Question 1

Discuss the various implications of the failure to capitalize operating assets when they should be capitalized.

Accepted Answer

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Question 2

The December 31, 2016 10-K filing for Great Golf Company provides the following footnote information for purchase obligations for the next five years:
Unconditional Purchase Obligations
During the normal course of its business, the Company enters into agreements to purchase goods and services, including purchase commitments for production materials, endorsement agreements with professional golfers and other endorsers, employment and consulting agreements, and intellectual property licensing agreements pursuant to which the Company is required to pay royalty fees. It is not possible to determine the amounts the Company will ultimately be required to pay under these agreements as they are subject to many variables including performance-based bonuses, reductions in payment obligations if designated minimum performance criteria are not achieved, the Company's sales levels, and severance arrangements. As of December 31, 2016, the Company has entered into many of these contractual agreements with terms ranging from one to six years. The minimum obligation that the Company is required to pay under these agreements is $158,436,000 over the next six years. In addition, the Company also enters into unconditional purchase obligations with various vendors and suppliers of goods and services in the normal course of operations through purchase orders or other documentation or that are undocumented except for an invoice. Such unconditional purchase obligations are generally outstanding for periods less than a year and are settled by cash payments upon delivery of goods and services and are not reflected in this total. Future purchase commitments as of December 31, 2016, are as follows (in thousands):
 No amounts are listed on Great Golf's balance sheet for commitments and contingencies. On its 2016 balance sheet, Great reported total liabilities and stockholders' equity of $1,275,272,000 and total stockholders' equity of $482,562,000.
If Great Golf reported the unconditional purchase obligations in its balance sheet, how would its debt-to-equity ratio change? (Ignore discounting.)

Accepted Answer

A)  It would increase by 0.328 
B)  It would increase by 0.164 
C)  It would not change 
D)  Not enough information is provided to answer

Question 3

Failure to capitalize leased assets and liabilities when they should be capitalized results in a number of distortions in the ROE disaggregation analysis.
Which of the following is not a distortion?

Accepted Answer

A)  Reported expense is lower in the early years of a capital lease relative to an operating lease, but is higher in later years. 
B)  Net operating asset turnover is overstated due to the non-reporting of leased assets. 
C)  Financial leverage is understated. 
D)  All of the above are distortions.

Question 4

GAAP identifies two different approaches in reporting leases by the lessee: capital lease method and the operating lease method.
Which option best describes the financial statement effects of leasing on the financial statements of the lessee?

Accepted Answer

A)   
B)   
C)   
D)

Question 5

Complete Foods Markets reports lease information in its 2016 annual report (in thousands). Excerpts follow:
  The present values of future minimum obligations for capital leases shown above are calculated based on interest rates determined at the inception of the lease, or upon acquisition of the original lease.
What economic liability is omitted from Complete Foods' balance sheet? Describe the effect on assets, liabilities and equity if this liability was included on Complete Foods' balance sheet.

Accepted Answer

The answer of Complete Foods Markets reports lease information in...

Question 6

Which of the following is a requirement under IFRS but not under U.S. GAAP?

Accepted Answer

A)  Companies must report the funded status of their defined benefit pension plans on the balance sheet. 
B)  Companies must calculate the unfunded status as the PBO less the fair value of the plan assets and add back actuarial gains. 
C)  Companies must include interest cost as part of pension expense. 
D)  Companies must report current period pension expense on the income statement.

Question 7

Pacific Northwest Sporting Goods reported annual depreciation on a newly acquired asset for 2016 in the amount of $80,000 using the straight-line method. For tax purposes, the company used the following schedule of depreciation expense:
Year 1: $144,000
Year 2: $116,000
Year 3: $ 92,000
Year 4: $ 84,000
Year 5: $ 64,000
Year 6: $ 56,000
Year 7: $ 48,000
Year 8: $ 36,000
Annual income before depreciation expense for each year is steady at $440,000 and the income tax rate is 35%. Show the financial statement effects relating to taxes in years 3 to 5 assuming taxes are paid at the same time they are accrued using the following template:

Accepted Answer

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Question 8

American Symbol Outfitters includes the following information about its operating leases in its fiscal 2016 annual report:
  A. Calculate the present value of operating lease payments using a discount rate of 6%.
B. Assume that the leased equipment has a useful life of 8 years and no salvage value. Estimate the effect on profit before taxes of capitalizing these leases. Assume straight-line depreciation. Assume that rental expense in 2016 is the same as 2017 lease payments.
C. How would ROE and other financial ratios from the ROE decomposition be affected if these the company capitalized these operating leases?

Accepted Answer

The answer of American Symbol Outfitters includes the following information...

Question 9

Sweets Corp. reported the following items in the 2016 pension footnote. Use the information to calculate the pension expense for the year.

Accepted Answer

The answer of Sweets Corp. reported the following items in...

Question 10

Operating leases increase interest expense in the income statement, while decreasing net cash flows in the cash flow statement, compared with capital leases.

