SOLUTIONS TO EXERCISES by hJT9vr

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									             SOLUTIONS TO UPDATE EXERCISES
UPDATE EXERCISE 10-1 (20-25 minutes)
(a) Exchange has commercial substance
   Depreciation Expense                                  700
       Accumulated Depreciation-Melter (Old)                             700
   Cost of old melter                      11,200
   Less: Salvage value                        700
   Depreciation cost                       10,500
   Depreciation per year ($10,500/5)        2,100
   Depreciation for 4 months (2,100 x 1/3)    700
   Melter (New)                                       15,200
   Accumulated Depreciation-Melter (Old)               7,000
        Gain on Disposal of Old Melter                              1,000
        Melter (Old)                                               11,200
        Cash                                                       10,000
  Computation of gain on old melter
   Cost of old melter                    $11,200
   Accumulated depreciation-melter (old)
      ($6,300 + $700)                      7,000
   Book value of old melter                4,200
   Fair value of old melter                5,200
   Gain on disposal of old melter        $ 1,000
  Computation of basis of new melter
   Cash paid                                $10,000
   Fair value of old melter                   5,200
   Cost of new melter                       $15,200

b. Exchange lacks commercial substance
     Depreciation Expense                                 700
         Accumulated Depreciation—Melter (Old)                           700
          ($11,200 – $700 = $10,500;
          $2,100 X 4/12 = $700)
     Melter (New)                                      14,200
     Accumulated Depreciation—Melter (Old)              7,000
         Melter (Old)                                                  11,200
         Cash                                                          10,000
         Cost of old melter                 $11,200
         Accumulated depreciation            (7,000) ($6,300 + $700)
         Book value                         $ 4,200
                                      -1-
UPDATE EXERCISE 10-1 (Continued)

             **Cash paid                        $10,000
               Book value of old melter           4,200
               Cost of new melter               $14,200


UPDATE EXERCISE 10-2 (15-20 minutes)
(a)    Exchange lacks commercial substance

                            Carlos Arruza Company
       Equipment (New)                                    12,000*
       Accumulated Depreciation-Equipment (Old)           19,000
          Equipment (Old)                                           28,000
          Cash                                                       3,000

      * Cost of new equipment:

         Cash paid                              $ 3,000
         Book value of old equipment              9,000
         Cost of new equipment                  $12,000

                           Tony LoBianco Company

       Cash                                                3,000
       Equipment (New)                                    15,000*
       Accumulated Depreciation-Equipment (New)           10,000
          Equipment (Old)                                           28,000

  * Cost of new equipment:

         Book value of equipment
          ($28,000-$10,000)                     $18,000
         Less: Cash received                      3,000
         Cost of new equipment                  $15,000




                                          -2-
UPDATE EXERCISE 10-2 (Continued)
(b) Exchange has commercial substance

                         Carlos Arruza Company
  Equipment (New)                                    15,500*
  Accumulated Depreciation-Equipment (Old)           19,000
     Equipment (Old)                                            28,000
     Cash                                                        3,000
     Gain on Disposal of Equipment                               3,500**
 * Cost of new equipment:
     Cash paid                             $ 3,000
     Fair value of old equipment            12,500
     Cost of new equipment                 $15,500


** Computation of gain on disposal of equipment:
    Fair value of old equipment            $12,500
    Book value of old equipment
          ($28,000-$19,000)                  9,000
    Gain on disposal of equipment          $ 3,500

                         Tony LoBianco Company
  Cash                                                3,000
  Equipment (New)                                    12,500*
  Accumulated Depreciation-Equipment (Old)           10,000
  Loss on Disposal of Equipment                       2,500**
     Equipment (Old)                                              28,000

 * Cost of new equipment:

     Fair value of equipment               $15,500
     Less: Cash received                     3,000
     Cost of new equipment                 $12,500

** Computation of loss on disposal of equipment:

     Book value of old equipment
           ($28,000-$10,000)               $18,000
     Fair value of equipment (Old)          15,500
     Loss on disposal of equipment         $ 2,500
                                     -3-
UPDATE EXERCISE 10-3 (10-15 minutes)

Busytown Corporation
Machine (New) ...........................................................               425*
Accumulated Depreciation-Machine (Old) ...............                                  140
Loss on Disposal of Machine ...................................                          65**
  Machine (Old) ........................................................                         290
  Cash.......................................................................                    340
      * Computation of basis of new machine:
          Cash paid                                                                    $340
          Fair value of old machine                                                      85
                                                                                       $425
     ** Computation of loss:
           Book value of old machine ($290 - $140)                                     $150
           Fair value of old machine                                                    (85)
           Loss on exchange                                                            $ 65

