Intermediate Accounting II

Spring 2011
Solution - Exam 2
Section I
1. B
2. D
This question requires you to work backwards from the final answer. Solving it is the normal way gives
you :
Tax Depreciation - Book Depreciation = Timing Difference
Timing Difference * tax rate = deferred tax expense for period (using method C)
Tax entry
Now, working it backwards:
Tax entry:
Tax Expense 1,125,000
Tax Payable 1,035,000
DTL 90,000
Timing Difference = X * .30 = 90,000; X = 300,000
Tax Depreciation = X - 1,500,000 = 300,000; X = 1,800,000 (Note that tax is higher than book
depreciation since we originated a DTL.
3. C 2010: 240,000 * .30 = 72,000
2011: 120,000 * .30 = 36,000
2012: 120,000 * .30 = 36,000
2013: 240,000 * .25 = 60,000
252,000
4. B
5. A
6. C
I have given you the tests and entries to see how I computed it:
1. Y
2. Not applicable since 1 is Y
3. 8 years (economic life is not given)
(8, 10%)
4. 200,000 * PVF-AD = 1,173,684 / 1,142,440
1/1/11 equip 1,142,440 (lower of two values in test 4)
Lease Payable 1,142,440
1/1/11 Cash 200,000
Lease payable 200,000
Lease payable at 1/1/11 = 942,440
Effective interest rate - since we are using fair value, we need to compute effective rate:
(8, ? %)
200,000 * PVF-AD = 1,142,440
(8, ? %)
PVF-AD = 1,142,440 / 200,000 = 5.7122
i = 11%
12/31/11 Interest Expense 103,668 (942,440 * .11)
Interest Payable 103,668
1/1/12 Cash 200,000
Interest Payable 103,668
Lease payable 96,332
Lease payable at 1/1/12 = 942,440 - 96,332 = 846,108
Note that balance at 1/1/12 would be the same at 12/31/12 since interest expense for 2012
would be credited to interest payable at the end of 2012.
7. A PBO without contract change:
Earned pension benefit = 46,000 * 1.5% * 6 = 4,140
(9, 6%) (12, 6%)
PBO = [ 4,140 * PVF-OA ] * PVF = 13,994
PBO with contract change:
Earned pension benefit = 46,000 * 2% * 6 = 5,520
(9, 6%) (12, 6%)
PBO = [ 5,520 * PVF-OA ] * PVF = 18,659
New prior service cost (PSC) = 18,659 - 13,994 = 4,665
8. A Entry to record this (in ledger and on work sheet) would be:
OCI - PSC 4,665
Pension Asset/Liab 4,665
Section III - Income Taxes
2009 (30 points)
Pre-tax financial income 30,000
PD - officer life insurance 600
30,600
TD - Depreciation +500 orig.
Taxable Income 31,100
Taxes Payable 9,330 (31,100 *.30)
Deferred Tax Adjustment = debit DTA for 500 * .30 = 150. (We can use method C since all tax rates are
constant) - Also it is a DTA since financial statement depreciation in 2009 is higher than tax
depreciation.
Income Taxes Payable 9,330
DTA-depreciation 150
Income Tax Expense 9,180
2010 (26 points)
Pre-tax financial income -90,000
PD - officer life insurance 800
-89,200
TD - Depreciation -1,500 (500 reversing, 1,000 originating)
TD - Warranty not deducted 20,000 orig
Taxable Income -70,000
Use of loss carry back 31,100
Loss Carry forwarded -39,600
Use of loss carry back creates a refund equal to taxes paid in 2009 of 9,330
Income Taxes Receivable 9,330
Tax Benefit due to loss carry back 9,330
Since tax rates are constant, we can still use Method C. However since the depreciation
difference is both a reversing and originating, I did the computation in two pieces:
Depreciation reversing 500 * .30 = 150 (reduction of DTA)
Depreciation originating 1,000 * .30 = 300 (create DTL)
Warranty not deducted 20,000 * .30 = 6,000 (create DTA)
Loss carry forward 39,600 * .30 = 11,880 (create DTA)
Taxes payable 0 (not required)
DTA - depreciaiton 150
DTL - depreciaiton 300
DTA - warranty 6,000
DTA - NOL 11,880
Tax Benefit due to loss carry forward 17,430
Since 60% of loss carry forwards are judged more likely than not to be realized, we need a
valuation allowance for the remaining 40%, which is 11,880 * .40 = 4,752
Valuation Allowance - DTA 4,752
Tax Benefit due to loss carry forward 4,752
2011 (14 points)
Pre-tax financial income 180,000
PD - officer life insurance 900
180,900
TD - Depreciation +200 (reversing)
TD - Warranty not deducted -12,000 (reversing)
Taxable Income before C.F. 169,100
Use of Loss carry forwarded - 39,600 (reversing)
Taxable Income 129,500
Taxes Payable 25,900 (129,500 * .20)
Due to the tax rate change for 2011 and beyond, we need to use Method B for depreciation DTL
and warranty DTA.
