332.38 309,703.17

d) Prepare the journal entries for the lessor for 2022 to record the lease agreement, the receipt of the
lease rentals, and the recognition of revenue (assume the use of a perpetual inventory method and
round all amounts to the nearest dollar)

January 1, 2022

Dr Lease receivable 600,000

Dr Cost of goods sold 540,000

Cr Sales Revenue 600,000

Cr Inventory 540,000

January 1, 2022

Dr Cash 120,175.22

Cr Lease Receivable 120,175.22

December 31, 2022

Dr Lease Receivable 38,386 ( 479,824.78 x 0.08 )

Cr Interest Revenue 38,386

Pr. 21-116—Lessee accounting—finance lease

Eubank Company, as lessee, enters into a lease agreement on July 1, 2022, for equipment. The following
data are relevant to the lease agreement:

1. The term of the noncancelable lease is 4 years. Payments of €978 446 are due on July 1 of each year,
beginning on July 1, 2022

2. The fair value of the equipment on July 1, 2022 is €3,500,000. The equipment has an economic life of
6 years with no salvage value

3. Eubank depreciates similar machinery it owns on the sum-of-the-years'-digits basis The lessee pays all
executory costs

4. Eubank's incremental borrowing rate is 10% per year. The lessee is aware that the lessor

used an implicit rate oí{ 8% in computing the lease payments (present value factor of an

ordinary annuity for 4 periods at 8%, 3.57710; at 10%, 3.48685)

Instructions

a) Indicate the type of lease Eubank Company has entered into and what accounting treatment

Capitalized amount = 978,446 x PV of an ordinary annuity for 4 periods at 8%

 = 978,446 x 3.5771

= 3,500

 Because the present value (3,500,000) of the lease payment equals the fair value of the asset
( 3,500,000 ) so this lease is a capital lease. Must be accounted for under the finance method

b) Prepare the journal entries on Eubank's books that relate to the lease agreement for the

following dates: (Round all amounts to the nearest dollar. include a partial amortization

schedule.)

Date Payment Interest expenses Reduction of Balance of leased

(8%) leased liability liability

01/07/2022 3,500,000.00

01/07/2022 978,466.0 0 978,466.00 2,521,534.00

01/07/2023 978,466.0 = 2,521,534.00 * = 978,466.0 - = 2,521,534.00 -

8% 201,722.72 776,743.28

201,722.72 776,743.28 1,744,790.72

01/07/2024 978,466.0 139,583.26 838,882.74 905,907.98

July 1, 2022

Dr Leased Equipment 3,500,000

Cr Lease Liability 2,521,534

Cr Cash 978,446

December 31, 2022

Dr Interest Expense 100,861.36 ((2,521,534 x 0.08 ) x 6/12 )

Cr Interest Payable 100,861.36

Dr Depreciation Expense 700,000 ((3,500,000 x 4/10 ) x 6/12 )

Cr Accumulated Depreciation 700,000

July 1,2023

Dr Leased Liability 776,743.28 ( 978,466.0 – 201,722.72 )

Dr Interest Expense 201,722.72 ( 2,521,534 x 0.08 )

Cr Cash 978,466.0

December 31, 2023

Dr Depreciation Expenses 1,225,000 ((3,500,000 x 4/10 x 6/12) + (3,500,000 x 3/10 x

6/12))
 Cr Accumulated Depreciation 1,225,000

December 31, 2023

Dr Interest Expense 69,791.63 ( 139,583.26 x 6/12 )

Cr Interest Payable 69,791.63

Ex. 19-123—Permanent and temporary differences

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

1. Investments accounted for under the equity method.

Temporary Difference, Deferred Tax Liability.This is a temporary difference because accounting

treatment (equity method) differs from the tax treatment. It may create a deferred tax liability.

2. Advance rental receipts.

Temporary difference, deferred tax asset. This will create a deferred tax liability because income is
recognized for tax purposes before

3. Fine for polluting.

Permanent difference. This is a permanent difference because fines are not deductible for tax purposes.

4. Estimated future warranty costs.

Temporary Difference, Deferred Tax Asset. This will create a deferred tax asset because the expenses
are recognized for accounting purposes before they are deductible for tax purposes.

5. Excess of contributions over pension expense.

Temporary Difference, Deferred Tax Liability. This will create a deferred tax liability because
contributions are deductible for tax purposes before they are recognized as expenses for accounting
purposes.

6. Expenses incurred in obtaining tax-exempt income.

Permanent Difference. This is a permanent difference because the expenses related to tax-exempt income
are not deductible.

