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```					                                         Accounting 381
Practice Midterm Exam Solution

Name _____________________________________

Section ____________________________________

General Instructions:

1. Please observe the Portland State University Code of Conduct.

2. This exam packet should have 14 pages. Please confirm that you have all of the pages.

3. Review the complete exam in order to allocate your time appropriately. You will have one
hour and 50 minutes to complete the exam.

4. In fairness to all students, questions will not be answered during the exam, except to explain
words or phrases. If a question is ambiguous, write your assumptions on the exam along with
reasonable.

6. Monitor your time and good luck!

Question I                       26

Question II                       21

Question III                      26

Question IV                       12

Question V                        15

TOTAL                           100
Question I: Adjusting Journal Entries (26 points)

Give journal entries to record each of the following transactions as well as any adjusting entries
that will be necessary on December 31, 2006. Assume that all firms use a calendar-year
accounting period and close their books on December 31. Please note that you are required to
record all related journal entries and any necessary adjusting entries.

a. Vidon Vineyards acquires a van on September 1, 2006, for \$46,000 cash. Salvage value is estimated
to be \$4000 and the useful life is estimated to be 8 years.

Sept 1         PPE                            46,000
Cash                                     46,000

Dec. 31        Depreciation Expense           1,750
Accum. dep.                           1,750
(46,000 – 4000)/8 years = \$5250/year X 4/12 = 1750)

b. Tate Company purchased land on November 1, 2006 by giving a 3-month, 9% note with a
face value of \$20,000 to the seller.

Nov. 1 Land                                   20,000
NP                                          20,000
Dec 31     Interest expense                   300
Interest payable                        300
(20,000 * .09= 1800/year X 2/12)

c. Finch Bungy Company purchases a 3-year insurance policy on June 1, 2006, paying the 3-year
paid as Prepaid Insurance on June 1, 2006.

June. 1        Prepaid Insurance              18,000
Cash                             18,000

Dec. 31        Insurance Expense             3,500
Prepaid Insurance            3,500
(18,000 / 3 = 6000/yr X 7/12)

2
Question I, continued

d. A-Boy Hardware begins business on April 1, 2006. It acquires supplies costing \$9,000 on account.
Of this amount, it pays \$7,000 by year-end. A physical inventory indicates that office supplies
costing \$1,400 are on hand at December 31, 2006.

Apr 1         Supplies Inventory          9,000
AP                            9,000

Apr 1 –       AP                          7,000
Dec. 31              Cash                          7,000

Dec. 31       Supplies Expense            7,600
Supplies Inventory            7,600

e. On November 1, 2006, Bogus Basin Co. receives \$10,800 for services to be performed November 1,
2006 through April 30, 2007. Bogus Basin Co. decides to record the amount received as Service
Revenue on November 1, 2006.

Nov. 1 Cash                               10,800
Service Revenue                       10,800

Dec. 31       Service Revenue             7,200
Unearned Revenue                      7,200
(10,800/ 6 mo’s = 1800 * 2 months)

f.      Gibson Company paid \$3,600 on June 1, 2006 for a two-year insurance policy and
recorded the entire amount as Insurance Expense.

June 1 Insurance expense                           3600
Cash                                            3600

Dec 31 Prepaid Insurance                        2550
Insurance Expense                            2550
(3600/24 = 150 * 7 mo’s = 1050 expense (3600-1050) = 2550 prepaid)

3
Question II: Income Statement (21 points)

a. Vincent Corporation had income from continuing operations of \$800,000 (after taxes) for the
year ended December 31, 2007. Preferred dividends declared and paid were \$20,000. Common
stock dividends declared and paid were \$50,000. In addition, the following information, which
has not been considered, is as follows.

1. In 2007, Vincent experienced an uninsured earthquake loss in the amount of \$200,000. This
is considered to be an extraordinary item.

2. A machine was sold for \$140,000 cash during the year at a time when its book value was
\$110,000. (Depreciation has been properly recorded.) The company often sells machinery of
this type.

3. Vincent decided to discontinue its stereo division in 2007. During the current year, the loss
on the disposal of this component of the business was \$150,000 less applicable taxes.