Dick Tracy Business Machine Company
Cash ...........................................................................        340
Inventory (Old) ...........................................................              85
Cost of Goods Sold ...................................................                  270
   Sales ......................................................................                  425
   Inventory (New) .....................................................                         270


UPDATE EXERCISE 10-4 (15-20 minutes)

a.      Equipment (New)                                                            56,900*
        Accumulated Depreciation-Equipment (Old)                                   20,000
             Equipment (old)                                                                    62,000
             Cash                                                                                9,100
             Gain on Disposal of Equipment                                                       5,800**

      * Cost of equipment:

          Cash paid for equipment                                            $ 8,000
          Cash paid for freight and installation                               1,100
          Fair value of old equipment                                         47,800
          Cost of equipment                                                  $56,900

                                                           -4-
  UPDATE EXERCISE 10-4 (Continued)

** Computation of gain on disposal of equipment:

     Fair value of old equipment              $47,800
     Book value of old equipment               42,000
     Gain on disposal of equipment            $ 5,800

b. Fair Values Not Determinable

     Equipment (New)                                51,100*
     Accumulated Depreciation-Equipment (Old)       20,000
          Equipment (Old)                                     62,000
          Cash                                                 9,100

  * Computation of cost of new equipment:

    Cash paid for equipment                   $ 8,000
    Cash paid for freight and installation      1,100
    Book value of old equipment                42,000
    Cost of new equipment                     $51,100




                                      -5-
                      UPDATE PROBLEM 10-1

1.   Susquehanna Corporation
     Cash                                              23,000
     Machine (New)                                     69,000
     Accumulated Depreciation- Machine (Old)           50,000
     Loss on Disposal of Machine                       18,000*
          Machine (Old)                                             160,000

     *Computation of loss: Book value    $110,000
                           Fair value      (92,000)
                           Loss          $ 18,000


     Choctaw Company
     Machine (New)                                      92,000
     Accumulated Depreciation- Machine (Old)            45,000
     Loss on Disposal of Machine                         6,000 *
         Cash                                                       23,000
         Machine (Old)                                             120,000

     *Computation of loss: Book value   $ 75,000
                           Fair value    (69,000)
                           Loss         $ 6,000

     Susquehanna Corporation
2.
     Machine (New)                                    110,000
     Accumulated Depreciation-Machine (old)            50,000
         Machine (old)                                             160,000

     Powhatan Company
     Machine (New)                                     76,000
     Accumulated Depreciation-Machine (Old)            71,000
         Machine (Old)                                             147,000




                                  -6-
UPDATE Problem 10-1 (Continued)

3.   Susquehanna Corporation
     Machine (New)                                       100,000
     Accumulated Depreciation-Machine (Old)               50,000
     Loss on Disposal of Machine                          18,000
          Machine (Old)                                            160,000
          Cash                                                       8,000

     Shawnee Company
     Machine (New)                                        92,000
     Accumulated Depreciation-Machine (Old)               75,000
     Cash                                                  8,000
         Machine (Old)                                             160,000
           Gain on Exchange of Machinery                            15,000*

     * Book value of old                   $ 160,000
                                             ( 75,000)
                                               85,000
      Fair value of asset received
       ($92,000 + 8,000)                    100,000
      Gain                                 $ 15,000




                                     -7-
                     UPDATE PROBLEM 10-2

(a)   Exchange has commercial substance:

                             Arna Inc.’s Books

      Asset B                                        75,000
      Accumulated Depreciation—Asset A               45,000
          Asset A                                               96,000
          Gain on Disposal of Plant Assets
            ($60,000 – [$96,000 – $45,000])                      9,000
          Cash                                                  15,000

                          Bontemps Inc.’s Books

      Cash                                           15,000
      Asset A                                        60,000
      Accumulated Depreciation—Asset B               52,000
           Asset B                                             110,000
           Gain on Disposal of Plant Assets
            ($75,000 – [$110,000 – $52,000])                    17,000

(b)   Exchange lacks commercial substance:

                             Arna Inc.’s Books

      Asset B ($75,000 – $9,000)                     66,000*
      Accumulated Depreciation—Asset A               45,000
          Asset A                                               96,000
          Cash                                                  15,000

      * Cost of asset:
           Book value – Asset A           $ 51,000
           Cash paid                        15,000
           Cost - Asset B                 $ 66,000




                                    -8-
UPDATE PROBLEM 10-2 (Continued)
                         Bontemps Inc.’s Books
     Cash                                          15,000
     Asset A                                       43,000*
     Accumulated Depreciation—Asset B              52,000
        Asset B                                                110,000