7. Litigation accruals.

Temporary Difference, Deferred Tax Asset. This will create a deferred tax asset because the accruals are
recognized for accounting purposes before they are deductible for tax purposes.

8. Excess tax depreciation over accounting depreciation.

Temporary Difference, Deferred Tax Liability. This will create deferred tax liability because
depreciation is higher for tax purposes, leading to lower taxable income in earlier years.

9. Long-term construction contracts.

Temporary Difference, Deferred Tax Liability. This will create a deferred tax liability if the revenue
recognition method differs between accounting and tax purposes, leading to taxable income being
recognized earlier for tax purposes.
10. Percentage depletion of natural resources in excess of their cost

Temporary Difference, Deferred Tax Liability. This will create a deferred tax liability if the depletion is
higher for tax purpose, leading to lower taxable income in earlier years.

Instruction: Provide solution and explain your choices in English

Ex. 15-154 —Treasury shares

Ellison Company's statement of financial position shows:

Share capital—ordinary, €20 par €3,000,000

Share premium—ordinary 1,050,000

Retained earnings 750,000

Instructions

Record the following transactions by the cost method

(a) Bought 5,000 ordinary shares at €29 a share

Dr Treasury Share €145,000 (€29 x 5,000)

Cr Cash €145,000

(b) Sold 2,500 treasury shares at €30 a share

Dr Cash €75,000 (2,500 x €30)

Cr Treasury Share €72,500 (2,500 x €29)

Cr Share Premium – Treasury €2,500

(c) Sold 1,000 shares of treasury shares at €26 a share

Dr Cash €26,000 (1,000 x €26)

Dr Share Premium – Treasury €3,000

Cr Treasury Share €29,000 (1,000 x 29)

Share Premium - Treasury

c) €3,000 b) €2,500

Balance €500

 Use Retained Earnings to compensate for losses due to re-issuance of Treasury Shares. Reduce the
remaining balance of Share Premium – Treasury.

Ex. 15-156—Equity transactions

Indicate the effect of each of the following transactions on total equity by placing an *X” in the

appropriate column

Increas Decrease No Effect

e
 1. Treasury shares are resold at more than cost X

2. Operating loss for the period X

3. Share split X

4. Declaration of a share dividend X

5. Acquisition of machinery for ordinary shares X

6. Conversion of bonds payable into ordinary shares X

7. Not declaring a dividend on cumulative preference shares X

8. Declaration of cash dividend X

9. Payment of cash dividend X

Instruction: Provide solutions and explain your choices in English

1. Treasury shares are resold at more than cost increase total assets (cash,…) and equity (share
premium)

2. Operating loss for the period

3. Share split reduces the market value of shares, decreases par value, and increases the number of
shares. It does not entail any change in the shareholders’ equity

4. Declaration of a share dividend: All dividends, except for share dividends, reduce the total equity in
the corporation.

5. Acquisition of machinery for ordinary shares to increase assets and decrease equity in the
corporation.

6. Conversion of bonds payable into ordinary shares increases share capital – ordinary and the amount
originally allocated to equity is transferred to the share premium – ordinary account

7. Not declaring a dividend on cumulative preference shares

8. Declaration of cash dividend is a liability, not an effect of total equity.

9. Payment of cash dividend: A cash dividend at the date of declaration is considered to be a liability, so
it just affects total assets and liabilities when you payment of cash dividend.

Ex. 16-146—Converftible Bonds

Koch Co. sold convertible bonds at a premium. Interest is paid on May 31 and November 30. On May 31,
after interest was paid, 100, €1,000 bonds were tendered for conversion into 3,000 shares of €10 par value
ordinary shares that had a market price of €40 per share. How should Koch Co. account for the conversion
of the bonds into ordinary shares under the book value method?

Discuss the rationale for this method

To account for the conversion of bonds under the book value method, Bonds Payable should be debited for
the face value, Premium on Bonds Payable should be debited, and Common Stock should be credited at
par for the shares issued. Using the book value method, no gain (loss) on conversion is recorded. The
amount to be recorded for the stock is equal to the book (carrying) value (face value plus unamortized
premium) of the bonds. Paid-in Capital in Excess of Par would be credited for the difference between the
book value of the bonds and the par value of the stock issued. The rationale for the book value method is
that the conversion is the completion of the transaction initiated when the bonds were issued. Since this is
viewed as a transaction with stockholders, no gain (loss) should be recognized.

