Question & Answer

Bridgewater Corp. offered holders of its 1,000 convertible bonds a premium of $160 per bond to induce conversion into shares of its common stock. Upon conversion of all the bonds, Bridgewater Corp. recorded the $160,000 premium as a reduction of paid-in capital. Comment on Bridgewater’s treatment of the $160,000 “sweetener.”

What factors could explain why some countries have a higher multiplier than others?

If the shares in a monopoly (such as a water company) were very widely distributed among the population, would the shareholders necessarily want the firm to use its monopoly power to make larger profits?

Brooks Corporation sells computers under a 2-year warranty contract that requires the corporation to replace defective parts and to provide the necessary repair labor. During 2014, the corporation sells for cash 400 computers at a unit price of $2,500. On the basis of past experience, the 2-year warranty costs are estimated to be $155 for parts and $185 for labor per unit. (For simplicity, assume that all sales occurred on December 31, 2014.) The warranty is not sold separately from the computer. Instructions (a) Record any necessary journal entries in 2014, applying the cash-basis method. (b) Record any necessary journal entries in 2014, applying the expense warranty accrual method. (c) What liability relative to these transactions would appear on the December 31, 2014, balance sheet and how would it be classified if the cash-basis method is applied? (d) What liability relative to these transactions would appear on the December 31, 2014, balance sheet and how would it be classified if the expense warranty accrual method is applied? In 2015, the actual warranty costs to Brooks Corporation were $21,400 for parts and $39,900 for labor. (e) Record any necessary journal entries in 2015, applying the cash-basis method. (f) Record any necessary journal entries in 2015, applying the expense warranty accrual method.

Volunteer Corporation reported taxable income of $500,000 from operations this year. The company paid federal income taxes of $105,000 on this taxable income.  During the year, the company made a distribution of land to its sole shareholder, Rocky. The land’s fair market value was $75,000 and its tax and E&P basis to Volunteer was $25,000. Rocky assumed a mortgage attached to the land of $15,000. Volunteer had accumulated E&P of $750,000 at the beginning of the year.

Carlton Company is involved in four separate industries. The following information is available for each of the four industries. Operating Segment Total Revenue Operating Profi t (Loss) Identifi able Assets W $ 60,000 $15,000 $167,000 X 10,000 3,000 83,000 Y 23,000 (2,000) 21,000 Z 9,000 1,000 19,000 $102,000 $17,000 $290,000 Instructions Determine which of the operating segments are reportable based on the: (a) Revenue test. (b) Operating profit (loss) test. (c) Identifiable assets test.

Why is the price inelasticity of demand for private car transport a problem when formulating a policy for the reduction of traffic congestion? What could be done to change the price elasticity of demand in a desirable direction?

1.15     Relevant information Suppose you are responsible for ordering a replacement for your office photocopy machine. Part of your job is to decide whether to buy it or lease it.   Required (a)          Describe something that could be considered relevant information in this decision and explain why it is relevant. (b)          Describe something that could be considered irrelevant information in this decision and explain why it is irrelevant. (c)           Explain why it was important to distinguish between relevant and irrelevant information in this problem.

Classify the following items as (1) operating, (2) investing, (3) financing, or (4) significant non-cash investing and financing activities, using the direct method. (a) Cash payments to employees. (b) Redemption of bonds payable. (c) Sale of building at book value. (d) Cash payments to suppliers. (e) Exchange of equipment for furniture. (f) Issuance of preferred stock. (g) Cash received from customers. (h) Purchase of treasury stock. (i) Issuance of bonds for land. (j) Payment of dividends. (k) Purchase of equipment. (l) Cash payments for operating expenses.

On April 1, 2014, Dougherty Inc. entered into a costplus- fixed-fee contract to construct an electric generator for Altom Corporation. At the contract date, Dougherty estimated that it would take 2 years to complete the project at a cost of $2,000,000. The fixed fee stipulated in the contract is $450,000. Dougherty appropriately accounts for this contract under the percentage-of-completion method. During 2014, Dougherty incurred costs of $800,000 related to the project. The estimated cost at December 31, 2014, to complete the contract is $1,200,000. Altom was billed $600,000 under the contract. Instructions Prepare a schedule to compute the amount of gross profit to be recognized by Dougherty under the contract for the year ended December 31, 2014. Show supporting computations in good form.

Explain why some companies that issue bonds engage in interest rate swaps in financial markets. Why do they not simply issue bonds that require the type of payments (fixed or variable) that they prefer to make? (LO1)

The records for the Clothing Department of Sharapova’s Discount Store are summarized below for the month of January. Inventory, January 1: at retail $25,000; at cost $17,000 Purchases in January: at retail $137,000; at cost $82,500 Freight-in: $7,000 Purchase returns: at retail $3,000; at cost $2,300 Transfers in from suburban branch: at retail $13,000; at cost $9,200 Net markups: $8,000 Net markdowns: $4,000 Inventory losses due to normal breakage, etc.: at retail $400 Sales revenue at retail: $95,000 Sales returns: $2,400 Instructions (a) Compute the inventory for this department as of January 31, at retail prices. (b) Compute the ending inventory using lower-of-average-cost-or-market.