Instructions
Present in good form the income statement of Vincent Corporation for 2007 starting with
"income from continuing operations." Assume that Vincent's tax rate is 30%. Common shares
outstanding throughout the year were as follows:

1/1/07 – 3/31/07: 120,000 shares
4/1/07 – 5/31/07: 132,000 shares
6/1/07 – 12/31/07: 162,000 shares

Weighted average calculation: 3/12 * 120,000 + 2/12*132,000 + 7/12* 162,000 = 146,500
shares

4
Question II, continued
Solution
Vincent Corporation
Partial Income Statement
For the Year Ended December 31, 2007

Income from continuing operations                                               \$821,000*
Discontinued operations
Loss on disposal of a component of a business,
\$150,000, less applicable income taxes, \$45,000                             (105,000)
Income before extraordinary item                                                 716,000
Extraordinary loss, net of applicable income taxes of \$60,000                   (140,000)
Net income                                                                      \$576,000
Per share of common stock—
Income from cont. operations (821,000 – 20,000)/146,500            \$5.47
Discontinued operations, net of tax (105,000)/146,500               (.72)
Income before extraordinary item                                    4.75
Extraordinary loss, net of tax (140,000)/146,500                    (.96)
Net income (576,000 – 20,000)/146,500                              \$3.80

*Income from cont. operations (unadjusted)                  \$800,000
Gain on sale of machinery (after tax)                         21,000
Income from cont. operations (adjusted)                     \$821,000

5
Question II, continued

6
Question III: Statement of Cash Flows (26 points)

The following financial statements are available for Cook Island Divers Inc. on December
31, 2006.

Cook Island Divers Inc.
Comparative Balance Sheets
As of December 31, 2005 and 2006

Dec. 31,        Dec. 31,
2005            2006
Assets
Current Assets:
Cash and cash equivalents                \$18,400        \$134,800
Accounts Receivable, Net                  49,000          83,200
Inventory                                 61,900          92,500
Total Current Assets                       129,300         310,500
Investments                                100,000          90,000
Property & Equipment                       220,000         240,000
Less Accumulated depreciation            -50,000         -30,000
Total Assets                              \$399,300        \$610,500

Liabilities and Equity
Current Liabilities:
Accounts payable                          \$67,000        \$100,000
Interest Payable                              300               0
Total Current Liabilities                   67,300         100,000
Notes payable                               73,500          50,000
Total Liabilities                         \$140,800        \$150,000

Common Stock                               125,000         175,000
Retained Earnings                          133,500         285,500
Total Equity                              \$258,500        \$460,500

Total Liabilities
and Stockholders' Equity                  \$399,300        \$610,500

7
Question III, continued

Cook Island Divers Inc.
Income Statement
For the Year Ended December 31, 2006

Sales                                                   \$300,000
Interest and other revenue                                10,000         310,000

Less:
Cost of goods sold                                      100,000
Depreciation expense                                     22,000
Income tax expense                                       \$5,000
Interest expense                                          3,000
Loss on sale of plant assets                              8,000         148,000

Net income                                                               162,000

Other available information:
 New plant assets costing \$80,000 were purchased during the year.

   Investments were sold at book value.

   No new debt was issued in 2005.

   Dividends of \$10,000 were declared and paid during the year.

Required:
a. Prepare the Statement of Cash Flows for Cook Island Divers Inc. for the year ended December 31,
2006 using the direct method to calculate cash flows from operations. Please use the template
provided on page X for your answer. You may use the space provided on page Y for other
calculations – however, please note that only the statement of cash flows provided on page X will be

b. Prepare a reconciliation of net income to cash from operations (the indirect method) for Cook Island
Divers for the year ended December 31, 2006. Please use the space on page 5 for your answer.

8
Question III, continued
Cook Island Divers Inc.
Statement of Cash Flows – Direct Method
For year ended December 31, 2006
SEE SOLUTION BELOW
Cash from Operating Activities:

Cash Collections from Customers                           ______________________

Cash Provided from interest revenue and other sources     ______________________

Cash Paid to Suppliers for Inventory                      ______________________

Cash Paid for Other Expenses                              ______________________

Cash Paid for Interest                                    ______________________

Cash Paid for Taxes                                       ______________________

Total Cash from Operations                         ______________________

Cash from Investing Activities:

Total Cash from Investing Activities               ______________________

Cash from Financing Activities:

Total Cash from Financing Activities               ______________________

Net Change in Cash                                        ______________________

______________________

9
_______________________

10
Solution:
STATEMENT OF CASH FLOWS - Direct Method

Cash flow from operations
Cash provided by customers                  265,800
Cash provided by interest and other          10,000
Cash used for merchandise                   (97,600)
Cash used for SG&A expenses (other)         (10,000)
Cash used for interest payments              (3,300)
Cash used for tax payments                   (5,000)
Cash from operations                        159,900

Investing                             Sale PPE         10,000

Purch PPE        (80,000)
Sale
Investments      10,000

Cash inves       (60,000)

Fin                                   Issue CS         50,000

Repay NP         (23,500)

Div pymt         (10,000)