Ending balance for DTL attributed to depreciation is:
Cumulative Difference $800 (+500 from 2009, -1,500 from 2010, +200 from 2011)
Tax rate .2 (Since all will reverse when rates are 20%
$160
Since the beginning balance of DTL - depreciation is 300 and the required ending balance is 160,
we need an adjustment of 140 debit to DTL.
Ending balance for DTA attributed to warranty is:
Cumulative Difference $8,000 (-20,000 from 2010, +12,00 from 2011)
Tax rate .2 (Since all will reverse when rates are 20%
$1,600
Since the beginning balance of DTA - warranty is 6,000 and the required ending balance is
1,600, we need an adjustment of 4,400 credit to DTA.
Since the NOL loss carry forwarded has been fully realized, we can credit DTA-NOL for the full
balance at the end of 2010. Also, we need to reverse the valuation allowance.
Taxes Payable 25,900
DTL - Depreciation 140
DTA - Warranty 4,400
DTA - NOL 11,880
Income Tax Expense 42,040
Valuation Allowance - DTA 4,752
Tax Expense 4,752
Section IV (See worksheet for details
(A) Compute pension expense for 2011 = 1,161
(B) 12/31/11 balances:
Pension Asset/Liability = 2,190 dr
Accumulated Other Comprehensive Income - Prior Service Cost 642 dr
Accumulated Other Comprehensive Income - Gains/Losses = 3,183 cr
Part 1
Capitalized lease test:
XYZ Super Lease Co
1. No, since title does not transfer. No
2. No No
3. 2/3 < 75%, therefore No 2/3 < 75%, therefore No
(2,6%) (2, 6%) (2,6%) (2,6%)
4. 6,400 * PVF-OA + 1,000 * PVF 6,400 * PVF-OA + 1,000 * PVF
= 12,624 / 12,624 > 90%, therefore Yes. = 12,624 / 12,624 > 90%, therefore YES
1/1/10 Equipment 12,624 Lease Receivable 12,624
Lease Liability 12,624 Equipment or Cash 12,624
12/31/10 Interest Expense 757 Interest Income 757
Cash 6,400 Cash 6,400
Lease Liability 5,643 Lease Receivable 5,643
Expense = 12,624 * .06 Income = 12,624 * .06
Balance of Liability = 6,981 Balance of Receivable = 6,981
Depreciation Exp. 5,812
Accumulated Dep. 5,812
(12,624 - 1,000) /2
12/31/11 Interest Expense 419 Interest Income 419
Cash 6,400 Cash 6,400
Lease Liability 5,981 Lease Receivable 5,981
Expense = 6,981 * .06 = 419 Income = 6,981 * .06 = 419
Balance of liability = 1,000 Balance of receivable = 1,000
Depreciation Exp. 5,812
Accumulated Dep. 5,812
12/31/11 Equipment 12,624 Equipment 700
Accumulated Dep. 11,624 Lease Receivable 1,000
Lease Liability 1,000 Cash 300
Cash 300
Loss 300
Part 2 Lease Receivable 12,624
Sales 12,624
Cost of Good Sold (plug) 9,300
Inventory 9,300
Part 3
If we changed to a BPO of 1,000 there would be no change in the present value of the minimum
lease payments since the 1,000 would be paid at the end of the two years.
Depreciation expense would now be (2,624 - 0) / 3 or 4,208 per year
The end of lease entry would now be:
Cash 1,000
Lease Liability 1,000

Pension Worksheet (You may use this if you want to but it is not required)
General Ledger Memo Record
Item
Pension
Expense Cash AOCI- PSC
AOCI -
Gain/loss
Pension
Asset/Liab PBO Assets
Balance, Jan. 1, 2011
700 Dr 900 Cr 200 Dr 7,000 Cr 7,200 Dr
Service Cost 1,200 Dr 1,200 Cr 1,200 cr
Interest Cost 350 Dr. 350 Cr 350 cr
Return on Assets 432 Cr. 2,298 Cr 2,730 Dr 2,730 dr
Amortization of PSC 58 Dr. 58 Cr
Amortization of Gain/Loss 15 Cr. 15 Dr
Contributions to plan 810 Cr 810 Dr 810 dr
Benefits paid 940 dr 940 cr
Change in assumptions
Balance, Dec. 31, 2011 1,161 642 dr 3,183 cr 2,190 dr 7,610 cr 9,800 dr
Interest cost = 7,000 * .05 = 350
Return on assets = 7,200 * .06 = 432
Amortization of PSC = 700 / 12 = 58
Amortization of Gain/Loss = {900 - 10% * max[7000, 7200]} / 12 = 15