     *Fair value of asset $60,000         Book value of        $58,000
       acquired                     OR     Asset B
      Less gain deferred                  Less cash received    15,000
       ($17,000)           17,000                              $43,000
      Basis of Asset A    $43,000




                                    -9-
                          UPDATE PROBLEM 10-3

(a)                                 Garrison Books
        (1)   Crane                                           190,000
              Accumulated Depreciation—Equipment               60,000
              Loss on Disposal of Crane                         8,000
                  Crane                                                 140,000
                  Cash                                                  118,000

                                    Keillor Books
        (2)   Cash                                            118,000
              Equipment Inventory                              72,000
                   Sales                                                190,000

              Cost of Goods Sold                              165,000
                   Equipment Inventory                                  165,000
(b)                                 Garrison Books
       Crane                                                 198,000*
       Accumulated Depreciation—Equipment                     60,000
            Crane                                                       140,000
            Cash                                                        118,000
      * Book value of old ($80,000) + cash paid ($118,000)
(c)                                   Garrison Books
        (1)   Equipment                                       190,000
              Accumulated Depreciation—Equipment               60,000
                  Equipment                                             140,000
                  Cash                                                   92,000
                  Gain on Disposal of Plant Assets                       18,000
                    ($98,000 – $80,000)
                                       Keillor Books
        (2)   Cash                                             92,000
              Equipment Inventory                              98,000
                   Sales                                                190,000
              Cost of Goods Sold                              165,000
                   Equipment Inventory                                  165,000
(d)                                  Garrison Books
              Equipment                                      183,000*
              Accumulated Depreciation—Equipment              60,000
                   Cash                                                 103,000
                   Equipment                                            140,000
      * Book value of old ($80,000) + Cash paid ($103,000)
                                         -10-
UPDATE EXERCISE 22-1 (10-15 minutes)

(a) The net income to be reported in 2005, using the retroactive
    approach, would be computed as follows:
        Income before income taxes                     $700,000
        Income taxes (35% X $700,000)                    245,000
        Net income                                     $455,000

(b) Construction in Process ..................................              190,000
       Deferred Tax Liability ...............................                          66,500
       Retained Earnings ....................................                         123,500*

      *($190,000 X 65% = $123,500)



UPDATE EXERCISE 22-2 (10-15 minutes)

(a) Inventory ...........................................................   14,000*
        Retained earnings .....................................                        14,000

      *($19,000 + $23,000 + $25,000) – ($15,000 + $18,000 + $20,000)

(b)    Net Income (FIFO)                       2002            $19,000
                                               2003             23,000
                                               2004             25,000

(c) Inventory ...........................................................   24,000*
        Retained Earnings ....................................                         24,000

      *($19,000 + $23,000 + $25,000) – ($12,000 + $14,000 + $17,000)




                                                      -11-
UPDATE EXERCISE 22-3 (30-35 minutes)

(a) Depreciation to date on equipment

      Sum-of-the-years’-digits depreciation
      2002 (5/15 X $510,000)     $170,000
      2003 (4/15 X $510,000)      136,000
      2004 (3/15 X $510,000)      102,000
                                 $408,000

      Cost of equipment                            $525,000
      Depreciation to date                          408,000
      Book value (December 31, 2004)               $117,000

      Book value – salvage value = Depreciable cost
      $117,000 - $15,000 = $102,000

      Depreciation for 2005: $102,000 / 2 = $51,000

      Depreciation Expense                                 51,000
          Accumulated Depreciation-Equipment                           51,000

(b)   Depreciation to date on building

      $693,000 / 30 years = $23,100 per year
      $23,100 x 3 = $69,300 depreciation to date

      Cost of building                        $693,000
      Depreciation to date                      69,300
      Book value (December 31, 2004)          $623,700

      Depreciation for 2005: $623,700 / (40-3) = $16,856.76

      Depreciation Expense                               16,856.76
          Accumulated Depreciation-Buildings                         16,856.76




                                      -12-
UPDATE EXERCISE 22-4 (25-35 minutes)

(a) Change in Asset Depreciation

    Cost of depreciable assets                $100,000
    Depreciation in 2004                        40,000
    Book value at December 31, 2004           $ 60,000


    Depreciation for 2005 using straight-line depreciation
     $60,000 / 3 = $20,000


                            DENISE HABBE INC.
                       Comparative Income Statements
                        For the Years 2005 and 2004

                                                2005              2004
    Sales                                       $ 340,000    $ 270,000
    Cost of sales                                 176,000*     166,000**
    Gross profit                                  164,000      104,000
    Expenses                                       78,000***    50,000


