Troubled Debt Restructuring and Lease Accounting Exam Questions, Exams of Accounting

Download Troubled Debt Restructuring and Lease Accounting Exam Questions and more Exams Accounting in PDF only on Docsity! Name: __________________________________ Exam 1 Acct 414 – Corporate Accounting & Reporting II Fall 2006 Show any necessary computations if you want to be eligible for partial credit. Present your work in a neat, well-organized manner. When you are using a financial calculator, spell out what you put in for n, i, PMT, FV, PV, etc. Draw a time-line if that would explain your thinking to me. You may use abbreviations in your essay answers but I need complete thoughts. Follow the instructions and answer all parts of the question as directed. 1-4. Time Value of Money (60 points total, 15 each) 5. Troubled debt (30 points total) 6. Leases. (70 points total) 7. Long-term contracts (20 points) 8. Serial Bonds (20 points) Extra credit points (if any) total: __________ Total points earned (max = 200) Do not attempt the extra credit items until you have completed all other sections of the exam! Exam 1 – Acct 414 – Fall 2006 Page 2 Are assets or an ownership interest transferred from debtor to creditor in settlement of debt? Is the debt settled in full? Is entity the CREDITOR? CREDITOR discounts expected future cash flows to be received under modified terms using original (historical) interest rate No No Yes Record ordinary gain or loss on asset. Difference between fair value of asset or equity interest and amount due on debt is ordinary gain for debtor and ordinary loss for creditor Yes Difference between carrying value of receivable and present value of expected future cash flows is ordinary loss for CREDITOR Are the cash flows to be made under the modified terms greater than the carrying value of the debt after transfer of any asset or equity interest? (Debtor pays LESS than amount owed at restructuring) The difference between carrying value of debt and total future cash flows is recorded as a gain from restructuring for DEBTOR. No interest expense will be recorded in future years. No (Debtor pays MORE than amount owed at restructuring) No gain is recorded by DEBTOR. Find interest rate to set cash flow equal to carrying value of debt. Use this interest rate to amortize the restructured debt over its term. Yes TROUBLED DEBT RESTRUCTURING (FASB 15, 114, 118 & 145) Prepared by T. Gordon 8-31-06 Record ordinary gain or loss on asset or equity interest transferred. Difference between fair value of asset or equity interest and carrying value of debt is recognized as an ordinary gain from restructuring for debtor and an ordinary credit loss for creditor. No Yes Exam 1 – Acct 414 – Fall 2006 Page 5 5. Troubled Debt (30 points). Bobs Brakes Inc. is a major creditor of Adam’s Auto Repair Inc. Adam’s Auto Repair Inc. is experiencing substantial financial difficulties. Its original note with Bobs Brakes Inc. was dated August 1, 2005 and has a face value of $100,000 and specifies a 10% interest rate. The interest for the year ending August 1, 2006 has not been paid. On August 1, 2006, the debtor persuaded Bobs Brakes to reduce the principal from $100,000 to $70,000 and to reduce interest payments to $3,500 per year for the remaining 3-year life of the debt. The modified terms also waive payment of the accrued interest currently due. Both debtor and creditor have fiscal years that coincide with the calendar year. Instructions a. Show all necessary entries on the books of the debtor (Adam’s Auto Repair) from August 1, 2006 through August 1, 2007. b. What is the amount of the loss that Bobs Brakes Inc. (the creditor) will recognize? (No journal entry is required) Exam 1 – Acct 414 – Fall 2006 Page 6 6. Lease Accounting. (70 points total) On May 31, 2006, Buffy Vans, Inc. (lessee) and Custom Vans Unlimited (lessor) sign a noncancelable lease with the following terms: 1. Term: 5 years 2. Annual payment = $12,336 3. Implicit interest rate (known to lessee) 8% 4. Est. fair value of asset at end of lease $10,000 5. Fair value of asset $60,000 6. Cost of asset $50,000 7. Incremental borrowing rate: 9% 8. First payment is due immediately 9. Estimated useful life of asset: 8 years 10. Purchase option at end of lease: $10,000 11. If the purchase option is not exercised, the lessee returns the asset to the lessor at end of five years. 12. The lease payments appear to be collectible and there are no additional costs expected by the lessor. 