19: LACTUM INC - MULTIPLE CHOICE EXERCISES:

MULTIPLE CHOICE EXERCISES:

CHAPTER 8-PROBLEM 19: LACTUM INC

CHAPTER 8-PROBLEM 19: LACTUM INC.

Entries made per books, operating lease:

January 1, 2014:

Rent expense 150,000

Cash 150,000

April 1, 2014:

Rent expense 150,000

Cash 150,000

July 1, 2014:

Rent expense 150,000

Cash 150,000

October 1, 2014:

Rent expense 150,000

Cash 150,000

AUDIT ANALYSIS:

1. There is no transfer of ownership.

2. There is no bargain purchase option.

3. The term (10 years) is not a major part (at least 75%) of the life (15 years) of the asset.

4. The PV of MLP (P4,185,388) is

4. The PV of MLP (P4,185,388) is substantially all (at least 90%) of the FMV of the leased asset (P4,185,388)substantially all (at least 90%) of the FMV of the leased asset (P4,185,388) The lease agreement does qualify as finance, thus should have been accounted for only under finance lease.

Correct entries per audit, finance lease January 1, 2014:

Building* 4,185,388

Cash 150,000

Lease liability 4,035,388

*PV of MLP at 2% for 40 quarters in advance. (P150,000*27.9025888) 26.9025888 27.9025888 0.4619482

Amortization table: Finance lease liabilty:

Periodic Payme Correct Int. Principal Balance

January 2014:1, 4,035,388

April 1, 2014: 150,000 80,708 69,292 3,966,096

July 1, 2014: 150,000 79,322 70,678 3,895,418

October 1, 2014: 150,000 77,908 72,092 3,823,3263,823,326

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CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES

Janaury 1, 2015: 150,000 76,467 73,533 3,749,793

April 1, 2015: 150,000 74,996 75,004 3,674,789

July 1, 2015: 150,000 73,496 76,504 3,598,285

October 1, 2015: 150,000 71,966 78,034 3,520,250

April 1, 2014:

Interest expense 80,708

Lease liability 69,292

Cash 150,000

July 1, 2014:

Interest expense 79,322

Lease liability 70,678

Cash 150,000

October 1, 2014:

Interest expense 77,908

Lease liability 72,092

Cash 150,000

December 31, 2014:

Interest expense 76,467

Interest payable 76,467

Depreciation expense 418,539

Accumulated depreciation 418,539

(P4,185,388/10years) * no transfer of ownership, thus depr shall be over term.

1. Ans. P132,943.

Expense per books

Rent expense (P150,000*4qtrs) 600,000

Expense per audit:

Interest expense 314,405

Depreciation expense 418,539 732,943

Unders

Understatemtatement ent in in ExpeExpense/Onse/Overstverstatemeatement nt Net Net IncomIncome e (132(132,943),943)

2. Ans. P3,823,326.

Leeaasse e lliiaabbiilliittyy, , 1122..3311..1144 33,,8 82233,,332266

Interest payable, 12.31.14 76,467

3. Ans. P303,076.

Principal due from January 1, 2015 to December 31, 2015 (see amortization table)

Janaury 1, 2015: 73,533

Sales price 420,000

Fair market value (420,000)

Deeffeerrrreed d ggaaiin n oon n ssaallee -

-Fair market vaue 420,000

Carrying value (360,000)

Reeaalliizzeed d ggaaiin n oon n ssaallee 6600,,000000

2. Ans. 40,000.

Sales price 420,000

Fair market value (380,000)

Deeffeerrrreed d ggaaiin n oon n sasallee 4400,,000000

Fair market vaue 380,000

Carrying value (360,000)

Reeaalliizzeed d ggaaiin n oon n ssaallee 2200,,000000

3. Ans. 100,000.

Sales price 420,000

Fair market value (320,000)

Deeffeerrrreed d ggaaiin n oon n ssaallee 110000,,000000

Fair market vaue 320,000

Carrying value (360,000)

Reeaalliizzeed d lloosss s oon n ssaallee ((4400,,000000))

4. Ans. 60,000.

Sales price 420,000

Fair market value (450,000)

Iggnnoorreedd ((3300,,000000))

Sales price 420,000

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CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES

Carrying value (360,000)

Reeaalliizzeed d lloosss s oon n ssaallee 6600,,000000

CASE 2:

1. Ans. P80,000.

Sales price 400,000

Fair market value (480,000)

Deeffeerrrreed d lloosss s oon n ssaallee ((8800,,000000)) * since the future rentals is below rent, there is an expected future benefit from the asset being sold at a loss.