Ex. 17-129—Debt lnvestments

On January 1, 2021, Ellison Company purchased 12% bonds, having a maturity value of €800,000, for
€860,652. The bonds provide the bondholders with a 10% yield. They are dated January 1, 2021, and
mature January 1, 2026, with interest receivable December 31 of each year. Ellison's business model is to
hold these bonds to collect contractual cash flows.

Instructions

(a) Prepare the journal entry at the date of the bond purchase

January 1, 2021
Dr Debt Investments 860,652
Cr Cash 860,652

(b)_ Prepare a bond amorfization schedule through 2022

Date Cash received Interest Revenue Bond Premium Amortization Carrying Amoun
(10%)

01/01/2021 860,652

31/12/2021 = 800,000 * 12% = 860,652 * 10% = 96,600 – 86,065 = 860,652 – 9

96,000 86,065 9,934.80 850,717.

31/12/2022 96,000 85,071.72 10,928.28 839,788.

31/12/2023 96,000 83,978.89 12,021.11 827,767.

31/12/2024 96,000 82,776.78 13,223.22 814,544.

31/12/2025 96,000 81,454.46 14,545.54 799,999.

(c) Prepare the journal entry to record the interest received and the amortization for 2021
 Dr Cash 96,000
Cr Debt Investment 9,935
Cr Interest revenue 86,065

(d) Prepare any entries necessary at December 31, 2021, using the fair value option, assuming the fair value
of the bonds is €860,000

December 31, 2021

Dr Debt Investment 9,283 ( 860,000 - 850,717 )

Cr Unrealized Holding Gain or Loss - Income 9,283

(e) Prepare any entries necessary at December 31, 2022, using the fair value option, assumingthe fair value
of the bonds is €840,000

Dr Unrealized Holding Gain or Loss – Income 9,072 (( 860,000 – 10,928 ) – 840,000)

Cr Debt Investments 9,072

Pr. 23-154—Statement of cash flows (direct and indirect methods)

Hartman, lInc. has prepared the following comparative statement of financial position for 2021 and

2022:

2022 2021

Plant assets €1,260,000 €1,050,000

Accumulated depreciation (450,000) (375.000)

Patent 153,000 174,000

Prepaid expenses 18,000 27,000

inventory 150.000 180,000

Receivables 159,000 117,000

Cash 297.000 153,000

€1,587,000 €1,326,000

Share capital-preference € 129,000 € 66,000

Share premium-preference 510,000 -

Share capital-ordinary 168,000 168,000

Retained earnings 60.000 42,000

Mortgage payable - 450,000

Accounts payable 120,000 —

 Accrued liabilities 600,000 600,000

€158/000 €1.326,000

1. The Accumulated Depreciation account has been credited only for the depreciation expense for the
period

2. The Retained Earnings account has been charged for dividends of €183,000 and credited for the net
income for the year

The income statement for 2022 is as follows:

Sales €1,980,000

Cost of sales 1.089.000

Gross profif 891,000

Operating expenses 690.000

Net income € 201.000

Instructions

(a) From the information above, prepare a statement of cash flows (indirect method) for Hartman, Inc. for
the year ended December 31, 2022

(a) Hartman, Inc.

Statement of Cash Flows

For the Year Ended December 31, 2022

Increase (Decrease) 1n Cash

Cash flows from operating activities

Net income
€ 201.000

Adjustments to reconcile net Income to net cash provided by operating activities:

Depreciation expense 75,000

Patent amortization 21,000

Increase in receivables ( 42,000 )

Decrease in prepaid expense 9,000

Decrease in Inventory 30,000

Increase 1n accounts payable 120,000

Net cash provided by operating activities
414,000 ( 201,000 + 75,000 + 21,000 – 42,000 + 9,000 + 30,000 + 120,000 )

Cash used in investing activities

Purchase of plant assets ( 210,000 )

Net cash used in Investing activities:

( 210,000)

Cash flows from financing activities

Payment of cash dividend ( 183,000 )

Retirement of mortgage payable ( 450,000 )

Sale of preference shares 510,000

Net cash provided by financial activities

( 123,000) ( 510,000 – 183,000 – 450,000 )

Net increase in cash : 81,000 ( 414,000 – 210,000 – 123,000 )

Cash, January 1, 2022: 153,000

Cash, December 31, 2022: 234,000 ( 153,000 + 81,000 )

Pr. 24-113——interim reporting

Interim financial reporting has become an important topic in accounting. There has been considerable
discussion as to the proper method of reflecting results of operations at interim dates

Instructions

(a) Discuss generally how revenue should be recognized at interim dates and specifically how revenue
should be recognized for industries subject to large seasonal fluctuations in revenue and for long-term
contracts using the percentage-of-completion method at annual reporting dates

Sales and other revenues should be recognized for interim financial statement purposes in the same manner
as revenues are recognized for annual reporting purposes. This means normally at the point of sale or, in
the case of services, at completion of the earnings process.