    Net income                                  $ 86,000        $ 54,000

    ***$200,000 – $24,000
    ***$142,000 + $24,000
    ***$88,000 – ($30,000 – $20,000)

                            DENISE HABBE INC.
                       Statement of Retained Earnings
                        For the Years 2005 and 2004


                                                         2005            2004
    Retained earnings (January 1)                   $101,000        $ 72,000
    Net income                                        86,000          54,000
    Dividends                                        (30,000)        (25,000)
    Retained earnings (December 31)                 $157,000        $101,000




                                       -13-
UPDATE EXERCISE 22-4 (Continued)

     Note to instructor:

     1.   2004 cost of sales increased $24,000; 2005 cost of sales
          decreased $24,000.

     2.   2004 expenses remained unchanged.

     3.   2005 expenses decreased $10,000 ($30,000 – $20,000).

     4.   Additional disclosures    would   be   a   footnote    describing
          accounting change.

     5.   Another acceptable presentation for the retained earnings state-
          ment for 2005 is:
             Retained earnings (January 1), unadjusted           $125,000
             Prior period adjustment—inventory error              (24,000)
             Retained earnings adjusted                           101,000
             Net income                                            86,000
             Dividends                                            (30,000)
             Retained earnings                                   $157,000



UPDATE EXERCISE 22-5 (5-10 minutes)

1.   a.        6.   a.
2.   b.        7.   b.
3.   a.        8.   a.
4.   b.        9.   b.
5.   b.       10.   b.




                                     -14-
                             SOLUTIONS TO PROBLEMS

                               UPDATE PROBLEM 22-1

(a) 1.   Cost of equipment                                              $65,000
         Less: Salvage value                                              5,000
         Depreciable cost                                               $60,000

         Depreciation to 2004
           2001 ($60,000 / 10)                        $ 6,000
           2002 ($60,000 / 10)                          6,000
           2003 ($60,000 / 10)                          6,000
                                                      $18,000
         Depreciation in 2004
           Cost of equipment                          $65,000
           Less: Depreciation to 2004                  18,000
           Book value (January 1, 2004)                47,000
           Less: Salvage value                          3,000
           Depreciable cost                           $44,000

         Depreciation in 2004
           $44,000 / 4 = $11,000

         Depreciation Expense ...................................   11,000
           Accumulated Depreciation-Equipment ...                            11,000

    2.   Cost of building                             $300,000
         Less: Depreciation to 2004
             2002                                       60,000
             2003                                       48,000
         Book value (January 1, 2004)                 $192,000
         Less: Salvage value                            30,000
         Depreciable cost                             $162,000

         Depreciation in 2004
            ($162,000 / 8) = $20,250

         Depreciation Expense ...................................   20,250
            Accumulated Depreciation-Building ......                         20,250




                                              -15-
      3.   Accumulated Depreciation—Machine ..........                 1,500
               Retained Earnings .................................               1,500
                 ( [2002: $10,000* – $9,000** X 1/2 year]
                     + [2003: $10,000* – $9,000**] )

           *$80,000 ÷ 8     **($80,000 – $8,000) ÷ 8


(b)                             BRUEGGEN COMPANY
                             Comparative Income Statements
                              For the Years 2004 and 2003
                                                                2004             2003
      Income before depreciation                              $300,000     $310,000
      Depreciation expense*                                     40,250       63,000
      Net income                                              $259,750     $247,000

       *Deprecation Expense                                     2004             2003
         Equipment                                            $ 11,000         $ 6,000
         Building                                               20,250           48,000
         Machine                                                 9,000            9,000
                                                              $ 40,250         $ 63,000




                                              -16-
                            UPDATE PROBLEM 22-2

(a) 1.     Bad debt expense for 2002 should not have been reduced by
           $12,000. A change in the experience rate is considered a change
           in estimate, which should be handled prospectively.

      2.   A change from LIFO to FIFO is considered a change in accounting
           principle, which must be handled retrospectively.

      3.   a. The inventory error in 2004 is a prior period adjustment and
               the 2004 and 2005 statements should be restated.

           b. The lawsuit settlement is correctly treated.