Fair market vaue 480,000

Carrying value (540,000)

Reeaalliizzeed d lloosss s oon n ssaallee ((6600,,000000))

2. Ans. P40,000.

Sales price 400,000

Fair market value (480,000)

Realized loss on sale (80,000) * since the future rentals is at mark et rate of rent, there is no expected future benefit from the asset sold at a loss.

Fair market vaue 480,000

Carrying value (540,000)

Realized loss on sale (60,000)

Interest expense on finance lease liab (600,000*10%) 60,000 Depreciation on the leased-back asset (600,000/3yrs) 600,000

Amortization of deferred gain on sale (100,000/3yrs) (33,333) - gain on a sale and leaseback (finance) is fully deferred and N

Neet t aammoouunnt t rreeccooggnniizzeed d iin n tthhe e pprrooffiit t oor r lloossss 662266,,666677 amortized over lease term.

*note that the lease back agreement is acconted for as finance lease since the term, 3yrs is 100% of the remaining life.

2. Ans. 141,269 2. Ans. 141,269

Rent expense 241,269

Realized gain on s ale (P600,000 - P 500,000) (100,000) *Selling price is at FMV Ne

Net at amomoununt rt rececogogninizezed id in tn the he proprofifit/t/lolossss 14141,1,262699

*note that the lease back agreement is acconted for as o perating lease since the term, 3yrs is less than 75% of the remaining life, 8 yrs.

CASE 4:

1. Ans. 115,000.

Interest expense on finance lease liab (150,000*10%) 15,000 Depreciation o n t he l eased-back a sset ( 150,000/3yrs) 50,000

Realized loss on sale 50,000 *loss on sale is fully realized since it is an indication of N

Neet t aammoouunnt t rreeccooggnniizzeed d iin n tthhe e pprrooffiit t oor r lloossss 111155,,000000 asset impairement.

*note that the lease back agreement is acconted for as finance lease since the term, 3yrs is 100% of the remaining life.

2. Ans. P158,205.

Rent expense 58,205

Realized loss on sale (P200,000 - P150,000) 100,000 *Selling price is at FMV (no expected future benefit) Ne

Net at amomoununt rt rececogogninizezed id in tn the he proprofifit/t/lolossss 15158,8,202055

*note that the lease back agreement is acconted for as o perating lease since the term, 3yrs is less than 75% of the remaining life, 8 yrs.

CHAPTER 8-PROBLEM 21:

CASE 1:

Minimum lease collections 200,000

Multiply by: PV factor of 1 a t 12% for 5 y ears with annuity 3.604776 1 Present value of minimum lease collection 720,955

Cost of the asset/FMV of asset (Under Direct Finance) 700,000 Add: Direct finance lease cost 20,955 Initial investment on the lease agreeement 720,955

Amortization table:

Periodic Coll. Interest Inc. Principal Balance

January 1, 2015: (CV 12%)* 720,955

December 31, 2015: 200,000 86,515 113,485 607,470

December 31, 2016: 200,000 72,89672,896 127,104 480,366480,366

December 31, 2017: 200,000 57,644 142,356 338,010

December 31, 2018: 200,000 40,561 159,439 178,571

December 31, 2019: 200,000 21,429 178,571 (0)

1. Ans. 0.

Under a Direct Finance Lease, the only source of income shall be interest. No profit shall be recognized from the sale of the asset since under Direct Finance Lease, the cost of the asset on the company's books shall be equal to its selling price to the customer.

*Direct lease costs incurred under direct finance lease is added to the initial investment on lease, thus increasing the amoun t receivable.

Entry upon inception/Sale of asset:

Finance lease receivable 720,955

Asset 700,000

Cash 20,955

2. Ans. 72,896.

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CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES Entry upon periodic collections:

Dec. 31, 2015:

Cash 200,000

Interest income 86,515

Finance lease receivable 113,485

Dec. 31, 2016:

Cash 200,000

Interest income 72,896

Finance lease receivable 127,104

3. Ans. 480,366.

See amortization table above.

CASE 2:

Minimum lease collections 200,000

Multiply by: PVF of 1 at 10% for 5yrs w/ annuity in advance 4.169865 1 Present value of minimum lease collection = Sales Price 833,973

Cost of the asset 600,000

Grroosss s p rprooffiit t oon n ssaallee 23233 3,,997733

Amortization table:

Periodic Coll. Interest Inc. Principal Balance

January 1, 2015: (CV 10%)* 633,973

January 1, 2016: 200,000 63,397 136,603 497,370497,370

January 1, 2017: 200,000 49,737 150,263 347,107

January 1, 2018: 200,000 34,711 165,289 181,818

January 1, 2019: 200,000 18,182 181,818 0

1. Ans. 233,973.

Under a Sales Type Lease, the manufacturer/dealer shall recognize gross profit from the sale of the asset which shall be the difference between the Sales Price of the asset and its Cost on the company's books.