Connie Chung Corporation adopted the dollar-value LIFO retail inventory method on January 1, 2013. At that time the inventory had a cost of $54,000 and a retail price of $100,000. The following information is available.8 Year-End Inventory at Retail Current Year Cost—Retail % Year-End Price Index 2013 $118,720 57% 106 2014 138,750 60% 111 2015 125,350 61% 115 2016 162,500 58% 125 The price index at January 1, 2013, is 100. Instructions Compute the ending inventory at December 31 of the years 2013–2016. (Round to the nearest dollar.)

Do the following events represent business transactions? Explain your answer in each case. (a) A computer is purchased on account. (b) A customer returns merchandise and is given credit on account. (c) A prospective employee is interviewed. (d) The owner of the business withdraws cash from the business for personal use. (e) Merchandise is ordered for delivery next month.

Under what conditions is it appropriate for a business to use the composite method of depreciation for its plant assets? What are the advantages and disadvantages of this method?

If pension expense recognized in a period exceeds the current amount funded by the employer, what kind of account arises, and how should it be reported in the financial statements? If the reverse occurs—that is, current funding by the employer exceeds the amount recognized as pension expense—what kind of account arises, and how should it be reported?

Nicole is a calendar-year taxpayer who accounts for her business using the cash method. On average, Nicole sends out bills for about $12,000 of her services at the first of each month. The bills are due by the end of the month, and typically 70 percent of the bills are paid on time and 98 percent are paid within 60 days.

Use the information for Rode Inc. given in BE19-13. Assume that it is more likely than not that the entire net operating loss carryforward will not be realized in future years. Prepare all the journal entries necessary at the end of 2014.

Fairbanks Corporation purchased 400 shares of Sherman Inc. common stock as an availablefor- sale investment for $13,200. During the year, Sherman paid a cash dividend of $3.25 per share. At yearend, Sherman stock was selling for $34.50 per share. Prepare Fairbanks’ journal entries to record (a) the purchase of the investment, (b) the dividends received, and (c) the fair value adjustment. (Assume a zero balance in the Fair Value Adjustment account.)

Donald Lennon is the president, founder, and majority owner of Wichita Medical Corporation, an emerging medical technology products company. Wichita is in dire need of additional capital to keep operating and to bring several promising products to final development, testing, and production. Donald, as owner of 51% of the outstanding stock, manages the company’s operations. He places heavy emphasis on research and development and long-term growth. The other principal stockholder is Nina Friendly who, as a nonemployee investor, owns 40% of the stock. Nina would like to deemphasize the R & D functions and emphasize the marketing function to maximize short-run sales and profits from existing products. She believes this strategy would raise the market price of Wichita’s stock. All of Donald’s personal capital and borrowing power is tied up in his 51% stock ownership. He knows that any offering of additional shares of stock will dilute his controlling interest because he won’t be able to participate in such an issuance. But, Nina has money and would likely buy enough shares to gain control of Wichita. She then would dictate the company’s future direction, even if it meant replacing Donald as president and CEO. The company already has considerable debt. Raising additional debt will be costly, will adversely affect Wichita’s credit rating, and will increase the company’s reported losses due to the growth in interest expense. Nina and the other minority stockholders express opposition to the assumption of additional debt, fearing the company will be pushed to the brink of bankruptcy. Wanting to maintain his control and to preserve the direction of “his” company, Donald is doing everything to avoid a stock issuance and is contemplating a large issuance of bonds, even if it means the bonds are issued with a high effective-interest rate. Instructions (a) Who are the stakeholders in this situation? (b) What are the ethical issues in this case? (c) What would you do if you were Donald?

Gershwin Corporation obtained a franchise from Sonic Hedgehog Inc. for a cash payment of $120,000 on April 1, 2014. The franchise grants Gershwin the right to sell certain products and services for a period of 8 years. Prepare Gershwin’s April 1 journal entry and December 31 adjusting entry.

What are hybrid securities? Give an example of a hybrid security.

How should the amount of interest capitalized be disclosed in the notes to the financial statements? How should interest revenue from temporarily invested excess funds borrowed to finance the construction of assets be accounted for?

In each of the following independent cases the company closes its books on December 31. 1. Sanford Co. sells $500,000 of 10% bonds on March 1, 2014. The bonds pay interest on September 1 and March 1. The due date of the bonds is September 1, 2017. The bonds yield 12%. Give entries through December 31, 2015. 2. Titania Co. sells $400,000 of 12% bonds on June 1, 2014. The bonds pay interest on December 1 and June 1. The due date of the bonds is June 1, 2018. The bonds yield 10%. On October 1, 2015, Titania buys back $120,000 worth of bonds for $126,000 (includes accrued interest). Give entries through December 1, 2016. 3 4 Instructions For the two cases prepare all of the relevant journal entries from the time of sale until the date indicated. Use the effective-interest method for discount and premium amortization (construct amortization tables where applicable). Amortize premium or discount on interest dates and at year-end. (Assume that no reversing entries were made.)

Bill Haley is learning about pension accounting. He is convinced that in years when companies record liability gains and losses, total comprehensive income will not be affected. Is Bill correct? Explain.