(b)                           LARRY KINGSTON INC.
                         Comparative Income Statements
                         For the Years 2002 through 2005

                                   2002            2003        2004        2005
      Income before
         extraordinary item     $143,000        $125,000*** $204,000     $271,000
      Extraordinary gain                          40,000


      Net income*                $143,000       $165,000     $204,000    $271,000

 *Computations:
                                  2002             2003       2004         2005
  Net income (unadjusted)        $140,000       $160,000     $205,000    $260,000**
  1. Bad debt expense             (12,000)
     adjustment
  2. Inventory adjustment          15,000          5,000       10,000
  3. Inventory over-
        statement                                             (11,000)     11,000
  4. Tax settlement
                                 $143,000       $165,000     $204,000    $271,000

       **Reflects FIFO inventory for 2005
      ***$160,000 – $40,000 + $5,000 = $125,000



                                         -17-
                                    UPDATE PROBLEM 22-3

1.   Retained Earnings ................................................             4,000
         Sales Commissions Payable ........................                                    2,500
         Sales Commissions Expense ......................                                      1,500

2.   Cost of Sales ($21,000 + $6,700)..........................                 27,700
         Retained Earnings ........................................                           21,000
         Inventory .......................................................                     6,700

                                                      Income Overstated (Understated)
                                                      2003                   2004            2005
      Beginning inventory                                               $16,000             $21,000
      Ending inventory                            $(16,000)              (21,000)             6,700
                                                  $(16,000)             $ (5,000)           $27,700

3.   Accumulated Depreciation—Equipment.............                                4,800
         Depreciation Expense ..................................                              4,800*

*    Equipment cost                                          $100,000
     Depreciation before 2005                                 (36,000)
     Book value                                              $ 64,000
          $64,000 / 8 =                                      $ 8,000
     Depreciation recorded                                     12,800
     Difference                                              $ 4,800



4.   Construction in Process ......................................             55,000
        Income Taxes Payable ..................................                               22,000
        Retained Earnings ........................................                            33,000




                                                    -18-
                            UPDATE PROBLEM 22-4

(a)                         PLATO CORPORATION
                         Projected Income Statement
                    For the Year Ended December 31, 2004
 _______________________________________________________________
    Sales                                                $29,000,000
    Cost of Goods Sold                    $14,000,000
    Depreciation  a                         1,600,000
    Operating Expenses                      6,400,000     22,000,000
    Income before Income Taxes                           $ 7,000,000
    Unrealized Holding Gain  b                              2,000,000
    Income before Taxes and Bonus                        $ 9,000,000
    President’s Bonus                                       1,000,000
    Income before Income Taxes                           $ 8,000,000
    Provision for Income Taxes
         Current                          $ 3,000,000
         Deferred c                         1,000,000      4,000,000
    Net Income                                           $ 4,000,000

      Conditions met:
      1.   Net income before taxes and bonus > $8,000,000.
      2.   Payable for income taxes does not exceed $3,000,000.
      aDepreciation for the current year includes $600,000 for the old
       equipment and $2,000,000 for the robotic equipment. If the robotic
       equipment is changed to straight-line, its depreciation is only
       $1,000,000 and the total is $1,600,000.
      bBy urging the Board of Directors to change the classification of
      Securities A and D to Trading securities, income is increased by a
      $2,000,000 recognition of a holding gain.
      cThe unrealized holding gain is not currently taxable.

(b) Students’ answers will vary.

      There is nothing unethical about changing the first-year election of
      depreciation back to the straight-line method provided that it meets
      with the approval of appropriate corporate decision makers.
      Considering the immediate needs for cash of $1,000,000 for the


                                       -19-
UPDATE PROBLEM 22-4 (Continued)

   president’s bonus and $3,000,000 for income taxes, there may be a
   need to sell some of the marketable securities. Therefore, the transfer
   of $3,000,000 of available-for-sale securities to trading securities may
   also be appropriate.

   It is naive to believe that corporate officers do no planning for year-
   end (or interim) financial statements. The slippery slope arises with
   manipulation of financial statements. The security reclassification for
   the selected securities clearly manipulates the income to the benefit
   of the president. While legal and within GAAP guidelines, the ethics
   of this situation are borderline. Any auditor would automatically bring
   this transaction to the attention of the board of directors.

   Some stakeholders and their interests are:

        Stakeholder                          Interests
    President           Personal gain of $1,000,000 bonus.
    CFO                 Placed in ethical dilemma between the interests
                        of the president and the corporation.
    Board of Directors May be subject to the manipulations of the CEO
                       for his personal gain.
    Stockholders        Increased income from higher (paper) income
                        may increase demand for dividends. Lower in-
                        come from bonus may decrease cash available
                        for dividends.
    Employees           President takes 25% of net income for himself.
                        For example, this could have been used to
                        provide other benefits to all employees, such as
                        a bonus or pension plan.

    Creditors           The increased income represents a 33% infla-
                        tion of the true net income of the corporation.
                        This may lead to unreliable decisions of
                        creditworthiness.




                                    -20-

								
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