13. Both lessor and lessee use the straight-line depreciation method (no salvage value) and have fiscal years that end on December 31. 14. The lessor pays a 1% commission to its sales staff based on the fair market value of leased equipment. a. What type of lease is this for Buffy Vans (the lessee) and for Custom Vans Unlimited (the lessor)? Explain briefly showing numeric computations. (12 points) Hint: Let me know that you know all the rules! b. Regardless of your answer to part (a), assume this is a sales-type lease for the lessor. Prepare a lease amortization schedule for Custom Vans Unlimited for the first two years. (18 points) Date Lease Payment Interest Revenue Amortized Principal Balance 0 1 2 c. Regardless of your answer to (a), assume that this is a sales-type lease for the lessor. Prepare the journal entries that the lessor would make at the inception of the lease on May 31, 2006. (15 points) 5/31/06 Exam 1 – Acct 414 – Fall 2006 Page 7 6 - continued (facts repeated for your convenience) On May 31, 2006, Buffy Vans, Inc. (lessee) and Custom Vans Unlimited (lessor) sign a noncancelable lease with the following terms: 1. Term: 5 years 2. Annual payment = $12,336 3. Implicit interest rate (known to lessee) 8% 4. Est. fair value of asset at end of lease $10,000 5. Fair value of asset $60,000 6. Cost of asset $50,000 7. Incremental borrowing rate: 9% 8. First payment is due immediately 9. Estimated useful life of asset: 8 years 10. Purchase option at end of lease: $10,000 11. If the purchase option is not exercised, the lessee returns the asset to the lessor at end of five years. 12. The lease payments appear to be collectible and there are no additional costs expected by the lessor. 13. Both lessor and lessee use the straight-line depreciation method (no salvage value) and have fiscal years that end on December 31. 14. The lessor pays a 1% commission to its sales staff based on the fair market value of leased equipment. d. Regardless of your answer to a, assume the lease is a capital lease for the lessee. Prepare all necessary journal entries for the lessee, Buffy Vans Inc. at 5/31/06, 12/31/06 and 5/31/07. (25 points) 5/31/06 12/31/06 5/31/07 Exam 1 – Acct 414 – Fall 2006 Page 10 9. Extra Credit Matching (optional – 5 points maximum) MATCHING: For each term, select the best phrase or description from the answers listed below. An answer may be used once, more than once, or not at all. _____1. Implicit interest rate _____4. Guaranteed residual value _____2. Unearned interest _____5. Initial direct costs _____3. Continent rentals CHOICES: A. Depreciation expense related to the leased asset is reported on the lessor's income statement over the lease term. B. The rate used by the lessee to determine the present value of the minimum lease payments if the lessee's incremental borrowing rate is less than the lessor's implicit interest rate (known to lesee). C. Increases or decreases in lease payments based upon sales volume or machine useage. D. Always included in minimum lease payments unless there is a title transfer or a bargain purchase option. E. Included in the lessor's gross investment, whether guaranteed or unguaranteed. F. Included in the lessor's gross investment in lease. G. The rate used by the lessee to determine the present value of the minimum lease payments if the lessee's incremental borrowing rate is greater than the lessor's implicit interest rate (known to lessee). H. Is not included in the minimum lease payments if it is large enough to assure that the lease will be renewed. I. Costs which are expensed immediately by lessor when the fair value of the leased asset exceeds its carrying value. J. The difference between the fair value of the leased asset and the total payments to be received over the lease term. Exam 1 – Acct 414 – Fall 2006 Page 11 SOLUTIONS Question 1 Problem 2 FV= (2,000,000) FV= 25,000 i= 3% pmt= 35,000.00 PV= 0 PV= (157,750) annuity due=1 1 annuity due=1 1 n= 12 n= 5 PMT= 136,820 i= 11.226% Calculator inputs: Calculator inputs: Problem 3 Problem 4 FV= 0 FV= 45,000 i= 1% pmt= 4,500.00 PV= (95,000) PV= (56,000) annuity due=1 0 annuity due=1 0 n= 48 n= 4 PMT= 2,502 i= 3.366% 5-a Debtor The carrying value is $110,000. Under new terms, the total cash flows are less than the carrying value at $80,500 [70,000 + (3,500 * 3 years)] so the debtor recognizes a gain on restructuring. The new carrying value for the note payable is the TOTAL future cash flows. Debtor