*Direct lease costs incurred under sales type lease is recognized as outright expense

Entry upon inception/Sale of asset:

Finance lease receivable 833,973

Sales 833,973

Entry to recognize cost of sales, if perpetual inventory is used:

Cost of sales 600,000

Inventory 600,000

Entry to recognize the direct lease expense:

Expense 20,000

Cash 20,000

2. Ans. 49,737.

Entry upon accrual of interest and periodic collections:

Dec. 31, 2015:

Interest receivable 63,397

Interest income 63,397

Jan. 1, 2016:

Cash 200,000

Interest receivable 63,397

Finance lease receivable 136,603

Dec. 31, 2016:

Interest receivable 49,737

Interest income 49,737

Jan. 1, 2017:

Cash 200,000

Interest receivable 49,737

Finance lease receivable 150,263

3. Ans. 497,370.

See amortization table

CASE 3:

Minimum lease collections 400,000

Multiply by: PV factor of 1 a t 10% for 5 y ears with annuity 3.790787 Present value of minimum lease collection 1,516,315

Guaranteed residual value 100,000

Multiply by: PV factor of 1 at 10% years w/o annuity 0.620921 Present value of the guaranteed residual value 62,092 Total Sales Price of the asset = Total Lease Receivable 1,578,407

Amortization table:

Periodic Coll. Interest Inc. Principal Balance

January 1, 2015: (CV 10%)* 1,578,407

December 31, 2015: 400,000 157,841 242,159 1,336,248

December 31, 2016: 400,000 133,625133,625 266,375 1,069,872

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CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES

December 31, 2017: 400,000 106,987 293,013 776,860

December 31, 2018: 400,000 77,686 322,314 454,545

December 31, 2019: 400,000 45,455 354,545 100,000

December 31, 2019: Guaranteed RV 100,000 100,000 0

1. Ans. P1,578,407.

Under Sales Type Lease, where residual value is guaranteed, that portion of the asset is deemed sold, thus the PV of the guaranteed residual value is added to the total sales price of the asset.

*Direct lease expense under sales type lease is recognized as outright operating expense.

Entry upon inception/Sale of asset:

Finance lease receivable 1,578,407

Sales 1,578,407

2. Ans. P1,000,000.

Entry to recognize cost of sales, if perpetual inventory is used:

Cost of sales 1,000,000

Inventory 1,000,000

Entry to recognize the direct lease expense:

Expense 50,000

Cash 50,000

3. Ans. 578,407.

Total Sales Price of the Asset 1,578,407 Less: Cost of the asset/FMV of asset (1,000,000)

Gross Profit on Sale 578,407

4. Ans. P133,625.

Entry upon periodic collections:

Dec. 31, 2015:

Cash 400,000

Interest income 157,841

Finance lease receivable 242,159

Dec. 31, 2016:

Cash 400,000

Interest income 133,625

Finance lease receivable 266,375

CASE 4:

Minimum lease collections 400,000

Multiply by: PV factor of 1 a t 10% for 5 y ears with annuity 3.790787

Present value of minimum lease collection = S ales Price of the asset 1,516,315

*Since the residual value is unguaranteed, that portion of the asset is not deemed sold. Thus was not included in the sales price.

Minimum lease collections 400,000

Multiply by: PV factor of 1 a t 10% for 5 y ears with annuity 3.790787 Present value of minimum lease collection 1,516,315

Guaranteed residual value 100,000

Multiply by: PV factor of 1 at 10% years w/o annuity 0.620921 Present value of the guaranteed residual value 62,092

Total Lease receivable. 1,578,407

*Since the residual value will still accrue to the benefit of the lessor (no trasfer of ownership), the unguaranteed residual value which will be received at the expiration of the lease term is still added to the receivable.

Total cost of the asset 1,000,000

Less: Present value of the u nguaranteed residual value (62,092)

Net cost of the asset sold 937,908

*Since the residual value is unguaranteed, that portion of the aset is not deemed sold. The PV of the unguaranteed residual value is therefore deducted from the cost of the inventory sold.