Cash fin         16,500

Net cash         116,400

Cash beg         18,400

Cash end         134,800

11
Direct Worksheet:

Interest and other revenue                     10,000
Subtract Incr in Int rec. (or + Decr in Int.
rec.)                                                     -

Revenues                                       300,000

Subtract Incr in AR (or + Decr in AR)          (34,200)

COGS                                           100,000

Add Incr in Inven (- decr)                     30,600

Subtract Incr in AP (+ decr)                   (33,000)

Cash paid for merchandise                      97,600

Other Expense                                  10,000
Prepaids                                                  -
Subtract Incr in Acc. Liab. (+decr)                       -

Cash paid for Other expenses                   10,000

Tax Exp                                        5,000
Subtract Incr in Accrued tax liab. (+ decr)               -

Cash paid for taxes                            5,000

Interest                                       3,000

Subtract Incr in Int pay. (+ decr)             300

Cash paid for taxes                            3,300

12
Question III, continued

Reconciliation of Net Income to Cash from Operations (Indirect Method):

Indirect:
Ops

NI            162,000

+ Depn        22,000

+ loss        8,000

- Incr AR     (34,200)

-Incr Inv     (30,600)

+Incr AP      33,000

-Decr IP      (300)

Cash ops      159,900

13
Question III, continued

14
Question IV: Balance Sheet Effects of Errors or Omissions (12 points)

Using the notation O/S (overstated), U/S (understated), and NO (no effect), indicate the effect on
assets, liabilities, and shareholders’ equity as of December 31, 2006, of the following independent
errors or omissions. Ignore income tax implications. Record your answers on the schedule on the
next page. You do not have to indicate the dollar effect.

a. Depreciation expense during December 2006 was debited to Interest Expense.

b. Interest on a note payable for Year 2006 of \$2000 was not recorded.

c. A check for \$12,000 was received from a customer during December 2006 for merchandise
to be delivered during January 2007. No journal entries was made to record this check.

d. Interest accrued on Notes Receivable of \$600 as of December 31, 2006, was not recorded.

e. Interest accrued on Notes Payable of \$450 as of December, Year 2006, was recorded as
\$540.

f. An expenditure of \$1,200 made on December 2, Year 2006, for six months rent on an
automobile was debited to Rent Expense. No adjusting entry was made on December 31,
2006.

g. The company rented out excess office space for the two-year period beginning January 1,
2006. A rental check for this period of \$10,000 was received on December 26, 2005, and
correctly credited to Rental Fees Received in Advance. No further journal entries were
made relating to this rental during Year 2006.

h. A check for \$250 was paid to a supplier on December 31, 2006, in settlement of an
accounts payable. No journal entries have been made to record this check.

15
Question IV, continued

ASSETS   LIABILITIES   SHAREHOLDERS’
EQUITY
a.
NO          NO             NO
b.
NO          U/S            O/S
c.
U/S         U/S            NO
d.
U/S         NO             U/S
e.
NO          O/S            U/S
f.
U/S         NO             U/S
g.
NO          O/S            U/S
h.
O/S         O/S            NO

16
Question V: Miscellaneous (15 points)

1.   Katmandu Corporation has an extraordinary loss of \$400,000, an unusual gain of
\$115,000, and a tax rate of 40%. At what amount should Katmandu report each item in
the income statement (2 points)?
Extraordinary loss         Unusual gain

(240,000)                 115,000

2.      Should either of the following be reported as a prior period adjustment (2 points)? Circle
a. Change from unaccepted principle to accepted principle?         YES             NO
b. Change in estimated lives of depreciable assets?                YES             NO

3. Use the code letters listed below (a – l) to indicate, for each balance sheet item (1 – 11) listed
below the usual valuation reported on the balance sheet. Letters (a – l) may be used more than
once or not at all (11 points).
_____ 1. Trade accounts payable                 _____ 7. Long-term bonds payable
_____ 2. Prepaid expenses                       _____ 8. Land (in use)
_____ 3. Merchandise inventory                  _____ 9. Land (future plant site)
_____ 4. Property, plant, and equipment         _____ 10. Patents

a.    Par value
b.    Current cost of replacement
c.    Amount payable when due, less unamortized discount or plus unamortized premium
d.    Amount payable when due
e.    Market value at balance sheet date
f.    Net realizable value
g.    Lower of cost or market
h.    Original cost less accumulated amortization
i.    Original cost less accumulated depletion
j.    Original cost less accumulated depreciation
k.    Historical cost
l.    Unexpired or unconsumed cost

17
Solution:
1.   d      6.   h   10.   h
2.   l               11.   e
3.   g      7.   c
4.   j      8.   k
5.   f      9.   k

18

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