Financial Accounting: Liabilities & Equities (FA3) Exam Review
Financial Accounting: Liabilities & Equities (FA3) Exam Review Financial Accounting: Liabilities & Equities (FA3) Exam Review
FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc. Question 4 (13 marks) Fred’s Fabricating Ltd., which has a December 31 year end, offers lease financing to customers who want to buy its prefabricated buildings. Fred’s Fabricating has just completed a building at a cost of $3,000,000 and will lease it on July 1, 2003, to Bill’s Building Corp., a manufacturing company. Fred’s Fabricating’s mark up on the building is 30% of cost. • The lease term is 15 years; the building’s estimated useful life is 22 years. • The building’s residual value at the end of the lease term is estimated to be $500,000. This value is not guaranteed. The salvage value is estimated to be $100,000. Terms of the lease allow Bill’s Building the option of purchasing the building at the end of the lease term for $200,000. • Bill’s Building’s incremental borrowing rate is 9%. • Bill’s Building knows that the interest rate implicit in the lease is 8%. • The first annual lease payment is due July 1, 2003. Required 2 a. Calculate the required annual lease payments. 8 b. Prepare all required journal entries for the lessee, Bill’s Building Corp., for the year 2003. 3 c. Accounting standards sets out the classification criteria that the lessee must use to determine if a lease qualifies as a capital lease for financial reporting purposes. Essentially, the 4 criteria are • a transfer of ownership at the end of the lease term or a bargain purchase option; • the lease term major/ ≥ 75% of economic life; or • the present value of the minimum lease payments substantially all/ ≥ 90% of fair market value. • IFRS: specialized nature of asset In addition to the foregoing, the lessor is required to use supplemental criteria. Identify the supplemental criteria used by the lessor and explain briefly (in one or two sentences) why these additional requirements are necessary. Solution: There is a bargain purchase option (option to purchase at $200,000 versus an estimated value at the end of the lease term of $500,000). Accordingly, this is a capital/financing lease as there is reasonable assurance that the lessee will obtain ownership of the leased property by the end of the lease. a. Selling price ($3,000,000 × 1.30) $3,900,000 BGN, PV = 3,900,000, n = 15, i = 8, FV = 200,000, PMT = ? = 415,064 (tables 415,067) b. July 1, 2003 (1) Asset under capital/financing lease ................................3,900,000 (1) Lease liability ............................................................ 3,900,000 14
FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc. (1) Lease liability ........................................................ 415,067 (1) Cash.................................................................................................... 415,067 December 31, 2003 (1) Interest expense [($3,900,000 – $415,067) × 0.08 × 6/12] ............ 139,397 (1) Accrued interest payable .................................................................... 139,397 (1) Amortization expense {[($3,900,000 – $100,000) / 22] × 6/12}.. 86,364 (1) Accumulated amortization.................................................................. 86,364 c. (1) • The credit risk associated with the lease is normal when compared with the risk of collection of similar receivables. (1) • The amounts of any non-reimbursable costs that are likely to be incurred by the lessor under the lease can be reasonably estimated. (1) • The profession wants to make sure that the lessor has really transferred the risks and rewards of ownership. Part 7: Module 6 – Accounting for Income Tax Blueprint: 11-15% a. Which of the following is true about intraperiod tax allocation? 1) It involves the allocation of income taxes between current and future periods. 2) It arises because items included in the determination of taxable income may be presented in different parts of the financial statements. 3) It arises because certain revenues and expenses appear in the financial statements either before or after they are included in the income tax return. 4) It is more directly related to the full disclosure principle than the matching principle. b. In 2006, DTY Inc. made an investment of $200,000 that qualifies for a 7% investment tax credit. How should DTY record the benefit of the investment tax credit? 1) As a decrease in tax expense for 2006 2) As a direct increase to retained earnings 3) As an increase in a deferred charge 4) As a reduction in the cost of the investment Multiple Choice solutions: a. 2 b. 4 15
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<strong>FA3</strong> <strong>Exam</strong> <strong>Review</strong> notes Barbara Wyntjes, CGA, MBA, B.Sc.<br />
(1) Lease liability ........................................................ 415,067<br />
(1) Cash.................................................................................................... 415,067<br />
December 31, 2003<br />
(1) Interest expense [($3,900,000 – $415,067) × 0.08 × 6/12] ............ 139,397<br />
(1) Accrued interest payable .................................................................... 139,397<br />
(1) Amortization expense {[($3,900,000 – $100,000) / 22] × 6/12}.. 86,364<br />
(1) Accumulated amortization.................................................................. 86,364<br />
c.<br />
(1) • The credit risk associated with the lease is normal when compared with the risk of<br />
collection of similar receivables.<br />
(1) • The amounts of any non-reimbursable costs that are likely to be incurred by the<br />
lessor under the lease can be reasonably estimated.<br />
(1) • The profession wants to make sure that the lessor has really transferred the risks and<br />
rewards of ownership.<br />
Part 7: Module 6 – <strong>Accounting</strong> for Income Tax<br />
Blueprint: 11-15%<br />
a. Which of the following is true about intraperiod tax allocation?<br />
1) It involves the allocation of income taxes between current and future periods.<br />
2) It arises because items included in the determination of taxable income may be<br />
presented in different parts of the financial statements.<br />
3) It arises because certain revenues and expenses appear in the financial statements<br />
either before or after they are included in the income tax return.<br />
4) It is more directly related to the full disclosure principle than the matching principle.<br />
b. In 2006, DTY Inc. made an investment of $200,000 that qualifies for a 7% investment<br />
tax credit. How should DTY record the benefit of the investment tax credit?<br />
1) As a decrease in tax expense for 2006<br />
2) As a direct increase to retained earnings<br />
3) As an increase in a deferred charge<br />
4) As a reduction in the cost of the investment<br />
Multiple Choice solutions:<br />
a. 2<br />
b. 4<br />
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