journal entries Debit Credit 8/1/06Accrued interest payable 10,000 Note payable (old) 100,000 Gain on troubled debt restructuring 29,500 Note payable (new) – valued at TOTAL future cash flows 80,500 12/31/06No entry at year end since interest rate Has been effectively set at ZERO 8/1/06 Interest expense 0 Notes payable 3,500 Cash 3,500 5b-Creditor The creditor finds the present value of the cash flows using the original interest rate n=3; i=10%; pmt=3,500, FV=$70,000 – solve for PV = $61,296 Since the carrying value is $110,000, the creditor has a loss of $48,704 6. Lease accounting a. Lessee classification of the lease. There is no title transfer and no bargain purchase option. The lease term = 0.71 of economic life. PVMLP (computed n=5, pmt=12336, i=8%, fv=0) is $53,194.40 which is less than 90% of FMV (54,000.00). Therefore, the lease fails all 4 tests. This is an operating lease for lessee. This is also an operating lease for the lessor. There is no Title Transfer, no BPO, the lease term is less than 75% of the economic life of the asset, and the PVMLP=53,194.23 which is less than 90% FMV. Note that there are no cost uncertainties and the payments are considered collectible from lessee (the two extra lessor rules). Since there is a profit (FMV > cost), this would be a sales-type and not a direct financing lease EXCEPT it is an operating lease because none of the first 4 criteria are met. b. amortization table (first 2 rows required) Exam 1 – Acct 414 – Fall 2006 Page 12 Lease Reduction LEASE Date Payment Interest in lease Receivable 60,000.00 60,000.00 8.0002% receivable BALANCE 05/31/06 60,000.00 0 05/31/06 12,336.00 0.00 12,336.00 47,664.00 1 05/31/07 12,336.00 3,813.21 8,522.79 39,141.21 2 05/31/08 12,336.00 3,131.37 9,204.63 29,936.58 3 05/31/09 12,336.00 2,394.98 9,941.02 19,995.56 4 05/31/10 12,336.00 1,599.68 10,736.32 9,259.24 5 05/31/11 10,000.00 740.76 9,259.24 0.00 ------------------------------- ------------------------------- ------------------------------- 71,680.00 11,680.00 60,000.00 0.00 debit credit Comments c. ASSUMING: SALES TYPE LEASE 05/31/06 Net Investment in Lease 47,664.00 formulas: Sales @PVMLP 53,194.23 (53,194.23) COGS PV of RV removed 43,194.23 ($6,805.77) Inventory 50,000.00 Cash 12,336.00 commission on FV COGS (or initial direct cost) 600.00 Salary expense, cash ,etc. 600.00 Point is that IDC for sales type lease is EXPENSED immediately total 103,194.23 103,194.23 ok Instructions were not clear – I accepted either lessee or lessor table for part b. Note that lessor and lessee amortization tables are different even though both are using same interest rate (8% known to lessee). The reason is the unguaranteed residual value which does not appear on lessee’s table. Making the lessee journal entries was easier if you did the lessee table. Lease 8% Reduction in Lease Date Payment Interest Lease Obligation 53,194.40 Expense Obligation BALANCE 05/31/06 53,194.40 05/31/06 12,336.00 0.00 12,336.00 40,858.40 05/31/07 12,336.00 3,268.67 9,067.33 31,791.07 05/31/08 12,336.00 2,543.29 9,792.71 21,998.35 05/31/09 12,336.00 1,759.87 10,576.13 11,422.22 05/31/10 12,336.00 913.78 11,422.22 0.00 05/31/11 0.00 0.00 0.00 0.00 ------------------------------- ------------------------------- ------------------------------- 61,680.00 8,485.60 53,194.40 0.00 d. Lessee JE s assuming it is a capital lease debit credit 05/31/06 Leased Asset =PVMLP 53,194.40 life: Lease Obligation 40,858.40 5 Cash 12,336.00 because lessee returns asset at end of LT Prorated: 0.58333 12/31/06 Depreciation Expense $53,194/5yrs * 7/12 6,206.01 Accumulated Depreciation 6,206.01 Interest Expense $3268.67 * 7/12 1,906.73 Interest payable 1,906.73 05/31/07 Lease Obligation on table 9,067.33 Interest expense $3268.67 * 5/12 1,361.95 Interest payable amt at 12/31/06 1,906.73 Cash 12,336.00 73,643.13 73,643.13 7. Construction accounting (a) $990,000 ————— = Percentage of completion of 55% × $3,000,000 = $1,650,000 construction revenue $1,800,000 Debit Credit (b) Accounts Receivable ........................................................................................... 1,000,000 Billings on Construction in Process ..................................................... 1,000,000 (c) Construction Expenses......................................................................................... 990,000 Construction in Process ....................................................................................... 660,000