In the case of industries whose sales vary greatly due to the seasonal nature of business, revenues should
still be recognized as earned, but a disclosure should be made of the seasonal nature of the business in the
notes.

In the case of long-term contracts recognizing earnings on the percentage-of-completion basis, the current
state of completion of the contract should be estimated and revenue recognized at interim dates in the same
manner as at the normal year end.

(b) Discuss generally how product and period costs should be recognized at interim dates. Also discuss
how inventory and cost of goods sold may be afforded special accounting treatment at interim dates

For interim reporting purposes, product costs (costs directly attributable to the production of goods or
services) should be matched with the product and associated revenues in the same manner as for annual
reporting purposes.

Period costs (costs not directly associated with the production of a particular good or service) should be
charged to earnings as incurred or allocated among interim periods based on an estimate of time expired,
benefit received, or other activity associated with the particular interim period(s). Also, if a gain or loss
occurs during an interim period and is a type that would not be deferred at year end, the gain or loss should
be recognized in full in the interim period in which it occurs. Finally, in allocating period costs among
interim periods, the basis for allocation must be supportable and may not be based on merely an arbitrary
assignment of costs between interim periods.

The profession allowed for some variances from the normal method of determining cost of goods sold and
valuation of inventories at interim dates in APB Opinion No. 28, but these methods are allowable only at
interim dates and must be fully disclosed in a note to the financial statements. Some companies use the
gross profit method of estimating cost of goods sold and ending inventory at interim dates instead of taking
a complete physical inventory. This is an allowable procedure at interim dates, but the company must
disclose the method used and any significant variances that subsequently result from reconciliation of the
results obtained using the gross profit method and the results obtained after taking the annual physical
inventory.

At interim dates, companies using the LIFO cost-flow assumption may temporarily have a reduction in
inventory level that results in a liquidation of base period layers of inventory. If this liquidation is
considered temporary and is expected to be replaced prior to year end, the company should charge cost of
goods sold at current prices. The difference between the carrying value of the inventory and the current
replacement cost of the inventory is a current liability for replacement of LIFO base inventory temporarily
depleted. When the temporary liquidation is replaced, inventory is debited for the original LIFO value and
the liability is removed.

Inventory losses from a decline in market value at interim dates should not be deferred but should be
recognized in the period in which they occur. However, if in a subsequent interim period the market price
of the written-down inventory increases, a gain should be recognized for the recovery up to the amount of
the loss previously recognized. If a temporary decline in market value below cost can reasonably be
expected to be recovered prior to year end, no loss should be recognized.

Finally, if a company uses a standard cost system to compute cost of goods sold and to value inventories,
variances from the standard should be deferred instead of being immediately recognized.

(c) Discuss how the provision for income taxes is computed and reflected in interim financial statements

The Board states that the provision for income taxes shown in interim financial statements must be based
upon the effective tax rate expected for the entire annual period for ordinary earnings. The effective tax
rate is, in accordance with previous APB opinions, based on earnings for financial statement purposes as
opposed to taxable income which may consider temporary differences. This effective tax rate is the
combined federal and state(s) income tax rate applied to expected annual earnings, taking into
consideration all anticipated investment tax credits, foreign tax rates, percentage depletion, capital gains
rates, and other available tax planning alternatives. Ordinary earnings do not include unusual or
extraordinary items, discontinued operations, or cumulative effects of changes in accounting principles, all
of which will be separately reported or reported net of their related tax effect in reports for the interim
period or for the fiscal year. The amount shown as the provision for income taxes at interim dates should
be computed on a year-to-date basis. For example, the provision for income taxes for the second quarter of
a company's fiscal year is the result of applying the expected rate to year-to-date earnings and subtracting
the provision recorded for the first quarter. There are several variables in this computation (expected
earnings may change; tax rates may change), and the year-to-date method of computation provides the only
continuous method of approximating the provision for income taxes at interim dates. However, if the
effective rate or expected annual earnings change between interim periods, the change is not reflected
retroactively but the effect of the change is absorbed in the current interim period.