Amortization table:

Periodic Coll. Interest Inc. Principal Balance

January 1, 2015: (CV 10%)* 1,578,407

December 31, 2015: 400,000 157,841 242,159 1,336,248

December 31, 2016: 400,000 133,625133,625 266,375 1,069,872

December 31, 2017: 400,000 106,987 293,013 776,860

December 31, 2018: 400,000 77,686 322,314 454,545

December 31, 2019: 400,000 45,455 354,545 100,000

December 31, 2019: Guaranteed RV 100,000 100,000 0

1. Ans. P1,516,315.

Entry upon inception/Sale of asset:

Finance lease receivable 1,516,315

Sales 1,516,315

2. Ans. P937,908.

Entry to recognize cost of sales, if perpetual inventory is used:

Finance lease recievable 62,092

Cost of sales 937,908

Inventory 1,000,000

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CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES Entry to recognize the direct lease expense:

Expense 50,000

Cash 50,000

3. Ans. 578,407.

Total Sales Price of the Asset 1,516,315 Less: Cost of the asset/FMV of asset (937,908)

Gross Profit on Sale 578,407

4. Ans. P133,625.

Entry upon periodic collections:

Dec. 31, 2015:

Cash 400,000

Interest income 157,841

Finance lease receivable 242,159

Dec. 31, 2016:

Cash 400,000

Interest income 133,625

Finance lease receivable 266,375

CHAPTER 8-PROBLEM 22: ABC CO.

Reconciliation:

Net income before any differences 10,000,000 Permanent Differences:

Nondeductible expenses 100,000

Nontaxable income (500,000)

Net income after permanent differences 9,600,000 Temporary Differences:

Future Deductible amounts

Accrued warranties 250,000

Advances from customers 500,000

Provision for probable losses 900,000 1,650,000 Future Taxable Amounts

Prepaid rent 400,000 (400,000)

Taxable income 10,850,000

1. Ans. P4,340,000.

Taxable income 10,850,000

Mulitply by: Current tax rate 40%

Cuurrrreennt t ttaax x eexxppeennssee 44,,334400,,000000

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CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES 2. Ans. P3,840,000.

2. Ans. P3,840,000.

Net income after permanent differences 9,600,000 Multiply by: Constant tax rate 40%

Toottaal l ttaax x eexxppeennssee 33,,884400,,000000

3. Ans. P660,000.

Future deductible amounts 1,650,000 Mulitply by: Constant tax rate 40%

Deeffeerrrreed d ttaax x aasssseett 666600,,000000

4. Ans. P160,000.

Future taxable amounts 400,000

Mulitply by: Constant tax rate 40%

Deeffeerrrreed d ttaax x lliiaabbiilliittyy 116600,,000000

To reconcile:

Current tax expense 4,340,000

Add: Deferred tax expense (FTA) 160,000 Less: Deferred tax benefit (FDA) (660,000)

Total tax expense 3,840,000

5. Ans. P3,902,500.

If tax rate in the future is expected to change (at 35%):

Current tax expense (P10.85M*40%) 4,340,000 Add: Deferred tax expense (FTA:P400,000*35%) 140,000 Less: Deferred tax benefit (FDA:P1,650,000*35%) (577,500) T

Toottaal ttal ax x eexxppeennssee 3,,93 90022,,550000

6. Ans. P140,000.

Future taxable amounts 400,000

Mulitply by: Futre tax rate 35%

Deeffeerrrreed d ttaax x lliiaabbiilliittyy 114400,,000000

7. Ans. P577,500.

Future deductible amounts 1,650,000 Mulitply by: Constant tax rate 35%

Deeffeerrrreed d ttaax x aasssseett 557777,,550000

CHAPTER 8-PROBLEM 23:XYZ CO.

Reconciliation:

Net income before any differences 5,000,000 Permanent Differences:

Nondeductible expenses 150,000

Nontaxable income (50,000)

Net income after permanent differences 5,100,000 Temporary Differences:

Increase in Future Deductible for the year:

Cummulative FDA, ending 1,600,000

Cummulative FDA, beginning 1,200,000 400,000 Decrease in Future Taxable Amount for the year:

Cummulative FTA, ending 500,000

Cummulative FTA, beginning 800,000 300,000

Taxable income 5,800,000

1. Ans. P2,320,000 1. Ans. P2,320,000

Taxable income 5,800,000

Mulitply by: Current tax rate 40%

Cuurrrreennt t ttaax x eexxppeennssee 22,,332200,,000000

2. Ans. P2,040,000.

Net income after permanent differences 5,100,000 Multiply by: Constant tax rate 40%

Toottaal l ttaax x eexxppeennssee 22,,004400,,000000

3. Ans. P660,000.

Cummulative Future Deductible Amt, end 1,600,000 Mulitply by: Constant tax rate 40%

Deeffeerrrreed d ttaax x aasssseett 664400,,000000

4. Ans. P200,000.

Cummulative Future Taxable Amt, end 500,000 Mulitply by: Constant tax rate 40%

Deeffeerrrreed d ttaax x lliiaabbiilliittyy 220000,,000000

To reconcile:

Current tax expense 2,320,000

Less: Deferred tax benefit ( dec in F TA) (120,000)(decrease in deferred tax liability) Less: Deferred tax benefit (inc in FDA) (160,000)

Total tax expense 2,040,000

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CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES CHAPTER 8: AUDIT OF LIABILITIES AND PURCHASES

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