Accepted Answer

A) True 
 B)False

Question 11

Andersen Laboratories' 2016 annual report includes the following excerpt about its defined benefit plans (in millions):
  A. What is service cost?
B. What is interest cost?
C. What pension payments did Andersen Labs' retired employees receive during the year?

Accepted Answer

The answer of Andersen Laboratories' 2016 annual report includes the...

Question 12

The increase in pension obligation due to an employee working an additional year for the employer will cause the net pension liability on the balance sheet to increase but have no direct effect on the income statement.

Accepted Answer

A) True 
 B)False

Question 13

Leases are often a better financing vehicle than traditional bank loans because leases often require less equity investment.

Accepted Answer

A) True 
 B)False

Question 14

La Grange Supply Company disclosed the following footnote regarding operating leases in its 2016 annual report:
Minimum rental commitments under non-cancelable operating leases are as follows:
  La Grange Supply has an 8% discount rate.
If the operating lease is treated as a capital lease, by how much will total liabilities increase?

Accepted Answer

The answer of La Grange Supply Company disclosed the following...

Question 15

For a defined benefit plan, which of the following is correct?

Accepted Answer

A)  The plan defines the contribution the employer is to make, with no promise concerning the ultimate payout to employees. 
B)  The plan requires that the pension expense and the cash funding amount be the same. 
C)  The plan requires that the employee bears the risk of loss or benefit of gain from assets contributed to the plan. 
D)  The plan defines the benefits that the employee will receive at retirement.

Question 16

Use the following information to answer questions below
Caroline Company began operations in 2015. The company reported $128,000 of depreciation expense on its income statement in 2015 and $84,000 in 2016. On its tax returns, the company deducted $192,000 for depreciation in 2015 and $112,000 in 2016. The 2016 tax return shows a tax obligation (liability) of $132,000 based on a 40% tax rate.
-How much deferred tax liability will Caroline report at the end of 2015?

Accepted Answer

A)  $32,000 
B)  $25,600 
C)  $12,800 
D)  $51,200

Question 17

Festival Corp. disclosed the following lease information in its 2016 annual report (in millions).
 What lease liability does Festival's report on its balance sheet at December 31, 2016?

Accepted Answer

A)  $21,644 
B)  $25,356 
C)  $47,000 
D)  Present value of operating lease payments, which must be calculated because it is not provided in the footnote above.

Question 18

Discuss the concept of "income smoothing" that is built into GAAP as it relates to pensions.

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Question 19

Monongahela Corporation includes the following in its 2016 annual report (in thousands).
On an ongoing basis, we evaluate our estimates, including those related to the value of deferred acquisition costs, incentive compensation, income taxes, pension benefits and contingencies and litigation. Our estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Our actual results may differ from these estimates under different assumptions or conditions.
A. What estimates does the company make when accounting for capital leases?
B. What estimates does the company make when accounting for defined benefit pensions?

Accepted Answer

The answer of Monongahela Corporation includes the following in its...

Question 20

How are operating leases reported in the lessee's financial statements?
I. As an asset that is depreciated, similar to the company's other assets
II. As a footnote disclosure
III. As either a short-term or long-term liability, depending on the length of the lease

Accepted Answer

A)  I and II 
B)  II and III 
C)  I only 
D)  II only

Exam 10: Reporting and Analyzing Leases, Pensions, and Income Taxes

Discuss the various implications of the failure to capitalize operating assets when they should be capitalized.

Failure to capitalize leased assets and liabilities when they should be capitalized results in a number of distortions in the ROE disaggregation analysis. Which of the following is not a distortion?

GAAP identifies two different approaches in reporting leases by the lessee: capital lease method and the operating lease method. Which option best describes the financial statement effects of leasing on the financial statements of the lessee?

Which of the following is a requirement under IFRS but not under U.S. GAAP?

Sweets Corp. reported the following items in the 2016 pension footnote. Use the information to calculate the pension expense for the year.

Operating leases increase interest expense in the income statement, while decreasing net cash flows in the cash flow statement, compared with capital leases.

Andersen Laboratories' 2016 annual report includes the following excerpt about its defined benefit plans (in millions): A. What is service cost? B. What is interest cost? C. What pension payments did Andersen Labs' retired employees receive during the year?

The increase in pension obligation due to an employee working an additional year for the employer will cause the net pension liability on the balance sheet to increase but have no direct effect on the income statement.

Leases are often a better financing vehicle than traditional bank loans because leases often require less equity investment.

For a defined benefit plan, which of the following is correct?

Festival Corp. disclosed the following lease information in its 2016 annual report (in millions) . What lease liability does Festival's report on its balance sheet at December 31, 2016?

Discuss the concept of "income smoothing" that is built into GAAP as it relates to pensions.

How are operating leases reported in the lessee's financial statements? I. As an asset that is depreciated, similar to the company's other assets II. As a footnote disclosure III. As either a short-term or long-term liability, depending on the length of the lease